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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
--------
COMMISSION REGISTRANT; STATE OF INCORPORATION; IRS EMPLOYER
FILE NUMBER ADDRESS; AND TELEPHONE NUMBER IDENTIFICATION NO.
- ----------- -------------------------------------------------------------- ------------------
1-9513 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
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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
October 31, 2001:
CMS ENERGY CORPORATION:
CMS Energy Common Stock, $.01 par value 132,980,247
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 SEPTEMBER 30, 2001
This combined Form 10-Q is separately filed by each of CMS Energy Corporation,
Consumers Energy Company and Panhandle Eastern Pipe Line Company. Information
contained herein relating to each individual registrant is filed by such
registrant on its own behalf. Accordingly, except for their respective
subsidiaries, Consumers Energy Company and Panhandle Eastern Pipe Line Company
make no representation as to information relating to any other companies
affiliated with CMS Energy Corporation.
TABLE OF CONTENTS
PAGE
------
Glossary 4
PART I: FINANCIAL INFORMATION
CMS Energy Corporation
Management's Discussion and Analysis
Results of Operations CMS-1
Market Risk Information CMS-7
Capital Resources and Liquidity CMS-9
Outlook CMS-12
Other Matters CMS-17
Consolidated Financial Statements
Consolidated Statements of Income CMS-20
Consolidated Statements of Cash Flows CMS-22
Consolidated Balance Sheets CMS-24
Consolidated Statements of Common Stockholders' Equity CMS-26
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Basis of Presentation CMS-27
2. Discontinued Operations CMS-28
3. Loss Contracts and Reduced Asset Valuations CMS-29
4. Uncertainties CMS-32
5. Short-Term and Long-Term Financings, and Capitalization CMS-44
6. Earnings Per Share and Dividends CMS-47
7. Risk Management Activities and Financial Instruments CMS-48
8. Reportable Segments CMS-54
9. Leases CMS-55
Report of Independent Public Accountants CMS-56
2
TABLE OF CONTENTS
(CONTINUED)
PAGE
----
Consumers Energy Company
Management's Discussion and Analysis
Results of Operations CE-1
Capital Resources and Liquidity CE-4
Outlook CE-5
Other Matters CE-8
Consolidated Financial Statements
Consolidated Statements of Income CE-12
Consolidated Statements of Cash Flows CE-13
Consolidated Balance Sheets CE-14
Consolidated Statements of Common Stockholder's Equity CE-16
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Summary of Significant
Accounting Policies CE-17
2. Uncertainties CE-20
3. Short-Term Financings and Capitalization CE-30
4. Leases CE-32
Report of Independent Public Accountants CE-33
Panhandle Eastern Pipe Line Company
Management's Discussion and Analysis
Results of Operations PE-1
Outlook PE-2
Other Matters PE-3
Consolidated Financial Statements
Consolidated Statements of Income PE-5
Consolidated Statements of Cash Flows PE-6
Consolidated Balance Sheets PE-7
Consolidated Statements of Common Stockholder's Equity PE-9
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure PE-10
2. Regulatory Matters PE-10
3. Related Party Transactions PE-11
4. Commitments and Contingencies PE-11
5. Implementation of SFAS No. 133 PE-13
6. System Gas PE-13
7. Trunkline LNG Financing PE-13
Report of Independent Public Accountants PE-14
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-2
Item 5. Other Information CO-2
Item 6. Exhibits and Reports on Form 8-K CO-2
Signatures CO-4
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
Alliance Alliance Regional Transmission Organization
Anadarko Anadarko Petroleum Corporation, a non-affiliated company
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
Btu British thermal unit
Clean Air Act Federal Clean Air Act, as amended
CMS Capital CMS Capital Corporation, 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 Company, 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 Holding CMS Panhandle Holding Company, a subsidiary of CMS Gas Transmission
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 Campus Holdings Consumers Campus Holdings, L.L.C., a wholly owned subsidiary of Consumers
Consumers Consumers Energy Company, a subsidiary of CMS Energy
Court of Appeals Michigan Court of Appeals
Customer Choice Act Customer Choice and Electricity Reliability Act, a Michigan statute enacted in
June 2000 that allows all retail customers choice of alternative electric
suppliers no later than January 1, 2002, provides for full recovery of net stranded
costs and implementation costs, establishes a five percent reduction in residential
rates, establishes rate freeze and rate cap, and allows for Securitization
Detroit Edison The Detroit Edison Company, a non-affiliated company
DIG Dearborn Industrial Generation, L.L.C., a wholly owned subsidiary of CMS Generation
DOE U.S. Department of Energy
4
Dow The Dow Chemical Company, a non-affiliated company
Duke Energy Duke Energy Corporation, a non-affiliated company
EITF Emerging Issues Task Force
Enterprises CMS Enterprises Company, a subsidiary of CMS Energy
EPA U.S. Environmental Protection Agency
EPS Earnings per share
FASB Financial Accounting Standards Board
FERC Federal Energy Regulatory Commission
FMLP First Midland Limited Partnership, a partnership which holds a lessor interest in
the MCV facility
FTC Federal Trade Commission
GCR Gas cost recovery
GTNs CMS Energy General Term Notes(R), $250 million Series A, $125 million Series B,
$150 million Series C, $200 million Series D, $400 million Series E and $300 million
Series F
INGAA Interstate Natural Gas Association of America
Jorf Lasfar The 1,356 MW coal-fueled power plant in Morocco, jointly owned by CMS Generation
and ABB Energy Venture, Inc.
kWh Kilowatt-hour
LIBOR London Inter-Bank Offered Rate
Loy Yang The 2,000 MW brown coal fueled Loy Yang A power plant and an associated coal mine
in Victoria, Australia, in which CMS Generation holds a 50 percent ownership interest
LNG Liquefied natural gas
Ludington Ludington pumped storage plant, jointly owned by Consumers and Detroit Edison
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
METC Michigan Electric Transmission Company, a subsidiary of Consumers Energy
Michigan Gas Storage Michigan Gas Storage Company, a subsidiary of Consumers
MMBtu Million British thermal unit
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
5
NMC Nuclear Management Company, a Wisconsin company, formed in 1999 by Northern States
Power Company (now Xcel Energy Inc.), Alliant Energy, Wisconsin Electric Power
Company, and Wisconsin Public Service Company to operate and manage nuclear
capacity owned by the four utilities.
NOx Nitrogen Oxide
NRC Nuclear Regulatory Commission
NYMEX New York Mercantile Exchange
OATT Open Access Transmission Tariff
Palisades Palisades nuclear power plant, owned by Consumers
Pan Gas Storage Pan Gas Storage Company, a subsidiary of Panhandle Eastern Pipe Line Company
Panhandle Panhandle Eastern Pipe Line Company, including its subsidiaries Trunkline, Pan Gas
Storage, Panhandle Storage, and Trunkline LNG. Panhandle is a wholly owned subsidiary
of CMS Gas Transmission
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
PFD Proposal For Decision
Powder River CMS Oil & Gas owns a significant interest in 13 coal bed methane fields or projects
developed within the Powder River Basin which spans the border between Wyoming
and Montana.
PPA The Power Purchase Agreement between Consumers and the MCV Partnership with a
35-year term commencing in March 1990
PSCR Power supply cost recovery
PUHCA Public Utility Holding Company Act of 1935
RTO Regional Transmission Organization
SAB Staff Accounting Bulletin
Sea Robin Sea Robin Pipeline Company
SEC U.S. Securities and Exchange Commission
Securitization A financing authorized by statute in which a MPSC approved flow of revenues from a
portion of the rates charged by a utility to its customers is set aside and pledged
as security for the repayment of Securitization bonds issued by a special purpose
entity affiliated with such utility.
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
SFAS Statement of Financial Accounting Standards
SIPS State Implementation Plans
SOP Statement of Position
Stranded Costs Costs incurred by utilities in order to serve their customers in a regulated
monopoly environment, but which may not be recoverable in a competitive environment
because of customers leaving their systems and ceasing to pay for their costs.
These
6
Superfund costs could include owned and purchased generation and regulatory assets. Comprehensive
Environmental Response, Compensation and Liability Act
TBtu Trillion british thermal unit
Transition Costs Stranded Costs, as defined, plus the costs incurred in the transition to competition.
Trunkline Trunkline Gas Company, a subsidiary of Panhandle Eastern Pipe Line Company
Trunkline LNG Trunkline LNG Company, a subsidiary of Panhandle Eastern Pipe Line Company
Trust Preferred Securities Securities representing an undivided beneficial interest in the assets of statutory
business trusts, which interests have a preference with respect to certain trust
distributions over the interests of either CMS Energy or Consumers, as applicable,
as owner of the common beneficial interests of the trusts
Union Utility Workers of America, AFL-CIO
7
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8
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 2000 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 2000 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 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
In October 2001, CMS Energy announced a plan to make significant changes in
its business strategy to strengthen its balance sheet, provide more transparent
and predictable future earnings and lower its business risk by focusing future
business growth primarily in North America. In connection with the change in
business strategy and associated plans to sell non-strategic assets CMS Energy
recorded a $613 million after-tax write-down in recognition of planned
divestitures, reduced asset valuations and loss contracts. Included were: a $183
million charge related to discontinuation of the Company's South American energy
distribution unit; a $218 million charge related to energy development projects
and international investments in recognition of the net recoverable value of
these investments; a $130 million charge related to the Dearborn Industrial
Generation plant power supply contract with the Ford/Rouge complex, due to
higher than expected fuel and operating costs; and an $82 million charge related
to revised estimates of Consumers Energy's payments to the Midland Cogeneration
Venture for purchased power. For CMS Energy's business units, the after-tax
write-down is comprised of: $32 million for the oil and gas exploration unit,
$28 million for the gas pipeline and processing business, $268 million for
independent power production, $93 million for Consumers Energy and $9 million
for other areas. For further information regarding the write-downs, see Note 2,
Discontinued Operations and Note 3, Loss Contracts and Reduced Asset Valuations,
incorporated by reference herein.
CMS-1
The following tables depict CMS Energy's Results of Operations before and
after the effects of reconciling items.
THREE MONTHS ENDED
SEPTEMBER 30
------------------
2001 2000
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In millions, Except Per Share Amounts
Net Income Before Reconciling Items $ 46 $ 46
Effects of Loss Contracts (212) -
Effects of Reduced Asset Valuations (218) -
Asset Sales - 5
Loss on Disposal of Discontinued Operations (183) -
Income (Loss) from Discontinued Operations (2) 2
------ -----
Consolidated Net Income (Loss) $ (569) $ 53
====== =====
Basic Earnings Per Average Common Share:
Earnings Per Share Before Reconciling Items $ 0.35 $0.43
Effects of Loss Contracts (1.60) -
Effects of Reduced Asset Valuations (1.64) -
Asset Sales - 0.04
Loss on Disposal of Discontinued Operations (1.38) -
Income (Loss) from Discontinued Operations (0.02) 0.02
------ -----
Earnings Per Share After Reconciling Items $(4.29) $0.49
====== =====
Diluted Earnings Per Average Common Share:
Earnings Per Share Before Reconciling Items $ 0.35 $0.43
Effects of Loss Contracts (1.60) -
Effects of Reduced Asset Valuations (1.64) -
Asset Sales - 0.04
Loss on Disposal of Discontinued Operations (1.38) -
Income (Loss) from Discontinued Operations (0.02) 0.02
------ -----
Earnings Per Share After Reconciling Items $(4.29) $0.49
====== =====
For the three months ended September 30, 2001, consolidated net income
before reconciling items compared to the comparable period in 2000 before
reconciling items, reflects increased earnings from CMS Energy's diversified
energy businesses offset by lower earnings at the utility due primarily to
increased power supply costs resulting from an unplanned outage at Consumers
Palisades nuclear plant.
CMS-2
NINE MONTHS ENDED
SEPTEMBER 30
-------------------
2001 2000
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In millions, Except Per Share Amounts
Net Income Before Reconciling Items $ 202 $ 152
Effects of Loss Contracts (212) -
Effects of Reduced Asset Valuations (218) -
Asset Sales 6 56
Cumulative Effects of Change in Accounting for Inventories - (5)
Loss on Disposal of Discontinued Operations (183) -
Income (Loss) from Discontinued Operations (2) 4
------ ------
Consolidated Net Income (Loss) $ (407) $ 207
====== ======
Basic Earnings Per Average Common Share:
Earnings Per Share Before Reconciling Items $ 1.55 $ 1.40
Effects of Loss Contracts (1.63) -
Effects of Reduced Asset Valuations (1.68) -
Asset Sales 0.05 0.47
Cumulative Effect of Change in Accounting for Inventories - (0.04)
Loss on Disposal of Discontinued Operations (1.41) -
Income (Loss) from Discontinued Operations (0.01) 0.03
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Earnings Per Share After Reconciling Items $(3.13) $ 1.86
====== ======
Diluted Earnings Per Average Common Share:
Earnings Per Share Before Reconciling Items $ 1.55 $ 1.39
Effects of Loss Contracts (1.63) -
Effects of Reduced Asset Valuations (1.68) -
Asset Sales 0.05 0.47
Cumulative Effect of Change in Accounting for Inventories - (0.04)
Loss on Disposal of Discontinued Operations (1.41) -
Income (Loss) from Discontinued Operations (0.01) 0.03
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Earnings Per Share After Reconciling Items $(3.13) $ 1.85
====== ======
For the nine months ended September 30, 2001, consolidated net income
before reconciling items increased over the comparable period in 2000 before
reconciling items primarily due to increased earnings from CMS Energy's
diversified energy businesses and improved earnings from Consumers Gas Utility
business segment, reflecting a $29 million after-tax regulatory obligation
related to gas prices recorded in the second quarter of 2000. The increase was
partially offset by lower earnings at Consumers Electric Utility as a result of
increased power supply costs associated with the unplanned outage at Consumers
Palisades nuclear plant.
For further information, see the individual results of operations for each
CMS Energy business segment in this MD&A.
CMS-3
CONSUMERS' ELECTRIC UTILITY RESULTS OF OPERATIONS
ELECTRIC PRETAX OPERATING INCOME:
SEPTEMBER 30
-------------------------
2001 2000 CHANGE
---- ---- ------
IN MILLIONS
Three months ended $(62) $118 $(180)
Nine months ended 157 342 (185)
==== ==== =====
For the three months ended September 30, 2001, electric pretax operating
income decreased $180 million from the comparable period in 2000. The earnings
decrease reflects a $126 million loss related to Consumers' Power Purchase
Agreement with the MCV and increased replacement power costs, discussed in the
consolidated earnings section, partially offset by higher electric deliveries to
higher margin customers. For the nine months ended September 30, 2001, electric
pretax operating income decreased $185 million from the comparable period in
2000. The earnings decrease reflects the above referenced loss related to the
MCV along with the increase in power costs, also partially offset by higher
electric deliveries to higher margin customers. The following table quantifies
these impacts on pretax operating income:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
CHANGE COMPARED TO PRIOR YEAR 2001 vs 2000 2001 vs 2000
- ----------------------------- ------------------ ------------------
IN MILLIONS
Electric deliveries $ 19 $ 21
Power supply costs and related production revenue (68) (71)
Rate decrease 0 (17)
Non-commodity revenue (13) (4)
Other operating expenses 8 12
Loss on MCV Power Purchases (126) (126)
----- -----
Total change $(180) $(185)
===== =====
ELECTRIC DELIVERIES: For the three months ended September 30, 2001,
electric deliveries including intersystem volumes were 11.0 billion kWh, an
increase of 0.3 billion kWh or 3.0 percent from the comparable period in 2000.
Total electric deliveries increased primarily due to higher residential and
commercial usage. For the nine months ended September 30, 2001, electric
deliveries were 30.2 billion kWh, which is a slight decrease from the comparable
period in 2000. Although total deliveries were below the 2000 level, current
year increased deliveries to the higher margin residential and commercial
sectors more than offset the impact of reductions to the lower margin industrial
sector.
POWER SUPPLY COSTS:
SEPTEMBER 30
-------------------------
2001 2000 CHANGE
------ ---- ------
IN MILLIONS
Three months ended $ 444 $355 $ 89
Nine months ended 1,050 949 101
====== ==== ====
For the three and nine months ended September 30, 2001, power supply costs
increased $89 million and $101 million, respectively, from the comparable period
in 2000, primarily due to higher interchange power
CMS-4
purchases. Consumers had to purchase greater quantities of higher-priced
external power primarily because of decreased internal generation resulting from
unscheduled outages. Further, the continuing unscheduled outage at Palisades
materially affected third quarter results because of the necessity to utilize
higher cost internal generation and purchase replacement power.
CONSUMERS' GAS UTILITY RESULTS OF OPERATIONS
GAS PRETAX OPERATING INCOME:
SEPTEMBER 30
-----------------------
2001 2000 CHANGE
---- ---- ------
IN MILLIONS
Three months ended $(1) $ 9 $(10)
Nine months ended 81 44 37
=== === ====
For the three months ended September 30, 2001, gas pretax operating income
decreased by $10 million. The earnings decrease is primarily the result of
higher operation and maintenance costs and lower gas deliveries due to the
economic slowdown. For the nine months ended September 30, 2001, gas pretax
operating income increased by $37 million, primarily the result of the recording
of a $45 million regulatory obligation related to gas prices in the second
quarter of 2000. The following table quantifies these impacts on pretax
operating income.
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
CHANGE COMPARED TO PRIOR YEAR 2001 VS 2000 2001 VS 2000
- ----------------------------- ------------------ ------------------
IN MILLIONS
Gas deliveries $ (1) $ 7
Gas commodity costs and related revenue (3) 38
Gas wholesale and retail services 1 7
Operation and maintenance expense (8) (15)
General taxes and depreciation expense 1 0
---- ----
Total change $(10) $ 37
==== ====
GAS DELIVERIES: For the three months ended September 30, 2001, gas system
deliveries, including miscellaneous transportation volumes totaled 42 bcf, a
decrease of 3 bcf or 7 percent from the comparable period in 2000. During the
third quarter of 2001, the decreased deliveries reflect a reduction in demand
due to decelerated economic activity. For the nine months ended September 30,
2001, gas system deliveries, including miscellaneous transportation totaled 258
bcf, a decrease of 15 bcf or 5.2 percent from the comparable period in 2000.
Although deliveries were below the 2000 level, year to date deliveries to the
higher margin residential and commercial sectors more than offset the impact of
reductions to the lower margin industrial sector.
COST OF GAS SOLD:
SEPTEMBER 30
-----------------------
2001 2000 CHANGE
---- ---- ------
IN MILLIONS
Three months ended $ 72 $ 60 $ 12
Nine months ended 562 450 112
==== ==== ====
CMS-5
For the three months ended September 30, 2001, the cost of gas sold
increased due to higher gas prices. During the third quarter of 2001, these
higher gas costs were partially offset by decreased sales due to reduced
economic demand. For the nine months ended September 30, 2001, higher gas prices
through the first three quarters contributed to the increased cost of gas sold.
NATURAL GAS TRANSMISSION RESULTS OF OPERATIONS
PRETAX OPERATING INCOME: For the three months ended September 30, 2001,
pretax operating income excluding the effects of write-downs increased $3
million (6 percent) from the comparable period in 2000. The increase reflects
increased earnings from the GasAtacama project and lower operating expenses. For
the nine months ended September 30, 2001, pretax operating income, excluding the
effects of write-downs increased $17 million (10 percent) from the comparable
period in 2000 primarily reflecting a 43 percent increase in LNG shipments (57
shipments compared to 40), and improved gas gathering and processing results of
operations.
INDEPENDENT POWER PRODUCTION RESULTS OF OPERATIONS
PRETAX OPERATING INCOME: For the three months ended September 30, 2001,
pretax operating income, excluding the effects of the investment write-downs,
the write-offs of unsuccessful development costs, and the recognition of the DIG
loss contract reserve, was unchanged from the comparable period in 2000,
reflecting decreased earnings from domestic plants due to reduced earnings from
the MCV facility, construction delays at the DIG plant that led to increased
steam generation costs and decreased international plant earnings primarily from
investments in Argentina offset by the earnings benefits from the expansion of
the Jorf Lasfar facility in Africa in late 2000 and early 2001. For the nine
months ended September 30, 2001, pretax operating income excluding the effects
of the write-downs, decreased $32 million (23 percent) from the comparable
period in 2000. The decrease reflects decreased earnings from domestic plants
due to the sale of power plants in 2000, construction delays at the DIG plant
that led to increased costs for steam generation, and a gain recorded in 2000
reflecting the restructuring of a power supply contract. These decreases were
partially offset by the earnings benefits from the expansion of the Jorf Lasfar
facility, the operation of additional units at the Takoradi facility and the
absence of operating losses in 2001 from the investment in Loy Yang, which was
written off in the fourth quarter of 2000.
OIL AND GAS EXPLORATION AND PRODUCTION RESULTS OF OPERATIONS
PRETAX OPERATING INCOME: Pretax operating income, excluding write-downs,
for the three months ended September 30, 2001, increased $14 million (147
percent) from the comparable period in 2000 as a result of higher realized oil
and natural gas prices and increased production from Equatorial Guinea and
Powder River properties. Partially offsetting these increases were higher
operating, exploration costs and general and administrative costs. Pretax
operating income, excluding write-downs, for the nine months ended September 30,
2001, increased $49 million (304 percent) as a result of higher oil and natural
gas commodity prices and increased production from Equatorial Guinea and Powder
River properties. Partially offsetting these increases were lower production due
to selling our Michigan and Ecuador properties and higher operating, exploration
costs and general and administrative costs.
MARKETING, SERVICES AND TRADING RESULTS OF OPERATIONS
PRETAX OPERATING INCOME: For the three months ended September 30, 2001,
pretax operating income increased $22 million from the comparable period in
2000. The increase reflects higher gas (159 bcf vs 119
CMS-6
bcf) and electric (21.4 billion kWh vs 12.6 billion kWh) volumes and improved
margins, the increased net value of long-term power contracts and wholesale
power trading activity, net of reserves. For the nine months ended September 30,
2001, pretax operating income increased $76 million from the comparable period
in 2000. The increase reflects higher gas (657 bcf vs 355 bcf) and electric
(69.9 billion kWh vs 15.6 kWh) volumes and gas margins, partially offset by
lower electric margins, the execution of long-term power sales contracts and
increased wholesale gas and power trading, net of reserves. Due to the variable
and competitive nature of energy trading, results for interim periods are not
necessarily indicative of results to be achieved for the fiscal year.
INTERNATIONAL ENERGY DISTRIBUTION RESULTS OF OPERATIONS
In the third quarter of 2001, CMS Energy discontinued the operations of
International Energy Distribution. For more information, see Note 2,
Discontinued Operations, incorporated by reference herein.
MARKET RISK INFORMATION
CMS Energy is exposed to market risks including, but not limited to,
changes in interest rates, currency exchange rates, and certain commodity 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. 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. Management believes that any losses incurred on derivative
instruments used to hedge risk would be offset by an opposite movement of the
value of the hedged risk. For further information on CMS Energy's use of
derivative instruments to manage risks, see Note 7, Risk Management Activities
and Financial Instruments, incorporated by reference herein.
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 and natural gas liquids. 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.) 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 remainder of 2001 would increase or decrease by
$1.9 million and $2.0 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
CMS-7
cash flows as of September 30, 2001. The analysis does not quantify short-term
exposure to hypothetically adverse price fluctuations in inventories.
Consumers enters into, for purposes other than trading, electricity and gas
fuel call options and swap contracts to protect against risk due to fluctuations
in the market price of these commodities and to ensure a reliable source of
capacity to meet its customers' electric needs.
As of September 30, 2001, the fair value based on quoted future market
prices of electricity-related option and swap contracts was $14 million.
Assuming a hypothetical 10 percent adverse change in market prices, the
potential reduction in fair value associated with these contracts would be $4
million. As of September 30, 2001, Consumers had an asset of $73 million as a
result of premiums incurred for electricity call option contracts. Consumers'
maximum exposure associated with the call option contracts is limited to the
premiums paid.
INTEREST RATE RISK: CMS Energy is exposed to interest rate risk resulting
from the issuance of fixed-rate and variable-rate debt, including that
associated with trust preferred securities, and from interest rate swaps and
interest rate lock agreements. CMS Energy uses a combination of fixed-rate and
variable-rate debt, as well as interest rate swaps and rate locks 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 the lowest cost of capital. At September 30, 2001, the carrying amounts
of long-term debt and trust preferred securities were $7.8 billion and $1.3
billion, respectively, with corresponding fair values of $7.7 billion and $1.2
billion, respectively. Based on a sensitivity analysis at September 30, 2001,
CMS Energy estimates that if market interest rates average 10 percent higher or
lower, earnings before income taxes for the subsequent 12 months would not have
a material impact on CMS Energy's consolidated financial position or cash flows.
In addition, based on a 10 percent adverse shift in market rates, CMS Energy
would have an exposure of approximately $429 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 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
September 30, 2001.
The fair value of CMS Energy's floating to fixed interest rate swaps at
September 30, 2001, with a notional amount of $569 million, was $15 million,
which represents the amount CMS Energy would pay upon settlement. The swaps
mature at various times through 2006 and are designated as cash flow hedges for
accounting purposes.
The fair value of CMS Energy's fixed to floating interest rate swaps at
September 30, 2001, with a notional amount of $850 million, was $1 million,
which represents the amount CMS Energy would receive upon settlement. The swaps
mature at various times through 2006 and are designated as fair value hedges for
accounting purposes.
