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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission Registrant; State of Incorporation; IRS Employer
File Number Address; and Telephone Number Identification No.
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1-9513 CMS ENERGY CORPORATION 38-2726431
(A Michigan Corporation)
Fairlane Plaza South, Suite 1100
330 Town Center Drive, Dearborn, Michigan 48126
(313)436-9200
1-5611 CONSUMERS ENERGY COMPANY 38-0442310
(A Michigan Corporation)
212 West Michigan Avenue, Jackson, Michigan 49201
(517)788-0550
1-2921 PANHANDLE EASTERN PIPE LINE COMPANY 44-0382470
(A Delaware Corporation)
5444 Westheimer Road, P.O. Box 4967, Houston, Texas 77210-4967
(713)989-7000
Indicate by check mark whether the Registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes X No
Panhandle Eastern Pipe Line Company meets the conditions set forth in General
Instructions H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q
with the reduced disclosure format. In accordance with Instruction H, Part I,
Item 2 has been reduced and Part II, Items 2, 3 and 4 have been omitted.
Number of shares outstanding of each of the issuer's classes of common stock at
April 30, 2002:
CMS ENERGY CORPORATION:
CMS Energy Common Stock, $.01 par value 134,794,941
CONSUMERS ENERGY COMPANY, $10 par value, privately held by CMS Energy 84,108,789
PANHANDLE EASTERN PIPE LINE COMPANY, no par value,
indirectly privately held by CMS Energy 1,000
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CMS ENERGY CORPORATION
AND
CONSUMERS ENERGY COMPANY
AND
PANHANDLE EASTERN PIPE LINE COMPANY
QUARTERLY REPORTS ON FORM 10-Q TO THE
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FOR THE QUARTER ENDED MARCH 31, 2002
This combined Form 10-Q is separately filed by each of CMS Energy Corporation,
Consumers Energy Company and Panhandle Eastern Pipe Line Company. Information
contained herein relating to each individual registrant is filed by such
registrant on its own behalf. Accordingly, except for their respective
subsidiaries, Consumers Energy Company and Panhandle Eastern Pipe Line Company
make no representation as to information relating to any other companies
affiliated with CMS Energy Corporation.
TABLE OF CONTENTS
Page
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Glossary.................................................................................................. 4
PART I: FINANCIAL INFORMATION
CMS Energy Corporation
Management's Discussion and Analysis
Results of Operations........................................................................... CMS-1
Critical Accounting Policies.................................................................... CMS-4
Capital Resources and Liquidity................................................................. CMS-9
Market Risk Information......................................................................... CMS-13
Outlook......................................................................................... CMS-15
Other Matters................................................................................... CMS-22
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CMS-23
Consolidated Statements of Cash Flows........................................................... CMS-24
Consolidated Balance Sheets..................................................................... CMS-26
Consolidated Statements of Common Stockholders' Equity.......................................... CMS-28
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Basis of Presentation.............................................. CMS-29
2. Discontinued Operations.................................................................... CMS-31
3. Asset Disposition.......................................................................... CMS-32
4. Uncertainties.............................................................................. CMS-32
5. Short-Term and Long-Term Financings, and Capitalization.................................... CMS-47
6. Earnings Per Share and Dividends........................................................... CMS-50
7. Risk Management Activities and Financial Instruments....................................... CMS-50
8. Reportable Segments........................................................................ CMS-55
Report of Independent Public Accountants............................................................ CMS-57
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TABLE OF CONTENTS
(CONTINUED)
Page
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Consumers Energy Company
Management's Discussion and Analysis
Critical Accounting Policies.................................................................... CE-1
Results of Operations........................................................................... CE-5
Capital Resources and Liquidity................................................................. CE-7
Outlook......................................................................................... CE-9
Other Matters................................................................................... CE-14
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CE-18
Consolidated Statements of Cash Flows........................................................... CE-19
Consolidated Balance Sheets..................................................................... CE-20
Consolidated Statements of Common Stockholder's Equity.......................................... CE-22
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Summary of Significant Accounting Policies......................... CE-23
2. Uncertainties.............................................................................. CE-26
3. Short-Term Financings and Capitalization................................................... CE-36
Report of Independent Public Accountants............................................................. CE-39
Panhandle Eastern Pipe Line Company
Management's Discussion and Analysis
Results of Operations........................................................................... PE-2
Critical Accounting Policies.................................................................... PE-3
Outlook........................................................................................ PE-4
Other Matters................................................................................... PE-5
Consolidated Financial Statements
Consolidated Statements of Income............................................................... PE-8
Consolidated Statements of Cash Flows........................................................... PE-9
Consolidated Balance Sheets..................................................................... PE-10
Consolidated Statements of Common Stockholder's Equity.......................................... PE-12
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Basis of Presentation.............................................. PE-13
2. Regulatory Matters......................................................................... PE-14
3. Related Party Transactions................................................................. PE-15
4. Commitments and Contingencies.............................................................. PE-16
5. System Gas ................................................................................ PE-18
Report of Independent Public Accountants............................................................. PE-19
Quantitative and Qualitative Disclosures about Market Risk................................................ CO-1
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................................................ CO-1
Item 4. Submission of Matters to a Vote of Security Holders.......................................... CO-1
Item 5. Other Information............................................................................ CO-1
Item 6. Exhibits and Reports on Form 8-K............................................................. CO-1
Signatures................................................................................................ CO-3
3
GLOSSARY
Certain terms used in the text and financial statements are defined below.
ABATE..................................... Association of Businesses Advocating Tariff Equity
ALJ....................................... Administrative Law Judge
APB....................................... Accounting Principles Board
APB Opinion No. 18........................ APB Opinion No. 18, "The Equity Method of Accounting for Investments
in Common Stock"
APB Opinion No. 30........................ APB Opinion No. 30, "Reporting Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business"
Alliance.................................. Alliance Regional Transmission Organization
Arthur Andersen........................... Arthur Andersen LLP
Articles.................................. Articles of Incorporation
Attorney General.......................... Michigan Attorney General
bcf....................................... Billion cubic feet
BG LNG Services........................... BG LNG Services, Inc., a subsidiary of BG Group of the United Kingdom
Big Rock.................................. Big Rock Point nuclear power plant, owned by Consumers
Board of Directors........................ Board of Directors of CMS Energy
Bookouts.................................. Unplanned netting of transactions from multiple contracts
Clean Air Act............................. Federal Clean Air Act, as amended
CMS Capital............................... CMS Capital Corp., a subsidiary of Enterprises
CMS Electric and Gas...................... CMS Electric and Gas Company, a subsidiary of Enterprises
CMS Energy................................ CMS Energy Corporation, the parent of Consumers and Enterprises
CMS Energy Common Stock................... Common stock of CMS Energy, par value $.01 per share
CMS Gas Transmission...................... CMS Gas Transmission Company, a subsidiary of Enterprises
CMS Generation............................ CMS Generation Co., a subsidiary of Enterprises
CMS Holdings.............................. CMS Midland Holdings Company, a subsidiary of Consumers
CMS Midland............................... CMS Midland Inc., a subsidiary of Consumers
CMS MST................................... CMS Marketing, Services and Trading Company, a subsidiary of Enterprises
CMS Oil and Gas .......................... CMS Oil and Gas Company, a subsidiary of Enterprises
CMS Panhandle Holdings, LLC .............. A subsidiary of Panhandle Eastern Pipe Line
Common Stock.............................. All classes of Common Stock of CMS Energy and each of its
subsidiaries, or any of them individually, at the time of an award or
grant under the Performance Incentive Stock Plan
Consumers................................. Consumers Energy Company, a subsidiary of CMS Energy
Consumers Campus Holdings................. Consumers Campus Holdings, L.L.C., a wholly owned subsidiary of
Consumers
Court of Appeals.......................... Michigan Court of Appeals
Customer Choice Act....................... Customer Choice and Electricity Reliability Act, a Michigan statute
enacted in June 2000 that allows all retail customers choice of
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
4
DIG....................................... Dearborn Industrial Generation, L.L.C., a wholly owned subsidiary of
CMS Generation
DIG Statement No. C16..................... Derivatives Implementation Group, Statement 133 Implementation Issue
No. C16, "Scope Exceptions: Applying the Normal Purchases and Normal
Sales Exception to Contracts That Combine a Forward Contract and a
Purchased Option Contract"
DOE....................................... U.S. Department of Energy
Dow....................................... The Dow Chemical Company, a non-affiliated company
Duke Energy............................... Duke Energy Corporation, a non-affiliated company
Enterprises............................... CMS Enterprises Company, a subsidiary of CMS Energy
EPA....................................... U. S. Environmental Protection Agency
EPS....................................... Earnings per share
FASB...................................... Financial Accounting Standards Board
FERC...................................... Federal Energy Regulatory Commission
FMLP...................................... First Midland Limited Partnership, a partnership that holds a lessor
interest in the MCV facility
GCR........................................Gas cost recovery
GTNs...................................... CMS Energy General Term Notes(R), $200 million Series D, $400 million
Series E and $300 million Series F
GWh....................................... Gigawatt-hour
INGAA .................................... Interstate Natural Gas Association of America
IPP....................................... Independent Power Producer
ISO....................................... Independent System Operator
Jorf Lasfar............................... The 1,356 MW coal-fueled power plant in Morocco, jointly owned by CMS
Generation and ABB Energy Venture, Inc.
kWh....................................... Kilowatt-hour
LIBOR..................................... London Inter-Bank Offered Rate
Loy Yang.................................. The 2,000 MW brown coal fueled Loy Yang A power plant and an
associated coal mine in Victoria, Australia, in which CMS Generation
holds a 50 percent ownership interest
LNG....................................... Liquefied natural gas
LNG Holdings.............................. CMS Trunkline LNG Holdings, LLC, jointly owned by CMS Panhandle
Holdings, LLC and Dekatherm Investor Trust
Ludington................................. Ludington pumped storage plant, jointly owned by Consumers and Detroit
Edison
mcf....................................... Thousand cubic feet
MCV Facility.............................. A natural gas-fueled, combined-cycle cogeneration facility operated by
the MCV Partnership
MCV Partnership........................... Midland Cogeneration Venture Limited Partnership in which Consumers
has a 49 percent interest through CMS Midland
MD&A...................................... Management's Discussion and Analysis
MEPCC..................................... Michigan Electric Power Coordination Center
5
METC...................................... Michigan Electric Transmission Company, a subsidiary of Consumers
Energy
Michigan Gas Storage...................... Michigan Gas Storage Company, a subsidiary of Consumers
MPSC...................................... Michigan Public Service Commission
MTH....................................... Michigan Transco Holdings, Limited Partnership
MW........................................ Megawatts
NEIL...................................... Nuclear Electric Insurance Limited, an industry mutual insurance
company owned by member utility companies
NMC....................................... Nuclear Management Company, LLC, formed in 1999 by Northern States
Power Company (now Xcel Energy Inc.), Alliant Energy, Wisconsin
Electric Power Company, and Wisconsin Public Service Company to
operate and manage nuclear generating facilities owned by the four
utilities
NRC....................................... Nuclear Regulatory Commission
OATT...................................... Open Access Transmission Tariff
OPEB...................................... Postretirement benefit plans other than pensions for retired employees
Palisades................................. Palisades nuclear power plant, which is owned by Consumers
Panhandle................................. Panhandle Eastern Pipe Line Company, including its subsidiaries
Trunkline, Pan Gas Storage, Panhandle Storage, and Panhandle Holdings.
Panhandle is a wholly owned subsidiary of CMS Gas Transmission
Panhandle Eastern Pipe Line............... Panhandle Eastern Pipe Line Company, a wholly owned subsidiary of CMS Gas
Transmission
Panhandle Storage......................... CMS Panhandle Storage Company, a subsidiary of Panhandle Eastern Pipe
Line Company
PCB....................................... Poly chlorinated biphenyl
Pension Plan.............................. The trusteed, non-contributory, defined benefit pension plan of
Panhandle, Consumers and CMS Energy
Powder River.............................. CMS Oil & Gas previously owned a significant interest in coalbed methane
fields or projects developed within the Powder River Basin which spans the
border between Wyoming and Montana. The Powder River properties have been sold and
reported as a discontinued operation for the three months ended March 31, 2002.
PPA....................................... The Power Purchase Agreement between Consumers and the MCV Partnership
with a 35-year term commencing in March 1990
Price Anderson Act........................ Price Anderson Act, enacted in 1957 as an amendment to the Atomic
Energy Act of 1954, as revised and extended over the years. This act
stipulates between nuclear licensees and the U.S. government the
insurance, financial responsibility, and legal liability for nuclear
accidents.
PSCR...................................... Power supply cost recovery
PUHCA..................................... Public Utility Holding Company Act of 1935
PURPA..................................... Public Utility Regulatory Policies Act of 1978
RTO....................................... Regional Transmission Organization
SEC....................................... U.S. Securities and Exchange Commission
Securitization............................ A financing method authorized by statute and approved by the MPSC which allows a utility
to set aside and pledge a portion of the rate payments received by its customers for the
repayment of
6
Securitization bonds issued by a special purpose entity affiliated with
such utility
Senior Credit Facilities.................. $450 million one-year revolving credit facility maturing in June 2002
and a $300 million three-year revolving credit facility, maturing in
June 2004 between CMS Energy and Barclays Bank
SFAS...................................... Statement of Financial Accounting Standards
SFAS No. 5................................ SFAS No. 5, "Accounting for Contingencies"
SFAS No. 13............................... SFAS No. 13 "Accounting for Leases"
SFAS No. 71............................... SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation"
SFAS No. 87............................... SFAS No. 87, "Employers' Accounting for Pensions"
SFAS No. 106.............................. SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions"
SFAS No. 115.............................. SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities"
SFAS No. 121.............................. SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of"
SFAS No. 133.............................. SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities, as amended and interpreted"
SFAS No. 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"
SIPS...................................... State Implementation Plans
Stranded Costs............................ Costs incurred by utilities in order to serve their customers in a
regulated monopoly environment, which may not be recoverable in a
competitive environment because of customers leaving their systems and
ceasing to pay for their costs. These costs could include owned and
purchased generation and regulatory assets.
Superfund................................. Comprehensive Environmental Response, Compensation and Liability Act
Transition Costs.......................... Stranded Costs, as defined, plus the costs incurred in the transition
to competition.
Trunkline................................. Trunkline Gas Company, LLC, a subsidiary of Panhandle Eastern Pipe
Line Company
Trunkline LNG............................. Trunkline LNG Company, LLC, a subsidiary of LNG Holdings, LLC
Trust Preferred Securities................ Securities representing an undivided beneficial interest in the assets of statutory
business trusts, the interests of which have a preference with respect to certain
trust distributions over the interests of either CMS Energy or Consumers,
as applicable, as owner of the common beneficial interests of the trusts
7
CMS Energy Corporation
CMS ENERGY CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
CMS Energy is the parent holding company of Consumers and Enterprises. Consumers
is a combination electric and gas utility company serving Michigan's Lower
Peninsula. Enterprises, through subsidiaries, including Panhandle and its
subsidiaries, is engaged in several domestic and international diversified
energy businesses including: natural gas transmission, storage and processing;
independent power production; oil and gas exploration and production; and energy
marketing, services and trading.
The MD&A of this Form 10-Q should be read along with the MD&A and other parts of
CMS Energy's 2001 Form 10-K. This MD&A refers to, and in some sections
specifically incorporates by reference, CMS Energy's Condensed Notes to
Consolidated Financial Statements and should be read in conjunction with such
Consolidated Financial Statements and Notes. This report and other written and
oral statements that CMS Energy may make contain forward-looking statements as
defined by the Private Securities Litigation Reform Act of 1995. CMS Energy's
intentions with the use of the words "anticipates," "believes," "estimates,"
"expects," "intends," and "plans," and variations of such words and similar
expressions, are solely to identify forward-looking statements that involve risk
and uncertainty. These forward-looking statements are subject to various factors
that could cause CMS Energy's actual results to differ materially from the
results anticipated in such statements. CMS Energy has no obligation to update
or revise forward-looking statements regardless of whether new information,
future events or any other factors affect the information contained in such
statements. CMS Energy does, however, discuss certain risk factors,
uncertainties and assumptions in this MD&A and in Item 1 of the 2001 Form 10-K
in the section entitled "Forward-Looking Statements Cautionary Factors and
Uncertainties" and in various public filings it periodically makes with the SEC.
CMS Energy designed this discussion of potential risks and uncertainties, which
is by no means comprehensive, to highlight important factors that may impact CMS
Energy's business and financial outlook. This report also describes material
contingencies in CMS Energy's Condensed Notes to Consolidated Financial
Statements, and CMS Energy encourages its readers to review these Notes.
RESULTS OF OPERATIONS
CMS ENERGY CONSOLIDATED EARNINGS
For the three months ended March 31, 2002, consolidated net income included a
$325 million gain on the sale of CMS Energy's ownership interests in Equatorial
Guinea, a $21 million charge related to Argentina devaluation and expropriation
issues and a $1 million extraordinary loss for early debt retirement. The
following tables depict CMS Energy's Results of Operations before and after the
effects of the items mentioned above.
In Millions, Except Per Share Amounts
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Three months ended March 31 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED NET INCOME OF CMS ENERGY $ 399 $ 109
Earnings Before Reconciling Items $ 96 $ 108
Asset Sales 325 -
Discontinued Operations - 1
Extraordinary Item (1) -
Argentine Monetary Adjustment (21) -
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Consolidated Net Income of CMS Energy $ 399 $ 109
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CMS-1
CMS Energy Corporation
BASIC EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY
Earnings Per Share Before Reconciling Items $ 0.72 $0.86
Asset Sales 2.44 -
Discontinued Operations - .01
Extraordinary Item (0.01) -
Argentine Monetary Adjustment (0.16) -
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Earnings Per Share After Reconciling Items $ 2.99 $0.87
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DILUTED EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY
Earnings Per Share Before Reconciling Items $ 0.72 $0.84
Asset Sales 2.36 -
Discontinued Operations - 0.01
Extraordinary Item (0.01) -
Argentine Monetary Adjustment (0.15) -
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Earnings Per Share After Reconciling Items $ 2.92 $0.85
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For the three months ended March 31, 2002, consolidated net income before
reconciling items decreased as compared to the same period in 2001. The decrease
was primarily due to the effects of a mild winter, increased power supply costs
resulting from the unscheduled Palisades outage that ended in late January 2002
and lower earnings from Trunkline LNG.
For further information, see the individual results of operations for each CMS
Energy business segment in this MD&A.
CONSUMERS' ELECTRIC UTILITY RESULTS OF OPERATIONS
ELECTRIC UTILITY NET INCOME:
In Millions
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March 31 2002 2001 Change
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Three months ended $ 49 $ 60 $ (11)
================================================================================================================
Reasons for the change:
Electric deliveries $ (4)
Power supply costs and related revenue (16)
Other operating expenses and non-commodity revenue (1)
Fixed charges 2
Income taxes 8
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Total change $ (11)
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ELECTRIC DELIVERIES: For the three months ended March 31, 2002, electric
deliveries, including transactions with other electric utilities, were 9.2
billion kWh, a decrease of 0.8 billion kWh or 7.9 percent from the comparable
period in 2001. Total electric deliveries decreased primarily due to lower
industrial usage driven by the economic downturn.
CMS-2
CMS Energy Corporation
POWER SUPPLY COSTS AND RELATED REVENUE: For the period ending March 31, 2002,
electric net income was adversely affected by lower power cost related revenues.
Additionally, the average power supply cost increased due to the need to
purchase greater quantities of higher-priced power to offset the loss of
internal generation resulting from the unscheduled Palisades outage.
OTHER OPERATING EXPENSES: In 2002, other operating expenses decreased due to
lower operating and maintenance costs resulting from cost controls throughout
the business unit.
CONSUMERS' GAS UTILITY RESULTS OF OPERATIONS
GAS UTILITY NET INCOME:
In Millions
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March 31 2002 2001 Change
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Three months ended $ 28 $ 28 $ -
================================================================================================================
Reasons for the change:
Gas deliveries (9)
Rate increase 7
Operation and maintenance 5
General taxes and depreciation (4)
Fixed charges 2
Income taxes (1)
- ----------------------------------------------------------------------------------------------------------------
Total change $ -
================================================================================================================
For the three months ended March 31, 2002, gas delivery revenues decreased due
to significantly milder temperatures during the first quarter of 2002. This
decrease was significantly offset by an interim gas rate increase granted in
December of 2001. System deliveries, including miscellaneous transportation
volumes, totaled 149 bcf, a decrease of 10 bcf or 6.5 percent compared with
2001.
NATURAL GAS TRANSMISSION RESULTS OF OPERATIONS
NET INCOME: For the three months ended March 31, 2002, net income was $41
million, a decrease of $4 million (9 percent) from the comparable period in
2001. The decrease was primarily due to lower earnings from Trunkline LNG due to
lower volumes and rates and the monetization of the facility that occurred in
2001, the impacts of the Argentina expropriation and devaluation on ongoing
operations and lower commodity revenues at Panhandle due to unseasonably warm
weather. These decreases were partially offset by the gain of $15 million on the
sale of Natural Gas Transmission's ownership interests in Equatorial Guinea,
lower operation and maintenance expenses, and $3 million due to the elimination
of goodwill amortization in 2002. CMS Energy has not yet completed its initial
review of any potential goodwill impairment but expects to complete the initial
review in the second quarter as required by SFAS No. 142. For further
information, see Note 1, Corporate Structure and Basis of Presentation.
INDEPENDENT POWER PRODUCTION RESULTS OF OPERATIONS
NET INCOME: For the three months ended March 31,2002, net income was $23 million
a $2 million decrease (8 percent) from the comparable period in 2001. The
decrease was primarily due to the impacts of the Argentina expropriation and
devaluation on ongoing operations and lower earnings at the MCV facility. These
decreases were partially offset by lower steam costs at DIG, which had
experienced construction delays in 2001 that led to increased costs for steam
generation, and from improved earnings at the Jorf Lasfar facility.
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CMS Energy Corporation
OIL AND GAS EXPLORATION AND PRODUCTION RESULTS OF OPERATIONS
NET INCOME: For the three months ended March 31, 2002 net income was $310
million, an increase of $307 million from the comparable period in 2001. The
increase was due primarily to a gain of $310 million on the sale of all of the
CMS Oil and Gas interests in Equatorial Guinea. Partially offsetting the
increase were lower net crude oil prices, lower crude oil production due to
timing of the actual sales and lower natural gas production due primarily to the
sale of the Equatorial Guinea properties.
MARKETING, SERVICES AND TRADING RESULTS OF OPERATIONS
NET INCOME: For the three months ended March 31, 2002, net income was $7
million, an increase of $3 million (75 percent) from the comparable period in
2001. This increase was the result of higher net margins on electric power sales
and increased earnings of the energy management services business, which were
partially offset by lower net margins on natural gas sales and increased
operating expenses.
Electric power sales volumes were 14,153 GWh, an increase of 10,666 GWh (306
percent) and natural gas sales volumes were 185 bcf, an increase of 37 bcf (25
percent) compared to the first quarter of 2001. Mark-to-market revenues, net of
reserves, decreased by $1.1 million from the comparable period in 2001. Due to
the extreme volatility in energy trading markets and the competitive nature of
the industry, results for this interim period are not necessarily an indication
of results to be achieved for the fiscal year. For further information, see
Recent Developments in Other Matters section of this MD&A.
CRITICAL ACCOUNTING POLICIES
The results of operations, as presented above, are based on the application of
generally accepted U.S. accounting principles. The application of these
principles often requires management to make certain judgments, assumptions and
estimates that may result in different financial presentations. CMS Energy
believes that certain accounting principles are critical in terms of
understanding its financial statements. These principles include the use of
estimates for long-lived assets, equity method investments and long-term
obligations, accounting for derivatives and financial instruments,
mark-to-market accounting, and international operations and foreign currency.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make judgments,
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Certain accounting principles require subjective and
complex judgments used in the preparation of financial statements. Accordingly,
a different financial presentation could result depending on the judgment,
estimates or assumptions that are used. Such estimates and assumptions, include,
but are not specifically limited to: depreciation, amortization, interest rates,
discount rates, future commodity prices, mark-to-market valuations, investment
returns, volatility in the price of CMS Energy Common Stock, impact of new
accounting standards, international economic policy, future costs associated
with long-term contractual obligations, future compliance costs associated with
environmental regulations and continuing creditworthiness of counterparties.
Actual results could materially differ from those estimates.
Periodically, in accordance with SFAS No. 121 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
CMS-4
CMS Energy Corporation
present or other factors exist that indicate that the carrying value of the
asset may not be recoverable, CMS Energy determines whether impairment has
occurred through the use of an undiscounted cash flows analysis of assets at the
lowest level for which identifiable cash flows exist. If impairment, other than
a temporary nature, has occurred, CMS Energy recognizes a loss for the
difference between the carrying value and the estimated fair value of the asset.
The fair value of the asset is measured using discounted cash flow analysis or
other 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 $16 billion at March 31, 2002, approximately 60 to 65
percent represent the carrying value of long-lived assets and equity method
investments that are subject to this type of analysis. If future market,
political or regulatory conditions warrant, CMS Energy and its subsidiaries may
be subject to write-downs in future periods. Conversely, if market, political or
regulatory conditions improve, accounting standards prohibit the reversal of
previous write-downs.
CMS Energy has recently recorded write-downs of non-strategic or
under-performing long-lived assets as a result of implementing a new strategic
direction. CMS Energy is pursuing the sale of all of these non-strategic and
under-performing assets, including some assets that were not determined to be
impaired. Upon the sale of these assets, the proceeds realized may be materially
different from the remaining carrying value of these assets. Even though these
assets have been identified for sale, management cannot predict when, nor make
any assurances that, these asset sales will occur.
Similarly, the recording of estimated liabilities for contingent losses,
including estimated losses on long-term obligations, within the financial
statements is guided by the principles in SFAS No. 5 that require a company to
record estimated liabilities in the financial statements when it is probable
that a loss will be incurred in the future as a result of a current event, and
the amount can be reasonably estimated. Management uses cash flow valuation
techniques similar to those described above to estimate contingent losses on
long-term contracts.
CMS Energy has recently recorded estimates of projected losses related to
specific long-term contracts such as Consumers' power purchase agreement with
MCV and the DIG plant power supply contract with the Ford/Rouge complex. Actual
results achieved upon performance under the terms of the contracts may be
materially different than current estimates.
ACCOUNTING FOR DERIVATIVE AND FINANCIAL INSTRUMENTS
DERIVATIVE INSTRUMENTS: CMS Energy uses the criteria in SFAS No. 133, as amended
and interpreted, to determine if certain contracts must be accounted for as
derivative instruments. The rules for determining whether a contract meets the
criteria for derivative accounting are numerous and complex. As a result,
significant judgment is required to determine whether a contract requires
derivative accounting, and similar contracts can sometimes be accounted for
differently.
The types of contracts CMS Energy currently accounts for as derivative
instruments are interest rate swaps, foreign currency exchange contracts,
certain electric call options, and gas fuel call options and swaps. CMS Energy
does not account for electric capacity and energy contracts, gas supply
contracts, coal supply contracts, or purchase orders for numerous supply items
as derivatives.
If a contract must be accounted for as a derivative instrument, the contract is
recorded as either an asset or a liability in the financial statements at the
fair value of the contract. Any difference between the recorded book value and
the fair value is reported either in earnings or other comprehensive income
depending on certain qualifying criteria. The recorded fair value of the
contract is then adjusted quarterly to reflect any change in the market value of
the contract.
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In order to value the contracts that are accounted for as derivative
instruments, CMS Energy uses a combination of market quoted prices and
mathematical models. Option models require various inputs, including forward
prices, volatilities, interest rates and exercise periods. Changes in forward
prices or volatilities could significantly change the calculated fair value of
the call option contracts. The models used by CMS Energy have been tested
against market quotes to ensure consistency between model outputs and market
quotes. At March 31, 2002, CMS Energy assumed an interest rate of 4.5 percent in
calculating the fair value of its electric call options.
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 and are reported at
fair value with any unrealized gains or losses resulting from changes in fair
value excluded from earnings and reported in equity as part of other
comprehensive income. Unrealized gains or losses resulting from changes in the
fair value of Consumers' nuclear decommissioning investments are reported in
accumulated depreciation. The fair value of these investments is determined from
quoted market prices.
MARK-TO-MARKET ACCOUNTING
CMS MST's trading activities are accounted for under the mark-to-market method
of accounting. Under mark-to-market accounting, energy-trading contracts are
reflected at fair market value, net of reserves, with unrealized gains and
losses recorded as an asset or liability in the consolidated balance sheets.
These assets and liabilities are affected by the timing of settlements related
to these contracts, current-period changes from newly originated transactions
and the impact of price movements. Changes in fair value are recognized as
revenues in the consolidated statements of income in the period in which the
changes occur. Market prices used to value outstanding financial instruments
reflect management's consideration of, among other things, closing exchange and
over-the-counter quotations. In certain of these markets, long-term contract
commitments may extend beyond the period in which market quotations for such
contracts are available. The lack of long-term pricing liquidity requires the
use of mathematical models to value these commitments under the accounting
method employed. These mathematical models utilize historical market data to
forecast future elongated pricing curves, which are used to value the
commitments that reside outside of the liquid market quotations. Realized cash
returns on these commitments may vary, either positively or negatively, from the
results estimated through application of forecasted pricing curves generated
through application of the mathematical model. CMS Energy believes that its
mathematical models utilize state-of-the-art technology, pertinent industry data
and prudent discounting in order to forecast certain elongated pricing curves.
These market prices are adjusted to reflect the potential impact of liquidating
the company's position in an orderly manner over a reasonable period of time
under present market conditions.
In connection with the market valuation of its energy commodity contracts, CMS
Energy maintains reserves for credit risks based on the financial condition of
counterparties. Counterparties in its trading portfolio consist principally of
financial institutions and major energy trading companies. The creditworthiness
of these
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counterparties will impact overall exposure to credit risk; however, CMS Energy
maintains credit policies that management believes minimize overall credit risk
with regard to its counterparties. Determination of its counterparties' credit
quality is based upon a number of factors, including credit ratings, financial
condition, and collateral requirements. When trading terms permit, CMS Energy
employs standardized agreements that allow for netting of positive and negative
exposures associated with a single counterparty. Based on these policies, its
current exposures and its credit reserves, CMS Energy does not anticipate a
material adverse effect on its financial position or results of operations as
a result of counterparty nonperformance.
The following tables provide a summary of the fair value of CMS Energy's energy
commodity contracts as of March 31, 2002.
In Millions
- ------------------------------------------------------------------------------------------------------------
Fair value of contracts outstanding as of December 31, 2001 $ 108
Contracts realized or otherwise settled during the period (a) (17)
Fair value of new contracts when entered into during the period 12
Changes in fair value attributable to changes in valuation techniques and assumptions -
Other changes in fair value (b) 6
- ------------------------------------------------------------------------------------------------------------
Fair value of contracts outstanding as of March 31, 2002 $ 109
============================================================================================================
Fair Value of Contracts at March 31, 2002 In Millions
- ------------------------------------------------------------------------------------------------------------
Maturity (in years)
Total ------------------------------------------------------------
Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5
- ------------------------------------------------------------------------------------------------------------
Prices actively quoted $ 55 $ 28 $ 21 $ 5 $ 1
Prices provided by other
external sources 22 2 4 10 6
Prices based on models and
other valuation methods 32 2 11 12 7
- ------------------------------------------------------------------------------------------------------------
Total $109 $ 32 $ 36 $ 27 $ 14
============================================================================================================
(a) Reflects value of contracts, included in December 31, 2001 values,
that expired during the first quarter of 2002.
(b) Reflects changes in price and net increase/decrease in size of forward
positions, as well as changes to mark-to-market reserve accounts.
ROUND TRIP TRADING
During 2001, CMS Energy entered into several energy trading contacts with
counterparties. The impact of these transactions increased operating revenue
with a corresponding increase in operating expenses. During the fourth quarter
of 2001, it was determined that under SFAS No. 133 and related interpretations,
these transactions should have been recorded on a net basis. First, second and
third quarter 2001 operating revenues and operating expenses were restated from
the amounts previously reported to reflect these transactions on a net basis.
There was no impact on previously recorded consolidated net income. For further
information, see Recent Developments in Other Matters section of this MD&A.
INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY
CMS Energy, through its subsidiaries and affiliates, has acquired investments in
energy-related projects throughout the world. As a result of a change in
business strategy, CMS Energy has begun divesting its non-strategic or
under-performing foreign investments. One goal of the new business strategy is
to have approximately 90 percent of CMS Energy's total assets in North American
investments.
BALANCE SHEET: CMS Energy's subsidiaries and affiliates whose functional
currency is other than the U.S. Dollar translate their assets and liabilities
into U.S. Dollars at the exchange rates in effect at the end of the fiscal
period. The revenue and expense accounts of such subsidiaries and affiliates are
translated into U.S. Dollars at the average exchange rate during the period. The
gains or losses that result from this process, and gains and losses on
intercompany foreign currency transactions that are long-term in nature that CMS
Energy does not intend to settle in the foreseeable future, are reflected as a
component of stockholders' equity in the consolidated balance sheets as "Foreign
Currency Translation" in accordance with the accounting guidance provided in
SFAS No. 52. As of March 31, 2002, the cumulative Foreign Currency Translation
decreased stockholders' equity by $290 million.
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INCOME STATEMENT: For subsidiaries operating in highly inflationary economies or
that meet the U.S. functional currency criteria outlined in SFAS No. 52, the
U.S. Dollar is deemed to be the functional currency. Gains and losses that arise
from exchange rate fluctuations on transactions denominated in a currency other
than the U.S. Dollar, except those that are hedged, are included in determining
net income.
Argentina: In January 2002, the Republic of Argentina enacted the Public
Emergency and Foreign Exchange System Reform Act. This law, among other things,
repealed the fixed exchange rate of one U.S. Dollar to one Argentina Peso,
converted all Dollar-denominated utility tariffs and energy contract obligations
into Pesos at the same one-to-one exchange rate, and directed the President of
Argentina to renegotiate such tariffs.
In February 2002, the Republic of Argentina enacted additional measures that
required all monetary obligations (including current debt and future contract
payment obligations) denominated in foreign currencies to be converted into
Pesos. These February measures also authorize the Argentine judiciary
essentially to rewrite private contracts denominated in Dollars or other foreign
currencies if the parties cannot agree on how to share equitably the impact of
the conversion of their contract payment obligations into Pesos.
For the three months ended March 31, 2002, CMS Energy recorded losses of $21
million or $0.15 per share, reflecting the negative impact of the actions of the
Argentine government. These losses represent changes in the value of
Peso-denominated monetary assets (such as receivables) and liabilities of
Argentina-based subsidiaries and lower net project earnings resulting from the
conversion to Pesos of utility tariffs and energy contract obligations that were
previously calculated in Dollars.
Effective April 30, 2002, CMS Energy adopted the Argentine Peso as the
functional currency for all of its Argentine investments. CMS had previously
used the U.S. Dollar as the functional currency for its Argentine investments.
As a result, on April 30, 2002, CMS Energy translated the assets and liabilities
of its Argentine entities into U.S. Dollars, in accordance with SFAS No. 52,
using an exchange rate of 3.45 Pesos per U.S. Dollar, and recorded a charge to
the Foreign Currency Translation component of Common Stockholders' Equity of
approximately $400 million.
While CMS Energy's management cannot predict the most likely future, average, or
end of period 2002 Peso to U.S. Dollar exchange rates, it does expect that this
non-cash charge substantially reduces the risk of further material balance sheet
impacts when combined with anticipated proceeds from international arbitration
currently in progress, political risk insurance, and the eventual sale of these
assets. This non-cash charge represents approximately eighty percent of the
affected assets' book value. As a result of this change, and the ongoing
translation of revenue and expense accounts of these investments into U.S.
Dollars, 2002 earnings for CMS Energy may be adversely affected by an additional
$19 million to $25 million or $0.13 to $0.18 per share assuming exchange rates
ranging from 3.00 to 4.00 Pesos per U.S. Dollar.
Australia: In 2000, an impairment loss of $329 million ($268 million after-tax)
was realized on the carrying amount of the investment in Loy Yang. This loss
does not include $168 million cumulative net foreign currency translation losses
due to unfavorable changes in the exchange rates, which, in accordance with SFAS
No. 52, will not be realized until there has been a sale, full liquidation, or
other disposition of CMS Energy's investment in Loy Yang, all of which are
currently being pursued but may not occur in 2002.
HEDGING STRATEGY: CMS Energy uses forward exchange and option contracts to hedge
certain receivables, payables, long-term debt and equity value relating to
foreign investments. The purpose of CMS Energy's foreign currency hedging
activities is to protect the company from risk that U.S. Dollar net cash flows
resulting from sales to foreign customers and purchases from foreign suppliers
and the repayment of non-U.S. Dollar borrowings, as well as the equity reported
on the company's balance sheet, may be adversely affected by changes in exchange
rates. These contracts do not subject CMS Energy to risk from exchange rate
movements
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because gains and losses on such contracts are inversely correlated with the
losses and gains, respectively, on the assets and liabilities being hedged.
Foreign currency adjustments for other CMS Energy international investments in
Thailand, Venezuela, Ghana, India and the Philippines were immaterial due to
relatively stable exchange rates, minimal investment amounts, or such
adjustments were not applicable due to U.S. functional currency classifications
of the foreign investments. These countries are excluded in the hedging
portfolio due to a lack of forward markets, relatively stable exchange rates and
minimal amounts of investment.
NEW ACCOUNTING STANDARDS
In addition to the identified critical accounting policies discussed above,
future results will be affected by new accounting standards that recently have
been issued.
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Issued by the FASB in
August 2001, the provisions of SFAS No. 143 require adoption as of January 1,
2003. The standard requires entities to record the fair value of a liability for
an asset retirement obligation in the period in which the obligation is
incurred. When the liability is initially recorded, the entity capitalizes a
cost by increasing the carrying amount of the related long-lived asset. Over
time, the liability is accreted to its present value each period, and the
capitalized cost is depreciated over the related asset's useful life. Upon
settlement of the liability, an entity either settles the obligation for its
recorded amount or incurs a gain or loss upon settlement. CMS Energy is
currently studying the effects of the new standard, but has yet to quantify the
effects of adoption on its financial statements.
SFAS NO. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS: Issued by the FASB on April 30,
2002, this Statement rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishment of Debt Made to Satisfy
Sinking-Fund Requirements. As a result, any gain or loss on extinguishment of
debt should be classified as an extraordinary item only if it meets the criteria
set forth in APB Opinion No. 30. The provisions of this section are applicable
to fiscal years beginning 2003. SFAS No. 145 amends SFAS No. 13, Accounting for
Leases, to require sale-leaseback accounting for certain lease modifications
that have similar economic impacts to sale-leaseback transactions. This
provision is effective for transactions occurring after May 15, 2002. Finally,
SFAS No. 145 amends other existing authoritative pronouncements to make various
technical corrections and rescinds SFAS No. 44, Accounting for Intangible
Assets of Motor Carriers. These provisions are effective for financial
statements issued on or after May 15, 2002. CMS Energy is currently studying
the effects of the new standard, but has yet to quantify the effects of
adoption on its financial statements.
DERIVATIVES IMPLEMENTATION GROUP ISSUES: In December 2001, the FASB issued final
guidance for DIG Statement No. C16, which is effective April 1, 2002. CMS Energy
has completed its study of DIG Statement No. C16, and has determined that this
issue will not affect the accounting for its fuel supply contracts.
CAPITAL RESOURCES AND LIQUIDITY
CASH POSITION, INVESTING AND FINANCING
CMS Energy's primary ongoing source of cash is dividends and other distributions
from subsidiaries. During the first quarter of 2002, Consumers paid $55 million
in common dividends and Enterprises paid $588 million in common dividends and
other distributions to CMS Energy. In April 2002, Consumers declared a $43
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CMS Energy Corporation
million common dividend to CMS Energy, payable in May 2002. CMS Energy's
consolidated cash requirements are met by its operating and financing
activities.
OPERATING ACTIVITIES: CMS Energy's consolidated net cash provided by operating
activities is derived mainly from the processing, storage, transportation and
sale of natural gas; the generation, transmission, distribution and sale of
electricity; and the sale of oil. For the first three months of 2002 and 2001,
consolidated cash from operations after interest charges totaled $252 million
and $361 million, respectively. The $109 million decrease in cash from
operations resulted primarily from a decrease in cash earnings, decreases in
accounts payable and accrued expenses, and other temporary changes in working
capital items due to timing of cash receipts and payments. These uses of cash
were partially offset by a decrease in accounts receivable and a decrease in
inventories. CMS Energy uses cash derived from its operating activities
primarily to maintain and expand its diversified energy businesses, to maintain
and expand electric and gas systems of Consumers, to pay interest on and retire
portions of its long-term debt, and to pay dividends.
