.
.
.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page Reference
in Annual Report
on Form 10-K
------------------
Report of Independent Public Accountants - PricewaterhouseCoopers LLP F-2
Report of Independent Public Accountants - Arthur Andersen, LLP F-3
Consolidated Balance Sheets as of December 31, 2002 and 2001 F-4
Consolidated Statements of Operations for the Years Ended December 31, 2002, 2001, and 2000 F-5
Consolidated Statements of Partners' Equity for the Years Ended December 31, 2002, 2001, and 2000 F-6
Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2001, and 2000 F-7
Notes to Consolidated Financial Statements F-8
F-1
PRICEWATERHOUSECOOPERS LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Partners and the Management Committee of the
Midland Cogeneration Venture Limited Partnership:
In our opinion, the accompanying consolidated balance sheet as of December 31,
2002 and the related consolidated statements of operations, partners' equity and
cash flows present fairly, in all material respects, the financial position of
the Midland Cogeneration Venture Limited Partnership (a Michigan limited
partnership) and subsidiaries (MCV) at December 31, 2002 and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of MCV's Management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion. The financial statements of MCV as of December
31, 2001 and for each of the two years in the period ended December 31, 2001,
were audited by other independent accountants who have ceased operations. Those
independent accountants expressed an unqualified opinion on those financial
statements in their report dated January 18, 2002.
As explained in Note 2 to the financial statements, effective April 1, 2002,
Midland Cogeneration Venture Limited Partnership changed its method of
accounting for derivative and hedging activities in accordance with Derivative
Implementation Group ("DIG") Issue C-16.
PricewaterhouseCoopers LLP
Detroit, Michigan,
January 17, 2003
F-2
THE FOLLOWING REPORT IS A COPY OF A PREVIOUSLY ISSUED REPORT BY ARTHUR
ANDERSEN LLP (ANDERSEN). THIS REPORT HAS NOT BEEN REISSUED BY ANDERSEN, AND
ANDERSEN DID CONSENT TO THE INCLUSION OF THIS REPORT INTO THIS FORM 10-K.
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Partners and the Management Committee of the
Midland Cogeneration Venture Limited Partnership:
We have audited the accompanying consolidated balance sheets of the MIDLAND
COGENERATION VENTURE LIMITED PARTNERSHIP (a Michigan limited partnership) and
subsidiaries (MCV) as of December 31, 2001 and 2000, and the related
consolidated statements of operations, partners' equity and cash flows for each
of the three years in the period ended December 31, 2001. These financial
statements are the responsibility of MCV's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Midland
Cogeneration Venture Limited Partnership and subsidiaries as of December 31,
2001 and 2000, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended December 31, 2001, in
conformity with accounting principles generally accepted in the United States.
As explained in Note 2 to the financial statements, effective January 1, 2001,
Midland Cogeneration Venture Limited Partnership changed its method of
accounting related to derivatives and hedging activities.
Arthur Andersen LLP
Detroit, Michigan
January 18, 2002
F-3
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31,
(In Thousands)
ASSETS 2002 2001
- ------ ------------- -------------
CURRENT ASSETS:
Cash and cash equivalents $ 160,425 $ 140,630
Restricted cash and cash equivalents -- 787
Accounts and notes receivable - related parties 48,448 108,780
Accounts receivable 32,479 20,490
Gas inventory 19,566 19,699
Unamortized property taxes 18,355 16,625
Derivative assets (Note 2) 73,819 --
Broker margin accounts and prepaid expenses 3,323 34,372
------------- -------------
Total current assets 356,415 341,383
------------- -------------
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment 2,449,148 2,439,541
Pipeline 21,432 21,398
------------- -------------
Total property, plant and equipment 2,470,580 2,460,939
Accumulated depreciation (920,614) (851,539)
------------- -------------
Net property, plant and equipment 1,549,966 1,609,400
------------- -------------
OTHER ASSETS:
Restricted investment securities held-to-maturity 138,701 141,467
Derivative assets non-current (Note 2) 31,037
Deferred financing costs, net of accumulated amortization
of $15,930 and $14,463, respectively 9,035 10,502
Prepaid gas costs, materials and supplies 12,919 14,295
------------- -------------
Total other assets 191,692 166,264
------------- -------------
TOTAL ASSETS $ 2,098,073 $ 2,117,047
============= =============
LIABILITIES AND PARTNERS' EQUITY
- --------------------------------
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 58,080 $ 73,596
Interest payable 56,386 60,334
Current portion of long-term debt 93,928 186,173
------------- -------------
Total current liabilities 208,394 320,103
------------- -------------
NON-CURRENT LIABILITIES:
Long-term debt 1,153,221 1,243,060
Other 2,148 2,172
------------- -------------
Total non-current liabilities 1,155,369 1,245,232
------------- -------------
COMMITMENTS AND CONTINGENCIES
TOTAL LIABILITIES 1,363,763 1,565,335
------------- -------------
PARTNERS' EQUITY 734,310 551,712
------------- -------------
TOTAL LIABILITIES AND PARTNERS' EQUITY $ 2,098,073 $ 2,117,047
============= =============
The accompanying notes are an integral part of these statements.
F-4
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31,
(In Thousands)
2002 2001 2000
-------------- ------------- -------------
OPERATING REVENUES:
Capacity $ 404,713 $ 409,633 $ 410,938
Electric 177,569 184,707 177,989
Steam and other 14,537 16,473 15,620
-------------- ------------- -------------
Total operating revenues 596,819 610,813 604,547
-------------- ------------- -------------
OPERATING EXPENSES:
Fuel costs (Note 2) 255,142 288,167 232,127
Depreciation 88,963 92,176 93,916
Operations 16,642 16,082 15,117
Maintenance 12,666 13,739 13,907
Property and single business taxes 27,087 26,410 26,860
Administrative, selling and general 8,195 16,404 9,807
-------------- ------------- -------------
Total operating expenses 408,695 452,978 391,734
-------------- ------------- -------------
OPERATING INCOME 188,124 157,835 212,813
-------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest and other income 5,555 16,725 24,211
Interest expense (119,783) (126,296) (146,903)
-------------- ------------- -------------
Total other income (expense), net (114,228) (109,571) (122,692)
-------------- ------------- -------------
NET INCOME BEFORE CUMULATIVE
EFFECT OF ACCOUNTING CHANGE 73,896 48,264 90,121
Cumulative effect of change in method of
accounting for derivative option contracts
(to April 1, 2002) (Note 2) 58,131 -- --
-------------- ------------- -------------
NET INCOME $ 132,027 $ 48,264 $ 90,121
============== ============= =============
The accompanying notes are an integral part of these statements.