CURRENCY EXCHANGE RISK: CMS Energy is exposed to currency exchange risk
that arises from net investments in foreign operations as well as various
international projects in which CMS Energy has an equity interest and have debt
denominated in the US dollar. CMS Energy uses forward exchange and option
contracts to hedge these currency exchange risks. At September 30, 2001, CMS
Energy's primary currency exchange rate exposure was the Argentine peso. The
impact of the hedges of the net investments in foreign operations is reflected
in other comprehensive income as a component of the foreign currency translation
adjustment. For the third quarter of 2001, the adjustment for hedging was $5
million of the total net foreign currency translation adjustment of $(17)
million. CMS Energy did not incur any significant gain or loss as a result of
exchange rate
CMS-8
fluctuations during the third quarter of 2001 related to hedges of US dollar
denominated debt that did not qualify as net investment hedges, and
consequently, were marked-to-market through earnings.
Based on a sensitivity analysis at September 30, 2001, 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
September 30, 2001, but would result in a net cash settlement of approximately
$16 million. The estimated fair value of the foreign exchange hedges at
September 30, 2001 was $18 million, which represents the amount CMS Energy would
receive 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. A hypothetical 10 percent adverse shift in equity security prices
would not have a material effect on CMS Energy's consolidated financial
position, results of operations or cash flows as of September 30, 2001.
For a discussion of accounting policies related to derivative transactions,
see Note 7, Risk Management Activities and Financial Instruments, incorporated
by reference herein.
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 nine months of 2001, Consumers
paid $134 million in common dividends and Enterprises paid $413 million in
common dividends and other distributions to CMS Energy. In September 2001,
Consumers declared a $55 million common dividend to CMS Energy, payable in
November 2001. 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 nine
months of 2001 and 2000, consolidated cash from operations totaled $246 million
and $163 million, respectively. The $83 million increase resulted primarily from
an increase in cash earnings, excluding the effects of asset revaluations and
discontinued operations, an increase in distributions from related parties, and
the timing of cash receipts and payments related to working capital items. CMS
Energy uses its cash derived from 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 nine months of 2001 and 2000, CMS
Energy's consolidated net cash used in investing activities totaled $994 million
and $372 million, respectively. In 2001 the increased use of cash of $622
million primarily reflects $474 million of reduced proceeds from the sales of
assets compared to 2000. CMS Energy's expenditures (excluding acquisitions)
during the first nine months of 2001 for its utility and diversified energy
businesses were $532 million and $530 million, respectively, compared to $377
million and $436 million, respectively, during the comparable period in 2000.
FINANCING ACTIVITIES: For the first nine months of 2001 and 2000, CMS
Energy's net cash provided by financing activities totaled $779 million and $358
million, respectively. The increase of $421 million resulted primarily from an
increase in the proceeds from notes, bonds, and other long term debt ($886
million), an increase in the issuance of common stock ($331 million), a decrease
in the retirement of trust preferred
CMS-9
securities ($250 million) and a decrease in the repurchase of common stock ($124
million), partially offset by an increase in the retirement of bonds and other
long-term debt ($595 million), an increase in the retirement of notes payable
($478 million) and a decrease in proceeds from trust preferred securities ($99
million). The following table summarizes securities issued during the first nine
months of 2001:
DISTRIBUTION/ PRINCIPAL
MONTH ISSUED MATURITY INTEREST RATE AMOUNT USE OF PROCEEDS
------------ -------- ------------- --------- --------------------------
IN MILLIONS
CMS ENERGY
GTNs Series F (1) (1) 8.28% $ 221 General corporate purposes
Common Stock February n/a 10.0 shares 296 Repay debt and general
corporate purposes
Common Stock (2) n/a 1.4 shares 41 General corporate purposes
Senior Notes March 2011 8.50% 350 Repay debt and general
corporate purposes
Senior Notes July 2008 8.90% 269 Repay debt and general
------ corporate purposes
Subtotal $1,177
------
CONSUMERS
Senior Notes September 2006 6.25% $ 350 General corporate purposes
Trust Preferred
Securities May 2031 9.00% 121 General corporate purposes
------
$ 471
------
Total $1,648
======
- ------------
(1) GTNs are issued from time to time with varying maturity dates. The rate
shown herein is a weighted average interest rate.
(2) Common Stock is issued from time to time in conjunction with the stock
purchase plan and various employee savings and stock incentive plans.
In the first nine months of 2001, CMS Energy paid $135 million in cash
dividends to holders of CMS Energy Common Stock. In September 2001, the Board of
Directors declared a quarterly dividend of $.365 per share, or $54 million on
CMS Energy Common Stock, payable in November 2001.
OTHER INVESTING AND FINANCING MATTERS: At September 30, 2001, the book
value per share of CMS Energy Common Stock was $14.98.
At November 1, 2001, CMS Energy had an aggregate $1.2 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 (Senior
Credit Facilities). CMS Energy also has 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
CMS-10
September 30, 2001, the total amount available under the Senior Credit
Facilities and the unsecured lines of credit were $325 million and $12 million,
respectively. For detailed information, see Note 5, Short-Term and Long-Term
Financings, and Capitalization, incorporated by reference herein.
Pursuant to the outstanding authorization by the Board of Directors to
repurchase shares of CMS Energy Common Stock from time to time, in open market
or private transactions, as of September 30,2001, CMS Energy has repurchased
approximately 232,000 shares for $5 million.
In September 2001, CMS Energy made cash infusions to Consumers in the
amount of $150 million. The proceeds are reflected as a financing activity on
the Consumers Consolidated Statement of Cash Flows.
CMS Energy intends to sell assets in 2001 and 2002 resulting in
approximately $2.4 billion in cash proceeds.
In November 2001, Consumers Funding LLC, a special purpose subsidiary of
Consumers, issued $469 million of Securitization bonds. For further information,
see Note 4, Uncertainties, Consumers' Electric Utility Rate Matters,
incorporated by reference herein.
Consumers has credit facilities, lines of credit and a trade receivable
sale program in place as anticipated sources of funds to fulfill its currently
expected capital expenditures. For detailed information about this source of
funds, see Note 5, Short-Term and Long-Term Financings and Capitalization,
incorporated by reference herein.
In April 2001, Consumers Campus Holdings, a wholly owned subsidiary of
Consumers, entered into a $70 million operating lease agreement for the
construction of an office building to be used as the main headquarters for
Consumers in Jackson, Michigan. The seven-year agreement, with payments
commencing upon completion of construction, includes options to renew the lease,
purchase the property under the lease, or return the property at the end of the
lease term and assist the lessor in remarketing the building. Lease payments
will be determined based on LIBOR rates and the total cost of the construction,
which is projected to be completed on or before March 2003. For further
information on the lease agreement, see Note 9, Leases, incorporated by
reference herein.
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 $3.3 billion during 2001 through
2003. 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 2001 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:
CMS-11
YEARS ENDING DECEMBER 31
--------------------------
2001 2002 2003
----- ------ ----
IN MILLIONS
Consumers electric operations(a)(b) $ 590 $ 480 $405
Consumers gas operations(a) 145 175 165
Natural gas transmission 218 185 140
Independent power production 140 30 25
Oil and gas exploration and production 195 125 170
Marketing, services and trading 3 15 15
International energy distribution 30 - -
Other 44 15 10
------ ------ ----
$1,365 $1,025 $930
====== ====== ====
- ------------
(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 possibly required
to comply with recently revised national air quality standards under the
Clean Air Act. For further information see Note 4, Uncertainties - Electric
Environmental Matters.
(c) The amounts for 2002 and 2003 exclude expenditures associated with a
potential LNG terminal expansion. The expansion expenditures, estimated at
$25 million in 2002 and $90 million in 2003, are currently expected to be
funded through a joint venture via loans or equity contributions from
Panhandle or equity investors or by third party financings acceptable to
the lenders of the joint venture.
For further explanation of CMS Energy's planned investments for the years
2001 through 2003, see the Outlook section below.
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
for its multiple existing businesses.
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, the Company plans to sell non-strategic international assets,
discontinue its international energy distribution business and sell its entire
interest in its Equatorial Guinea oil and gas production and reserves and
methanol plant. CMS Energy has entered into a definitive agreement to sell with
Marathon Oil Company. CMS Energy also 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. CMS Energy is pursuing the sale of these non-strategic and
non-performing assets, including those that were not determined to be impaired.
Upon the sale of these assets, the proceeds realized may be materially different
than the remaining book 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.
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. As a result, CMS Energy's focus will
be in North America, particularly in the United States' central corridor and in
existing operations including commitments in the Middle East. At the plan's
completion, approximately 90% of CMS Energy's assets are expected to be in North
America.
CMS-12
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
the nation's largest operating LNG receiving terminal through expansion and
better utilization of its existing facilities and construction of new
facilities. In October 2001 CMS Trunkline LNG Company announced the expansion of
its Lake Charles, Louisiana facility to approximately 1.2 billion cubic feet 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
billion cubic feet from its current storage capacity of 6.3 billion cubic feet.
With FERC approval, the expanded facility is planned to be in operation in early
2005. In addition, CMS Energy is pursuing financings and monetizations of
several of its assets, including the value created by contracts for capacity at
its Lake Charles, Louisiana, LNG receiving facility. By providing additional
transportation, storage and other asset-based, value-added services to customers
such as new gas-fueled power plants, local distribution companies, industrial
and end-users, marketers and others, CMS Energy expects to expand its natural
gas pipeline business. CMS Energy is in the process of converting certain
Panhandle pipeline facilities through a joint venture to permit the throughput
of liquid products, such as gasoline. CMS Energy is also participating in the
Guardian Pipeline project, a 150-mile natural gas pipeline venture from Illinois
to Wisconsin to meet the needs of significantly growing markets. In November
2001, Guardian Pipeline closed project financing in the amount of $180 million
for construction of the pipeline. Completion and operation of the Guardian
Pipeline is expected by November 2002. Panhandle continues to attempt to
maximize revenues from existing assets and to advance acquisition opportunities
and development projects that provide expanded services to meet the specific
needs of customers. In May 2001, Trunkline LNG signed an agreement with BG Group
of the United Kingdom that provides for a 22-year contract, beginning January
2002, for all the existing uncommitted capacity at Trunkline LNG's facility. CMS
Energy and Sempra Energy announced an agreement in October 2001 to jointly
develop a major new LNG receiving terminal to bring much-needed natural gas
supplies into northwestern Mexico and Southern California. The plant will be
located on the Pacific Coast, north of Ensenada, Baja California, Mexico. It
will have a send out capacity of approximately 1 billion cubic feet per day of
natural gas via a new 40-mile pipeline between the terminal and existing
pipelines in the region. Commercial operation of the LNG terminal is expected to
begin in late 2005.
INDEPENDENT POWER PRODUCTION OUTLOOK: CMS Energy's independent power
production business 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
non-performing, non-region focused and non-synergistic with other CMS Energy
business units. The independent power production business unit will continue to
strive to improve 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 currently negotiating a definitive agreement for the sale
of its interest in the Loy Yang Power facility in Australia. Even though a
deadline has not been established, and the sale cannot be assured, management
anticipates that the transaction will close early in 2002.
OIL AND GAS EXPLORATION AND PRODUCTION OUTLOOK: CMS Energy seeks to
accelerate natural gas exploration, development and production in North America
by exploiting the significant natural gas potential in its existing properties
in West Texas, Wyoming and Montana. CMS Energy also seeks to explore for, or
acquire, natural gas reserves in North America where integrated development
opportunities exist with other CMS Energy
CMS-13
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. In November 2001, CMS
Energy announced that it has signed a definitive agreement with Marathon Oil
Company for the sale of all of CMS's ownership interests in Equatorial Guinea,
West Africa, for approximately $1 billion. Included in the sale are 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 transaction
is expected to close in January 2002 and is subject to approval by the
Government of Equatorial Guinea.
MARKETING, SERVICES AND TRADING OUTLOOK: CMS Energy intends to use its
marketing, services and trading business to focus on wholesale customers such as
municipals, cooperative utilities and large industrial customers in the central
United States where CMS Energy's existing assets are concentrated. CMS Energy's
marketing, services and trading business also intends to contract for use of
significant gas transportation and storage assets in the central United States
to provide a platform for wholesale marketing, trading, and physical arbitrage.
CMS Energy also seeks to continue developing 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.
Recent events related to very large market makers in the energy trading
market have raised concerns about the 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.
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 and cash flows. Such trends and
uncertainties include: 1) the ability to sell or refinance assets or businesses
and achieve balance sheet and credit improvement in accordance with its
financial plan; 2) the international monetary fluctuations, particularly in
Argentina, Brazil and Australia; 3) the changes in foreign governmental and
regulatory policies that could significantly reduce the tariffs charged and
revenues recognized by certain foreign projects; 4) the imposition of stamp
taxes on certain South American contracts that could significantly increase
project expenses; 5) the ability to resolve alleged environmental violations at
an independent power plant; 6) the increased competition in the market for
transmission of natural gas to the Midwest causing pressure on prices charged by
Panhandle; and 7) the expected increase in competition for LNG terminalling
services, and the volatility in natural gas prices, creating volatility in LNG
terminalling revenues.
Since the September 11, 2001 terrorists 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 potential federal and state regulatory
security measures. As a result, CMS Energy anticipates increased operating costs
related to security after September 11, 2001 that could be significant. CMS
Energy cannot quantify these costs at this time. Additionally, it is not certain
that these additional costs will be recovered in Consumers' or Panhandle's
rates.
CMS Energy has become aware that Rouge Steel Company (Rouge), with whom DIG
has contracted to provide steam for industrial use and to supply DIG with blast
furnace gas at prices significantly less than the cost of natural gas, is
pursuing a significant capital investment for their operations which may result
in Rouge altering certain of its operational processes as early as 2004. These
alterations could have an adverse operational and financial impact on DIG by
resulting in Rouge requiring significantly less steam from DIG and not being in
a position to provide economical blast furnace gas for DIG's use in the
production of steam and electricity. However, these alterations may result in
additional electric sales to Rouge that DIG may be able to supply. CMS Energy is
currently assessing these potential operational and financial impacts and DIG is
evaluating alternatives to its current contractual arrangements with Rouge but
CMS Energy cannot predict the ultimate outcome of these matters at this time.
CONSUMERS' ELECTRIC UTILITY BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects electric system
deliveries (including both full service sales and delivery service to customers
who choose to buy generation service from an alternate energy 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 or changes in economic
conditions including utilization and expansion of manufacturing facilities.
CMS-14
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'
market share and can reduce profit margins.
Consumers has in the last several years experienced and expects to continue
to experience a significant increase in competition for generation services with
the introduction of retail direct access in the State of Michigan. Under
Michigan's Customer Choice Act, effective in June 2000, all electric customers
will have the choice of electric generation suppliers by January 1, 2002.
The Customer Choice Act imposes certain rate caps 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 wholly or partially
beyond Consumers' ability to control. In particular, if Consumers needs to
purchase power from wholesale suppliers at market-based prices during the period
when retail rates are frozen or capped, the rate caps imposed by the Customer
Choice Act may make it difficult for Consumers to purchase the power at prices
that it could recover in 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 rate freeze.
In December 2000, as a result of electric restructuring, the MPSC issued a
new code of conduct that applies to electric utilities and alternative energy
suppliers. The code of conduct seeks to prevent cross-subsidization, information
sharing and preferential treatment between a utility's regulated and unregulated
services as well as between a utility and its affiliates. 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 and could restrict the level of business between Consumers and other
CMS Energy subsidiaries or adversely affect the terms on which that business is
conducted. The new code of conduct was recently reaffirmed after hearing without
substantial modification, and is scheduled to be effective at the end of 2001.
Consumers anticipates that it will appeal MPSC orders related to the code of
conduct and seek a stay of its effective date. In addition, Consumers
anticipates that it will seek waivers to the code of conduct with respect to
utility activities that may be prohibited by the new code of conduct, and CMS
Energy non-utility subsidiaries may seek waivers for certain of their activities
that may be prohibited by the new code of conduct. The full impact of the new
code of conduct on CMS Energy's businesses will remain uncertain until the MPSC
or appellate courts issue definitive rulings in regard to the implementation
issues.
Several years prior to the enactment of the Customer Choice Act, in
response to industry restructuring efforts, Consumers entered into multi-year
electric supply contracts with some of its largest industrial customers to
provide power to some of their facilities. The MPSC approved those 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 September 2001, neither Consumers nor
any of its industrial customers have terminated or restructured any of these
contracts. These contracts involve approximately 600 MW of customer power supply
requirements. Consumers cannot predict the ultimate financial impact of changes
related to these power supply contracts.
Uncertainty exists with respect to the enactment of 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,
and recently the House of Representatives passed a bill that is currently before
the Senate. If the federal government enacts legislation restructuring the
electric industry, then that legislation could potentially affect or even
supercede state regulation.
In part because of certain policy pronouncements by the FERC, Consumers
joined the Alliance RTO. In January 2001, the FERC granted Consumers'
application to transfer ownership and control of its transmission facilities to
a wholly owned subsidiary, METC. On April 1, 2001, Consumers transferred the
transmission facilities to METC. In October 2001, Consumers announced an
agreement to sell METC to MTH, an independent limited partnership whose general
partner is a subsidiary of Trans-Elect Inc. METC will continue to own and
operate the system until the companies meet all conditions of closing, including
approval of the
CMS-15
transaction from the FERC. Regulatory approvals and operational transfer are
expected to take place in the second quarter of 2002; however, Consumers can
make no assurances as to when or if the transaction will be completed. For
further information, see Note 4, Uncertainties, Consumers' Electric Utility Rate
Matters, incorporated by reference herein.
CMS Energy cannot predict the outcome of these electric
industry-restructuring issues on its financial position, liquidity, or results
of operations.
RATE MATTERS: Prior to the enactment of the Customer Choice Act, there were
several pending rate issues that could have affected Consumers' electric
business. As a result of the passage of this legislation, the MPSC dismissed
certain rate proceedings and a complaint filed by ABATE seeking a reduction in
rates. ABATE filed a petition for rehearing with the MPSC, which was denied in
October 2001.
For further information and material changes relating to the rate matters
and restructuring of the electric utility industry, see Note 1, Corporate
Structure and Basis of Presentation, Utility Matters, and Note 4, Uncertainties,
Consumers' Electric Utility Rate Matters, incorporated by reference herein.
NUCLEAR MATTERS: In June 2001, an unplanned outage began at Palisades that
negatively affected, and will continue to negatively affect, power costs through
fourth quarter 2001. 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 immediately, as
opposed to partially repairing the components now followed eventually by
complete replacement during a future outage. The Company adopted this approach
because it provides more certainty of schedule for return to service, greater
regulatory acceptability, and avoids future plant outage time and associated
replacement power costs. Installation of the new components is expected to be
completed in December 2001, with the plant expected to return to service in
January 2002. Consumers cannot, however, make any assurances as to the date on
which the new components will be installed or the plant will return to service.
For further information and material changes relating to nuclear matters, see
Note 4, Uncertainties, Nuclear Matters, incorporated by reference herein.
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) capital expenditures and increased 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, including: a)
how the MPSC ultimately calculates the amount of Stranded Costs and the related
true-up adjustments and the manner in which the true-up operates; b) the ability
to recover fully the cost of doing business under the rate caps; c) the ability
to meet peak electric demand requirements at a reasonable cost and without
market disruption and initiatives undertaken to reduce exposure to energy price
increases; d) the restructuring of the MEPCC and the termination of joint
merchant operations with Detroit Edison; e) the ability to sell wholesale power
at market based rates; f) the effect of the transfer of Consumers transmission
facilities to METC and its successful disposition or integration into an RTO;
and g) the MPSC adoption of proposed electric distribution performance standards
requiring customer credits for prolonged outages; 5) the power outage at
Palisades and the incremental cost of replacement power and maintenance; and 6)
the effects of derivative accounting and
CMS-16
potential earnings volatility. For detailed information about these trends or
uncertainties, see Note 4, Uncertainties, incorporated by reference herein.
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
energy costs, changes in competitive conditions, and the level of natural gas
consumption per customer.
During the spring and summer months of 2001, Consumers purchased natural
gas for inventory to meet anticipated future customer needs during the winter
heating season. Consumers anticipates that it will incur financing costs on
these natural gas purchases that are higher than the costs recovered in current
rates.
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) implementation of the permanent gas
customer choice program for all gas retail customers; 4) any initiatives
undertaken to protect customers against gas price increases; and 5) market and
regulatory responses to increases in gas costs. For detailed information about
these uncertainties, see Note 4, Uncertainties, incorporated by reference
herein.
CONSUMERS' OTHER OUTLOOK
Consumers offers a variety of energy-related services to electric and gas
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
energy-related services for Consumers' customers.
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
separated from future rates and the services could be provided by an approved
third party. Consumers was directed to make this filing in connection with its
June 2001 request for a gas service rate increase and Consumers has complied
with this request.
OTHER MATTERS
FOREIGN CURRENCY TRANSLATION
CMS Energy adjusts common stockholders' equity to reflect foreign currency
translation adjustments for the operation of long-term investments in foreign
countries. During the first nine months of 2001, the change in the
CMS-17
foreign currency translation adjustment decreased equity by $64 million, of
which $17 million was recognized during the third quarter, net of after-tax
hedging proceeds. Although management currently believes that the currency
exchange rate fluctuations over the long term will not have a material adverse
affect on CMS Energy's financial position, liquidity or results of operations,
CMS Energy hedges its exposure to the Argentine peso. Previous hedges for the
Australian dollar and the Brazilian real expired during the third quarter. CMS
Energy uses forward exchange and option contracts to hedge certain receivables,
payables, long-term debt and equity value relating to foreign investments. The
notional amount of the outstanding foreign exchange contracts on the Argentine
peso was $223 million at September 30, 2001. The estimated fair value of the
foreign exchange and option contracts at September 30, 2001 was $18 million,
which represents the amount CMS Energy would receive upon settlement.
In 2000, an impairment loss of $329 million ($268 million after-tax) was
realized on the carrying amount of the Loy Yang investment. This loss does not
include cumulative net foreign currency losses of $164 million due to
unfavorable changes in the exchange rates, which, in accordance with SFAS No.
52, Foreign Currency Translation, will not be realized until there has been a
sale or full liquidation of CMS Energy's investment.
NEW ACCOUNTING RULES
During July 2001, FASB issued SFAS No. 141, Business Combinations, and SFAS
No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all
business combinations initiated after June 30, 2001, be accounted for under the
purchase method; use of the pooling of interests method is no longer permitted.
The adoption of SFAS No. 141 effective July 1, 2001 will result in CMS Energy
accounting for any future business combinations under the purchase method of
accounting, but will not change the method of accounting used in previous
business combinations.
SFAS No. 142 requires that goodwill no longer be amortized to earnings, but
instead be reviewed for impairment on an annual basis. The amortization of
goodwill ceases upon adoption of the standard. At September 30, 2001 the amount
of unamortized goodwill was $824 million. Goodwill amortization was
approximately $6 million and $18 million, excluding the effects of write-downs,
for the three months and nine months ended September 30, 2001, respectively. The
provisions of SFAS No. 142 require adoption as of January 1, 2002 for calendar
year entities. 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 upon adoption.
In August 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. 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 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 useful life of the related asset. 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.
FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, in October 2001 that supersedes SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
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, Reporting Results of Operations - Reporting
the Effects of Disposal of a Segment of a Business, for the disposal of segments
of a business.
CMS-18
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 CMS Energy accounting for any future impairments or disposals of
long-lived assets under the provisions of SFAS No. 144, but will not change the
accounting principles used in previous asset impairments or disposals.
In October 2001, the FASB also issued clarifying guidance for Derivative
Implementation Issue No. C15, Scope Exceptions: Normal Purchases and Normal
Sales Exception for Option-Type Contracts and Forward Contracts in Electricity,
and final guidance for Derivative 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. These
issues could have a significant impact upon the implementation of derivative
accounting for certain contracts, and are effective January 1, 2002 and April 1,
2002, respectively.