INVESTING ACTIVITIES: For the first three months of 2002, CMS Energy's
consolidated net cash provided by investing activities totaled $629 million,
while net cash used in investing activities totaled $332 million for the first
three months of 2001. The $961 million increase in cash reflects increased net
proceeds from the sale of assets ($878 million) and a reduction in capital
expenditures ($81 million). CMS Energy's expenditures in the first three months
of 2002 for its utility and diversified energy businesses were $148 million and
$67 million, respectively, compared to $194 million and $116 million,
respectively, during the comparable period in 2001.
FINANCING ACTIVITIES: For the first three months of 2002, CMS Energy's net cash
used in financing activities totaled $910 million, while net cash provided by
financing activities totaled $11 million for the first three months of 2001. The
decrease of $921 million resulted primarily from an increase in the retirement
of bonds and other long-term debt ($513 million), an increase in the retirement
of Trust Preferred Securities ($30 million), a decrease in proceeds from notes,
bonds and other long-term debt ($74 million) and a decrease in proceeds from the
issuance of common stock ($287 million). The following table summarizes
securities issued during the first three months of 2002:
Distribution/ Amount
Month Issued Maturity Interest Rate (In Millions) Use of Proceeds
- -------------------------------------------------------------------------------------------------------------------
CMS ENERGY
GTNs Series F January (1) 8.09% $ 12 General corporate purposes
Common Stock (2) n/a 1.3 million shares 29 Repay debt and general
----- corporate purposes
$ 41
CONSUMERS
Senior Notes March 2005 6.00% $ 300 Repay debt
-----
Total $ 341
=====
- -------------------------------------------------------------------------------------------------------------------
(1) GTNs are issued with varying maturity dates. The interest rate shown
herein is a weighted average interest rate.
(2) One million shares were issued in conjunction with CMS Energy's
Continuous Stock Offering Program, activated in February 2002, for
which two million shares are registered. CMS Energy also issued Common
Stock from time to time in conjunction with the stock purchase plan
and various employee savings and stock incentive plans.
In the first quarter of 2002, CMS Energy declared and paid $48 million in cash
dividends to holders of CMS Energy Common Stock. In April 2002, the Board of
Directors declared a quarterly dividend of $.365 per share on CMS Energy Common
Stock, payable in May 2002.
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CMS Energy Corporation
OTHER INVESTING AND FINANCING MATTERS: At March 31, 2002, the book value per
share of CMS Energy Common Stock was $17.05.
At May 1, 2002, CMS Energy had an aggregate $1.3 billion in securities
registered for future issuance.
CMS Energy has $750 million of Senior Credit Facilities consisting of a $450
million one-year revolving credit facility maturing in June 2002 and a $300
million three-year revolving credit facility maturing in June 2004. At March 31,
2002, the total amount available under the Senior Credit Facilities was $587
million. CMS Energy has contractual restrictions pursuant to the Senior Credit
Facilities that require the company to maintain, as of the last day of each
fiscal quarter, a Consolidated Leverage Ratio, as defined by the agreements, of
not more than 5.50 to 1.0 and a Cash Dividend Coverage Ratio, as defined by the
agreements, of not less than 1.40 to 1.0. As of March 31, 2001, CMS Energy's
Consolidated Leverage Ratio was 4.91 to 1.0 and CMS Energy's Cash Dividend
Coverage Ratio was 2.06 to 1.0. Failure to maintain these ratios would
constitute an Event of Default and prevent CMS Energy from receiving any
extensions under the Senior Credit Facilities and from paying dividends.
CMS Energy also has $22 million of unsecured lines of credit as anticipated
sources of funds to finance working capital requirements and to pay for capital
expenditures between long-term financings. At March 31, 2002, the amount
available under the unsecured lines of credit was $22 million. For further
information, see Note 5, Short-Term and Long-Term Financings and Capitalization,
incorporated by reference herein.
In April 2002, CMS Energy signed a definitive agreement with Mirant for the sale
of CMS Generation's ownership interest in Toledo Power Company in the
Philippines for $10 million. CMS Generation expects the sale to close in the
second quarter of 2002. On May 1, 2002, CMS Energy completed the sale of CMS Oil
and Gas' coalbed methane holdings in the Powder River Basin to XTO Energy for
$101 million. Also on May 1, 2002, CMS Energy completed the sale of Consumers'
electric transmission system to a non-affiliated limited partnership for
approximately $290 million. CMS Energy plans to continue to pursue the sale of
targeted assets throughout 2002. Even though assets have been identified for
sale, management cannot predict when, nor make assurances regarding the value of
the consideration to be received or whether these sales will occur.
The following information on CMS Energy's contractual obligations, commercial
commitments, and off-balance sheet financings is provided to collect information
in a single location so that a picture of liquidity and capital resources is
readily available.
CONTRACTUAL OBLIGATIONS: Contractual obligations include CMS Energy's long-term
debt, notes payable, lease obligations, sales of accounts receivable and other
unconditional purchase obligations, that represent normal business operating
contracts used to assure adequate supply of and minimize exposure to market
price 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 $48 million per month for year 2002, which
includes $33 million related to the MCV Facility. If a plant is not available to
deliver electricity to Consumers, then Consumers would not be obligated to make
the capacity payment until the plant could deliver.
COMMERCIAL COMMITMENTS: As of March 31, 2002 CMS Energy, Enterprises, and their
subsidiaries have guaranteed payment of obligations through guarantees,
indemnities and letters of credit, of unconsolidated affiliates and related
parties approximating $2.2 billion. Included in this amount, Enterprises, in the
ordinary course of its business, has guaranteed contracts of CMS MST that
contain certain schedule and performance requirements. As of March 31, 2002, the
actual amount of financial exposure covered by these guarantees and indemnities
was $928 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.
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CMS Energy Corporation
Consumers has $300 million credit facilities, $200 million aggregate lines of
credit and a $325 million trade receivable sale program in place as anticipated
sources of funds to fulfill its currently expected capital expenditures. For
further information about this source of funds, see Note 5, Short-Term
Financings, incorporated by reference herein.
OFF-BALANCE SHEET ARRANGEMENTS: CMS Energy, through its subsidiary companies,
has equity investments in partnerships and joint ventures in which they have a
minority ownership interest. As of March 31, 2002, 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.
CAPITAL EXPENDITURES
CMS Energy estimates that capital expenditures, including new lease commitments
and investments in new business developments through partnerships and
unconsolidated subsidiaries, will total $2.8 billion during 2002 through 2004.
These estimates are prepared for planning purposes and are subject to revision.
CMS Energy expects to satisfy a substantial portion of the capital expenditures
with cash from operations. CMS Energy will continue to evaluate capital markets
in 2002 as a potential source for financing its subsidiaries' investing
activities. CMS Energy estimates capital expenditures by business segment over
the next three years as follows:
In Millions
- --------------------------------------------------------------------------------------------------------------------
Years Ending December 31 2002 2003 2004
- --------------------------------------------------------------------------------------------------------------------
Consumers electric operations (a) (b) $ 450 $ 405 $ 440
Consumers gas operations (a) 175 165 150
Natural gas transmission 205 220 190
Independent power production 35 25 85
Oil and gas exploration and production 75 80 60
Marketing, services and trading 10 15 5
Other 25 10 5
----------------------------------------------
$975(c) $920(c) $935(c)
====================================================================================================================
(a) These amounts include an attributed portion of Consumers' anticipated
capital expenditures for plant and equipment common to both the electric and gas
utility businesses.
(b) These amounts include estimates for capital expenditures that may be
required by recent revisions to the Clean Air Act's national air quality
standards. For further information see Note 4, Uncertainties - Electric
Environmental Matters.
(c) These amounts include expenditures associated with the Trunkline LNG
terminal expansion, for which an application was filed with the FERC on December
26, 2001, estimated at $21 million in 2002, $81 million in 2003 and $49 million
in 2004.
For further explanation of CMS Energy's planned investments for the years 2002
through 2004, see the Outlook section below.
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CMS Energy Corporation
MARKET RISK INFORMATION
CMS Energy is exposed to market risks including, but not limited to, changes in
interest rates, currency exchange rates, commodity prices and equity security
prices. CMS Energy's derivative activities are subject to the direction of the
Executive Oversight Committee, which is comprised of certain members of CMS
Energy's senior management, and its Risk Committee, which is comprised of CMS
Energy business unit managers and chaired by the CMS Chief Risk Officer. The
purpose of the risk management policy is to measure and limit CMS Energy's
overall energy commodity risk by implementing an enterprise-wide policy across
all CMS Energy business units. This allows CMS Energy to maximize the use of
hedges among its business units before utilizing derivatives with external
parties. The role of the Risk Committee is to review the corporate commodity
position and ensure that net corporate exposures are within the economic risk
tolerance levels established by the Board of Directors. Management employs
established policies and procedures to manage its risks associated with market
fluctuations, including the use of various derivative instruments such as
futures, swaps, options and forward contracts. When management uses these
derivative instruments, it intends that an opposite movement in the value of the
hedged item would offset any losses incurred on the derivative instruments.
CMS Energy has performed sensitivity analyses to assess the potential loss in
fair value, cash flows and earnings based upon hypothetical 10 percent increases
and decreases in market exposures. Management does not believe that sensitivity
analyses alone provide an accurate or reliable method for monitoring and
controlling risks; therefore, CMS Energy and its subsidiaries rely on the
experience and judgment of senior management and traders to revise strategies
and adjust positions as they deem necessary. Losses in excess of the amounts
determined in the sensitivity analyses could occur if market rates or prices
exceed the 10 percent shift used for the analyses.
COMMODITY PRICE RISK: CMS Energy is exposed to market fluctuations in the price
of natural gas, oil, electricity, coal, natural gas liquids and other
commodities. CMS Energy employs established policies and procedures to manage
these risks using various commodity derivatives, including futures contracts,
options and swaps (which require a net cash payment for the difference between a
fixed and variable price), for non-trading purposes. The prices of these energy
commodities can fluctuate because of, among other things, changes in the supply
of and demand for those commodities. To minimize adverse price changes, CMS
Energy also hedges certain inventory and purchases and sales contracts. Based on
a sensitivity analysis, CMS Energy estimates that if energy commodity prices
average 10 percent higher or lower, pretax operating income for the subsequent
nine months would increase or decrease by $4.4 million and $4.3 million,
respectively. These hypothetical 10 percent shifts in quoted commodity prices
would not have had a material impact on CMS Energy's consolidated financial
position or cash flows as of March 31, 2002. The analysis does not quantify
short-term exposure to hypothetically adverse price fluctuations in inventories
or for commodity positions related to trading activities.
Consumers enters into, for purposes other than trading, electricity and gas fuel
for generation call options and swap contracts, and gas supply contracts
containing embedded 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 its customers' electric needs. The
gas fuel for generation call options and swap contracts are used to protect
generation activities against risk due to fluctuations in the market price of
natural gas. The gas supply contracts containing embedded put options are used
to purchase reasonably priced gas supply.
As of March 31, 2002 and 2001, the fair value based on quoted future market
prices of electricity-related call option and swap contracts was $19 million and
$97 million, respectively. At March 31, 2002 and 2001, assuming a hypothetical
10 percent adverse change in market prices, the potential reduction in fair
value associated with these contracts would be $4 million and $14 million,
respectively. As of March 31, 2002 and
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CMS Energy Corporation
2001, Consumers had an asset of $48 million and $104 million, respectively,
related to premiums incurred for electric call option contracts. Consumers'
maximum exposure associated with the call option contracts is limited to the
premiums incurred. As of March 31, 2002, the fair value based on quoted future
market prices of gas supply contracts containing embedded put options was $4
million. At March 31, 2002, assuming a hypothetical 10 percent adverse change in
market prices, the potential reduction in fair value associated with these
contracts would be $1 million.
INTEREST RATE RISK: CMS Energy is exposed to interest rate risk resulting from
the issuance of fixed-rate and variable-rate debt, including interest rate risk
associated with Trust Preferred Securities, and from interest rate swaps. CMS
Energy uses a combination of fixed-rate and variable-rate debt, as well as
interest rate swaps to manage and mitigate interest rate risk exposure when
deemed appropriate, based upon market conditions. CMS Energy employs these
strategies to attempt to provide and maintain a balance between risk and the
lowest cost of capital. At March 31, 2002, the carrying amounts of long-term
debt and Trust Preferred Securities were $6.5 billion and $1.2 billion,
respectively, with corresponding fair values of $6.4 billion and $1.1 billion,
respectively. Based on a sensitivity analysis at March 31, 2002, CMS Energy
estimates that if market interest rates average 10 percent higher or lower,
earnings before income taxes for the subsequent twelve months would decrease or
increase, respectively, by approximately $4 million. In addition, based on a 10
percent adverse shift in market interest rates, CMS Energy would have an
exposure of approximately $374 million to the fair value of its long-term debt
and Trust Preferred Securities if it had to refinance all of its long-term
fixed-rate debt and Trust Preferred Securities. CMS Energy does not intend to
refinance its entire fixed-rate debt and Trust Preferred Securities in the near
term and believes that any adverse change in interest rates would not have a
material effect on CMS Energy's consolidated financial position as of March 31,
2002.
At March 31, 2002, the fair value of CMS Energy's floating to fixed interest
rate swaps, with a notional amount of $295 million, was $7 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.
At March 31, 2002, the fair value of CMS Energy's fixed to floating interest
rate swaps, with a notional amount of $822 million, was $3 million, which
represents the amount CMS Energy would pay to settle. The swaps mature at
various times through 2005 and are designated as fair value hedges for
accounting purposes.
CURRENCY EXCHANGE RISK: CMS Energy is exposed to currency exchange risk arising
from investments in foreign operations as well as various international projects
in which CMS Energy has an equity interest and which have debt denominated in
U.S. Dollars. CMS Energy typically uses forward exchange contracts and other
risk mitigating instruments to hedge currency exchange rates. The impact of the
hedges on the investments in foreign operations is reflected in other
comprehensive income as a component of foreign currency translation adjustment.
For the first quarter of 2002, the mark-to-market adjustment for hedging was $6
million of the total net foreign currency translation adjustment of $6 million.
Based on a sensitivity analysis at March 31, 2002, a 10 percent adverse shift in
currency exchange rates would not have a material effect on CMS Energy's
consolidated financial position or results of operations as of March 31, 2002,
but would result in a net cash settlement of approximately $1 million. At March
31, 2002, the estimated fair value of the foreign exchange hedges was $6
million, which represents the amount CMS would pay upon settlement.
EQUITY SECURITY PRICE RISK: CMS Energy and certain of its subsidiaries have
equity investments in companies in which they hold less than a 20 percent
interest. As of March 31, 2002 a hypothetical 10 percent adverse shift in
equity securities prices would not have a material effect on CMS Energy's
consolidated financial position, results of operations or cash flows.
For a discussion of accounting policies related to derivative transactions, see
Note 7, Risk Management Activities and Financial Instruments, incorporated by
reference herein.
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CMS Energy Corporation
OUTLOOK
CMS Energy's vision is to be an integrated energy company with a strong asset
base, supplemented with an active marketing, services and trading capability.
CMS Energy intends to integrate the skills and assets of its business units to
obtain optimal returns and to provide expansion opportunities.
To achieve this vision, CMS Energy announced in October 2001 significant changes
in its business strategy in order to strengthen its balance sheet, provide more
transparent and predictable future earnings, and lower its business risk by
focusing its future business growth primarily in North America. Specifically,
CMS Energy announced its plans to sell or optimize non-strategic and
under-performing international assets and discontinue its international energy
distribution business. CMS Energy also announced its plans to discontinue all
new development outside North America, which includes closing all non-U.S.
development offices, except for exploration and production projects and prior
commitments in the Middle East.
Consistent with this refocused business strategy, CMS Energy has pursued the
sale of non-strategic and under-performing assets and the optimization of
retained assets. In May 2002, CMS Energy completed the sale of CMS Oil and Gas'
coalbed methane holdings in the Powder River Basin to XTO Energy for $101
million and the sale of Consumers' electric transmission system to a
non-affiliated limited partnership for approximately $290 million. With the
closing of these sales, CMS Energy has received approximately $2.4 billion of
cash from asset sales, securitization proceeds and proceeds from LNG
monetization out of its $2.9 billion program to improve its balance sheet. Upon
the sale of additional non-strategic and under-performing assets, the proceeds
realized may be materially different than the book value of those assets. Even
though these assets have been identified for sale, management cannot predict
when, nor make any assurances that, these asset sales will occur. CMS Energy
anticipates, however, that the sales, if any, will result in additional cash
proceeds that will be used to retire additional debt of CMS Energy, Consumers
and/or Panhandle.
Consistent with changes in its business strategy, CMS Energy will continue to
sharpen its geographic focus on key growth areas where it already has
significant investments and opportunities. CMS Energy's focus will be in North
America, particularly in the United States' central corridor, and in certain
existing international operations including commitments in the Middle East. As a
result, approximately 90% of CMS Energy's assets are expected to be North
American investments.
CMS Energy is currently evaluating longer-term growth initiatives, including
acquisitions and joint ventures in CMS Energy's North American diversified
energy businesses and expanded and new North American LNG regasification
terminals.
DIVERSIFIED ENERGY OUTLOOK
NATURAL GAS TRANSMISSION OUTLOOK: CMS Energy seeks to build on Panhandle's
position as a leading United States interstate natural gas pipeline system and
its significant ownership interest in and operation of the nation's largest
operating LNG receiving terminal through expansion and better utilization of its
existing facilities and construction of new facilities. By providing additional
transportation, storage and other asset-based value-added services to customers
such as gas-fueled power plants, local distribution companies, industrial and
end-users, marketers and others, CMS Energy expects to expand its natural gas
pipeline business. Panhandle has a one-third interest in Guardian Pipeline LLC,
which is currently constructing a 141-mile, 36-inch pipeline from Illinois to
southeastern Wisconsin for the transportation of natural gas beginning late
2002. Upon completion of the project, Trunkline will operate and maintain the
pipeline. Panhandle also has a one-third interest in the Centennial Pipeline
Company which operates a 720-mile, 26-inch pipeline extending from the U.S. Gulf
Coast to Illinois for the transportation of interstate refined petroleum
products.
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CMS Energy Corporation
The pipeline began commercial service in April 2002.
In April 2001, FERC approved Trunkline's rate settlement without modification.
The settlement resulted in Trunkline reducing its maximum rates in May 2001. The
reduction is expected to reduce revenues by approximately $2 million annually.
In October 2001 Trunkline LNG, in which Panhandle owns an interest through its
equity interest in LNG Holdings, announced the planned expansion of the Lake
Charles, Louisiana facility to approximately 1.2 bcf per day of send out
capacity, up from its current send out capacity of 630 million cubic feet per
day. The terminal's storage capacity will also be expanded to 9 bcf from its
current storage capacity of 6.3 bcf. Assuming FERC approval, the expanded
facility is planned to be in operation in early 2005. The expansion expenditures
are currently expected to be funded by Panhandle loans or equity contributions
to CMS Trunkline LNG Holdings, which would be sourced by repayment by CMS
Capital to Panhandle on its outstanding note receivable.
In October 2001, CMS Energy and Sempra Energy announced an agreement to jointly
develop a major new LNG receiving terminal to bring much-needed natural gas
supplies into northwestern Mexico and southern California. The plant would be
located on the Pacific Coast, north of Ensenada, Baja California, Mexico. As
currently planned, it will have a send out capacity of approximately 1 bcf per
day of natural gas through a new 40-mile pipeline between the terminal and
existing pipelines in the region. The terminal would be operated and maintained
by a joint operating company with majority oversight by Panhandle when
commercial operations begin, which is currently estimated to be in 2007.
INDEPENDENT POWER PRODUCTION OUTLOOK: CMS Energy's independent power production
subsidiary plans to complete the restructuring of its operations during 2002 by
narrowing the scope of its existing operations and commitments from four regions
to two regions: the U.S. and the Middle East/North Africa. In addition, its
plans include selling designated assets and investments that are
under-performing, non-region focused and non-synergistic with other CMS Energy
business units. The independent power production business unit will continue to
optimize the operations and management of its remaining portfolio of assets in
order to contribute to CMS Energy's earnings and to maintain its reputation for
solid performance in the construction and operation of power plants. CMS Energy
is actively pursuing the sale, full liquidation, or other disposition of several
of its designated assets and investments, but management cannot predict when,
nor make any assurances that, these asset and investment sales will occur.
OIL AND GAS EXPLORATION AND PRODUCTION OUTLOOK: CMS Energy seeks to optimize its
significant natural gas exploration, development and production properties in
North America. CMS Energy also seeks to explore for, or acquire, natural gas
reserves in North America where integrated development opportunities exist with
other CMS Energy businesses involved in gathering, processing and pipeline
activities. CMS Energy plans to further explore and develop its oil and gas
assets in the Republic of Congo, Eritrea, Tunisia, Cameroon, Colombia and
Venezuela.
MARKETING, SERVICES AND TRADING OUTLOOK: CMS Energy intends to use its
marketing, services and trading business to focus on customers such as Local
Distribution Companies, municipals, cooperative electric companies, and
industrial and commercial businesses in selected locations in North America. CMS
Energy's marketing and trading business also intends to contract for use of
significant gas transportation and storage assets as well as energy and
generating capacity in North America to provide a platform for wholesale
marketing, trading, and physical arbitrage. CMS Energy also seeks to continue
the development of importing and marketing opportunities for LNG. CMS Energy
plans to capitalize on favorable market conditions for energy performance
contracting by expanding its services business in selected markets.
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CMS Energy Corporation
Recent events related to very large market makers in the energy trading market
have raised concerns about liquidity in this market. Management cannot predict
what effect these events may have on the liquidity of the trading markets in the
short-term, but believes the markets will be stable and grow over the long term.
For further information, see Recent Developments in Other Matters section of
this MD&A.
UNCERTAINTIES: The results of operations and financial position of CMS Energy's
diversified energy businesses may be affected by a number of trends or
uncertainties that have, or CMS Energy reasonably expects could have, a material
impact on income from continuing operations, cash flows as well as balance sheet
and credit improvement. Such trends and uncertainties include: 1) the ability to
sell or optimize assets or businesses in accordance with its financial plan; 2)
the international monetary fluctuations, particularly in Argentina, as well as
Brazil and Australia; 3) the changes in foreign laws, governmental and
regulatory policies that could significantly reduce the tariffs charged and
revenues recognized by certain foreign investments; 4) the imposition of stamp
taxes on certain South American contracts that could significantly increase
project expenses; 5) the impact of future rate cases on regulated businesses and
the effects of changing regulatory and accounting related matters resulting from
current events; and 6) the increased competition in the market for transmission
of natural gas to the Midwest causing pressure on prices charged by Panhandle.
OTHER OUTLOOK: Since the September 11, 2001 terrorist attack in the United
States, CMS Energy has increased security at substantially all facilities and
infrastructure, and will continue to evaluate security on an ongoing basis. CMS
Energy may be required to comply with federal and state regulatory security
measures promulgated in the future. As a result, CMS Energy anticipates that
increased operating costs related to security after September 11, 2001 could be
significant. It is not certain that any additional costs will be recovered in
Consumers' or Panhandle's rates.
Rouge Steel Company, with whom DIG has contracted to sell steam for industrial
use and purchase blast furnace gas as fuel at prices significantly less than the
cost of natural gas, is considering altering certain of its operational
processes as early as mid-2004. These alterations could have an adverse
operational and financial impact on DIG by significantly reducing Rouge Steel
Company's demands for steam from DIG and its ability to provide DIG with
economical blast furnace gas. However, these alterations may result in
additional electric sales to Rouge Steel Company. CMS Energy is currently
assessing these potential operational and financial impacts and DIG is
evaluating alternatives to its current contractual arrangements with Rouge Steel
Company, but CMS Energy cannot predict the ultimate outcome of these matters at
this time.
CMS Energy provides post retirement benefits under its Pension Plan, and post
retirement health and life benefits under its OPEB plan to substantially all its
employees. Pension and OPEB plan assets, net of contributions, have reduced in
value from the previous year due to a downturn in the equities market. As a
result, CMS Energy expects to see an increase in pension and OPEB expense levels
over the next few years unless market performance improves. CMS Energy
anticipates pension expense and OPEB expense to rise in 2002 by approximately
$10 million and $21 million, respectively, over 2001 expenses. For pension
expense, this increase is due to a downturn in the value of pension assets
during the past two years, forecasted increases in pay and added service,
decline in the interest rate used to value the liability of the plan, and
expiration of the transition gain amortization. For OPEB expense, the increase
is due to the trend of rising health care costs, the market return on plan
assets being below expected levels and a lower discount rate, based on recent
economic conditions, used to compute the benefit obligation. Health care cost
decreases gradually under the assumptions used in the OPEB plan from current
levels through 2009; however, CMS Energy cannot predict the impact that interest
rates or market returns will have on pension and OPEB expense in the future.
In January 2002, CMS Energy made a contribution to the Pension Trust of $64
million and a contribution to the 401(h) segment of the Pension Trust of $21
million.
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CMS Energy Corporation
CONSUMERS' ELECTRIC UTILITY BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects electric deliveries
(including both full service sales and delivery service to customers who choose
to buy generation service from an alternative electric supplier) to grow at an
average rate of approximately two percent per year based primarily on a steadily
growing customer base. This growth rate reflects a long-range expected trend of
growth. Growth from year to year may vary from this trend due to customer
response to abnormal weather conditions and changes in economic conditions
including, utilization and expansion of manufacturing facilities.
COMPETITION AND REGULATORY RESTRUCTURING: Regulatory changes and other
developments have resulted and will continue to result in increased competition
in the electric business. Generally, increased competition threatens Consumers'
share of the market for generation services and can reduce profitability.
Competition is increasing as a result of the introduction of retail open access
in the state of Michigan pursuant to the enactment of Michigan's Customer Choice
Act, and therefore, alternative electric suppliers for generation services have
entered Consumers' market. The Customer Choice Act allows all electric customers
to have the choice of buying electric generation service from an alternative
electric supplier as of January 1, 2002. To the extent Consumers experiences
"net" Stranded Costs as determined by the MPSC, the Customer Choice Act provides
for the recovery of such "net" Stranded Costs through a charge that would be
paid by those customers that choose to switch to an alternative electric
supplier.
Stranded and Implementation Costs: The Customer Choice Act allows for the
recovery by an electric utility of the cost of implementing the act's
requirements and "net" Stranded Costs, without defining the term. The act
directs the MPSC to establish a method of calculating "net" Stranded Costs and
of conducting related true-up adjustments. In December 2001, the MPSC adopted a
methodology for calculating "net" Stranded Costs as the shortfall between (a)
the revenue needed 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 those revenue needs. According to the MPSC,
"net" Stranded Costs are to be recovered from retail open access customers
through a Stranded Cost transition charge. Even though the MPSC ruled that the
Stranded Cost transition charge to be in effect on January 1, 2002 for the
recovery of "net" Stranded Costs for calendar year 2000 for Consumers is zero,
the MPSC also indicated that the "net" Stranded Costs for 2000 would be subject
to further review in the context of its subsequent determinations of "net"
Stranded Costs for 2001 and later years. The MPSC authorized Consumers to use
deferred accounting to recognize the future recovery of costs determined to be
stranded by application of the MPSC's methodology. Consumers is seeking a
rehearing and clarification of the methodology adopted, and in April 2002, made
"net" Stranded Cost filings with the MPSC for $22 million and $43 million for
2000 and 2001, respectively. In the same filing, Consumers estimated that it
would experience "net" Stranded Costs of $126 million for 2002. The outcome of
these proceedings before the MPSC is uncertain at this time.
Since 1997, Consumers has incurred significant electric utility implementation
costs. The following table outlines the applications filed by Consumers with the
MPSC and the status of recovery for these costs.
In Millions
- --------------------------------------------------------------------------------------------------------------
YEAR FILED YEAR INCURRED REQUESTED PENDING ALLOWED DISALLOWED
1999 1997 & 1998 $ 20 $ - $ 15 $ 5
2000 1999 30 - 25 5
2001 2000 25 25 - -
2002 2001 8 8 - -
==============================================================================================================
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CMS Energy Corporation
The MPSC disallowed certain costs based upon a conclusion that these amounts did
not represent costs incremental to costs already reflected in rates. In the
orders received for the years 1997 through 1999, the MPSC also ruled that it
reserved the right to undertake another review of the total implementation costs
depending upon the progress and success of the retail open access program, and
ruled that due to the rate freeze imposed by the Customer Choice Act, it was
premature to establish a cost recovery method for the allowable implementation
costs. Consumers expects to receive final orders for the 2000 and 2001
implementation costs in 2002. In addition to the amounts shown, as of March
2002, Consumers incurred and deferred as a regulatory asset, $3 million of
additional implementation costs and has also recorded as a regulatory asset $11
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; however, Consumers
cannot predict the amounts the MPSC will approve as recoverable costs.
Rate Caps: The Customer Choice Act imposes certain limitations on rates that
could result in Consumers being unable to collect customer rates sufficient to
fully recover its cost of conducting business. Some of these costs may be beyond
Consumers' ability to control. In particular, if Consumers needs to purchase
power supply from wholesale suppliers during the period when retail rates are
frozen or capped, the rate restrictions imposed by the Customer Choice Act may
make it impossible for Consumers to fully recover the cost of purchased power
through the rates it charges its customers. As a result, it is not certain that
Consumers can maintain its profit margins in its electric utility business
during the period of the rate freeze or rate caps.
Industrial Contracts: In response to industry restructuring efforts, Consumers
entered into multi-year electric supply contracts with certain of its largest
industrial customers to provide electricity to certain of their facilities at
specially negotiated prices. The MPSC approved these special contracts as part
of its phased introduction to competition. During the period from 2001 through
2005, either Consumers or these industrial customers can terminate or
restructure some of these contracts. As of December 2001, neither Consumers nor
any of its industrial customers have terminated or restructured any of these
contracts, but some contracts have expired by their terms. Outstanding contracts
involve approximately 510 MW of customer power supply requirements. 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 customers in Michigan,
and internal transfer pricing between Consumers' departments and affiliates. In
October 2001, the new code of conduct was reaffirmed without substantial
modification. Consumers appealed the MPSC orders related to the code of conduct
and sought a stay of the orders until the appeal was complete; however, the
request for a stay was denied. Consumers has filed a compliance plan in
accordance with the code of conduct, and has sought waivers to the code of
conduct with respect to utility activities that provide approximately $50
million in annual revenues that may be restricted. The full impact of the new
code of conduct on Consumers' business will remain uncertain until the appellate
courts issue definitive rulings or the MPSC rules on the waivers.
Energy Policy: Uncertainty exists with respect to the enactment of a national
comprehensive energy policy, specifically federal electric industry
restructuring legislation. A variety of bills introduced in Congress in recent
years have sought to change existing federal regulation of the industry. If the
federal government enacts a comprehensive energy policy or legislation
restructuring the electric industry, then that legislation could potentially
affect or even supercede state regulation.
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CMS Energy Corporation
Transmission: On May 1, 2002, Consumers sold its electric transmission
facilities for approximately $290 million in cash to MTH, a non-affiliated
limited partnership whose general partner is a subsidiary of Trans-Elect, Inc.
In 1999, the FERC issued Order No. 2000, that strongly encouraged utilities like
Consumers to either transfer operating control of their transmission facilities
to an RTO, or sell their transmission facilities to an independent company. In
addition, in June 2000, the Michigan legislature passed Michigan's Customer
Choice Act, which contains a requirement that utilities transfer the operating
authority of transmission facilities to an independent company or divest the
facilities. Consumers chose to sell its transmission facilities as a form of
compliance with Michigan's Customer Choice Act and FERC Order No. 2000 rather
than own and invest in an asset it cannot control.
In January 2001, the FERC granted Consumers' application to transfer ownership
and control of its electric transmission facilities to METC, and in April 2001
the transfer took place. Trans-Elect, Inc. submitted the winning bid to purchase
METC through a competitive bidding process, and various federal agencies
approved the transactions. Consumers did not provide any financial or credit
support to Trans-Elect, Inc. in connection with its purchase of METC. Certain of
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and certain of their subsidiaries, but all had left the
employment of such affiliates prior to the period when the transaction was
discussed internally and negotiated with purchasers. After selling its
transmission facilities, Consumers anticipates a reduction in after-tax earnings
of approximately $6 million and $14 million in 2002 and 2003, respectively, as a
result of the loss in revenue associated with wholesale and retail open access
customers that would buy services directly from MTH including the loss of a
return on the transmission assets upon the sale of METC to MTH. Under the
agreement with MTH, and subject to certain additional RTO surcharges,
transmission rates charged to Consumers will be fixed at current levels until
December 2005, and will be subject to FERC ratemaking thereafter. MTH will
complete the capital program to expand the transmission system's capability to
import electricity into Michigan, as required by the Customer Choice Act, and
Consumers will continue to maintain the system under a five-year contract with
MTH. In April 2002, Consumers received unconditional regulatory approvals for
the sale of the transmission facilities to MTH, and effective April 30, 2002,
Consumers and METC withdrew from Alliance. For further information, see Note 4,
Uncertainties, "Electric Rate Matters - Transmission."
Wholesale Market Competition: In 1996, as a result of the FERC's efforts to move
the electric industry in Michigan to competition, Detroit Edison gave Consumers
the required four-year contractual notice of its intent to terminate the
agreements under which the companies had jointly operated the MEPCC. Detroit
Edison and Consumers restructured and continued certain parts of the MEPCC
control area and joint transmission operations, but expressly excluded any
merchant operations (electricity purchasing, sales, and dispatch operations). On
April 1, 2001, the former joint merchant operations began operating
independently. The termination of joint merchant operations with Detroit Edison
has opened Detroit Edison and Consumers to wholesale market competition as
individual companies. Consumers cannot predict the long-term financial impact
from the termination of these joint merchant operations with Detroit Edison.
Wholesale Market Pricing: Consumers is authorized by the FERC to sell
electricity at wholesale market prices. In authorizing sales at market prices,
the FERC considers several factors, including the extent to which the seller
possesses "market power" as a result of the seller's dominance of generation
resources and surplus generation resources in adjacent wholesale markets. In
order to continue to be authorized to sell at market prices, Consumers filed a
traditional market dominance analysis in October 2001. In November 2001, the
FERC issued an order modifying the method to be used to determine an entity's
degree of market power. Due, however, to several reliability issues brought
before the FERC regarding this order, the FERC has issued a stay of the order.
If the modified market power test in the order is not amended, Consumers cannot
be certain at this time if it will be granted authorization to continue to sell
wholesale electricity at market-based prices and
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CMS Energy Corporation
may be limited to charging prices no greater than its cost-based rates. A final
decision about the proposed assessment method is not expected for several
months.
Consumers cannot predict the impact of these electric industry-restructuring
issues on its financial position, liquidity, or results of operations.
PERFORMANCE STANDARDS: In July 2001, the MPSC proposed electric distribution
performance standards applicable to Consumers and other Michigan distribution
utilities. The proposal would establish standards related to restoration after
an outage, safety, and customer relations. Failure to meet the proposed
performance 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. Consumers will continue to participate in this process.
Consumers cannot predict the outcome of the proposed performance 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 4, Uncertainties,
"Electric Rate Matters - Electric Restructuring" and "Electric Rate Matters -
Electric Proceedings."
UNCERTAINTIES: Several electric business trends or uncertainties may affect
Consumers' financial results and condition. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing electric operations. Such trends and
uncertainties include: 1) the need to make additional capital expenditures and
increase operating expenses for compliance with the Clean Air Act; 2)
environmental liabilities arising from various federal, state and local
environmental laws and regulations, including potential liability or expenses
relating to the Michigan Natural Resources and Environmental Protection Acts and
Superfund; 3) uncertainties relating to the storage and ultimate disposal of
spent nuclear fuel and the successful operation of the Palisades plant by NMC;
4) electric industry restructuring issues, including those described above; 5)
Consumers' ability to meet peak electric demand requirements at a reasonable
cost, without market disruption, and initiatives undertaken to reduce exposure
to electric price increases for purchased power; 6) the recovery of electric
restructuring implementation costs; 7) Consumers new status as an electric
transmission customer and not as an electric transmission owner/operator: 8)
sufficient reserves for OATT rate refunds; and 9) the effects of derivative
accounting and potential earnings volatility. For further information about
these trends or uncertainties, see Note 4, Uncertainties.
CONSUMERS' GAS UTILITY BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers anticipates gas deliveries,
including gas customer choice deliveries (excluding transportation to the MCV
Facility and off-system deliveries), to grow at an average of about one percent
per year based primarily on a steadily growing customer base. Actual gas
deliveries in future periods may be affected by abnormal weather, alternative
electric costs, changes in competitive and economic conditions, and the level of
natural gas consumption per customer.
GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. Contemporaneously with this
filing, Consumers requested partial and immediate relief in the annual amount of
$33 million. In October 2001, Consumers revised its filing to reflect lower
operating costs and requested a $133 million annual distribution service rate
increase. In December 2001, the MPSC authorized a $15 million annual interim
increase in distribution service revenues. In February 2002, Consumers revised
its filing to reflect lower estimated gas inventory prices and revised
depreciation expense and is now requesting a $105 million distribution service
rate increase. See Note 4, Uncertainties "Gas Rate Matters -- Gas Rate Case" for
further information.
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CMS Energy Corporation
UNBUNDLING STUDY: In July 2001, the MPSC directed gas utilities under its
jurisdiction to prepare and file an unbundled cost of service study. The purpose
of the study is to allow parties to advocate or oppose the unbundling of the
following services: metering, billing information, transmission, balancing,
storage, backup and peaking, and customer turn-on and turn-off services.
Unbundled services could be separately priced in the future and made subject to
competition by other providers. The subject is likely to remain the topic of
further study by the utilities in 2002 and under further consideration by the
MPSC. Consumers cannot predict the outcome of unbundling costs on its financial
results and conditions.
UNCERTAINTIES: Several gas business trends or uncertainties may affect
Consumers' financial results and conditions. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing gas operations. Such trends and
uncertainties include: 1) potential environmental costs at a number of sites,
including sites formerly housing manufactured gas plant facilities; 2) future
gas industry restructuring initiatives; 3) any initiatives undertaken to protect
customers against gas price increases; 4) an inadequate regulatory response to
applications for requested rate increases; and 5) market and regulatory
responses to increases in gas costs. For further information about these
uncertainties, see Note 4, Uncertainties.
CONSUMERS' OTHER OUTLOOK
ENERGY-RELATED SERVICES: Consumers offers a variety of energy-related services
to retail customers that focus on appliance maintenance, home safety, commodity
choice and assistance to customers purchasing heating, ventilation and air
conditioning equipment. Consumers continues to look for additional growth
opportunities in providing energy-related services to its customers. The ability
to offer all or some of these services and other utility related revenue
generating services, which provide approximately $50 million in annual revenues,
may be restricted by the new code of conduct issued by the MPSC as discussed
above in Electric Business Outlook, "Competition and Regulatory Restructuring -
Code of Conduct."
OTHER MATTERS
RECENT DEVELOPMENTS
Recent press reports have been examining so-called "round trip" commodity trades
involving simultaneous purchases and sales with the same counter-parties at the
same price. CMS Energy disclosed that CMS MST entered into such transactions
during the period of May 2000 through mid-January 2002. Thirteen of the trades
accounted for about 98 percent of the volume. All such CMS MST trades were with
either Dynegy Power Marketing, Inc. or Reliant Energy Services, Inc. These
simultaneous transactions, in which electricity was sold and repurchased without
profit, loss or cash flow impact to CMS Energy, had the effect of increasing
trading volumes. After internally concluding that the cessation of such trades
was in the CMS Energy's best interests, CMS MST stopped such trades in January
2002.
CMS Energy decided after the third quarter of 2001 that not recording these
trades in either revenue or expense was a more appropriate representation of the
nature of these transactions. Therefore, no revenue or expense was recorded in
its financial statements in the fourth quarter of 2001 from such trades. Revenue
and expense were re-stated for the first three quarters of 2001 to eliminate
$3.4 billion of previously reported revenue and expense. The Company's Annual
Report on Form 10-K for 2001, issued in March 2002, reflects only $5 million
revenue and expense from such trades, which was inadvertently included. For
2000, these trades represented $1.0 billion of revenue and expense. The trades
had no effect on the Company's earnings, cash flow or balance sheet for 2001 or
2000.
CMS Energy's internal review found that these trades included 79.3 million
megawatt-hours in 2001 and 29.6 million megawatt-hours in 2000. With these
trades subtracted, electric trading volumes for 2001 totaled 31 million
megawatt-hours and for 2000 totaled 8.3 million megawatt-hours.
CMS Energy announced on May 10, 2002 that the Securities and Exchange Commission
had asked it to provide information in connection with an informal inquiry into
these types of industry transactions. CMS Energy is cooperating with the
informal inquiry by the Securities and Exchange Commission and is also
cooperating with the Commodity Futures Trading Commission, which has requested
that the Company furnish information on the same general subject.