F-5
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF PARTNERS' EQUITY FOR THE YEARS ENDED DECEMBER 31,
(In Thousands)
General Limited
Partners Partners Total
------------- ------------- -------------
BALANCE, DECEMBER 31, 1999 $ 369,638 $ 67,979 $ 437,617
Net income 78,462 11,659 90,121
------------- ------------- -------------
BALANCE, DECEMBER 31, 2000 $ 448,100 $ 79,638 $ 527,738
Comprehensive Income
Net Income 42,020 6,244 48,264
Other Comprehensive Income
Cumulative effect of accounting change 13,688 2,034 15,722
Unrealized loss on hedging activities (42,444) (6,307) (48,751)
Reclassification adjustments recognized
in net income above 7,608 1,131 8,739
------------- ------------- -------------
Total Other Comprehensive Income (21,148) (3,142) (24,290)
Total Comprehensive Income 20,872 3,102 23,974
------------- ------------- -------------
BALANCE, DECEMBER 31, 2001 $ 468,972 $ 82,740 $ 551,712
Comprehensive Income
Net Income 114,947 17,080 132,027
Other Comprehensive Income
Unrealized gain on hedging activities
since beginning of period 33,311 4,950 38,261
Reclassification adjustments recognized
in net income above 10,717 1,593 12,310
------------- ------------- -------------
Total other comprehensive income 44,028 6,543 50,571
Total Comprehensive Income 158,975 23,623 182,598
------------- ------------- -------------
BALANCE, DECEMBER 31, 2002 $ 627,947 $ 106,363 $ 734,310
============= ============= =============
The accompanying notes are an integral part of these statements.
F-6
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,
(In Thousands)
2002 2001 2000
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 132,027 $ 48,264 $ 90,121
Adjustments to reconcile net income to net cash provided by operating
activities
Depreciation and amortization 90,430 93,835 95,295
Cumulative effect of change in accounting principle (58,131) -- --
(Increase) Decrease in accounts receivable 48,343 55,127 (65,629)
(Increase) decrease in gas inventory 133 (5,225) (996)
(Increase) decrease in unamortized property taxes (1,730) (415) 599
(Increase) decrease in broker margin accounts and prepaid expenses 31,049 (26,587) (1,817)
Increase in derivative assets (20,444) -- --
Decrease in prepaid gas costs, materials and supplies 1,376 8,414 760
(Increase) decrease in accounts payable and accrued liabilities 8,774 (43,704) 33,040
Decrease in interest payable (3,948) (7,082) (8,703)
(Decrease) increase in other non-current liabilities (24) 245 381
------------- ------------- -------------
Net cash provided by operating activities 227,855 122,872 143,051
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Plant modifications and purchases of plant and equipment (29,529) (30,530) (33,082)
------------- ------------- -------------
Net cash used in investing activities (29,529) (30,530) (33,082)
-------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of financing obligation (182,084) (155,632) (139,095)
Debt refinancing costs -- -- (6,388)
Maturity of restricted investment securities held-to-maturity 377,192 538,327 282,091
Purchase of restricted investment securities held-to-maturity (374,426) (539,918) (282,164)
-------------- ------------- -------------
Net cash used in financing activities (179,318) (157,223) (145,556)
-------------- ------------- -------------
NET INCREASE (DECREASE) IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH -
CURRENT 19,008 (64,881) (35,587)
CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT, AT BEGINNING
OF PERIOD 141,417 206,298 241,885
-------------- ------------- -------------
CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT, AT END OF PERIOD $ 160,425 $ 141,417 $ 206,298
============== ============= =============
The accompanying notes are an integral part of these statements.
F-7
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) THE PARTNERSHIP AND ASSOCIATED RISKS
MCV was organized to construct, own and operate a combined-cycle,
gas-fired cogeneration facility (the "Facility") located in Midland,
Michigan. MCV was formed on January 27, 1987, and the Facility began
commercial operation in 1990.
In 1992, MCV acquired the outstanding common stock of PVCO Corp., a
previously inactive company. MCV and PVCO Corp. entered into a partnership
agreement to form MCV Gas Acquisition General Partnership ("MCV GAGP") for
the purpose of buying and selling natural gas on the spot market and other
transactions involving natural gas activities. Currently, MCV GAGP is not
actively engaged in any business activity.
The Facility was originally designed to provide approximately 1370
megawatts ("MW") of electricity and approximately 1.5 million pounds of
process steam per hour. Subsequent improvements to the Facility have
increased net electrical generating capacity to approximately 1500 MW. MCV
has entered into three principal energy sales agreements. MCV has
contracted to (i) supply up to 1240 MW of electric capacity ("Contract
Capacity") to Consumers Energy Company ("Consumers") under the Power
Purchase Agreement ("PPA"), for resale to its customers, (ii) supply
electricity and steam to The Dow Chemical Company ("Dow") under the Steam
and Electric Power Agreement ("SEPA") and (iii) supply steam to Dow
Corning Corporation ("DCC") under the Steam Purchase Agreement ("SPA").
From time to time, MCV enters into other sales agreements for the sale of
excess capacity and/or energy available above MCV's internal use and
obligations under the PPA, SEPA and SPA. Results of operations are
primarily dependent on successfully operating the Facility at or near
contractual capacity levels and on Consumers' ability to perform its
obligations under the PPA with MCV. Sales pursuant to the PPA have
historically accounted for over 90% of MCV's revenues.
The PPA permits Consumers, under certain conditions, to reduce the
capacity and energy charges payable to MCV and/or to receive refunds of
capacity and energy charges paid to MCV if the Michigan Public Service
Commission ("MPSC") does not permit Consumers to recover from its
customers the capacity and energy charges specified in the PPA (the
"regulatory-out" provision). Until September 15, 2007, however, the
capacity charge may not be reduced below an average capacity rate of 3.77
cents per kilowatt hour for the available Contract Capacity
notwithstanding the "regulatory-out" provision. Consumers and MCV are
required to support and defend the terms of the PPA.
The Facility is a qualifying cogeneration facility ("QF") originally
certified by the Federal Energy Regulatory Commission ("FERC") under the
Public Utility Regulatory Policies Act of 1978, as amended ("PURPA"). In
order to maintain QF status, certain operating and efficiency standards
must be maintained on a calendar-year basis and certain ownership
limitations must be met. In the case of a topping-cycle generating plant
such as the Facility, the applicable operating standard requires that the
portion of total energy output that is put to some useful purpose other
than facilitating the production of power (the "Thermal Percentage") be at
least 5%. In addition, the Facility must achieve a PURPA efficiency
standard (the sum of the useful power output plus one-half of the useful
thermal energy output, divided by the energy input (the "Efficiency
Percentage")) of at least 45%. If the Facility maintains a Thermal
Percentage of 15% or higher, the required Efficiency Percentage is reduced
to 42.5%. Since 1990, the Facility has achieved the applicable Thermal and
Efficiency Percentages. For the twelve months ended December 31, 2002, the
Facility achieved a Thermal Percentage of 18.6% and a PURPA Efficiency
Percentage of 47.0%. The loss of QF status could, among other things,
cause the Facility to lose its rights under PURPA to sell power to
Consumers at Consumers' "avoided cost" and subject the Facility to
additional federal and state regulatory requirements. MCV believes that
the Facility will meet the required Thermal and the corresponding
Efficiency Percentages in 2003 and beyond, as well as the PURPA ownership
limitations.
The Facility is wholly dependent upon natural gas for its fuel supply and
a substantial portion of the Facility's operating expenses consist of the
costs of natural gas. MCV recognizes that its existing gas contracts are
not sufficient to satisfy the anticipated gas needs over the term of the
PPA and, as such, no assurance can be given as to the availability or
price of natural gas after the expiration of the existing gas contracts.
In addition, to the extent that the costs associated with production of
electricity rise faster than the energy charge payments,
F-8
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
MCV's financial performance will be negatively affected. The amount of
such impact will depend upon the amount of the average energy charge
payable under the PPA, which is based upon costs incurred at Consumers'
coal-fired plants and upon the amount of energy scheduled by Consumers for
delivery under the PPA. However, given the unpredictability of these
factors, the overall economic impact upon MCV of changes in energy charges
payable under the PPA and in future fuel costs under new or existing
contracts cannot accurately be predicted.
