AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 16, 2003
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-4
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
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CONSUMERS ENERGY COMPANY
(Exact name of registrant as specified in its charter)
MICHIGAN 4939 38-0442310
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
ONE ENERGY PLAZA
JACKSON, MICHIGAN 49201
517-788-0351
(Address, including zip code, and telephone number, including area
code, of registrant's principal executive offices)
---------------
THOMAS J. WEBB
EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
CONSUMERS ENERGY COMPANY
One Energy Plaza
Jackson, Michigan 49201
517-788-0351
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
With copies to:
ROBERT C. SHROSBREE, ESQ.
ASSISTANT GENERAL COUNSEL
CMS ENERGY CORPORATION
One Energy Plaza
Jackson, Michigan 49201
517-768-7323
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
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If the only securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box: [ ]
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering: [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [ ]
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CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE PER AGGREGATE OFFERING REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED UNIT(1) PRICE(1) FEE
----------------------------------------------------------------------------------------------------------------
4.25% First Mortgage Bonds due 2008, Series
C........................................ $ 250,000,000 100% $ 250,000,000 $ 20,225.00
5.375% First Mortgage Bonds due 2013,
Series D................................. 375,000,000 100% 375,000,000 30,337.50
4.00% First Mortgage Bonds due 2010, Series
F........................................ 250,000,000 100% 250,000,000 20,225.00
4.80% First Mortgage Bonds due 2009, Series
H........................................ 200,000,000 100% 200,000,000 16,180.00
6.00% First Mortgage Bonds due 2014, Series
J........................................ 200,000,000 100% 200,000,000 16,180.00
Total...................................... $1,275,000,000 100% $ 1,275,000,000 $103,147.50
(1) Estimated pursuant to Rule 457(f) solely for the purpose of calculating the
registration fee.
WE HERE BY AMEND THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE
NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL WE FILE A FURTHER AMENDMENT WHICH
SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME
EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL
THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE
COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT CONSUMMATE THE EXCHANGE OFFER UNTIL THE REGISTRATION STATEMENT FILED WITH
THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN
OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED DECEMBER 16, 2003
Preliminary Prospectus
$1,275,000,000
CONSUMERS ENERGY COMPANY
Exchange Offer for all Outstanding
4.25% First Mortgage Bonds due 2008, Series A
5.375% First Mortgage Bonds due 2013, Series B
4.00% First Mortgage Bonds due 2010, Series E
4.80% First Mortgage Bonds due 2009, Series G
and
6.00% First Mortgage Bonds due 2014, Series I
The Exchange Offer will expire at 5:00 p.m., New York City time, on
____________, 2004 unless we extend it.
Terms of the Exchange Offer
---------------------------
We are offering to exchange new registered 4.25% First Mortgage Bonds due 2008,
Series C for all of our old unregistered 4.25% First Mortgage Bonds due 2008,
Series A; new registered 5.375% First Mortgage Bonds due 2013, Series D, for all
of our old unregistered 5.375% First Mortgage Bonds due 2013, Series B; new
registered 4.00% First Mortgage Bonds due 2010, Series F for all old
unregistered 4.00% First Mortgage Bonds due 2010, Series E; new registered 4.80%
First Mortgage Bonds due 2009, Series H for all old unregistered 4.80% First
Mortgage Bonds due 2009 Series G; and new registered 6.00% First Mortgage Bonds
due 2014, Series J for all old unregistered 6.00% First Mortgage Bonds due 2014
Series, I.
The terms of the new bonds will be identical in all material respects to the
terms of the old bonds, except that the registration rights and related
liquidated damages provisions and the transfer restrictions applicable to the
old bonds will not be applicable to the new bonds. The new bonds will have the
same financial terms and covenants as the old bonds, and will be subject to the
same business and financial risks. Any outstanding old bonds not validly
tendered will remain subject to existing transfer restrictions.
Subject to the satisfaction or waiver of specified conditions, we will exchange
the new bonds for all old bonds that are validly tendered and not withdrawn by
you at any time prior to the expiration of the Exchange Offer as described in
this prospectus.
The new bonds will not be listed on any securities exchange or included in any
automatic quotation system.
We will not receive any proceeds for the exchange.
We are not asking you for a proxy and you are requested not to send us a proxy.