Although CMS Energy believes its actions were appropriate, the Company is unable
to predict the outcome of these ongoing inquiries.
CHANGE IN AUDITORS
On April 22, 2002, the Board of Directors, based upon the recommendation of the
Audit Committee of the Board, voted to discontinue the use of Arthur Andersen to
audit CMS Energy's financial statements at and for the year ending December 31,
2002. The Audit Committee was directed to search for a replacement independent
auditor from among nationally recognized auditing firms and recommend such
replacement firm to the Board for appointment as soon as practical. Arthur
Andersen previously had been retained to review CMS Energy's financial
statements at and for the quarter ended March 31, 2002.
Arthur Andersen's reports on CMS Energy's consolidated financial statements for
each of the fiscal years ended December 31, 2001 and December 31, 2000 did not
contain an adverse opinion or disclaimer of opinion, nor were they qualified or
modified as to uncertainty, audit scope or accounting principles.
During the fiscal years ended December 31, 2001 and December 31, 2000, and
through the date of their opinion for the quarter ended March 31, 2002, there
were no disagreements with Arthur Andersen on any matter of accounting principle
or practice, financial statement disclosure, or auditing scope or procedure
which, if not resolved to Arthur Andersen's satisfaction, would have caused
Arthur Andersen to make reference to the subject matter in connection with its
report on CMS Energy's consolidated financial statements for such years; and
there were no reportable events as defined by SEC laws and regulations.
CMS-22
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2002 2001
- ---------------------------------------------------------------------------------------------------
In Millions, Except Per Share Amounts
OPERATING REVENUE
Electric utility $ 608 $ 665
Gas utility 616 540
Natural gas transmission 201 386
Independent power production 89 109
Oil and gas exploration and production 22 36
Marketing, services and trading 985 1,113
Other 4 4
--------------------
2,525 2,853
- ---------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Operation
Fuel for electric generation 87 83
Purchased and interchange power - Marketing, services and trading 420 212
Purchased and interchange power 63 119
Purchased power - related parties 140 118
Cost of gas sold - Marketing, services and trading 461 782
Cost of gas sold 495 580
Other operating expenses 298 348
--------------------
1,964 2,242
Maintenance 63 66
Depreciation, depletion and amortization 140 149
General taxes 66 69
--------------------
2,233 2,526
- ---------------------------------------------------------------------------------------------------
PRETAX OPERATING INCOME (LOSS)
Electric utility 114 135
Gas utility 63 65
Natural gas transmission 61 93
Independent power production 38 25
Oil and gas exploration and production - 11
Marketing, services and trading 11 7
Other 5 (9)
--------------------
292 327
- ---------------------------------------------------------------------------------------------------
OTHER INCOME (DEDUCTIONS)
Accretion expense (9) (9)
Gain on asset sales 520 -
Other, net 10 13
--------------------
521 4
- ---------------------------------------------------------------------------------------------------
EARNINGS BEFORE INTEREST AND TAXES 813 331
- ---------------------------------------------------------------------------------------------------
FIXED CHARGES
Interest on long-term debt 131 145
Other interest 8 12
Capitalized interest (4) (14)
Preferred securities distributions 25 23
--------------------
160 166
- ---------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND MINORITY INTERESTS 653 165
INCOME TAXES 253 56
MINORITY INTERESTS - 1
--------------------
INCOME FROM CONTINUING OPERATIONS 400 108
DISCONTINUED OPERATIONS - 1
--------------------
INCOME BEFORE EXTRAORDINARY ITEM 400 109
EXTRAORDINARY ITEM (1) -
--------------------
CONSOLIDATED NET INCOME $ 399 $ 109
===================================================================================================
AVERAGE COMMON SHARES OUTSTANDING 133 125
===================================================================================================
BASIC EARNINGS PER AVERAGE COMMON SHARE $ 2.99 $ .87
===================================================================================================
DILUTED EARNINGS PER AVERAGE COMMON SHARE $ 2.92 $ .85
===================================================================================================
DIVIDENDS DECLARED PER COMMON SHARE $ .365 $.365
===================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-23
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2002 2001
- ---------------------------------------------------------------------------------------------------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Consolidated net income $ 399 $ 109
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $2 and $2, respectively) 140 149
Discontinued operations (Note 2) - (1)
Capital lease and debt discount amortization 4 9
Accretion expense 9 9
Undistributed earnings of related parties (31) (32)
Gain on the sale of assets (520) -
Changes in other assets and liabilities:
Decrease in accounts receivable 250 169
Decrease in inventories 179 125
Decrease in accounts payable and accrued expenses (86) (160)
Deferred income taxes and investment tax credit (31) 31
Regulatory obligation - gas customer choice (7) (16)
Change in postretirement benefits, net (47) (28)
Changes in other assets and liabilities (7) (3)
----- -----
Net cash provided by operating activities 252 361
- ---------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (192) (273)
Investments in partnerships and unconsolidated subsidiaries (17) (31)
Cost to retire property, net (15) (26)
Investments in nuclear decommissioning trust funds (2) (2)
Proceeds from nuclear decommissioning trust funds 8 10
Net proceeds from sale of assets 878 -
Other (31) (10)
----- -----
Net cash provided by (used in) investing activities 629 (332)
- ---------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes, bonds and other long-term debt 299 373
Issuance of common stock 29 316
Retirement of bonds and other long-term debt (902) (389)
Retirement of trust preferred securities (30) -
Payment of common stock dividends (48) (45)
Payment of capital lease obligations (3) (8)
Decrease in notes payable, net (252) (233)
Other financing (3) (3)
----- -----
Net cash provided by (used in) financing activities (910) 11
- ---------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS (29) 40
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 189 182
----- -----
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 160 $ 222
===================================================================================================
CMS-24
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 139 $ 166
Income taxes paid (net of refunds) (42) (6)
NON-CASH TRANSACTIONS
Nuclear fuel placed under capital lease $ - $ 2
Other assets placed under capital leases 8 7
===================================================================================================
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-25
CMS ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS MARCH 31 MARCH 31
2002 DECEMBER 31 2001
(UNAUDITED) 2001 (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------------
In Millions
PLANT AND PROPERTY (AT COST)
Electric utility $ 7,733 $ 7,661 $ 7,298
Gas utility 2,625 2,593 2,524
Natural gas transmission 2,278 2,271 2,193
Oil and gas properties (successful efforts method) 667 849 660
Independent power production 918 916 395
International energy distribution 239 228 229
Other 114 113 101
----------------------------------------------
14,574 14,631 13,400
Less accumulated depreciation, depletion and amortization 6,950 6,833 6,317
----------------------------------------------
7,624 7,798 7,083
Construction work-in-progress 611 564 905
----------------------------------------------
8,235 8,362 7,988
- ----------------------------------------------------------------------------------------------------------------------------------
INVESTMENTS
Independent power production 745 718 1,002
Natural gas transmission 423 501 457
Midland Cogeneration Venture Limited Partnership 316 300 302
First Midland Limited Partnership 257 253 248
Other 80 123 75
----------------------------------------------
1,821 1,895 2,084
- ----------------------------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 160 189 222
Accounts receivable, notes receivable and accrued revenue, less
allowances of $16, $17 and $16, respectively 587 681 726
Accounts receivable - Marketing, services and trading,
less allowances of $15, $14 and $4, respectively 445 683 536
Inventories at average cost
Gas in underground storage 402 587 150
Materials and supplies 175 174 142
Generating plant fuel stock 50 52 50
Price risk management assets 417 461 1,094
Deferred income taxes - - 41
Prepayments and other 252 206 250
----------------------------------------------
2,488 3,033 3,211
- ----------------------------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS
Regulatory Assets
Securitization costs 714 717 709
Postretirement benefits 203 209 226
Abandoned Midland project 11 12 15
Other 171 167 84
Price risk management assets 549 424 350
Goodwill, net 811 811 880
Nuclear decommissioning trust funds 576 581 585
Notes receivable - related parties 213 177 161
Notes receivable 129 134 151
Other 558 580 733
----------------------------------------------
3,935 3,812 3,894
----------------------------------------------
TOTAL ASSETS $16,479 $17,102 $17,177
==================================================================================================================================
CMS-26
STOCKHOLDERS' INVESTMENT AND LIABILITIES MARCH 31 MARCH 31
2002 DECEMBER 31 2001
(UNAUDITED) 2001 (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------------
CAPITALIZATION
Common stockholders' equity $ 2,289 $ 1,890 $ 2,703
Preferred stock of subsidiary 44 44 44
Company-obligated convertible Trust Preferred Securities
Of subsidiaries (a) 694 694 694
Company-obligated mandatorily redeemable preferred securities
Of Consumer's subsidiaries (a) 490 520 395
Long-term debt 6,543 6,923 7,150
Non-current portion of capital leases 60 60 58
----------------------------------------------
10,120 10,131 11,044
- ----------------------------------------------------------------------------------------------------------------------------------
MINORITY INTERESTS 87 86 86
----------------------------------------------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 743 981 302
Notes payable 179 416 170
Accounts payable 538 547 576
Accounts payable - Marketing, services and trading 323 574 321
Accrued taxes 314 125 288
Accrued interest 155 163 137
Accounts payable - related parties 67 62 69
Price risk management liabilities 396 381 1,061
Deferred income taxes 14 51 -
Other 430 510 557
----------------------------------------------
3,159 3,810 3,481
- ----------------------------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES
Deferred income taxes 781 773 758
Postretirement benefits 280 333 404
Deferred investment tax credit 100 102 108
Regulatory liabilities for income taxes, net 276 276 260
Price risk management liabilities 461 352 341
Power loss contract reserves 341 354 52
Gas supply contract obligations 277 287 300
Other 597 598 343
----------------------------------------------
3,113 3,075 2,566
- ----------------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 2)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $16,479 $17,102 $17,177
==================================================================================================================================
(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-27
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2002 2001
- --------------------------------------------------------------------------------------------------------------
In Millions
COMMON STOCK
At beginning and end of period $ 1 $ 1
- --------------------------------------------------------------------------------------------------------------
OTHER PAID-IN CAPITAL
At beginning of period 3,269 2,936
Common stock repurchased - -
Common stock reissued - -
Common stock issued 29 316
------------------
At end of period 3,298 3,252
- --------------------------------------------------------------------------------------------------------------
REVALUATION CAPITAL
Investments
At beginning of period (4) (2)
Unrealized gain (loss) on investments (a) 5 (1)
------------------
At end of period 1 (3)
------------------
Derivative Instruments
At beginning of period (b) (26) 13
Unrealized gain (loss) on derivative instruments (a) 7 (14)
Reclassification adjustments included in consolidated net income (a) 2 (6)
------------------
At end of period (17) (7)
- --------------------------------------------------------------------------------------------------------------
FOREIGN CURRENCY TRANSLATION
At beginning of period (295) (254)
Change in foreign currency translation (a) 5 (30)
------------------
At end of period (290) (284)
- --------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS (DEFICIT)
At beginning of period (1,055) (320)
Consolidated net income (a) 399 109
Common stock dividends declared (48) (45)
------------------
At end of period (704) (256)
------------------
TOTAL COMMON STOCKHOLDERS' EQUITY $ 2,289 $ 2,703
==============================================================================================================
(a) Disclosure of Consolidated Comprehensive Income:
Revaluation capital
Investments
Unrealized gain (loss) on investments, net of tax of
$(4) and $-, respectively $ 5 $ (1)
Derivative Instruments
Unrealized gain (loss) on derivative instruments,
net of tax of $(1) and $8, respectively 7 (14)
Reclassification adjustments included in consolidated net income,
net of tax of $(1) and $4, respectively 2 (6)
Foreign currency translation 5 (30)
Consolidated net income 399 109
------------------
Total Consolidated Comprehensive Income $ 418 $ 58
==================
(b) Cumulative effect of change in accounting principle, net of $(8) tax in 2001.
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-28
CMS Energy Corporation
CMS ENERGY CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
These interim Consolidated Financial Statements have been prepared by CMS Energy
and reviewed by the independent public accountant in accordance with SEC rules
and regulations. As such, certain information and footnote disclosures normally
included in full year financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. Certain prior
year amounts have been reclassified to conform to the presentation in the
current year. In management's opinion, the unaudited information contained in
this report reflects all adjustments necessary to assure the fair presentation
of financial position, results of operations and cash flows for the periods
presented. The Condensed Notes to Consolidated Financial Statements and the
related Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
contained in CMS Energy's Form 10-K for the year ended December 31, 2001, which
includes the Reports of Independent Public Accountants. Due to the seasonal
nature of CMS Energy's operations, the results as presented for this interim
period are not necessarily indicative of results to be achieved for the fiscal
year.
1: CORPORATE STRUCTURE AND BASIS OF PRESENTATION
CMS Energy is the parent holding company of Consumers and Enterprises. Consumers
is a combination electric and gas utility company serving Michigan's Lower
Peninsula. Enterprises, through subsidiaries, including Panhandle and its
subsidiaries, is engaged in several domestic and international diversified
energy businesses including: natural gas transmission, storage and processing;
independent power production; oil and gas exploration and production; and energy
marketing, services and trading.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of CMS Energy, Consumers and Enterprises and their majority-owned
subsidiaries. Investments in affiliated companies where CMS Energy has the
ability to exercise significant influence, but not control, are accounted for
using the equity method. For the three months ended March 31, 2002 and 2001,
undistributed equity earnings were $31 million and $32 million, respectively.
Intercompany transactions and balances have been eliminated.
USE OF ESTIMATES: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make judgments, estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
materially differ from those estimates.
The recording of estimated liabilities for contingent losses within the
financial statements is guided by the principles in SFAS No. 5. SFAS No. 5
requires a company to record estimated liabilities in the financial statements
when it is probable that a loss will be paid in the future as a result of a
current event, and that amount can be reasonably estimated. CMS Energy has used
this accounting principle to record estimated liabilities discussed in Note 4,
Uncertainties.
CMS-29
CMS Energy Corporation
OIL AND GAS PROPERTIES: CMS Oil and Gas follows the successful efforts method of
accounting for its investments in oil and gas properties. CMS Oil and Gas
capitalizes, as incurred, the costs of property acquisitions, successful
exploratory wells, all development costs, and support equipment and facilities.
It expenses unsuccessful exploratory wells when they are determined to be
non-productive. CMS Oil and Gas also charges to expense, as incurred, production
costs, overhead, and all exploration costs other than exploratory drilling. CMS
Oil and Gas determines depreciation, depletion and amortization of proved oil
and gas properties on a field-by-field basis using the units-of-production
method over the life of the remaining proved reserves.
UTILITY REGULATION: Consumers accounts for the effects of regulation based on
the regulated utility accounting standard SFAS No. 71. As a result, the actions
of regulators affect when Consumers recognizes revenues, expenses, assets and
liabilities.
In March 1999, Consumers received MPSC electric restructuring orders and as a
result, discontinued application of SFAS No. 71 for the electric supply portion
of its business. Discontinuation of SFAS No. 71 for the generation portion of
Consumers' business resulted in Consumers reducing the carrying value of its
Palisades plant-related assets by approximately $535 million and establishing a
regulatory asset for a corresponding amount. According to current accounting
standards, Consumers can continue to carry its electric supply-related
regulatory assets if legislation or an MPSC rate order allows the collection of
cash flows to recover these regulatory assets from its regulated transmission
and distribution customers. As of March 31, 2002, Consumers had a net investment
in electric supply facilities of $1.403 billion included in electric plant and
property. See Note 4, Uncertainties, "Electric Rate Matters - Electric
Restructuring."
IMPLEMENTATION OF SFAS NO. 133: CMS Energy adopted SFAS No. 133 on January 1,
2001. This standard requires CMS Energy to recognize at fair value on the
balance sheet, as assets or liabilities, all contracts that meet the definition
of a derivative instrument. The standard also requires CMS Energy to record all
changes in fair value directly in earnings unless the derivative instrument
meets certain qualifying hedge criteria, in which case, the changes in fair
value would be reflected in other comprehensive income. CMS Energy determines
fair value based upon quoted market prices and mathematical models using current
and historical pricing data. The ineffective portion, if any, of all hedges are
recognized in earnings.
CMS Energy believes that the majority of its contracts, power purchase
agreements and gas transportation contracts qualify for the normal purchases and
sales exception of SFAS No. 133 and are not subject to the accounting rules for
derivative instruments. CMS Energy uses derivative instruments that require
derivative accounting, to limit its exposures to electricity and gas commodity
price risk. The interest rate and foreign currency exchange contracts met the
requirements for hedge accounting under SFAS No. 133 and CMS Energy recorded the
changes in the fair value of these contracts in other comprehensive income.
The financial statement impact of recording the SFAS No. 133 transition
adjustment on January 1, 2001 is as follows:
In Millions
- -----------------------------------------------------------------------------------------------
Fair value of derivative assets $35
Fair value of derivative liabilities 14
Increase in accumulated other comprehensive income, net of tax 7
- -----------------------------------------------------------------------------------------------
On January 1, 2001, upon initial adoption of the standard including adjustments
for subsequent guidance, CMS Energy recorded a $7 million, net of tax,
cumulative effect adjustment as an increase in accumulated other comprehensive
income. This adjustment relates to the difference between the fair value and
recorded book value of contracts related to gas call options, gas fuel for
generation swap contracts, and interest rate swap contracts that qualified for
hedge accounting prior to the initial adoption of SFAS No. 133 and Consumers'
proportionate share of the effects of adopting SFAS No. 133 related to its
equity investment in the MCV Partnership. Based on the pretax initial transition
adjustment of $20 million recorded in accumulated other comprehensive income at
January 1, 2001, Consumers reclassified to earnings $12 million as a reduction
to the cost of gas, $1 million as a reduction to the cost of power supply, $2
million as an increase in interest expense and $8 million as an increase in
other revenues for the twelve months ended December 31, 2001. CMS Energy
recorded $12 million as an increase in interest expense during 2001, which
includes the $2 million of additional interest expense at Consumers. The
difference between the initial transition adjustment and the amounts
reclassified to earnings represents an unrealized loss in the fair value of the
derivative instruments since January 1, 2001, resulting in a decrease of other
comprehensive income.
At adoption of the standard on January 1, 2001, derivative and hedge accounting
for certain utility industry contracts, particularly electric call option
contracts and option-like contracts, and contracts subject to Bookouts was
uncertain. Consumers accounted for these types of contracts as derivatives that
qualified for the normal purchase exception of SFAS No. 133 and, therefore, did
not record these contracts on the balance sheet at fair value. In June and
December 2001, the FASB issued guidance that resolved the accounting for these
contracts. As a result, on July 1, 2001, Consumers recorded a $3 million, net of
tax, cumulative effect adjustment as an unrealized loss decreasing accumulated
other comprehensive income, and on December 31, 2001, recorded an $11 million,
net of tax, cumulative effect adjustment as a decrease to earnings. These
adjustments relate to the difference between the fair value and the recorded
book value of electric call option contracts.
As of March 31, 2002, Consumers had a total of $1 million, net of tax, recorded
as an unrealized loss in other comprehensive income related to its proportionate
share of the effects of derivative accounting related to its equity investment
in the MCV Partnership. Consumers expects to reclassify this loss as a decrease
to other operating revenue during the next 12 months, if this value remains.
For further discussion of derivative activities, see Note 4, Uncertainties,
"Other Electric Uncertainties - Derivative Activities" and "Other Gas
Uncertainties - Derivative Activities".
FOREIGN CURRENCY TRANSLATION: CMS Energy's subsidiaries and affiliates whose
functional currency is other than the U.S. dollar translate their assets and
liabilities into U.S. dollars at the current exchange rates in effect at the end
of the fiscal period. The revenue and expense accounts of such subsidiaries and
affiliates are translated into U.S. dollars at the average exchange rates that
prevailed during the period. The gains or losses that result from this process,
and gains and losses on intercompany foreign currency transactions that are
long-term in nature, and which CMS Energy does not intend to settle in the
foreseeable future, are shown in the stockholders' equity section of the balance
sheet. For subsidiaries operating in highly inflationary economies, the U.S.
dollar is considered to be the functional currency, and transaction gains and
losses are included in determining net income. Gains and losses that arise from
exchange rate fluctuations on transactions denominated in a currency other than
the functional currency, except those that are hedged, are included in
determining net income. During the first quarter of 2002, the change in the
foreign currency translation adjustment increased equity by $5 million, net of
after-tax hedging proceeds.
RECLASSIFICATIONS: During 2001, CMS Energy entered into several energy trading
contracts with counterparties. The impact of these transactions increased
operating revenue with a corresponding increase in operating expenses. During
the fourth quarter of 2001, it was determined that under SFAS No. 133 and
related interpretations, these transactions should have been recorded on a net
basis. First, second and third quarter 2001 operating revenues and operating
expenses were restated from the amounts previously reported to reflect these
transactions on a net basis. There was no impact on previously recorded
consolidated net income. For further information, see Management's Discussion
and Analysis - Other Matters - Recent Developments.
EXTRAORDINARY LOSS: Cash proceeds received from the sale of CMS Energy's
interest in Equatorial Guinea in January 2002 were used to retire existing debt.
As a result, the cost associated with the early extinguishment of debt, $1
million, net of tax, was reflected as an extraordinary loss in the Consolidated
Statements of Income for the three months ended March 31, 2002.
SFAS NO. 142, GOODWILL AND OTHER INTANGIBLE ASSETS: SFAS No. 142, issued in July
2001, requires that goodwill and other intangible assets no longer be amortized
to earnings, but instead be reviewed for impairment on an annual basis. The
amortization of goodwill ceased upon adoption of the standard at January 1,
2002. CMS Energy is currently studying the effects of the new standard, but
cannot predict at this time if any amounts will be recognized as impairments of
goodwill or other intangible assets. In accordance with the new standard,
initial testing for impairment is expected to be completed in the second quarter
and subsequent
CMS-30
CMS Energy Corporation
testing, if required, should be completed by year-end. Any impairment, if
discovered by such testing, will be recognized in the first quarter 2002 and
subsequent periods by restatement of the financial information. At March 31,
2002, the amount of unamortized goodwill was $811 million.
SFAS NO. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS:
This new standard was issued by the FASB in October 2001, and supersedes SFAS
No. 121. The accounting model for long-lived assets to be disposed of by sale
applies to all long-lived assets, including discontinued operations, and
replaces the provisions of APB Opinion No. 30 for the disposal of segments of a
business. SFAS No. 144 requires that those long-lived assets be measured at the
lower of carrying amount or fair value less cost to sell, whether reported in
continuing operations or in discontinued operations. Therefore, discontinued
operations will no longer be measured at net realizable value or include amounts
for operating losses that have not yet occurred. SFAS No. 144 also broadens the
reporting of discontinued operations to include all components of an entity with
operations that can be distinguished from the rest of the entity and which
components will be eliminated from the ongoing operations of the entity in a
disposal transaction. The adoption of SFAS No. 144, effective January 1, 2002,
will result in CMS Energy accounting for any future impairments or disposals of
long-lived assets under the foregoing provisions, but will not change the
accounting principles used in previous asset impairments or disposals.
2: DISCONTINUED OPERATIONS
In April 2002, CMS Energy signed a definitive agreement with XTO Energy for the
sale of CMS Oil and Gas' coalbed methane holdings in the Powder River Basin for
$101 million. Since the sale did not close until May 1, 2002, the Powder River
properties have been reported as a discontinued operation for the three months
ended March 31, 2002. Revenues from such operations were $4 million and $5
million for the three months ended March 31, 2002 and 2001, respectively.
In September 2001, CMS Energy discontinued the operations of the International
Energy Distribution segment. CMS Energy is actively seeking a buyer for the
assets of CMS Electric and Gas, and although the timing of this sale is
difficult to predict, nor can it be assured, management expects the sale to
occur within one year.
The following summarizes the balance sheet information of the discontinued
operations:
In Millions
March 31 2002 2001
- -----------------------------------------------------------------------------------------------------
Assets
Accounts receivable, net $ 44 $ 34
Materials and supplies 8 9
Property, plant and equipment, net 103 262
Goodwill 39 45
Other 66 76
------------------------------
$ 260 $ 426
- ----------------------------------------------------------------------------------------------------
CMS-31
CMS Energy Corporation
Liabilities
Accounts payable $ 23 $ 14
Current and long-term debt 7 6
Accrued taxes 25 24
Minority interest 21 83
Other 21 23
-----------------------------
$ 97 $ 150
- ----------------------------------------------------------------------------------------------------
In accordance with APB Opinion No. 30, the net losses of the operations are
included in the consolidated statements of income under "discontinued
operations". See table below for income statement components of the discontinued
operations.
In Millions
- -------------------------------------------------------------------------------------------------------------------
Three months ended March 31 2002 2001
- -------------------------------------------------------------------------------------------------------------------
Discontinued operations:
Income (loss) from discontinued operations, net of taxes of $(0.2) $(0.2) $ 1
and $3.3
Disposal of discontinued operations, net of taxes of $0.4 - -
---------------------------
Total $(0.2) $ 1
===================================================================================================================
3: ASSET DISPOSITION
In January 2002, CMS Energy completed the sale of its ownership interests in
Equatorial Guinea to Marathon Oil Company for approximately $993 million.
Proceeds from this transaction were used primarily to retire existing debt.
Included in the sale were all of CMS Oil and Gas' oil and gas reserves in
Equatorial Guinea and CMS Gas Transmission's ownership interest in the related
methanol plant. The pretax gain, as shown on the Consolidated Statements of
Income, was $520 million ($325 million, net of tax, or $2.44 and $2.36 per basic
and diluted share, respectively).
4: UNCERTAINTIES
CONSUMERS' ELECTRIC UTILITY CONTINGENCIES
ELECTRIC ENVIRONMENTAL MATTERS: Consumers is subject to costly and increasingly
stringent environmental regulations. Consumers expects that the cost of future
environmental compliance, especially compliance with clean air laws, will be
significant.
Clean Air - In 1997, the EPA introduced new regulations regarding the standard
for ozone and particulate-related emissions that were the subject of litigation.
The United States Supreme Court determined that the EPA has the power to revise
the standards but that the EPA implementation plan was not lawful. In 1998, the
EPA Administrator issued final regulations requiring the state of Michigan to
further limit nitrogen oxide emissions. The EPA has also issued additional final
regulations regarding nitrogen oxide emissions that require
CMS-32
CMS Energy Corporation
certain generators, including some of Consumers' electric generating facilities,
to achieve the same emissions rate as that required by the 1998 plan. These
regulations will require Consumers to make significant capital expenditures
estimated between $530 million and $660 million, calculated in year 2002
dollars. Much of the future expenditures are for retrofit post-combustion
technology. Cost estimates have been developed, in part, by independent
contractors with expertise in this field. The estimates are dependent on
regulatory outcome, market forces associated with emission reduction, and with
regional and national economic conditions. As of March 2002, Consumers has
incurred $326 million in capital expenditures to comply with these regulations
and anticipates that the remaining capital expenditures will be incurred between
2002 and 2005. At some point after 2005, if new environmental standards for
multi-pollutants become effective, Consumers may need additional capital
expenditures to comply with the standards. Consumers is unable to estimate the
additional capital expenditures required until the proposed standards are
further defined. Beginning January 2004, an annual return of and on these types
of capital expenditures, to the extent they are above depreciation levels, is
expected to be recoverable, subject to an MPSC prudency hearing, in future
rates.
These and other required environmental expenditures, if not recovered in
Consumers rates, may have a material adverse effect upon Consumers' financial
condition and results of operations.
Cleanup and Solid Waste - Under the Michigan Natural Resources and Environmental
Protection Act, Consumers expects that it will ultimately incur investigation
and remedial action costs at a number of sites. Consumers believes that these
costs will be recoverable in rates under current ratemaking policies.
Consumers is a potentially responsible party at several contaminated sites
administered under Superfund. Superfund liability is joint and several. Along
with Consumers, many other creditworthy, potentially responsible parties with
substantial assets cooperate with respect to the individual sites. Based upon
past negotiations, Consumers estimates that its share of the total liability for
the known Superfund sites will be between $2 million and $9 million. As of March
31, 2002, Consumers had accrued the minimum amount of the range for its
estimated Superfund liability.
In October 1998, during routine maintenance activities, Consumers identified PCB
as a component in certain paint, grout and sealant materials at the Ludington
Pumped Storage facility. Consumers removed and replaced part of the PCB
material. In April 2000, Consumers proposed a plan to deal with the remaining
materials and is awaiting a response from the EPA.
CONSUMERS' ELECTRIC 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 exercise choice of electric generation suppliers by
January 1, 2002; 2) cuts residential electric rates by five percent; 3) freezes
all electric rates through December 31, 2003, and establishes a rate cap for
residential customers through at least December 31, 2005, and a rate cap for
small commercial and industrial customers through at least December 31, 2004; 4)
allows for the use of low-cost Securitization bonds to refinance qualified
costs, as defined by the act, as a means of offsetting the earnings impact of
the five percent residential rate reduction; 5) establishes a market power
supply test that may require the transfer of control of a portion of generation
resources in excess of that required to serve firm retail sales requirements (a
requirement with which Consumers believes itself to be in compliance with at
this time); 6) requires Michigan utilities to join a FERC-approved RTO or divest
their interest in transmission facilities to an independent transmission owner;
7) requires the joint expansion of available transmission capability by
Consumers, Detroit Edison and American Electric Power by at least 2,000
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MW by June 5, 2002; 8) allows for the deferred recovery of an annual return of
and on capital expenditures in excess of depreciation levels incurred during and
before the rate cap period; and 9) allows for the recovery of "net" Stranded
Costs and implementation costs incurred as a result of the passage of the act.
Consumers is highly confident that it will meet the conditions of items 5 and 7
above, prior to the earliest rate cap termination dates specified in the act.
Failure to do so could result in an extension of the rate caps to as late as
December 31, 2013. As of March 31, 2002, Consumers spent $28 million on the
required expansion of transmission capabilities. In May 2002, Consumers sold its
transmission facilities to MTH, who will complete the capital program to expand
transmission capabilities.
In October 2000 and January 2001, the MPSC issued orders that authorized
Consumers to issue Securitization bonds. Securitization typically involves the
issuance of asset-backed bonds with a higher credit rating than conventional
utility corporate financing. The orders authorized Consumers to securitize
approximately $469 million in qualified costs, which were primarily regulatory
assets plus recovery of the Securitization expenses. Securitization is expected
to result in lower interest costs and a longer amortization period for the
securitized assets, that would offset the majority of the revenue impact of the
five percent residential rate reduction of approximately $22 million in 2000 and
$49 million on an annual basis thereafter that Consumers was required to
implement by the Customer Choice Act. The orders direct Consumers to apply any
cost savings in excess of the five percent residential rate reduction to rate
reductions for non-residential customers and reductions in Stranded Costs for
retail open access customers after the bonds are sold. Excess savings are
currently estimated to be approximately $12 million annually.
In November 2001, Consumers Funding LLC, a special purpose consolidated
subsidiary of Consumers formed to issue the bonds, issued $469 million of
Securitization bonds, Series 2001-1. The Securitization bonds mature at
different times over a period of up to 14 years and have an average interest
rate of 5.3 percent. The last expected maturity date is October 20, 2015. Net
proceeds from the sale of the Securitization bonds after issuance expenses were
approximately $460 million. The net proceeds were used by Consumers to buy back
$164 million of its common stock from its parent, CMS Energy. Beginning in
December 2001, and completed in March 2002, the remainder of these proceeds were
used to pay down long-term debt. CMS Energy used the $164 million received from
Consumers to pay down its own short-term debt.
Consumers and Consumers Funding LLC will recover the repayment of principal,
interest and other expenses relating to the issuance of the bonds through a
securitization charge and a tax charge that began in December 2001. These
charges are subject to an annual true-up until one year prior to the last
expected bond maturity date, and no more than quarterly thereafter. Current
electric rate design covers these charges, and there will be no impact on rates
for most of Consumers' electric customers until the rate freeze imposed under
the Customer Choice Act expires. Securitization charges collected will be
remitted to a trustee for the Securitization bonds and are not available to
Consumers' creditors.
Regulatory assets are normally amortized over their period of regulated
recovery. Beginning January 1, 2001, the amortization of the approved regulatory
assets being securitized as qualified costs was deferred, which effectively
offset the loss in revenue in 2001 resulting from the five percent residential
rate reduction. In December 2001, after the Securitization bonds were sold, the
amortization was re-established based on a schedule that is the same as the
recovery of the principal amounts of the securitized qualified costs. In 2002,
the amortization amount is expected to be approximately $31 million and the
securitized assets will be fully amortized by the end of 2015.
In 1998, Consumers submitted a plan for electric retail open access to the MPSC
and in March 1999 the MPSC
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issued orders that generally supported the plan. Implementation began in
September 1999. The Customer Choice Act states that orders issued by the MPSC
before the date of this act that: 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 are in
compliance with this act and enforceable by the MPSC. In September 2000, as
required by the MPSC, Consumers once again filed tariffs governing its retail
open access program and addressed revisions appropriate to comply with the
Customer Choice Act. In December 2001, the MPSC approved revised retail open
access service tariffs. The revised tariffs establish the rates, terms, and
conditions under which retail customers will be permitted to choose an
alternative electric supplier for generation services. The tariffs were
effective January 1, 2002, and, in general, did not require any significant
modifications in the existing retail open access program. The terms of the
tariff allow retail open access customers, upon thirty days notice to Consumers,
to return to Consumers' generation service at current tariff rates. Consumers
may not have sufficient, reasonably priced, capacity to meet the additional
demand needs of returning retail open access customers, and may be forced to
purchase electricity on the spot market at prices higher than it could recover
from its customers.
POWER SUPPLY COSTS: During periods when electric demand is high, the cost of
purchasing electricity on the spot market can be substantial. To reduce
Consumers' exposure to the fluctuating cost of electricity, and to ensure
adequate supply to meet demand, Consumers intends to maintain sufficient
generation and to purchase electricity from others to create a power supply
reserve, also called a reserve margin, of approximately 15 percent. The reserve
margin provides Consumers with additional power supply above its anticipated
peak power supply demands. It also allows Consumers to provide reliable service
to its electric service customers and to protect itself against unscheduled
plant outages and unanticipated demand. For the summers 2002 and 2003, as it has
in previous summers, Consumers is planning for a reserve margin of 15 percent.
The actual reserve margin needed will depend primarily on summer weather
conditions, the level of retail open access requirements being served by others
during the summer, and any unscheduled plant outages. As of April 2002,
alternative electric suppliers are providing generation services to customers
with 332 MW of demand.
To reduce the risk of high electric prices during peak demand periods and to
achieve its reserve margin target, Consumers employs a strategy of purchasing
electric call option contracts for the physical delivery of electricity during
the months of June through September. As of March 31, 2002, Consumers had
purchased or had commitments to purchase electric call option contracts covering
the estimated reserve margin requirement for the summer 2002 and partially
covering the estimated reserve margin requirements for summers 2003 through
2007, and has recorded an asset of $47 million for these call options, of which
$10 million pertains to 2002.
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 of fuel for electric generation, and purchased and
interchange power. In 1998, as part of the electric restructuring efforts, the
MPSC suspended the PSCR process through December 31, 2001. Under the suspension,
the MPSC 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 for all customers 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.
TRANSMISSION: On May 1, 2002, Consumers sold its electric transmission
facilities for approximately $290 million in cash to MTH, a non-affiliated
limited partnership whose general partner is a subsidiary of Trans-Elect Inc.
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In 1999, the FERC issued Order No. 2000, that strongly encouraged utilities like
Consumers to either transfer operating control of their transmission facilities
to an RTO, or sell their transmission facilities to an independent company. In
addition, in June 2000, the Michigan legislature passed Michigan's Customer
Choice Act, which contains a requirement that utilities transfer the operating
authority of transmission facilities to an independent company or divest the
facilities. Consumers chose to sell its transmission facilities as a form of
compliance with Michigan's Customer Choice Act and FERC Order No. 2000 rather
than own and invest in an asset that it cannot control.
In January 2001, the FERC granted Consumers' application to transfer ownership
and control of its electric transmission facilities to METC, and in April 2001,
the transfer took place. Trans-Elect, Inc. submitted the winning bid to purchase
METC through a competitive bidding process, and various federal agencies
approved the transaction. Consumers did not provide any financial or credit
support to Trans-Elect, Inc. in connection with its purchase of METC. Certain of
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and certain of their subsidiaries, but all had left the
employment of such affiliates prior to the period when the transaction was
discussed internally and negotiated with purchasers. After selling its
transmission facilities, Consumers anticipates a reduction in after-tax earnings
of approximately $6 million and $14 million in 2002 and 2003, respectively, as a
result of the loss in revenue associated with wholesale and retail open access
customers that would buy services directly from MTH, including the loss of a
return on the transmission assets upon the sale of METC to MTH. Under the
agreement with MTH, and subject to additional RTO surcharges, transmission rates
charged to Consumers will be fixed at current levels until December 31, 2005,
and will be subject to FERC ratemaking thereafter. MTH will complete the capital
program to expand the transmission system's capability to import electricity
into Michigan, as required by the Customer Choice Act, and Consumers will
continue to maintain the system under a five-year contract with MTH. In April
2002, Consumers received unconditional regulatory approval for the sale of the
transmission facilities to MTH, and effective April 30, 2002, Consumers and METC
withdrew from Alliance.
In the past, when IPPs connected to transmission systems they paid a fee that
was used by transmission companies to offset capital costs incurred to connect
the IPP to the transmission system and provide the system upgrades needed as a
result of the interconnection. In order to promote competition in the electric
generation market, the FERC recently issued an order that requires the system
upgrade portion of the fee to be refunded to IPPs over time as transmission
service is taken. As a result, transmission companies no longer have the
benefit of lowering their capital costs for transmission system upgrades. This
has resulted in METC recording a $30 million liability for a refund to IPPs.
Subsequently, MTH assumed this liability as part of its purchase of the
transmission facilities.
In June 2001, the Michigan South Central Power Agency and the Michigan Public
Power Agency filed suit against Consumers and METC in a Michigan circuit court.
The suit sought to prevent the sale or transfer of transmission facilities
without first binding a successor to honor the municipal agencies' ownership
interests, contractual agreements and rights that preceded the transfer of the
transmission facilities to METC. In August 2001, the parties reached two
settlements. The settlements were approved by the Michigan circuit court and
were amended in February 2002 to assure that closing could occur if all
conditions to closing are satisfied. The circuit court has retained jurisdiction
over the matter and should dismiss the lawsuit after closing.
ELECTRIC PROCEEDINGS: The Customer Choice Act allows for the recovery by an
electric utility of the cost of implementing the act's requirements and "net"
Stranded Costs, without defining the term. The act directs the MPSC to establish
a method of calculating "net" Stranded Costs and of conducting related true-up
adjustments. In December 2001, the MPSC adopted a methodology for calculating
"net" Stranded Costs as the shortfall between (a) the revenue needed 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
those revenue needs. According to the MPSC, "net" Stranded Costs are to be
recovered from retail open access customers through a Stranded Cost transition
charge. Even though the MPSC ruled that the Stranded Cost transition charge to
be in effect on January 1, 2002 for the recovery of "net" Stranded Costs for
calendar year 2000 for Consumers is zero, the MPSC also indicated that the "net"
Stranded Costs for 2000 would be subject to further review in the context of its
subsequent determinations of "net" Stranded Costs for 2001 and later years. The
MPSC authorized
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Consumers to use deferred accounting to recognize the future recovery of costs
determined to be stranded by application of the MPSC's methodology. Consumers is
seeking a rehearing and clarification of the methodology adopted, and in April
2002, made "net" Stranded Cost filings with the MPSC for $22 million and $43
million for 2000 and 2001, respectively. In the same filing, Consumers estimated
that it would experience "net" Stranded Costs of $126 million for 2002. The
outcome of these proceedings before the MPSC is uncertain at this time.
Since 1997, Consumers has incurred significant electric utility implementation
costs. The following table outlines the applications filed by Consumers with the
MPSC and the status of recovery for these costs.
In Millions
- --------------------------------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- --------------------------------------------------------------------------------------------------------------
1999 1997 & 1998 $ 20 $ - $ 15 $ 5
2000 1999 30 - 25 5
2001 2000 25 25 - -
2002 2001 8 8 - -
==============================================================================================================
The MPSC disallowed certain costs based upon a conclusion that these amounts did
not represent costs incremental to costs already reflected in rates. In the
orders received for the years 1997 through 1999, the MPSC also ruled that it
reserved the right to undertake another review of the total implementation costs
depending upon the progress and success of the retail open access program, and
ruled that due to the rate freeze imposed by the Customer Choice Act, it was
premature to establish a cost recovery method for the allowable implementation
costs. Consumers expects to receive final orders for the 2000 and 2001
implementation costs in 2002. In addition to the amounts shown, as of March
2002, Consumers incurred and deferred as a regulatory asset, $3 million of
additional implementation costs and has also recorded as a regulatory asset $11
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; however, Consumers
cannot predict the amounts the MPSC will approve as recoverable costs.