At both the state and federal level, efforts continue to restructure the
electric industry. A significant issue to MCV is the potential for future
regulatory denial of recovery by Consumers from its customers of above
market PPA costs Consumers pays MCV. At the state level, the MPSC entered
a series of orders from June 1997 through February 1998 (collectively the
"Restructuring Orders"), mandating that utilities "wheel" third-party
power to the utilities' customers, thus permitting customers to choose
their power provider. MCV, as well as others, filed an appeal in the
Michigan Court of Appeals to protect against denial of recovery by
Consumers of PPA charges. The Michigan Court of Appeals found that the
Restructuring Orders do not unequivocally disallow such recovery by
Consumers and, therefore, MCV's issues were not ripe for appellate review
and no actual controversy regarding recovery of costs could occur until
2008, at the earliest. In June 2000, the State of Michigan enacted
legislation which, among other things, states that the Restructuring
Orders (being voluntarily implemented by Consumers) are in compliance with
the legislation and enforceable by the MPSC. The legislation provides that
the rights of parties to existing contracts between utilities (like
Consumers) and QFs (like MCV), including the rights to have the PPA
charges recovered from customers of the utilities, are not abrogated or
diminished, and permitted utilities to securitize certain stranded costs
including PPA charges.
In 1999, the U.S. District Court granted summary judgment to MCV declaring
that the Restructuring Orders are preempted by federal law to the extent
they prohibit Consumers from recovering from its customers any charge for
avoided costs (or "stranded costs") to be paid to MCV under PURPA pursuant
to the PPA. In 2001, the United States Court of Appeals ("Appellate
Court") vacated the U.S. District Court's 1999 summary judgment and
ordered the case dismissed based upon a finding that no actual case or
controversy existed for adjudication between the parties. The Appellate
Court determined that the parties' dispute is hypothetical at this time
and the QFs' (including MCV) claims are premised on speculation about how
an order might be interpreted by a future MPSC.
MCV continues to monitor and participate in these industry restructuring
matters as appropriate, and to evaluate potential impacts on both cash
flows and recoverability of the carrying value of property, plant and
equipment. MCV Management cannot, at this time, predict the impact or
outcome of these matters.
(2) SIGNIFICANT ACCOUNTING POLICIES
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. Following is a discussion of MCV's significant accounting
policies.
Principles of Consolidation
The consolidated financial statements include the accounts of MCV and its
wholly owned subsidiaries. All material transactions and balances among
entities, which comprise MCV, have been eliminated in the consolidated
financial statements.
Revenue Recognition
MCV recognizes revenue for the sale of variable energy and fixed energy
when delivered. Capacity and other installment revenues are recognized
based on plant availability or other contractual arrangements.
F-9
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Fuel Costs
MCV's fuel costs are those costs associated with securing natural gas,
transportation and storage services necessary to generate electricity and
steam from the Facility. These costs are recognized in the income
statement based upon actual volumes burned to produce the delivered
energy. In addition, MCV engages in certain cost mitigation activities to
offset the fixed charges MCV incurs for these activities. The gains or
losses resulting from these activities have resulted in net gains of
approximately $3.9 million, $5.5 million and $6.1 million for the years
ended 2002, 2001 and 2000, respectively. These net gains are reflected as
a component of fuel costs.
Beginning in July 2000, in response to the rapidly escalating cost of
natural gas, MCV and Consumers agreed to reduce the dispatch level of the
Facility, from time to time. In the event of reduced dispatch, MCV agreed
to share the savings realized by not having to generate the electricity.
For the twelve months ended December 31, 2002 and December 31, 2001, MCV
estimates that these electric dispatch reduction transactions resulted in
net savings of approximately $2.5 million and $7.6 million, respectively,
a portion of which will be realized in reduced maintenance expenditures in
future years. MCV anticipates entering into similar transactions in the
future to mitigate the impact of high market gas prices, if circumstances
warrant such use.
Inventory
MCV's inventory of natural gas is stated at the lower of cost or market,
and valued using the last-in, first-out ("LIFO") method. Inventory
includes the costs of purchased gas, variable transportation and storage.
The amount of reserve to reduce inventories from first-in, first-out
("FIFO") basis to the LIFO basis at December 31, 2002 and 2001, was $7.4
million and $6.8 million, respectively. Inventory cost, determined on a
FIFO basis, approximates current replacement cost.
Materials and Supplies
Materials and supplies are stated at the lower of cost or market using the
weighted average cost method.
Depreciation
Plant, equipment and pipeline are valued at cost for new construction and
at the asset transfer price for purchased and contributed assets, and are
depreciated using the straight-line method over an estimated useful life
of 3 to 35 years. Major renewals and replacements, which extend the useful
life of plant and equipment are capitalized, while maintenance and repairs
are expensed when incurred. Major equipment overhauls are capitalized and
amortized to the next equipment overhaul. Personal property is depreciated
using the straight-line method over an estimated useful life of 3 to 15
years. The cost to remove an asset is assumed to equal the proceeds of any
asset disposition. The cost of assets and related accumulated depreciation
are removed from the accounts when sold or retired, and any resulting gain
or loss reflected in operating income.
Federal Income Tax
MCV is not subject to Federal or State income taxes. Partnership earnings
are taxed directly to each individual partner.
Statement of Cash Flows
All liquid investments purchased with a maturity of three months or less
at time of purchase are considered to be current cash equivalents.
F-10
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents and short-term
investments approximate fair value because of the short maturity of these
instruments. MCV's short-term investments, which are made up of investment
securities held-to-maturity, as of December 31, 2002 and December 31, 2001
have original maturity dates of approximately one year or less. The unique
nature of the negotiated financing obligation discussed in Note 5 makes it
unnecessary to estimate the fair value of the Owner Participants'
underlying debt and equity instruments supporting such financing
obligation, since SFAS No. 107 "Disclosures about Fair Value of Financial
Instruments" does not require fair value accounting for the lease
obligation.
Accounting for Derivative Instruments and Hedging Activities
Effective January 1, 2001, MCV adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and
Hedging Activities" which was issued in June 1998 and then amended by SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of SFAS No. 133" and SFAS No. 138
"Accounting for Certain Derivative Instruments and Certain Hedging
Activities - An amendment of FASB Statement No. 133" (collectively
referred to as "SFAS No. 133"). SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded
on the balance sheet as either an asset or liability measured at its fair
value. SFAS No. 133 requires that changes in a derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria
are met. Special accounting for qualifying hedges in some cases allows a
derivative's gains and losses to offset related results on the hedged item
in the income statement or permits recognition of the hedge results in
other comprehensive income, and requires that a company formally document,
designate and assess the effectiveness of transactions that receive hedge
accounting.
Electric Sales Agreements
MCV believes that its electric sales agreements currently do not
qualify as derivatives under SFAS No. 133, due to the lack of an active
energy market in the State of Michigan, as defined by SFAS No. 133, and
the transportation cost to deliver the power under the contracts to the
closest active energy market at the Cinergy hub in Ohio and as such
does not record the fair value of these contracts on its balance sheet.
If a market develops in the future, MCV may be required to account for
these contracts as derivatives.