CMS-19
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPEMBER 30 SEPEMBER 30
--------------------- ---------------------
2001 2000 2001 2000
------ ------ ------- -------
IN MILLIONS, EXCEPT PER SHARE AMOUNTS
OPERATING REVENUE
Electric utility $ 738 $ 715 $ 2,027 $2,002
Gas utility 149 142 928 765
Natural gas transmission 205 247 854 604
Independent power production 97 144 314 357
Oil and gas exploration and production 62 33 158 96
Marketing, services and trading 1,743 1,034 7,176 1,776
Other 2 8 15 20
------ ------ ------- ------
2,996 2,323 11,472 5,620
------ ------ ------- ------
OPERATING EXPENSES
Operation
Fuel for electric generation 94 104 265 286
Purchased and interchange power - Marketing, services and trading 1,283 574 4,282 685
Purchased and interchange power 190 140 416 311
Purchased power - related parties 155 141 399 438
Cost of gas sold - Marketing, services and trading 377 471 2,519 1,065
Cost of gas sold 120 133 991 560
Other 336 254 1,060 717
------ ------ ------- ------
2,555 1,817 9,932 4,062
Maintenance 60 67 190 214
Depreciation, depletion and amortization 125 145 388 446
General taxes 54 57 177 178
Loss contracts and reduced asset valuations (Note 3) 603 - 603 -
------ ------ ------- ------
3,397 2,086 11,290 4,900
------ ------ ------- ------
PRETAX OPERATING INCOME (LOSS)
Electric utility (62) 118 157 342
Gas utility (1) 9 81 44
Natural gas transmission 8 48 146 172
Independent power production (327) 51 (273) 137
Oil and gas exploration and production (25) 10 16 16
Marketing, services and trading 20 (2) 78 2
Other (14) 3 (23) 7
------ ------ ------- ------
(401) 237 182 720
------ ------ ------- ------
OTHER INCOME (DEDUCTIONS)
Accretion income - - - 2
Accretion expense (9) (8) (26) (25)
Gain on asset sales, net of foreign currency translation losses of $25
in 2000 - 7 10 76
Other, net 6 4 17 12
------ ------ ------- ------
(3) 3 1 65
------ ------ ------- ------
EARNINGS (LOSS) BEFORE INTEREST AND TAXES (404) 240 183 785
------ ------ ------- -------
FIXED CHARGES
Interest on long-term debt 139 152 426 443
Other interest 18 10 46 17
Capitalized interest (7) (14) (34) (34)
Preferred dividends - - 1 1
Preferred securities distributions 25 24 71 71
------ ------ ------- ------
175 172 510 498
------ ------ ------- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND
MINORITY INTERESTS (579) 68 (327) 287
INCOME TAXES (BENEFITS) (196) 17 (108) 78
MINORITY INTERESTS 1 - 3 1
------ ------ ------- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS (384) 51 (222) 208
DISCONTINUED OPERATIONS, NET OF TAX BENEFIT OF $20 (NOTE 2) (185) 2 (185) 4
------ ------ ------- ------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (569) 53 (407) 212
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR TREATMENT OF INVENTORY,
NET OF TAX BENEFIT OF $(2) - - - (5)
------ ------ ------- ------
CONSOLIDATED NET INCOME (LOSS) $ (569) $ 53 $ (407) $ 207
====== ====== ======= ======
CMS-20
THREE MONTHS ENDED NINE MONTHS ENDED
SEPEMBER 30 SEPEMBER 30
--------------------- ---------------------
2001 2000 2001 2000
------ ------ ------- ------
AVERAGE COMMON SHARES OUTSTANDING 133 110 130 111
====== ====== ======= ======
BASIC EARNINGS (LOSS) PER AVERAGE COMMON SHARE:
CONTINUING OPERATIONS $(2.89) $ .47 $ (1.71) $ 1.83
DISCONTINUED OPERATIONS $(1.40) $ .02 $ (1.42) $ .03
------ ------ ------- ------
$(4.29) $ .49 $ (3.13) $ 1.86
====== ====== ======= ======
DILUTED EARNINGS (LOSS) PER AVERAGE COMMON SHARE:
CONTINUING OPERATIONS $(2.89) $ .47 $ (1.71) $ 1.82
DISCONTINUED OPERATIONS $(1.40) $ .02 $ (1.42) $ .03
------ ------ ------- ------
$(4.29) $ .49 $ (3.13) $ 1.85
====== ====== ======= ======
DIVIDENDS DECLARED PER COMMON SHARE $ .365 $ .365 $ 1.095 $1.095
====== ====== ======= ======
The accompanying condensed notes are an integral part of these statements.
CMS-21
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30
----------------------
2001 2000
------ ------
IN MILLIONS
CASH FLOWS FROM OPERATING ACTIVITIES
Consolidated net income $ (407) $ 207
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $5 and $29, respectively) 388 446
Contract losses and asset revaluations (Note 3) 628 -
Discontinued operations (Note 2) 185 (4)
Capital lease and debt discount amortization 17 25
Accretion expense 26 25
Accretion income - abandoned Midland project - (2)
MCV power purchases (9) (42)
Undistributed earnings from related parties (2) (125)
Cumulative effect of an accounting change - 7
Gain on the sale of assets, net of foreign currency translation losses (10) (76)
Changes in other assets and liabilities:
Decrease (increase) in accounts receivable and accrued revenues 180 (592)
Increase in inventories (365) (143)
Increase (decrease) in accounts payable and accrued expenses (334) 454
Decrease in deferred income taxes and investment tax credit (30) (2)
Regulatory obligation - gas choice (16) 27
Changes in other assets and liabilities (5) (42)
------ ------
Net cash provided by operating activities 246 163
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (862) (732)
Acquisition of companies, net of cash acquired - (74)
Investments in partnerships and unconsolidated subsidiaries (163) (48)
Cost to retire property, net (73) (78)
Proceeds from sale of property 109 583
Other (5) (23)
------ ------
Net cash used in investing activities (994) (372)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes, bonds, and other long-term debt 1,644 758
Proceeds from trust preferred securities 121 220
Issuance of common stock 334 3
Retirement of bonds and other long-term debt (923) (328)
Retirement of trust preferred securities - (250)
Repurchase of common stock (5) (129)
Payment of common stock dividends (135) (122)
Increase (decrease) in notes payable, net (250) 228
Payment of capital lease obligations (17) (22)
Other financing 10 -
------ ------
Net cash provided by financing activities 779 358
------ ------
NET INCREASE IN CASH AND TEMPORARY CASH INVESTMENTS 31 149
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 182 132
------ ------
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 213 $ 281
====== ======
CMS-22
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30
-----------------------
2001 2000
------- ------
IN MILLIONS
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 450 $ 423
Income taxes paid (net of refunds) (6) 24
NON-CASH TRANSACTIONS
Nuclear fuel placed under capital lease $ 13 $ 3
Other assets placed under capital leases 15 10
======= ======
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-23
CMS ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30
2001 2000 2000
------------ ----------- -----------
(UNAUDITED) (UNAUDITED)
IN MILLIONS
ASSETS
PLANT AND PROPERTY (AT COST)
Electric utility $ 7,513 $ 7,241 $ 7,146
Gas utility 2,566 2,503 2,529
Natural gas transmission 2,207 2,191 2,119
Independent power production 888 398 736
Oil and gas properties (successful efforts method) 783 630 577
International energy distribution 215 258 460
Other 91 101 96
------- ------- -------
14,263 13,322 13,663
Less accumulated depreciation, depletion and amortization 6,735 6,252 6,315
------- ------- -------
7,528 7,070 7,348
Construction work-in-progress 567 761 817
------- ------- -------
8,095 7,831 8,165
------- ------- -------
INVESTMENTS
Independent power production 781 924 959
Natural gas transmission 540 436 410
Midland Cogeneration Venture Limited Partnership 296 290 273
First Midland Limited Partnership 249 245 241
Other 93 121 69
------- ------- -------
1,959 2,016 1,952
------- ------- -------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 213 182 281
Accounts receivable - Marketing, services and trading, less
allowances of $4, $3 and $2, respectively 634 526 837
Accounts receivable, notes receivable and accrued revenue, less
allowances of $16, $15 and $20, respectively 585 914 741
Inventories at average cost
Gas in underground storage 630 297 334
Materials and supplies 145 124 172
Generating plant fuel stock 50 46 48
Deferred income taxes - 39 28
Prepayments and other 295 325 241
------- ------- -------
2,552 2,453 2,682
------- ------- -------
NON-CURRENT ASSETS
Regulatory Assets
Securitization costs 710 709 -
Postretirement benefits 214 232 317
Abandoned Midland Project 12 22 28
Unamortized nuclear costs - 6 476
Other 89 87 116
Goodwill, net 824 891 903
Nuclear decommissioning trust funds 568 611 617
Notes receivable - related party 163 155 180
Notes receivable 142 150 148
Other 761 688 657
------- ------- -------
3,483 3,551 3,442
------- ------- -------
TOTAL ASSETS $16,089 $15,851 $16,241
======= ======= =======
CMS-24
SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30
2001 2000 2000
------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
IN MILLIONS
STOCKHOLDERS' INVESTMENT AND LIABILITIES
CAPITALIZATION
Common stockholders' equity $ 1,987 $ 2,361 $ 2,300
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) 520 395 395
Long-term debt 7,402 6,770 7,246
Non-current portion of capital leases 57 54 81
------- ------- -------
10,704 10,318 10,760
------- ------- -------
MINORITY INTERESTS 82 88 221
------- ------- -------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 802 707 542
Notes payable 153 403 432
Accounts payable 593 614 620
Accounts payable - Marketing, services and trading 392 410 735
Accrued interest 155 159 145
Accrued taxes 72 309 276
Accounts payable - related parties 68 70 67
Deferred income taxes 9 - -
Other 657 530 515
------- ------- -------
2,901 3,202 3,332
------- ------- -------
NON-CURRENT LIABILITIES
Deferred income taxes 646 749 639
Postretirement benefits 347 437 450
Deferred investment tax credit 104 110 119
Regulatory liabilities for income taxes, net 270 246 86
Power loss contract reserves 365 54 37
Gas supply contract obligations 291 304 283
Other 379 343 314
------- ------- -------
2,402 2,243 1,928
------- ------- -------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 4)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $16,089 $15,851 $16,241
======= ======= =======
- ------------
(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-25
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPEMBER 30 SEPEMBER 30
--------------------- --------------------
2001 2000 2001 2000
------ ------ ------ ------
IN MILLIONS
COMMON STOCK
At beginning and end of period $ 1 $ 1 $ 1 $ 1
OTHER PAID-IN CAPITAL
At beginning of period 3,264 2,626 2,936 2,749
Common stock repurchased (5) - (5) (129)
Common stock reacquired - (14) - (14)
Common stock reissued - 8 - 11
Common stock issued 6 3 334 6
------ ------ ------ ------
At end of period 3,265 2,623 3,265 2,623
------ ------ ------ ------
REVALUATION CAPITAL
Investments
At beginning of period (4) 1 (2) 3
Unrealized gain (loss) on investments (a) (1) - (3) (2)
------ ------ ------ ------
At end of period (5) 1 (5) 1
------ ------ ------ ------
Derivative Instruments
At beginning of period (b) (24) - 13 -
Unrealized gain (loss) on derivative instruments (a) (15) - (44) -
Reclassification adjustments included in consolidated net income (a) - - (8) -
------ ------ ------ ------
At end of period (39) - (39) -
------ ------ ------ ------
FOREIGN CURRENCY TRANSLATION
At beginning of period (301) (173) (254) (108)
Change in foreign currency translation realized from asset sale (a) - - - 25
Change in foreign currency translation (a) (17) (48) (64) (138)
------ ------ ------ ------
At end of period (318) (221) (318) (221)
------ ------ ------ ------
RETAINED EARNINGS (DEFICIT)
At beginning of period (252) (117) (320) (189)
Consolidated net income (a) (569) 53 (407) 207
Common stock dividends declared (96) (40) (190) (122)
------ ------ ------ ------
At end of period (917) (104) (917) (104)
------ ------ ------ ------
TOTAL COMMON STOCKHOLDERS' EQUITY $1,987 $2,300 $1,987 $2,300
====== ====== ====== ======
- ------------
(a) Disclosure of Comprehensive Income:
Revaluation capital
Investments
Unrealized gain (loss) on investments, net of tax of
$1, $-, $1 and $1, respectively $ (1) $ - $ (3) $ (2)
Derivative Instruments
Unrealized gain (loss) on derivative instruments,
net of tax of $2, $-, $13 and $-, respectively (15) - (44) -
Reclassification adjustments included in consolidated net income,
net of tax of $-, $-, $4 and $-, respectively _ - (8) -
Foreign currency translation, net (17) (48) (64) (113)
Consolidated net income (569) 53 (407) 207
----- ------ ----- -----
Total Consolidated Comprehensive Income $(602) $ 5 $(526) $ 92
===== ====== ===== =====
(b) Nine months ended September 30, 2001 reflects the cumulative effect of
change in accounting principle, net of $(8) tax (Note 7)
The accompanying condensed notes are an integral part of these statements.
CMS-26
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 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, 2000, 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
CORPORATE STRUCTURE AND BASIS OF PRESENTATION
CMS Energy is the parent holding company of Consumers and Enterprises.
Consumers, a combination electric and gas utility company serving Michigan's
Lower Peninsula, is a subsidiary of CMS Energy. Enterprises, through
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 preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The 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 and nine months ended September 30, 2001, undistributed equity earnings
were $28 million and $2 million, respectively, compared to $24 million and $125
million for the three and nine months ended September 30, 2000, respectively.
Intercompany transactions and balances have been eliminated.
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.
CMS-27
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 nine months of 2001, the change in the
foreign currency translation adjustment decreased equity by $64 million, net of
after-tax hedging proceeds.
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, Accounting for the Effects of Certain
Types of Regulation. 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.
Consistent with these orders, Consumers discontinued application of SFAS No. 71
for the energy supply portion of its business in the first quarter of 1999
because Consumers expected to implement retail open access for its electric
customers in September 1999. Discontinuation of SFAS No. 71 for the energy
supply portion of Consumers' business resulted in Consumers reducing the
carrying value of its Palisades plant-related assets by approximately $535
million and establishing a regulatory asset for a corresponding amount, which is
now included as a component of securitization assets. According to current
accounting standards, Consumers can continue to carry its energy 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 September 30, 2001, Consumers had a net
investment in energy supply facilities of $1.284 billion included in electric
plant and property. See Note 4, Uncertainties.
2: DISCONTINUED OPERATIONS
In September 2001, management recommended and the Board of Directors
approved, a plan to discontinue the operations of the International Energy
Distribution segment. Incorporated in 1996, CMS Electric and Gas had been formed
to purchase, invest in and operate gas and electric distribution systems
worldwide and currently, has significant ownership interests in electric
distribution companies located in Brazil and Venezuela. 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.
CMS-28
The following summarizes the balance sheet information of the discontinued
operations:
September 30
------------------------
2001 2000(a)
---- -------
In millions
Assets
Accounts receivable, net $11 $75
Materials and supplies 8 14
Property, plant and equipment, net 10 454
Goodwill 34 54
Deferred taxes 26 27
Other 30 54
---- ----
$119 $678
---- ----
Liabilities
Accounts payable $13 $31
Current and long-term debt 3 85
Accrued taxes -- 27
Minority interest 47 151
Other 20 34
---- ----
$ 83 $328
---- ----
- -----------
(a) For the nine months ended September 30, 2000, total assets included assets
of EDEERSA, which was subsequently sold, of $289 million. Total liabilities
included debt and other liabilities of EDEERSA of $77 million and $34
million, respectively.
Revenues from such operations were $105 million and $196 million for the
nine months ended September 30, 2001 and 2000, respectively. In accordance with
APB Opinion No. 30, the net losses of the operation are included in the
consolidated statements of income under "discontinued operations". The pre-tax
loss recorded for the period ended September 30, 2001 on the anticipated sale of
the operation was $203 million, which included a reduction in asset values, a
provision for anticipated closing costs and operating losses until disposal, and
a portion of CMS Energy's interest expense. Interest expense was allocated to
the operation based on its ratio of total capital to that of CMS Energy. See
table below for income statement components of the discontinued operations.
Nine months ended
September 30
----------------------
2001 2000
----- ----
In millions
Discontinued operations:
Income (loss) from discontinued operations, net of taxes of $1 $(2) $4
Loss on disposal of discontinued operations, including provision
of $1 for operating losses during phase-out period, net of
tax benefit of $21 (183) --
----- --
Total $(185) $4
----- --
3: LOSS CONTRACTS AND REDUCED ASSET VALUATIONS
DEARBORN INDUSTRIAL GENERATION LOSS CONTRACT: In 1998, DIG, which operates
the Dearborn Industrial Generation complex, a 710 MW combined cycle facility
constructed primarily to fulfill the contract requirements, executed Electric
Sales Agreements with Ford Motor Company, Rouge Industries and certain other
Ford and Rouge affiliates that require DIG to deliver up to 300 MWs of
electricity at pre-determined prices for a fifteen year term beginning in June
2000. As a result of continued plant construction delays, the majority of the
DIG project did not achieve commercial operation until the third quarter of
2001. At that time,
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DIG entered into long-term natural gas fuel contracts that fixed portions
of the anticipated fuel requirements related to the electricity contracts and
defined an operational model that reasonably reflects the expected economics of
the project and the contracts involved. Based on this operational model, CMS
Energy determined the estimated costs to perform under the electric contracts
using an incremental-cost (net of revenues) approach. Using this approach, CMS
Energy estimated that the incremental costs to provide electricity under the
Electric Sales Agreements exceeded the anticipated revenues to be earned over
the life of the contracts by $200 million. Accordingly, in the third quarter,
CMS Energy recorded a reserve for the loss on these contracts of $200 million
($130 million after-tax, or $.98 per basic and diluted share) in "Loss contracts
and reduced asset valuations" on the Consolidated Statements of Income.
MIDLAND COGENERATION VENTURE LOSS CONTRACT: In 1992, Consumers recognized a
loss for the present value of the estimated future underrecoveries of power
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. Management's
assumptions of these factors have changed significantly enough that the
expectation of the level of future underrecoveries has increased. As a result,
in September 2001, Consumers increased the PPA liability by $126 million ($82
million, after-tax, or $.62 per basic and diluted share), which appears on the
Consolidated Statements of Income in the caption "Loss contracts and reduced
asset valuations". Management believes that, following this increase, the
liability adequately reflects the PPA's future effect on Consumers. At September
30, 2001 and 2000, the remaining after-tax present value of the estimated future
PPA liability associated with the loss totaled $122 million and $55 million,
respectively. For further discussion on the impact of the frozen PSCR, see Note
4, Uncertainties - Electric Rate Matters.
PLANNED DIVESTITURES AND REDUCED ASSET VALUATIONS: Implementing a new
strategic direction of CMS Energy has resulted in assets and development
projects that have been identified by the business units as non-strategic or
non-performing. These assets include, both domestic and international, electric
power plants, gas processing facilities, exploration and production assets and
certain equity method and other investments. CMS Energy has written off the
carrying value of the development projects that will no longer be pursued. In
addition, management evaluated the operating assets for impairment in accordance
with the provisions of SFAS No. 121 for asset projects and APB Opinion No. 18
for equity investments. Based on this evaluation, certain of these assets were
determined to be impaired. Reductions in asset valuations related to these
write-downs were recognized in the third quarter in the amount of $277 million
($203 million, after tax, or $1.53 per basic and diluted share) to reflect the
excess of the carrying value of these assets over their fair value. The charges
are reflected in the Consolidated Statements of Income under the caption "Loss
contracts and reduced asset valuations".
CMS Energy is pursuing the sale of all of these non-strategic and
non-performing assets, including those that were not determined to be impaired.
Upon the sale of these assets, the proceeds realized may be materially different
than the remaining book 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.
OTHER CHARGES: The total of other charges recognized in the third quarter
were $25 million ($15 million, after tax, or $.11 per basic and diluted share)
that consisted of the following items:
In 1996, Consumers filed with the FERC and self-implemented OATT
transmission rates. Certain intervenors contested these rates, and hearings were
held before an ALJ in 1998. During 1999, the ALJ rendered an initial decision,
which if upheld by the FERC, would ultimately reduce Consumers' OATT rates and
require Consumers to refund, with interest, any over-collections for past
services. Consumers, since that time has been
CMS-30
reserving a portion of revenues billed to customers under these OATT rates. At
the time of the initial decision, the company believed that certain issues would
be decided in Consumers' favor, and that a relatively quick order would be issue
by the FERC regarding this matter. However, due to changes in regulatory
interpretations Consumers believes that a successful resolution of certain
issues is less likely. As a result, in September 2001, Consumers reserved an
additional $12 million, including interest, to fully reflect the financial
impacts of the initial decision. Consumers expects that its reserve levels for
future transmission service will also be in compliance with the PFD until an
order from the FERC is received.
In 1996, Consumers and its wholesale customers entered into five-year
contracts that fixed the portion of nuclear decommissioning costs that were
expected to end in 2001 associated with these customers. Since that time, the
total estimated decommissioning costs for Big Rock increased substantially over
the estimates used to calculate the decommissioning costs attributed to
wholesale customers. As a result of a reduction in decommissioning trust
earnings in August 2001, along with the higher estimated costs of
decommissioning, Consumers, in September 2001, expensed approximately $5 million
related to this issue to recognize the unrecoverable portion of Big Rock
decommissioning costs associated with these customers.
Panhandle recorded a lower of cost or market adjustment of $7 million in
the third quarter of 2001, reducing its current gas inventory to market value.
Loss contracts, reduced asset valuations and other charges recognized by
CMS Energy business segments during the third quarter of 2001 are as follows:
Business Segment Pre-tax impact After-tax impact
- ---------------- -------------- ----------------
In millions
Valuation Losses:
Natural Gas Transmission $ 36 $ 24
Independent Power Production 178 138
Oil and Gas Exploration & Production 49 32
Corporate 14 9
---- ----
Total Valuation Losses 277 203
---- ----
Loss Contracts:
Consumers Electric Utility 126 82
Independent Power Production 200 130
---- ----
Total Loss Contracts 326 212
---- ----
Subtotal: 603 415
---- ----
Other Charges:
Consumers Electric Utility 18 11
Panhandle 7 4
---- ----
Grand Total $628 $430
---- ----
CMS-31
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.
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 $470
million and $560 million, calculated in year 2001 dollars. Consumers anticipates
that it will incur these capital expenditures between 2000 and 2004. As of
September 2001, Consumers has incurred $251 million in capital expenditures to
comply with these regulations.
At some point after 2004, 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 capital
expenditures above depreciation levels are expected to be recoverable, subject
to an MPSC prudence hearing, in future rates.
These and other required environmental expenditures may have a material
adverse effect upon our 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 does,
however, believe that these costs are 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
September 30, 2001, 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.
CMS-32
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 Stranded Costs as a means of offsetting the earnings impact of the
five percent residential rate reduction; 5) establishes a market power 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 is in compliance); 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 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 would result in an extension of the rate caps to as
late as December 31, 2013. As of September 30, 2001, Consumers spent $25 million
on the required expansion of transmission capabilities. Consumers anticipates it
will spend an additional $13 million in 2001 and 2002, until Consumers sells
METC to MTH, as discussed below under "Transmission Business".
In July 2000, in accordance with the Customer Choice Act, Consumers filed
an application with the MPSC seeking approval to issue Securitization bonds.
Securitization typically involves the issuance of asset backed bonds with a
higher credit rating than conventional utility corporate financing. In October
2000 and January 2001, the MPSC issued a financing order and a final financing
order, respectively. In January 2001, Consumers accepted the MPSC's final
financing order. Although the Michigan Attorney General appealed the financing
order after Consumers accepted the order, the Attorney General did not appeal
the order to the Michigan Supreme Court after the Michigan Court of Appeals
unanimously affirmed the MPSC's order in July 2001.
The orders authorize 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 offsetting
substantially all 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. Actual cost savings from Securitization depends upon the level of
debt or equity securities ultimately retired, the amortization schedule for the
securitized qualified costs and the interest rates of the retired debt
securities and the Securitization bonds. The orders direct Consumers to apply
any cost savings in excess of the five percent residential rate reduction to
rate reductions for non-residential and retail open access customers after the
bonds are sold. Excess savings are currently estimated to be approximately $13
million annually.
In November 2001, Consumers Funding LLC, a special purpose 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.
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 beginning in December
CMS-33
2001. These charges are subject to an annual true-up until one year prior to the
last expected bond maturity date, October 20, 2015, and no more than quarterly
thereafter. Current electric rates will not increase for most of Consumers'
electric customers under the MPSC's order. Funds collected will be remitted to
the trustee for the Securitization bonds and are not available to Consumers'
creditors.
Beginning January 1, 2001, the amortization of the approved regulatory
assets being securitized as qualified costs is being deferred, which effectively
offsets the loss in revenue resulting from the five percent residential rate
reduction. In December 2001, the amortization will be reestablished based on a
schedule that is the same as the recovery of the principal amounts of the
securitized qualified costs. The amortization amount is expected to be
approximately $31 million in 2002 and the securitized assets will be fully
amortized by the end of 2015.
In September 1999, Consumers began implementing a plan for electric retail
customer open access. In 1998, Consumers submitted this plan to the MPSC and in
March 1999 the MPSC issued orders that generally supported the plan. 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
filed tariffs governing its retail open access program and addressed revisions
appropriate to comply with the Customer Choice Act. Consumers cannot predict how
the MPSC will modify the tariff or enforce the existing restructuring orders.
POWER COSTS: During periods when electric demand is high, the cost of
purchasing energy 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 reserve, also called a
reserve margin, of approximately 15 percent. The reserve margin provides
Consumers with additional power above its anticipated peak power demands. It
also allows Consumers to provide reliable service to its electric service
customers and to protect itself against unscheduled plant outages and
unanticipated demand. As it has in previous summers, Consumers is planning for a
reserve margin of 15 percent for the summers 2002 and 2003. 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. The existing retail open access plan allows other
electric service providers with the opportunity to serve up to 750 MW of nominal
retail open access requirements. As of October 2001, alternative electric
service providers are providing service to 223 MW of retail open access
requirements. In June 2001, an unscheduled plant outage commenced at Palisades
that will affect future power costs. Consumers has secured additional power and
expects to have sufficient power to meet its customers' needs. For further
information, refer to the "Nuclear Matters" section of this note.
To reduce the risk of high energy prices during peak demand periods and to
achieve its reserve margin target, Consumers employs a strategy of purchasing
electricity call option contracts for the physical delivery of electricity
during the months of June through September. The cost of these electricity call
option contracts for summer 2001 was approximately $61 million. Consumers
expects to use a similar strategy in the future, but cannot predict the cost of
this strategy at this time. As of September 30, 2001, Consumers had purchased or
had commitments to purchase electricity call option contracts partially covering
the estimated reserve margin requirements for summers 2002 through 2008, at a
recognized cost of $73 million, of which $27 million pertains to 2002.