In 1996, Consumers filed new OATT transmission rates with the FERC for approval.
Certain interveners contested these rates, and hearings were held before an ALJ
in 1998. In 1999, the ALJ rendered an initial decision that was largely upheld
by the FERC in March 2002 and requires Consumers refund, with interest, any
over-collections for past services as measured by new OATT rates. Consumers,
since the initial decision, has been reserving a portion of revenues billed to
customers under then existing OATT rates. In April 2002, FERC issued a decision
largely affirming the initial decision but increasing the recommended rate of
return. A compliance proceeding will be held at FERC to determine Consumers'
refund responsibility. Consumers believes its reserve is sufficient to satisfy
its estimated refund obligation.
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OTHER CONSUMERS' ELECTRIC UTILITY UNCERTAINTIES
THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and operates
the MCV Facility, contracted to sell electricity to Consumers for a 35-year
period beginning in 1990 and to supply electricity and steam to Dow. Consumers,
through two wholly owned subsidiaries, holds the following assets related to the
MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general
partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through
FMLP, a 35 percent lessor interest in the MCV Facility.
Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended
March 31 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Pretax operating income $9 $13
Income taxes and other 3 4
- ------------------------------------------------------------------------------------------------------------------
Net Income $6 $ 9
Power Supply Purchases from the MCV Partnership - Consumers' annual obligation
to purchase capacity from the MCV Partnership is 1,240 MW through the
termination of the PPA in 2025. The PPA requires Consumers to pay, based on the
MCV Facility's availability, a levelized average capacity charge of 3.77 cents
per kWh, a fixed energy charge, and a variable energy charge based primarily on
Consumers' average cost of coal consumed for all kWh delivered. Since January 1,
1993, the MPSC has permitted Consumers to recover capacity charges averaging
3.62 cents per kWh for 915 MW, plus a substantial portion of the fixed and
variable energy charges. Since January 1, 1996, the MPSC has also permitted
Consumers to recover capacity charges for the remaining 325 MW of contract
capacity with an initial average charge of 2.86 cents per kWh increasing
periodically to an eventual 3.62 cents per kWh by 2004 and thereafter. However,
due to the current freeze of Consumers' retail rates that the Customer Choice
Act requires, the capacity charge for the 325 MW is now frozen at 3.17 cents per
kWh. After September 2007, the PPA's terms require Consumers to pay the MCV
Partnership capacity and energy charges that the MPSC has authorized for
recovery from electric customers.
In 1992, Consumers recognized a loss for the present value of the estimated
future underrecoveries of power supply costs under the PPA based on MPSC cost
recovery orders. Consumers continually evaluates the adequacy of the PPA
liability for future underrecoveries. These evaluations consider management's
assessment of operating levels at the MCV Facility through 2007 along with
certain other factors including MCV related costs that are included in
Consumers' frozen retail rates. During the third quarter of 2001, in connection
with Consumers' long-term electric supply planning, management reviewed the PPA
liability assumptions related to increased expected long-term dispatch of the
MCV Facility and increased MCV related costs. As a result, in September 2001,
Consumers increased the PPA liability by $126 million. Management believes that,
following the increase, the PPA liability adequately reflects the present value
of the PPA's future effect on Consumers. At March 31, 2002 and 2001, the
remaining after-tax present value of the estimated future PPA liability
associated with the loss totaled $116 million and $43 million, respectively. For
further discussion on the impact of the frozen PSCR, see "Electric Rate Matters"
in this Note.
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In March 1999, Consumers and the MCV Partnership reached an agreement effective
January 1, 1999, that capped availability payments to the MCV Partnership at
98.5 percent. If the MCV Facility generates electricity at the maximum 98.5
percent level during the next five years, Consumers' after-tax cash
underrecoveries associated with the PPA could be as follows:
In Millions
- ------------------------------------------------------------------------------------------------------------------
2002 2003 2004 2005 2006
- ------------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $37 $36 $36 $36
==================================================================================================================
In February 1998, the MCV Partnership appealed the January 1998 and February
1998 MPSC orders related to electric utility restructuring. At the same time,
MCV Partnership filed suit in the United States District Court in Grand Rapids
seeking a declaration that the MPSC's failure to provide Consumers and MCV
Partnership a certain source of recovery of capacity payments after 2007
deprived MCV Partnership of its rights under the Public Utilities Regulatory
Policies Act of 1978. In July 1999, the District Court granted MCV Partnership's
motion for summary judgment. The Court permanently prohibited enforcement of the
restructuring orders in any manner that denies any utility the ability to
recover amounts paid to qualifying facilities such as the MCV Facility or that
precludes the MCV Partnership from recovering the avoided cost rate. The MPSC
appealed the Court's order to the 6th Circuit Court of Appeals in Cincinnati. In
June 2001, the 6th Circuit overturned the lower court's order and dismissed the
case against the MPSC. The appellate court determined that the case was
premature and concluded that the qualifying facilities needed to wait until 2008
for an actual factual record to develop before bringing claims against the MPSC
in federal court. The MCV Partnership has requested rehearing of the appellate
court's order.
NUCLEAR FUEL COST: Consumers amortizes nuclear fuel cost to fuel expense based
on the quantity of heat produced for electric generation. Through November 2001,
Consumers expensed the interest on leased nuclear fuel as it was incurred.
Effective December 2001, Consumers no longer leases its nuclear fuel.
For nuclear fuel used after April 6, 1983, Consumers charges disposal costs to
nuclear fuel expense, recovers these costs through electric rates, and then
remits them to the DOE quarterly. Consumers elected to defer payment for
disposal of spent nuclear fuel burned before April 7, 1983. As of March 31,
2002, Consumers has a recorded liability to the DOE of $136 million, including
interest, which is payable upon the first delivery of spent nuclear fuel to the
DOE. Consumers recovered through electric rates the amount of this liability,
excluding a portion of interest. In 1997, a federal court decision has confirmed
that the DOE was to begin accepting deliveries of spent nuclear fuel for
disposal by January 31, 1998. Subsequent litigation in which Consumers and
certain other utilities participated has not been successful in producing more
specific relief for the DOE's failure to comply.
In July 2000, the DOE reached a settlement agreement with one utility to address
the DOE's delay in accepting spent fuel. The DOE may use that settlement
agreement as a framework that it could apply to other nuclear power plants;
however, certain other utilities are challenging the validity of the settlement.
Additionally, there are two court decisions that support the right of utilities
to pursue damage claims in the United States Court of Claims against the DOE for
failure to take delivery of spent fuel. A number of utilities have commenced
litigation in the Court of Claims. Consumers is evaluating its options with
respect to its contract with the DOE.
NUCLEAR MATTERS: In April 2002, Palisades received its annual performance review
in which the NRC stated that Palisades operated in a manner that preserved
public health and safety. With the exception of one fire
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protection smoke detector location finding with low safety significance, the NRC
classified all inspection findings to have very low safety significance. Other
than the follow-up fire protection inspection associated with this one finding,
the NRC plans to conduct only baseline inspections at the facility through May
31, 2003.
The amount of spent nuclear fuel discharged from the reactor to date exceeds
Palisades' temporary on-site storage pool capacity. Consequently, Consumers is
using NRC-approved steel and concrete vaults, commonly known as "dry casks", for
temporary on-site storage. As of March 31, 2002, Consumers had loaded 18 dry
casks with spent nuclear fuel at Palisades. Palisades will need to load
additional dry casks by the fall of 2004 in order to continue operation.
Palisades currently has three empty storage-only dry casks on-site, with storage
pad capacity for up to seven additional loaded dry casks. Consumers anticipates
that licensed transportable dry casks for additional storage, along with more
storage pad capacity, will be available prior to 2004.
In December 2000, the NRC issued an amendment revising the operating license for
Palisades and extending the expiration date to March 2011, with no restrictions
related to reactor vessel embrittlement.
In 2000, Consumers made an equity investment and entered into an operating
agreement with NMC. NMC was formed in 1999 by four utilities to operate and
manage the nuclear generating plants owned by these utilities. Consumers
benefits by consolidating expertise, cost control and resources among all of the
nuclear plants being operated on behalf of the NMC member companies.
In November 2000, Consumers requested approval from the NRC to transfer
operating authority for Palisades to NMC and the request was granted in April
2001. The formal transfer of authority from Consumers to NMC took place in May
2001. Consumers retains ownership of Palisades, its 789 MW output, the current
and future spent fuel on site, and ultimate responsibility for the safe
operation, maintenance and decommissioning of the plant. Under the agreement
that transferred operating authority of the plant to NMC, salaried Palisades'
employees became NMC employees on July 1, 2001. Union employees work under the
supervision of NMC pursuant to their existing labor contract as Consumers'
employees. NMC currently has responsibility for operating eight units with 4,500
MW of generating capacity in Wisconsin, Minnesota, Iowa and Michigan. As a
result of the equity ownership in NMC, Consumers may be exposed to additional
financial impacts from the operation of all of those units.
On June 20, 2001, the Palisades reactor was shut down so technicians could
inspect a small steam leak on a control rod drive assembly. There was no risk to
the public or workers. In August 2001, Consumers completed an expanded
inspection that included all similar control rod drive assemblies and elected to
completely replace the defective components. Installation of the new components
was completed in December 2001 and the plant returned to service and has been
operating since January 21, 2002. Consumers' capital expenditures for the
components and their installation was approximately $31 million.
From the start of the June 20th outage through the end of 2001, the impact on
net income of replacement power supply costs associated with the outage was
approximately $59 million. Subsequently, in January 2002, the impact on 2002 net
income was $5 million.
Consumers maintains insurance against property damage, debris removal, personal
injury liability and other risks that are present at its nuclear facilities.
Consumers also maintains coverage for replacement power supply costs during
prolonged accidental outages at Palisades. Insurance would not cover such costs
during the first 12 weeks of any outage, but would cover most of such costs
during the next 52 weeks of the outage, followed by reduced coverage to 80
percent for 110 additional weeks. The June 2001 through January 2002 Palisades
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outage, however, was not an insured event. If certain covered losses occur at
its own or other nuclear plants similarly insured, Consumers could be required
to pay maximum assessments of $26.9 million in any one year to NEIL; $88 million
per occurrence under the nuclear liability secondary financial protection
program, limited to $10 million per occurrence in any year; and $6 million if
nuclear workers claim bodily injury from radiation exposure. Consumers considers
the possibility of these assessments to be remote. NEIL limits its coverage from
multiple acts of terrorism during a twelve-month period to a maximum aggregate
of $3.24 billion, allocated among the claimants, plus recoverable reinsurance,
indemnity and other sources. The nuclear liability insurers for Palisades and
Big Rock also limit the amount of their coverage for liability from terrorist
acts to $200 million. This could affect the amount of loss coverage for
Consumers should multiple acts of terrorism occur. The Price Anderson Act
expires on August 1, 2002 and is currently in the process of reauthorization by
the U.S. Congress. It is possible that the Price Anderson Act will not be
reauthorized or changes may be made that significantly affect the insurance
provisions for nuclear plants.
DERIVATIVE ACTIVITIES: Consumers' electric business uses purchased electric call
option contracts to meet its regulatory obligation to serve, which requires
providing a physical supply of electricity to customers, and to manage electric
cost and to ensure a reliable source of capacity during periods of peak demand.
These contracts are subject to derivative accounting in accordance with SFAS No.
133, and as such are required to be recorded at fair value on the balance sheet,
with changes in fair value recorded either directly in earnings or other
comprehensive income if the contract meets certain qualifying hedge criteria. On
July 1, 2001, upon initial adoption of the standard for these contracts,
Consumers recorded a $3 million, net of tax, cumulative effect adjustment as an
unrealized loss decreasing accumulated other comprehensive income. This
adjustment relates to the difference between the fair value and the recorded
book value of these electric call option contracts. The adjustment to
accumulated other comprehensive income relates to electric call option contracts
that qualified for cash flow hedge accounting prior to the initial adoption of
SFAS No. 133. After July 1, 2001, these contracts will not qualify for hedge
accounting under SFAS No. 133 and, therefore, Consumers will record any change
in fair value subsequent to July 1, 2001 directly in earnings, which could cause
earnings volatility. The initial amount recorded in other comprehensive income
will be reclassified to earnings as the forecasted future transactions occur or
the call options expire. The majority of these contracts expired in the third
quarter 2001 and the remaining contracts will expire in 2002. As of December 31,
2001, $2 million, net of tax, was reclassified to earnings as part of cost of
power supply. The remainder is expected to be reclassified to earnings in the
third quarter of 2002.
In December 2001, the FASB issued revised guidance regarding derivative
accounting for electric call option contracts and option-like contracts. The
revised guidance amended the criteria to be used to determine if derivative
accounting is required. Consumers re-evaluated its electric call option and
option-like contracts and determined that under the revised guidance additional
contracts require derivative accounting. Therefore, as of December 31, 2001,
upon initial adoption of the revised guidance for these contracts, Consumers
recorded an $11 million, net of tax, cumulative effect adjustment as a decrease
to earnings. This adjustment relates to the difference between the fair value
and the recorded book value of these electric call option contracts. Consumers
will record any change in fair value subsequent to December 31, 2001 directly in
earnings, which could cause earnings volatility. As of March 31, 2002, all of
Consumers' purchased electric call option contracts subject to derivative
accounting were recorded on the balance sheet at a fair value of $3 million. A
change in value from December 31, 2001 to March 31, 2002, representing a gain of
$2 million was recorded in earnings as a reduction in the cost of power.
Consumers' electric business also uses gas swap contracts to protect against
price risk due to the fluctuations in the market price of gas used as fuel for
generation of electricity. These contracts are financial contracts that
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CMS Energy Corporation
will be used to offset increases in the price of probable forecasted gas
purchases. These contracts do not qualify for hedge accounting and, therefore,
Consumers will record any change in the fair value of these contracts directly
in earnings as part of the cost of power supply, which could cause earnings
volatility. As of March 31, 2002, a gain of $1 million has been recorded for
2002, which represents the fair value of these contracts at March 31, 2002.
These contracts expire in December 2002.
CONSUMERS' GAS UTILITY CONTINGENCIES
GAS ENVIRONMENTAL MATTERS: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will ultimately incur
investigation and remedial action costs at a number of sites. These include 23
former manufactured gas plant facilities, which were operated by Consumers for
some part of their operating lives, including sites in which it has a partial or
no current ownership interest. Consumers has completed initial investigations at
the 23 sites. For sites where Consumers has received site-wide study plan
approvals, it will continue to implement these plans. It will also work toward
closure of environmental issues at sites as studies are completed. Consumers has
estimated its costs related to further investigation and remedial action for all
23 sites using the Gas Research Institute-Manufactured Gas Plant Probabilistic
Cost Model. The estimated total costs are between $82 million and $113 million;
these estimates are based on discounted 2001 costs and follow EPA recommended
use of discount rates between 3 and 7 percent for this type of activity.
Consumers expects to recover a significant portion of these costs through
insurance proceeds and through MPSC approved rates charged to its customers. As
of March 31, 2002, Consumers has an accrued liability of $55 million, (net of
$27 million of expenditures incurred to date), and a regulatory asset of $70
million. Any significant change in assumptions, such as an increase in the
number of sites, different remediation techniques, nature and extent of
contamination, and legal and regulatory requirements, could affect Consumers'
estimate of remedial action costs. The MPSC currently allows Consumers to
recover $1 million of manufactured gas plant facilities environmental clean-up
costs annually. Consumers defers and amortizes, over a period of ten years,
manufactured gas plant facilities environmental clean-up costs above the amount
currently being recovered in rates. Additional rate recognition of amortization
expense cannot begin until after a prudency review in a future general gas rate
case. Consumers' position in the current general gas rate case is that all
manufactured gas plant facilities environmental clean-up expenditures for years
1998 through 2002 are prudent.
CONSUMERS' GAS UTILITY RATE MATTERS
GAS RESTRUCTURING: From April 1, 1998 to March 31, 2001, Consumers conducted an
experimental gas customer choice pilot program that froze gas distribution and
GCR rates through the period. On April 1, 2001, a permanent gas customer choice
program commenced under which Consumers returned to a GCR mechanism that allows
it to recover from its bundled customers all prudently incurred costs to
purchase the natural gas commodity and transport it to Consumers for ultimate
distribution to customers.
GAS COST RECOVERY: As part of a settlement agreement approved by the MPSC in
July 2001, Consumers agreed not to bill a price in excess of $4.69 per mcf of
natural gas under the GCR factor mechanism through March 2002. This agreement is
not expected to affect Consumers' earnings outlook because Consumers recovers
from customers the amount that it actually pays for natural gas in the
reconciliation process. The settlement does not affect Consumers' June 2001
request to the MPSC for a distribution service rate increase. The MPSC also
approved a methodology to adjust bills for market price increases quarterly
without returning to the MPSC for approval. In December 2001, Consumers filed
its GCR Plan for the period April 2002
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CMS Energy Corporation
through March 2003. Consumers is requesting authority to bill a GCR factor up to
$3.50 per mcf for this period.
GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. Consumers is seeking a 12.25
percent authorized return on equity. Contemporaneously with this filing,
Consumers requested partial and immediate relief in the annual amount of $33
million. The relief is primarily for higher carrying costs on more expensive
natural gas inventory than is currently included in rates. In October 2001,
Consumers revised its filing to reflect lower operating costs and requested a
$133 million annual distribution service rate increase. In December 2001, the
MPSC authorized a $15 million annual interim increase in distribution service
rate revenues. The order authorizes Consumers to apply the interim increase on
its gas sales customers' bills for service effective December 21, 2001. The
increase is under bond and subject to refund if the final rate increase is less
than the interim rate increase. In February 2002, Consumers revised its filing
to reflect lower estimated gas inventory prices and revised depreciation expense
and is now requesting a $105 million annual distribution service rate increase.
If the MPSC approves Consumers' total request, then Consumers could bill an
additional amount of approximately $4.78 per month, representing an 8.9 percent
increase in the typical residential customer's average monthly bill.
OTHER GAS UNCERTAINTIES
DERIVATIVE ACTIVITIES: Consumers' gas business uses fixed price gas supply
contracts to meet its regulatory obligation to provide gas to its customers as
the lowest possible prudent cost. Some of these contracts contain embedded put
options that disqualify the contracts from the normal purchase exception of SFAS
No. 133, and therefore require derivative accounting. As of March 31, 2002,
Consumers gas supply contracts requiring derivative accounting had a fair value
of $4 million, representing a fair value gain on the contract since the date of
inception, and this gain was recorded directly in earnings as part of other
income, and then directly offset and recorded as a regulatory liability on the
balance sheet. Any subsequent changes in fair value will be recorded in the same
manner. These contracts expire in October 2002.
PANHANDLE MATTERS
REGULATORY MATTERS: In conjunction with a FERC order issued in September 1997,
FERC required certain natural gas producers to refund previously collected
Kansas ad-valorem taxes to interstate natural gas pipelines, including Panhandle
Eastern Pipe Line. FERC ordered these pipelines to refund these amounts to their
customers. In June 2001, Panhandle Eastern Pipe Line filed a proposed settlement
with the FERC which was supported by most of the customers and affected
producers. In October 2001, the FERC approved that settlement. The settlement
provided for a resolution of the Kansas ad-valorem tax matter on the Panhandle
Eastern Pipe Line system for a majority of refund amounts. Certain producers and
the state of Missouri elected to not participate in the settlement. At March 31,
2002 and December 31, 2001, accounts receivable included $8 million due from
natural gas producers, and other current liabilities included $12 million and
$11 million, respectively, for related obligations. Remaining amounts collected
but not refunded are subject to refund pending resolution of issues remaining in
the FERC docket and Kansas intrastate proceeding.
In July 2001, Panhandle Eastern Pipe Line filed a settlement with customers on
Order 637 matters to resolve issues including capacity release and imbalance
penalties, among others. On October 12, 2001 and December 19, 2001 FERC issued
orders approving the settlement, with modifications. The settlement changes
became final effective February 1, 2002, resulting in a non-recurring gain of $4
million in Other Revenue and a $2 million reversal of interest expense for
previously collected penalties retained.
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In August 2001, an offer of settlement of Trunkline LNG rates sponsored jointly
by Trunkline LNG, BG LNG Services and Duke LNG Sales was filed with the FERC and
was approved on October 11, 2001. The settlement was placed into effect on
January 1, 2002. As part of the settlement, Trunkline LNG, now owned by LNG
Holdings, reduced its maximum rates.
Panhandle has sought refunds from the State of Kansas concerning certain
corporate income tax issues for the years 1981 through 1984. On January 25,
2002, the Kansas Supreme Court entered an order affirming a previous Board of
Tax Court finding that Panhandle was entitled to refunds which with interest
total approximately $26 million. Pursuant to the provisions of the purchase
agreement between CMS Energy and a subsidiary of Duke Energy, Duke retains the
benefits of any tax refunds or liabilities for periods prior to the date of the
sale of Panhandle to CMS Energy.
ENVIRONMENTAL MATTERS: Panhandle is subject to federal, state and local
regulations regarding air and water quality, hazardous and solid waste disposal
and other environmental matters. Panhandle has identified environmental
contamination at certain sites on its systems and has undertaken clean-up
programs at these sites. The contamination resulted from the past use of
lubricants in compressed air systems containing PCBs and the prior use of
wastewater collection facilities and other on-site disposal areas. Panhandle
communicated with the EPA and appropriate state regulatory agencies on these
matters. Under the terms of the sale of Panhandle to CMS Energy, a subsidiary of
Duke Energy is obligated to complete the Panhandle clean-up programs at certain
agreed-upon sites and to indemnify against certain future environmental
litigation and claims. Panhandle expects these clean-up programs to continue for
several years. The Illinois EPA included Panhandle Eastern Pipe Line and
Trunkline, together with other non-affiliated parties, in a cleanup of former
waste oil disposal sites in Illinois. Prior to a partial cleanup by the EPA, a
preliminary study estimated the cleanup costs at one of the sites to be between
$5 million and $15 million. The State of Illinois contends that Panhandle
Eastern Pipe Line's and Trunkline's share for the costs of assessment and
remediation of the sites, based on the volume of waste sent to the facilities,
is approximately 17 percent. Management believes that the costs of cleanup, if
any, will not have a material adverse impact on Panhandle's financial position,
liquidity, or results of operations.
AIR QUALITY CONTROL: In 1998, the EPA issued a final rule on regional ozone
control that requires revised SIPS for 22 states, including five states in which
Panhandle operates. This EPA ruling was challenged in court by various states,
industry and other interests, including the INGAA, an industry group to which
Panhandle belongs. In March 2000, the court upheld most aspects of the EPA's
rule, but agreed with INGAA's position and remanded to the EPA the sections of
the rule that affected Panhandle. Based on the court's decision, most of the
states subject to the rule submitted their SIP revisions in October 2000.
However, the EPA must revise the section of the rule that affected Panhandle's
facilities. Panhandle expects the EPA to make this section of the rule effective
in 2002 and expects the future costs to range from $13 million to $29 million
for capital improvements to comply.
In 1997, the Illinois Environmental Protection Agency initiated an enforcement
proceeding relating to alleged air quality permit violations at Panhandle's
Glenarm Compressor Station. On November 15, 2001 the Illinois Pollution Control
Board approved an order imposing a penalty of $850 thousand, plus fees and cost
reimbursements of $116 thousand. Under terms of the sale of Panhandle to CMS
Energy, a subsidiary of Duke Energy was obligated to indemnify Panhandle against
this environmental penalty. The state issued a permit in February of 2002
requiring the installation of certain capital improvements at the facility at a
cost of approximately $3 million. It is expected that the capital improvements
will occur in 2002 and 2003.
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OTHER UNCERTAINTIES
CMS GENERATION-OXFORD TIRE RECYCLING: In 1999, the California Regional Water
Control Board of the State of California named CMS Generation as a potentially
responsible party for the cleanup of the waste from a fire that occurred in
September 1999 at the Filbin tire pile. The tire pile was maintained as fuel for
an adjacent power plant owned by Modesto Energy Limited Partnership. Oxford Tire
Recycling of Northern California, Inc., a subsidiary of CMS Generation until
1995, owned the Filbin tire pile. CMS Generation has not owned an interest in
Oxford Tire Recycling of Northern California, Inc. or Modesto Energy Limited
Partnership since 1995. In 2000, the California Attorney General filed a
complaint against the potentially responsible parties for cleanup of the site
and assessed penalties for violation of the California Regional Water Control
Board order. The parties have reached a settlement with the state, which the
court approved, pursuant to which we must pay $6 million, $2 million of which
CMS Energy had already paid.
In connection with this fire, several class action lawsuits were filed claiming
that the fire resulted in damage to the class and that management of the site
caused the fire. CMS Generation has reached a settlement in principle with the
plaintiffs in the amount of $9 million. The primary insurance carrier will cover
one hundred percent of the settlement once the agreement is finalized.
DEARBORN INDUSTRIAL GENERATION: In October 2001, Duke/Fluor Daniel (DFD)
presented DIG with a change order to their construction contract and filed an
action in Michigan state court claiming damages in the amount of $110 million,
plus interest and costs, which DFD states represents the cumulative amount owed
by DIG for delays DFD believes DIG caused and for prior change orders that DIG
previously rejected. DFD also filed a construction lien for the $110 million.
DIG, in addition to drawing down on three letters of credit totaling $30 million
that it obtained from DFD has filed an arbitration claim against DFD asserting
in excess of an additional $75 million in claims against DFD. The judge in the
Michigan State Court case entered an order staying DFD's prosecution of its
claims in the court case and permitting the arbitration to proceed. CMS Energy
believes the claims are without merit and will continue to vigorously contest
them, but any change order costs ultimately paid would be capitalized as a
project construction cost.
Ford Motor Company and Rouge Steel Company, the customers of the DIG facility,
continue to be in discussion with DIG regarding several commercial issues that
have arisen between the parties.
CMS OIL AND GAS: In 1999, a former subsidiary of CMS Oil and Gas, Terra Energy
Ltd., was sued by Star Energy, Inc. and White Pines 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 it had committed to drill. 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 Pines. The jury then awarded Star Energy and
White Pines $8 million in damages. Terra has filed an appeal. CMS Energy
believes Terra has meritorious grounds for either reversal of the judgment or
reduction of damages. CMS Energy has an indemnification obligation in favor of
the purchaser of its Michigan properties with respect to this litigation.
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ARGENTINA ECONOMIC EMERGENCY: In January 2002, the Republic of Argentina enacted
the Public Emergency and Foreign Exchange System Reform Act. This law, among
other things, repealed the fixed exchange rate of one U.S. Dollar to one
Argentina Peso, converted all Dollar-denominated utility tariffs and energy
contract obligations into Pesos at the same one-to-one exchange rate, and
directed the President of Argentina to renegotiate such tariffs.
In February 2002, the Republic of Argentina enacted additional measures that
required all monetary obligations (including current debt and future contract
payment obligations) denominated in foreign currencies to be converted into
Pesos. These February measures also authorize the Argentine judiciary
essentially to rewrite private contracts denominated in Dollars or other foreign
currencies if the parties cannot agree on how to share equitably the impact of
the conversion of their contract payment obligations into Pesos.
For the three months ended March 31, 2002, CMS Energy recorded losses of $21
million or $0.15 per share, reflecting the negative impact of the actions of the
Argentine government. These losses represent changes in the value of
Peso-denominated monetary assets (such as receivables) and liabilities of
Argentina-based subsidiaries and lower net project earnings resulting from the
conversion to Pesos of utility tariffs and energy contract obligations that were
previously calculated in Dollars.
Effective April 30, 2002, CMS Energy adopted the Argentine Peso as the
functional currency for all of its Argentine investments. CMS had previously
used the U.S. Dollar as the functional currency for its Argentine investments.
As a result, on April 30, 2002, CMS Energy translated the assets and liabilities
of its Argentine entities into U.S. Dollars, in accordance with SFAS No. 52,
using an exchange rate of 3.45 Pesos per U.S. Dollar, and recorded a charge to
the Foreign Currency Translation component of Common Stockholders' Equity of
approximately $400 million.
While CMS Energy's management cannot predict the most likely future, average, or
end of period 2002 Peso to U.S. Dollar exchange rates, it does expect that this
non-cash charge substantially reduces the risk of further material balance sheet
impacts when combined with anticipated proceeds from international arbitration
currently in progress, political risk insurance, and the eventual sale of these
assets. This non-cash charge represents approximately eighty percent of the
affected assets' book value. As a result of this change, and the ongoing
translation of revenue and expense accounts of these investments into U.S.
Dollars, 2002 earnings for CMS Energy may be adversely affected by an additional
$19 million to $25 million or $0.13 to $0.18 per share assuming exchange rates
ranging from 3.00 to 4.00 Pesos per U.S. Dollar.
ENRON BANKRUPTCY: On December 2, 2001, Enron Corporation, along with certain of
its affiliates, filed a voluntary petition for Chapter 11 reorganization.
Consumers, CMS MS&T, CMS Field Services, CMS Panhandle and three affiliates in
which MS&T owns a 50% interest had contracts with various Enron affiliates at
that time. CMS Energy has terminated all gas, power, liquids, petroleum
products, and financial contracts with the various Enron affiliates, and
exercised all applicable rights of setoff. Enron, creditors of Enron, or others
may challenge the actions taken by CMS Energy to terminate the contracts and
exercise rights of setoff. These parties may also challenge CMS Energy's
calculations of the value attributed to certain contracts and the return by
Enron of a cash margin previously posted by CMS Energy pursuant to these
contracts. CMS Energy believes that the contracts it terminated constitute
either forward contracts or swap agreements, for which the Federal Bankruptcy
Code provides special rights of termination and setoff, and that the return of
the cash margin is permitted under the Federal Bankruptcy Code and other laws.
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CMS Energy Corporation
CAPITAL EXPENDITURES: CMS Energy estimates capital expenditures, including
investments in unconsolidated subsidiaries and new lease commitments, of $975
million for 2002, $920 million for 2003 and $935 million for 2004. These amounts
include expenditures associated with the LNG terminal expansion for which an
application was filed with the FERC on December 26, 2001, estimated at $21
million in 2002, $81 million in 2003 and $49 million in 2004.
OTHER: 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 $2.2 billion as of
March 31, 2002. Included in this amount, Enterprises, in the ordinary course of
business, has guarantees in place for contracts of CMS MST that contain certain
schedule and performance requirements. As of March 31, 2002, the actual amount
of financial exposure covered by these guarantees was $928 million. This amount
excludes the guarantees associated with CMS MST's natural gas sales arrangements
totaling $277 million, which are recorded as liabilities on the Consolidated
Balance Sheet at March 31, 2002. Management monitors and approves these
obligations and believes it is unlikely that CMS Energy or Enterprises would be
required to perform or otherwise incur any material losses associated with the
above obligations.
Certain CMS Gas Transmission and CMS Generation affiliates in Argentina received
notice from various Argentine provinces claiming stamp taxes and associated
penalties and interest arising from various gas transportation transactions.
Although these claims total approximately $75 million, the affiliates and CMS
Energy believe the claims are without merit and will continue to vigorously
contest them.
CMS Generation does not currently expect to incur significant capital costs at
its power facilities for compliance with current U.S. environmental regulatory
standards.
In addition to the matters disclosed in this Note, Consumers, Panhandle and
certain other subsidiaries of CMS Energy are parties to certain lawsuits and
administrative proceedings before various courts and governmental agencies
arising from the ordinary course of business. These lawsuits and proceedings may
involve personal injury, property damage, contractual matters, environmental
issues, federal and state taxes, rates, licensing and other matters.
CMS Energy has accrued estimated losses for certain contingencies discussed in
this Note. Resolution of these contingencies is not expected to have a material
adverse impact on CMS Energy's financial position, liquidity, or results of
operations.
5: SHORT-TERM AND LONG-TERM FINANCINGS, AND CAPITALIZATION
CMS ENERGY: CMS Energy's $750 million Senior Credit Facilities consist of a $450
million one-year revolving credit facility, maturing in June 2002 and a $300
million three-year revolving credit facility, maturing in June 2004.
Additionally, CMS Energy has unsecured lines of credit in an aggregate amount of
$22 million. As of March 31, 2002, $163 million was outstanding under the Senior
Credit Facilities, all of which represented letters of credit, and no amounts
were outstanding under the unsecured lines of credit.
In the first quarter of 2002, CMS Energy called $211 million of Series A through
E GTNs at interest rates ranging from 7.00 percent to 9.00 percent using funds
available from asset sales proceeds. At March 31, 2002, CMS Energy had remaining
$110 million Series D GTNs, $318 million Series E GTNs and $300 million of
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CMS Energy Corporation
Series F GTNs issued and outstanding with weighted average interest rates of 7.1
percent, 7.8 percent and 7.6 percent, respectively.
Under its most restrictive debt covenant, CMS Energy could pay $1.1 billion in
common dividends at March 31, 2002.
CONSUMERS: At March 31, 2002, Consumers had FERC authorization to issue or
guarantee through June 2002, up to $1.4 billion of short-term securities
outstanding at any one time. Consumers also had remaining FERC authorization to
issue through June 2002 up to $520 million of long-term securities for general
corporate purposes and $200 million of First Mortgage Bonds to be issued solely
as security for the long-term securities.
Consumers has an unsecured $300 million credit facility maturing in July 2002
and unsecured lines of credit aggregating $200 million. These facilities are
available to finance seasonal working capital requirements and to pay for
capital expenditures between long-term financings. At March 31, 2002, a total of
$150 million was outstanding at a weighted average interest rate of 2.6 percent,
compared with $170 million outstanding at March 31, 2001, at a weighted average
interest rate of 6.0 percent.
Consumers currently has in place a $325 million trade receivables sale program.
At March 31, 2002 and 2001, receivables sold under the program totaled $325
million and $432 million, respectively. Accounts receivable and accrued revenue
in the Consolidated Balance Sheets have been reduced to reflect receivables
sold.
On April 1, 2002, Consumers established a new subsidiary, Consumers Receivable
Funding, LLC. This consolidated subsidiary was established to sell accounts
receivable to an unrelated third party.
In March 2002, Consumers sold $300 million principal amount of six percent
senior notes, maturing in March 2005. Net proceeds from the sale were $299
million. Consumers used the net proceeds to replace a first mortgage bond that
was to mature in 2003.
Consumers secures its First Mortgage Bonds by a mortgage and lien on
substantially all of its property. Consumers' ability to issue and sell
securities is restricted by certain provisions in its First Mortgage Bond
Indenture, its Articles of Incorporation and the need for regulatory approvals
to meet appropriate federal law.
Under the provisions of its Articles of Incorporation, Consumers had $258
million of unrestricted retained earnings available to pay common dividends at
March 31, 2002. In January 2002, Consumers declared a $55 million common
dividend that was paid in February 2002. In April 2002, Consumers declared a $43
million dividend payable in May 2002.
CMS OIL AND GAS: CMS Oil and Gas had a $225 million floating rate revolving
credit facility that was due to mature in May 2002. On January 3, 2002, CMS Oil
and Gas used the proceeds from the Equatorial Guinea sale to repay all
outstanding borrowings.
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
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CMS Energy Corporation
Security and related note or debenture are also defined in the related indenture
through which the note or debenture was issued, the parent guarantee of the
related Trust Preferred Security and the declaration of trust for the particular
trust. All of these documents together with their related note or debenture and
Trust Preferred Security constitute a full and unconditional guarantee by the
parent company of the trust's obligations under the Trust Preferred Security. In
addition to the similar provisions previously discussed, specific terms of the
securities follow:
CMS Energy Trust and Securities In Millions
- -------------------------------------------------------------------------------------------------------------------
Amount
Outstanding Earliest
March 31 Rate(%) 2002 2001 Maturity Redemption
- -------------------------------------------------------------------------------------------------------------------
CMS Energy Trust I (a) 7.75 $173 $173 2027 2001
CMS Energy Trust II (b) 8.75 301 301 2004 -
CMS Energy Trust III (c) 7.25 220 220 2004 -
- -------------------------------------------------------------------------------------------------------------------
Total Amount Outstanding $694 $694
=============
(a) Represents Quarterly Income Preferred Securities that are convertible into
1.2255 shares of CMS Energy Common Stock (equivalent to a conversion price of
$40.80). Effective July 2001, CMS Energy can revoke the conversion rights if
certain conditions are met.
(b) Represents Adjustable Convertible Preferred Securities that include 0.125
percent annual contract payments for the stock purchase contract that obligates
the holder to purchase not more than 1.2121 and not less than .7830 shares of
CMS Energy Common Stock in July 2002.
(c) Represents Premium Equity Participating Security Units in which holders are
obligated to purchase a variable number of shares of CMS Energy Common Stock by
the August 2003 conversion date.
Consumers Energy Trust and Securities In Millions
- -------------------------------------------------------------------------------------------------------------------
Amount
Outstanding Earliest
March 31 Rate(%) 2002 2001 Maturity Redemption
- -------------------------------------------------------------------------------------------------------------------
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36 $70 $100 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities 8.20 120 120 2027 2002
Consumers Energy Company Financing III,
Trust Originated Preferred Securities 9.25 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities 9.00 125 - 2031 2006
- ------------------------------------------------------------------------------------------------------------------
Total Amount Outstanding $490 $395
==============
In March 2002, Consumers reduced its' outstanding debt to Consumers Power
Company Financing I, Trust Originated Preferred Securities by $30 million.
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6: EARNINGS PER SHARE AND DIVIDENDS
The following table presents a reconciliation of the numerators and denominators
of the basic and diluted earnings per share computations.
COMPUTATION OF EARNINGS PER SHARE:
In Millions, Except Per Share Amounts
- ---------------------------------------------------------------------------------------------------
Three Months Ended March 31 2002 2001
- ---------------------------------------------------------------------------------------------------
NET INCOME APPLICABLE TO BASIC AND DILUTED EPS
Consolidated Net Income $ 399 $ 109
==============================
Net Income Attributable to Common Stock:
CMS Energy - Basic $ 399 $ 109
Add conversion of 7.75% Trust
Preferred Securities (net of tax) 2 2
------------------------------
CMS Energy - Diluted $ 401 $ 111
==============================
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
CMS Energy:
Average Shares - Basic 133.3 125.4
Add conversion of 7.75% Trust
Preferred Securities 4.2 4.2
Stock Options - .3
------------------------------
Average Shares - Diluted 137.5 129.9
==============================
EARNINGS PER AVERAGE COMMON SHARE
Basic $ 2.99 $ .87
Diluted $ 2.92 $ .85
===================================================================================================
In February 2002, CMS Energy paid dividends of $.365 per share on CMS Energy
Common Stock. In April 2002, the Board of Directors declared a quarterly
dividend of $.365 per share on CMS Energy Common Stock, payable in May 2002.
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 it regulated and
non-regulated subsidiaries, utilizes a variety of derivative instruments for
both trading and non-trading purposes and executes these transactions with
external parties through its marketing subsidiary, CMS MST. These derivative
instruments include futures contracts, swaps, options and forward contracts to
manage exposure to fluctuations in commodity prices, interest rates and foreign
exchange rates. In order for derivative instruments to qualify for hedge
accounting under SFAS No. 133, the hedging relationship must be formally
documented at inception and be highly effective in achieving offsetting cash
flows or offsetting changes in fair value attributable to the
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risk being hedged.
Derivative instruments contain credit risk if the counterparties, including
financial institutions and energy marketers, fail to perform under the
agreements. CMS Energy minimizes such risk by performing financial credit
mitigation programs including, among other things, using publicly available
credit ratings of such counterparties, internally developed statistical models
for credit scoring and use of internal hedging programs to minimize exposure to
external counterparties. No material nonperformance is expected.
COMMODITY DERIVATIVES: Prior to January 1, 2001, CMS Energy accounted for its
non-trading commodity contracts as hedges and deferred any changes in the market
value and gains/losses resulting from settlements until the hedged transaction
was completed. As of January 1, 2001, commodity contracts are now accounted for
in accordance with the requirements of SFAS No. 133, as amended and interpreted,
and may or may not qualify for hedge accounting treatment depending on the
characteristics of each contract.
Consumers' electric business uses purchased electric call option contracts to
meet its regulatory obligation to serve, which requires providing a physical
supply of electricity to customers, and to manage electric cost and to ensure a
reliable source of capacity during periods of peak demand. These contracts are
subject to derivative accounting in accordance with SFAS No. 133, and as such
are required to be recorded at fair value on the balance sheet, with changes in
fair value recorded either directly in earnings or other comprehensive income if
the contract meets certain qualifying hedge criteria. On July 1, 2001, upon
initial adoption of the standard for these contracts, Consumers recorded a $3
million, net of tax, cumulative effect adjustment as an unrealized loss
decreasing accumulated other comprehensive income. This adjustment relates to
the difference between the fair value and the recorded book value of these
electric call option contracts. The adjustment to accumulated other
comprehensive income relates to electric call option contracts that qualified
for cash flow hedge accounting prior to the initial adoption of SFAS No. 133.