Forward Foreign Exchange Contracts
An amended service agreement was entered into between MCV and Alstom
Power Company ("Alstom") (the "Amended Service Agreement"), under which
Alstom will provide hot gas path parts for MCV's twelve gas turbines
through the ninth series of major gas turbine generator ("GTG")
inspections, which are expected to be completed by year-end 2008. The
payments due to Alstom under the Amended Service Agreement are adjusted
annually based on the U.S. dollar to Swiss franc currency exchange
rate.
To manage this currency exchange rate risk and hedge against adverse
currency fluctuations impacting the payments under the Amended Service
Agreement, MCV maintains a foreign currency hedging program. Under this
program, MCV periodically enters into forward purchase contracts for
Swiss francs. Under SFAS No. 133, the forward foreign currency exchange
contracts qualify as fair value hedges, since they hedge the
identifiable foreign currency commitment of the Amended Service
Agreement. The gains and losses on these forward contracts, as well as
the change in value of the firm commitment, are to be recognized
currently in earnings. Since the currency, notional amounts and
maturity dates on the hedged transactions and forward contracts
essentially match, the January 1, 2001 adoption of SFAS No. 133
resulted in an immaterial cumulative effect accounting change and is
expected to have an immaterial earnings impact on an ongoing basis. The
final gains and losses on these transactions, accounted for as hedges,
will be included in the measurement of the underlying capitalized major
renewal costs when incurred. As of December 31, 2002 and December 31,
2001, MCV had forward purchase contracts involving Swiss Francs in the
notional amount of $5.0 million and $10.0 million, respectively, these
hedges are considered highly effective, therefore, there is no material
gain or loss recognized during the periods ended December 31, 2002 and
December 31, 2001.
F-11
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Natural Gas Supply Contracts
MCV Management believes that its long-term natural gas contracts, which
do not contain volume optionality, qualify under SFAS No. 133 for the
normal purchases and normal sales exception. Therefore, these contracts
are currently not recognized at fair value on the balance sheet.
The FASB issued DIG Issue C-16, which became effective April 1, 2002,
regarding natural gas commodity contracts that combine an option
component and a forward component. This guidance requires either that
the entire contract be accounted for as a derivative or the components
of the contract be separated into two discrete contracts. Under the
first alternative, the entire contract considered together would not
qualify for the normal purchases and sales exception under the revised
guidance. Under the second alternative, the newly established forward
contract could qualify for the normal purchases and sales exception,
while the option contract would be treated as a derivative under SFAS
No. 133 with changes in fair value recorded through earnings. At April
1, 2002, MCV had nine long-term gas contracts that contained both an
option and forward component. As such, they were no longer accounted
for under the normal purchases and sales exception and MCV began
mark-to-market accounting of these nine contracts through earnings.
Based on the natural gas prices, at the beginning of April 2002, MCV
recorded a $58.1 million gain for the cumulative effect of this
accounting change. As of December 31, 2002, MCV recorded in "Fuel
costs" an additional $21.9 million net mark-to-market gain in earnings,
associated with these contracts and "Derivative assets" in Current
Assets and Other Assets in the amounts of $48.9 million and $31.0
million, respectively, representing the mark-to-market gain on these
long term contracts. During the fourth quarter, MCV removed the option
component from three of the nine long term gas contracts discussed
above, which should reduce the earnings volatility. MCV expects future
earnings volatility on the six remaining long term contracts that
contain volume optionality, since changes to this mark-to-market gain
will be recorded on a quarterly basis during the remaining life of
approximately five years for these gas contracts.
Natural Gas Supply Futures and Options
To manage market risks associated with the volatility of natural gas
prices, MCV maintains a gas hedging program. MCV enters into natural
gas futures and option contracts in order to hedge against unfavorable
changes in the market price of natural gas in future months when gas is
expected to be needed. These financial instruments are being utilized
principally to secure anticipated natural gas requirements necessary
for projected electric and steam sales, and to lock in sales prices of
natural gas previously obtained in order to optimize MCV's existing gas
supply, storage and transportation arrangements.
These financial instruments are derivatives under SFAS No. 133 and the
contracts that are utilized to secure the anticipated natural gas
requirements necessary for projected electric and steam sales qualify
as cash flow hedges under SFAS No. 133, since they hedge the price risk
associated with the cost of natural gas. MCV also engages in cost
mitigation activities to offset the fixed charges MCV incurs in
operating the Facility. These cost mitigation activities include the
use of futures and options contracts to purchase and/or sell natural
gas to maximize the use of the transportation and storage contracts
when it is determined that they will not be needed for Facility
operation. Although these cost mitigation activities do serve to offset
the fixed monthly charges, these cost mitigation activities are not
considered a normal course of business for MCV and do not qualify as
hedges under SFAS No. 133. Therefore, the resulting mark-to-market
gains and losses from cost mitigation activities are flowed through
MCV's earnings.
Cash is deposited with the broker in a margin account at the time
futures or options contracts are initiated. The change in market value
of these contracts requires adjustment of the margin account balances.
The margin balance, recorded as a current asset in "Broker margin
accounts and prepaid expenses," was $.8 million and $32.0 million as of
December 31, 2002 and December 31, 2001, respectively.
Upon the January 1, 2001 adoption of SFAS No. 133, under the
transaction rules, the cumulative effect accounting gain related to the
fair value of the derivative instruments held for cost mitigation
activities and derivatives that do not qualify for hedge accounting,
were reflected in other comprehensive income based on previous hedging
relationships. These futures and options totaled 1.9 billion cubic feet
("Bcf") with a total fair value loss of $2.2 million. Fair value
changes in these contracts were recognized currently in income and the
amount reflected in other comprehensive income was reclassified to
income when the
F-12
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
original underlying transactions occurred during the first quarter of
2001. The adoption of SFAS No. 133 resulted in a total cumulative
effect accounting gain, including cost mitigation activities of $15.7
million, which was recognized in other comprehensive income.
For the twelve month period ended December 31, 2002, MCV has recognized
in other comprehensive income, an unrealized $50.6 million increase on
the futures contracts, which are hedges of forecasted purchases for
plant use of market priced gas. This resulted in a net $26.3 million
gain balance in other comprehensive income as of December 31, 2002.
This balance represents natural gas futures and options with maturities
ranging from January 2003 to December 2005, of which $20.3 million of
this gain is expected to be reclassified into earnings within the next
twelve months. MCV also has recorded, as of December 31, 2002, a $24.9
million derivative asset in "Derivative assets," representing the
mark-to-market gain on natural gas futures for anticipated projected
electric and steam sales accounted for as hedges. In addition, for the
twelve months ended December 31, 2002, MCV has recorded a net $12.2
million loss in earnings from hedging activities related to MCV natural
gas requirements for Facility operations and a net $.4 million gain in
earnings from cost mitigation activities. For the twelve months ended
December 31, 2001, MCV recognized an unrealized $40.0 million decrease
in other comprehensive income on the futures contracts, which are
hedges of forecasted purchases for plant use of market priced gas,
resulting in a $24.3 million loss in other comprehensive income as of
December 31, 2001. As of December 31, 2001, the outstanding derivative
liability in "Accounts payable and accrued liabilities" was $22.6
million. For the twelve months ended December 31, 2001, MCV had
recorded a net $6.6 million loss in earnings from hedging activities
related to MCV natural gas requirements for Facility operations, which
includes a $.4 million gain which was reclassified into earnings as a
result of the discontinuance of several cash flow hedges since it was
probable that the original forecasted transaction would not occur. In
addition, for the twelve months ended December 31, 2001, MCV has
recorded a net $1.0 million loss in earnings from cost mitigation
activities.