In 1996, as a result of 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
CMS-34
companies jointly operate the MEPCC. Detroit Edison and Consumers negotiated to
restructure and continue 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 of terminating these
joint merchant operations with Detroit Edison.
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, interchange power and purchased 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
until at least December 31, 2003. Therefore, changes in power supply costs as a
result of fluctuating energy prices will not be reflected in rates during the
rate freeze period.
Consumers is authorized by the FERC to sell power at wholesale prices that
are either 1) no greater than its cost-based rates or 2) at market price. 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 market dominance analysis in October 2001. In
September 2001, the FERC staff issued a report suggesting that the FERC may
reconsider the method it currently uses to evaluate market power assessments for
electric generators. If the FERC determines that this method is not sufficient,
Consumers cannot be certain at this time if it will be granted authorization to
continue to sell wholesale power at market-based prices and may be limited to
charging prices no greater than its cost-based rates. A decision on reliance of
the current assessment method is not expected for several months.
TRANSMISSION BUSINESS: 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 by December 31, 2001.
In 1999, Consumers and four other electric utility companies joined
together to form a coalition known as the Alliance Companies for the purpose of
creating a FERC-approved RTO. In October 2000, Consumers filed a request with
the FERC to transfer ownership and control of its transmission facilities to a
wholly owned subsidiary, METC. This request was granted in January 2001. In
December 2000, the MPSC issued an order authorizing an anticipated sale or
ownership transfer of Consumers' transmission facilities. On April 1, 2001, the
transfer of the electric transmission facilities to METC took place.
In October 2001, in compliance with Michigan's Customer Choice Act, and in
conformance with FERC Order No. 2000, Consumers executed an agreement to sell
METC for approximately $290 million to MTH, an independent limited partnership
whose general partner is a subsidiary of Trans-Elect, Inc. Proceeds from the
sale of METC will be used to improve Consumers' balance sheet. MTH and Consumers
are currently seeking to satisfy the conditions of closing including approval of
the transaction from the FERC. Consumers will continue to own and operate the
system until all approvals are received and the sale is final. Regulatory
CMS-35
approvals and operational transfer are expected to take place in the second
quarter of 2002; however, Consumers can make no assurances as to when or if the
transaction will be completed. METC will continue to maintain the system under a
long-term contract with MTH.
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 which it can not control. As a result of the sale of its
transmission facilities, Consumers anticipates that after tax earnings will be
reduced by approximately $6 million and $14 million in 2002 and 2003,
respectively. Through 2005, Consumers' total revenues should not be materially
affected from the sale of METC due to frozen retail rates.
Under the agreement with MTH, transmission rates charged to Consumers'
bundled electric customers will be frozen 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 power
into Michigan, as required by the Customer Choice Act.
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 that would either fully or partially resolve this
litigation. The settlements were approved by the Michigan circuit court and are
contingent upon the approval by the FERC and certain other contingencies. The
circuit court has retained jurisdiction over the matter.
ELECTRIC PROCEEDINGS: In 1997, ABATE filed a complaint with the MPSC. The
complaint alleged that Consumers' electric earnings are more than its authorized
rate of return and sought an immediate reduction in Consumers' electric rates
that approximated $189 million annually. As a result of the rate freeze imposed
by the Customer Choice Act, the MPSC issued an order in June 2000 dismissing the
ABATE complaint. In July 2000, ABATE filed a rehearing petition with the MPSC,
which was denied in October 2001.
In March 2000 and 2001, Consumers filed applications with the MPSC for the
recovery of electric utility restructuring implementation costs of $30 million
and $25 million, incurred in 1999 and 2000, respectively. In July 2001,
Consumers received a final order that granted recovery of $25 million of
restructuring implementation costs for 1999. The MPSC disallowed recovery of $5
million, based upon a conclusion that this amount did not represent incremental
costs. The MPSC also ruled that it reserved the right to undertake another
review of the total 1999 restructuring implementation costs depending upon the
progress and success of the retail open access program. In addition, the MPSC
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 costs. Consumers
expects to receive a final order for the 2000 cost in early 2002. Consumers
believes these costs are fully recoverable in accordance with the Customer
Choice Act; however, Consumers cannot predict the amounts the MPSC will approve
as recoverable costs.
Also, in July 2001, Consumers received an order from the MPSC that proposed
electric distribution performance standards applicable to electric distribution
companies operating in Michigan. The proposed performance standards would
establish standards related to outage restoration, safety, and customer
relations. Failure to meet the proposed performance standards would result in
customer credits. Consumers has submitted comments to the MPSC. Consumers cannot
predict the outcome of the proposed performance standards.
CMS-36
In 1996, Consumers filed with the FERC and self-implemented OATT
transmission rates. Certain intervenors contested these rates, and hearings were
held before an ALJ in 1998. During 1999, the ALJ rendered an initial decision,
which if upheld by the FERC, would ultimately reduce Consumers' OATT rates and
require Consumers to refund, with interest, any over-collections for past
services. Consumers, since that time has been reserving a portion of revenues
billed to customers under these OATT rates. At the time of the initial decision,
the company believed that certain issues would be decided in Consumers' favor,
and that a relatively quick order would be issue by the FERC regarding this
matter. However, due to changes in regulatory interpretations Consumers believes
that a successful resolution of certain issues is less likely. As a result, in
September 2001, Consumers reserved an additional $12 million, including
interest, to fully reflect the financial impacts of the initial decision.
Consumers expects that its reserve levels for future transmission service will
also be in compliance with the initial decision until an order from the FERC is
received.
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
Nine Months Ended
September 30
-------------------
2001 2000
---- ----
In Millions
Pretax operating income $31 $35
Income taxes and other 9 11
--- ---
Net income $22 $24
--- ---
Power 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
CMS-37
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' strategic planning process,
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 PPA's future affect on Consumers. At September 30, 2001
and 2000, the remaining after-tax present value of the estimated future PPA
liability associated with the loss totaled $122 million and $55 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 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:
2001 2002 2003 2004 2005
---- ---- ---- ---- ----
In Million
Estimated cash underrecoveries at 98.5%, net of tax $37 $38 $37 $36 $35
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. Consumers
expenses interest on leased nuclear fuel as it is incurred. Under current
federal law, as a federal court decision confirmed, the DOE was to begin
accepting deliveries of spent nuclear fuel for disposal by January 31, 1998. For
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 September 30, 2001, Consumers
has a recorded liability to the DOE of $135 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, the DOE declared that it would not begin to accept
spent nuclear fuel deliveries in 1998. Also in 1997, a federal court affirmed
the DOE's duty to take delivery of spent fuel. 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.
CMS-38
In July 2000, the DOE reached a settlement agreement with another utility
to address the DOE's delay in accepting spent fuel. The DOE may use that
settlement xagreement as a framework that it could apply to other nuclear power
plants; however, certain other utilities are challenging the validity of such
settlement. Consumers is evaluating this matter further. 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. Consumers is evaluating those rulings and their
applicability to its contracts with the DOE.
NUCLEAR MATTERS: In May 2001, Palisades received its annual performance
review in which the NRC stated that Palisades operated in a manner that
preserved public health and safety. The NRC classified all inspection findings
to have very low safety significance. At the time of the annual performance
review, the NRC had planned to conduct only baseline inspections at the facility
through May 31, 2002. The NRC, however, is currently conducting an inspection to
oversee the Palisades unplanned outage, which is discussed in more detail below.
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 September 30, 2001, Consumers
had loaded 18 dry storage casks with spent nuclear fuel at Palisades. Palisades
will need to load additional casks by 2004 in order to continue operation.
Palisades currently has three additional empty storage-only casks on-site, with
storage pad capacity for up to seven additional loaded casks. Consumers
anticipates, however, that licensed transportable casks, for additional storage,
will be available prior to 2004.
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 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 nature of the current Palisades outage,
however, is not likely to be 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 $12.8 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.
In February 2000, Consumers submitted an analysis to the NRC that shows
that the NRC's screening criteria for reactor vessel embrittlement at Palisades
will not be reached until 2014. On December 14, 2000, the NRC issued an
amendment revising the operating license for Palisades extending the expiration
date to March 2011, with no restrictions related to reactor vessel
embrittlement.
In April 2001, Consumers received approval from the NRC to amend the
license of the Palisades nuclear plant to transfer plant operating authority to
NMC. The formal operating authority transfer from Consumers to NMC took place in
May 2001. Consumers will retain ownership of Palisades, its 789 MW output, the
spent fuel on site, and ultimate responsibility for the safe operation,
maintenance and decommissioning of the plant. Under this agreement, salaried
Palisades' employees became NMC employees on July 1, 2001. Union employees will
work under the supervision of NMC pursuant to their existing labor contract as
Consumers' employees. Consumers will benefit by consolidating expertise and
controlling costs and resources among all of the nuclear plants being operated
on behalf of the five NMC member companies. With Consumers as a partner, 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
CMS-39
additional financial impacts.
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 immediately, as opposed to partially
repairing the component followed eventually by complete replacement during a
future outage. The Company adopted this approach because it provides more
certainty of schedule for return to service, greater regulatory acceptability,
and avoids future plant outage time and associated replacement power costs.
Installation of the new components is expected to be completed in December 2001,
with the plant expected to return to service in January 2002. Consumers cannot,
however, make any assurances as to the date on which the new components will be
installed or the plant will return to service. Consumers estimates capital
expenditures for the components and their installation to be approximately $25
to $30 million.
From the start of the June 20th outage through the end of 2001, the impact
on net income of replacement power and maintenance costs associated with the
outage is currently estimated to be approximately $.49 per share of CMS Energy
Common Stock. An additional month of incremental replacement power and
maintenance costs would impact net income by approximately an additional $.06 to
$.07 per share of CMS Energy Common Stock. However, replacement power and
maintenance costs in early 2002, if any, would be offset by the postponement of
a previously scheduled refueling outage in 2002, which is now not needed until
2003. Consumers expects to have sufficient power at all times to meet its load
requirements from its other plants or purchase arrangements.
NUCLEAR DECOMMISSIONING: In 1996, Consumers and its wholesale customers
entered into five-year contracts that fixed the portion of nuclear
decommissioning costs that were expected to end in 2001 associated with these
customers. Since that time, the total estimated decommissioning costs for Big
Rock increased substantially over the estimates used to calculate the
decommissioning costs attributed to wholesale customers. As a result of a
reduction in decommissioning trust earnings in August 2001, along with the
higher estimated costs of decommissioning, Consumers, in September 2001,
expensed approximately $5 million related to this issue to recognize the
unrecoverable portion of Big Rock decommissioning costs associated with these
customers.
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
sites that formerly housed manufactured gas plant facilities, including those in
which it has a partial or no current ownership interest. Consumers has completed
initial investigations at the 23 sites. On 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. Using this model,
Consumers estimates the total costs to be between $82 million and $113 million.
These estimates are based on discounted 2001 costs. As of September 30, 2001,
Consumers has an accrued liability of $60 million, (net of $22 million of
expenditures incurred to date), and a regulatory asset of $71 million. Any
significant change in assumptions, such as remediation techniques, nature and
extent of contamination, and legal and regulatory requirements, could affect the
estimate of remedial action costs for the sites. The MPSC currently allows
Consumers to recover $1 million of manufactured gas plant facilities
environmental clean-up costs annually. Consumers defers and
CMS-40
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 prudence review in a future general gas rate case. Consumers' current
general gas rate case considers the prudence of manufactured gas plant
facilities environmental clean-up expenditures for years 1998 through 2002.
CONSUMERS' GAS UTILITY RATE MATTERS
GAS RESTRUCTURING: From April 1, 1998 to March 31, 2001, Consumers
conducted an experimental gas customer choice pilot program which 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' facilities.
GAS COST RECOVERY: As part of a settlement agreement approved by the MPSC
in July 2001, Consumers agreed not to exceed a ceiling price 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 charges
customers the amount that it pays for natural gas in the reconciliation process.
In December 2000, Consumers initiated the negotiations, requesting a ceiling
price of $5.69 per mcf. The settlement reflects the decreasing prices in the
natural gas market. The settlement does not affect Consumers' June 2001 request
to the MPSC for the gas service rate increase. The MPSC also approved a
methodology to adjust for market price increases quarterly without returning to
the MPSC for approval.
GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a gas service rate increase. If the MPSC approves Consumers' request,
then Consumers could bill an additional amount of approximately $6.50 per month,
representing a 10% increase in the typical residential customer's average
monthly bill. Consumers is seeking a 12.25% authorized return on equity.
Contemporaneously with this filing, Consumers has requested partial and
immediate relief in the amount of $33 million. The relief is primarily for
higher carrying costs on more expensive natural gas inventory than is currently
included in rates and actual earnings below the authorized return. In October
2001, Consumers revised its filing to reflect lower operating costs and is now
requesting a $133 million gas service rate increase.
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. FERC ordered these pipelines to refund these amounts to their
customers. The pipelines must make all payments in compliance with prescribed
FERC requirements. In June 2001, Panhandle filed a proposed settlement with the
FERC which is supported by most of the customers and affected producers. That
settlement was approved by the Commission in October 2001. At September 30, 2001
and December 31, 2000, Panhandle's Accounts Receivable included $63 million and
$59 million, respectively, due from natural gas producers, and Other Current
Liabilities included $63 million and $59 million, respectively, for related
obligations. The settlement provides for a reduction in these balances resulting
in an amount due from natural gas producers of $33 million and an amount due to
jurisdictional customers of $29 million. These adjustments will be recorded in
the fourth quarter.
In March 2001, Trunkline received FERC approval to abandon 720 miles of its
26-inch diameter pipeline that extends from Longville, Louisiana to Bourbon,
Illinois. This filing is in conjunction with a plan for Centennial Pipeline to
convert the line from natural gas transmission service to a refined products
pipeline by January 2002.
CMS-41
Panhandle owns a one-third interest in the venture along with TEPPCO Partners
L.P. and Marathon Ashland Petroleum L.L.C. Effective April 2001, the 26-inch
pipeline was conveyed to Centennial and the book value of the asset, including
related goodwill, is now reflected in Investments on the Consolidated Balance
Sheet.
In July 2001, Panhandle filed a settlement with customers on Order 637
matters to resolve matters including capacity release and imbalance penalties,
among others. On October 12, 2001 FERC issued an order approving the settlement,
with modifications. This order is pending potential requests for rehearing.
Management believes that this matter will not have a material adverse effect on
consolidated results of operations or financial position.
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 will take effect in
January 2002. This will result in reduced revenues from 2001 levels but less
volatility due to the 22-year contract with BG LNG Services.
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
through 2001. 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 17.32 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.
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. We have reached a settlement with the state, pursuant to
which we must pay $6 million, $2 million of which we have already paid. The
court has entered a Good Faith Settlement Order and we remitted payment.
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 believes these cases are without merit
and intends to vigorously defend against them. CMS Generation's primary
insurance carrier has agreed
CMS-42
to defend and indemnify CMS Generation for a portion of defense costs up to the
policy limits. We are currently in settlement negotiations regarding the private
toxic tort lawsuit.
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 the three letters of credit totaling $30
million that it obtained from DFD, will be asserting additional claims against
DFD. 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.
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 $768 million as of
September 30, 2001.
Additionally, Enterprises, in the ordinary course of business, has
guarantees in place for contracts of CMS MST that contain certain schedule and
performance requirements. As of September 30, 2001, the actual amount of
financial exposure covered by these guarantees was $726 million. This amount
excludes the guarantees associated with CMS MST's natural gas sales arrangements
totaling $291 million, which are recorded as liabilities on the Consolidated
Balance Sheet at September 30, 2001. 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.
In March 2000, Adams Affiliates, Inc. and Cottonwood Partnership (prior
majority owners of Continental Natural Gas) initiated arbitration proceedings
through the American Arbitration Association against CMS
CMS-43
Energy. The plaintiffs claim, in connection with an Agreement and Plan of Merger
among CMS Energy, CMS Merging Corporation, Continental Natural Gas and the
plaintiffs, damages for breach of warranty, implied duty of good faith,
violation of the Michigan Uniform Securities Act, and common law fraud and
negligent misrepresentation. The plaintiffs allege $13 million of compensatory
damages and $26 million in exemplary damages. CMS Energy filed a response
denying all the claims made by the plaintiffs and asserting several
counterclaims. Arbitration on this matter was completed in July 2001. The
parties submitted post-hearing briefs to the Arbitrator in September 2001. We
expect, but cannot assure, that the Arbitrator will reach a decision during the
fourth quarter of 2001. CMS Energy believes the claims are without merit and
will continue to vigorously defend against them, but cannot predict the outcome
of this matter.
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.
CAPITAL EXPENDITURES: CMS Energy estimates capital expenditures, including
investments in unconsolidated subsidiaries and new lease commitments, of $1.365
billion for 2001, $1.025 billion for 2002 and $930 million for 2003. The amounts
for 2002 and 2003 exclude expenditures associated with a potential LNG terminal
expansion. The expansion expenditures, estimated at $25 million in 2002 and $90
million in 2003, are currently expected to be funded through a joint venture via
loans or equity contributions from Panhandle or equity investors or by third
party financings acceptable to the lenders of the joint venture.
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 (Senior
Credit Facilities). Additionally, CMS Energy has unsecured lines of credit in an
aggregate amount of $37 million. As of September 30, 2001, $430 million was
outstanding under the Senior Credit Facilities, including $5 million letters of
credit, and $25 million was outstanding under the unsecured lines of credit.
At September 30, 2001, CMS Energy had $31 million Series A GTNs, $18
million Series B GTNs, $58 million Series C GTNs, $173 million Series D GTNs,
$391 million Series E GTNs and $232 million Series F GTNs issued and outstanding
with weighted average interest rates of 7.5 percent, 7.6 percent, 7.6 percent,
7.1 percent, 7.8 percent and 8.3 percent, respectively.
In February 2001, CMS Energy sold 10 million shares of CMS Energy Common
Stock. CMS Energy used the net proceeds of approximately $296 million to repay
borrowings under the Senior Credit Facility.
In March 2001, CMS Energy sold $350 million aggregate principal amount of
8.50 percent senior notes due 2011. Net proceeds from the sale were
approximately $337 million. CMS Energy used the net proceeds to reduce
borrowings under the Senior Credit Facility and for general corporate purposes.
CMS-44
In July 2001, CMS Energy sold $269 million aggregate principal amount of
8.9 percent senior notes due 2008. Net proceeds from the sale of approximately
$262 million were used to repay the $250 million aggregate principal amount of
8.0 percent Reset Put Securities due 2011, which were called at par by Banc of
America Securities LLC, and to pay the related call option of approximately $12
million.
In July 2001, CMS Energy called $240 million of GTNs at interest rates
ranging from 7.75% to 8.375% using funds available under CMS Energy's Senior
Credit Facilities at a lower borrowing cost.
Pursuant to outstanding authorization by the Board of Directors to
repurchase shares of CMS Energy Common Stock from time to time, in open market
or private transactions, as of September 30, 2001, CMS Energy repurchased
approximately 232 thousand shares for $5 million.
MANDATORILY REDEEMABLE PREFERRED SECURITIES: CMS Energy and Consumers each
have wholly-owned statutory business trusts that are consolidated with the
respective parent company. CMS Energy and Consumers created their respective
trusts for the sole purpose of issuing Trust Preferred Securities. In each case,
the primary asset of the trust is a note or debenture of the parent company. The
terms of the Trust Preferred Security parallel the terms of the related parent
company note or debenture. The terms, rights and obligations of the Trust
Preferred Security and related note or debenture are also defined in the related
indenture through which the note or debenture was issued, the parent guarantee
of the related Trust Preferred Security and the declaration of trust for the
particular trust. All of these documents together with their related note or
debenture and Trust Preferred Security constitute a full and unconditional
guarantee by the parent company of the trust's obligations under the Trust
Preferred Security. In addition to the similar provisions previously discussed,
specific terms of the securities follow:
Amount Outstanding
---------------------------------------------
September 30 December 31 September 30 Earliest
Rate(%) 2001 2000 2000 Maturity Redemption
-------- ------------ ----------- ------------ -------- ----------
In Millions
CMS Energy Trust and Securities
CMS Energy Trust I (a) 7.75 $173 $173 $173 2027 2001
CMS Energy Trust II (b) 8.75 301 301 301 2004 -
CMS Energy Trust III (c) 7.25 220 220 220 2004 -
---- ---- ---- ---- ---- ----
Total Amount Outstanding $694 $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). CMS Energy may cause conversion rights to expire on or after
July 2001.
(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 August 2003.
CMS-45
Amount Outstanding
---------------------------------------------
September 30 December 31 September 30 Earliest
Rate 2001 2000 2000 Maturity Redemption
---- ------------ ----------- ------------ -------- ----------
In Millions
Consumers Energy Trust and Securities
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36% $100 $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 Originated Preferred Securities 9.00% 125 - - 2031 2006
---- ---- ---- ---- ---- ----
Total Amount Outstanding $520 $395 $395
---- ---- ----
CONSUMERS: At September 30, 2001, Consumers had FERC authorization to issue
or guarantee through June 2002, up to $900 million of short-term securities
outstanding at any one time. Consumers also had remaining FERC authorization to
issue through June 2002 up to $250 million and $125 million of long-term
securities for refinancing or refunding purposes and for general corporate
purposes, respectively.
In August 2001, Consumers filed an amendment with the FERC to request
authorization of an additional $500 million of long-term securities for general
corporate purposes and up to an additional $500 million of long term First
Mortgage Bonds to be issued solely as security for the long-term securities.
Further, in October 2001, FERC granted Consumers' August 2001 request for
authorization of an additional $500 million of short-term debt so that $1.4
billion may be outstanding at any one time and up to $500 million in of First
Mortgage Bonds to be issued as collateral for the outstanding short-term
securities.
Consumers has an unsecured $300 million credit facility maturing in July
2002 and unsecured lines of credit aggregating $215 million. These facilities
are available to finance seasonal working capital requirements and to pay for
capital expenditures between long-term financings. At September 30, 2001, a
total of $153 million was outstanding at a weighted average interest rate of 3.5
percent, compared with $430 million outstanding at September 30, 2000, at a
weighted average interest rate of 7.4 percent.
Consumers currently has in place a $325 million trade receivables sale
program. At September 30, 2001 and 2000, receivables sold under the program
totaled $325 million and $307 million, respectively. Accounts receivable and
accrued revenue in the Consolidated Balance Sheets have been reduced to reflect
receivables sold.
In September 2001, Consumers sold $350 million aggregate principal amount
of 6.25 percent senior notes, maturing in September 2006. Net proceeds from the
sale were $347 million. Consumers used the net proceeds to reduce borrowings on
various lines of credit and on a revolving credit facility.
Under the provisions of its Articles of Incorporation, Consumers had $240
million of unrestricted retained earnings available to pay common dividends at
September 30, 2001 and in September 2001, Consumers declared a $55 million
common dividend payable in November 2001.
CMS OIL AND GAS: CMS Oil and Gas has a $150 million floating rate revolving
credit facility that matures in May 2002. At September 30, 2001, the amount
utilized under the credit facility was $110 million.
CMS-46
6: EARNINGS PER SHARE AND DIVIDENDS
Basic and diluted earnings per share are based on the weighted average
number of shares of common stock and potential common stock outstanding during
the period. Potential common stock, for purposes of determining diluted earnings
per share, includes the effects of dilutive stock options and convertible
securities. The effect of such potential common stock is computed using the
treasury stock method or the if-converted method, as applicable.
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:
Three Months
Ended September 30
-------------------------
2001 2000(a)
---- -------
In Millions, Except Per Share Amounts
NET INCOME APPLICABLE TO BASIC AND DILUTED EPS
Consolidated Net Income $(569) $53
----- ---
Net Income Attributable to Common Stock:
CMS Energy - Basic $(569) $53
Add conversion of 7.75% Trust
Preferred Securities (net of tax) - (c) 2
----- ---
CMS Energy - Diluted $(569) $55
----- ---
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
CMS Energy:
Average Shares - Basic 132.6 109.9
Add conversion of 7.75% Trust
Preferred Securities - (c) 4.2
Options-Treasury Shares - .3
----- ---
Average Shares - Diluted 132.6 114.4
----- ---
EARNINGS PER AVERAGE COMMON SHARE
Basic $ (4.29) $ .49
Diluted $ (4.29) $ .49
----- ---
Nine Months
Ended September 30
-------------------------
2001 2000(b)
---- -------
In Millions, Except Per Share Amounts
NET INCOME APPLICABLE TO BASIC AND DILUTED EPS
Consolidated Net Income $(407) $207
Net Income Attributable to Common Stock:
CMS Energy - Basic $(407) $207
Add conversion of 7.75% Trust
Preferred Securities (net of tax) - (c) 7
CMS Energy - Diluted $(407) $214
CMS-47
Nine Months
Ended September 30
-------------------------
2001 2000(b)
---- -------
In Millions, Except Per Share Amounts
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
CMS Energy:
Average Shares - Basic 130.0 111.1
Add conversion of 7.75% Trust
Preferred Securities - (c) 4.2
Options-Treasury Shares - .2
Average Shares - Diluted 130.0 115.5
EARNINGS PER AVERAGE COMMON SHARE
Basic $(3.13) $1.86
Diluted $(3.13) $1.85
- ------------
(a) For the three months ended September 30, 2000, the accounting change for
crude oil inventories decreased net income by $2 million, or $.02 per basic
and diluted share.