THIS INVESTMENT INVOLVES RISK. SEE "RISK FACTORS" BEGINNING ON PAGE 17.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The date of this prospectus is _______, 2004
TABLE OF CONTENTS
PAGE
----
Important Notice about Information in this Prospectus.................. 1
Where You Can Find More Information.................................... 1
Forward-Looking Statements and Information............................. 2
Summary................................................................ 5
Risk Factors........................................................... 17
Use of Proceeds........................................................ 25
Ratio of Earnings to Fixed Charges..................................... 25
Description of the New Bonds........................................... 26
Ratings................................................................ 34
The Exchange Offer .................................................... 34
Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Nine Months Ended September 30, 2003... 45
Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Fiscal Year Ended December 31, 2002.... 76
Our Business........................................................... 104
Legal Proceedings...................................................... 114
Our Management......................................................... 116
Affiliate Relationships and Transactions............................... 125
Certain United States Federal Income Tax Consequences.................. 125
Plan of Distribution................................................... 128
Legal Opinions......................................................... 128
Experts................................................................ 128
Glossary............................................................... 130
Index to Consolidated Financial Statements............................. F-1
IMPORTANT NOTICE ABOUT INFORMATION IN THIS PROSPECTUS
You should rely only on the information contained in this prospectus or
to which we have referred you. We have not authorized anyone to provide you with
information that is different or to make any representations about us or the
transactions we discuss in the prospectus. If you receive information about
these matters that is not included in this prospectus, you must not rely on that
information. This document may only be used where it is legal to sell these
securities. The information in this document may only be accurate on the date of
this document.
WHERE YOU CAN FIND MORE INFORMATION
We file reports, proxy statements and other information with the
Securities and Exchange Commission ("SEC") under File No. 1-5611. Our SEC
filings are also available over the Internet at the SEC's web site at
http://www.sec.gov. You may also read and copy any document we file at the SEC's
public reference room at 450 Fifth Street N.W., Room 1024, Washington, D.C.
20549. Please call the SEC at 1-800-SEC-0330 for more information on the public
reference rooms and their copy charges. You may also inspect our SEC reports and
other information at the New York Stock Exchange, 20 Broad Street, New York, New
York 10005. You can find additional information about us, including our Annual
Report on Form 10-K for the year ended December 31, 2002, our Quarterly Report
on Form 10-Q/A for the quarter ended March 31, 2003, our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003 and our Quarterly Report on Form
10-Q for the quarter ended September 30, 2003, on the Web site of our parent
company at http://www.cmsenergy.com. The information on this Web site is not a
part of this prospectus.
We have filed with the SEC a registration statement on Form S-4 under
the Securities Act, and the rules and regulations promulgated under the
Securities Act of 1933 (the "SECURITIES ACT"), with respect to the new bonds
offered for exchange under this prospectus. This prospectus, which constitutes
part of that registration statement, does not contain all of the information set
forth in the registration statement and the attached exhibits and schedules. The
statements contained in this prospectus as to the contents of any contract,
agreement or other document that is filed as an exhibit to the registration
statement are not necessarily complete. Accordingly, each of those statements is
qualified in all respects by reference to the full text of the contract,
agreement or document filed as an exhibit to the registration statement or
otherwise filed with the SEC.
FORWARD-LOOKING STATEMENTS AND INFORMATION
This prospectus includes forward-looking statements. From time to time,
we may make statements regarding our assumptions, projections, expectations,
intentions or beliefs about future events. These statements are intended as
"forward-looking statements" under the Private Securities Litigation Reform Act
of 1995. Forward-looking statements give our expectations or forecasts of future
events. You can identify these statements by the fact that they do not relate
strictly to historical or current facts. Forward-looking statements have been
and will be made in this prospectus and in our other written documents (such as
press releases, visual presentations, and securities disclosure documents) and
oral presentations (such as analyst conference calls). Such statements are based
on management's beliefs as well as assumptions made by and information currently
available to management. When used in our documents or oral presentations, we
intend the words "anticipate", "believe", "estimate", "expect", "forecast",
"intend", "objective", "plan", "possible", "potential", "project", "projection"
and variations of such words and similar expressions to target forward-looking
statements that involve risk and uncertainty.
Any or all of our forward-looking statements in oral or written
statements or in other publications may turn out to be wrong. They can be
affected by inaccurate assumptions or by known or unknown risks and
uncertainties. Many such factors will be important in determining our actual
future results. Consequently, we cannot guarantee any forward-looking statement.