In addition, MCV had two long-term natural gas supply contracts with
affiliates of the Enron Corporation ("Enron"), which had filed
voluntary bankruptcy petitions for reorganization under Chapter 11 of
the U.S. Bankruptcy Code in December 2001. Both of these contracts had
been accounted for under SFAS No. 133 as normal purchases exempt from
mark to market accounting under the normal purchases and normal sales
exception. In December 2001, due to the uncertain nature of the future
viability of these contracts, MCV expensed $8.2 million of unamortized
prepaid gas costs associated with one of the Enron contracts, which was
subsequently terminated during the bankruptcy proceedings.
Interest Rate Swaps
To manage the effects of interest rate volatility on interest income
while maximizing return on permitted investments, MCV established an
interest rate hedging program. The notional amounts of the hedges are
tied directly to MCV's anticipated cash investments, without physically
exchanging the underlying notional amounts. Cash is deposited with the
broker in a margin account at the time the interest rate swap
transactions are initiated. The change in market value of these
contracts may require further adjustment of the margin account balance.
The margin balance recorded as a current asset in "Broker margin
accounts and prepaid expenses," was approximately $25,000 and $30,000
for the periods ending December 31, 2002 and December 31, 2001,
respectively.
As of December 31, 2002 and December 31, 2001, MCV did not have any
interest rate swap transactions outstanding which qualified for cash
flow hedge accounting. The January 1, 2001 adoption of SFAS No. 133
resulted in an immaterial cumulative effect accounting change gain
recognized in other comprehensive income, and for the twelve months
ended December 31, 2001, MCV recorded a gain of approximately $.1
million in earnings for the cash flow hedging activity.
MCV has one interest rate swap, with a notional amount of $20 million
with a period of performance that extended to December 1, 2002, which
did not qualify as a hedge under SFAS No. 133. The gains and losses on
this swap are recorded currently in earnings. For the twelve months
ended December 31, 2002 and 2001, MCV recorded a $.1 million loss and a
$1.1 million gain in earnings, respectively.
F-13
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
New Accounting Rules
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations", which provides accounting requirements for
retirement obligations associated with tangible long-lived assets. SFAS
No. 143 requires entities to record the fair value of a liability for an
asset retirement obligation in the period in which it is incurred. This is
done by capitalizing the estimated asset retirement cost which will then
be depreciated over the life of the asset. This standard is effective for
fiscal years beginning after June 15, 2002. MCV has reviewed its current
commitments and key contracts to operate the MCV Facility. Based on this
review, MCV finds no material asset retirement obligations that need to be
accrued upon the adoption of this standard.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which supercedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of" and APB 30, "Reporting Results of
Operations - Reporting the Effects of Disposal of a Segment of a
Business." SFAS No. 144, amends accounting and reporting standards for the
disposal of segments of a business and addresses various issues related to
the accounting for impairments or disposals of long-lived assets. The
standard is effective beginning January 1, 2002. At this time, MCV does
not anticipate this standard will have a significant impact on MCV's
financial position.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the
existing disclosure requirements for most guarantees, including loan
guarantees and standby letters of credit. It also clarifies that at the
time a company issues a guarantee, the company must recognize an initial
liability for the fair value, or market value of the obligations it
assumes under the guarantee and must disclose that information in its
interim and annual financial statements. The provisions of FIN 45 related
to recognizing a liability at inception of the guarantee do not apply to
product warranties or guarantees accounted for as derivatives. The initial
recognition and initial measurement provisions of FIN 45 apply on a
prospective basis to guarantees issued or modified after December 31,
2002. The disclosure provisions are effective for financial statements for
periods ending after December 15, 2002. As new contracts are entered into,
MCV will review and determine whether any such guarantees exist that are
required to be recorded in the consolidated financial statements. MCV's
guarantees are disclosed herein.
On January 17, 2003, the FASB issued Interpretation No. 46 "Consolidation
of Variable Interest Entities, an Interpretation of ARB No. 51" ("FIN
46"). The primary objective of FIN 46 is to provide guidance on the
identification of, and financial reporting for, entities over which
control is achieved through means other than voting rights; such entities
are known as variable-interest entities (VIEs). Although the FASB's
initial focus was on special-purpose entities ("SPEs"), the final guidance
applies to a wide range of entities. FIN 46 has far-reaching effects and
applies to new entities that are created after the effective date, as well
as applies to existing entities. Once it goes into effect, FIN 46 will be
the guidance that determines (1) whether consolidation is required under
the "controlling financial interest" model of Accounting Research Bulletin
No. 51, Consolidated Financial Statements, or (b) other existing
authoritative guidance, or, alternatively (2) whether the
variable-interest model under FIN 46 should be used to account for
existing and new entities. MCV believes that FIN 46 will not have a
material impact on its financial statements.
F-14
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(3) RESTRICTED CASH AND CASH EQUIVALENTS AND INVESTMENT SECURITIES
HELD-TO-MATURITY
Current and non-current restricted cash and cash equivalents consist of
the following at December 31 (in thousands):
Current: 2002 2001
------- -------------- --------------
Funds restricted for plant modifications $ -- $ 787
============== ==============
Non-current:
-----------
Funds restricted for rental payments pursuant to
the Overall Lease Transaction $ 136,554 $ 139,301
Funds restricted for management non-qualified
plans 2,147 2,166
-------------- --------------
Total $ 138,701 $ 141,467
============== ==============
(4) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following at
December 31 (in thousands):
2002 2001
-------------- --------------
Accounts payable
Related parties $ 12,224 $ 10,918
Trade creditors 27,935 24,678
Property and single business taxes 14,842 12,946
Other 3,079 25,054
-------------- --------------
Total $ 58,080 $ 73,596
============== ==============
(5) LONG-TERM DEBT
Long-term debt consists of the following at December 31 (in thousands):
2002 2001
-------------- --------------
Financing obligation, maturing through 2015,
payable in semi-annual installments of
principal and interest, collateralized by
property, plant and equipment $ 1,247,149 $ 1,429,233
Less current portion (93,928) (186,173)
-------------- --------------
Total long-term debt $ 1,153,221 $ 1,243,060
============== ==============
Financing Obligation
In June 1990, MCV obtained permanent financing for the Facility by
entering into sale and leaseback agreements ("Overall Lease Transaction")
with a lessor group, related to substantially all of MCV's fixed assets.
Proceeds of the financing were used to retire borrowings outstanding under
existing loan
F-15
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
commitments, make a capital distribution to the Partners and retire a
portion of notes issued by MCV to MEC Development Corporation ("MDC") in
connection with the transfer of certain assets by MDC to MCV. In
accordance with SFAS No. 98, "Accounting For Leases," the sale and
leaseback transaction has been accounted for as a financing arrangement.
The financing obligation utilizes the effective interest rate method,
which is based on the minimum lease payments required through the end of
the basic lease term of 2015 and management's estimate of additional
anticipated obligations after the end of the basic lease term. The
effective interest rate during the remainder of the basic lease term is
approximately 9.4%.