After July 1, 2001, these contracts do not qualify for hedge accounting under
SFAS No. 133 and, therefore, Consumers will record any change in fair value
subsequent to July 1, 2001 directly in earnings, which could cause earnings
volatility. The initial amount recorded in other comprehensive income will be
reclassified to earnings as the forecasted future transactions occur or the call
options expire. The majority of these contracts expired in the third quarter
2001 and the remaining contracts will expire in 2002. As of December 31, 2001,
$2 million, net of tax, was reclassified to earnings as part of cost of power
supply. The remainder is expected to be reclassified to earnings in the third
quarter of 2002.
In December 2001, the FASB issued revised guidance regarding derivative
accounting for electric call option contracts and option-like contracts. The
revised guidance amended the criteria to be used to determine if derivative
accounting is required. Consumers re-evaluated its electric call option and
option-like contracts and determined that under the revised guidance additional
contracts require derivative accounting. Therefore, as of December 31, 2001,
upon initial adoption of the revised guidance for these contracts, Consumers
recorded an $11 million, net of tax, cumulative effect adjustment as a decrease
to earnings. This adjustment relates to the difference between the fair value
and the recorded book value of these electric call option contracts. Consumers
will record any change in fair value subsequent to December 31, 2001 directly in
earnings, which could cause earnings volatility. As of March 31, 2002, all of
Consumers' purchased electric call option contracts subject to derivative
accounting were recorded on the balance sheet at a fair value of $3 million. A
change in value from December 31, 2001 to March 31, 2002, representing a gain of
$2 million was recorded in earnings as a reduction in the cost of power.
Consumers' electric business also uses gas swap contracts to protect against
price risk due to the fluctuations in
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CMS Energy Corporation
the market price of gas used as fuel for generation of electricity. These
contracts are financial contracts that will be used to offset increases in the
price of probable forecasted gas purchases. These contracts do not qualify for
hedge accounting and therefore, Consumers will record any change in the fair
value of these contracts directly in earnings as part of the cost of power
supply, which could cause earnings volatility. As of March 31, 2002, a gain of
$1 million has been recorded for 2002, which represents the fair value of these
contracts at March 31, 2002. These contracts expire in December 2002.
Consumers' gas business uses fixed price gas supply contracts to meet its
regulatory obligation to provide gas to its customers as the lowest possible
prudent cost. Some of these contracts contain embedded put options that
disqualify the contracts from the normal purchase exception of SFAS No. 133, and
therefore require derivative accounting. As of March 31, 2002, Consumers gas
supply contracts requiring derivative accounting had a fair value of $4 million,
representing a fair value gain on the contract since the date of inception, and
this gain was recorded directly in earnings as part of other income, and then
directly offset and recorded as a regulatory liability on the balance sheet. Any
subsequent changes in fair value will be recorded in the same manner. These
contracts expire in October of 2002.
CMS Energy, through its subsidiary CMS MST, engages in trading activities. CMS
MST manages any open positions within certain guidelines that limit its exposure
to market risk and requires timely reporting to management of potential
financial exposure. These guidelines include statistical risk tolerance limits
using historical price movements to calculate daily value at risk measurements.
CMS MST's trading activities are accounted for under the mark-to-market method
of accounting. Under mark-to-market accounting, energy-trading contracts are
reflected at fair market value, net of reserves, with unrealized gains and
losses recorded as an asset or liability in the consolidated balance sheets.
These assets and liabilities are affected by the timing of settlements related
to these contracts; current-period changes from newly originated transactions
and the impact of price movements. Changes in fair values are recognized as
revenues in the consolidated statements of income in the period in which the
changes occur. Market prices used to value outstanding financial instruments
reflect management's consideration of, among other things, closing exchange and
over-the-counter quotations. In certain of these markets, long-term contract
commitments may extend beyond the period in which market quotations for such
contracts are available. The lack of long-term pricing liquidity requires the
use of mathematical models to value these commitments under the accounting
method employed. These mathematical models utilize historical market data to
forecast future elongated pricing curves, which are used to value the
commitments that reside outside of the liquid market quotations. Realized cash
returns on these commitments may vary, either positively or negatively, from the
results estimated through application of forecasted pricing curves generated
through application of the mathematical model. CMS Energy believes that its
mathematical models utilize state-of-the-art technology, pertinent industry data
and prudent discounting in order to forecast certain elongated pricing curves.
These market prices are adjusted to reflect the potential impact of liquidating
the company's position in an orderly manner over a reasonable period of time
under present market conditions.
In connection with the market valuation of its energy commodity contracts, CMS
Energy maintains reserves for credit risks based on the financial condition of
counterparties. Counterparties in its trading portfolio consist principally of
financial institutions and major energy trading companies. The creditworthiness
of these counterparties will impact overall exposure to credit risk; however,
with regard to its counterparties, CMS Energy maintains credit policies that
management believes minimize overall credit risk. Determination of the credit
quality of its counterparties is based upon a number of factors, including
credit ratings, financial condition, and collateral requirements. When trading
terms permit, CMS Energy employs standardized agreements that allow for netting
of positive and negative exposures associated with a single counterparty.
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CMS Energy Corporation
Based on these policies, its current exposures and its credit reserves, CMS
Energy does not anticipate a material adverse effect on its financial position
or results of operations as a result of counterparty nonperformance.
At March 31, 2002, CMS MST has recorded a net asset of $109 million, net of
reserves, related to the unrealized mark-to-market gains on existing
arrangements. For the quarters ended March 31, 2002 and 2001, CMS MST reflected
$1 million and $2 million, respectively, of mark-to-market revenues, net of
reserves, primarily from newly originated long-term power sales contracts and
wholesale gas trading transactions.
The following tables provide a summary of the fair value of CMS Energy's energy
commodity contracts as of March 31, 2002.
In Millions
- -----------------------------------------------------------------------------------------------------------
Fair value of contracts outstanding as of December 31, 2001 $108
Contracts realized or otherwise settled during the period (a) (17)
Fair value of new contracts when entered into during the period 12
Changes in fair value attributable to changes in valuation techniques and assumptions -
Other changes in fair value (b) 6
- -----------------------------------------------------------------------------------------------------------
Fair value of contracts outstanding as of March 31, 2002 $109
===========================================================================================================
Fair Value of Contracts at March 31, 2002 In Millions
- -------------------------------------------------------------------------------------------------------------------------------
Maturity (in years)
Total
Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5
- -------------------------------------------------------------------------------------------------------------------------------
Prices actively quoted $ 55 $ 28 $ 21 $ 5 $ 1
Prices provided by other
external sources 22 2 4 10 6
Prices based on models and
other valuation methods 32 2 11 12 7
- -------------------------------------------------------------------------------------------------------------------------------
Total $109 $ 32 $ 36 $ 27 $14
===============================================================================================================================
(a) Reflects value of contracts, included in December 31, 2001 values,
that expired during 2002.
(b) Reflects changes in price and net increase/decrease in size of forward
positions, as well as changes to mark-to-market reserve accounts.
FLOATING TO FIXED INTEREST RATE SWAPS: CMS Energy and its subsidiaries enter
into floating to fixed interest rate swap agreements to reduce the impact of
interest rate fluctuations. These swaps are designated as cash flow hedges and
the difference between the amounts paid and received under the swaps is accrued
and recorded as an adjustment to interest expense over the term of the
agreement. Changes in the fair value of these swaps are recorded in accumulated
other comprehensive income until the swaps are terminated. As of March 31, 2002,
these swaps had a negative fair value of $7 million that if sustained, will be
reclassified to earnings as the swaps are settled on a quarterly basis. No
ineffectiveness was recognized during the first quarter of 2002 under the
requirements of SFAS No. 133.
Notional amounts reflect the volume of transactions but do not represent the
amount exchanged by the parties
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CMS Energy Corporation
to the financial instruments. Accordingly, notional amounts do not necessarily
reflect CMS Energy's exposure to credit or market risks. As of March 31, 2002
and 2001, the weighted average interest rate associated with outstanding swaps
was approximately 5.2 percent and 6.4 percent, respectively.
In Millions
- --------------------------------------------------------------------------------------------------------------------
Floating to Fixed Notional Maturity Fair Unrealized
Interest Rate Swaps Amount Date Value Gain (Loss)
- --------------------------------------------------------------------------------------------------------------------
March 31, 2002 $ 295 2003-2006 $ (7) $ 4
March 31, 2001 $1,069 2001-2006 $(15) $(7)
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.
The outstanding swaps as of March 31, 2002, had a negative fair value of $3
million that were recognized on the consolidated balance sheets as a derivative
liability. No ineffectiveness was recognized during the first quarter of 2002
under the requirements of SFAS No. 133.
Amortization of gains on swaps during the first quarter of 2002, which were
terminated in 2001, was approximately $1 million that was recorded as an
adjustment to interest expense.
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.
In Millions
- --------------------------------------------------------------------------------------------------------------------
Fixed to Floating Notional Maturity Fair Unrealized
Interest Rate Swaps Amount Date Value Gain (Loss)
- --------------------------------------------------------------------------------------------------------------------
March 31, 2002 $ 822 2004-2005 $ (3) $(2)
March 31, 2001 - - - -
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 March 31,
2002 and 2001 was $(6) million and $4 million, respectively; representing the
amount CMS Energy would receive or (pay) upon settlement.
Foreign exchange contracts outstanding as of March 31, 2002 had a total notional
amount of $152 million. Of this amount, $100 million is related to CMS Energy's
investments in Brazil, $25 million is related to CMS Energy's investments in
Australia and $27 million in Euro hedges. All contracts are short-term in nature
and are scheduled to expire within twelve months.
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CMS Energy Corporation
The notional amount of the outstanding foreign exchange contracts at March 31,
2001 was $824 million consisting of $21 million, $25 million, and $778 million
for Australian, Brazilian and Argentine, respectively. All of these contracts
have expired.
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments and
current liabilities approximate their fair values due to their short-term
nature. The estimated fair values of long-term investments are based on quoted
market prices or, in the absence of specific market prices, on quoted market
prices of similar investments or other valuation techniques. Judgment may also
be required to interpret market data to develop certain estimates of fair value.
Accordingly, the estimates determined as of March 31, 2002 and 2001 are not
necessarily indicative of the amounts that may be realized in current market
exchanges. The carrying amounts of all long-term investments in financial
instruments, except for those as shown below, approximate fair value.
In Millions
As of March 31 2002 2001
- --------------------------------------------------------------------------- ---------------------------------------
Carrying Fair Unrealized Carrying Fair Unrealized
Cost Value Gain (Loss) Cost Value Gain (Loss)
----------- ---------- -------------- ----------- ----------- ---------------
Long-Term Debt (a) $6,543 $6,442 $(101) $7,150 $7,016 $ (134)
Preferred Stock and
Trust Preferred Securities 1,183 1,099 (84) 1,133 1,075 (58)
(a) Settlement of long-term debt is generally not expected until maturity.
8: REPORTABLE SEGMENTS
CMS Energy operates principally in the following six reportable segments:
electric utility; gas utility; independent power production; oil and gas
exploration and production; natural gas transmission; and marketing, services
and trading.
CMS Energy"s reportable segments are strategic business units organized and
managed by the nature of the products and services each provides. Management
evaluates performance based on the pretax operating income, as well as the net
income of each segment. The electric utility segment consists of regulated
activities associated with the generation, transmission and distribution of
electricity in the state of Michigan through its subsidiary, Consumers Energy.
The gas utility segment consists of regulated activities associated with the
transportation, storage and distribution of natural gas in the state of Michigan
through its subsidiary, Consumers Energy. Independent power production invests
in, acquires, develops, constructs and operates non-utility power generation
plants in the United States and abroad. The oil and gas exploration and
production segment conducts oil and gas exploration and development operations
in the United States, primarily the Permian Basin in Texas and in the countries
of Cameroon, Colombia, Congo, Tunisia and Venezuela. Natural gas transmission
owns, develops, and manages domestic and international natural gas facilities.
The marketing, services and trading segment provides gas, oil, and electric
marketing, risk management and energy management services to industrial,
commercial, utility and municipal energy users throughout the United States and
abroad. Revenues from a land development business fall below the quantitative
thresholds for reporting and have never met any of the quantitative thresholds
for determining reportable segments.
The Consolidated Statements of Income show operating revenue and pretax
operating income by reportable segment. Revenues from a land development
business fall below the quantitative thresholds for reporting, and
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CMS Energy Corporation
has never met any of the quantitative thresholds for determining reportable
segments. The table below shows net income by reportable segment.
Reportable Segments
In Millions
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Net Income by Reportable Segment
Electric utility $ 49 $ 60
Gas utility 28 28
Natural gas transmission 41 45
Independent power production 23 27
Oil and gas exploration and production 310 3
Marketing, services and trading 7 4
Corporate interest and other (59) (58)
- ------------------------------------------------------------------------------------------------------------------
$ 399 $109
==================================================================================================================
CMS-56
[ANDERSEN LOGO]
Report of Independent Public Accountants
To CMS Energy Corporation:
We have reviewed the accompanying consolidated balance sheets of CMS ENERGY
CORPORATION (a Michigan corporation) and subsidiaries as of March 31, 2002 and
2001, and the related consolidated statements of income, cash flows and common
stockholders' equity for the three-month periods then ended. These financial
statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with accounting principles generally accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of CMS Energy
Corporation and subsidiaries as of December 31, 2001, and, in our report dated
March 22, 2002, we expressed an unqualified opinion on that statement. In our
opinion, the information set forth in the accompanying consolidated balance
sheet as of December 31, 2001, is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
[ARTHUR ANDERSEN LLP SIGNATURE]
Detroit, Michigan,
April 30, 2002.
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CMS Energy Corporation
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Consumers Energy Company
CONSUMERS ENERGY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS
Consumers, a subsidiary of CMS Energy, a holding company, is an electric and gas
utility company that provides service to customers in Michigan's Lower
Peninsula. Consumers' customer base includes a mix of residential, commercial
and diversified industrial customers, the largest segment of which is the
automotive industry.
This MD&A refers to, and in some sections specifically incorporates by
reference, Consumers' Condensed Notes to Consolidated Financial Statements and
should be read in conjunction with such Consolidated Financial Statements and
Notes. This Form 10-Q and other written and oral statements that Consumers may
make contain forward-looking statements as defined by the Private Securities
Litigation Reform Act of 1995. Consumers' intentions with the use of the words,
"anticipates," "believes," "estimates," "expects," "intends," and "plans," and
variations of such words and similar expressions, are solely to identify
forward-looking statements that involve risk and uncertainty. These
forward-looking statements are subject to various factors that could cause
Consumers' actual results to differ materially from the results anticipated in
such statements. Consumers has no obligation to update or revise forward-looking
statements regardless of whether new information, future events or any other
factors affect the information contained in such statements. Consumers does,
however, discuss certain risk factors, uncertainties and assumptions in this
Management's Discussion and Analysis in the section entitled "CMS Energy,
Consumers and Panhandle Forward-Looking Statements Cautionary Factors" in
Consumers' 2001 Form 10-K Item 1 and in various public filings it periodically
makes with the SEC. Consumers designed this discussion of potential risks and
uncertainties, which is by no means comprehensive, to highlight important
factors that may impact Consumers' outlook. This Form 10-Q also describes
material contingencies in Consumers Notes to Consolidated Financial Statements,
and Consumers encourages its readers to review these Notes.
CRITICAL ACCOUNTING POLICIES
Presenting financial statements in accordance with generally accepted accounting
principles requires using estimates, assumptions, and accounting methods that
are often subject to judgment. Presented below, are the accounting policies and
assumptions that Consumers believes are most critical to both the presentation
and understanding of its financial statements. Applying these accounting
policies to financial statements can involve very complex judgments.
Accordingly, applying different judgments, estimates or assumptions could result
in a different financial presentation.
USE OF ESTIMATES IN ACCOUNTING FOR CONTINGENCIES
The principles in SFAS No. 5 guide the recording of estimated liabilities for
contingencies within the financial statements. SFAS No. 5 requires a company to
record estimated liabilities when it is probable that a current event will cause
a future loss payment and that loss amount can be reasonably estimated.
Consumers used this principle to record estimated liabilities for the following
significant events.
ELECTRIC ENVIRONMENTAL ESTIMATES: Consumers is subject to costly and
increasingly stringent environmental regulations. Consumers expects to incur
significant costs for future environmental compliance, especially compliance
with clean air laws.
The EPA issued regulations regarding ozone and particulate-related emissions
that require some Consumers' electric generating facilities to lower their
emissions rates. These regulations will require Consumers to spend between $530
million and $660 million, estimated in 2002 dollars. As of March 2002, Consumers
incurred
CE-1
Consumers Energy Company
$326 million of capital expenditures to comply. Consumers expects to
make the remaining capital expenditures between 2002 and 2005.
At some point after 2005, Consumers may incur additional capital expenditures if
new environmental standards for multi-pollutants become effective. These and
other required environmental expenditures may have a material adverse impact
upon Consumers' financial condition and results of operations after 2005. For
further information see Note 2, Uncertainties, "Electric Environmental Matters."
GAS ENVIRONMENTAL ESTIMATES: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will incur investigation
and remedial action costs at a number of sites. Consumers estimates the costs
for 23 former Manufactured Gas Plant sites will be between $82 million and $113
million, using the Gas Research Institute-Manufactured Gas Plant Probabilistic
Cost Model. These estimates are based on discounted 2001 costs and follow EPA
recommended use of discount rates between 3 and 7 percent. Consumers expects to
recover a significant portion of these costs through MPSC-approved rates charged
to its customers. Any significant change in assumptions, such as remediation
techniques, nature and extent of contamination, and legal and regulatory
requirements, could change the remedial action costs for the sites. For further
information see Note 2, Uncertainties, "Gas Environmental Matters."
MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the MCV
Facility, contracted to sell electricity to Consumers for a 35-year period
beginning in 1990 and to supply electricity and steam to Dow. Consumers, through
two wholly owned subsidiaries, holds a partnership interest in the MCV
Partnership, and a lessor interest in the MCV Facility.
Consumers' annual obligation to purchase capacity from the MCV Partnership is
1,240 MW through 2025. The PPA requires Consumers to pay, based on the MCV
Facility's availability, a levelized average capacity charge of 3.77 cents per
kWh, a fixed energy charge, and a variable energy charge based primarily on
Consumers' average cost of coal consumed for all kWh delivered. Consumers has
not been allowed full recovery of the capacity charges in rates and has recorded
the estimated contract losses on this through 2007.
Consumers' availability payments to the MCV Partnership are capped at 98.5
percent. If the MCV Facility generates electricity at the maximum 98.5 percent
level during the next five years, Consumers' after-tax cash underrecoveries
associated with the PPA could be as follows:
In Millions
- ------------------------------------------------------------------------------------------------------------------
2002 2003 2004 2005 2006
- ------------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $37 $36 $36 $36
==================================================================================================================
For further information see Note 2, Uncertainties "The Midland Cogeneration
Venture" for additional detail.
ACCOUNTING FOR DERIVATIVE AND FINANCIAL INSTRUMENTS
DERIVATIVE INSTRUMENTS: Consumers uses SFAS No. 133 criteria to determine which
contracts must be accounted for as derivative instruments. These rules, however,
are numerous and complex. As a result, significant judgment is required and
similar contracts can sometimes be accounted for differently.
Consumers currently accounts for the following contracts as derivative
instruments: interest rate swaps and locks, certain electric call options and
gas supply contracts with embedded put options, and gas fuel swaps. Consumers
does not account for as derivatives: electric capacity and energy contracts, gas
supply contracts without embedded options, coal and nuclear fuel supply
contracts, or purchase orders for numerous supply items.
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Consumers Energy Company
If a contract is accounted for as a derivative instrument, it is recorded in the
financial statements as an asset or a liability, at the fair value of the
contract. Any difference between the recorded book value and the fair value is
reported either in earnings or other comprehensive income, depending on certain
qualifying criteria. The recorded fair value of the contract is then adjusted
quarterly to reflect any change in the market value of the contract.
In order to fair value the contracts that are accounted for as derivative
instruments, Consumers uses a combination of market quoted prices and
mathematical models. Option models require various inputs, including forward
prices, volatilities, interest rates and exercise periods. Changes in forward
prices or volatilities could significantly change the calculated fair value of
the call option contracts. At March 31, 2002, Consumers assumed an interest rate
of 4.5 percent in calculating the fair value of its electric call options.
In order for derivative instruments to qualify for hedge accounting under SFAS
No. 133, the hedging relationship must be formally documented at inception and
be highly effective in achieving offsetting cash flows or offsetting changes in
fair value, attributable to the risk being hedged. If hedging a forecasted
transaction, the forecasted transaction must be probable. If a derivative
instrument, used as a cash flow hedge, is terminated early because it is
probable that a forecasted transaction will not occur, any gain or loss as of
such date is immediately recognized in earnings. If a derivative instrument,
used as a cash flow hedge, is terminated early for other economic reasons, any
gain or loss as of the termination date is deferred and recorded when the
forecasted transaction affects earnings. For further information see Note 1,
Corporate Structure and Summary of Significant Accounting Policies,
"Implementation of New Accounting Standards," Note 2, Uncertainties, "Other
Electric Uncertainties - Derivative Activities," and Note 3, Short-Term
Financings and Capitalization, "Derivative Activities."
FINANCIAL INSTRUMENTS: Consumers accounts for its debt and equity investment
securities in accordance with SFAS No. 115. As such, debt and equity securities
can be classified into one of three categories: held-to-maturity, trading, or
available-for-sale securities. Consumers' equity securities investments are
classified as available-for-sale securities. They are reported at fair value,
with any unrealized gains or losses from changes in fair value reported in
equity as part of other comprehensive income and excluded from earnings.
Unrealized gains or losses from changes in the fair value of Consumers' nuclear
decommissioning investments are reported in accumulated depreciation. The fair
value of these instruments is determined from quoted market prices.
ACCOUNTING FOR LEASES
Consumers uses SFAS No. 13 to account for any leases to which it may be a party.
Depending upon satisfaction of certain criteria, they are classified as
operating leases or capital leases. Under an operating lease, payments are
expensed as incurred, and there is no recognition of an asset or liability on
the balance sheet. Capital leases, on the other hand, require that an asset and
liability be recorded on the balance sheet at the inception of the lease for the
present value of the minimum lease payments required during the term of the
lease.
To determine whether to classify a lease as operating or capital under SFAS No.
13 and related statements, Consumers must use judgment. A lease must be
evaluated for transfer of ownership, provision for bargain purchase option, the
lease term relative to the estimated economic life of the leased property, and
the present value of the minimum lease payments at the beginning of the lease
term. Judgment is required for leases involving special purpose entities such as
trusts, sales and leasebacks and when the lessee is involved in the construction
of the property it will lease. Different financial presentations of leases could
result if different judgment, estimates or assumptions are made.
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Consumers Energy Company
Consumers is party to a number of leases, the most significant are the leases
associated with its new headquarters building and its railcar lease. For further
information see "Contractual Obligations and Commercial Commitments" in the
Capital Resources and Liquidity section.
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.
Items that may normally be expensed for a non-regulated entity may be
capitalized as regulatory assets if the actions of the regulator indicate that
such expenses will be recovered in future rates charged to customers designed to
recover such costs. Conversely, items that may normally be recognized as
revenues for a non-regulated entity may be recorded as regulatory liabilities if
the actions of the regulator indicate that such revenues will be required to be
refunded to customers at a future time. Judgment is required to discern the
recoverability of items recorded as regulatory assets and liabilities. As of
March 31, 2002, Consumers had $1.217 billion recorded as regulatory assets and
$292 million recorded as regulatory liabilities.
ACCOUNTING FOR PENSION AND OPEB
Consumers uses SFAS No. 87 to account for pension costs and uses SFAS No. 106 to
account for other postretirement benefit costs. These statements require
liabilities to be recorded on the balance sheet at the present value of these
future obligations to employees net of any plan assets. The calculation of these
liabilities and associated expenses require the expertise of actuaries and are
subject to many assumptions including life expectancies, present value discount
rates, expected long-term rate of return on plan assets, rate of compensation
increase and anticipated health care costs. Any change in these assumptions can
significantly change the liability and associated expenses recognized in any
given year. For further information see the Other Outlook section.
ACCOUNTING FOR NUCLEAR DECOMMISSIONING COSTS
Consumers' decommissioning cost estimates for the Big Rock and Palisades plants
assume that each plant site will eventually be restored to conform to the
adjacent landscape, and all contaminated equipment will be disassembled and
disposed of in a licensed burial facility. On December 31, 2000, Big Rock trusts
were fully funded per a March 1999 MPSC order. A December 1999 MPSC order set
the annual decommissioning surcharge for Palisades decommissioning at $6 million
a year. Consumers estimates that at the time Palisades is fully decommissioned
in year 2049, the trust funds will have provided $2.5 billion, including trust
earnings, to pay for the anticipated expenditures over the entire
decommissioning period. Earning assumptions are that the trust funds are
invested in equities and fixed income investments, the trust funds will be
converted to municipal bonds after decommissioning becomes fully funded, and
that municipal bonds are converted to cash one year before expenditures are
made. The Palisades and Big Rock trust funds are currently estimated to earn 7.1
percent and 5.7 percent, respectively, annually.
The funds provided by the trusts are expected to fully fund the decommissioning
costs, which have been developed, in part, by independent contractors with
expertise in decommissioning. These costs have been developed using various
inflation rates for labor, non-labor, and for contaminated equipment burial
costs. Variance from trust earnings, changes in decommissioning technology,
regulations, estimates or assumptions could affect the cost of decommissioning
these sites.
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Consumers Energy Company
RELATED PARTY TRANSACTIONS
Consumers enters into a number of significant transactions with related parties.
These transactions include the purchase of capacity and energy from the MCV
Partnership and from affiliates of Enterprises, the purchase of electricity from
CMS MST, the purchase of gas supply from CMS MST and CMS Oil and Gas, the
purchase of gas transportation from Panhandle and its subsidiary Trunkline, the
payment of parent company overhead costs to CMS Energy, the sale, storage and
transportation of natural gas and other services to the MCV Partnership, certain
transactions involving derivative instruments with CMS MST, and an investment in
CMS Energy Common Stock.
Transactions involving CMS Energy and its affiliates and the sale, storage and
transportation of natural gas and other services to the MCV Partnership are
based on regulated prices, market prices or competitive bidding. Purchases are
based upon the lowest market price available or most competitive bid submitted.
Transactions involving the power supply purchases from the MCV Partnership are
based upon avoided costs under PURPA; and the payment of parent company overhead
costs to CMS Energy are based upon use or accepted industry allocation
methodologies.
Consumers also sold its transmission facilities to MTH, a non-affiliated limited
partnership whose general partner is a subsidiary of Trans-Elect, Inc., an
independent company, whose management employs former executive employees of
Consumers, and the transaction was based on competitive bidding.
For detailed information about related party transactions see Note 2,
Uncertainties, "Electric Rate Matters - Transmission", and "Other Electric
Uncertainties - The Midland Cogeneration Venture".
RESULTS OF OPERATIONS
CONSUMERS CONSOLIDATED EARNINGS
In Millions
- ----------------------------------------------------------------------------------------------------------------
March 31 2002 2001 Change
- ----------------------------------------------------------------------------------------------------------------
Three months ended $ 81 $ 98 $ (17)
================================================================================================================
2002 COMPARED TO 2001: For the three months ended March 31, 2002, Consumers' net
income available to the common stockholder totaled $81 million, a decrease of
$17 million from the comparable period in 2001. The earnings decrease reflects
reduced electric and gas deliveries due to milder winter temperatures, the
continued economic downturn, and increased electric operating expense in 2002,
primarily for replacement power supply costs related to an unscheduled plant
outage.
For further information, see the Electric and Gas Utility Results of Operations
sections and Note 2, Uncertainties.
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ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
- ----------------------------------------------------------------------------------------------------------------
March 31 2002 2001 Change
- ----------------------------------------------------------------------------------------------------------------
Three months ended $ 49 $ 61 $ (12)
================================================================================================================
Reasons for the change:
Electric deliveries $ (4)
Power supply costs and related revenue (16)
Other operating expenses and non-commodity revenue (2)
Fixed charges 2
Income taxes 8
- ----------------------------------------------------------------------------------------------------------------
Total change $ (12)
================================================================================================================
ELECTRIC DELIVERIES: For the period ending March 31, 2002, electric deliveries,
including transactions with other electric utilities, were 9.2 billion kWh, a
decrease of 0.8 billion kWh or 7.9 percent from the comparable period in 2001.
Total electric deliveries decreased primarily due to lower industrial usage
driven by the economic downturn.
POWER SUPPLY COSTS AND RELATED REVENUE: For the period ending March 31, 2002,
electric net income was adversely affected by lower power cost related revenues.
Additionally, the average power supply cost increased due to the need to
purchase greater quantities of higher-priced power to offset the loss of
internal generation resulting from the unscheduled Palisades outage.
OTHER OPERATING EXPENSES: In 2002, other operating expenses decreased due to
lower operating and maintenance costs resulting from cost controls throughout
the business unit.
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GAS UTILITY RESULTS OF OPERATIONS
In Millions
- ----------------------------------------------------------------------------------------------------------------
March 31 2002 2001 Change
- ----------------------------------------------------------------------------------------------------------------
Three months ended $ 28 $ 29 $ (1)
================================================================================================================
Reasons for the change:
Gas deliveries (9)
Rate increase 7
Fixed charges 2
Income taxes (1)
- ----------------------------------------------------------------------------------------------------------------
Total change $ (1)
================================================================================================================
For the period ending March 31, 2002, gas delivery revenues decreased due to
significantly milder temperatures during the first quarter of 2002. This
decrease was significantly offset by an interim gas rate increase granted in
December of 2001. System deliveries, including miscellaneous transportation
volumes, totaled 149 bcf, a decrease of 10 bcf or 6.5 percent compared
with 2001.
CAPITAL RESOURCES AND LIQUIDITY
CASH POSITION, INVESTING AND FINANCING
OPERATING ACTIVITIES: Consumers' principal source of liquidity is from cash
derived from operating activities involving the sale and transportation of
natural gas and the generation, delivery and sale of electricity. Cash from
operations totaled $271 million and $479 million for the first three months of
2002 and 2001, respectively. The $208 million decrease resulted primarily from a
$163 million decrease in cash collected from customers and related parties and a
$115 million decrease in sale of accounts receivable, partially offset by a $70
million increase in cash due to fewer expenditures for natural gas inventories.
Consumers primarily uses cash derived from operating activities to maintain and
expand 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, Short-Term
Financings and Capitalization for additional details about this source of funds.
INVESTING ACTIVITIES: Cash used for investing activities totaled $154 million
and $204 million for the first three months of 2002 and 2001, respectively. The
change of $50 million is primarily the result of fewer capital expenditures to
comply with the Clean Air Act than the first three months of 2001.
FINANCING ACTIVITIES: Cash used in financing activities totaled $105 million and
$286 million for the first three months of 2002 and 2001, respectively. The
change of $181 million is primarily the result of a $150 million cash infusion
from CMS Energy, $298 million net proceeds from issuance of senior notes, and
$94 million net increase in notes payable, offset by a $344 million retirement
of bonds and other long-term debt.
OFF-BALANCE SHEET ARRANGEMENTS: Consumers' use of long-term contracts for the
purchase of commodities and services, the sale of its accounts receivables, and
operating leases are considered to be off-balance sheet arrangements. Consumers
has responsibility for the collectability of the accounts receivables sold, and
the full obligation of its leases becomes due in case of lease payment default.
Consumers uses these off-balance sheet arrangements in its normal business
operations.
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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 about these
obligations, see Note 2, Uncertainties, and Note 3, Short-Term Financings and
Capitalization.
Contractual Obligations In Millions
- --------------------------------------------------------------------------------------------------------------
Payments Due
------------------------------------------------------------
March 31 Total 2002 2003 2004 2005 2006 and beyond
- --------------------------------------------------------------------------------------------------------------
On-balance sheet:
Long-term debt $ 2,691 $ 220 $333 $ 28 $170 $ 1,940
Notes payable 150 150 - - - -
Capital lease obligations 82 15 17 14 13 23
Off-balance sheet:
Operating leases 164 11 16 14 12 111
Non-recourse debt of FMLP 264 65 8 54 41 96
Sale of accounts receivable 325 325 - - - -
Unconditional purchase
Obligations 18,059 1,283 1,050 848 781 14,097
==============================================================================================================
Unconditional purchase obligations are for natural gas and electricity and
represent normal business operating contracts used to assure adequate supply and
minimize exposure to market price fluctuations.
Consumers has long-term power purchase agreements with various generating plants
including the MCV Facility. These contracts require monthly capacity payments
based on the plants' availability or deliverability. These payments are
approximately $48 million per month for year 2002, which includes $33 million
related to the MCV Facility. If a plant is not available to deliver electricity
to Consumers, then Consumers would not be obligated to make the capacity payment
until the plant could deliver. See Electric Utility Results of Operations above
and Note 2, Uncertainties, "Electric Rate Matters - Power Supply Costs" and
"Other Electric Uncertainties - The Midland Cogeneration Venture" for further
information concerning power supply costs.
Commercial Commitments In Millions
- --------------------------------------------------------------------------------------------------------------
Commitment Expiration
-----------------------------------------------------------
March 31 Total 2002 2003 2004 2005 2006 and beyond
- --------------------------------------------------------------------------------------------------------------
Off-balance sheet:
Guarantees $16 $16 - - - -
Indemnities 17 - - - - 17
Letters of Credit 7 7 - - - -
==============================================================================================================
Consumers has $300 million credit facilities, $200 million aggregate lines of
credit and a $325 million trade receivable sale program in place as anticipated
sources of funds to fulfill its currently expected capital expenditures. For
further information about this source of funds see Note 3, Short-Term Financings
and Capitalization.
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OUTLOOK
CAPITAL EXPENDITURES OUTLOOK
Over the next three years, Consumers estimates the following capital
expenditures, including new lease commitments, by expenditure type and by
business segments. Consumers prepares these estimates for planning purposes and
may revise them.
In Millions
- ----------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2003 2004
- ----------------------------------------------------------------------------------------------------------------
Construction $590 $550 $540
Nuclear fuel lease 10 0 30
Capital leases other than nuclear fuel 25 20 20
-------------------------------
$625 $570 $590
================================================================================================================
Electric utility operations (a)(b) $450 $405 $440
Gas utility operations (a) 175 165 150
-------------------------------
$625 $570 $590
================================================================================================================
(a) These amounts include an attributed portion of Consumers' anticipated
capital expenditures for plant and equipment common to both the electric and gas
utility businesses.
(b) These amounts include estimates for capital expenditures that may be
required by recent revisions to the Clean Air Act's national air quality
standards. For further information see Note 2, Uncertainties.
ELECTRIC BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects electric deliveries
(including both full service sales and delivery service to customers who choose
to buy generation service from an alternative electric supplier) to grow at an
average rate of approximately two percent per year based primarily on a steadily
growing customer base. This growth rate reflects a long-range expected trend of
growth. Growth from year to year may vary from this trend due to customer
response to abnormal weather conditions and changes in economic conditions
including, utilization and expansion of manufacturing facilities.
COMPETITION AND REGULATORY RESTRUCTURING: Regulatory changes and other
developments have resulted and will continue to result in increased competition
in the electric business. Generally, increased competition threatens Consumers'
share of the market for generation services and can reduce profitability.
Competition is increasing as a result of the introduction of retail open access
in the state of Michigan pursuant to the enactment of Michigan's Customer Choice
Act, and therefore, alternative electric suppliers for generation services have
entered Consumers' market. The Customer Choice Act allows all electric customers
to have the choice of buying electric generation service from an alternative
electric supplier as of January 1, 2002. To the extent Consumers experiences
"net" Stranded Costs as determined by the MPSC, the Customer Choice Act provides
for the recovery of such "net" Stranded Costs through a charge that would be
paid by those customers that choose to switch to an alternative electric
supplier.
Stranded and Implementation Costs: The Customer Choice Act allows for the
recovery by an electric utility of the cost of implementing the act's
requirements and "net" Stranded Costs, without defining the term. The act
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directs the MPSC to establish a method of calculating "net" Stranded Costs and
of conducting related true-up adjustments. In December 2001, the MPSC adopted a
methodology for calculating "net" Stranded Costs as the shortfall between (a)
the revenue needed 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 those revenue needs. According to the MPSC,
"net" Stranded Costs are to be recovered from retail open access customers
through a Stranded Cost transition charge. Even though the MPSC ruled that the
Stranded Cost transition charge to be in effect on January 1, 2002 for the
recovery of "net" Stranded Costs for calendar year 2000 for Consumers is zero,
the MPSC also indicated that the "net" Stranded Costs for 2000 would be subject
to further review in the context of its subsequent determinations of "net"
Stranded Costs for 2001 and later years. The MPSC authorized Consumers to use
deferred accounting to recognize the future recovery of costs determined to be
stranded by application of the MPSC's methodology. Consumers is seeking a
rehearing and clarification of the methodology adopted, and in April 2002, made
"net" Stranded Cost filings with the MPSC for $22 million and $43 million for
2000 and 2001, respectively. In the same filing, Consumers estimated that it
would experience "net" Stranded Costs of $126 million for 2002. The outcome of
these proceedings before the MPSC is uncertain at this time.
Since 1997, Consumers has incurred significant electric utility implementation
costs. The following table outlines the applications filed by Consumers with the
MPSC and the status of recovery for these costs.
In Millions
- --------------------------------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- --------------------------------------------------------------------------------------------------------------
1999 1997 & 1998 $ 20 $ - $ 15 $ 5
2000 1999 30 - 25 5
2001 2000 25 25 - -
2002 2001 8 8 - -
==============================================================================================================
The MPSC disallowed certain costs based upon a conclusion that these amounts did
not represent costs incremental to costs already reflected in rates. In the
orders received for the years 1997 through 1999, the MPSC also ruled that it
reserved the right to undertake another review of the total implementation costs
depending upon the progress and success of the retail open access program, and
ruled that due to the rate freeze imposed by the Customer Choice Act, it was
premature to establish a cost recovery method for the allowable implementation
costs. Consumers expects to receive final orders for the 2000 and 2001
implementation costs in 2002. In addition to the amounts shown, as of March
2002, Consumers incurred and deferred as a regulatory asset, $3 million of
additional implementation costs and has also recorded as a regulatory asset $11
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; however, Consumers
cannot predict the amounts the MPSC will approve as recoverable costs.
Rate Caps: The Customer Choice Act imposes certain limitations on rates that
could result in Consumers being unable to collect customer rates sufficient to
fully recover its cost of conducting business. Some of these costs may be beyond
Consumers' ability to control. In particular, if Consumers needs to purchase
power supply from wholesale suppliers during the period when retail rates are
frozen or capped, the rate restrictions imposed by the Customer Choice Act may
make it impossible for Consumers to fully recover the cost of purchased power
through the rates it charges its customers. As a result, it is not certain that
Consumers can maintain its profit margins in its electric utility business
during the period of the rate freeze or rate caps.
Industrial Contracts: In response to industry restructuring efforts, Consumers
entered into multi-year electric supply contracts with certain of its largest
industrial customers to provide electricity to certain of their facilities at
specially negotiated prices. The MPSC approved these special contracts as part
of its phased introduction to
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competition. During the period from 2001 through 2005, either Consumers or these
industrial customers can terminate or restructure some of these contracts. As of
December 2001, neither Consumers nor any of its industrial customers have
terminated or restructured any of these contracts, but some contracts have
expired by their terms. Outstanding contracts involve approximately 510 MW of
customer power supply requirements. 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 customers in Michigan,
and internal transfer pricing between Consumers' departments and affiliates. In
October 2001, the new code of conduct was reaffirmed without substantial
modification. Consumers appealed the MPSC orders related to the code of conduct
and sought a stay of the orders until the appeal was complete; however, the
request for a stay was denied. Consumers has filed a compliance plan in
accordance with the code of conduct, and has sought waivers to the code of
conduct with respect to utility activities that provide approximately $50
million in annual revenues that may be restricted. The full impact of the new
code of conduct on Consumers' business will remain uncertain until the appellate
courts issue definitive rulings or the MPSC rules on the waivers.
Energy Policy: Uncertainty exists with respect to the enactment of a national
comprehensive energy policy, specifically federal electric industry
restructuring legislation. A variety of bills introduced in Congress in recent
years have sought to change existing federal regulation of the industry. If the
federal government enacts a comprehensive energy policy or legislation
restructuring the electric industry, then that legislation could potentially
affect or even supercede state regulation.
Transmission: On May 1, 2002, Consumers sold its electric transmission
facilities for approximately $290 million in cash to MTH, a non-affiliated
limited partnership whose general partner is a subsidiary of Trans-Elect, Inc.