(b) For the nine months ended September 30, 2000, the accounting change for
crude oil inventories decreased net income by $9 million, or $.08 per basic
and diluted share.
(c) The effects of converting the 7.75% Trust Preferred Securities were not
included in the 2001 computation of diluted earnings per share because to
do so would have been antidilutive.
In February, May, and August 2001, CMS Energy paid dividends of $.365 per
share on CMS Energy Common Stock. In September 2001, the Board of Directors
declared a quarterly dividend of $.365 per share on CMS Energy Common Stock,
payable in November 2001.
7: RISK MANAGEMENT ACTIVITIES AND FINANCIAL INSTRUMENTS
The overall goal of the CMS Energy risk management policy is to analyze and
manage individual business unit commodity exposures in order to take advantage
of the presence of internal hedge opportunities within its diversified business
units. CMS Energy and its subsidiaries, primarily through CMS MST, utilize a
variety of derivative instruments (derivatives) for both trading and non-trading
purposes. These derivatives include futures contracts, swaps, options and
forward contracts with external parties to manage exposure to fluctuations in
commodity prices, interest rates and foreign exchange rates. To qualify for
hedge accounting, derivatives must meet the following criteria: i) the item to
be hedged exposes the enterprise to price, interest or exchange rate risk; and
ii) the derivative reduces that exposure and is designated as a hedge.
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
reviews using, among other things, publicly available credit ratings of such
counterparties. No material nonperformance is expected.
IMPLEMENTATION OF SFAS NO. 133: Effective January 1, 2001, CMS Energy
adopted SFAS No. 133. CMS Energy reflected the difference between the fair
market value and the recorded book value of the derivative instruments as a
cumulative effect type adjustment to accumulated other comprehensive income. CMS
Energy will reclassify the gains and losses on the derivative instruments that
are reported in accumulated other comprehensive income as earnings in the
periods in which earnings are impacted by the variability of the cash flows of
the hedged item. The ineffective portion, if any, of all hedges will be
recognized in current period earnings. CMS Energy determines fair market value
based upon mathematical models using current and historical pricing data.
CMS-48
CMS Energy believes that the majority of its non-trading derivative
contracts, power purchase agreements and gas transportation contracts qualify
for the normal purchases and sales exception of SFAS No. 133 and therefore,
would not be recognized at fair value on the balance sheet. CMS Energy does,
however, use certain derivative instruments to limit its exposures to commodity
price risk, interest rate risk, and currency exchange risk. The interest rate
and foreign exchange contracts meet the requirements for hedge accounting under
SFAS No. 133 and CMS Energy recorded the changes in the fair value of these
contracts in accumulated other comprehensive income on the balance sheet.
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 13
Upon initial adoption of the standard, CMS Energy recorded a $13 million,
net of tax, cumulative effect adjustment to accumulated other comprehensive
income. This adjustment relates to the difference between the fair value and
recorded book value of contracts related to gas options, gas fuel swap
contracts, and interest rate swap contracts that qualified for cash flow 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. This amount will reduce, or be charged
to cost of gas, cost of power, interest expense, or other operating revenue
respectively, when the related hedged transaction occurs. Based on the pretax
amount recorded in accumulated other comprehensive income on the January 1, 2001
transition date, Consumers recorded $12 million as a reduction to the cost of
gas, $1 million as a reduction to the cost of power, and $2 million as an
increase in interest expense for the nine months ended September 30, 2001.
Consumers does not expect to reclassify any additional amounts from the
cumulative effect adjustment to earnings that would affect the cost of gas, the
cost of power, interest expense, or other operating revenue during the next 12
months. As of September 30, 2001, Consumers had a total of $9 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 is sustained. CMS Energy recorded $8 million as additional interest
expense during the first nine months of 2001, $4 million was recognized during
the third quarter.
On January 1, 2001, upon initial adoption of the standard, 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 2001, the FASB issued guidance that effectively resolved most of
these matters as of July 1, 2001. Consumers evaluated its option and option-like
contracts and determined that the majority of these contracts qualify for the
normal purchase exception of SFAS No. 133, however, certain electricity option
contracts are required to be accounted for as derivatives. 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 a decrease to accumulated
other comprehensive income. This adjustment relates to the difference between
the current fair value and the recorded book value of these electricity option
contracts. The adjustment to accumulated other comprehensive income relates to
electricity 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
CMS-49
amount recorded in other comprehensive income will be reclassified to earnings
as the forecasted future transaction occurs or the option expires. As of
September 30, 2001, $2 million, net of tax, was reclassified to earnings as part
of cost of power. The remainder is expected to be reclassified to earnings in
the third quarter of 2002.
In October 2001, the FASB issued further clarifying guidance regarding
derivative accounting for electricity call option contracts and option-like
contracts. The clarifying guidance amends the criteria to be used to determine
if derivative accounting is required. Consumers is in the process of
re-evaluating its electricity option and option-like contracts in order to
determine if additional contracts will require derivative accounting. The
effective date of this change is January 1, 2002. Consumers is currently
studying the financial effects of the adoption of SFAS No. 133 for these
contracts but has yet to quantify these effects.
In addition, in October 2001, the FASB issued final guidance regarding
derivative accounting for certain fuel supply contracts with quantity
variability. Under the final guidance, effective April 1, 2002, certain
contracts would not qualify for the normal purchase exception of SFAS No. 133
and would require derivative accounting. Consumers initially believed that its
fuel supply contracts qualified for the normal purchase exception of SFAS No.
133 and has not, therefore, recorded these contracts on the balance sheet at
fair value. Consumers is in the process of reviewing its fuel supply contracts
in accordance with the final guidance.
COMMODITY DERIVATIVES (NON-TRADING): CMS Energy accounts for its
non-trading activities as cash flow hedges and, as such, defers any changes in
market value and gains and losses resulting from settlements until the hedged
transaction is complete. If there was a material lack of correlation between the
changes in the market value of the commodity price contracts and the market
price ultimately received for the hedged item, the open commodity price
contracts would be marked-to-market and gains and losses would be recognized in
the income statement. At September 30, 2001, these commodity derivatives
extended for periods up to 5 years.
CMS Energy had unrealized net losses of $32 million at September 30, 2001,
related to non-trading activities. The determination of unrealized net gains and
losses represents management's best estimate of prices including the use of
exchange and other third party quotes, time value and volatility factors in
estimating fair value. Accordingly, the unrealized net losses at September 30,
2001 are not necessarily indicative of the amounts CMS Energy could realize in
the current market.
Consumers' electric business uses purchased electricity call option
contracts to meet its regulatory obligation to serve, which requires providing a
physical supply of energy to customers, and to manage energy cost and to ensure
a reliable source of capacity during periods of peak demand. On January 1, 2001,
upon initial adoption of SFAS No. 133, accounting for these contracts 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 the fair value of these contracts on the balance sheet. In June 2001,
the FASB issued guidance that effectively resolved the accounting for these
contracts as of July 1, 2001. Consumers evaluated its option and option-like
contracts and determined that the majority of these contracts qualify for the
normal purchase exception of SFAS No. 133, however, certain electricity option
contracts are required to be accounted for as derivatives. 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 a decrease to accumulated
other comprehensive income, and an immaterial loss to earnings. This adjustment
relates to the difference between the current fair value and the recorded book
value of these electricity option contracts. The adjustment to accumulated other
comprehensive income relates to electricity 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 majority of these contracts
CMS-50
expired in the third quarter 2001 and the remaining contracts will expire in
2002. The initial amount recorded in other comprehensive income will be
reclassified to earnings as the forecasted future transaction occurs or the
option expires. As of September 30, 2001, $2 million, net of tax, was
reclassified to earnings as part of cost of power. The remainder is expected to
be reclassified to earnings in the third quarter 2002.
In October 2001, the FASB issued further clarifying guidance regarding
derivative accounting for electricity call option contracts and option-like
contracts. The clarifying guidance amends the criteria to be used to determine
if derivative accounting is required. CMS Energy is in the process of
re-evaluating its electricity option and option-like contracts in order to
determine if additional contracts will require derivative accounting. The
effective date of this change is January 1, 2002. CMS Energy is currently
studying the financial effects of the adoption of SFAS No. 133 for these
contracts but has yet to quantify these effects.
In addition, in October 2001, the FASB issued final guidance regarding
derivative accounting for certain fuel supply contracts with quantity
variability. Under the final guidance, effective April 1, 2002, certain
contracts would not qualify for the normal purchase exception of SFAS No. 133
and would require derivative accounting. CMS Energy initially believed that its
fuel supply contracts qualified for the normal purchase exception of SFAS No.
133 and has not, therefore, recorded these contracts on the balance sheet at
fair value. CMS Energy is in the process of reviewing its fuel supply contracts
in accordance with the final guidance. CMS Energy is currently studying the
financial effects of the adoption of SFAS No. 133 for these contracts and has
yet to quantify these effects.
Consumers' electric business also uses purchased gas call option and gas
swap contracts to hedge 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 are designated as cash flow
hedges and, therefore, Consumers will record any change in the fair value of
these contracts in other comprehensive income until the forecasted transaction
occurs. Once the forecasted gas purchases occurs, the net gain or loss on these
contracts will be reclassified to earnings and recorded as part of the cost of
power. These contracts have been highly effective in achieving offsetting cash
flows of future gas purchases, and no component of the gain or loss was excluded
from the assessment of the hedge's effectiveness. As a result, no net gain or
loss has been recognized in earnings as a result of hedge ineffectiveness as of
September 30, 2001. At September 30, 2001, Consumers had a derivative liability
with a fair value of $.4 million. These contracts expire in 2001, and Consumers
expects to reclassify, in 2001, a $.7 million decrease in fair value to earnings
as an increase to power costs, if this fair value is sustained. The ultimate
fair value of these derivative assets is dependent upon market conditions
related to the derivative instruments.
COMMODITY DERIVATIVES (TRADING): 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 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
CMS-51
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 certain reserves for a number of risks associated with
these future commitments. Among others, these include 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 may impact
overall exposure to credit risk, either positively or negatively; 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
applicable, 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.
At September 30, 2001, CMS MST has recorded an asset of $70 million, net of
reserves, related to the unrealized mark-to-market gains on existing
arrangements. For the three and nine months ended September 30, 2001, CMS MST
reflected $10 million and $54 million, respectively, of mark-to-market revenues,
net of reserves, primarily from newly originated long-term power sales contracts
and wholesale gas trading transactions.
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. Notional amounts reflect the volume of transactions but do not
represent the amount exchanged by the parties to the financial instruments.
Accordingly, notional amounts do not necessarily reflect CMS Energy's exposure
to credit or market risks. As of September 30, 2001, the weighted average
interest rate associated with outstanding swaps was approximately 6.5 percent.
Floating to Fixed Notional Maturity Fair Unrealized
Interest Rate Swaps Amount Date Value Gain (Loss)
- ------------------- -------- -------- ----- -----------
In Millions
September 30, 2001 $569 2001-06 $(15) $2
September 30, 2000 $1,719 2000-06 $(4) $(3)
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
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.
Notional amounts reflect the volume of transactions but do not represent the
amount exchanged
CMS-52
by the parties to the financial instruments. Accordingly, notional amounts do
not necessarily reflect CMS Energy's exposure to credit or market risks. As of
September 30, 2001, the weighted average interest rate associated with
outstanding swaps was approximately 6.8 percent.
Floating to Fixed Notional Maturity Fair Unrealized
Interest Rate Swaps Amount Date Value Gain (Loss)
- ------------------- -------- -------- ----- -----------
In Millions
September 30, 2001 $850 2003-06 $1 $1
September 30, 2000 -- -- -- --
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 September
30, 2001 and 2000 was $18 million and $(24) million, respectively; which
represents the amount CMS Energy would receive or (pay) upon settlement. The
impacts of the hedges of the net investments in foreign operations are reflected
in other comprehensive income as a component of the foreign currency translation
adjustment. For the first nine months of 2001, the adjustment for hedging was
$11 million of the total net foreign currency translation adjustment of $(64)
million. CMS Energy did not incur any significant gain or loss as a result of
exchange rate fluctuations during the third quarter of 2001 related to hedges of
US dollar denominated debt that did not qualify as net investment hedges, and
consequently, were marked-to-market through earnings.
Foreign exchange contracts outstanding as of September 30, 2001 had a total
notional amount of $223 million, which is related to CMS Energy's investments in
Argentina. The Argentine contracts mature at various times during 2001 and 2002.
The foreign exchange contracts related to Brazilian and Australian investments
that were in place at the end of the second quarter, expired during the third
quarter and were not replaced.
The notional amount of the outstanding foreign exchange contracts at
September 30, 2000 was $601 million consisting of $1 million, $150 million and
$450 million for Australian, Brazilian and Argentine, respectively.
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments
and current liabilities approximate their fair values due to their short-term
nature. The estimated fair values of long-term investments are based on quoted
market prices or, in the absence of specific market prices, on quoted market
prices of similar investments or other valuation techniques. Judgment may also
be required to interpret market data to develop certain estimates of fair value.
Accordingly, the estimates determined as of September 30, 2001 and 2000 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 as shown below, approximate fair value.
CMS-53
As of September 30
---------------------------------------------------------------------------
2001 2000
----------------------------------- -----------------------------------
Carrying Fair Unrealized Carrying Fair Unrealized
Cost Value Gain (Loss) Cost Value Gain (Loss)
-------- ------- ----------- -------- ------- -----------
In Millions
Long-Term Debt (a) $7,827 $7,720 $(107) $7,246 $6,987 $(259)
Preferred Stock and
Trust Preferred Securities $1,257 $1,162 $(95) $1,133 $1,025 $(108)
- ------------
(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 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 the Powder River Basin in Wyoming 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 accounting policies of each reportable segment are the same as those
described in the summary of significant accounting policies contained in CMS
Energy's 2000 Form 10-K. 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 pretax operating income by segment.
The only material changes in assets during the first nine months of 2001 is
that management has decided to discontinue operation of the international energy
distribution segment. For more detailed information, see Note 2, Discontinued
Operations. Also, Consumers Energy announced the sale of their transmission
facilities to Trans-Elect under the requirements of Michigan Public Act 141.
FERC approval to complete the sale to Trans-Elect is expected in the first
quarter of 2002.
CMS-54
9: LEASES
In April 2001, Consumers Campus Holdings, entered into a lease agreement
for the construction of an office building to be used as the main headquarters
for Consumers in Jackson, Michigan. Consumers' current headquarters building
leases expire in June 2003. The lessor has committed to fund up to $70 million
for construction of the building. Consumers is acting as the construction agent
of the lessor for this project. The agreement is a seven-year lease term with
payments commencing upon completion of construction, which is projected for
March of 2003. Consumers Campus Holdings has the right to acquire the property
at any time during the life of the agreement. At the end of the lease term,
Consumers Campus Holdings has the option to renew the lease, purchase the
property, or return the property and assist the lessor in the sale of the
building. The return option obligates Consumers Campus Holdings to pay the
lessor an amount equal to the outstanding debt associated with the building.
This lease is classified as an operating lease. Estimated minimum lease
commitments, assuming an investment of $70 million, based on LIBOR at inception
of the lease, under this non-cancelable operating lease would be approximately
$5 million each year from 2003 through 2007 and a total of $52 million for the
remainder of the lease. Actual lease payments will depend upon final total
construction costs and LIBOR rates.
CMS-55
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 September 30, 2001
and 2000, and the related consolidated statements of income and common
stockholders' equity for the three-month and nine-month periods then ended and
related consolidated statements of cash flows for the nine-month periods then
ended. 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 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 review, 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, 2000, and, in our report dated
February 2, 2001, 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, 2000, is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
/s/ Arthur Andersen LLP
Detroit, Michigan,
October 31, 2001.
CMS-56
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' 2000 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.
RESULTS OF OPERATIONS
CONSUMERS CONSOLIDATED EARNINGS
SEPTEMBER 30
---------------------------------------
2001 2000 CHANGE
---- ---- ------
IN MILLIONS
Three months ended $(74) $ 63 $(137)
Nine months ended 57 172 (115)
==== ==== =====
For the three months ended September 30, 2001, net income available to the
common stockholder decreased $137 million from the comparable period in 2000.
The earnings decrease reflects an $82 million after tax loss related to
Consumers' Power Purchase Agreement with the MCV. This loss reflects
management's current assessment of increased operating levels at the MCV
Facility after the current frozen PSCR factor expires. Additionally, energy
payments to the MCV during the frozen PSCR period are now expected to be higher
than originally anticipated. These factors required Consumers to recognize an
additional loss related to the MCV PPA. The earnings decrease also reflects
increased replacement power costs that cannot be recovered from customers during
the frozen PSCR period. The increase in replacement power costs was due, in
large part, to a continuing unscheduled outage at Palisades. The Palisades
outage will continue through the fourth quarter, thereby, materially affecting
the fourth quarter results. It is anticipated, however, that Palisades will
return to service in January 2002. For the nine months ended September 30, 2001,
net income decreased $115 million from the comparable period in
CE-1
2000. The earnings decrease primarily reflects the losses and unrecoverable
costs referenced above, partially offset by the recording of a $29 million,
after tax, regulatory obligation related to gas prices in the second quarter of
2000. For further information, see the Electric and Gas Utility Results of
Operations sections and Note 2, Uncertainties.
ELECTRIC UTILITY RESULTS OF OPERATIONS
ELECTRIC PRETAX OPERATING INCOME:
SEPTEMBER 30
------------------------------------------
2001 2000 CHANGE
---- ---- ------
IN MILLIONS
Three months ended $(62) $118 $(180)
Nine months ended 157 342 (185)
==== ==== =====
For the three months ended September 30, 2001, electric pretax operating
income decreased $180 million from the comparable period in 2000. The earnings
decrease reflects a $126 million loss related to Consumers' Power Purchase
Agreement with the MCV and increased replacement power costs, discussed in the
consolidated earnings section, partially offset by higher electric deliveries to
higher margin customers. For the nine months ended September 30, 2001, electric
pretax operating income decreased $185 million from the comparable period in
2000. The earnings decrease reflects the above referenced loss related to the
MCV along with the increase in power costs, also partially offset by higher
electric deliveries to higher margin customers. The following table quantifies
these impacts on pretax operating income:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
CHANGE COMPARED TO PRIOR YEAR 2001 VS 2000 2001 VS 2000
- ----------------------------- ------------------ ------------------
IN MILLIONS
Electric deliveries $ 19 $ 21
Power supply costs and related production revenue (68) (71)
Rate decrease 0 (17)
Non-commodity revenue (13) (4)
Other operating expenses 8 12
Loss on MCV Power Purchases (126) (126)
----- -----
Total change $(180) $(185)
===== =====
ELECTRIC DELIVERIES: For the three months ended September 30, 2001,
electric deliveries including intersystem volumes were 11.0 billion kWh, an
increase of 0.3 billion kWh or 3.0 percent from the comparable period in 2000.
Total electric deliveries increased primarily due to higher residential and
commercial usage. For the nine months ended September 30, 2001, electric
deliveries were 30.2 billion kWh, which is a slight decrease from the comparable
period in 2000. Although total deliveries were below the 2000 level, current
year increased deliveries to the higher margin residential and commercial
sectors more than offset the impact of reductions to the lower margin industrial
sector.
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POWER SUPPLY COSTS:
SEPTEMBER 30
----------------------------------------
2001 2000 CHANGE
------ ---- ------
IN MILLIONS
Three months ended $ 444 $355 $ 89
Nine months ended 1,050 949 101
====== ==== ====
For the three and nine months ended September 30, 2001, power supply costs
increased $89 million and $101 million, respectively, from the comparable period
in 2000, primarily due to higher interchange power purchases. Consumers had to
purchase greater quantities of higher-priced external power primarily because of
decreased internal generation resulting from unscheduled outages. Further, the
continuing unscheduled outage at Palisades materially affected third quarter
results because of the necessity to utilize higher cost internal generation and
purchase replacement power.
GAS UTILITY RESULTS OF OPERATIONS
GAS PRETAX OPERATING INCOME:
SEPTEMBER 30
--------------------------------------
2001 2000 CHANGE
---- ---- ------
IN MILLIONS
Three months ended $(1) $ 9 $(10)
Nine months ended 81 44 37
=== === ====
For the three months ended September 30, 2001, gas pretax operating income
decreased by $10 million. The earnings decrease is primarily the result of
higher operation and maintenance costs and lower gas deliveries due to the
economic slowdown. For the nine months ended September 30, 2001, gas pretax
operating income increased by $37 million, primarily the result of the recording
of a $45 million regulatory obligation related to gas prices in the second
quarter of 2000. The following table quantifies these impacts on pretax
operating income.
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
CHANGE COMPARED TO PRIOR YEAR 2001 VS 2000 2001 VS 2000
- ----------------------------- ------------------ ------------------
IN MILLIONS
Gas deliveries $ (1) $ 7
Gas commodity costs and related revenue (3) 38
Gas wholesale and retail services 1 7
Operation and maintenance expense (8) (15)
General taxes and depreciation expense 1 0
---- ----
Total change $(10) $ 37
==== ====
GAS DELIVERIES: For the three months ended September 30, 2001, gas system
deliveries, including miscellaneous transportation volumes totaled 42 bcf, a
decrease of 3 bcf or 7 percent from the comparable period in 2000. During the
third quarter of 2001, the decreased deliveries reflect a reduction in demand
due to decelerated economic activity. For the nine months ended September 30,
2001, gas system deliveries, including miscellaneous transportation totaled 258
bcf, a decrease of 15 bcf or 5.2 percent from the comparable period in 2000.
Although deliveries were below the 2000 level, year to date deliveries to
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the higher margin residential and commercial sectors more than offset the impact
of reductions to the lower margin industrial sector.
COST OF GAS SOLD:
SEPTEMBER 30
--------------------------------------
2001 2000 CHANGE
---- ---- ------
IN MILLIONS
Three months ended $ 72 $ 60 $ 12
Nine months ended 562 450 112
==== ==== ====
For the three months ended September 30, 2001, the cost of gas sold
increased due to higher gas prices. During the third quarter of 2001, these
higher gas costs were partially offset by decreased sales due to reduced
economic demand. For the nine months ended September 30, 2001, higher gas prices
through the first three quarters contributed to the increased cost of gas sold.
CAPITAL RESOURCES AND LIQUIDITY
CASH POSITION, INVESTING AND FINANCING
OPERATING ACTIVITIES: Consumers derives cash from operating activities
involving the sale and transportation of natural gas and the generation,
transmission, distribution and sale of electricity. For the first nine months of
2001 and 2000, cash from operations totaled $321 million and $352 million,
respectively. The $31 million decrease resulted primarily from a $250 million
use of cash to increase natural gas inventories, offset by a $157 million
increase in cash collected from customers and related parties and a $62 million
of other temporary changes in working capital items due to timing of cash
receipts and payments. 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.
INVESTING ACTIVITIES: For the first nine months of 2001 and 2000, cash used
for investing activities totaled $511 million and $394 million, respectively.
The change of $117 million is primarily the result of a $151 million increase in
capital expenditures, primarily to comply with the Clean Air Act.
FINANCING ACTIVITIES: For the first nine months of 2001 and 2000, cash
provided by financing activities totaled $193 million and $33 million,
respectively. The change of $160 million is primarily the result of $121 million
net proceeds from the sale of Trust Originated Preferred Securities, $352
million net proceeds from Senior notes and $150 million cash infusion from CMS
Energy, offset by a $463 million net decrease in notes payable.
In November 2001, Consumers Funding LLC, a special purpose subsidiary of
Consumers, issued $469 million of Securitization bonds. For further information,
see Note 2, Uncertainties, Electric Rate Matters.
OTHER: Consumers has credit facilities, lines of credit and a trade
receivable sale program in place as anticipated sources of funds to fulfill its
currently expected capital expenditures. For detailed information about this
source of funds, see Note 3, Short-Term Financing and Capitalization.
In April 2001, Consumers Campus Holdings, a wholly owned subsidiary of
Consumers, entered into a $70 million operating lease agreement for the
construction of an office building to be used as the main headquarters for
Consumers in Jackson, Michigan. The seven-year agreement, with payments
commencing upon completion of construction, includes options to renew the lease,
purchase the property under the lease, or return the property at the end of the
lease term and assist the lessor in remarketing the
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building. Lease payments will be determined based on LIBOR rates and the total
cost of the construction, which is projected to be completed on or before March
2003. For further information on the lease agreement, see Note 4, Leases.
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.
YEARS ENDED DECEMBER 31
------------------------------
2001 2002 2003
---- ---- ----
IN MILLIONS
Construction $692 $601 $548
Nuclear fuel lease 16 27 0
Capital leases other than nuclear fuel 27 27 22
---- ---- ----
$735 $655 $570
==== ==== ====
Electric utility operations(a)(b) $590 $480 $405
Gas utility operations(a) 145 175 165
---- ---- ----
$735 $655 $570
==== ==== ====
- ------------
(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 system
deliveries (including both full service sales and delivery service to customers
who choose to buy generation service from an alternate energy 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'
market share and can reduce profit margins.
Consumers has in the last several years experienced and expects to continue
to experience a significant increase in competition for generation services with
the introduction of retail direct access in the State of Michigan. Under
Michigan's Customer Choice Act, effective in June 2000, all electric customers
will have the choice of electric generation suppliers by January 1, 2002.