Under the terms of the Overall Lease Transaction, MCV sold undivided
interests in all of the fixed assets of the Facility for approximately
$2.3 billion, to five separate owner trusts ("Owner Trusts") established
for the benefit of certain institutional investors ("Owner Participants").
U.S. Bank National Association (formerly known as State Street Bank and
Trust Company) serves as owner trustee ("Owner Trustee") under each of the
Owner Trusts, and leases undivided interests in the Facility on behalf of
the Owner Trusts to MCV for an initial term of 25 years. CMS Midland
Holdings Company ("CMS Holdings"), currently a wholly owned subsidiary of
Consumers, acquired a 35% indirect equity interest in the Facility through
its purchase of an interest in one of the Owner Trusts.
The Overall Lease Transaction requires MCV to achieve certain rent
coverage ratios and other financial tests prior to a distribution to the
Partners. Generally, these financial tests become more restrictive with
the passage of time. Further, MCV is restricted to making permitted
investments and incurring permitted indebtedness as specified in the
Overall Lease Transaction. The Overall Lease Transaction also requires
filing of certain periodic operating and financial reports, notification
to the lessors of events constituting a material adverse change,
significant litigation or governmental investigation, and change in status
as a qualifying facility under FERC proceedings or court decisions, among
others. Notification and approval is required for plant modification, new
business activities, and other significant changes, as defined. In
addition, MCV has agreed to indemnify various parties to the sale and
leaseback transaction against any expenses or environmental claims
asserted, or certain federal and state taxes imposed on the Facility, as
defined in the Overall Lease Transaction.
On June 15, 2000, MCV closed on the sale of $200 million of tax-exempt
bonds, the proceeds of which were used on July 24, 2000 to refund a like
amount of previously issued tax-exempt bonds. This refinancing activity
has reduced the amount of interest expense over the remaining life of the
tax-exempt bonds.
Under the terms of the Overall Lease Transaction, approximately $18.6
million of transaction costs were a liability of MCV and have been
recorded as a deferred cost. Financing costs incurred with the issuance of
debt are deferred and amortized using the interest method over the
remaining portion of the 25-year lease term. In 2000, MCV also incurred
approximately $6.4 million of debt refinancing fees associated with the
refinancing of the tax-exempt bonds. Deferred financing costs of
approximately $1.5 million, $1.7 million and $1.4 million were amortized
in the years 2002, 2001 and 2000, respectively.
Interest and fees incurred related to long-term debt arrangements during
2002, 2001 and 2000 were $118.3 million, $124.6 million and $142.5
million, respectively. In addition, as of December 31, 2000, MCV has
expensed approximately $3.0 million of costs associated with MCV's
refinancing of its tax-exempt bonds.
Interest and fees paid during 2002, 2001 and 2000 were $122.1 million,
$131.7 million and $151.3 million, respectively.
F-16
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Minimum payments due under these long-term debt arrangements over the next
five years are (in thousands):
Principal Interest Total
------------- ------------- ------------
2003 $ 93,928 $ 114,963 $ 208,891
2004 134,576 108,233 242,809
2005 76,547 97,836 174,383
2006 63,459 92,515 155,974
2007 62,916 87,988 150,904
------------- ------------- ------------
$ 431,426 $ 501,535 $ 932,961
============= ============= ============
Revolving Credit Agreement
MCV has also entered into a revolving credit agreement with the Bank of
Montreal ("Working Capital Lender"), which expires August 29, 2003. Under
the terms of the existing agreement, MCV can borrow up to the $50 million
commitment, in the form of short-term borrowings or letters of credit
collateralized by MCV's natural gas inventory and earned receivables. At
any given time, borrowings and letters of credit are limited by the amount
of the borrowing base, defined as 90% of earned accounts receivable and
50% of natural gas inventory. During 2002, MCV did not utilize the Working
Capital Facility, except for letters of credit associated with normal
business practice. At December 31, 2002, MCV had no outstanding borrowings
or letters of credit.
Intercreditor Agreement
MCV has also entered into an Intercreditor Agreement with the Owner
Trustee, Working Capital Lender, U.S. Bank National Association as
Collateral Agent ("Collateral Agent") and the Senior and Subordinated
Indenture Trustees. Under the terms of this agreement, MCV is required to
deposit all revenues derived from the operation of the Facility with the
Collateral Agent for purposes of paying operating expenses and rent. In
addition, these funds are required to pay construction modification costs
and to secure future rent payments. As of December 31, 2002, MCV has
deposited $136.6 million into the reserve account. The reserve account is
to be maintained at not less than $40 million nor more than $137 million
(or debt portion of next succeeding basic rent payment, whichever is
greater). Excess funds in the reserve account are periodically transferred
to MCV. This agreement also contains provisions governing the distribution
of revenues and rents due under the Overall Lease Transaction, and
establishes the priority of payment among the Owner Trusts, creditors of
the Owner Trusts, creditors of MCV and the Partnership.
(6) COMMITMENTS AND OTHER AGREEMENTS
MCV has entered into numerous commitments and other agreements related to
the Facility. Principal agreements are summarized as follows:
Power Purchase Agreement
MCV and Consumers have executed the PPA for the sale to Consumers of a
minimum amount of electricity, subject to the capacity requirements of Dow
and any other permissible electricity purchasers. Consumers has the right
to terminate and/or withhold payment under the PPA if the Facility fails
to achieve certain operating levels or if MCV fails to provide adequate
fuel assurances. In the event of early termination of the PPA, MCV would
have a maximum liability of approximately $270 million if the PPA were
terminated in the 12th through 24th years. The term of this agreement is
35 years from the commercial operation date and year-to-year thereafter.
F-17
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Steam and Electric Power Agreement
MCV and Dow executed the SEPA for the sale to Dow of certain minimum
amounts of steam and electricity for Dow's facilities.
If the SEPA is terminated, and Consumers does not fulfill MCV's
commitments as provided in the Backup Steam and Electric Power Agreement,
MCV will be required to pay Dow a termination fee, calculated at that
time, ranging from a minimum of $60 million to a maximum of $85 million.
This agreement provides for the sale to Dow of steam and electricity
produced by the Facility for terms of 25 years and 15 years, respectively,
commencing on the commercial operation date and year-to-year thereafter.
Steam Purchase Agreement
MCV and DCC executed the SPA for the sale to DCC of certain minimum
amounts of steam for use at the DCC Midland site. Steam sales under the
SPA commenced in July 1996. Termination of this agreement, prior to
expiration, requires the terminating party to pay to the other party a
percentage of future revenues, which would have been realized had the
initial term of 15 years been fulfilled. The percentage of future revenues
payable is 50% if termination occurs prior to the fifth anniversary of the
commercial operation date and 33-1/3% if termination occurs after the
fifth anniversary of this agreement. The term of this agreement is 15
years from the commercial operation date of steam deliveries under the
contract and year-to-year thereafter.
Gas Supply Agreements
MCV has entered into gas purchase agreements with various producers for
the supply of natural gas. The current contracted volume totals 209,089
MMBtu per day annual average for 2003. As of January 1, 2003, gas
contracts with U.S. suppliers provide for the purchase of 128,363 MMBtu
per day while gas contracts with Canadian suppliers provide for the
purchase of 80,726 MMBtu per day. Some of these contracts require MCV to
pay for a minimum amount of natural gas per year, whether or not taken.