In 1999, the FERC issued Order No. 2000, that strongly encouraged utilities like
Consumers to either transfer operating control of their transmission facilities
to an RTO, or sell their transmission facilities to an independent company. In
addition, in June 2000, the Michigan legislature passed Michigan's Customer
Choice Act, which contains a requirement that utilities transfer the operating
authority of transmission facilities to an independent company or divest the
facilities. Consumers chose to sell its transmission facilities as a form of
compliance with Michigan's Customer Choice Act and FERC Order No. 2000 rather
than own and invest in an asset it cannot control.
In January 2001, the FERC granted Consumers' application to transfer ownership
and control of its electric transmission facilities to METC, and in April 2001
the transfer took place. Trans-Elect, Inc. submitted the winning bid to purchase
METC through a competitive bidding process, and various federal agencies
approved the transactions. Consumers did not provide any financial or credit
support to Trans-Elect, Inc. in connection with its purchase of METC. Certain of
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and certain of their subsidiaries, but all had left the
employment of such affiliates prior to the period when the transaction was
discussed internally and negotiated with purchasers. After selling its
transmission facilities, Consumers anticipates a reduction in after-tax earnings
of approximately $6 million and $14 million in 2002 and 2003, respectively, as a
result of the loss in revenue associated with wholesale and retail open access
customers that would buy services directly from MTH including the loss of a
return on the transmission assets upon the sale of METC to MTH. Under the
agreement with MTH, and subject to certain additional RTO surcharges,
transmission rates charged to Consumers will be fixed at current levels until
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December 2005, and will be subject to FERC ratemaking thereafter. MTH will
complete the capital program to expand the transmission system's capability to
import electricity into Michigan, as required by the Customer Choice Act, and
Consumers will continue to maintain the system under a five-year contract with
MTH. In April 2002, Consumers received unconditional regulatory approvals for
the sale of the transmission facilities to MTH, and effective April 30, 2002,
Consumers and METC withdrew from Alliance. For further information, see Note 2,
Uncertainties, "Electric Rate Matters - Transmission."
Wholesale Market Competition: In 1996, as a result of the FERC's efforts to move
the electric industry in Michigan to competition, Detroit Edison gave Consumers
the required four-year contractual notice of its intent to terminate the
agreements under which the companies had jointly operated the MEPCC. Detroit
Edison and Consumers restructured and continued certain parts of the MEPCC
control area and joint transmission operations, but expressly excluded any
merchant operations (electricity purchasing, sales, and dispatch operations).
The former joint merchant operations began operating independently on April 1,
2001. The termination of joint merchant operations with Detroit Edison has
opened Detroit Edison and Consumers to wholesale market competition as
individual companies. Consumers cannot predict the long-term financial impact
from the termination of these joint merchant operations with Detroit Edison.
Wholesale Market Pricing: Consumers is authorized by the FERC to sell
electricity at wholesale market prices. In authorizing sales at market prices,
the FERC considers several factors, including the extent to which the seller
possesses "market power" as a result of the seller's dominance of generation
resources and surplus generation resources in adjacent wholesale markets. In
order to continue to be authorized to sell at market prices, Consumers filed a
traditional market dominance analysis in October 2001. In November 2001, the
FERC issued an order modifying the method to be used to determine an entity's
degree of market power. Due, however, to several reliability issues brought
before the FERC regarding this order, the FERC has issued a stay of the order.
If the modified market power test in the order is not amended, Consumers cannot
be certain at this time if it will be granted authorization to continue to sell
wholesale electricity at market-based prices and may be limited to charging
prices no greater than its cost-based rates. A final decision about the proposed
assessment method is not expected for several months.
Consumers cannot predict the impact of these electric industry-restructuring
issues on its financial position, liquidity, or results of operations.
PERFORMANCE STANDARDS: In July 2001, the MPSC proposed electric distribution
performance standards applicable to Consumers and other Michigan distribution
utilities. The proposal would establish standards related to restoration after
an outage, safety, and customer relations. Failure to meet the proposed
performance 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. Consumers will continue to participate in this process.
Consumers cannot predict the outcome of the proposed performance standards or
the likely effect, if any, on Consumers.
For further information and material changes relating to the rate matters and
restructuring of the electric utility industry, see Note 1, Corporate Structure
and Summary of Significant Accounting Policies, and Note 2, Uncertainties,
"Electric Rate Matters - Electric Restructuring" and "Electric Rate Matters -
Electric Proceedings."
UNCERTAINTIES: Several electric business trends or uncertainties may affect
Consumers' financial results and condition. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing electric operations. Such trends and
uncertainties include: 1) the need to make additional capital expenditures and
increase operating expenses for compliance with the Clean Air Act; 2)
environmental liabilities arising from various federal, state and local
environmental laws and regulations, including potential liability or expenses
relating to the Michigan Natural Resources and
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Environmental Protection Acts and Superfund; 3) uncertainties relating to the
storage and ultimate disposal of spent nuclear fuel and the successful operation
of the Palisades plant by NMC; 4) electric industry restructuring issues,
including those described above; 5) Consumers' ability to meet peak electric
demand requirements at a reasonable cost, without market disruption, and
initiatives undertaken to reduce exposure to electric price increases for
purchased power; 6) the recovery of electric restructuring implementation costs;
7) Consumers new status as an electric transmission customer and not as an
electric transmission owner/operator; 8) sufficient reserves for OATT rate
refunds; and 9) the effects of derivative accounting and potential earnings
volatility. For further information about these trends or uncertainties, see
Note 2, Uncertainties.
GAS BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers anticipates gas deliveries,
including gas customer choice deliveries (excluding transportation to the MCV
Facility and off-system deliveries), to grow at an average of about one percent
per year based primarily on a steadily growing customer base. Actual gas
deliveries in future periods may be affected by abnormal weather, alternative
electric costs, changes in competitive and economic conditions, and the level of
natural gas consumption per customer.
GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. Contemporaneously with this
filing, Consumers requested partial and immediate relief in the annual amount of
$33 million. In October 2001, Consumers revised its filing to reflect lower
operating costs and requested a $133 million annual distribution service rate
increase. In December 2001, the MPSC authorized a $15 million annual interim
increase in distribution service revenues. In February 2002, Consumers revised
its filing to reflect lower estimated gas inventory prices and revised
depreciation expense and is now requesting a $105 million distribution service
rate increase. See Note 2, Uncertainties "Gas Rate Matters - Gas Rate Case" for
further information.
UNBUNDLING STUDY: In July 2001, the MPSC directed gas utilities under its
jurisdiction to prepare and file an unbundled cost of service study. The purpose
of the study is to allow parties to advocate or oppose the unbundling of the
following services: metering, billing information, transmission, balancing,
storage, backup and peaking, and customer turn-on and turn-off services.
Unbundled services could be separately priced in the future and made subject to
competition by other providers. The subject is likely to remain the topic of
further study by the utilities in 2002 and under further consideration by the
MPSC. Consumers cannot predict the outcome of unbundling costs on its financial
results and conditions.
UNCERTAINTIES: Several gas business trends or uncertainties may affect
Consumers' financial results and conditions. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing gas operations. Such trends and
uncertainties include: 1) potential environmental costs at a number of sites,
including sites formerly housing manufactured gas plant facilities; 2) future
gas industry restructuring initiatives; 3) any initiatives undertaken to protect
customers against gas price increases; 4) an inadequate regulatory response to
applications for requested rate increases; and 5) market and regulatory
responses to increases in gas costs. For further information about these
uncertainties, see Note 2, Uncertainties.
OTHER OUTLOOK
TERRORIST ATTACKS: Since the September 11, 2001 terrorists attack in the United
States, Consumers has increased security at all facilities and over its
infrastructure, and will continue to evaluate security on an ongoing basis.
Consumers may be required to comply with federal and state regulatory security
measures promulgated in the future. As a result, Consumers anticipates increased
operating costs related to security after September 11, 2001 that could be
significant. Consumers would attempt to seek recovery of these costs from its
customers.
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Consumers Energy Company
ENERGY-RELATED SERVICES: Consumers offers a variety of energy-related services
to retail customers that focus on appliance maintenance, home safety, commodity
choice and assistance to customers purchasing heating, ventilation and air
conditioning equipment. Consumers continues to look for additional growth
opportunities in providing energy-related services to its customers. The ability
to offer all or some of these services and other utility related revenue
generating services, which provide approximately $50 million in annual revenues,
may be restricted by the new code of conduct issued by the MPSC as discussed
above in Electric Business Outlook, "Competition and Regulatory Restructuring -
Code of Conduct."
PENSION AND OPEB COSTS: Consumers provides post retirement benefits under its
Pension Plan, and post retirement health and life benefits under its OPEB plan
to substantially all its employees. Pension and OPEB plan assets, net of
contributions, have reduced in value from the previous year due to a downturn in
the equities market. As a result, Consumers expects to see an increase in
pension and OPEB expense levels over the next few years unless market
performance improves. Consumers anticipates pension expense and OPEB expense to
rise in 2002 by approximately $8 million and $20 million, respectively, over
2001 expenses. For pension expense, this increase is due to a downturn in value
of pension assets during the past two years, forecasted increases in pay and
added service, decline in the interest rate used to value the liability of the
plan, and expiration of the transition gain amortization. For OPEB expense, the
increase is due to the trend of rising health care costs, the market return on
plan assets being below expected levels and a lower discount rate, based on
recent economic conditions, used to compute the benefit obligation. Health care
cost decreases gradually under the assumptions used in the OPEB plan from
current levels through 2009; however, Consumers cannot predict the impact that
interest rates or market returns will have on pension and OPEB expense in the
future.
In January 2002, Consumers made a contribution to the Pension Trust of $47
million and a contribution to the 401(h) segment of the Pension Trust of $15
million.
OTHER MATTERS
NEW ACCOUNTING STANDARDS
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Issued by the FASB in
August 2001, the provisions of SFAS No. 143 require adoption as of January 1,
2003. The standard requires entities to record the fair value of a liability for
an asset retirement obligation in the period in which it is incurred. When the
liability is initially recorded, the entity would capitalize an offsetting
amount by increasing the carrying amount of the related long-lived asset. Over
time, the liability is accreted to its present value each period and the
capitalized cost is depreciated over the related asset's useful life. Consumers
is currently studying the new standard but has yet to quantify the effects of
adoption on its financial statements.
SFAS NO. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS: Issued by the FASB in April 2002,
this Statement rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishment of Debt Made to Satisfy
Sinking-Fund Requirements. As a result, any gain or loss on extinguishment of
debt should be classified as an extraordinary item only if it meets the criteria
set forth in APB Opinion No. 30. The provisions of this section are applicable
to fiscal years beginning 2003. SFAS No. 145 amends SFAS No. 13, Accounting for
Leases, to require sale-leaseback accounting for certain lease modifications
that have similar economic impacts to sale-leaseback transactions. This
provision is effective for transactions occurring after May 15, 2002. Finally,
SFAS No. 145 amends other existing authoritative pronouncements to make various
technical corrections and rescinds SFAS No. 44, Accounting for Intangible Assets
of Motor Carriers. These provisions are effective for financial statements
issued on or after May 15, 2002. Consumers is currently
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studying the effects of the new standard, but has yet to quantify the effects of
adoption on its financial statements.
DERIVATIVE IMPLEMENTATION GROUP ISSUES: In December 2001, the FASB issued final
guidance for DIG Statement No. C16, which is effective April 1, 2002. Consumers
has completed its study of DIG Statement No. C16, and has determined that this
issue will not affect the accounting for its fuel supply contracts.
DERIVATIVES AND HEDGES
MARKET RISK INFORMATION: Consumers is exposed to market risks including, but not
limited to, changes in interest rates, commodity prices, and equity security
prices. Consumers' market risk, and activities designed to minimize this risk,
are subject to the direction of an executive oversight committee consisting of
designated members of senior management and a risk committee, consisting of
business unit managers. The role of the risk committee is to review the
corporate commodity position and ensure that net corporate exposures are within
the economic risk tolerance levels established by Consumers' Board of Directors.
Established policies and procedures are used to manage the risks associated with
market fluctuations.
Consumers uses various contracts, including swaps, options, and forward
contracts to manage its risks associated with the variability in expected future
cash flows attributable to fluctuations in interest rates and commodity prices.
Consumers enters into all risk management contracts for purposes other than
trading.
Contracts entered into to manage interest rate and commodity price risk may be
considered derivative instruments that are subject to derivative and hedge
accounting pursuant to SFAS No. 133. In order for derivative instruments to
qualify for hedge accounting under SFAS No. 133, the hedging relationship must
be formally documented at inception and be highly effective in achieving
offsetting cash flows or offsetting changes in fair value attributable to the
risk being hedged. If hedging a forecasted transaction, the forecasted
transaction must be probable. If a derivative instrument, used as a cash flow
hedge, is terminated early because it is probable that a forecasted transaction
will not occur, any gain or loss as of such date is immediately recognized in
earnings. If a derivative instrument, used as a cash flow hedge, is terminated
early for other economic reasons, any gain or loss as of the termination date is
deferred and recorded when the forecasted transaction affects earnings.
Derivative instruments contain credit risk if the counterparties, including
financial institutions and energy marketers, fail to perform under the
agreements. Consumers minimizes such risk by performing financial credit reviews
using, among other things, publicly available credit ratings of such
counterparties.
In accordance with SEC disclosure requirements, Consumers performs sensitivity
analyses to assess the potential loss in fair value, cash flows and earnings
based upon a hypothetical 10 percent adverse change in market rates or prices.
Consumers determines fair value based upon mathematical models using current and
historical pricing data. Management does not believe that sensitivity analyses
alone provide an accurate or reliable method for monitoring and controlling
risks; therefore, Consumers relies on the experience and judgment of its senior
management to revise strategies and adjust positions, as it deems necessary.
Losses in excess of the amounts determined in sensitivity analyses could occur
if market rates or prices exceed the ten percent shift used for the analyses.
INTEREST RATE RISK: Consumers is exposed to interest rate risk resulting from
the issuance of fixed-rate debt and variable-rate debt, and from interest rate
swap and rate lock agreements. Consumers uses a combination of these instruments
to manage and mitigate interest rate risk exposure when it deems it appropriate,
based upon market conditions. These strategies attempt to provide and maintain
the lowest cost of capital. As of March 31, 2002 and 2001, Consumers had entered
into floating-to-fixed interest rate swap agreements for a notional amount of
$375 million and $300 million, respectively. As of March 31, 2002 and 2001,
Consumers had
CE-15
Consumers Energy Company
outstanding $729 million and $719 million of variable-rate debt, respectively.
At March 31, 2002 and 2001, assuming a hypothetical 10 percent adverse change in
market interest rates, Consumers' exposure to earnings, before tax on its
variable rate debt, would be $1 million and $4 million, respectively. As of
March 31, 2002 and 2001, Consumers had outstanding long-term fixed-rate debt
including fixed-rate swaps of $2.952 billion and $2.583 billion, respectively,
with a fair value of $2.943 billion and $2.531 billion, respectively. As of
March 31, 2002 and 2001, assuming a hypothetical 10 percent adverse change in
market rates, Consumers would have an exposure of $148 million and $131 million
to the fair value of these instruments, respectively, if it had to refinance all
of its long-term fixed-rate debt. Consumers does not intend to refinance its
fixed-rate debt in the near term and believes that any adverse change in debt
price and interest rates would not have a material effect on either its
consolidated financial position, results of operation or cash flows.
COMMODITY MARKET RISK: Consumers enters into, for purposes other than trading,
electricity and gas fuel for generation call options and swap contracts, and gas
supply contracts containing embedded 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 its customers'
electric needs. The gas fuel for generation call options and swap contracts are
used to protect generation activities against risk due to fluctuations in the
market price of natural gas. The gas supply contracts containing embedded put
options are used to purchase reasonably priced gas supply.
As of March 31, 2002 and 2001, the fair value based on quoted future market
prices of electricity-related call option and swap contracts was $19 million and
$97 million, respectively. At March 31, 2002 and 2001, assuming a hypothetical
10 percent adverse change in market prices, the potential reduction in fair
value associated with these contracts would be $4 million and $14 million,
respectively. As of March 31, 2002 and 2001, Consumers had an asset of $48
million and $104 million, respectively, related to premiums incurred for
electric call option contracts. Consumers' maximum exposure associated with the
call option contracts is limited to the premiums incurred. As of March 31, 2002,
the fair value based on quoted future market prices of gas supply contracts
containing embedded put options was $4 million. At March 31, 2002, assuming a
hypothetical 10 percent adverse change in market prices, the potential reduction
in fair value associated with these contracts would be $1 million.
EQUITY SECURITY PRICE RISK: Consumers has a less than 20 percent equity
investment in CMS Energy. At March 31, 2002 and 2001, a hypothetical 10 percent
adverse change in market price would have resulted in an $8 million and $10
million change in its equity investment, respectively. This instrument is
currently marked-to-market through equity. Consumers believes that such an
adverse change would not have a material effect on its consolidated financial
position, results of operation or cash flows.
For further information on market risk and derivative activities, see Note 1,
Corporate Structure and Summary of Significant Accounting Policies, "Risk
Management Activities and Derivative Transactions" and "Implementation of New
Accounting Standards", Note 2, Uncertainties, "Other Electric Uncertainties -
Derivative Activities", "Other Gas Uncertainties - Derivative Activities", and
Note 3, Short-Term Financings and Capitalization, "Derivative Activities."
CHANGE IN AUDITORS
On April 22, 2002, the Board of Directors of Consumers , upon the recommendation
of the Audit Committee of the Board, voted to discontinue the use of Arthur
Andersen to audit the Consumers' financial statements at and for the year ending
December 31, 2002. The Audit Committee of the Board was directed to search for a
replacement independent auditor from among nationally recognized auditing firms
and recommend such replacement firm to the Board for appointment as soon as
practical. Arthur Andersen previously had been retained to review Consumers'
financial statements at and for the quarter ended March 31, 2002.
CE-16
Arthur Andersen's reports on Consumers' consolidated financial statements for
each of the fiscal years ended December 31, 2001 and December 31, 2000 did not
contain an adverse opinion or disclaimer of opinion, nor were they qualified or
modified as to uncertainty, audit scope or accounting principles.
During the fiscal years ended December 31, 2001 and December 31, 2000, and
through the date of their opinion for the quarter ended March 31, 2002, there
were no disagreements with Arthur Andersen on any matter of accounting principle
or practice, financial statement disclosure, or auditing scope or procedure
which, if not resolved to Arthur Andersen's satisfaction, would have caused
Arthur Andersen to make reference to the subject matter in connection with its
report on Consumers' consolidated financial statements for such years; and there
were no reportable events as defined by SEC laws and regulations.
CE-17
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2002 2001
- ----------------------------------------------------------------------------------------------------------------
In Millions
OPERATING REVENUE
Electric $ 609 $ 665
Gas 616 540
Other 11 14
--------------------
1,236 1,219
- ----------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Operation
Fuel for electric generation 67 71
Purchased power - related parties 140 118
Purchased and interchange power 61 112
Cost of gas sold 396 318
Cost of gas sold - related parties 30 31
Other 141 141
-------------------
835 791
Maintenance 50 55
Depreciation, depletion and amortization 107 105
General taxes 57 55
--------------------
1,049 1,006
- ----------------------------------------------------------------------------------------------------------------
PRETAX OPERATING INCOME
Electric 114 135
Gas 63 65
Other 10 13
--------------------
187 213
- ----------------------------------------------------------------------------------------------------------------
OTHER INCOME (DEDUCTIONS)
Dividends and interest from affiliates 1 2
Accretion expense (3) (2)
Other, net 1 2
--------------------
(1) 2
- ----------------------------------------------------------------------------------------------------------------
INTEREST CHARGES
Interest on long-term debt 33 38
Other interest 9 10
Capitalized interest (2) (1)
---------------------
40 47
- ----------------------------------------------------------------------------------------------------------------
NET INCOME BEFORE INCOME TAXES 146 168
INCOME TAXES 54 61
--------------------
NET INCOME 92 107
PREFERRED STOCK DIVIDENDS - -
PREFERRED SECURITIES DISTRIBUTIONS 11 9
--------------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 81 $ 98
================================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-18
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2002 2001
- ----------------------------------------------------------------------------------------------------------------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 92 $ 107
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $2 and $2, respectively) 107 105
Deferred income taxes and investment tax credit 34 13
Capital lease and other amortization 3 8
Undistributed earnings of related parties (10) (13)
Changes in assets and liabilities
Decrease (increase) in accounts receivable and accrued revenue (55) 223
Increase (decrease) in accounts payable (28) (9)
Decrease (increase) in inventories 193 123
Regulatory obligation - gas customer choice (7) (16)
Changes in other assets and liabilities (58) (62)
-----------------------
Net cash provided by operating activities 271 479
- ----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (142) (183)
Cost to retire property, net (15) (26)
Investment in Electric Restructuring Implementation Plan (3) (3)
Investments in nuclear decommissioning trust funds (2) (2)
Proceeds from nuclear decommissioning trust funds 8 10
-----------------------
Net cash used in investing activities (154) (204)
- ----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Retirement of bonds and other long-term debt (344) -
Increase (decrease) in notes payable, net (109) (203)
Payment of common stock dividends (55) (66)
Redemption of preferred securities (30) -
Preferred securities distributions (11) (9)
Payment of capital lease obligations (3) (8)
Payment of preferred stock dividends (1) -
Proceeds from CMS cash infusion 150 -
Proceeds from senior notes and bank loans 298 -
-----------------------
Net cash used in financing activities (105) (286)
- ----------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS 12 (11)
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 16 21
-----------------------
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 28 $ 10
================================================================================================================
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 31 $ 47
Income taxes paid (net of refunds) - -
NON-CASH TRANSACTIONS
Nuclear fuel placed under capital lease $ - $ 2
Other assets placed under capital leases 8 7
=================================================================================================================
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-19
CONSUMERS ENERGY COMPANY
CONSOLIDATED BALANCE SHEETS
ASSETS MARCH 31 MARCH 31
2002 DECEMBER 31 2001
(UNAUDITED) 2001 (UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------
In Millions
PLANT (AT ORIGINAL COST)
Electric $7,733 $7,661 $7,298
Gas 2,625 2,593 2,524
Other 21 23 21
----------------------------------------
10,379 10,277 9,843
Less accumulated depreciation, depletion and amortization 6,022 5,934 5,802
---------------------------------------
4,357 4,343 4,041
Construction work-in-progress 508 464 391
----------------------------------------
4,865 4,807 4,432
- ----------------------------------------------------------------------------------------------------------------
INVESTMENTS
Stock of affiliates 56 59 80
First Midland Limited Partnership 257 253 248
Midland Cogeneration Venture Limited Partnership 316 300 302
---------------------------------------
629 612 630
- ----------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 28 16 10
Accounts receivable and accrued revenue, less allowances
of $4, $4 and $3, respectively 183 125 43
Accounts receivable - related parties 14 17 69
Inventories at average cost
Gas in underground storage 378 569 143
Materials and supplies 69 69 67
Generating plant fuel stock 50 52 50
Prepaid property taxes 120 144 113
Regulatory assets 19 19 19
Other 18 14 24
----------------------------------------
879 1,025 538
- ----------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS
Regulatory assets
Securitization costs 714 717 709
Postretirement benefits 203 209 226
Abandoned Midland Project 11 12 15
Other 171 167 84
Nuclear decommissioning trust funds 576 581 585
Other 162 176 297
---------------------------------------
1,837 1,862 1,916
- ----------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $8,210 $8,306 $7,516
================================================================================================================
CE-20
STOCKHOLDERS' INVESTMENT AND LIABILITIES MARCH 31 MARCH 31
2002 DECEMBER 31 2001
(UNAUDITED) 2001 (UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------
In Millions
CAPITALIZATION
Common stockholder's equity
Common stock $ 841 $ 841 $ 841
Paid-in capital 782 632 646
Revaluation capital 12 4 29
Retained earnings since December 31, 1992 399 373 538
---------------------------------------
2,034 1,850 2,054
Preferred stock 44 44 44
Company-obligated mandatorily redeemable preferred securities
of subsidiaries (a) 490 520 395
Long-term debt 2,433 2,472 2,097
Non-current portion of capital leases 59 56 51
----------------------------------------
5,060 4,942 4,641
- ----------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 253 257 243
Notes payable 150 416 170
Notes payable - CMS Energy 157 - 30
Accounts payable 258 291 242
Accrued taxes 162 219 216
Accounts payable - related parties 85 80 69
Deferred income taxes 23 12 -
Other 248 260 235
---------------------------------------
1,336 1,535 1,205
- ----------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES
Deferred income taxes 772 747 713
Postretirement benefits 242 279 354
Regulatory liabilities for income taxes, net 276 276 260
Power purchase agreement - MCV Partnership 166 169 -
Deferred investment tax credit 100 102 107
Other 258 256 236
---------------------------------------
1,814 1,829 1,670
- ----------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 2)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $8,210 $8,306 $7,516
================================================================================================================
(a) See Note 3, Short-Term Financings and Capitalization
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE BALANCE SHEETS.
CE-21
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31 2002 2001
- ----------------------------------------------------------------------------------------------------------------
In Millions
COMMON STOCK
At beginning and end of period(a) $ 841 $ 841
- ---------------------------------------------------------------------------------------------------------------
OTHER PAID-IN CAPITAL
At beginning of period 632 646
Stockholder's contribution 150 -
----------------------
At end of period 782 646
- ---------------------------------------------------------------------------------------------------------------
REVALUATION CAPITAL
Investments
At beginning of period 16 33
Unrealized gain (loss) on investments(b) - (5)
----------------------
At end of period 16 28
----------------------
Derivative Instruments
At beginning of period(c) (12) 21
Unrealized gain (loss) on derivative instruments(b) 5 (13)
Reclassification adjustments included in net income(b) 3 (7)
----------------------
At end of period (4) 1
- ---------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS
At beginning of period 373 506
Net income(b) 92 107
Cash dividends declared- Common Stock (55) (66)
Cash dividends declared- Preferred Stock - -
Preferred securities distributions (11) (9)
----------------------
At end of period 399 538
- ---------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKHOLDER'S EQUITY $2,034 $2,054
===============================================================================================================
(a) Number of shares of common stock outstanding was 84,108,789 for all periods
presented.
(b) Disclosure of Comprehensive Income:
Revaluation capital
Investments
Unrealized gain (loss) on investments, net of tax of $- and $3, respectively $ - $ (5)
Derivative Instruments
Unrealized gain (loss) on derivative instruments, net of tax of $(3) and
$7, respectively 5 (13)
Reclassification adjustments included in net income, net of tax of $(1) and
$4, respectively 3 (7)
Net income 92 107
----------------------
Total Comprehensive Income $ 100 $ 82
======================
(c) Three Months Ended 2001 is the cumulative effect of change in accounting
principle, net of $(11) tax (Note 1)
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-22
Consumers Energy Company
CONSUMERS ENERGY COMPANY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
These interim Consolidated Financial Statements have been prepared by Consumers
and reviewed by the independent public accountant in accordance with SEC rules
and regulations. As such, certain information and footnote disclosures normally
included in full year financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. Certain prior
year amounts have been reclassified to conform to the presentation in the
current year. In management's opinion, the unaudited information contained in
this report reflects all adjustments necessary to assure the fair presentation
of financial position, results of operations and cash flows for the periods
presented. The Condensed Notes to Consolidated Financial Statements and the
related Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
contained in the Consumers Form 10-K for the year ended December 31, 2001, which
includes the Reports of Independent Public Accountants. Due to the seasonal
nature of Consumers operations, the results as presented for this interim period
are not necessarily indicative of results to be achieved for the fiscal year.
1: CORPORATE STRUCTURE AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CORPORATE STRUCTURE: Consumers, a subsidiary of CMS Energy, a holding company,
is an electric and gas utility company that provides service to customers in
Michigan's Lower Peninsula. Consumers' customer base includes a mix of
residential, commercial and diversified industrial customers, the largest
segment of which is the automotive industry.
BASIS OF PRESENTATION: The consolidated financial statements include Consumers
and its wholly owned subsidiaries. Consumers prepared the financial statements
in conformity with generally accepted accounting principles that include the use
of management's estimates. Consumers uses the equity method of accounting for
investments in its companies and partnerships where it has more than a twenty
percent but less than a majority ownership interest and includes these results
in operating income.
REPORTABLE SEGMENTS: Consumers has two reportable segments: electric and gas.
The electric segment consists of activities associated with the generation,
transmission and distribution of electricity. The gas segment consists of
activities associated with the transportation, storage and distribution of
natural gas. Consumers' reportable segments are domestic strategic business
units organized and managed by the nature of the product and service each
provides. The accounting policies of the segments are the same as those
described in Consumers' 2001 Form 10-K. Consumers' management changed its
evaluation of the performance of the electric and gas segments from pretax
operating income to net income available to common stockholder. The Consolidated
Statements of Income show operating revenue and pretax operating income by
reportable segment. Intersegment sales and transfers are accounted for at
current market prices and are eliminated in consolidated net income available to
common stockholder by segment. The net income available to common stockholder by
reportable segment is as follows:
CE-23
Consumers Energy Company
In Millions
Three Months Ended
March 31 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Net income available to common stockholder
Electric $49 $61
Gas 28 29
Other 4 8
- ------------------------------------------------------------------------------------------------------------------
Total Consolidated $81 $98
==================================================================================================================
UTILITY REGULATION: Consumers accounts for the effects of regulation based on
SFAS No. 71. As a result, the actions of regulators affect when Consumers
recognizes revenues, expenses, assets and liabilities.
In March 1999, Consumers received MPSC electric restructuring orders and, as a
result, discontinued application of SFAS No. 71 for the electric supply portion
of its business. Discontinuation of SFAS No. 71 for the generation portion of
Consumers' business resulted in Consumers reducing the carrying value of its
Palisades plant-related assets by approximately $535 million and establishing a
regulatory asset for a corresponding amount. According to current accounting
standards, Consumers can continue to carry its electric supply-related
regulatory assets if legislation or an MPSC rate order allows the collection of
cash flows to recover these regulatory assets from its regulated transmission
and distribution customers. As of March 31, 2002, Consumers had a net investment
in electric supply facilities of $1.403 billion included in electric plant and
property. See Note 2, Uncertainties, "Electric Rate Matters - Electric
Restructuring."
RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS: Consumers is exposed to
market risks including, but not limited to, changes in interest rates, commodity
prices, and equity security prices. Consumers' market risk, and activities
designed to minimize this risk, are subject to the direction of an executive
oversight committee consisting of designated members of senior management and a
risk committee, consisting of business unit managers. The role of the risk
committee is to review the corporate commodity position and ensure that net
corporate exposures are within the economic risk tolerance levels established by
Consumers' Board of Directors. Established policies and procedures are used to
manage the risks associated with market fluctuations.
Consumers uses various contracts, including swaps, options, and forward
contracts to manage its risks associated with the variability in expected future
cash flows attributable to fluctuations in interest rates and commodity prices.
Consumers enters into all risk management contracts for purposes other than
trading. Contracts entered into to manage interest rate and commodity price risk
may be considered derivative instruments that are subject to derivative and
hedge accounting pursuant to SFAS No. 133.
For further discussion see "Implementation of New Accounting Standards" below,
Note 2, Uncertainties, "Other Electric Uncertainties - Derivative Activities",
"Other Gas Uncertainties - Derivative Activities" and Note 3, Short-Term
Financings and Capitalization, "Derivative Activities."
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS: Consumers adopted SFAS No. 133 on
January 1, 2001. This standard requires Consumers to recognize at fair value,
all contracts that meet the definition of a derivative instrument on the balance
sheet as either assets or liabilities. The standard also requires Consumers to
record all changes in fair value directly in earnings, or other comprehensive
income if the derivative meets certain qualifying hedge criteria. Consumers
determines fair value based upon quoted market prices and mathematical models
using current and historical pricing data. The ineffective portion, if any, of
all hedges are recognized in earnings.
CE-24
Consumers Energy Company
Consumers believes that the majority of its contracts qualify for the normal
purchases and sales exception of SFAS No. 133 and, therefore, are not subject to
derivative accounting. There are, however, certain contracts used to limit
Consumers' exposure to electricity and gas commodity price risk and interest
rate risk that require derivative accounting.
On January 1, 2001, upon initial adoption of the standard, Consumers recorded a
$21 million, net of tax, ($32 million, pretax) cumulative effect adjustment as
an unrealized gain increasing accumulated other comprehensive income. Based on
the pretax initial transition adjustment of $32 million recorded in accumulated
other comprehensive income on January 1, 2001, Consumers reclassified to
earnings $12 million as a reduction to the cost of gas, $1 million as a
reduction to the cost of power supply, $2 million as an increase in interest
expense, and $8 million as an increase in other revenue for the twelve months
ended December 31, 2001. The difference between the initial transition
adjustment and the amounts reclassified to earnings represents an unrealized
loss in the fair value of the derivative instruments since January 1, 2001,
decreasing other comprehensive income. As of December 31, 2001, there were no
amounts remaining in accumulated other comprehensive income related to the
initial transition adjustment.
On January 1, 2001, upon initial adoption of SFAS No. 133, derivative and hedge
accounting for certain utility industry contracts, particularly electric call
option contracts and option-like contracts, and contracts subject to Bookouts
was uncertain. Consumers accounted for these types of contracts as derivatives
that qualified for the normal purchase exception of SFAS No. 133 and, therefore,
did not record these contracts on the balance sheet at fair value. In June and
December 2001, the FASB issued guidance that resolved the accounting for these
contracts. As a result, on July 1, 2001, Consumers recorded a $3 million, net of
tax, cumulative effect adjustment as an unrealized loss decreasing accumulated
other comprehensive income, and on December 31, 2001, recorded an $11 million,
net of tax, cumulative effect adjustment as a decrease to earnings. These
adjustments relate to the difference between the fair value and the recorded
book value of electric call option contracts.
As of March 31, 2002, Consumers had a total of $1 million, net of tax, recorded
as an unrealized loss in other comprehensive income related to its proportionate
share of the effects of derivative accounting related to its equity investment
in the MCV Partnership. Consumers expects to reclassify this loss as a decrease
to other operating revenue during the next 12 months, if this value remains.
For further discussion of derivative activities, see Note 2, Uncertainties,
"Other Electric Uncertainties - Derivative Activities" and "Other Gas
Uncertainties - Derivative Activities" and Note 3, Short-Term Financings and
Capitalization, "Derivative Activities."
SFAS NO. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS:
This new standard was issued by the FASB in October 2001, and supersedes SFAS
No. 121, and APB Opinion No. 30. SFAS No. 144 requires long-lived assets to be
measured at the lower of either the carrying amount or of the fair value less
the cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable value or include amounts for operating losses that have not yet
occurred. SFAS No. 144 also broadens the reporting of discontinued operations to
include all components of an entity with operations that can be distinguished
from the rest of the entity and that will be eliminated from the ongoing
operations of the entity in a disposal transaction. The adoption of SFAS No.
144, effective January 1, 2002, will result in Consumers accounting for any
future impairment or disposal of long-lived assets under the provisions of SFAS
No. 144, but has not changed the accounting used for previous asset impairments
or disposals.
CE-25
Consumers Energy Company
2: UNCERTAINTIES
ELECTRIC CONTINGENCIES
ELECTRIC ENVIRONMENTAL MATTERS: Consumers is subject to costly and increasingly
stringent environmental regulations. Consumers expects that the cost of future
environmental compliance, especially compliance with clean air laws, will be
significant.
Clean Air - In 1997, the EPA introduced new regulations regarding the standard
for ozone and particulate-related emissions that were the subject of litigation.
The United States Supreme Court determined that the EPA has the power to revise
the standards but that the EPA implementation plan was not lawful. In 1998, the
EPA Administrator issued final regulations requiring the state of Michigan to
further limit nitrogen oxide emissions. The EPA has also issued additional final
regulations regarding nitrogen oxide emissions that require certain generators,
including some of Consumers' electric generating facilities, to achieve the same
emissions rate as that required by the 1998 plan. These regulations will require
Consumers to make significant capital expenditures estimated between $530
million and $660 million, calculated in year 2002 dollars. Much of the future
expenditures are for retrofit post-combustion technology. Cost estimates have
been developed, in part, by independent contractors with expertise in this
field. The estimates are dependent on regulatory outcome, market forces
associated with emission reduction, and with regional and national economic
conditions. As of March 2002, Consumers has incurred $326 million in capital
expenditures to comply with these regulations and anticipates that the remaining
capital expenditures will be incurred between 2002 and 2005. At some point after
2005, if new environmental standards for multi-pollutants become effective,
Consumers may need additional capital expenditures to comply with the standards.
Consumers is unable to estimate the additional capital expenditures required
until the proposed standards are further defined. Beginning January 2004, an
annual return of and on these types of capital expenditures, to the extent they
are above depreciation levels, is expected to be recoverable, subject to an MPSC
prudency hearing, in future rates.
These and other required environmental expenditures, if not recovered in
Consumers rates, may have a material adverse effect upon Consumers' financial
condition and results of operations.
Cleanup and Solid Waste - Under the Michigan Natural Resources and Environmental
Protection Act, Consumers expects that it will ultimately incur investigation
and remedial action costs at a number of sites. Consumers believes that these
costs will be recoverable in rates under current ratemaking policies.
Consumers is a potentially responsible party at several contaminated sites
administered under Superfund. Superfund liability is joint and several. Along
with Consumers, many other creditworthy, potentially responsible parties with
substantial assets cooperate with respect to the individual sites. Based upon
past negotiations, Consumers estimates that its share of the total liability for
the known Superfund sites will be between $2 million and $9 million. As of March
31, 2002, Consumers had accrued the minimum amount of the range for its
estimated Superfund liability.
In October 1998, during routine maintenance activities, Consumers identified PCB
as a component in certain paint, grout and sealant materials at the Ludington
Pumped Storage facility. Consumers removed and replaced part of the PCB
material. In April 2000, Consumers proposed a plan to deal with the remaining
materials and is awaiting a response from the EPA.
ELECTRIC RATE MATTERS
ELECTRIC RESTRUCTURING: In June 2000, the Michigan Legislature passed electric
utility restructuring legislation known as the Customer Choice Act. This act: 1)
permits all customers to exercise choice of electric generation
CE-26
Consumers Energy Company
suppliers by January 1, 2002; 2) cuts residential electric rates by five
percent; 3) freezes all electric rates through December 31, 2003, and
establishes a rate cap for residential customers through at least December 31,
2005, and a rate cap for small commercial and industrial customers through at
least December 31, 2004; 4) allows for the use of low-cost Securitization bonds
to refinance qualified costs, as defined by the act, as a means of offsetting
the earnings impact of the five percent residential rate reduction; 5)
establishes a market power supply test that may require the transfer of control
of a portion of generation resources in excess of that required to serve firm
retail sales requirements (a requirement with which Consumers believes itself to
be in compliance with at this time); 6) requires Michigan utilities to join a
FERC-approved RTO or divest their interest in transmission facilities to an
independent transmission owner; 7) requires the joint expansion of available
transmission capability by Consumers, Detroit Edison and American Electric Power
by at least 2,000 MW by June 5, 2002; 8) allows for the deferred recovery of an
annual return of and on capital expenditures in excess of depreciation levels
incurred during and before the rate cap period; and 9) allows for the recovery
of "net" Stranded Costs and implementation costs incurred as a result of the
passage of the act. Consumers is highly confident that it will meet the
conditions of items 5 and 7 above, prior to the earliest rate cap termination
dates specified in the act. Failure to do so could result in an extension of the
rate caps to as late as December 31, 2013. As of March 31, 2002, Consumers spent
$28 million on the required expansion of transmission capabilities. In May 2002,
Consumers sold its transmission facilities to MTH, who will complete the capital
program to expand transmission capabilities.
In October 2000 and January 2001, the MPSC issued orders that authorized
Consumers to issue Securitization bonds. Securitization typically involves the
issuance of asset-backed bonds with a higher credit rating than conventional
utility corporate financing. The orders authorized Consumers to securitize
approximately $469 million in qualified costs, which were primarily regulatory
assets plus recovery of the Securitization expenses. Securitization is expected
to result in lower interest costs and a longer amortization period for the
securitized assets, that would offset the majority of the revenue impact of the
five percent residential rate reduction of approximately $22 million in 2000 and
$49 million on an annual basis thereafter that Consumers was required to
implement by the Customer Choice Act. The orders direct Consumers to apply any
cost savings in excess of the five percent residential rate reduction to rate
reductions for non-residential customers and reductions in Stranded Costs for
retail open access customers after the bonds are sold. Excess savings are
currently estimated to be approximately $12 million annually.
In November 2001, Consumers Funding LLC, a special purpose consolidated
subsidiary of Consumers formed to issue the bonds, issued $469 million of
Securitization bonds, Series 2001-1. The Securitization bonds mature at
different times over a period of up to 14 years and have an average interest
rate of 5.3 percent. The last expected maturity date is October 20, 2015. Net
proceeds from the sale of the Securitization bonds after issuance expenses were
approximately $460 million. The net proceeds were used by Consumers to buy back
$164 million of its common stock from its parent, CMS Energy. Beginning in
December 2001, and completed in March 2002, the remainder of these proceeds were
used to pay down long-term debt. CMS Energy used the $164 million received from
Consumers to pay down its own short-term debt.