In addition to any assumptions and other factors referred to
specifically in connection with such forward-looking statements, there are
numerous factors that could cause our actual results to differ materially from
those contemplated in any forward-looking statements. Such factors include our
inability to predict and/or control:
- Achievement of capital expenditure reductions and cost
savings;
- Capital and financial market conditions, including the current
price of the common stock of CMS Energy Corporation ("CMS
ENERGY"), our parent company, and the effect of such
conditions on our pension plan, interest rates and
availability of financing to us or CMS Energy or any of its
affiliates and the energy industry;
- Market perception of the energy industry, us or CMS Energy or
any of its affiliates;
- Our or CMS Energy's or any of its affiliate's ability to
successfully access the capital markets;
- Our or CMS Energy's or any of its affiliates' securities
ratings;
2
- Factors affecting utility and diversified energy operations
such as unusual weather conditions, catastrophic
weather-related damage, unscheduled generation outages,
maintenance or repairs, or environmental incidents;
- Electric transmission or gas pipeline system constraints;
- National, regional and local economic, competitive and
regulatory conditions and developments;
- Adverse regulatory or legal decisions, including environmental
laws and regulations;
- Federal regulation of electric sales and transmission of
electricity including re-examination by federal regulators of
the market-based sales authorizations by which our affiliates
participate in wholesale power markets without price
restrictions and proposals by the Federal Energy Regulatory
Commission ("FERC") to change the way it currently lets us and
other public utilities and natural gas companies interact with
each other;
- Energy markets, including the timing, volatility and extent of
unanticipated changes in commodity prices for oil, coal,
natural gas, natural gas liquids, electricity and certain
related products due to lower or higher demand, shortages,
transportation problems or other developments;
- Nuclear power plant performance, decommissioning, policies,
procedures, incidents, and regulation, including the
availability of spent nuclear fuel storage;
- Technological developments in energy production, delivery and
usage;
- Changes in financial or regulatory accounting principles or
policies;
- Outcome, cost and other effects of legal and administrative
proceedings, settlements, investigations and claims;
- Disruptions in the normal commercial insurance and surety bond
markets that may increase costs or reduce traditional
insurance coverage, particularly terrorism and sabotage
insurance and performance bonds;
- Other business or investment considerations that may be
disclosed from time to time in CMS Energy's or our SEC filings
or in other publicly disseminated written documents; and
- Other uncertainties, which are difficult to predict and many
of which are beyond our control.
Except to the extent required by the federal securities laws, we and
our affiliates undertake no obligation to update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
The foregoing review of factors pursuant to the Private Securities Litigation
Reform Act of 1995 should not be construed as exhaustive or as any admission
regarding the adequacy of our disclosures. Certain risk factors are detailed
from time to time in our various public filings. You are advised, however, to
consult any further disclosures we make on related subjects in our reports to
the SEC. In particular, you should read the discussion in the section entitled
"Consumers Forward-Looking Statements Cautionary Factors and Uncertainties" in
our most recent reports to the SEC on Form 10-K or Form 8-K filed subsequent to
such Form 10-K. See "Where You Can Find More Information".
3
The factors identified under "Risk Factors" beginning on page 17 are
also important factors, but not necessarily all of the important factors, that
could cause actual results to differ materially from those expressed in any
forward-looking statement made by, or on behalf of, us or our subsidiaries.
4
SUMMARY
This summary may not contain all the information that may be important
to you. You should read this prospectus and the documents to which we refer you
to in their entirety before making an investment decision. The terms
"Consumers", "Company", "our", "us", and "we" as used in this prospectus refer
to Consumers Energy Company and its subsidiaries and predecessors as a combined
entity, except where it is made clear that such term means only Consumers Energy
Company.
In this document, "bcf" means billion cubic feet, "kWh" means
kilowatt-hour, "mcf" means thousand cubic feet and "MW" means megawatts.
CONSUMERS ENERGY COMPANY
Consumers is a public utility that provides natural gas and/or
electricity to almost 6.0 million of the approximately 10 million residents in
Michigan's lower peninsula. Consumers' electric operations include the
generation, purchase, distribution and sale of electricity. It provides electric
services in 61 of the 68 counties of Michigan's lower peninsula. In 2002,
Consumers' electric utility owned and operated 30 electric generating plants
with an aggregate of 6,444 MW of capacity and served 1.73 million customers in
Michigan's lower peninsula. Consumers' gas utility operation purchases,
transports, stores, distributes and sells natural gas. It renders gas sales and
delivery service in 54 of the 68 counties in Michigan's lower peninsula. In
2002, Consumers' gas utility owned and operated over 25,218 miles of
distribution mains and 1,624 miles of transmission lines throughout the lower
peninsula of Michigan, providing natural gas to 1.65 million customers.