The estimated minimum commitments under these contracts based on current
long term prices for gas for the years 2003 through 2007 are $207.8
million, $245.7 million, $304.6 million, $312.1 million and $304.9
million, respectively. A portion of these payments may be utilized in
future years to offset the cost of quantities of natural gas taken above
the minimum amounts.
Gas Transportation Agreements
MCV has entered into firm natural gas transportation agreements with
various pipeline companies. These agreements require MCV to pay certain
reservation charges in order to reserve the transportation capacity. MCV
incurred reservation charges in 2002, 2001 and 2000, of $35.1 million,
$36.2 million and $35.6 million, respectively. The estimated minimum
reservation charges required under these agreements for each of the years
2003 through 2007 are $35.1 million, $35.1 million, $33.9 million, $30.1
million and $21.7 million, respectively. These projections are based on
current commitments.
Gas Turbine Service Agreement
MCV entered into a service agreement, as amended, with Alstom, which
commenced on January 1, 1990 and will expire upon the earlier of the
completion of the sixth series of major GTG inspections or December 31,
2009. Under the terms of this agreement, Alstom sold MCV an initial
inventory of spare parts for the GTGs and provides qualified service
personnel and supporting staff to assist MCV, to perform scheduled
inspections on the GTGs, and to repair the GTGs at MCV's request. Upon
termination of the Service Agreement (except for nonperformance by
Alstom), MCV must pay a cancellation payment. MCV and Alstom amended the
Service Agreement, effective December 31, 1993, to include the supply of
hot gas path parts. Under the amended Service Agreement, Alstom provides
hot gas path parts for MCV's twelve gas
F-18
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
turbines through the fourth series of major GTG inspections, which were
completed in 2002. In January 1998, MCV and Alstom amended the length of
the amended Service Agreement to extend through the sixth series of major
GTG inspections, which are expected to be completed by year end 2008, for
a lump sum fixed price covering the entire term of the amended Service
Agreement of $266.5 million (in 1993 dollars, which is adjusted based on
exchange rates and Swiss inflation indices), payable on the basis of
operating hours as they occur over the same period. MCV has made payments
totaling approximately $161.5 million under this amended Service Agreement
through December 31, 2001.
MCV has signed a new maintenance service and parts agreement with General
Electric International, Inc. ("GEII"), effective December 31, 2002 ("GEII
Agreement"). GEII will provide maintenance services and hot gas path parts
for MCV's twelve GTG's. The GEII Agreement, under terms and conditions
similar to the MCV/Alstom Service Agreement, as described above, will
cover four rounds of major GTG inspections, which are expected to be
completed by the year 2015, at a savings to MCV as compared to the Service
Agreement with Alstom. The GEII Agreement is expected to replace the
current Alstom Service Agreement, during the first half of 2004, but in no
event later than January 1, 2005. The GEII Agreement can be terminated by
either party for cause or convenience. Should termination for convenience
occur, a buy out amount will be paid by the terminating party with
payments ranging from approximately $19.0 million to $.9 million, based
upon the number of operating hours utilized since commencement of the GEII
Agreement.
Steam Turbine Service Agreement
MCV entered into a nine year Steam Turbine Maintenance Agreement with
General Electric Company effective January 1, 1995, which is designed to
improve unit reliability, increase availability and minimize unanticipated
maintenance costs. In addition, this contract includes performance
incentives and penalties, which are based on the length of each scheduled
outage and the number of forced outages during a calendar year. MCV is
making monthly payments over the life of the contract, which will total
$13.0 million (in 1995 dollars) over the nine year term.
Site Lease
In December 1987, MCV leased the land on which the Facility is located
from Consumers ("Site Lease"). MCV and Consumers amended and restated the
Site Lease to reflect the creation of five separate undivided interests in
the Site Lease as of June 1, 1990. Pursuant to the Overall Lease
Transaction, MCV assigned these undivided interests in the Site Lease to
the Owner Trustees, which in turn subleased the undivided interests back
to MCV under five separate site subleases.
The Site Lease is for a term which commenced on December 29, 1987, and
ends on December 31, 2035, including two renewal options of five years
each. The rental under the Site Lease is $.6 million per annum, including
the two five-year renewal terms.
Gas Turbine Generator Compressor Blade Agreement
MCV has entered into an agreement with MTS Machinery Tools & Services AG
("MTS"), effective January 18, 2002. Under this agreement MTS will
redesign, manufacture and install new design compressor blades in MCV's
twelve GTG's, which is expected to increase the overall electrical
capacity and efficiency of each GTG. MCV has agreed to purchase one set of
such blades and has the option to purchase an additional eleven sets which
would be installed during the fifth series of major GTG inspections, which
are expected to be completed by the third quarter of 2006. The cost of
this project to upgrade all twelve GTG's, including the purchase of spare
parts, is approximately $32.7 million (in 2001 dollars), payable based
upon performance milestones. The first set of compressor blades is
expected to be installed by the second quarter of 2003 for approximately
$4.2 million.
F-19
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(7) RETIREMENT BENEFITS
Postretirement Health Care Plans
In 1992, MCV established defined cost postretirement health care plans
that cover all full-time employees, excluding key management. The plans
provide health care credits, which can be utilized to purchase medical
plan coverage and pay qualified health care expenses. Participants become
eligible for the benefits if they retire on or after the attainment of age
65 or upon a qualified disability retirement, or if they have 10 or more
years of service and retire at age 55 or older. The plans granted
retroactive benefits for all employees hired prior to January 1, 1992.
This prior service cost has been amortized to expense over a five year
period. MCV annually funds the current year service and interest cost as
well as amortization of prior service cost to both qualified and
non-qualified trusts.
The following table reconciles the change in the plans' benefit obligation
and change in plan assets as reflected on the balance sheet as of December
31 (in thousands):
2002 2001
-------------- -------------
Change in benefit obligation:
Benefit obligation at beginning of year $ 2,405.1 $ 1,937.6
Service cost 197.3 173.5
Interest cost 188.7 142.9
Unrecognized prior service cost -- 199.0
Actuarial gain (loss) 136.6 (43.3)
Benefits paid during year (3.5) (4.6)
-------------- -------------
Benefit obligation at end of year 2,924.2 2,405.1
-------------- -------------
Change in plan assets:
Fair value of plan assets at beginning of year 2,088.0 2,015.4
Actual return on plan assets (230.3) (153.4)
Employer contribution 233.3 230.6
Benefits paid during year (3.5) (4.6)
-------------- -------------
Fair value of plan assets at end of year 2,087.5 2,088.0
-------------- -------------
Unfunded (funded) status 836.7 317.1
Unrecognized prior service cost (184.6) (199.0)
Unrecognized net gain (loss) (652.1) (118.1)
-------------- -------------
Accrued benefit cost $ -- $ --
============== =============
Net periodic postretirement health care cost for years ending December 31,
included the following components (in thousands):
2002 2001 2000
------------- -------------- ------------
Components of net periodic benefit cost:
Service cost $ 197.3 $ 173.5 $ 155.3
Interest cost 188.7 142.9 134.9
Expected return on plan assets (167.0) (171.3) (175.7)
Amortization of unrecognized net (gain) or loss 14.3 (12.6) (16.5)
------------- -------------- ------------
Net periodic benefit cost $ 233.3 $ 132.5 $ 98.0
============= ============== ============
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage-point change
in assumed health care cost trend rates would have the following effects
(in thousands):
F-20
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
1-Percentage 1-Percentage
Point Increase Point Decrease
---------------- -----------------
Effect on total of service and interest cost components $ 54.0 $ 46.2
Effect on postretirement benefit obligation $ 487.5 $ 321.1
Assumptions used in accounting for the Post-Retirement Health Care Plan
were as follows:
2002 2001 2000
-------------- ------------- --------------
Discount rate 6.75% 7.25% 7.50%
Long-term rate of return on plan assets 8.00% 8.00% 8.50%
Inflation benefit amount
1998 through 2004 0.00% 0.00% 0.00%
2005 and later years 4.00% 4.00% 4.00%
Retirement and Savings Plans
MCV sponsors a defined contribution retirement plan covering all
employees. Under the terms of the plan, MCV makes contributions to the
plan of either five or ten percent of an employee's eligible annual
compensation dependent upon the employee's age. MCV also sponsors a 401(k)
savings plan for employees. Contributions and costs for this plan are
based on matching an employee's savings up to a maximum level. In 2002,
2001 and 2000, MCV contributed $1.2 million, $1.1 million and $1.1
million, respectively under these plans.