Consumers and Consumers Funding LLC will recover the repayment of principal,
interest and other expenses relating to the issuance of the bonds through a
securitization charge and a tax charge that began in December 2001. These
charges are subject to an annual true-up until one year prior to the last
expected bond maturity date, and no more than quarterly thereafter. Current
electric rate design covers these charges, and there will be no impact on rates
for most of Consumers' electric customers until the rate freeze imposed under
the Customer Choice Act expires. Securitization charges collected will be
remitted to a trustee for the Securitization bonds and are not available to
Consumers' creditors.
Regulatory assets are normally amortized over their period of regulated
recovery. Beginning January 1, 2001, the amortization of the approved regulatory
assets being securitized as qualified costs was deferred, which
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effectively offset the loss in revenue in 2001 resulting from the five percent
residential rate reduction. In December 2001, after the Securitization bonds
were sold, the amortization was re-established based on a schedule that is the
same as the recovery of the principal amounts of the securitized qualified
costs. In 2002, the amortization amount is expected to be approximately $31
million and the securitized assets will be fully amortized by the end of 2015.
In 1998, Consumers submitted a plan for electric retail open access to the MPSC
and in March 1999 the MPSC issued orders that generally supported the plan.
Implementation began in September 1999. The Customer Choice Act states that
orders issued by the MPSC before the date of this act that: 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 are in compliance with this act and enforceable by the MPSC.
In September 2000, as required by the MPSC, Consumers once again filed tariffs
governing its retail open access program and addressed revisions appropriate to
comply with the Customer Choice Act. In December 2001, the MPSC approved revised
retail open access service tariffs. The revised tariffs establish the rates,
terms, and conditions under which retail customers will be permitted to choose
an alternative electric supplier for generation services. The tariffs were
effective January 1, 2002, and, in general, did not require any significant
modifications in the existing retail open access program. The terms of the
tariff allow retail open access customers, upon thirty days notice to Consumers,
to return to Consumers' generation service at current tariff rates. Consumers
may not have sufficient, reasonably priced, capacity to meet the additional
demand needs of returning retail open access customers, and may be forced to
purchase electricity on the spot market at prices higher than it could recover
from its customers.
POWER SUPPLY COSTS: During periods when electric demand is high, the cost of
purchasing electricity on the spot market can be substantial. To reduce
Consumers' exposure to the fluctuating cost of electricity, and to ensure
adequate supply to meet demand, Consumers intends to maintain sufficient
generation and to purchase electricity from others to create a power supply
reserve, also called a reserve margin, of approximately 15 percent. The reserve
margin provides Consumers with additional power supply above its anticipated
peak power supply demands. It also allows Consumers to provide reliable service
to its electric service customers and to protect itself against unscheduled
plant outages and unanticipated demand. For the summers 2002 and 2003, as it has
in previous summers, Consumers is planning for a reserve margin of 15 percent.
The actual reserve margin needed will depend primarily on summer weather
conditions, the level of retail open access requirements being served by others
during the summer, and any unscheduled plant outages. As of April 2002,
alternative electric suppliers are providing generation services to customers
with 332 MW of demand.
To reduce the risk of high electric prices during peak demand periods and to
achieve its reserve margin target, Consumers employs a strategy of purchasing
electric call option contracts for the physical delivery of electricity during
the months of June through September. As of March 31, 2002, Consumers had
purchased or had commitments to purchase electric call option contracts covering
the estimated reserve margin requirement for the summer 2002 and partially
covering the estimated reserve margin requirements for summers 2003 through
2007, and has recorded an asset of $47 million for these call options, of which
$10 million pertains to 2002.
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 of fuel for electric generation, and purchased and
interchange power. In 1998, as part of the electric restructuring efforts, the
MPSC suspended the PSCR process through December 31, 2001. Under the suspension,
the MPSC 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 for all customers 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.
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TRANSMISSION: On May 1, 2002, Consumers sold its electric transmission
facilities for approximately $290 million in cash to MTH, a non-affiliated
limited partnership whose general partner is a subsidiary of Trans-Elect Inc.
In 1999, the FERC issued Order No. 2000, that strongly encouraged utilities like
Consumers to either transfer operating control of their transmission facilities
to an RTO, or sell their transmission facilities to an independent company. In
addition, in June 2000, the Michigan legislature passed Michigan's Customer
Choice Act, which contains a requirement that utilities transfer the operating
authority of transmission facilities to an independent company or divest the
facilities. Consumers chose to sell its transmission facilities as a form of
compliance with Michigan's Customer Choice Act and FERC Order No. 2000 rather
than own and invest in an asset that it cannot control.
In January 2001, the FERC granted Consumers' application to transfer ownership
and control of its electric transmission facilities to METC, and in April 2001,
the transfer took place. Trans-Elect, Inc. submitted the winning bid to purchase
METC through a competitive bidding process, and various federal agencies
approved the transaction. Consumers did not provide any financial or credit
support to Trans-Elect, Inc. in connection with its purchase of METC. Certain of
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and certain of their subsidiaries, but all had left the
employment of such affiliates prior to the period when the transaction was
discussed internally and negotiated with purchasers. After selling its
transmission facilities, Consumers anticipates a reduction in after-tax earnings
of approximately $6 million and $14 million in 2002 and 2003, respectively, as a
result of the loss in revenue associated with wholesale and retail open access
customers that would buy services directly from MTH, including the loss of a
return on the transmission assets upon the sale of METC to MTH. Under the
agreement with MTH, and subject to additional RTO surcharges, transmission rates
charged to Consumers will be fixed at current levels until December 31, 2005,
and will be subject to FERC ratemaking thereafter. MTH will complete the capital
program to expand the transmission system's capability to import electricity
into Michigan, as required by the Customer Choice Act, and Consumers will
continue to maintain the system under a five-year contract with MTH. In April
2002, Consumers received unconditional regulatory approval for the sale of the
transmission facilities to MTH, and effective April 30, 2002, Consumers and METC
withdrew from Alliance.
In the past, when IPPs connected to transmission systems they paid a fee that
was used by transmission companies to offset capital costs incurred to connect
the IPP to the transmission system and provide the system upgrades needed as a
result of the interconnection. In order to promote competition in the electric
generation market, the FERC recently issued an order that requires the system
upgrade portion of the fee to be refunded to IPPs over time as transmission
service is taken. As a result, transmission companies no longer have the benefit
of lowering their capital costs for transmission system upgrades. This has
resulted in METC recording a $30 million liability for a refund to IPPs.
Subsequently, MTH assumed this liability as part of its purchase of the
transmission facilities.
In June 2001, the Michigan South Central Power Agency and the Michigan Public
Power Agency filed suit against Consumers and METC in a Michigan circuit court.
The suit sought to prevent the sale or transfer of transmission facilities
without first binding a successor to honor the municipal agencies' ownership
interests, contractual agreements and rights that preceded the transfer of the
transmission facilities to METC. In August 2001, the parties reached two
settlements. The settlements were approved by the Michigan circuit court and
were amended in February 2002 to assure that closing could occur if all
conditions to closing are satisfied. The circuit court has retained jurisdiction
over the matter and should dismiss the lawsuit after closing.
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ELECTRIC PROCEEDINGS: The Customer Choice Act allows for the recovery by an
electric utility of the cost of implementing the act's requirements and "net"
Stranded Costs, without defining the term. The act directs the MPSC to establish
a method of calculating "net" Stranded Costs and of conducting related true-up
adjustments. In December 2001, the MPSC adopted a methodology for calculating
"net" Stranded Costs as the shortfall between (a) the revenue needed 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
those revenue needs. According to the MPSC, "net" Stranded Costs are to be
recovered from retail open access customers through a Stranded Cost transition
charge. Even though the MPSC ruled that the Stranded Cost transition charge to
be in effect on January 1, 2002 for the recovery of "net" Stranded Costs for
calendar year 2000 for Consumers is zero, the MPSC also indicated that the "net"
Stranded Costs for 2000 would be subject to further review in the context of its
subsequent determinations of "net" Stranded Costs for 2001 and later years. The
MPSC authorized Consumers to use deferred accounting to recognize the future
recovery of costs determined to be stranded by application of the MPSC's
methodology. Consumers is seeking a rehearing and clarification of the
methodology adopted, and in April 2002, made "net" Stranded Cost filings with
the MPSC for $22 million and $43 million for 2000 and 2001, respectively. In the
same filing, Consumers estimated that it would experience "net" Stranded Costs
of $126 million for 2002. The outcome of these proceedings before the MPSC is
uncertain at this time.
Since 1997, Consumers has incurred significant electric utility implementation
costs. The following table outlines the applications filed by Consumers with the
MPSC and the status of recovery for these costs.
In Millions
- --------------------------------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
- --------------------------------------------------------------------------------------------------------------
1999 1997 & 1998 $ 20 $ - $ 15 $ 5
2000 1999 30 - 25 5
2001 2000 25 25 - -
2002 2001 8 8 - -
==============================================================================================================
The MPSC disallowed certain costs based upon a conclusion that these amounts did
not represent costs incremental to costs already reflected in rates. In the
orders received for the years 1997 through 1999, the MPSC also ruled that it
reserved the right to undertake another review of the total implementation costs
depending upon the progress and success of the retail open access program, and
ruled that due to the rate freeze imposed by the Customer Choice Act, it was
premature to establish a cost recovery method for the allowable implementation
costs. Consumers expects to receive final orders for the 2000 and 2001
implementation costs in 2002. In addition to the amounts shown, as of March
2002, Consumers incurred and deferred as a regulatory asset, $3 million of
additional implementation costs and has also recorded as a regulatory asset $11
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; however, Consumers
cannot predict the amounts the MPSC will approve as recoverable costs.
In 1996, Consumers filed new OATT transmission rates with the FERC for approval.
Certain interveners contested these rates, and hearings were held before an ALJ
in 1998. In 1999, the ALJ rendered an initial decision that was largely upheld
by the FERC in March 2002 and requires Consumers refund, with interest, any
over-collections for past services as measured by new OATT rates. Consumers,
since the initial decision, has been reserving a portion of revenues billed to
customers under then existing OATT rates. In April 2002, FERC issued a decision
largely affirming the initial decision but increasing the recommended rate of
return. A compliance proceeding will be held at FERC to determine Consumers'
refund responsibility. Consumers believes its reserve is sufficient to satisfy
its estimated refund obligation.
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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.
Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended
March 31 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Pretax operating income $9 $13
Income taxes and other 3 4
- ------------------------------------------------------------------------------------------------------------------
Net income $6 $ 9
==================================================================================================================
Power Supply Purchases from the MCV Partnership - Consumers' annual obligation
to purchase capacity from the MCV Partnership is 1,240 MW through the
termination of the PPA in 2025. The PPA requires Consumers to pay, based on the
MCV Facility's availability, a levelized average capacity charge of 3.77 cents
per kWh, a fixed energy charge, and a variable energy charge based primarily on
Consumers' average cost of coal consumed for all kWh delivered. Since January 1,
1993, the MPSC has permitted Consumers to recover capacity charges averaging
3.62 cents per kWh for 915 MW, plus a substantial portion of the fixed and
variable energy charges. Since January 1, 1996, the MPSC has also permitted
Consumers to recover capacity charges for the remaining 325 MW of contract
capacity with an initial average charge of 2.86 cents per kWh increasing
periodically to an eventual 3.62 cents per kWh by 2004 and thereafter. However,
due to the current freeze of Consumers' retail rates that the Customer Choice
Act requires, the capacity charge for the 325 MW is now frozen at 3.17 cents per
kWh. After September 2007, the PPA's terms require Consumers to pay the MCV
Partnership capacity and energy charges that the MPSC has authorized for
recovery from electric customers.
In 1992, Consumers recognized a loss for the present value of the estimated
future underrecoveries of power supply costs under the PPA based on MPSC cost
recovery orders. Consumers continually evaluates the adequacy of the PPA
liability for future underrecoveries. These evaluations consider management's
assessment of operating levels at the MCV Facility through 2007 along with
certain other factors including MCV related costs that are included in
Consumers' frozen retail rates. During the third quarter of 2001, in connection
with Consumers' long-term electric supply planning, management reviewed the PPA
liability assumptions related to increased expected long-term dispatch of the
MCV Facility and increased MCV related costs. As a result, in September 2001,
Consumers increased the PPA liability by $126 million. Management believes that,
following the increase, the PPA liability adequately reflects the present value
of the PPA's future effect on Consumers. At March 31, 2002 and 2001, the
remaining after-tax present value of the estimated future PPA liability
associated with the loss totaled $116 million and $43 million, respectively. For
further discussion on the impact of the frozen PSCR, see "Electric Rate Matters"
in this Note.
In March 1999, Consumers and the MCV Partnership reached an agreement effective
January 1, 1999, that capped availability payments to the MCV Partnership at
98.5 percent. If the MCV Facility generates electricity
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at the maximum 98.5 percent level during the next five years, Consumers'
after-tax cash underrecoveries associated with the PPA could be as follows:
In Millions
- ------------------------------------------------------------------------------------------------------------------
2002 2003 2004 2005 2006
- ------------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $37 $36 $36 $36
==================================================================================================================
In February 1998, the MCV Partnership appealed the January 1998 and February
1998 MPSC orders related to electric utility restructuring. At the same time,
MCV Partnership filed suit in the United States District Court in Grand Rapids
seeking a declaration that the MPSC's failure to provide Consumers and MCV
Partnership a certain source of recovery of capacity payments after 2007
deprived MCV Partnership of its rights under the Public Utilities Regulatory
Policies Act of 1978. In July 1999, the District Court granted MCV Partnership's
motion for summary judgment. The Court permanently prohibited enforcement of the
restructuring orders in any manner that denies any utility the ability to
recover amounts paid to qualifying facilities such as the MCV Facility or that
precludes the MCV Partnership from recovering the avoided cost rate. The MPSC
appealed the Court's order to the 6th Circuit Court of Appeals in Cincinnati. In
June 2001, the 6th Circuit overturned the lower court's order and dismissed the
case against the MPSC. The appellate court determined that the case was
premature and concluded that the qualifying facilities needed to wait until 2008
for an actual factual record to develop before bringing claims against the MPSC
in federal court. The MCV Partnership has requested rehearing of the appellate
court's order.
NUCLEAR FUEL COST: Consumers amortizes nuclear fuel cost to fuel expense based
on the quantity of heat produced for electric generation. Through November 2001,
Consumers expensed the interest on leased nuclear fuel as it was incurred.
Effective December 2001, Consumers no longer leases its nuclear fuel.
For nuclear fuel used after April 6, 1983, Consumers charges disposal costs to
nuclear fuel expense, recovers these costs through electric rates, and then
remits them to the DOE quarterly. Consumers elected to defer payment for
disposal of spent nuclear fuel burned before April 7, 1983. As of March 31,
2002, Consumers has a recorded liability to the DOE of $136 million, including
interest, which is payable upon the first delivery of spent nuclear fuel to the
DOE. Consumers recovered through electric rates the amount of this liability,
excluding a portion of interest. In 1997, a federal court decision has confirmed
that the DOE was to begin accepting deliveries of spent nuclear fuel for
disposal by January 31, 1998. Subsequent litigation in which Consumers and
certain other utilities participated has not been successful in producing more
specific relief for the DOE's failure to comply.
In July 2000, the DOE reached a settlement agreement with one utility to address
the DOE's delay in accepting spent fuel. The DOE may use that settlement
agreement as a framework that it could apply to other nuclear power plants;
however, certain other utilities are challenging the validity of the settlement.
Additionally, there are two court decisions that support the right of utilities
to pursue damage claims in the United States Court of Claims against the DOE for
failure to take delivery of spent fuel. A number of utilities have commenced
litigation in the Court of Claims. Consumers is evaluating its options with
respect to its contract with the DOE.
NUCLEAR MATTERS: In April 2002, Palisades received its annual performance review
in which the NRC stated that Palisades operated in a manner that preserved
public health and safety. With the exception of one fire protection smoke
detector location finding with low safety significance, the NRC classified all
inspection findings to have very low safety significance. Other than the
follow-up fire protection inspection associated with this one finding, the NRC
plans to conduct only baseline inspections at the facility through May 31, 2003.
The amount of spent nuclear fuel discharged from the reactor to date exceeds
Palisades' temporary on-site
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storage pool capacity. Consequently, Consumers is using NRC-approved steel and
concrete vaults, commonly known as "dry casks", for temporary on-site storage.
As of March 31, 2002, Consumers had loaded 18 dry casks with spent nuclear fuel
at Palisades. Palisades will need to load additional dry casks by the fall of
2004 in order to continue operation. Palisades currently has three empty
storage-only dry casks on-site, with storage pad capacity for up to seven
additional loaded dry casks. Consumers anticipates that licensed transportable
dry casks for additional storage, along with more storage pad capacity, will be
available prior to 2004.
In December 2000, the NRC issued an amendment revising the operating license for
Palisades and extending the expiration date to March 2011, with no restrictions
related to reactor vessel embrittlement.
In 2000, Consumers made an equity investment and entered into an operating
agreement with NMC. NMC was formed in 1999 by four utilities to operate and
manage the nuclear generating plants owned by these utilities. Consumers
benefits by consolidating expertise, cost control and resources among all of the
nuclear plants being operated on behalf of the NMC member companies.
In November 2000, Consumers requested approval from the NRC to transfer
operating authority for Palisades to NMC and the request was granted in April
2001. The formal transfer of authority from Consumers to NMC took place in May
2001. Consumers retains ownership of Palisades, its 789 MW output, the current
and future spent fuel on site, and ultimate responsibility for the safe
operation, maintenance and decommissioning of the plant. Under the agreement
that transferred operating authority of the plant to NMC, salaried Palisades'
employees became NMC employees on July 1, 2001. Union employees work under the
supervision of NMC pursuant to their existing labor contract as Consumers'
employees. NMC currently has responsibility for operating eight units with 4,500
MW of generating capacity in Wisconsin, Minnesota, Iowa and Michigan. As a
result of the equity ownership in NMC, Consumers may be exposed to additional
financial impacts from the operation of all of those units.
On June 20, 2001, the Palisades reactor was shut down so technicians could
inspect a small steam leak on a control rod drive assembly. There was no risk to
the public or workers. In August 2001, Consumers completed an expanded
inspection that included all similar control rod drive assemblies and elected to
completely replace the defective components. Installation of the new components
was completed in December 2001 and the plant returned to service and has been
operating since January 21, 2002. Consumers' capital expenditures for the
components and their installation was approximately $31 million.
From the start of the June 20th outage through the end of 2001, the impact on
net income of replacement power supply costs associated with the outage was
approximately $59 million. Subsequently, in January 2002, the impact on 2002 net
income was $5 million.
Consumers maintains insurance against property damage, debris removal, personal
injury liability and other risks that are present at its nuclear facilities.
Consumers also maintains coverage for replacement power supply costs during
prolonged accidental outages at Palisades. Insurance would not cover such costs
during the first 12 weeks of any outage, but would cover most of such costs
during the next 52 weeks of the outage, followed by reduced coverage to 80
percent for 110 additional weeks. The June 2001 through January 2002 Palisades
outage, however, was not an insured event. If certain covered losses occur at
its own or other nuclear plants similarly insured, Consumers could be required
to pay maximum assessments of $26.9 million in any one year to NEIL; $88 million
per occurrence under the nuclear liability secondary financial protection
program, limited to $10 million per occurrence in any year; and $6 million if
nuclear workers claim bodily injury from radiation exposure. Consumers considers
the possibility of these assessments to be remote. NEIL limits its coverage from
multiple acts of terrorism during a twelve-month period to a maximum aggregate
of $3.24 billion, allocated among the claimants, plus recoverable reinsurance,
indemnity and other sources. The nuclear liability insurers for Palisades and
Big Rock also limit the amount of their coverage for liability from terrorist
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acts to $200 million. This could affect the amount of loss coverage for
Consumers should multiple acts of terrorism occur. The Price Anderson Act
expires on August 1, 2002 and is currently in the process of reauthorization by
the U. S. Congress. It is possible that the Price Anderson Act will not be
reauthorized or changes may be made that significantly affect the insurance
provisions for nuclear plants.
CAPITAL EXPENDITURES: In 2002, 2003, and 2004, Consumers estimates electric
capital expenditures, including new lease commitments and environmental costs
under the Clean Air Act, of $450 million, $405 million, and $440 million. For
further information, see the Capital Expenditures Outlook section in the MD&A.
DERIVATIVE ACTIVITIES: Consumers' electric business uses purchased electric call
option contracts to meet its regulatory obligation to serve, which requires
providing a physical supply of electricity to customers, and to manage electric
cost and to ensure a reliable source of capacity during periods of peak demand.
These contracts are subject to derivative accounting in accordance with SFAS No.
133, and as such are required to be recorded at fair value on the balance sheet,
with changes in fair value recorded either directly in earnings or other
comprehensive income if the contract meets certain qualifying hedge criteria. On
July 1, 2001, upon initial adoption of the standard for these contracts,
Consumers recorded a $3 million, net of tax, cumulative effect adjustment as an
unrealized loss decreasing accumulated other comprehensive income. This
adjustment relates to the difference between the fair value and the recorded
book value of these electric call option contracts. The adjustment to
accumulated other comprehensive income relates to electric call option contracts
that qualified for cash flow hedge accounting prior to the initial adoption of
SFAS No. 133. After July 1, 2001, these contracts will not qualify for hedge
accounting under SFAS No. 133 and, therefore, Consumers will record any change
in fair value subsequent to July 1, 2001 directly in earnings, which could cause
earnings volatility. The initial amount recorded in other comprehensive income
will be reclassified to earnings as the forecasted future transactions occur or
the call options expire. The majority of these contracts expired in the third
quarter 2001 and the remaining contracts will expire in 2002. As of December 31,
2001, $2 million, net of tax, was reclassified to earnings as part of cost of
power supply. The remainder is expected to be reclassified to earnings in the
third quarter of 2002.
In December 2001, the FASB issued revised guidance regarding derivative
accounting for electric call option contracts and option-like contracts. The
revised guidance amended the criteria to be used to determine if derivative
accounting is required. Consumers re-evaluated its electric call option and
option-like contracts and determined that under the revised guidance additional
contracts require derivative accounting. Therefore, as of December 31, 2001,
upon initial adoption of the revised guidance for these contracts, Consumers
recorded an $11 million, net of tax, cumulative effect adjustment as a decrease
to earnings. This adjustment relates to the difference between the fair value
and the recorded book value of these electric call option contracts. Consumers
will record any change in fair value subsequent to December 31, 2001 directly in
earnings, which could cause earnings volatility. As of March 31, 2002, all of
Consumers' purchased electric call option contracts subject to derivative
accounting were recorded on the balance sheet at a fair value of $3 million. A
change in value from December 31, 2001 to March 31, 2002, representing a gain of
$2 million was recorded in earnings as a reduction in the cost of power.
Consumers' electric business also uses gas swap contracts to protect against
price risk due to the fluctuations in the market price of gas used as fuel for
generation of electricity. These contracts are financial contracts that will be
used to offset increases in the price of probable forecasted gas purchases.
These contracts do not qualify for hedge accounting and, therefore, Consumers
will record any change in the fair value of these contracts directly in earnings
as part of the cost of power supply, which could cause earnings volatility. As
of March 31, 2002, a gain of $1 million has been recorded for 2002, which
represents the fair value of these contracts at March 31, 2002. These contracts
expire in December 2002.
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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 further investigation and remedial action for all
23 sites using the Gas Research Institute-Manufactured Gas Plant Probabilistic
Cost Model. The estimated total costs are between $82 million and $113 million;
these estimates are based on discounted 2001 costs and follow EPA recommended
use of discount rates between 3 and 7 percent for this type of activity.
Consumers expects to recover a significant portion of these costs through
insurance proceeds and through MPSC approved rates charged to its customers. As
of March 31, 2002, Consumers has an accrued liability of $55 million, (net of
$27 million of expenditures incurred to date), and a regulatory asset of $70
million. Any significant change in assumptions, such as an increase in the
number of sites, different remediation techniques, nature and extent of
contamination, and legal and regulatory requirements, could affect Consumers'
estimate of remedial action costs. The MPSC currently allows Consumers to
recover $1 million of manufactured gas plant facilities environmental clean-up
costs annually. Consumers defers and amortizes, over a period of ten years,
manufactured gas plant facilities environmental clean-up costs above the amount
currently being recovered in rates. Additional rate recognition of amortization
expense cannot begin until after a prudency review in a future general gas rate
case. Consumers' position in the current general gas rate case is that all
manufactured gas plant facilities environmental clean-up expenditures for years
1998 through 2002 are prudent.
GAS RATE MATTERS
GAS RESTRUCTURING: From April 1, 1998 to March 31, 2001, Consumers conducted an
experimental gas customer choice pilot program that froze gas distribution and
GCR rates through the period. On April 1, 2001, a permanent gas customer choice
program commenced under which Consumers returned to a GCR mechanism that allows
it to recover from its bundled customers all prudently incurred costs to
purchase the natural gas commodity and transport it to Consumers for ultimate
distribution to customers.
GAS COST RECOVERY: As part of a settlement agreement approved by the MPSC in
July 2001, Consumers agreed not to bill a price in excess of $4.69 per mcf of
natural gas under the GCR factor mechanism through March 2002. This agreement is
not expected to affect Consumers' earnings outlook because Consumers recovers
from customers the amount that it actually pays for natural gas in the
reconciliation process. The settlement does not affect Consumers' June 2001
request to the MPSC for a distribution service rate increase. The MPSC also
approved a methodology to adjust bills for market price increases quarterly
without returning to the MPSC for approval. In December 2001, Consumers filed
its GCR Plan for the period April 2002 through March 2003. Consumers is
requesting authority to bill a GCR factor up to $3.50 per mcf for this period.
GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. Consumers is seeking a 12.25
percent authorized return on equity. Contemporaneously with this filing,
Consumers requested partial and immediate relief in the annual amount of $33
million. The relief is primarily for higher carrying costs on more expensive
natural gas inventory than is currently included in rates. In October 2001,
Consumers revised its filing to reflect lower operating costs and requested a
$133 million annual distribution service rate increase. In December 2001, the
MPSC authorized a $15 million annual interim increase in distribution service
rate revenues. The order authorizes Consumers to apply the interim
CE-35
Consumers Energy Company
increase on its gas sales customers' bills for service effective December 21,
2001. The increase is under bond and subject to refund if the final rate
increase is less than the interim rate increase. In February 2002, Consumers
revised its filing to reflect lower estimated gas inventory prices and revised
depreciation expense and is now requesting a $105 million annual distribution
service rate increase. If the MPSC approves Consumers' total request, then
Consumers could bill an additional amount of approximately $4.78 per month,
representing an 8.9 percent increase in the typical residential customer's
average monthly bill.
OTHER GAS UNCERTAINTIES
CAPITAL EXPENDITURES: In 2002, 2003, and 2004, Consumers estimates gas capital
expenditures, including new lease commitments, of $175 million, $165 million,
and $150 million. For further information, see the Capital Expenditures Outlook
section in the MD&A.
DERIVATIVE ACTIVITIES: Consumers' gas business uses fixed price gas supply
contracts to meet its regulatory obligation to provide gas to its customers as
the lowest possible prudent cost. Some of these contracts contain embedded put
options that disqualify the contracts from the normal purchase exception of SFAS
No. 133, and therefore require derivative accounting. As of March 31, 2002,
Consumers gas supply contracts requiring derivative accounting had a fair value
of $4 million, representing a fair value gain on the contract since the date of
inception, and this gain was recorded directly in earnings as part of other
income, and then directly offset and recorded as a regulatory liability on the
balance sheet. Any subsequent changes in fair value will be recorded in the same
manner. These contracts expire in October 2002.
OTHER UNCERTAINTIES
In addition to the matters disclosed in this note, Consumers and certain of its
subsidiaries are parties to certain lawsuits and administrative proceedings
before various courts and governmental agencies arising from the ordinary course
of business. These lawsuits and proceedings may involve personal injury,
property damage, contractual matters, environmental issues, federal and state
taxes, rates, licensing and other matters.
Consumers has accrued estimated losses for certain contingencies discussed in
this note. Resolution of these contingencies is not expected to have a material
adverse impact on Consumers' financial position, liquidity, or results of
operations.
3: SHORT-TERM FINANCINGS AND CAPITALIZATION
AUTHORIZATION: At March 31, 2002, Consumers had FERC authorization to issue or
guarantee through June 2002, up to $1.4 billion of short-term securities
outstanding at any one time. Consumers also had remaining FERC authorization to
issue through June 2002 up to $520 million of long-term securities for general
corporate purposes and $200 million of First Mortgage Bonds to be issued solely
as security for the long-term securities.
SHORT-TERM FINANCINGS: Consumers has an unsecured $300 million credit facility
maturing in July 2002 and unsecured lines of credit aggregating $200 million.
These facilities are available to finance seasonal working capital requirements
and to pay for capital expenditures between long-term financings. At March 31,
2002, a total of $150 million was outstanding at a weighted average interest
rate of 2.6 percent, compared with $170 million outstanding at March 31, 2001,
at a weighted average interest rate of 6.0 percent.
Consumers currently has in place a $325 million trade receivables sale program.
At March 31, 2002 and 2001, receivables sold under the program totaled $325
million and $432 million, respectively. Accounts receivable and accrued revenue
in the Consolidated Balance Sheets have been reduced to reflect receivables
sold.
CE-36
Consumers Energy Company
On April 1, 2002, Consumers established a new subsidiary, Consumers Receivable
Funding, LLC. This consolidated subsidiary was established to sell accounts
receivable to an unrelated third party.
LONG-TERM FINANCINGS: In March 2002, Consumers sold $300 million principal
amount of six percent senior notes, maturing in March 2005. Net proceeds from
the sale were $299 million. Consumers used the net proceeds to replace a first
mortgage bond that was to mature in 2003.
FIRST MORTGAGE BONDS: Consumers secures its First Mortgage Bonds by a mortgage
and lien on substantially all of its property. Consumers' ability to issue and
sell securities is restricted by certain provisions in its First Mortgage Bond
Indenture, its Articles of Incorporation and the need for regulatory approvals
to meet appropriate federal law.
MANDATORILY REDEEMABLE PREFERRED SECURITIES: Consumers has wholly owned
statutory business trusts that are consolidated within its financial statements.
Consumers created these trusts for the sole purpose of issuing Trust Preferred
Securities. The primary asset of the trusts is a note or debenture of Consumers.
The terms of the Trust Preferred Security parallel the terms of the related
Consumers' note or debenture. The term, rights and obligations of the Trust
Preferred Security and related note or debenture are also defined in the related
indenture through which the note or debenture was issued, Consumers' guarantee
of the related Trust Preferred Security and the declaration of trust for the
particular trust. All of these documents together with their related note or
debenture and Trust Preferred Security constitute a full and unconditional
guarantee by Consumers of the trust's obligations under the Trust Preferred
Security. In addition to the similar provisions previously discussed, specific
terms of the securities follow:
In Millions
- -------------------------------------------------------------------------------------------------------------------
Earliest
Trust and Securities Rate Amount Outstanding Maturity Redemption
- -------------------------------------------------------------------------------------------------------------------
March 31 2002 2001 2000 Year
- -------------------------------------------------------------------------------------------------------------------
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36% $ 70 $100 $100 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities 8.20% 120 120 120 2027 2002
Consumers Energy Company Financing III,
Trust Originated Preferred Securities 9.25% 175 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities 9.00% 125 - - 2031 2006
---------------------------
Total $490 $395 $395
==================================================================================================================
In March 2002, Consumers reduced its' outstanding debt to Consumers Power
Company Financing I, Trust Originated Preferred Securities by $30 million.
OTHER: Under the provisions of its Articles of Incorporation, Consumers had $258
million of unrestricted retained earnings available to pay common dividends at
March 31, 2002. In January 2002, Consumers declared a $55 million common
dividend that was paid in February 2002. In April 2002, Consumers declared a $43
million common dividend payable in May 2002.
DERIVATIVE ACTIVITIES: Consumers uses interest rate swaps to hedge the risk
associated with forecasted interest payments on variable rate debt. These
interest rate swaps are designated as cash flow hedges. As such, Consumers will
record any change in the fair value of these contracts in other comprehensive
income unless
CE-37
Consumers Energy Company
the swap is sold. As of March 31, 2002, Consumers had entered into a swap to fix
the interest rate on $75 million of variable rate debt. This swap will expire in
June 2005. As of March 31, 2002, this interest rate swap had a negative fair
value of $2 million. This amount, if sustained, will be reclassified to earnings
increasing interest expense when the swaps are settled on a monthly basis. As of
March 31, 2001, Consumers had entered into swaps to fix the interest rate on
$300 million of variable rate debt. The swaps expired at varying times from June
through December 2001. As of March 31, 2001, these interest rate swaps had a
negative fair value of $4 million.
Consumers also uses interest rate swaps to hedge the risk associated with the
fair value of its debt. These interest rate swaps are designated as fair value
hedges. In March 2002, Consumers entered into a fair value hedge to hedge the
risk associated with the fair value of $300 million of fixed rate debt issued in
March 2002. Any change in fair value will be recorded in earnings as part of
interest expense. This change in value should be perfectly offset by a change in
the fair value of the associated hedged debt which will also be fair valued and
should move in the opposite direction of the fair value of the swap. As of March
2002, the swap had a negative fair value of less than $1 million. The swap
expires in March 2005.
CE-38
[ANDERSEN LOGO]
Report of Independent Public Accountants
To Consumers Energy Company:
We have reviewed the accompanying consolidated balance sheets of CONSUMERS
ENERGY COMPANY (a Michigan corporation and wholly owned subsidiary of CMS Energy
Corporation) and subsidiaries as of March 31, 2002 and 2001, and the related
consolidated statements of income, cash flows and common stockholders' equity
for the three-month periods then ended. These financial statements are the
responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with accounting principles generally accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Consumers
Energy Company and subsidiaries as of December 31, 2001, and, in our report
dated March 22, 2002, we expressed an unqualified opinion on that statement. In
our opinion, the information set forth in the accompanying consolidated balance
sheet as of December 31, 2001, is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
[ARTHUR ANDERSEN LLP SIGNATURE]
Detroit, Michigan,
April 30, 2002.
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Consumers Energy Corporation
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Panhandle Eastern Pipe Line Company
PANHANDLE EASTERN PIPE LINE COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS
Panhandle is primarily engaged in the interstate transportation and storage of
natural gas. Panhandle also owns an interest in an LNG regasification plant and
related facilities. The rates and conditions for service of interstate natural
gas transmission and storage operations of Panhandle as well as the LNG
operations are subject to the rules and regulations of the FERC.
The MD&A of this Form 10-Q should be read along with the MD&A and other parts of
Panhandle's 2001 Form 10-K. This MD&A also refers to, and in some sections
specifically incorporates by reference, Panhandle's Condensed Notes to
Consolidated Financial Statements and should be read in conjunction with such
Statements and Notes. This report and other written and oral statements that
Panhandle may make contain forward-looking statements, as defined by the Private
Securities Litigation Reform Act of 1995. Panhandle's intentions with the use of
the words "anticipates," "believes," "estimates," "expects," "intends," and
"plans" and variations of such words and similar expressions, are solely to
identify forward-looking statements that involve risk and uncertainty. These
forward-looking statements are subject to various factors that could cause
Panhandle's actual results to differ materially from those anticipated in such
statements. Panhandle has no obligation to update or revise forward-looking
statements regardless of whether new information, future events or any other
factors affect the information contained in such statements. Panhandle does,
however discuss certain risk factors, uncertainties and assumptions in this MD&A
and in Item 1 of the 2001 Form 10-K in the section entitled "Forward-Looking
Statements Cautionary Factors and Uncertainties" and in various public filings
it periodically makes with the SEC. Panhandle designed this discussion of
potential risks and uncertainties, which is by no means comprehensive, to
highlight important factors that may impact Panhandle's business and financial
outlook. This report also describes material contingencies in Panhandle's
Condensed Notes to Consolidated Financial Statements, and Panhandle encourages
its readers to review these Notes.
The following information is provided to facilitate increased understanding of
the Consolidated Financial Statements and accompanying Notes of Panhandle and
should be read in conjunction with these financial statements. Because all of
the outstanding common stock of Panhandle Eastern Pipe Line is owned by a
wholly-owned subsidiary of CMS Energy, the following discussion uses the reduced
disclosure format permitted by Form 10-Q for issuers that are wholly-owned
direct or indirect subsidiaries of reporting companies.
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Panhandle Eastern Pipe Line Company
RESULTS OF OPERATIONS
NET INCOME:
In Millions
- -----------------------------------------------------------------------------------------------------------------
March 31 2002 2001 Change
- -----------------------------------------------------------------------------------------------------------------
Three months ended $25 $37 $(12)
=================================================================================================================
Reasons for the change:
LNG terminalling revenue (28)
Commodity revenue (6)
Other revenue (1)
Operation and maintenance 5
Depreciation and amortization 5
General taxes 1
Interest charges 4
Income taxes 8
- -----------------------------------------------------------------------------------------------------------------
Total change $(12)
=================================================================================================================
LNG TERMINALLING REVENUE: In May 2001, Trunkline LNG signed an agreement with BG
LNG Services that provides for a 22-year contract for the existing uncommitted
long-term capacity at the company's facility. The 22-year contract, in
conjunction with new rates which became effective January 2002 (see Note 2,
Regulatory Matters), along with significantly lower natural gas prices in the
first quarter of 2002 compared to the first quarter of 2001, resulted in reduced
revenues for Trunkline LNG from 2001 levels. In December 2001, Panhandle
completed a $320 million monetization of the Trunkline LNG business. The joint
venture transaction results in a reduced share of Trunkline LNG's income and
distributions being received by Panhandle due to the existence of debt on the
books of the joint venture as well as a reduced equity ownership in the project,
partially offset by lower consolidated interest expense due to Panhandle debt
being retired with the proceeds generated by the transaction. Panhandle uses the
Hypothetical Liquidation at Book Value method of equity income measurement for
its investment in LNG Holdings, the unconsolidated joint venture which owns 100
percent of Trunkline LNG. Using this approach, primarily because LNG Holdings
made no cash distributions to Panhandle in the first quarter of 2002, no equity
income was recorded by Panhandle in the first quarter of 2002. Cash
distributions by LNG Holdings began in April of 2002 and are expected to be made
quarterly in the future.
COMMODITY REVENUE: Commodity revenue decreased primarily due to decreased
natural gas transportation volumes delivered for the first quarter of 2002
compared to the first quarter of 2001. Volumes decreased 15 percent from 2001
primarily due to an unseasonably warm winter in the Midwest market area in 2002.
OTHER REVENUE: Other revenue includes a non-recurring gain of $4 million in the
first quarter of 2002 for settlement of Order 637 matters related to capacity
release and imbalance penalties (see Note 2,
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Panhandle Eastern Pipe Line Company
Regulatory Matters), equaling a non-recurring gain related to a gas purchase
contract in the first quarter of 2001.
OPERATION AND MAINTENANCE: Operating expenses were reduced by $4 million in the
first quarter of 2002 primarily due to a non-recurring adjustment for lower
final incentive plan payouts approved in 2002 for 2001 awards, which more than
offset other benefit cost increases, and also due to Trunkline LNG expenses
which are zero in 2002 since Trunkline LNG is no longer consolidated with
Panhandle (see Off Balance Sheet Arrangements).
DEPRECIATION AND AMORTIZATION: Amortization expense was reduced by $5 million in
the first quarter of 2002 due to adoption of SFAS No. 142. Panhandle has not yet
completed its initial review of any potential goodwill impairment but expects to
complete the initial review in the second quarter as required by SFAS No. 142
(see Note 1, Corporate Structure and Basis of Presentation - Implementation of
New Accounting Standards).
INTEREST CHARGES: Interest Charges include a non-recurring gain of $2 million in
the first quarter of 2002 for reversal of interest expense related to the Order
637 settlement.
CRITICAL ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States requires management to make
judgments, estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Certain accounting principles require subjective
and complex judgments used in the preparation of financial statements.
Accordingly, a different financial presentation could result depending on the
judgment, estimates or assumptions that are used. Such estimates and
assumptions, include, but are not specifically limited to: depreciation and
amortization, interest rates, discount rates, future commodity prices,
mark-to-market valuations, investment returns, volatility in the price of CMS
Energy Common Stock, impact of new accounting standards, future costs associated
with long-term contractual obligations, future compliance costs associated with
environmental regulations and continuing creditworthiness of counterparties.
Actual results could materially differ from those estimates.