The Customer Choice Act imposes certain rate caps that could result in
Consumers being unable to collect
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customer rates sufficient to fully recover its cost of conducting business. Some
of these costs may be wholly or partially beyond Consumers' ability to control.
In particular, if Consumers needs to purchase power from wholesale suppliers at
market-based prices during the period when retail rates are frozen or capped,
the rate caps imposed by the Customer Choice Act may make it difficult for
Consumers to purchase the power at prices that it could recover in 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 rate
freeze.
In December 2000, as a result of electric restructuring, the MPSC issued a
new code of conduct that applies to electric utilities and alternative energy
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. The new code of conduct was recently
reaffirmed after hearing without substantial modification, and is scheduled to
be effective at the end of 2001. Consumers anticipates that it will appeal MPSC
orders related to the code of conduct and seek a stay of its effective date. In
addition, Consumers anticipates that it will seek waivers to the code of conduct
with respect to utility activities that may be prohibited by the new code of
conduct. The full impact of the new code of conduct on Consumers' business will
remain uncertain until the MPSC or appellate courts issue definitive rulings in
regard to the implementation issues.
Several years prior to the enactment of the Customer Choice Act, in
response to industry restructuring efforts, Consumers entered into multi-year
electric supply contracts with some of its largest industrial customers to
provide power to some of their facilities. The MPSC approved those 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 September 2001, neither Consumers nor
any of its industrial customers have terminated or restructured any of these
contracts. These contracts involve approximately 600 MW of customer power supply
requirements. Consumers cannot predict the ultimate financial impact of changes
related to these power supply contracts.
Uncertainty exists with respect to the enactment of 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,
and recently the House of Representatives passed a bill that is currently before
the Senate. If the federal government enacts legislation restructuring the
electric industry, then that legislation could potentially affect or even
supercede state regulation.
In part because of certain policy pronouncements by the FERC, Consumers
joined the Alliance RTO. In January 2001, the FERC granted Consumers'
application to transfer ownership and control of its transmission facilities to
a wholly owned subsidiary, METC. On April 1, 2001, Consumers transferred the
transmission facilities to METC. In October 2001, Consumers announced an
agreement to sell METC to MTH, an independent limited partnership whose general
partner is a subsidiary of Trans-Elect, Inc. METC will continue to own and
operate the system until the companies meet all conditions of closing, including
approval of the transaction from the FERC. Regulatory approvals and operational
transfer are expected to take place in the second quarter of 2002; however,
Consumers can make no assurances as to when or if the transaction will be
completed. For further information, see Note 2, Uncertainties, "Electric Rate
Matters - Transmission Business", incorporated by reference herein.
Consumers cannot predict the outcome of these electric
industry-restructuring issues on its financial position, liquidity, or results
of operations.
RATE MATTERS: Prior to the enactment of the Customer Choice Act, there were
several pending rate issues that could have affected Consumers' electric
business. As a result of the passage of this legislation, the MPSC dismissed
certain rate proceedings and a complaint filed by ABATE seeking a reduction in
rates.
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ABATE filed a petition for rehearing with the MPSC, which was denied in October
2001.
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," incorporated by reference herein.
NUCLEAR MATTERS: In June 2001, an unplanned outage began at Palisades that
negatively affected, and will continue to negatively affect, power costs through
fourth quarter 2001. 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 immediately, as
opposed to partially repairing the components now followed eventually by
complete replacement during a future outage. The Company adopted this approach
because it provides more certainty of schedule for return to service, greater
regulatory acceptability, and avoids future plant outage time and associated
replacement power costs. Installation of the new components is expected to be
completed in December 2001, with the plant expected to return to service in
January 2002. Consumers cannot, however, make any assurances as to the date on
which the new components will be installed or the plant will return to service.
For further information and material changes relating to nuclear matters, see
Note 2, Uncertainties, "Other Electric Uncertainties - Nuclear Matters."
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) capital expenditures and increased 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, including: a)
how the MPSC ultimately calculates the amount of Stranded Costs and the related
true-up adjustments and the manner in which the true-up operates; b) the ability
to recover fully the cost of doing business under the rate caps; c) the ability
to meet peak electric demand requirements at a reasonable cost and without
market disruption and initiatives undertaken to reduce exposure to energy price
increases; d) the restructuring of the MEPCC and the termination of joint
merchant operations with Detroit Edison; e) the ability to sell wholesale power
at market based rates; f) the effect of the transfer of Consumers transmission
facilities to METC and its successful disposition or integration into an RTO;
and g) the MPSC adoption of proposed electric distribution performance standards
requiring customer credits for prolonged outages; 5) the power outage at
Palisades and the incremental cost of replacement power and maintenance; and 6)
the effects of derivative accounting and potential earnings volatility. For
detailed information about these trends or uncertainties, see Note 2,
Uncertainties, incorporated by reference herein.
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
energy costs, changes in competitive conditions, and the level of natural gas
consumption per customer.
During the spring and summer months of 2001, Consumers purchased natural
gas for inventory to meet anticipated future customer needs during the winter
heating season. Consumers anticipates that it will
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incur financing costs on these natural gas purchases that are higher than the
costs recovered in current rates.
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) implementation of the permanent gas
customer choice program for all gas retail customers; 4) any initiatives
undertaken to protect customers against gas price increases; and 5) market and
regulatory responses to increases in gas costs. For detailed information about
these uncertainties, see Note 2, Uncertainties, incorporated by reference
herein.
OTHER OUTLOOK
Since the September 11, 2001 terrorists attack in the United States,
Consumers has increased security at all facilities and infrastructure, and will
continue to evaluate security on an ongoing basis. Consumers may be required to
comply with potential federal and state regulatory security measures. As a
result, Consumers anticipates increased operating costs related to security
after September 11, 2001 that could be significant. Consumers cannot quantify
these costs at this time but would plan to seek recovery from its customers.
Consumers offers a variety of energy-related services to electric and gas
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
energy-related services for Consumers' customers.
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
separated from future rates and the services could be provided by an approved
third party. Consumers was directed to make this filing in connection with its
June 2001 request for a gas service rate increase and Consumers has complied
with this request.
OTHER MATTERS
NEW ACCOUNTING STANDARDS
In July 2001, FASB issued SFAS No. 141, Business Combinations, and SFAS No.
142, Goodwill and Other Intangible Assets.
SFAS No. 141 requires that entities account for all business combinations
initiated after June 30, 2001, under the purchase method and prohibits the use
of the pooling-of-interests method. The adoption of SFAS No. 141, effective July
1, 2001, will result in Consumers accounting for any future business
combinations under the purchase method of accounting, but not change the method
of accounting used in previous business combinations.
SFAS No. 142 requires that goodwill no longer be amortized to earnings, but
instead be reviewed for impairment. As of January 1, 2002, the amortization of
goodwill ceases upon adoption of the standard. The provisions of SFAS No. 142
require adoption for calendar year entities. Upon adoption, Consumers will no
longer amortize its existing goodwill. Consumers does not expect that the
provisions of SFAS No.
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142 will have a material impact on Consumers' consolidated results of operations
or financial position.
In August 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations, effective 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 while the capitalized cost is depreciated over the useful life of the
related asset. Consumers is currently studying the new standard but has yet to
quantify the effects of adoption on its financial statements.
In October 2001, FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which replaces SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of and
APB No. 30, Reporting Results of Operations-Reporting the Effects of Disposal of
a Segment of a Business.
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 will not change the accounting used for previous asset impairments
or disposals.
In October 2001, the FASB also issued clarifying guidance for Derivative
Implementation Issue No. C15, Scope Exceptions: Normal Purchases and Normal
Sales Exception for Option-Type Contracts and Forward Contracts in Electricity,
and final guidance for Derivative 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. These
issues could have a significant impact upon the implementation of derivative
accounting for certain contracts, and are effective January 1, 2002 and April 1,
2002, respectively. For further information about the potential effect, see Note
1, Corporate Structure and Summary of Significant Accounting Policies,
"Implementation of New Accounting Standards" and Note 2, Uncertainties, Other
Electric Uncertainties, "Derivative Activities".
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 in which Consumers holds less than a 20 percent interest.
Consumers' derivative activities 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. 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. Management believes that an opposite movement of the value of
the hedged risk would offset any losses incurred on derivative instruments used
to hedge that risk. Consumers enters into all derivative financial instruments
for purposes other than trading.
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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 provides an accurate or reliable method for
monitoring and controlling risks. Therefore, Consumers relies on the experience
and judgment of its senior management to revise strategies and adjust positions,
as they deem necessary. 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.
EQUITY SECURITY PRICE RISK: Consumers has a less than 20 percent equity
investment in CMS Energy. At September 30, 2001 and 2000, 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.
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 fixed-rate
and variable-rate debt, as well as interest rate swaps and rate locks 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 September 30, 2001, Consumers had entered into
fixed-to-floating interest rate swap agreements for a notional amount of $400
million and floating-to-fixed interest rate swap agreements for a notional
amount of $150 million. As of September 30, 2001 and 2000, Consumers had
outstanding $1.373 billion and $851 million of variable-rate debt, including
variable rate swaps, respectively. At September 30, 2001 and 2000, assuming a
hypothetical 10 percent adverse change in market interest rates, Consumers'
exposure to earnings, before tax on its variable rate debt, would be $4 million
and $6 million, respectively. As of September 30, 2001 and 2000, Consumers had
outstanding long-term fixed-rate debt including fixed-rate swaps of $2.158
billion and $2.360 billion, respectively, with a fair value of $2.525 billion
and $2.262 billion, respectively. As of September 30, 2001 and 2000, assuming a
hypothetical 10 percent adverse change in market rates, Consumers would have an
exposure of $143 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. For further discussion, see Note
3, Short-Term Financings and Capitalization, "Derivative Activities"
COMMODITY MARKET RISK: Consumers enters into, for purposes other than
trading, electricity and gas fuel call options and swap contracts to protect
against risk due to fluctuations in the market price of these commodities and to
ensure a reliable source of capacity to meet its customers' electric needs.
As of September 30, 2001, the fair value based on quoted future market
prices of electricity-related option and swap contracts was $14 million.
Assuming a hypothetical 10 percent adverse change in market prices, the
potential reduction in fair value associated with these contracts would be $4
million. As of September 30, 2001, Consumers had an asset of $73 million as a
result of premiums incurred for electricity call option contracts. Consumers'
maximum exposure associated with the call option contracts is limited to the
premiums paid. For further discussion on commodity derivatives see "Derivative
Activities" under Note 2, Uncertainties, Other Electric Uncertainties and Other
Gas Uncertainties.
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CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------- ---------------------
2001 2000 2001 2000
----- ----- ------ ------
IN MILLIONS
OPERATING REVENUE
Electric $ 739 $ 715 $2,028 $2,002
Gas 149 142 928 765
Other 11 17 36 41
----- ----- ------ ------
899 874 2,992 2,808
----- ----- ------ ------
OPERATING EXPENSES
Operation
Fuel for electric generation 102 94 250 240
Purchased power - related parties 155 127 399 417
Purchased and interchange power 187 134 401 292
Cost of gas sold 72 60 562 450
Loss on MCV power purchases 126 - 126 -
Other 154 134 456 398
----- ----- ------ ------
796 549 2,194 1,797
Maintenance 41 38 146 130
Depreciation, depletion and amortization 71 96 242 312
General taxes 44 49 142 148
----- ----- ------ ------
952 732 2,724 2,387
----- ----- ------ ------
PRETAX OPERATING INCOME (LOSS)
Electric (62) 118 157 342
Gas (1) 9 81 44
Other 10 15 30 35
----- ----- ------ ------
(53) 142 268 421
----- ----- ------ ------
OTHER INCOME (DEDUCTIONS)
Dividends and interest from affiliates 2 2 6 7
Accretion income - - - 2
Accretion expense (2) (2) (6) (6)
Other, net - 1 2 3
----- ----- ------ ------
- 1 2 6
----- ----- ------ ------
INTEREST CHARGES
Interest on long-term debt 35 35 111 105
Other interest 14 12 35 29
Capitalized interest (1) (2) (5) (2)
----- ----- ------ ------
48 45 141 132
----- ----- ------ ------
NET INCOME (LOSS) BEFORE INCOME TAXES (101) 98 129 295
INCOME TAXES (BENEFITS) (39) 26 41 96
----- ----- ------ ------
NET INCOME (LOSS) (62) 72 88 199
PREFERRED STOCK DIVIDENDS - - 1 1
PREFERRED SECURITIES DISTRIBUTIONS 12 9 30 26
----- ----- ------ -------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDER $ (74) $ 63 $ 57 $ 172
===== ===== ====== =======
The accompanying condensed notes are an integral part of these statements.
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CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30
---------------------
2001 2000
---- -----
IN MILLIONS
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 88 $ 199
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $5 and $29 respectively) 242 312
Loss on MCV power purchases 126 -
Accounts receivable 251 94
Capital lease and other amortization 16 23
Deferred income taxes and investment tax credit 1 (22)
Regulatory obligation - gas choice (16) 27
Undistributed earnings of related parties (25) (28)
Inventories (340) (90)
Changes in other assets and liabilities (22) (163)
---- ----
Net cash provided by operating activities 321 352
---- ----
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (495) (344)
Cost to retire property, net (73) (78)
Investment in Electric Restructuring Implementation Plan (9) (20)
Investments in nuclear decommissioning trust funds (5) (29)
Proceeds from nuclear decommissioning trust funds 21 28
Associated company preferred stock redemption 50 49
---- ----
Net cash used in investing activities (511) (394)
---- ----
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in notes payable, net (247) 216
Payment of common stock dividends (134) (126)
Preferred securities distributions (30) (26)
Payment of capital lease obligations (17) (23)
Retirement of bonds and other long-term debt (2) (7)
Payment of preferred stock dividends - (1)
Proceeds from senior notes & bank loans 352 -
Proceeds from CMS Energy cash infusion 150 -
Proceeds from preferred securities 121 -
---- ----
Net cash provided by (used in) financing activities 193 33
---- ----
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS 3 (9)
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 21 18
---- ----
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 24 $ 9
==== ====
Other cash flow activities and non-cash investing and financing activities were:
Cash transactions
Interest paid (net of amounts capitalized) $129 $122
Income taxes paid (net of refunds) 36 110
Non-cash transactions
Nuclear fuel placed under capital lease $ 13 $ 3
Other assets placed under capital leases 15 10
==== ====
- ------------
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-13
CONSUMERS ENERGY COMPANY
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30
2001 2000 2000
------------ ----------- ------------
(UNAUDITED) (UNAUDITED)
IN MILLIONS
ASSETS
PLANT (AT ORIGINAL COST)
Electric $ 7,513 $7,241 $7,146
Gas 2,566 2,503 2,529
Other 16 23 25
------- ------ ------
10,095 9,767 9,700
Less accumulated depreciation, depletion and amortization 5,873 5,768 5,818
------- ------ ------
4,222 3,999 3,882
Construction work-in-progress 416 279 294
------- ------ ------
4,638 4,278 4,176
------- ------ ------
INVESTMENTS
Stock of affiliates 54 86 73
First Midland Limited Partnership 249 245 241
Midland Cogeneration Venture Limited Partnership 296 290 273
------- ------ ------
599 621 587
------- ------ ------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 24 21 9
Accounts receivable and accrued revenue, less allowances
of $3, $3 and $3, respectively 22 225 4
Accounts receivable - related parties 13 111 66
Inventories at average cost
Gas in underground storage 603 271 301
Materials and supplies 70 66 64
Generating plant fuel stock 50 46 48
Prepaid property taxes 86 136 83
Regulatory assets 19 19 25
Deferred income taxes - 2 2
Other 12 13 15
------- ------ ------
899 910 617
------- ------ ------
NON-CURRENT ASSETS
Regulatory assets
Securitization costs 710 709 -
Postretirement benefits 214 232 317
Abandoned Midland Project 12 22 28
Unamortized nuclear costs - 6 476
Other 89 87 116
Nuclear decommissioning trust funds 568 611 617
Other 265 297 198
1,858 1,964 1,752
------- ------ ------
TOTAL ASSETS $ 7,994 $7,773 $7,132
======= ====== ======
CE-14
SEPTEMBER 30 DECEMBER 31 SEPTERMBER 30
2001 2000 2000
------------ ----------- -------------
(UNAUDITED) (UNAUDITED)
IN MILLIONS
STOCKHOLDERS' INVESTMENT AND LIABILITIES
CAPITALIZATION
Common stockholder's equity
Common stock $ 841 $ 841 $ 841
Paid-in capital 796 646 646
Revaluation capital (4) 33 26
Retained earnings since December 31, 1992 373 506 531
------ ------ ------
2,006 2,026 2,044
Preferred stock 44 44 44
Company-obligated mandatorily redeemable preferred securities
of subsidiaries (a) 520 395 395
Long-term debt 2,452 2,110 2,009
Non-current portion of capital leases 53 49 81
------ ------ ------
5,075 4,624 4,573
------ ------ ------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 251 231 80
Notes payable 155 403 430
Accounts payable 258 254 186
Accrued taxes 115 247 106
Accounts payable - related parties 78 67 61
Deferred income taxes 17 - -
Other 319 253 235
------ ------ ------
1,193 1,455 1,098
------ ------ ------
NON-CURRENT LIABILITIES
Deferred income taxes 668 716 651
Postretirement benefits 294 366 385
Regulatory liabilities for income taxes, net 270 246 86
Power purchases - MCV Partnership 175 54 37
Deferred investment tax credit 104 109 119
Other 215 203 183
------ ------ ------
1,726 1,694 1,461
------ ------ ------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 2)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $7,994 $7,773 $7,132
====== ====== ======
- ------------
(a) See Note 3, Short-Term Financings and Capitalization
The accompanying condensed notes are an integral part of these balance sheets.
CE-15
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------------- ---------------------
2001 2000 2001 2000
------ ------ ------ ------
IN MILLIONS
COMMON STOCK
At beginning and end of period(a) $ 841 $ 841 $ 841 $ 841
OTHER PAID-IN CAPITAL
At beginning of period 646 645 646 645
Stockholder's contribution 150 - 150 -
Miscellaneous - 1 - 1
------ ------ ------ ------
At beginning of period 796 646 796 646
------ ------ ------ ------
REVALUATION CAPITAL
Investments
At beginning of period 26 19 33 37
Unrealized gain (loss) on investments(b) (15) 7 (22) (11)
------ ------ ------ ------
At end of period 11 26 11 26
------ ------ ------ ------
Derivative Instruments
At beginning of period(c) (10) - 18 -
Unrealized gain (loss) on derivative instruments(b) (9) - (30) -
Reclassification adjustments included in net income(b) 4 - (3) -
------ ------ ------ ------
At end of period (15) - (15) -
------ ------ ------ ------
RETAINED EARNINGS
At beginning of period 541 485 506 485
Net income (62) 72 88 199
Cash dividends declared- Common Stock (94) (17) (190) (126)
Cash dividends declared- Preferred Stock - - (1) (1)
Preferred securities distributions (12) (9) (30) (26)
------ ------ ------ ------
At end of period 373 531 373 531
------ ------ ------ ------
TOTAL COMMON STOCKHOLDER'S EQUITY $2,006 $2,044 $2,006 $2,044
====== ====== ====== ======
- ------------
(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
$8, $(4), $12 and $6, respectively $(15) $ 7 $(22) $(11)
Derivative Instruments
Unrealized gain (loss) on derivative instruments,
net of tax of $4, $- , $15 and $-, respectively (9) - (30) -
Reclassification adjustments included in net income,
net of tax of $(2), $-, $2 and $- , respectively 4 - (3) -
Net income (62) 72 88 199
---- ---- ---- ----
Total Comprehensive Income $(82) $ 79 $ 33 $188
==== ==== ==== ====
(c) Nine Months Ended 2001 is the cumulative effect of change in accounting
principle, as of 1/1/01 and 7/1/01, net of $(9) tax (Note 1)
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-16
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 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, 2000, 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 preparation of financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
UTILITY REGULATION: Consumers accounts for the effects of regulation based
on the regulated utility accounting standard SFAS No. 71, Accounting for the
Effects of Certain Types of Regulation. 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.
Consistent with these orders, Consumers discontinued application of SFAS No. 71
for the energy supply portion of its business in the first quarter of 1999
because Consumers expected to implement retail open access for its electric
customers in September 1999. Discontinuation of SFAS No. 71 for the energy
supply portion of Consumers' business resulted in Consumers reducing the
carrying value of its Palisades plant-related assets by approximately $535
million and establishing a regulatory asset for a corresponding amount, which is
now included as a component of securitization assets. According to current
accounting standards, Consumers can continue to carry its energy 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 September 30, 2001, Consumers had a net
investment in energy supply facilities of $1.284 billion included in electric
plant and property. See Note 2, Uncertainties, "Electric Rate Matters - Electric
Restructuring."
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
CE-17
the product and service each provides. The accounting policies of the segments
are the same as those described in Consumers' 2000 Form 10-K. Consumers'
management evaluates performance based on pretax operating income. 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 pretax operating
income by segment.
RISK MANAGEMENT ACTIVITIES AND DERIVATIVES TRANSACTIONS: Consumers'
derivative activities 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 debt or commodity position and ensure that net
corporate exposures are within the economic risk tolerance levels established by
Consumers' Board of Directors. Consumers and its subsidiaries use derivative
instruments, including swaps and options, as hedges to manage exposure to
variability in expected future cash flows attributable to fluctuations in
interest rates and commodity prices. To qualify for hedge accounting, the
hedging relationship must be formally documented, be highly effective in
achieving offsetting cash flows of the hedged risk, and the forecasted
transaction must be probable. If a derivative instrument 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 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. Consumers considers the risk of nonperformance by the
counterparties remote. For further discussion see "Implementation of New
Accounting Standards" below, "Derivative Activities" under Note 2,
Uncertainties, Other Electric Uncertainties and Other Gas Uncertainties and Note
3, Short-Term Financing and Capitalization, "Derivative Activities".
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS: Effective January 1, 2001,
Consumers adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities as amended and interpreted. SFAS No. 133 requires Consumers
to recognize at fair value, all contracts that meet the definition of a
derivative instrument on the balance sheet as either assets or liabilities. This
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
mathematical models using current and historical pricing data.
Consumers believes that the majority of its contracts qualify for the
normal purchases and sales exception pursuant to SFAS No. 133 and, therefore,
are not subject to derivative accounting. Consumers does, however, use certain
contracts that qualify as derivative instruments to limit its exposure to
electricity and gas commodity price risk and interest rate risk.
On January 1, 2001, upon initial adoption of the standard, Consumers
recorded a $21 million, net of tax, cumulative effect adjustment as an increase
to accumulated other comprehensive income. This adjustment relates to the
difference between the current fair value and recorded book value of contracts
related to gas options, gas fuel swap contracts, and interest rate swap
contracts that qualified for cash flow 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.
This amount will reduce, or be charged to cost of gas, cost of power, interest
expense, or other operating revenue, respectively, when the related hedged
transaction occurs. Based on the pretax amount recorded in accumulated other
comprehensive income on the January 1, 2001 transition date, Consumers recorded
$12 million as a reduction to the cost of gas, $1 million as a reduction to the
cost of power, and $2 million as an increase in interest expense for the nine
months ended September 30, 2001. Consumers does not expect to reclassify any
additional amounts from
CE-18
the cumulative effect adjustment to earnings that would affect the cost of gas,
the cost of power, interest expense, or other operating revenue during the next
12 months.
As of September 30, 2001, Consumers had a total of $9 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 is sustained.
On January 1, 2001, upon initial adoption of the standard, 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 2001, the FASB issued guidance that effectively resolved most of
these matters as of July 1, 2001. Consumers evaluated its option and option-like
contracts and determined that the majority of these contracts qualify for the
normal purchase exception of SFAS No. 133, however, certain electricity option
contracts are required to be accounted for as derivatives. 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 a decrease to accumulated
other comprehensive income. This adjustment relates to the difference between
the current fair value and the recorded book value of these electricity option
contracts. The adjustment to accumulated other comprehensive income relates to
electricity 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 transaction occurs or the option expires. As of September 30,
2001, $2 million, net of tax, was reclassified to earnings as part of cost of
power. The remainder is expected to be reclassified to earnings in the third
quarter of 2002.
In October 2001, the FASB issued further clarifying guidance regarding
derivative accounting for electricity call option contracts and option-like
contracts. The clarifying guidance amends the criteria to be used to determine
if derivative accounting is required. Consumers is in the process of
re-evaluating its electricity option and option-like contracts in order to
determine if additional contracts will require derivative accounting. The
effective date of this change is January 1, 2002. Consumers is currently
studying the financial effects of the adoption of SFAS No. 133 for these
contracts, but has yet to quantify these effects.
In addition, in October 2001, the FASB issued final guidance regarding
derivative accounting for certain fuel supply contracts with quantity
variability. Under the final guidance, effective April 1, 2002, certain
contracts would not qualify for the normal purchase exception of SFAS No. 133
and would require derivative accounting. Consumers initially believed that its
fuel supply contracts qualified for the normal purchase exception of SFAS No.
133 and has not, therefore, recorded these contracts on the balance sheet at
fair value. Consumers is in the process of reviewing its fuel supply contracts
in accordance with the final guidance.