Supplemental Retirement Benefits
MCV provides supplemental retirement, postretirement health care and
excess benefit plans for key management. These plans are not qualified
plans under the Internal Revenue Code; therefore, earnings of the trusts
maintained by MCV to fund these plans are taxable to the Partners and
trust assets are included in the assets of MCV.
F-21
MIDLAND COGENERATION VENTURE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(8) PARTNERS' EQUITY AND RELATED PARTY TRANSACTIONS
The following table summarizes the nature and amount of each of MCV's
Partner's equity interest, interest in profits and losses of MCV at
December 31, 2002, and the nature and amount of related party transactions
or agreements that existed with the Partners or affiliates as of December
31, 2002, 2001 and 2000, and for each of the twelve month periods ended
December 31 (in thousands).
Beneficial Owner, Equity Partner,
Type of Partner and Nature of Equity
Related Party Interest Interest Related Party Transactions and Agreements 2002 2001 2000
- ------------------------------------- -------- -------- --------------------------------------------- -------- --------- --------
CMS Energy Company
CMS Midland, Inc. $359,812 49.0% Power purchase agreements $557,149 $550,477 $568,838
======== =======
General Partner; wholly-owned Purchases under gas transportation agreements 23,552 24,059 23,295
subsidiary of Consumers Energy Purchases under spot gas agreements 3,631 3,756 4,735
Company Purchases under gas supply agreements 11,306 10,725 12,679
Gas storage agreement 2,563 2,563 2,563
Land lease/easement agreements 600 600 600
Accounts receivable 44,289 48,843 43,278
Accounts payable 3,502 4,772 5,560
Sales under spot gas agreements 1,084 7,107 10,521
El Paso Corporation $127,682 18.1%
- -------------------
Source Midland Limited Partnership Purchase under gas transportation agreements 12,463 13,653 14,229
("SMLP") General Partner; owned by Purchases under spot gas agreement 15,655 45,130 21,563
subsidiaries of El Paso Purchases under gas supply agreement 47,136 5,912 5,248
Corporation (1) Gas agency agreement 365 1,989 2,361
Deferred reservation charges under gas -- 7,880 6,895
purchase agreement
Accounts receivable 523 -- 11,481
Accounts payable 7,706 5,198 11,839
Sales under spot gas agreements 14,007 28,451 14,815
Partner cash withdrawal (including accrued -- 56,714 50,886
interest) (2)
El Paso Midland, Inc. ("El Paso
Midland") 76,609 10.9 See related party activity listed under SMLP.
General Partner; wholly-owned
subsidiary of El Paso
Corporation (1)
MEI Limited Partnership ("MEI") See related party activity listed under SMLP.
A General and Limited Partner;
50% interest owned by El Paso
Midland, Inc. and 50% interest
owned by SMLP (1)
General Partnership Interest 63,844 9.1
Limited Partnership Interest 6,383 .9
Micogen Limited Partnership 31,919 4.5 See related party activity listed under SMLP.
("MLP") Limited Partner, owned
subsidiaries of El Paso
Corporation (1)
-------- -------
Total El Paso Corporation $306,437 43.5%
======== =======
The Dow Chemical Company
The Dow Chemical Company $ 68,060 7.5% Steam and electric power agreement 29,385 33,727 31,319
======== =======
Limited Partner Steam purchase agreement - Dow Corning Corp 3,746 3,781 3,615
(affiliate)
Purchases under demineralized water supply 6,605 6,913 6,570
agreement
Accounts receivable 3,635 3,191 3,536
Accounts payable 1,016 948 745
Standby and backup fees 734 696 676
Alanna Corporation Sales of gas under tolling agreement 6,442 -- --
- ------------------
Alanna Corporation $ 1(3) .00001%
======== =======
Limited Partner; wholly-owned Note receivable 1 1 1
subsidiary of Alanna Holdings
Corporation
Footnotes to Partners' Equity and Related Party Transactions
(1) On January 29, 2001, El Paso Corporation ("El Paso") announced that it had
completed its merger with The Coastal Corporation ("Coastal"). Coastal was
the previous parent company of El Paso Midland (formerly known as Coastal
Midland, Inc.), SMLP, MLP and, through SMLP, MEI. After the merger, Coastal
became a wholly-owned subsidiary of El Paso and has changed its name to El
Paso CGP Company.
(2) A letter of credit has been issued and recorded as a note receivable from
El Paso Midland, this amount includes their share of cash available, as
well as, cash available to MEI, MLP and SMLP.
(3) Alanna's capital stock is pledged to secure MCV's obligation under the
lease and other overall lease transaction documents.
F-22
SUPPLEMENTAL INFORMATION
Supplemental information is to be furnished with reports filed pursuant to
Section 15 (d) of the Act by registrants, which have not registered securities
pursuant to Section 12 of the Act. No such annual report or proxy statement has
been sent to security holders.
F-23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
MIDLAND COGENERATION VENTURE
LIMITED PARTNERSHIP
Date: March 25, 2003 By /s/ James M. Kevra
-------------------------------------
James M. Kevra
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
Signature Title Date
- --------- ----- ----
/s/ James M. Kevra President and Chief Executive Officer March 25, 2003
- --------------------------------------- (Principal Executive Officer)
James M. Kevra
/s/ James M. Rajewski Chief Financial Officer March 25, 2003
- --------------------------------------- Vice President and Controller
James M. Rajewski (Principal Accounting Officer)
/s/ John J. O'Rourke Chairman, Management Committee March 25, 2003
- ---------------------------------------
John J. O'Rourke
/s/ David W. Joos Member, Management Committee March 25, 2003
- ---------------------------------------
David W. Joos
F-24
CERTIFICATIONS
I, James M. Kevra, certify that:
1. I have reviewed this annual report on Form 10-K of Midland
Cogeneration Venture Limited Partnership;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation
Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 25, 2003
/s/ James M. Kevra
- -------------------------------------
James M. Kevra
President and Chief Executive Officer
F-25
I, James M. Rajewski, certify that:
1. I have reviewed this annual report on Form 10-K of Midland
Cogeneration Venture Limited Partnership;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
d) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation
Date"); and
e) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
b) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
c) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 25, 2003
/s/ James M. Rajewski
- -----------------------------------------------
James M. Rajewski
Chief Financial Officer, Vice President and Controller
F-26