OFF BALANCE SHEET ARRANGEMENTS
In December 2001, Panhandle entered into a joint venture transaction involving
LNG Holdings, which now owns 100 percent of Trunkline LNG. LNG Holdings is
jointly owned by a subsidiary of Panhandle Eastern Pipe Line and Dekatherm
Investor Trust, an unaffiliated entity. Panhandle initially contributed its
interest in Trunkline LNG to the joint venture. The joint venture then raised
$30 million from the issuance of equity to Dekatherm Investor Trust and then
$290 million from bank loans. The net proceeds were distributed to Panhandle
Eastern Pipe Line, with $75 million of the proceeds coming in the form of a
loan. While earnings are divided pursuant to a sharing formula, LNG Holdings'
owners require unanimous consent over significant governance issues, including,
among others, issuance of additional debt or equity, budgets, asset
dispositions, and appointment of officers.
The LNG Holdings transaction monetized the value of Trunkline LNG and the value
created by a 22-year contract with BG LNG Services, which began in January 2002,
for the existing uncommitted long-term capacity at the facility. Due to the
commitment by Panhandle to reinvest the proceeds in the joint venture to finance
the LNG expansion project, the $183 million of proceeds received by Panhandle in
excess of Panhandle's
PE-3
Panhandle Eastern Pipe Line Company
book basis in Trunkline LNG was not recognized as a gain, but instead has been
recorded as a deferred credit on Panhandle's balance sheet. Panhandle Eastern
Pipe Line has provided indemnities to certain parties involved in the
transaction for pre-closing claims and liabilities, and subsidiaries of
Panhandle have provided indemnities for certain post-closing expenses and
liabilities as the manager/operator of the joint venture.
NEW ACCOUNTING STANDARDS
In addition to the identified critical accounting policies discussed above,
future results will be affected by new accounting standards that recently have
been issued.
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Issued by the FASB in
August 2001, the provisions of SFAS No. 143 require adoption as of January 1,
2003. The standard requires entities to record the fair value of a liability for
an asset retirement obligation in the period in which the obligation is
incurred. When the liability is initially recorded, the entity capitalizes a
cost by increasing the carrying amount of the related long-lived asset. Over
time, the liability is accreted to its present value each period, and the
capitalized cost is depreciated over the related asset's useful life. Upon
settlement of the liability, an entity either settles the obligation for its
recorded amount or incurs a gain or loss upon settlement. Panhandle is currently
studying the effects of the new standard, but has yet to quantify the effects of
adoption on its financial statements.
SFAS NO. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS: Issued by the FASB on April 30,
2002, this Statement rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishment of Debt Made to Satisfy
Sinking-Fund Requirements. As a result, any gain or loss on extinguishment of
debt should be classified as an extraordinary item only if it meets the criteria
set forth in APB Opinion No. 30. The provisions of this section are applicable
to fiscal years beginning 2003. SFAS No. 145 amends SFAS No. 13, Accounting for
Leases, to require sale-leaseback accounting for certain lease modifications
that have similar economic impacts to sale-leaseback transactions. This
provision is effective for transactions occurring after May 15, 2002. Finally,
SFAS No. 145 amends other existing authoritative pronouncements to make various
technical corrections and rescinds SFAS No. 44, Accounting for Intangible Assets
of Motor Carriers. These provisions are effective for financial statements
issued on or after May 15, 2002. Panhandle is currently studying the effects of
the new standard, but has yet to quantify the effects of adoption on its
financial statements.
For a discussion of new accounting standards effective January 1, 2002, see Note
1, Corporate Structure and Basis of Presentation.
OUTLOOK
CMS Energy seeks to build on Panhandle's position as a leading United States
interstate natural gas pipeline system and its significant ownership interest in
and operation of the nation's largest operating LNG receiving terminal through
expansion and better utilization of its existing facilities and construction of
new facilities. By providing additional transportation, storage and other
asset-based value-added services to customers such as gas-fueled power plants,
local distribution companies, industrial and end-users, marketers and others,
CMS Energy expects to expand its natural gas pipeline business. Panhandle has a
one-third interest in Guardian Pipeline LLC, which is currently constructing a
141-mile, 36-inch pipeline from Illinois to southeastern Wisconsin for the
transportation of natural gas beginning late 2002. Upon completion of the
project, Trunkline will operate and maintain the pipeline. Panhandle also has a
one-third interest in the Centennial Pipeline LLC which operates a 720-mile,
26-inch pipeline extending from the U.S. Gulf Coast to Illinois for the
transportation of interstate refined petroleum products. The pipeline began
commercial service in April 2002.
In April 2001, FERC approved Trunkline's rate settlement without modification.
The settlement resulted in Trunkline reducing its maximum rates in May 2001. The
reduction is expected to reduce revenues by approximately $2 million annually.
For further information, see Note 2, Regulatory Matters.
In October 2001 Trunkline LNG, in which Panhandle owns an interest through its
equity interest in LNG Holdings, announced the planned expansion of the Lake
Charles, Louisiana facility to approximately 1.2 bcf per day of send out
capacity, up from its current send out capacity of 630 million cubic feet per
day. The terminal's storage capacity will also be expanded to 9 bcf from its
current storage capacity of 6.3 bcf. Assuming FERC approval, the expanded
facility is planned to be in operation in early 2005. The expansion expenditures
are currently expected to be funded by Panhandle loans or equity contributions
to CMS Trunkline LNG Holdings, which would be sourced by repayment by CMS
Capital to Panhandle on its outstanding note receivable.
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Panhandle Eastern Pipe Line Company
In October 2001, CMS Energy and Sempra Energy announced an agreement to jointly
develop a major new LNG receiving terminal to bring much-needed natural gas
supplies into northwestern Mexico and southern California. The plant would be
located on the Pacific Coast, north of Ensenada, Baja California, Mexico. As
currently planned, it will have a send out capacity of approximately 1 bcf per
day of natural gas through a new 40-mile pipeline between the terminal and
existing pipelines in the region. The terminal would be operated and maintained
by a joint operating company with majority oversight by Panhandle when
commercial operations begin, which is currently estimated to be in 2007.
UNCERTAINTIES: Panhandle's results of operations and financial position may be
affected by a number of trends or uncertainties that have, or Panhandle
reasonably expects could have, a material impact on income from continuing
operations and cash flows. Such trends and uncertainties include: 1) the
increased competition in the market for transmission of natural gas to the
Midwest causing pressure on prices charged by Panhandle; 2) the current market
conditions causing more contracts to be of shorter duration, which may increase
revenue volatility; 3) the increased potential for declining financial condition
of certain customers within the industry due to recession and other factors; 4)
the possibility of decreased demand for natural gas resulting from a downturn in
the economy and scaling back of new power plants; 5) the impact of any future
rate cases, for any of Panhandle's regulated operations; 6) current initiatives
for additional federal rules and legislation regarding pipeline safety; 7)
capital spending requirements for safety, environmental or regulatory
requirements that could result in depreciation expense increases not covered by
additional revenues; 8) market and other risks associated with Panhandle's
investment in the liquids pipeline business via the Centennial Pipeline venture;
and 9) increased security costs as a result of the September 11, 2001 terrorist
attack in the United States. It is not certain what these cost levels will be or
to what extent these additional costs will be recoverable through Panhandle's
rates.
OTHER MATTERS
CUSTOMER CONCENTRATION
During the first quarter of 2002, sales to Proliance Corporation, a
nonaffiliated gas marketer, accounted for 18 percent of Panhandle's consolidated
revenues and sales to subsidiaries of CMS Energy accounted for 11 percent of
Panhandle's consolidated revenues. No other customer accounted for 10 percent or
more of consolidated revenues during the same period. Aggregate sales to
Panhandle's top ten customers accounted for 64 percent of revenues during the
first quarter of 2001.
ENVIRONMENTAL MATTERS
Panhandle is subject to federal, state, and local laws and regulations governing
environmental quality and pollution control. These laws and regulations under
certain circumstances require Panhandle to remove or remedy the effect on the
environment of the disposal or release of specified substances at its operating
sites.
PCB (POLYCHLORINATED BIPHENYL) ASSESSMENT AND CLEAN-UP PROGRAMS: Panhandle
previously identified environmental contamination at certain sites on its
systems and undertook clean-up programs at these sites. For further information,
see Note 4, Commitments and Contingencies - Environmental Matters.
AIR QUALITY CONTROL: In 1998, the EPA issued a final rule on regional ozone
control that requires revised State Implementation Plans (SIPS) for 22 states,
including five states in which Panhandle
PE-5
Panhandle Eastern Pipe Line Company
operates. For further information, see Note 4, Commitments and Contingencies -
Environmental Matters.
In 1997, the Illinois Environmental Protection Agency initiated an enforcement
proceeding relating to alleged air quality permit violations at Panhandle's
Glenarm Compressor Station. On November 15, 2001 the Illinois Pollution Control
Board approved an order imposing a penalty of $850 thousand, plus fees and cost
reimbursements of $116 thousand. Under terms of the sale of Panhandle to CMS
Energy, a subsidiary of Duke Energy was obligated to indemnify Panhandle against
this environmental penalty. The state issued a permit in February of 2002
requiring the installation of certain capital improvements at the facility at a
cost of approximately $3 million. It is expected that the capital improvements
will occur in 2002 and 2003.
CHANGE IN AUDITORS
On April 22, 2002, the Board of Directors, based upon the recommendation of the
Audit Committee of the Board, voted to discontinue the use of Arthur Andersen
to audit Panhandle's financial statements at and for the year ending December
31, 2002. The Audit Committee was directed to search for a replacement
independent auditor from among nationally recognized auditing firms and
recommend such replacement firm to the Board for appointment as soon as
practical. Arthur Andersen previously had been retained to review Panhandle's
financial statements at and for the quarter ended March 31, 2002.
Arthur Andersen's reports on Panhandle's consolidated financial statements for
each of the fiscal years ended December 31, 2001 and December 31, 2000 did not
contain an adverse opinion or disclaimer of opinion, nor were they qualified or
modified as to uncertainty, audit scope or accounting principles.
During the fiscal years ended December 31, 2001 and December 31, 2000, and
through the date of their opinion for the quarter ended March 31, 2002, there
were no disagreements with Arthur Andersen on any matter of accounting
principle or practice, financial statement disclosure, or auditing scope or
procedure which, if not resolved to Arthur Andersen's satisfaction, would have
caused Arthur Andersen to make reference to the subject matter in connection
with its report on Panhandle's consolidated financial statements for such
years; and there were no reportable events as defined by SEC laws and
regulations.
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Panhandle Eastern Pipe Line Company
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PE-7
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN MILLIONS)
Three Months Ended March 31,
2002 2001
---------- -----------
OPERATING REVENUE
Transportation and storage of natural gas $114 $120
LNG terminalling revenue - 28
Other 6 7
----- -----
Total operating revenue 120 155
----- -----
OPERATING EXPENSES
Operation and maintenance 45 50
Depreciation and amortization 13 17
General taxes 6 8
----- -----
Total operating expenses 64 75
----- -----
PRETAX OPERATING INCOME 56 80
OTHER INCOME, NET 2 2
INTEREST CHARGES
Interest on long-term debt 17 21
----- -----
Total interest charges 17 21
NET INCOME BEFORE INCOME TAXES 41 61
INCOME TAXES 16 24
----- -----
CONSOLIDATED NET INCOME $25 $37
===== =====
The accompanying condensed notes are an integral part of these statements.
PE-8
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
Three Months Ended March 31,
2002 2001
---------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $25 $ 37
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 13 17
Deferred income taxes 20 15
Changes in current assets and liabilities (35) (43)
Other, net (1) (3)
----- -----
Net cash provided by operating activities 22 23
----- -----
CASH FLOWS FROM INVESTING ACTIVITIES
Capital and investment expenditures (8) (18)
Retirements and other (5)
----- -----
Net cash used in investing activities (13) (18)
----- -----
CASH FLOWS FROM FINANCING ACTIVITIES
Net (increase)/decrease in current note receivable - CMS Capital (75) 24
Net decrease in non-current note receivable - CMS Capital 82 -
Dividends paid (16) (29)
----- -----
Net cash used in financing activities (9) (5)
----- -----
Net Increase (Decrease) in Cash and Temporary Cash Investments - -
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD - -
----- -----
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ - $ -
===== =====
OTHER CASH FLOW ACTIVITIES WERE:
Interest paid (net of amounts capitalized) $33 $ 38
Income taxes paid (net of refunds) - -
The accompanying condensed notes are an integral part of these statements.
PE-9
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
March 31,
2002 December 31,
(Unaudited) 2001
------------- --------------
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Cost $1,681 $1,675
Less accumulated depreciation and amortization 155 142
------- -------
Sub-total 1,526 1,533
Construction work-in-progress 26 24
------- -------
Net property, plant and equipment 1,552 1,557
------- -------
INVESTMENTS IN AFFILIATES 66 66
------- -------
CURRENT ASSETS
Accounts receivable, less allowances of $4 and $3 as of March 31, 2002
and December 31, 2001, respectively 107 114
Gas imbalances - receivable 35 26
System gas and operating supplies 64 55
Deferred income taxes 8 7
Note receivable - CMS Capital 161 86
Other 24 24
------- -------
Total current assets 399 312
------- -------
NON-CURRENT ASSETS
Goodwill, net 700 700
Note receivable - CMS Capital 255 337
Debt issuance cost 7 8
Other 40 30
------- -------
Total non-current assets 1,002 1,075
------- -------
TOTAL ASSETS $3,019 $3,010
======= =======
The accompanying condensed notes are an integral part of these statements.
PE-10
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
March 31,
2002 December 31,
(Unaudited) 2001
------------- --------------
COMMON STOCKHOLDER'S EQUITY AND LIABILITIES
CAPITALIZATION
Common stockholder's equity
Common stock, no par, 1,000 shares authorized, issued and outstanding $ 1 $ 1
Paid-in capital 1,286 1,286
Retained earnings 4 (5)
------- -------
Total common stockholder's equity 1,291 1,282
Long-term debt 1,066 1,082
------- -------
Total capitalization 2,357 2,364
------- -------
CURRENT LIABILITIES
Accounts payable 19 22
Current portion of long-term debt 15 -
Gas imbalances - payable 81 64
Accrued taxes 10 8
Accrued interest 12 26
Accrued liabilities 19 35
Other 34 40
------- -------
Total current liabilities 190 195
------- -------
NON-CURRENT LIABILITIES
Deferred income taxes 206 185
Deferred commitments 180 183
Other 86 83
------- -------
Total non-current liabilities 472 451
------- -------
TOTAL COMMON STOCKHOLDER'S EQUITY AND LIABILITIES $3,019 $3,010
======= =======
The accompanying condensed notes are an integral part of these statements.
PE-11
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
(IN MILLIONS)
Three Months Three Months
Ended March 31, Ended March 31,
2002 2001
----------------- ------------------
COMMON STOCK
At beginning and end of period $ 1 $ 1
------ ------
OTHER PAID-IN CAPITAL
At beginning and end of period 1,286 1,127
RETAINED EARNINGS
At beginning of period (5) (6)
Net income 25 37
Common stock dividends (16) (29)
------ ------
At end of period 4 2
------ ------
TOTAL COMMON STOCKHOLDER'S EQUITY $1,291 $1,130
====== ======
The accompanying condensed notes are an integral part of these statements.
PE-12
Panhandle Eastern Pipe Line Company
PANHANDLE EASTERN PIPE LINE COMPANY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
These interim Consolidated Financial Statements have been prepared by Panhandle
and reviewed by the independent public accountants in accordance with SEC rules
and regulations. As such, certain information and footnote disclosures normally
included in full year financial statements prepared in accordance with
accounting principles generally accepted in the United States have been
condensed or omitted. Certain prior year amounts have been reclassified to
conform to the presentation in the current year. In management's opinion, the
unaudited information contained in this report reflects all adjustments
necessary to assure the fair presentation of financial position, results of
operations and cash flows for the periods presented. The Condensed Notes to
Consolidated Financial Statements and the related Consolidated Financial
Statements contained within should be read in conjunction with the Consolidated
Financial Statements and Notes to Consolidated Financial Statements contained
in Panhandle's Form 10-K for the year ended December 31, 2001, which includes
the Report of Independent Public Accountants. Due to the seasonal nature of
Panhandle's operations, the results as presented for this interim period are
not necessarily indicative of results to be achieved for the fiscal year.
1. CORPORATE STRUCTURE AND BASIS OF PRESENTATION
Panhandle Eastern Pipe Line is a wholly owned subsidiary of CMS Gas
Transmission. Panhandle Eastern Pipe Line was incorporated in Delaware in 1929.
Panhandle is engaged primarily in interstate transportation and storage of
natural gas, including LNG terminalling, and is subject to the rules and
regulations of the FERC.
In December 2001, Panhandle completed a $320 million monetization transaction of
its Trunkline LNG business and the value created by long-term contracts for
capacity at the Trunkline LNG Lake Charles terminal. The joint venture
transaction resulted in LNG Holdings owning 100 percent of Trunkline LNG. LNG
Holdings is jointly owned by a subsidiary of Panhandle Eastern Pipe Line and
Dekatherm Investor Trust, an unaffiliated entity. The joint venture (including
its $290 million of newly issued long-term debt) is not consolidated with
Panhandle, reflecting Panhandle's lack of control of the new entity.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of Panhandle Eastern Pipe Line and its wholly owned subsidiaries.
Intercompany transactions and balances have been eliminated. Investments in
affiliated companies where Panhandle has the ability to exercise significant
influence, but not control, are accounted for using the equity method. When
special conditions warrant, for example when an affiliate is a highly leveraged
entity and its capital structure is such that Panhandle's share of net income
cannot be simply stated as a percentage of net income based on its equity
ownership percentage, accounting rules dictate that the preferred approach to
equity income measurement is determined by using the Hypothetical Liquidation at
Book Value (HLBV) method. Panhandle believes such conditions exist with its LNG
Holdings investment, therefore Panhandle uses the HLBV method to account for
earnings from this investment.
USE OF ESTIMATES: The preparation of financial statements, in conformity with
accounting principles generally accepted in the United States, requires
management to make judgments, estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could
materially differ from those estimates.
PE-13
Panhandle Eastern Pipe Line Company
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS: SFAS No. 142, issued in July 2001,
requires that goodwill no longer be amortized to earnings, but instead be
reviewed for impairment on an annual basis. Goodwill represents the excess of
the purchase price over the fair value of the net assets of acquired companies
and was amortized using the straight-line method, with a forty-year life,
through December 31, 2001. The amortization of goodwill ceased upon adoption of
the standard at January 1, 2002. Panhandle is currently studying the effects of
the new standard, but cannot predict at this time if any amounts will be
recognized as impairments of goodwill or other intangible assets. In accordance
with the new standard, initial testing for impairment is expected to be
completed in the second quarter and subsequent testing, if required, should be
completed by year-end. Any impairment, if discovered by such testing, will be
recognized in the first quarter 2002 and subsequent periods by restatement of
the financial information. At March 31, 2002, the amount of unamortized goodwill
was $700 million.
For purposes of comparison, the following table presents what net income would
have been in the first quarter of 2001 had there been no amortization of
goodwill in the period.
IN MILLIONS
- ----------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31 2002 2001
- ----------------------------------------------------------------------------------------------------
Reported Net Income $25 $37
Add back: Goodwill amortization - 5
Add back: Tax effect - (2)
-----------------------------
Adjusted Net Income $25 $40
=============================
SFAS No. 144 was issued by the FASB in October 2001, and supersedes SFAS No.
121. The accounting model for long-lived assets to be disposed of by sale
applies to all long-lived assets, including discontinued operations, and
replaces the provisions of APB Opinion No. 30. SFAS No. 144 requires that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable value or include amounts for operating losses that have not yet
occurred. SFAS No. 144 also broadens the reporting of discontinued operations to
include all components of an entity with operations that can be distinguished
from the rest of the entity and that will be eliminated from the ongoing
operations of the entity in a disposal transaction. The adoption of SFAS No.
144, effective January 1, 2002, will result in Panhandle accounting for any
future impairments or disposals of long-lived assets under the foregoing
provisions, but will not change the accounting principles used in previous asset
impairments or disposals.
2. REGULATORY MATTERS
In conjunction with a FERC order issued in September 1997, FERC required certain
natural gas producers to refund previously collected Kansas ad-valorem taxes to
interstate natural gas pipelines, including Panhandle Eastern Pipe Line. FERC
ordered these pipelines to refund these amounts to their customers. In June
2001, Panhandle Eastern Pipe Line filed a proposed settlement with the FERC
which was supported by most of the customers and affected producers. In October
2001, the FERC approved that settlement. The settlement provided for a
resolution of the Kansas ad-valorem tax matter on the Panhandle Eastern Pipe
Line system for a majority of refund amounts. Certain producers and the state of
Missouri elected to not participate in the settlement. At March 31, 2002 and
December 31, 2001, accounts receivable included $8 million due from natural gas
producers, and other current liabilities included $12 million and $11 million,
respectively, for
PE-14
Panhandle Eastern Pipe Line Company
related obligations. Remaining amounts collected but not refunded are subject to
refund pending resolution of issues remaining in the FERC docket and Kansas
intrastate proceeding.
In July 2001, Panhandle Eastern Pipe Line filed a settlement with customers on
Order 637 matters to resolve issues including capacity release and imbalance
penalties, among others. On October 12, 2001 and December 19, 2001 FERC issued
orders approving the settlement, with modifications. The settlement changes
became final effective February 1, 2002, resulting in a non-recurring gain of $4
million in Other Revenue and a $2 million reversal of interest expense for
previously collected penalties retained.
In August 2001, an offer of settlement of Trunkline LNG rates sponsored jointly
by Trunkline LNG, BG LNG Services and Duke LNG Sales was filed with the FERC and
was approved on October 11, 2001. The settlement was placed into effect on
January 1, 2002. As part of the settlement, Trunkline LNG, now owned by LNG
Holdings, reduced its maximum rates.
Panhandle has sought refunds from the State of Kansas concerning certain
corporate income tax issues for the years 1981 through 1984. On January 25,
2002, the Kansas Supreme Court entered an order affirming a previous Board of
Tax Court finding that Panhandle was entitled to refunds which with interest
total approximately $26 million. Pursuant to the provisions of the purchase
agreement between CMS Energy and a subsidiary of Duke Energy, Duke retains the
benefits of any tax refunds or liabilities for periods prior to the date of the
sale of Panhandle to CMS Energy.
3. RELATED PARTY TRANSACTIONS
IN MILLIONS
- -------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31 2002 2001
- -------------------------------------------------------------------------------------------------
Transportation and storage of natural gas $13 $13
Other operating revenue - 13
Operation and maintenance (a) 12 9
Interest income 2 2
(a) Includes allocated benefit plan costs
In the three months ended March 31, 2002 and 2001, other income includes $2
million of interest on the note receivable from CMS Capital.
A summary of certain balances due to or due from related parties included in the
Consolidated Balance Sheets is as follows:
IN MILLIONS
- ---------------------------------------------------------------------------------------------------
MARCH 31 2002 2001
- ---------------------------------------------------------------------------------------------------
Note receivable - CMS Capital $416 $423
Accounts receivable 59 61
Accounts payable 8 7
Accrued liabilities - 2
Current portion of long-term debt 15 -
Long-term debt 60 75
Deferred commitments 180 183
PE-15
Panhandle Eastern Pipe Line Company
At March 31, 2002, Note Receivable - CMS Capital represented a $416 million note
that bore interest at the 30-day commercial paper interest rate, $161 million of
which is shown as current based on estimated draws during the next twelve
months. During April and May 2002, $124 million of the $161 million in Current
Note Receivable was utilized to pay off Panhandle long-term debt in the second
quarter of 2002. Deferred Commitments represents proceeds received by Panhandle
from the LNG monetization transaction which are committed to be reinvested in
the LNG Holdings expansion project filed with FERC by Trunkline LNG in December
2001.
4. COMMITMENTS AND CONTINGENCIES
CAPITAL EXPENDITURES: Panhandle estimates capital expenditures and investments,
including interest costs capitalized, to be $114 million in 2002, $159 million
in 2003 and $160 million in 2004. These amounts include expenditures associated
with an LNG terminal expansion which was filed with FERC in December 2001 by
Trunkline LNG. The expansion expenditures (excluding capitalized interest),
estimated at $21 million in 2002, $87 million in 2003 and $62 million in 2004,
are currently expected to be funded by Panhandle loans or equity contributions
to LNG Holdings, sourced by repayments by CMS Capital on the outstanding note
receivable. Panhandle prepared these estimates for planning purposes and they
are therefore subject to revision. Panhandle satisfies capital expenditures
using cash from operations and contributions from the parent.
LITIGATION: Panhandle is involved in legal, tax and regulatory proceedings
before various courts, regulatory commissions and governmental agencies
regarding matters arising in the ordinary course of business, some of which
involve substantial amounts. Where appropriate, Panhandle has made accruals in
accordance with SFAS No. 5 in order to provide for such matters. Management
believes the final disposition of these proceedings will not have a material
adverse effect on consolidated results of operations, liquidity, or financial
position.
ENVIRONMENTAL MATTERS: Panhandle is subject to federal, state and local
regulations regarding air and water quality, hazardous and solid waste disposal
and other environmental matters. Panhandle has identified environmental
contamination at certain sites on its systems and has undertaken clean-up
programs at these sites. The contamination resulted from the past use of
lubricants in compressed air systems containing PCBs and the prior use of
wastewater collection facilities and other on-site disposal areas. Panhandle
communicated with the EPA and appropriate state regulatory agencies on these
matters. Under the terms of the sale of Panhandle to CMS Energy, a subsidiary of
Duke Energy is obligated to complete the Panhandle clean-up programs at certain
agreed-upon sites and to indemnify against certain future environmental
litigation and claims. Panhandle expects these clean-up programs to continue for
several years. The Illinois EPA included Panhandle Eastern Pipe Line and
Trunkline, together with other non-affiliated parties, in a cleanup of former
waste oil disposal sites in Illinois. Prior to a partial cleanup by the EPA, a
preliminary study estimated the cleanup costs at one of the sites to be between
$5 million and $15 million. The State of Illinois contends that Panhandle
Eastern Pipe Line's and Trunkline's share for the costs of assessment and
remediation of the sites, based on the volume of waste sent to the facilities,
is approximately 17 percent. Management believes that the costs of cleanup, if
any, will not have a material adverse impact on Panhandle's financial position,
liquidity, or results of operations.
AIR QUALITY CONTROL: In 1998, the EPA issued a final rule on regional ozone
control that requires revised SIPS for 22 states, including five states in which
Panhandle operates. This EPA ruling was challenged in court by various states,
industry and other interests, including the INGAA, an industry group to which
Panhandle belongs. In March 2000, the court upheld most aspects of the EPA's
rule, but agreed with INGAA's position and remanded to the EPA the sections of
the rule that affected Panhandle. Based on the court's decision, most of the
states subject to the rule submitted their SIP revisions in
PE-16
Panhandle Eastern Pipe Line Company
October 2000. However, the EPA must revise the section of the rule that affected
Panhandle's facilities. Panhandle expects the EPA to make this section of the
rule effective in 2002 and expects the future costs to range from $13 million to
$29 million for capital improvements to comply.
In 1997, the Illinois Environmental Protection Agency initiated an enforcement
proceeding relating to alleged air quality permit violations at Panhandle's
Glenarm Compressor Station. On November 15, 2001 the Illinois Pollution Control
Board approved an order imposing a penalty of $850 thousand, plus fees and cost
reimbursements of $116 thousand. Under terms of the sale of Panhandle to CMS
Energy, a subsidiary of Duke Energy was obligated to indemnify Panhandle against
this environmental penalty. The state issued a permit in February of 2002
requiring the installation of certain capital improvements at the facility at a
cost of approximately $3 million. It is expected that the capital improvements
will occur in 2002 and 2003.
OTHER COMMITMENTS AND CONTINGENCIES: In 1993, the U.S. Department of the
Interior announced its intention to seek additional royalties from gas producers
as a result of payments received by such producers in connection with past
take-or-pay settlements, and buyouts and buydowns of gas sales contracts with
natural gas pipelines. Panhandle's pipelines, with respect to certain producer
contract settlements, may be contractually required to reimburse or, in some
instances, to indemnify producers against such royalty claims. The potential
liability of the producers to the government and of the pipelines to the
producers involves complex issues of law and fact which are likely to take
substantial time to resolve. If required to reimburse or indemnify the
producers, Panhandle's pipelines will file with FERC to recover a portion of
these costs from pipeline customers. Management believes these commitments and
contingencies will not have a material adverse effect on consolidated results of
operations, liquidity or financial position.
In December 2001, Panhandle contributed its interest in Trunkline LNG to LNG
Holdings which then raised $30 million from the issuance of equity to Dekatherm
Investor Trust and $290 million from non-recourse bank loans. Panhandle
guaranteed repayment of $90 million of these loans if the joint venture had not
obtained replacement lenders by March 2002. Replacement lenders were found by
LNG Holdings, and Panhandle was not required to perform under the guaranty,
which is now expired. Panhandle Eastern Pipe Line has provided indemnities to
certain parties involved in the transaction for pre-closing claims and
liabilities, and subsidiaries of Panhandle have provided indemnities for certain
post-closing expenses and liabilities as the manager/operator of the joint
venture.
Panhandle owns a one-third interest in the Centennial Pipeline LLC along with
TEPPCO Partners L.P. and Marathon Ashland Petroleum LLC. In May 2001, in
conjunction with the Centennial Pipeline project which began commercial service
in April 2002, Panhandle has provided a guaranty related to project financing
in an amount up to $50 million during the initial operating period of the
project. The guaranty will be released when Centennial reaches certain
operational and financial targets.
Panhandle owns a one-third interest in the Guardian Pipeline LLC along with
Viking Gas Transmission and WICOR. Guardian is currently constructing a
141-mile, 36-inch pipeline from Illinois to Wisconsin for the transportation of
natural gas. In November 2001, in conjunction with the Guardian Pipeline
project, Panhandle provided a guaranty related to project financing for a
maximum of $60 million during the construction and initial operating period of
the project, which is expected to be completed in November 2002. The guaranty
will be released when Guardian reaches certain operational and financial
targets.
PE-17
Panhandle Eastern Pipe Line Company
5. SYSTEM GAS
Panhandle classifies its non-current system gas in Other Non-Current Assets and
it is recorded at cost of $16 million and $18 million at March 31, 2002 and
December 31, 2001, respectively.
PE-18
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Panhandle Eastern Pipe Line Company:
We have reviewed the accompanying consolidated balance sheet of Panhandle
Eastern Pipe Line Company (a Delaware corporation) and subsidiaries as of March
31, 2002, and the related consolidated statements of income, common
stockholder's equity and cash flows for the three-month periods ended March 31,
2002 and 2001. These financial statements are the responsibility of the
company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States, the objective
of which is the expression of an opinion regarding the financial statements
taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the consolidated financial statements referred to above for them to
be in conformity with accounting principles generally accepted in the United
States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Panhandle
Eastern Pipe Line Company and subsidiaries as of December 31, 2001, and, in our
report dated February 15, 2002, we expressed an unqualified opinion on that
statement. In our opinion, the information set forth in the accompanying
consolidated balance sheet as of December 31, 2001, is fairly stated, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
Houston, Texas
April 30, 2002
PE-19
Panhandle Eastern Pipe Line Company
(This page intentionally left blank)
PE-20
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
CMS ENERGY
Quantitative and Qualitative Disclosures about Market Risk is contained in PART
I: CMS ENERGY CORPORATION'S MANAGEMENT'S DISCUSSION AND ANALYSIS, which is
incorporated by reference herein.
CONSUMERS
Quantitative and Qualitative Disclosures about Market Risk is contained in PART
I: CONSUMERS ENERGY COMPANY'S MANAGEMENT'S DISCUSSION AND ANALYSIS, which is
incorporated by reference herein.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The discussion below is limited to an update of developments that have occurred
in various judicial and administrative proceedings, many of which are more fully
described in CMS Energy's, Consumers' and Panhandle's Form 10-K for the year
ended December 31, 2001. Reference is also made to the CONDENSED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, in particular Note 4 - Uncertainties for CMS
Energy, Note 2 - Uncertainties for Consumers, and Note 4 - Commitments and
Contingencies for Panhandle, included herein for additional information
regarding various pending administrative and judicial proceedings involving
rate, operating, regulatory and environmental matters.
CMS ENERGY, CONSUMERS AND PANHANDLE
ENVIRONMENTAL MATTERS: CMS Energy, Consumers, Panhandle and their subsidiaries
and affiliates are subject to various federal, state and local laws and
regulations relating to the environment. Several of these companies have been
named parties to various actions involving environmental issues. Based on their
present knowledge and subject to future legal and factual developments, CMS
Energy, Consumers and Panhandle believe that it is unlikely that these actions,
individually or in total, will have a material adverse effect on their financial
condition. See CMS Energy's, Consumers' and Panhandle's MANAGEMENT'S DISCUSSION
AND ANALYSIS; and CMS Energy's, Consumers' and Panhandle's CONDENSED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS CMS ENERGY
CORPORATION
During the 1st Quarter 2002, CMS Energy did not submit any matters to a vote of
security holders.
ITEM 5. OTHER INFORMATION
In order for a shareholder to submit a proposal for a vote at the CMS Energy
2003 Annual Meeting, the shareholder must assure that CMS Energy receives the
proposal on or before March 6, 2003. CMS Energy will not include shareholder's
proposals in the CMS Energy's proxy statement. The shareholder must address the
proposal to: Mr. Rodger A. Kershner, Corporate Secretary, Fairlane Plaza South,
Suite 1100, 330 Town Center Drive, Dearborn, Michigan 48126. If the shareholder
fails to submit the proposal on or before March 6, 2003, then management may use
its discretionary voting authority to decide if it will submit the proposal to
vote when the shareholder raises the proposal at the CMS Energy 2003 Annual
Meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) LIST OF EXHIBITS
(12) - CMS Energy: Statements regarding computation of Ratio of Earnings
to Fixed Charges
(15)(a) - CMS Energy: Letter of Independent Public Accountant
(15)(b) - Consumers: Letter of Independent Public Accountant
CO-1
(B) REPORTS ON FORM 8-K
CMS ENERGY
During 1st Quarter 2002, CMS Energy filed reports of Form 8-K on January 8,
2002, March 7, 2002 and May 1, 2002, covering matters pursuant to ITEM 5. OTHER
EVENTS and on April 29, 2002 covering matters pursuant to ITEM 4. CHANGES IN
REGISTRANT'S CERTIFYING ACCOUNTANT and ITEMS 7. FINANCIAL STATEMENTS AND
EXHIBITS.
CONSUMERS
During 1st Quarter 2002, Consumers filed reports of Form 8-K on January 8,
2002, March 7, 2002 and May 1, 2002, covering matters pursuant to ITEM 5. OTHER
EVENTS and on April 29, 2002 covering matters pursuant to ITEM 4. CHANGES IN
REGISTRANT'S CERTIFYING ACCOUNTANT and ITEMS 7. FINANCIAL STATEMENTS AND
EXHIBITS.
PANHANDLE
During 1st Quarter 2002, Panhandle filed reports of Form 8-K on January 8, 2002
and March 7, 2002, covering matters pursuant to ITEM 5. OTHER EVENTS and on
April 29, 2002 covering matters pursuant to ITEM 4. CHANGES IN REGISTRANT'S
CERTIFYING ACCOUNTANT and ITEMS 7. FINANCIAL STATEMENTS AND EXHIBIT.
CO-2
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, each
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. The signature for each undersigned
company shall be deemed to relate only to matters having reference to such
company or its subsidiary.
CMS ENERGY CORPORATION
---------------------------------------
(Registrant)
Dated: May 15, 2002 By: /s/ A.M. Wright
-------------------------------------
Alan M. Wright
Executive Vice President,
Chief Financial Officer and
Chief Administrative Officer
CONSUMERS ENERGY COMPANY
----------------------------------------
(Registrant)
Dated: May 15, 2002 By: /s/ A.M. Wright
-------------------------------------
Alan M. Wright
Executive Vice President,
Chief Financial Officer and
Chief Administrative Officer
PANHANDLE EASTERN PIPE LINE COMPANY
----------------------------------------
(Registrant)
Dated: May 15, 2002 By: /s/ C.A. Helms
-------------------------------------
Christopher A. Helms
President and Chief Executive Officer
CO-3
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
CMS ENERGY CORPORATION,
CONSUMERS ENERGY COMPANY
AND
PANHANDLE EASTERN PIPE LINE COMPANY
FORM 10-Q
EXHIBITS
FOR QUARTER ENDED MARCH 31, 2002
================================================================================
CMS ENERGY, CONSUMERS AND PANHANDLE EXHIBITS
Exhibit
Number Description
- -------------------------------------------------------------------------------
(12) - Statements regarding computation of CMS Energy's Ratio of
Earnings to Fixed Charges.
(15)(a) - CMS Energy: Letter of Independent Public Accountant
(15)(b) - Consumers Energy: Letter of Independent Public Accountant
EXHIBIT (12)
Exhibit (12)
CMS ENERGY CORPORATION
Ratio of Earnings to Fixed Charges and Preferred Securities
Dividends and Distributions
(Millions of Dollars)
Three Months
Ended Years Ended December 31 -
March 31, 2002 2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
(b) (c) (d)
Earnings as defined (a)
Consolidated net income $399 $(545) $ 36 $ 277 $ 242 $ 244
Discontinued operations - 185 (3) 14 12 (1)
Income taxes 253 (73) 50 63 100 108
Exclude equity basis subsidiaries (31) - (171) (84) (92) (80)
Fixed charges as defined, adjusted to
exclude capitalized interest of $xx, $38,
$48, $41, $29, and $13 million for
the three months ended March 31, 2002,
and the years ended December 31, 2001,
2000, 1999, 1998, and 1997, respectively 175 751 736 594 393 360
-------------------------------------------------------------
Earnings as defined $796 $ 318 $ 648 $ 864 $ 655 $ 631
=============================================================
Fixed charges as defined (a)
Interest on long-term debt $131 $ 573 $ 591 $ 502 $ 318 $ 273
Estimated interest portion of lease rental 1 6 7 8 8 10
Other interest charges 8 58 38 62 47 49
Preferred securities dividends and
distributions 39 152 147 96 77 67
-------------------------------------------------------------
Fixed charges as defined $179 $ 789 $ 784 $ 668 $ 450 $ 397
=============================================================
Ratio of earnings to fixed charges and
preferred securities dividends and distributions 4.45 - - 1.29 1.46 1.59
=============================================================
NOTES:
(a) Earnings and fixed charges as defined in instructions for Item 503 of
Regulation S-K.
(b) For the year ended December 31, 2001, fixed charges exceeded earnings by
$471 million. Earnings as defined include $704 million of pretax contract
losses, asset revaluations and other charges. The ratio of earnings to fixed
charges and preferred securities dividends and distributions would have been
1.30 excluding these amounts.
(c) For the year ended December 31, 2000, fixed charges exceeded earnings by
$136 million. Earnings as defined include a $329 million pretax impairment loss
on the Loy Yang investment. The ratio of earnings to fixed charges and preferred
securities dividends and distributions would have been 1.25 excluding this
amount.
(d) Excludes a cumulative effect of change in accounting after-tax gain of $43
million.
EXHIBIT (15)(a)
[ANDERSEN LOGO]
Exhibit (15)(a)
ARTHUR ANDERSEN LLP
Suite 2700
500 Woodward Avenue
Detroit MI 48226-3424
April 30, 2002 Tel 313 596 9000
Fax 313 596 9055
www.andersen.com
CMS Energy Corporation:
We are aware that CMS Energy Corporation has incorporated by reference in its
Registration Statements No. 33-55805, No. 33-60007, No. 333-27849, No.
333-32229, No. 333-37241, No. 333-45556, No. 333-51932, No. 333-52560, No.
333-58686, No. 333-74958, and No. 333-76347 its Form 10-Q for the quarter ended
March 31, 2002, which includes our report dated April 30, 2002 covering the
unaudited interim financial information contained therein. Pursuant to
Regulation C of the Securities Act of 1933, that report is not considered a part
of the registration statement prepared or certified by our firm or a report
prepared or certified by our firm within the meaning of Sections 7 and 11 of the
Act.
Very truly yours,
[ARTHUR ANDERSEN LLP SIGNATURE]
EXHIBIT (15)(b)
[ANDERSEN LOGO]
Exhibit (15)(b)
ARTHUR ANDERSEN LLP
Suite 2700
500 Woodward Avenue
Detroit MI 48226-3424
April 30, 2002 Tel 313 596 9000
Fax 313 596 9055
www.andersen.com
Consumers Energy Company:
We are aware that Consumers Energy Company has incorporated by reference in its
Registration Statement No. 333-73922 its Form 10-Q for the quarter ended March
31, 2002, which includes our report dated April 30, 2002 covering the unaudited
interim financial information contained therein. Pursuant to Regulation C of the
Securities Act of 1933, that report is not considered a part of the registration
statement prepared or certified by our firm or a report prepared or certified by
our firm within the meaning of Sections 7 and 11 of the Act.
Very truly yours,
[ARTHUR ANDERSEN LLP SIGNATURE]