RECENT DEVELOPMENTS
THIRD QUARTER 2003 RESULTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ---------------------
2003 2002 CHANGE 2003 2002 CHANGE
----- ------ ------ ----- ----- ------
(UNAUDITED)
(IN MILLIONS)
Consumers Net Income................... $ 44 $ 85 $ (41) $ 206 $ 301 $ (95)
For the three months ended September 30, 2003, Consumers' net income
totaled $44 million, a decrease of $41 million from the previous year.
A decrease in electric delivery revenues reduced earnings by $22
million after-tax. This decrease was primarily due to reduced deliveries to the
higher margin residential sector resulting from milder summer weather compared
to the same period in 2002, which included record setting monthly sendout and
monthly hourly peak demand volumes. Commercial and industrial customers
switching to alternative electric suppliers as allowed by the Customer Choice
Act further reduced electric delivery revenues. Lower gas deliveries reduced
after-tax earnings by $9 million. Earnings were also reduced $10 million
after-tax due to a decrease in the fair value of certain long-term gas contracts
held by the Midland Cogeneration Venture Limited Partnership (the "MCV
PARTNERSHIP"). The earnings decrease also reflects increased costs of borrowing
that reduced earnings by $4 million after-tax, and increased general tax expense
of $3 million after-tax. Offsetting the earnings decrease is an after-tax
benefit of $3 million due to the final gas rate order issued in 2002 authorizing
Consumers to increase its gas tariff rates.
For the nine months ended September 30, 2003, Consumers' net income
totaled $206 million, a decrease of $95 million from the previous year.
5
This decrease in earnings reflects the absence of the nonrecurring
benefits from 2002, including the $31 million after-tax gain on asset sales, and
the $18 million of after-tax earnings related to an adjustment to the fair value
of certain long-term gas contracts held by the MCV Partnership. Reduced earnings
also reflect a $12 million charge to non-utility expense in order to recognize a
decline in market value of CMS Energy common stock held by Consumers.
Decreased electric deliveries reduced after tax earnings by $25
million. This decrease can be attributed to the continuing switch by commercial
and industrial customers to alternative electric suppliers allowed by the
Customer Choice Act. A reduction in residential consumption also contributed to
the decrease in electric deliveries. This decrease was due to milder summer
temperatures in 2003 compared to the same period in 2002, which included record
setting monthly send out and monthly hourly peak demand volumes.
Increased electric and gas operating expenses reduced after-tax
earnings by $32 million. Increased costs of borrowings reduced after-tax
earnings by $16 million, and a $7 million after-tax charge at CMS Midland
Holdings Company reflecting the loss of certain tax credits also contributed to
the earnings decrease.
Offsetting these decreases is an after-tax benefit of $9 million due to
increased gas deliveries reflecting colder winter weather in early 2003, a $23
million after-tax benefit due to the final gas rate order issued in 2002
authorizing Consumers to increase its gas tariff rates, and the $13 million
after-tax benefit relating to the reduction in Michigan single business tax
expenses relating to years 2000 and 2001. The reduction in Michigan single
business tax expense is a result of CMS Energy receiving approval to file
consolidated tax returns for years 2000 and 2001. These returns were filed in
the second quarter of 2003.
Finally, earnings for the three and nine month period ended September
30, 2003, were reduced by $1 million after-tax as a result of the Northeast
United States blackout that commenced August 14, 2003.
MICHIGAN'S CUSTOMER CHOICE AND ELECTRIC RELIABILITY ACT
Michigan's Customer Choice and Electric Reliability Act (the "CUSTOMER
CHOICE ACT") allows for the securitization of certain costs that fit the
definition of qualified costs for securitization purposes. In March 2003,
Consumers filed an application with the Michigan Public Service Commission
("MPSC") pursuant to the Customer Choice Act seeking approval to issue
additional securitization bonds in the amount of approximately $1.084 billion.