The ultimate financial statement impact of adopting SFAS No. 133 depends
upon clarification of the above issues. Consumers is currently studying the
recent changes, but has yet to quantify these effects. For further discussion of
derivative activities, see "Derivative Activities" under Note 2, Uncertainties,
Other Electric Uncertainties and Other Gas Uncertainties and Note 3, Short-Term
Financings and Capitalization.
CE-19
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.
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 $470
million and $560 million, calculated in year 2001 dollars. Consumers anticipates
that it will incur these capital expenditures between 2000 and 2004. As of
September 2001, Consumers has incurred $251 million in capital expenditures to
comply with these regulations.
At some point after 2004, 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 capital
expenditures above depreciation levels are expected to be recoverable, subject
to an MPSC prudence hearing, in future rates.
These and other required environmental expenditures may have a material
adverse effect upon our 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 does,
however, believe that these costs are 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
September 30, 2001, 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
suppliers by January 1, 2002; 2) cuts residential electric rates by five
percent; 3) freezes all electric rates
CE-20
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 Stranded Costs as a means of
offsetting the earnings impact of the five percent residential rate reduction;
5) establishes a market power 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 is in compliance); 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 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 would result in an extension of the rate caps to as late as December
31, 2013. As of September 30, 2001, Consumers spent $25 million on the required
expansion of transmission capabilities. Consumers anticipates it will spend an
additional $13 million in 2001 and 2002, until Consumers sells METC to MTH, as
discussed below under "Transmission Business".
In July 2000, in accordance with the Customer Choice Act, Consumers filed
an application with the MPSC seeking approval to issue Securitization bonds.
Securitization typically involves the issuance of asset backed bonds with a
higher credit rating than conventional utility corporate financing. In October
2000 and January 2001, the MPSC issued a financing order and a final financing
order, respectively. In January 2001, Consumers accepted the MPSC's final
financing order. Although the Michigan Attorney General appealed the financing
order after Consumers accepted the order, the Attorney General did not appeal
the order to the Michigan Supreme Court after the Michigan Court of Appeals
unanimously affirmed the MPSC's order in July 2001.
The orders authorize 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 offsetting 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. Actual cost
savings from Securitization depends upon the level of debt or equity securities
ultimately retired, the amortization schedule for the securitized qualified
costs and the interest rates of the retired debt securities and the
Securitization bonds. The orders direct Consumers to apply any cost savings in
excess of the five percent residential rate reduction to rate reductions for
non-residential and retail open access customers after the bonds are sold.
Excess savings are currently estimated to be approximately $13 million annually.
In November 2001, Consumers Funding LLC, a special purpose 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.
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 beginning in December 2001.
These charges are subject to an annual true-up until one year prior to the last
expected bond maturity date, October 20, 2015, and no more than quarterly
thereafter. Current electric rates will not increase for most of Consumers'
electric customers under the MPSC's order. Funds collected will be remitted to
the trustee for the Securitization bonds and are not available to Consumers'
creditors.
Beginning January 1, 2001, the amortization of the approved regulatory
assets being securitized as qualified costs is being deferred, which effectively
offsets the loss in revenue resulting from the five percent residential
CE-21
rate reduction. In December 2001, the amortization will be reestablished based
on a schedule that is the same as the recovery of the principal amounts of the
securitized qualified costs. The amortization amount is expected to be
approximately $31 million in 2002 and the securitized assets will be fully
amortized by the end of 2015.
In September 1999, Consumers began implementing a plan for electric retail
customer open access. In 1998, Consumers submitted this plan to the MPSC and in
March 1999 the MPSC issued orders that generally supported the plan. 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
filed tariffs governing its retail open access program and addressed revisions
appropriate to comply with the Customer Choice Act. Consumers cannot predict how
the MPSC will modify the tariff or enforce the existing restructuring orders.
POWER COSTS: During periods when electric demand is high, the cost of
purchasing energy 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 reserve, also called a
reserve margin, of approximately 15 percent. The reserve margin provides
Consumers with additional power above its anticipated peak power demands. It
also allows Consumers to provide reliable service to its electric service
customers and to protect itself against unscheduled plant outages and
unanticipated demand. As it has in previous summers, Consumers is planning for a
reserve margin of 15 percent for the summers 2002 and 2003. 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. The existing retail open access plan allows other
electric service providers with the opportunity to serve up to 750 MW of nominal
retail open access requirements. As of October 2001, alternative electric
service providers are providing service to 223 MW of retail open access
requirements. In June 2001, an unscheduled plant outage commenced at Palisades
that will affect future power costs. Consumers has secured additional power and
expects to have sufficient power to meet its customers' needs. For further
information, refer to the "Nuclear Matters" section of this note.
To reduce the risk of high energy prices during peak demand periods and to
achieve its reserve margin target, Consumers employs a strategy of purchasing
electricity call option contracts for the physical delivery of electricity
during the months of June through September. The cost of these electricity call
option contracts for summer 2001 was approximately $61 million. Consumers
expects to use a similar strategy in the future, but cannot predict the cost of
this strategy at this time. As of September 30, 2001, Consumers had purchased or
had commitments to purchase electricity call option contracts partially covering
the estimated reserve margin requirements for summers 2002 through 2008, at a
recognized cost of $73 million, of which $27 million pertains to 2002.
In 1996, as a result of 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
jointly operate the MEPCC. Detroit Edison and Consumers negotiated to
restructure and continue 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 of terminating these
joint merchant operations with Detroit Edison.
CE-22
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, interchange power and purchased 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
until at least December 31, 2003. Therefore, changes in power supply costs as a
result of fluctuating energy prices will not be reflected in rates during the
rate freeze period.
Consumers is authorized by the FERC to sell power at wholesale prices that
are either 1) no greater than its cost-based rates or 2) at market price. 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 market dominance analysis in October 2001. In
September 2001, the FERC staff issued a report suggesting that the FERC may
reconsider the method it currently uses to evaluate market power assessments
for electric generators. If the FERC determines that this method is not
sufficient, Consumers cannot be certain at this time if it will be granted
authorization to continue to sell wholesale power at market-based prices and may
be limited to charging prices no greater than its cost-based rates. A decision
on reliance of the current assessment method is not expected for several months.
TRANSMISSION BUSINESS: 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 by December 31, 2001.
In 1999, Consumers and four other electric utility companies joined
together to form a coalition known as the Alliance Companies for the purpose
of creating a FERC-approved RTO. In October 2000, Consumers filed a request
with the FERC to transfer ownership and control of its transmission facilities
to a wholly owned subsidiary, METC. This request was granted in January 2001.
In December 2000, the MPSC issued an order authorizing an anticipated sale or
ownership transfer of Consumers' transmission facilities. On April 1, 2001,
the transfer of the electric transmission facilities to METC took place.
In October 2001, in compliance with Michigan's Customer Choice Act, and in
conformance with FERC Order No. 2000, Consumers executed an agreement to sell
METC for approximately $290 million to MTH, an independent limited partnership
whose general partner is a subsidiary of Trans-Elect, Inc. Proceeds from the
sale of METC will be used to improve Consumers' balance sheet. MTH and Consumers
are currently seeking to satisfy the conditions of closing including approval of
the transaction from the FERC. Consumers will continue to own and operate the
system until all approvals are received and the sale is final. Regulatory
approvals and operational transfer are expected to take place in the second
quarter of 2002; however, Consumers can make no assurances as to when or if the
transaction will be completed. METC will continue to maintain the system under a
long-term contract with MTH.
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 which it can not control. As a result of the sale of its
transmission facilities, Consumers anticipates that after tax earnings will be
reduced by approximately $6 million and $14 million in 2002 and 2003,
respectively. Through 2005, Consumers' total revenues should not be materially
affected from the sale of METC due to frozen retail rates.
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Under the agreement with MTH, transmission rates charged to Consumers'
bundled electric customers will be frozen 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 power
into Michigan, as required by the Customer Choice Act.
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 that would either fully or partially resolve this
litigation. The settlements were approved by the Michigan circuit court and are
contingent upon the approval by the FERC and certain other contingencies. The
circuit court has retained jurisdiction over the matter.
ELECTRIC PROCEEDINGS: In 1997, ABATE filed a complaint with the MPSC. The
complaint alleged that Consumers' electric earnings are more than its authorized
rate of return and sought an immediate reduction in Consumers' electric rates
that approximated $189 million annually. As a result of the rate freeze imposed
by the Customer Choice Act, the MPSC issued an order in June 2000 dismissing the
ABATE complaint. In July 2000, ABATE filed a rehearing petition with the MPSC,
which was denied in October 2001.
In March 2000 and 2001, Consumers filed applications with the MPSC for the
recovery of electric utility restructuring implementation costs of $30 million
and $25 million, incurred in 1999 and 2000, respectively. In July 2001,
Consumers received a final order that granted recovery of $25 million of
restructuring implementation costs for 1999. The MPSC disallowed recovery of $5
million, based upon a conclusion that this amount did not represent incremental
costs. The MPSC also ruled that it reserved the right to undertake another
review of the total 1999 restructuring implementation costs depending upon the
progress and success of the retail open access program. In addition, the MPSC
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 costs. Consumers
expects to receive a final order for the 2000 cost in early 2002. Consumers
believes these costs are fully recoverable in accordance with the Customer
Choice Act; however, Consumers cannot predict the amounts the MPSC will approve
as recoverable costs.
Also, in July 2001, Consumers received an order from the MPSC that proposed
electric distribution performance standards applicable to electric distribution
companies operating in Michigan. The proposed performance standards would
establish standards related to outage restoration, safety, and customer
relations. Failure to meet the proposed performance standards would result in
customer credits. Consumers has submitted comments to the MPSC. Consumers cannot
predict the outcome of the proposed performance standards.
In 1996, Consumers filed with the FERC and self-implemented OATT
transmission rates. Certain intervenors contested these rates, and hearings were
held before an ALJ in 1998. During 1999, the ALJ rendered an initial decision,
which if upheld by the FERC, would ultimately reduce Consumers' OATT rates and
require Consumers to refund, with interest, any over-collections for past
services. Consumers, since that time has been reserving a portion of revenues
billed to customers under these OATT rates. At the time of the initial decision,
the company believed that certain issues would be decided in Consumers' favor,
and that a relatively quick order would be issued by the FERC regarding this
matter. However, due to changes in regulatory interpretations, Consumers
believes that a successful resolution of certain issues is less likely. As a
result, in September 2001, Consumers reserved an additional $12 million,
including interest, to fully reflect the financial impacts of the initial
decision. Consumers expects that its reserve levels for future transmission
service will also be in compliance with the initial decision until an order from
the FERC is received.
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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
Nine Months Ended
September 30
-------------------
2001 2000
---- ----
In Millions
Pretax operating income $31 $35
Income taxes and other 9 11
--- ---
Net income $22 $24
--- ---
Power 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 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'
strategic planning process, 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 PPA's future affect on
Consumers. At September 30, 2001 and 2000, the remaining after-tax present value
of the estimated future PPA liability associated with the loss totaled $122
million and $55 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 at the
maximum 98.5 percent level during the next five years, Consumers' after-tax cash
underrecoveries associated with the PPA could be as follows:
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2001 2002 2003 2004 2005
---- ---- ---- ---- ----
In Millions
Estimated cash underrecoveries at 98.5%, net of tax $37 $38 $37 $36 $35
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. Consumers
expenses interest on leased nuclear fuel as it is incurred. Under current
federal law, as a federal court decision confirmed, the DOE was to begin
accepting deliveries of spent nuclear fuel for disposal by January 31, 1998. For
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 September 30, 2001, Consumers
has a recorded liability to the DOE of $135 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, the DOE declared that it would not begin to accept
spent nuclear fuel deliveries in 1998. Also in 1997, a federal court affirmed
the DOE's duty to take delivery of spent fuel. 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 another 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 such
settlement. Consumers is evaluating this matter further. 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. Consumers is evaluating those rulings and their
applicability to its contracts with the DOE.
NUCLEAR MATTERS: In May 2001, Palisades received its annual performance
review in which the NRC stated that Palisades operated in a manner that
preserved public health and safety. The NRC classified all inspection findings
to have very low safety significance. At the time of the annual performance
review, the NRC had planned to conduct only baseline inspections at the facility
through May 31, 2002. The NRC, however, is currently conducting an inspection to
oversee the Palisades unplanned outage, which is discussed in more detail below.
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 September 30, 2001, Consumers
had loaded 18 dry
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storage casks with spent nuclear fuel at Palisades. Palisades will need to load
additional casks by 2004 in order to continue operation. Palisades currently has
three additional empty storage-only casks on-site, with storage pad capacity for
up to seven additional loaded casks. Consumers anticipates, however, that
licensed transportable casks, for additional storage, will be available prior to
2004.
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 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 nature of the current Palisades outage,
however, is not likely to be 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 $12.8 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.
In February 2000, Consumers submitted an analysis to the NRC that shows
that the NRC's screening criteria for reactor vessel embrittlement at Palisades
will not be reached until 2014. On December 14, 2000, the NRC issued an
amendment revising the operating license for Palisades extending the expiration
date to March 2011, with no restrictions related to reactor vessel
embrittlement.
In April 2001, Consumers received approval from the NRC to amend the
license of the Palisades nuclear plant to transfer plant operating authority to
NMC. The formal operating authority transfer from Consumers to NMC took place in
May 2001. Consumers will retain ownership of Palisades, its 789 MW output, the
spent fuel on site, and ultimate responsibility for the safe operation,
maintenance and decommissioning of the plant. Under this agreement, salaried
Palisades' employees became NMC employees on July 1, 2001. Union employees will
work under the supervision of NMC pursuant to their existing labor contract as
Consumers' employees. Consumers will benefit by consolidating expertise and
controlling costs and resources among all of the nuclear plants being operated
on behalf of the five NMC member companies. With Consumers as a partner, 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.
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 immediately, as opposed to partially
repairing the component followed eventually by complete replacement during a
future outage. The Company adopted this approach because it provides more
certainty of schedule for return to service, greater regulatory acceptability,
and avoids future plant outage time and associated replacement power costs.
Installation of the new components is expected to be completed in December 2001,
with the plant expected to return to service in January 2002. Consumers cannot,
however, make any assurances as to the date on which the new components will be
installed or the plant will return to service. Consumers estimates capital
expenditures for the components and their installation to be approximately $25
to $30 million.
From the start of the June 20th outage through the end of 2001, the impact on
net income of replacement power and maintenance costs associated with the outage
is currently estimated to be approximately $65 million. An additional month of
incremental replacement power and maintenance costs would impact net income by
approximately an additional $8 to $10 million. However, replacement power and
maintenance costs in early 2002, if any, would be offset by the postponement of
a previously scheduled refueling outage in 2002, which is now not needed until
2003. Consumers expects to have sufficient power at all times to meet its load
CE-27
requirements from its other plants or purchase arrangements.
NUCLEAR DECOMMISSIONING: In 1996, Consumers and its wholesale customers
entered into five-year contracts that fixed the portion of nuclear
decommissioning costs that were expected to end in 2001 associated with these
customers. Since that time, the total estimated decommissioning costs for Big
Rock increased substantially over the estimates used to calculate the
decommissioning costs attributed to wholesale customers. As a result of a
reduction in decommissioning trust earnings in August 2001, along with the
higher estimated costs of decommissioning, Consumers, in September 2001,
expensed approximately $5 million related to this issue to recognize the
unrecoverable portion of Big Rock decommissioning costs associated with these
customers.
CAPITAL EXPENDITURES: Consumers estimates electric capital expenditures,
including new lease commitments and environmental costs under the Clean Air Act,
of $590 million for 2001, $480 million for 2002, and $405 million for 2003. For
further information, see the Capital Expenditures Outlook section in the MD&A.
DERIVATIVE ACTIVITIES: Consumers' electric business uses purchased
electricity call option contracts to meet its regulatory obligation to serve,
which requires providing a physical supply of energy to customers, and to manage
energy cost and to ensure a reliable source of capacity during periods of peak
demand. On January 1, 2001, upon initial adoption of SFAS No. 133, accounting
for these contracts 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 the fair value of these contracts on
the balance sheet. In June 2001, the FASB issued guidance that effectively
resolved the accounting for these contracts as of July 1, 2001. Consumers
evaluated its option and option-like contracts and determined that the majority
of these contracts qualify for the normal purchase exception of SFAS No. 133,
however, certain electricity option contracts are required to be accounted for
as derivatives. 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 a decrease to accumulated other comprehensive income. This
adjustment relates to the difference between the current fair value and the
recorded book value of these electricity option contracts. The adjustment to
accumulated other comprehensive income relates to electricity 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 majority of these contracts expired in the third
quarter 2001 and the remaining contracts will expire in 2002. The initial
amount recorded in other comprehensive income will be reclassified to earnings
as the forecasted future transaction occurs or the option expires. As of
September 30, 2001, $2 million, net of tax, was reclassified to earnings as
part of cost of power. The remainder is expected to be reclassified to earnings
in the third quarter 2002.
In October 2001, the FASB issued further clarifying guidance regarding
derivative accounting for electricity call option contracts and option-like
contracts. The clarifying guidance amends the criteria to be used to determine
if derivative accounting is required. Consumers is in the process of
re-evaluating its electricity option and option-like contracts in order to
determine if additional contracts will require derivative accounting. The
effective date of this change is January 1, 2002. Consumers is currently
studying the financial effects of the adoption of SFAS No. 133 for these
contracts, but has yet to quantify these effects.
In addition, in October 2001, the FASB issued final guidance regarding
derivative accounting for certain fuel supply contracts with quantity
variability. Under the final guidance, certain contracts would not qualify for
the normal purchase exception of SFAS No. 133 and would require derivative
accounting. Consumers initially believed that its fuel supply contracts
qualified for the normal purchase exception of SFAS No. 133 and has not,
therefore, recorded these contracts on the balance sheet at fair value.
Consumers is in the process of reviewing its fuel supply contracts in accordance
with the final guidance. The effective date of this change is
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April 1, 2002. Consumers is currently studying the financial effects of the
adoption of SFAS No. 133 for these contracts, but has yet to quantify these
effects.
Consumers' electric business also uses purchased gas call option and gas
swap contracts to hedge 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 are designated as cash flow
hedges and, therefore, Consumers will record any change in the fair value of
these contracts in other comprehensive income until the forecasted transaction
occurs. Once the forecasted gas purchases occurs, the net gain or loss on these
contracts will be reclassified to earnings and recorded as part of the cost of
power. These contracts have been highly effective in achieving offsetting cash
flows of future gas purchases, and no component of the gain or loss was excluded
from the assessment of the hedge's effectiveness. As a result, no net gain or
loss has been recognized in earnings as a result of hedge ineffectiveness as of
September 30, 2001. At September 30, 2001, Consumers had a derivative liability
with a fair value of $.4 million. These contracts expire in 2001, and Consumers
expects to reclassify, in 2001, a $.7 million decrease in fair value to earnings
as an increase to power costs, if this fair value is sustained. The ultimate
fair value of these derivative assets is dependent upon market conditions
related to the derivative instruments.
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
sites that formerly housed manufactured gas plant facilities, including those in
which it has a partial or no current ownership interest. Consumers has completed
initial investigations at the 23 sites. On 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. Using this model,
Consumers estimates the total costs to be between $82 million and $113 million.
These estimates are based on discounted 2001 costs. As of September 30, 2001,
Consumers has an accrued liability of $60 million, (net of $22 million of
expenditures incurred to date), and a regulatory asset of $71 million. Any
significant change in assumptions, such as remediation techniques, nature and
extent of contamination, and legal and regulatory requirements, could affect the
estimate of remedial action costs for the sites. 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 prudence review
in a future general gas rate case. Consumers' current general gas rate case
considers the prudence of manufactured gas plant facilities environmental
clean-up expenditures for years 1998 through 2002.
GAS RATE MATTERS
GAS RESTRUCTURING: From April 1, 1998 to March 31, 2001, Consumers
conducted an experimental gas customer choice pilot program which 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' facilities.
GAS COST RECOVERY: As part of a settlement agreement approved by the MPSC
in July 2001, Consumers agreed not to exceed a ceiling price 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
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charges customers the amount that it pays for natural gas in the reconciliation
process. In December 2000, Consumers initiated the negotiations, requesting a
ceiling price of $5.69 per mcf. The settlement reflects the decreasing prices in
the natural gas market. The settlement does not affect Consumers' June 2001
request to the MPSC for the gas service rate increase. The MPSC also approved a
methodology to adjust for market price increases quarterly without returning to
the MPSC for approval.
GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a gas service rate increase. If the MPSC approves Consumers' request,
then Consumers could bill an additional amount of approximately $6.50 per month,
representing a 10% increase in the typical residential customer's average
monthly bill. Consumers is seeking a 12.25% authorized return on equity.
Contemporaneously with this filing, Consumers has requested partial and
immediate relief in the amount of $33 million. The relief is primarily for
higher carrying costs on more expensive natural gas inventory than is currently
included in rates and actual earnings below the authorized return. In October
2001, Consumers revised its filing to reflect lower operating costs and is now
requesting a $133 million gas service rate increase.
OTHER GAS UNCERTAINTIES
CAPITAL EXPENDITURES: Consumers estimates gas capital expenditures,
including new lease commitments, of $145 million for 2001, $175 million for
2002, and $165 million for 2003. For further information, see the Capital
Expenditures Outlook section in the MD&A.
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 September 30, 2001, Consumers had FERC authorization to
issue or guarantee through June 2002, up to $900 million of short-term
securities outstanding at any one time. Consumers also had remaining FERC
authorization to issue through June 2002 up to $250 million and $125 million of
long-term securities for refinancing or refunding purposes and for general
corporate purposes, respectively.
In August 2001, Consumers filed an amendment with the FERC to request
authorization of an additional $500 million of long term securities for general
corporate purposes and up to an additional $500 million of long term First
Mortgage Bonds to be issued solely as security for the long term securities.
Further, in October 2001, FERC granted Consumers' August 2001 request for
authorization of an additional $500 million of short-term debt so that $1.4
billion may be outstanding at any one time and up to $500 million in of First
Mortgage Bonds to be issued as collateral for the outstanding short-term
securities.
SHORT-TERM FINANCINGS: Consumers has an unsecured $300 million credit
facility maturing in July 2002 and unsecured lines of credit aggregating $215
million. These facilities are available to finance seasonal working capital
requirements and to pay for capital expenditures between long-term financings.
At September 30,
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2001, a total of $153 million was outstanding at a weighted average interest
rate of 3.5 percent, compared with $430 million outstanding at September 30,
2000, at a weighted average interest rate of 7.4 percent.
Consumers currently has in place a $325 million trade receivables sale
program. At September 30, 2001 and 2000, receivables sold under the program
totaled $325 million and $307 million, respectively. Accounts receivable and
accrued revenue in the Consolidated Balance Sheets have been reduced to reflect
receivables sold.
LONG-TERM FINANCINGS: In September 2001, Consumers sold $350 million
aggregate principal amount of 6.25 percent senior notes, maturing in September
2006. Net proceeds from the sale were $347 million. Consumers used the net
proceeds to reduce borrowings on various lines of credit and on a revolving
credit facility.
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:
Trust and Securities Amount Outstanding
- -------------------- ---------------------------------------
September 30 December 31 September 30 Earliest
Rate 2001 2000 2000 Maturity Redemption
----- ------------ ----------- ------------ -------- ----------
In Millions
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36% $100 $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 Originated Preferred Securities 9.00% 125 - - 2031 2006
---- ---- ----
Total $520 395 $395
==== ==== ====
OTHER: Under the provisions of its Articles of Incorporation , Consumers
had $240 million of unrestricted retained earnings available to pay common
dividends at September 30, 2001 and in September 2001, Consumers declared a $55
million common dividend payable in November 2001.
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 the swap is sold. These swaps fix the interest rate on $150
million of variable rate debt, and expire in December 2001 and 2002. As of
September 30, 2001, these interest rate swaps had a negative fair value of $4
million. This amount, if sustained, will be reclassified to earnings when the
swaps are settled on a monthly basis.
CE-31
In September 2001, Consumers entered into a cash flow hedge to fix the
interest rate on $100 million of debt to be issued. In September 2001, the swap
terminated and resulted in a $2 million loss that has been recorded in other
comprehensive income and will be amortized to interest expense over the life of
the debt using the effective interest method.
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. As such, Consumers will record any change in the fair value of
these contracts and the fair value of the debt directly in earnings. These
hedges are considered to be fully effective, and as such changes in the fair
value of the swaps offset changes in the fair value of the debt. These swaps
hedge the fair value on $400 million of fixed rate debt, and expire in May 2003
and December 2006. As of September 30, 2001, these interest rate swaps had a
fair value of $1 million. Subsequently in November 2001, these swaps were
terminated and resulted in a $4 million gain that will be deferred and recorded
as part of the debt. It is anticipated that this gain will be recognized over
the remaining life of the debt.
During the third quarter 2001, Consumers entered into fair value hedges to
hedge the risk associated with the fair value of $250 million of debt. These
swaps terminated in the third quarter 2001, and resulted in a $4 million gain
that has been deferred and recorded as part of the debt. It is anticipated that
this gain will be recognized over the remaining life of the debt.
4: LEASES
In April 2001, Consumers Campus Holdings, entered into a lease agreement
for the construction of an office building to be used as the main headquarters
for Consumers in Jackson, Michigan. Consumers' current headquarters building
leases expire in June 2003. The lessor has committed to fund up to $70 million
for construction of the building. Consumers is acting as the construction agent
of the lessor for this project. The agreement is a seven-year lease term with
payments commencing upon completion of construction, which is projected for
March of 2003. Consumers Campus Holdings has the right to acquire the property
at any time during the life of the agreement. At the end of the lease term,
Consumers Campus Holdings has the option to renew the lease, purchase the
property, or return the property and assist the lessor in the sale of the
building. The return option obligates Consumers Campus Holdings to pay the
lessor an amount equal to the outstanding debt associated with the building.