In June 2003, the MPSC issued a financing order authorizing the issuance of the
securitization bonds in the amount of approximately $554 million. This amount
relates to Clean Air Act expenditures and an associated return on those
expenditures through December 31, 2002, retail open access implementation costs
and previously authorized return on those expenditures through December 31,
2000, and the "up front" other qualified costs related to issuance of the
securitization bonds. Consumers believes unsecuritized Palisades nuclear power
plant expenditures should be included as a component of "net" Stranded Costs. In
the June 2003 financing order, the MPSC also adopted a rate design that would
allow retail open access customers to pay a securitization charge (and related
tax charge) that are a small fraction of the amounts paid by full service
bundled sales customers and special contract customers of Consumers. The
financing order provides that the securitization charges (and related tax
charges) for the full service bundled sales customers are increased under the
rate design ordered by the MPSC in order to be sufficient to repay the
principal, interest and all other "ongoing" qualified costs related to servicing
the securitization bonds. The financing order also restricts the amount of
common dividends payable by Consumers
6
to its "earnings". In July 2003, Consumers filed for rehearing and clarification
on a number of features in the financing order, including the rate design,
accounting treatment of unsecuritized qualified costs and dividend restriction.
Also in July 2003, the Michigan Attorney General filed a claim of appeal related
to the financing order and the Michigan Attorney General indicated it would
challenge the lawfulness of the rate design. In October 2003, the Michigan Court
of Appeals dismissed the appeal and indicated that the Michigan Attorney General
could resubmit the appeal after the MPSC acted on Consumers' rehearing request.
Subsequently, the Michigan Attorney General filed a motion for rehearing asking
for reconsideration of the Michigan Court of Appeals' dismissal. The financing
order will become effective after rehearing, resolution of appeals and upon
acceptance by Consumers. Depending upon the results and timing of the rehearing
and if there are no further court appeals and no delays in the offering process,
Consumers anticipates, but cannot assure, that securitization bonds could be
issued during the first quarter of 2004.
GAS RATE CASE
In March 2003, Consumers filed an application with the MPSC seeking a
$156 million increase in its gas delivery and transportation rates, which amount
includes a 13.5% authorized return on equity, based on a 2004 test year.
Contemporaneously with this filing, Consumers has requested interim relief in
the same amount. In August 2003, the MPSC staff recommended interim rate relief
of $80 million be granted in this proceeding, subject to Consumers voluntarily
agreeing to limit its dividends to its parent, CMS Energy, to a maximum of $190
million in any calendar year. In September 2003, Consumers filed an update to
its gas rate case that lowered the requested revenue increase from $156 million
to $139 million and revised the return on common equity from 13.5 percent to
12.75 percent. The MPSC staff and the Association of Businesses Advocating
Tariff Equity ("ABATE") filed their cases in early October 2003. The MPSC staff
made no change to its interim position of $80 million and continued to propose
the same dividend limitation. ABATE opposes rate relief. On December 8, 2003,
Consumers reduced its interim rate request to $33 million subject to approval by
the MPSC of revised depreciation expense for accounting and rate making
purposes. The administrative law judge is scheduled to issue a proposal for
decision in January 2004.
GAS COST RECOVERY
As part of the ongoing gas cost recovery ("GCR") process, which
includes an annual reconciliation process with the MPSC, Consumers expects to
collect all of its incurred gas costs. In June 2003, Consumers filed a
reconciliation of GCR costs and revenues for the 12-month period April 2002
through March 2003. In the filing, Consumers proposed to recover from customers
a net under-recovery of approximately $6 million according to a "roll-in"
methodology, which incorporates the under-recovery in rates charged in the
succeeding GCR year. The "roll-in" tariff provision was approved by the MPSC in
a November 2002 order.
Under an order issued by the MPSC in July 2003, the MPSC approved a
settlement agreement authorizing Consumers to increase its GCR factor for the
remainder of the current GCR plan year (August 2003 through March 2004) and to
implement a quarterly ceiling price adjustment mechanism, based on a formula
that tracks changes in New York Mercantile Exchange natural gas prices.
Consistent with the terms of the settlement, the ceiling price is $6.11 per mcf.
However, Consumers as of the December 2003 billing month will use a GCR factor
of $5.41 mcf to bill its customers.
7
RECENT FINANCINGS
Consumers has met its liquidity and capital requirements to date in
2003 through a combination of cash from operations and new debt along with
reduced capital expenditures, cost reductions and other measures. Consumers has
initiated several transactions with various financial institutions, regulators,
banks, lenders, and others that are designed to provide liquidity:
- On March 26, 2003, Consumers entered into a six-year $140
million term loan secured by first mortgage bonds with a
private investor bank. Proceeds from this loan were used for
general corporate purposes.