This lease is classified as an operating lease. Estimated minimum lease
commitments, assuming an investment of $70 million, based on LIBOR at inception
of the lease, under this non-cancelable operating lease would be approximately
$5 million each year from 2003 through 2007 and a total of $52 million for the
remainder of the lease. Actual lease payments will depend upon final total
construction costs and LIBOR rates.
CE-32
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 September 30, 2001 and 2000, and the related
consolidated statements of income and common stockholder's equity for the
three-month and nine-month periods then ended and related consolidated
statements of cash flows for the nine-month periods then ended. 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 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 review, 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, 2000, and, in our report
dated February 2, 2001, 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, 2000, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
/s/ Arthur Andersen LLP
Detroit, Michigan,
October 31, 2001.
CE-33
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 a LNG regasification plant and related
facilities. The rates and conditions for service of interstate natural gas
transmission, storage and LNG operations of Panhandle 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 2000 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 made by
Panhandle from time to time contain forward-looking statements, as defined by
the Private Securities Litigation Reform Act of 1995. The words "anticipates,"
"believes," "estimates," "expects," "intends," and "plans" and variations of
such words and similar expressions, are intended to identify forward-looking
statements that involve risk and uncertainty. These forward-looking
statements are subject to various factors, which 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 factor affects
the information contained in such statements. Panhandle does, however discuss
certain risk factors, uncertainties and assumptions in this MD&A and
particularly in the section entitled "CMS Energy, Consumers, and Panhandle
Forward-Looking Statements Cautionary Factors" in CMS Energy's 2000 Form 10-K,
Item 1 and periodically in various public filings it 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 outlook. This report also describes material contingencies in the
Condensed Notes to Consolidated Financial Statements and the readers are
encouraged to read such 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
subsidiaries of reporting companies.
RESULTS OF OPERATIONS
NET INCOME:
September 30
-------------------
2001 2000 Change
---- ----------- ------
In Millions
Three Months Ended $ 8 $14 $(6)
Nine Months Ended $56 $55 $ 1
For the three months ended September 30, 2001, net income was $8 million,
down $6 million from the same period in 2000. Total natural gas transportation
volumes delivered for the three months ended September 30, 2001 decreased
4 percent from 2000 primarily due to decreased transportation volumes for
Panhandle Eastern Pipe Line. For the nine months ended September 30, 2001, net
income was $56 million, up $1 million from the same period in 2000. Total
natural gas transportation volumes delivered
PE-1
for the nine months ended September 30, 2001 increased 1 percent from 2000
primarily due to increased supply area transportation volumes for Trunkline and
the addition of Sea Robin in March 2000 (see Note 1, Corporate Structure),
partially offset by decreased transportation volumes for Panhandle Eastern Pipe
Line.
Revenues for the three month and nine month periods ended September 30,
2001 increased $6 million and $35 million, respectively, from the corresponding
periods in 2000 due primarily to increased LNG terminalling revenues resulting
from increased LNG demand due to extremely high gas prices in early 2001.
Operating expenses for the three months ended September 30, 2001 increased
$18 million from the corresponding period in 2000 due primarily to a $7 million
lower of cost or market adjustment to Panhandle's current supply of system gas
and higher corporate charges. Operating expenses for the nine months ended
September 30, 2001 increased $33 million from the corresponding period in 2000
due primarily to $10 million of lower of cost or market adjustments to
Panhandle's current supply of system gas, higher corporate charges and increased
expenses for nine months in 2001 for Sea Robin versus seven months in 2000. For
further information about the Sea Robin acquisition, see Note 1, Corporate
Structure.
PRETAX OPERATING INCOME:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
CHANGE COMPARED TO PRIOR YEAR 2001 VS 2000 2001 VS 2000
- ----------------------------- ------------------ ------------------
IN MILLIONS
Reservation revenue $ -- ($13)
LNG terminalling revenue 5 41
Commodity revenue 2 10
Other revenue (1) (3)
Operation and maintenance (14) (26)
Depreciation and amortization (2) (3)
General taxes (2) (4)
---- -----
Total Change $(12) $ 2
==== =====
OUTLOOK
CMS Energy seeks to build on Panhandle's position as a leading United
States interstate natural gas pipeline system and the nation's largest operating
LNG receiving terminal through expansion and better utilization of its existing
facilities and construction of new facilities. In October 2001 CMS Trunkline LNG
Company announced the expansion of its 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 billion cubic
feet. With FERC approval, the expanded facility is planned to be in operation in
early 2005. In addition, CMS Energy is pursuing financings and monetization of
several of its assets, including the value created by contracts for capacity at
its Lake Charles, Louisiana, LNG receiving facility. For further information,
see Note 7, Trunkline LNG Monetization. By providing additional transportation,
storage and other asset-based, value-added services to customers such as new
gas-fueled
PE-2
power plants, local distribution companies, industrial and end-users, marketers
and others, CMS Energy expects to expand its natural gas pipeline business. CMS
Energy is in the process of converting certain Panhandle pipeline facilities
through a joint venture to permit the throughput of liquid products, such as
gasoline and is participating in a 150-mile natural gas pipeline venture from
Illinois to Wisconsin to meet the needs of those significantly growing markets.
Panhandle continues to attempt to maximize revenues from existing assets and to
advance acquisition opportunities and development projects that provide expanded
services to meet the specific needs of customers. In May 2001, Trunkline LNG
signed an agreement with BG LNG Services that provides for a 22-year contract,
beginning January 2002, for all the uncommitted capacity at Trunkline LNG's
facility. Pursuant to a Trunkline LNG rate settlement approved by FERC in
October 2001 (See Note 2, Regulatory Matters), most of Trunkline LNG's revenues
received beginning January 2002 will be coming from reservation (capacity)
charges and not subject to the volatility of the spot LNG market. This will
result in Trunkline LNG's revenues in 2002 being more certain during a time
period when competition from other terminals is increasing, but at a level
approximately 30% below the revenues expected in 2001. In addition, the LNG
monetization currently being pursued by CMS Energy will result in a reduced
share of Trunkline LNG's income being received by Panhandle, partially offset by
lower interest expense from debt retired with the proceeds from the transaction.
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 cashflows. 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 shorter duration, which may increase
revenue volatility; 3) the impact of potential future rate cases, for any of
Panhandle's regulated operations; 4) current initiatives for additional federal
rules and legislation regarding pipeline safety; 5) capital spending
requirements for safety, environmental or regulatory requirements that could
result in depreciation expense increases not covered by additional revenues; and
6) construction and market risks associated with Panhandle's investment in the
liquids pipeline business through the Centennial Pipeline venture.
OTHER MATTERS
ENVIRONMENTAL MATTERS
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, incorporated
by reference herein.
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. For further information, see Note 4, Commitments and
Contingencies - Environmental Matters, incorporated by reference herein.
In 1997, the Illinois Environmental Protection Agency initiated an
enforcement proceeding relating to alleged air quality permit violations at
Panhandle's Glenarm Compressor Station. Panhandle expects a resolution of this
penalty proceeding during the fourth quarter of 2001. For further information,
see Note 4, Commitments and Contingencies - Air Quality Control, incorporated by
reference herein.
PE-3
NEW ACCOUNTING RULES
In July 2001, FASB issued SFAS No. 141, Business Combinations, and SFAS No.
142, Goodwill and Other Intangible Assets.
SFAS No. 141 requires that all business combinations initiated after June
30, 2001, be accounted for under the purchase method; use of
pooling-of-interests method is no longer permitted. The adoption of SFAS No. 141
effective July 1, 2001 will result in Panhandle accounting for any future
business combinations under the purchase method of accounting, but will not
change the method of accounting used in previous business combinations.
SFAS No. 142 requires that goodwill no longer be amortized to earnings, but
instead be reviewed for impairment on an annual basis. The amortization of
goodwill ceases upon adoption of the standard. The provisions of SFAS No. 142
require adoption as of January 1, 2002 for calendar year entities. 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 upon adoption. At September 30, 2001 goodwill was
approximately $718 million and goodwill amortization was approximately $5
million and $15 million for the three months and nine months ended September 30,
2001, respectively.
In August 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. 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 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 useful life of the related asset. 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 new
standard but has yet to quantify the effects of the new standard.
In October 2001 FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, that supersedes SFAS NO. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. 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, Reporting Results of Operations - Reporting
the Effects of Disposal of a Segment of a Business, 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 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 provisions of SFAS No. 144, but will not change the
accounting principles used in previous asset impairments or disposals.
PE-4
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN MILLIONS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2001 2000 2001 2000
----- ---- ---- ----
OPERATING REVENUE
Transportation and storage of natural gas $ 96 $ 94 $308 $311
LNG terminalling revenue 20 15 69 28
Other 4 5 13 16
---- ---- ---- ----
Total operating revenue 120 114 390 355
---- ---- ---- ----
OPERATING EXPENSES
Operation and maintenance 63 49 168 142
Depreciation and amortization 19 17 52 49
General taxes 8 6 22 18
---- ---- ---- ----
Total operating expenses 90 72 242 209
---- ---- ---- ----
PRETAX OPERATING INCOME 30 42 148 146
OTHER INCOME, NET 4 2 8 5
INTEREST CHARGES
Interest on long-term debt 20 21 63 62
Other interest - - (1) -
---- ---- ---- ----
Total interest charges 20 21 62 62
NET INCOME BEFORE INCOME TAXES 14 23 94 89
INCOME TAXES 6 9 38 34
---- ---- ---- ----
CONSOLIDATED NET INCOME $ 8 $ 14 $ 56 $ 55
==== ==== ==== ====
The accompanying condensed notes are an integral part of these statements.
PE-5
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2001 2000
----- -----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 56 $ 55
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 52 49
Deferred income taxes 52 47
Changes in current assets and liabilities (70) (48)
Other, net (5) (10)
----- -----
Net cash provided by operating activities 85 93
----- -----
CASH FLOWS FROM INVESTING ACTIVITIES
Capital and investment expenditures (50) (110)
Other, net (22) -
----- -----
Net cash used in investing activities (72) (110)
----- -----
CASH FLOWS FROM FINANCING ACTIVITIES
Contribution from parent 150 -
Proceeds from senior notes - 99
Net increase in note receivable - CMS Capital (111) (28)
Dividends paid (50) (54)
----- -----
Net cash provided by/(used by) financing activities (11) 17
----- -----
Net Increase in Cash and Temporary Cash Investments 2 -
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD - -
----- -----
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 2 $ -
===== =====
OTHER CASH FLOW ACTIVITIES WERE:
Interest paid (net of amounts capitalized) $ 80 $ 75
Income taxes paid (net of refunds) 8 6
The accompanying condensed notes are an integral part of these statements.
PE-6
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
(UNAUDITED)
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Cost $1,666 $1,679
Less accumulated depreciation and amortization 134 99
------ ------
Sub-total 1,532 1,580
Construction work-in-progress 35 20
------ ------
Net property, plant and equipment 1,567 1,600
------ ------
INVESTMENTS 65 7
------ ------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 2 --
Accounts receivable, less allowances of $2 as of September 30, 2001 176 140
and $1 as of Dec. 31, 2000
Gas imbalances - receivable 65 71
System gas and operating supplies 24 21
Deferred income taxes 8 12
Note receivable - CMS Capital 273 162
Other 19 21
------ ------
Total current assets 567 427
------ ------
NON-CURRENT ASSETS
Goodwill, net 718 753
Debt issuance cost 10 11
Other 90 8
------ ------
Total non-current assets 818 772
------ ------
TOTAL ASSETS $3,017 $2,806
====== ======
The accompanying condensed notes are an integral part of these statements.
PE-7
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
(UNAUDITED)
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 1,277 1,127
Retained earnings - (6)
------ ------
Total common stockholder's equity 1,278 1,122
Long-term debt 1,192 1,193
------ ------
Total capitalization 2,470 2,315
------ ------
CURRENT LIABILITIES
Accounts payable 19 32
Gas imbalances - payable 123 56
Accrued taxes 10 3
Accrued interest 15 31
Accrued liabilities 25 45
Other 93 104
------ ------
Total current liabilities 285 271
------ ------
NON-CURRENT LIABILITIES
Deferred income taxes 181 134
Other 81 86
------ ------
Total non-current liabilities 262 220
------ ------
TOTAL COMMON STOCKHOLDER'S EQUITY AND LIABILITIES $3,017 $2,806
====== ======
The accompanying condensed notes are an integral part of these statements.
PE-8
PANHANDLE EASTERN PIPE LINE COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
(IN MILLIONS)
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000
----------------- -----------------
COMMON STOCK
At beginning and end of period $ 1 $ 1
------ ------
ADDITIONAL PAID-IN CAPITAL
At beginning of period 1,127 1,127
Contribution from parent 150 -
------ ------
At end of period 1,277 1,127
------ ------
RETAINED EARNINGS
At beginning of period (6) -
Net income 56 55
Common stock dividends (50) (54)
------ ------
At end of period - 1
------ ------
TOTAL COMMON STOCKHOLDER'S EQUITY $1,278 $1,129
====== ======
The accompanying condensed notes are an integral part of these statements.
PE-9
PANHANDLE EASTERN PIPE LINE COMPANY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 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, 2000, 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
Panhandle Eastern Pipe Line is a wholly owned subsidiary of CMS Gas
Transmission. Panhandle Eastern Pipe Line Company 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 March 2000, Trunkline, a subsidiary of Panhandle Eastern Pipe Line,
acquired the Sea Robin pipeline from El Paso Energy Corporation for cash of
approximately $74 million and certain other consideration. Sea Robin is a 1 bcf
per day capacity pipeline system located in the Gulf of Mexico. Year to date
results for 2001 include nine months of Sea Robin activity whereas results for
2000 only include seven months.
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. FERC ordered
these pipelines to refund these amounts to their customers. The pipelines must
make all payments in compliance with prescribed FERC requirements. In June 2001,
Panhandle filed a proposed settlement with the FERC which is supported by most
of the customers and affected producers. That settlement was approved by the
Commission in October 2001. At September 30, 2001 and December 31, 2000,
Panhandle's Accounts Receivable included $63 million and $59 million,
respectively, due from natural gas producers, and Other Current Liabilities
included $63 million and $59 million, respectively, for related obligations. The
settlement provides for a reduction in these balances resulting in an amount due
from natural gas producers of $33 million and an amount due to jurisdictional
customers of $29 million. These adjustments will be recorded in the fourth
quarter.
In March 2001, Trunkline received FERC approval to abandon 720 miles of its
26-inch diameter pipeline that extends from Longville, Louisiana to Bourbon,
Illinois. This filing is in conjunction with a plan for Centennial Pipeline to
convert the line from natural gas transmission service to a refined products
pipeline by January 2002. Panhandle owns a one-third interest in the venture
along with TEPPCO Partners L.P. and Marathon Ashland Petroleum L.L.C. Effective
April 2001, the 26-inch pipeline was conveyed to Centennial and the book value
of the asset, including related goodwill, is now reflected in Investments on the
Consolidated Balance Sheet.
PE-10
In July 2001, Panhandle filed a settlement with customers on Order 637
matters to resolve matters including capacity release and imbalance penalties,
among others. On October 12, 2001 FERC issued an order approving the settlement,
with modifications. This order is pending potential requests for rehearing.
Management believes that this matter will not have a material adverse effect on
consolidated results of operations or financial position.
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 will take effect in
January 2002. This will result in reduced revenues from 2001 levels but
less volatility due to the 22-year contract with BG LNG Services.
3. RELATED PARTY TRANSACTIONS
Other income includes $7 million for the nine months ended September 30,
2001 for interest on Note Receivable from CMS Capital. In June 2001, Panhandle
Eastern Pipe Line received a $150 million capital contribution from CMS Gas
Transmission. Panhandle also loaned CMS Capital $150 million in June 2001.
A summary of certain balances due to or due from related parties included
in the Consolidated Balance Sheets is as follows:
September 30, December 31,
2001 2000
------------- ------------
In Millions
Notes receivable $273 $162
Accounts receivable 73 48
Accounts payable 8 27
4. COMMITMENTS AND CONTINGENCIES
CAPITAL EXPENDITURES: Panhandle currently estimates capital expenditures
and investments, including interest costs capitalized, to be $83 million in
2001, $98 million in 2002 and $70 million in 2003. The amounts for 2002 and 2003
exclude expenditures associated with a potential LNG terminal expansion which is
planned to be filed with FERC in November 2001. The expansion expenditures,
estimated at $25 million in 2002 and $90 million in 2003, are currently expected
to be funded through a joint venture (See Note 7, Trunkline LNG Monetization)
via loans or equity contributions from Panhandle or equity investors or by third
party financings acceptable to the lenders of the joint venture. 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 5, Accounting for Contingencies, 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.
PE-11
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
through 2001. 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 17.32 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 2001 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. Panhandle expects a resolution of this
penalty proceeding during the fourth quarter of 2001. The resolution could
result in a penalty of $100,000 or potentially a significantly greater amount
and, upon the approval of a pending permit application, will require the
installation of certain capital improvements at the Glenarm facility at a cost
of approximately $3 million. It is expected the capital outlay will occur in
2003 or 2004. Under the terms of the Stock Purchase Agreement between CMS Energy
and an affiliate of Duke Energy, penalties relating to this facility remain the
obligation of a Duke Energy affiliate. Management believes that the resolution
of this matter will not have a material adverse effect on consolidated results
of operations, liquidity, or financial position.
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 that 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.
PE-12
Under the terms of a settlement related to a transportation agreement
between Panhandle and Northern Border Pipeline Company, Panhandle guarantees
payment to Northern Border Pipeline Company under a transportation agreement
held by a third party. The transportation agreement requires estimated total
payments of $5 million through October 2001. The Panhandle guarantee expires on
October 31, 2001.
In conjunction with the Centennial Pipeline project, Panhandle has provided
a guaranty related to project financing for a maximum of $50 million during the
construction and initial operating period of the project. The guaranty will be
released when Centennial reaches certain operational and financial targets. For
further information about the Centennial Pipeline project, see Note 2,
Regulatory Matters.
In March 1999, CMS Gas Transmission, Panhandle's parent company, became a
partner with a one-third interest in Guardian Pipeline L.L.C. along with Viking
Gas Transmission and WICOR. Guardian is currently constructing a 150-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. In November 2001,
CMS Gas Transmission will convey its investment in Guardian to Panhandle, and
upon completion of the project, Trunkline will operate and maintain the
pipeline.
5. IMPLEMENTATION OF SFAS NO. 133
Panhandle adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities as amended, effective January 1, 2001. SFAS No. 133 requires
companies to recognize all derivative instruments as assets or liabilities on
the Balance Sheet and to measure those instruments at fair value. As of
September 30, 2001, Panhandle believes its contracts qualify for the normal
purchase and sales exception of SFAS No. 133, and therefore no impact has been
reflected in the financial statements.
6. SYSTEM GAS
Panhandle recorded a lower of cost or market adjustment of approximately $7
million in the third quarter of 2001, reducing its current system gas to market
value. Panhandle classifies its non-current system gas in Other Non-Current
Assets and it is recorded at a cost of $74 million and $1 million at September
30, 2001 and December 31, 2000, respectively.
7. TRUNKLINE LNG MONETIZATION
Panhandle is pursuing a monetization of the value created by contracts for
capacity at the Trunkline LNG terminal. The monetization transaction is planned
to involve an equity investor who will have a 50% voting interest and share
control in Trunkline LNG. The new joint venture (JV) will be deconsolidated from
Panhandle to reflect its loss of majority control of the new entity. The
transaction is expected to result in a book gain, if it is closed by year end,
due to proceeds received by Panhandle from financings of the JV in excess of
Panhandle's current book basis in Trunkline LNG. The transaction is expected to
close in December 2001, and proceeds from the transaction are to be utilized for
Panhandle debt retirement and dividends to CMS Energy for additional debt
retirement at that level.
PE-13
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
September 30, 2001, and the related consolidated statements of income, common
stockholder's equity and cash flows for the three-month and nine-month periods
then ended. 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, 2000, and, in our
report dated March 6, 2001, 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, 2000, is fairly stated, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
Houston, Texas
October 25, 2001
PE-14
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, 2000 and Forms 10-Q for the quarters ended March 31,
2001 and June 30, 2001. Reference is also made to the CONDENSED NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS, in particular Note 4 - Uncertainties for CMS
Energy and 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.
CONSUMERS
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.
CO-1
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
CMS ENERGY CORPORATION
During the 3rd Quarter 2001, 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 2002 Annual Meeting, the shareholder must assure that CMS Energy receives
the proposal on or before March 10, 2002. CMS Energy will not include
shareholder's proposals in the CMS Energy's proxy statement. The shareholder
must address the proposal to: Mr. Thomas A. McNish, 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 10,
2002, 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 2002 Annual Meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) LIST OF EXHIBITS
(4)(a) Fourth Supplemental Indenture dated as of May 31, 2001 between Consumers
Energy Company and The Bank of New York, as Trustee.
(4)(b) Seventy-Ninth Supplemental Indenture dated as of September 26, 2001 between
Consumers Energy Company and The Chase Manhattan Bank, as Trustee.
(4)(c) Amendment No. 1 to Credit Agreement dated June 18, 2001 among CMS
Energy, the Banks, the Administrative Agent and Collateral Agent,
the Co-Syndication Agents, the Documentation Agents and the Advisor,
Arranger and Book Manager, all as defined thereto.
(4)(d) Amendment No. 1 to Credit Agreement dated June 18, 2001 among CMS
Energy, the Banks, the Administrative Agent and Collateral Agent,
the Co-Syndication Agents, the Documentation Agents and the Advisor,
Arranger and Book Manager, all as defined thereto.
(10)(a) Purchase and Sale Agreement by and between CMS Gas
Transmission Company and Marathon Oil Company dated October 31,
2001.
Share Purchase Agreement by and among CMS Methanol Company, CMS
Enterprises Company, Marathon E.G. Methanol Limited, and Marathon
Oil Company dated October 31, 2001.
Stock Purchase Agreement by and among CMS Oil and Gas Company,
CMS Enterprises Company, Marathon E.G. Holding Limited and
Marathon Oil Company dated October 31, 2001.
(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-2
(b) REPORTS ON FORM 8-K
CMS ENERGY
During 3rd Quarter 2001, CMS Energy filed reports of Form 8-K on, July 12,
2001, August 1, 2001, August 31, 2001, October 26, 2001 and November 2, 2001.
The reports covered matters pursuant to ITEM 5. OTHER EVENTS.
CONSUMERS
During 3rd Quarter 2001, Consumers filed reports of Form 8-K on July 12,
2001, August 1, 2001, August 31, 2001 and October 26, 2001. The reports covered
matters pursuant to ITEM 5. OTHER EVENTS.
PANHANDLE
During 3rd Quarter 2001, Panhandle filed reports of Form 8-K filed August
1, 2001 and October 26, 2001. The reports covered matters pursuant to ITEM 5.
OTHER EVENTS.
CO-3
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, each
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. The signature for each undersigned
company shall be deemed to relate only to matters having reference to such
company or its subsidiary.
CMS ENERGY CORPORATION
------------------------------------------
(Registrant)
Dated: November 14, 2001 By: /s/ A.M. Wright
--------------------------------------
Alan M. Wright
Executive Vice President
Chief Financial Officer and
Chief Administrative Officer
CONSUMERS ENERGY COMPANY
------------------------------------------
(Registrant)
Dated: November 14, 2001 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: November 14, 2001 By: /s/ A.M. Wright
---------------------------------------
Alan M. Wright
Senior Vice President,
Chief Financial Officer and Treasurer
CO-4
================================================================================
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 SEPTEMBER 30, 2001
================================================================================
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
(4)(a) - Consumers: Fourth Supplemental Indenture dated as of May 31, 2001
between Consumers Energy Company and The Bank of New
York, as Trustee.
(4)(b) - Consumers: Seventy-Ninth Supplemental Indenture dated as of
September 26, 2001 between Consumers Energy Company and The
Chase Manhattan Bank, as Trustee.
(4)(c) - CMS Energy: Amendment No. 1 to Credit Agreement dated June 18,
2001 among CMS Energy, the Banks, the Administrative
Agent and Collateral Agent, the Co-Syndication Agents,
the Documentation Agents and the Advisor, Arranger and
Book Manager, all as defined thereto.
(4)(d) - CMS Energy: Amendment No. 1 to Credit Agreement dated June 18,
2001 among CMS Energy, the Banks, the Administrative
Agent and Collateral Agent, the Co-Syndication Agents,
the Documentation Agents and the Advisor, Arranger and
Book Manager, all as defined thereto.
(10)(a) - CMS Energy: Purchase and Sale Agreement by and between CMS Gas
Transmission Company and Marathon Oil Company dated October 31,
2001.
CMS Energy: Share Purchase Agreement by and among CMS Methanol
Company, CMS Enterprises Company, Marathon E.G. Methanol
Limited, and Methanol Oil Company dated October 31, 2001.
CMS Energy: Stock Purchase Agreement by and among CMS
Oil and Gas Company, CMS Enterprises Company,
Marathon E.G. Holding Limited and Marathon Oil
Company dated October 31, 2001.
(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