- On March 27, 2003, Consumers obtained a replacement revolving
credit facility in the amount of $250 million secured by first
mortgage bonds. This new credit facility matures in March 2004
with two annual extensions at Consumers' option, which would
extend the maturity to March 2006. The prior facility was due
to expire in July 2003.
- On March 28, 2003, Consumers entered into a three-year $150
million term loan secured by first mortgage bonds. Proceeds
from this loan were used for general corporate purposes.
- On April 30, 2003, Consumers sold $625 million principal
amount of first mortgage bonds in a private offering to
institutional investors; $250 million were issued at 4.25%,
maturing on April 15, 2008, and net proceeds were
approximately $248 million, $375 million were issued at
5.375%, maturing on April 15, 2013, and net proceeds were
approximately $371 million. Consumers used the net proceeds to
replace a $250 million senior reset put bond that matured in
May 2003, to pay an associated $32 million option call
payment, and for general corporate purposes.
- On May 23, 2003, Consumers sold $250 million principal amount
of first mortgage bonds in a private offering to institutional
investors; the first mortgage bonds were issued at 4.00%,
maturing on May 15, 2010, and net proceeds were approximately
$247 million. Consumers used the net proceeds to prepay a
portion of a $300 million term loan that matures on July 11,
2004.
- On August 26, 2003, Consumers sold $400 million principal
amount of first mortgage bonds in a private offering to
institutional investors; $200 million were issued at 4.80%,
maturing on February 17, 2009, and net proceeds were
approximately $198 million, $200 million were issued at 6.00%,
maturing on February 15, 2014, and net proceeds were
approximately $198 million. Consumers used the net proceeds to
prepay the remaining $50 million of a term loan that matures
on July 11, 2004 that had a variable interest rate at 5.92%,
to prepay a $150 million term loan maturing March 28, 2006
that had a variable interest rate at 5.62%, and for general
corporate purposes including the financing of natural gas
inventory to be held in storage.
- On September 19, 2003, Consumers increased its revolving
credit facility from $250 million to $400 million. Consumers
holds annual extension options through March 2006.
- On November 7, 2003, Consumers closed a three-year $60 million
term loan at an interest rate of LIBOR plus 135 points. The
term loan is secured by first mortgage bonds. The proceeds of
the loan were used to purchase Consumers' headquarters
building lease from the lessor, resulting in cost savings to
Consumers.
8
AUGUST 14, 2003 ELECTRICAL BLACKOUT
On August 14, 2003, the electric transmission grid serving parts of the
Midwest and the Northeast experienced a significant disturbance, which impacted
electric service to millions of homes and businesses throughout a vast region.
In Michigan, more than 2 million electric customers were without electricity.
Consumers had five fossil-fueled generating unit outages and, of Consumers' 1.7
million electric customers, approximately 100,000 were without power for
approximately 24 hours as a result of the disturbance. The impact was felt most
heavily in the southeastern part of Consumers' service territory.
Consumers sold its transmission system in May 2002 to Michigan Transco
Holdings, Limited Partnership ("MTH"), with Consumers providing transmission
system maintenance under a five-year contract with MTH. MTH now owns, controls,
and plans for the transmission system that serves Consumers. Consumers incurred
approximately $1 million of immediate financial impact as a result of the
blackout. Consumers continues to cooperate with investigations of the blackout
by several federal and state agencies. Consumers cannot predict the outcome of
these investigations.
In November 2003, the MPSC released its report on the August 14th
blackout, which found no evidence to suggest that the events in Michigan or
actions taken by the Michigan utilities or transmission operators were factors
contributing to the cause of the blackout. As a result of its investigation, the
MPSC is recommending that Congress pass legislation that would empower the FERC,
where necessary, to order membership into a regional transmission organization
and that Congress should provide the FERC with the authority to develop and
enforce mandatory transmission reliability standards with penalties for
noncompliance.
Also in November 2003, the U.S.- Canada Power System Outage Task Force
released an interim report on its investigation of the August 14th blackout
stating that transmission line contact with trees in First Energy Corp's Ohio
service territory was among the most important causes of the blackout. In
December, 2003, the MPSC issued an order requiring that all Michigan
investor-owned utilities file reports with the MPSC regarding the status of the
transmission and distribution lines used to serve their customers in Michigan,
including details of vegetation trimming practices in calendar year 2003 by
April 1, 2004. Consumers intends to fully and timely comply with the MPSC's
request.
SETTLEMENT WITH THE COMMODITY FUTURES TRADING COMMISSION
On November 25, 2003, the Commodity Futures Trading Commission (the "CFTC")
issued a settlement order regarding the inaccurate reporting of natural gas
trading information to energy industry publications. CMS Marketing, Services and
Trading Company ("CMS MST") and CMS Field Services, Inc. were the CMS Energy
subsidiaries that were being investigated by the CFTC. The affected subsidiaries
will pay a fine to the CFTC totaling $16 million in the settlement. CMS Energy
neither admits nor denies the findings of the CFTC in the CFTC's settlement
order.
9
THE OLD BONDS
The Old Bonds On April 30, 2003, we sold $250 million principal
amount of our 4.25% First Mortgage Bonds due 2008,
Series A and $375 million principal amount of our
5.375% First Mortgage Bonds due 2013, Series B; on
May 23, 2003, we sold $250 million principal amount
of our 4.00% First Mortgage Bonds due May 15, 2010,
Series E; and on August 26, 2003, we sold $200
million principal amount of our 4.80% First Mortgage
Bonds due 2009, Series G and $200 million principal
amount of our 6.00% First Mortgage Bonds due 2014,
Series I (each series collectively referred to as the
"OLD BONDS"). The old bonds were offered to qualified
institutional buyers under Rule 144A.
Registration Rights
Agreement For each issuance of the old bonds, we executed a
Registration Rights Agreement that provides that we
would grant certain registration and exchange rights
to old bond holders (the "REGISTRATION RIGHTS
AGREEMENTS"). As a result, we have filed a
registration statement with the SEC which will permit
you to exchange the old bonds for new bonds which are
registered under the Securities Act. The transfer
restrictions and liquidated damages provisions will
be removed from the new bonds. We are conducting the
Exchange Offer to satisfy our obligations with
respect to certain exchange and registration rights.
Except for a few limited circumstances, these rights
will terminate when the Exchange Offer ends.
THE EXCHANGE OFFER
Securities Offered - $250 million principal amount of our 4.25% First
Mortgage Bonds due 2008, Series C;
- $375 million principal amount of our 5.375% First
Mortgage Bonds due 2013, Series D;
- $250 million principal amount of our 4.00% First
Mortgage Bonds due May 15, 2010, Series F;
- $200 million principal amount of our 4.80% First
Mortgage Bonds due 2009, Series H; and
- $200 million principal amount of our 6.00% First
Mortgage Bonds due 2014, Series J (each series
collectively referred to as the "NEW BONDS").
10
Exchange Offer We are offering to exchange (the "EXCHANGE OFFER") up
to:
- $250 million principal amount of our 4.25% First
Mortgage Bonds due 2008, Series C that have been
registered under the Securities Act for a like
principal amount of our 4.25% First Mortgage
Bonds due 2008, Series A;
- $375 million principal amount of our 5.375% First
Mortgage Bonds due 2013, Series D that have been
registered under the Securities Act for a like
principal amount of our $375 million principal
amount of our 5.375% First Mortgage Bonds due
2013, Series B;
- $250 million principal amount of our 4.00% First
Mortgage Bonds due 2010, Series F that have been
registered under the Securities Act for a like
principal amount of our 4.00% First Mortgage
Bonds due 2010, Series E;
- $200 million principal amount of our 4.80% First
Mortgage Bonds due 2009, Series H that have been
registered under the Securities Act for a like
principal amount of our 4.80% First Mortgage
Bonds due 2009, Series G; and
- $200 million principal amount of our 6.00% First
Mortgage Bonds due 2014, Series J that have been
registered under the Securities Act for a like
principal amount of our 6.00% First Mortgage
Bonds due 2014, Series I.
The new bonds will be offered for all of the
outstanding old bonds. The terms of the new bonds
will be identical to the terms of the old bonds,
except that the registration rights and related
liquidated damages provisions and the transfer
restrictions are not applicable to the new bonds. The
old bonds may be tendered only in integral amounts of
$1,000.
Resale of New Bonds Based on SEC no action letters, we believe that after
the Exchange Offer you may offer and sell the new
bonds without registration under the Securities Act
so long as:
- You acquire the new bonds in the ordinary course
of business.
- When the Exchange Offer begins you do not have an
arrangement with another person to participate in
a distribution of the new bonds.
11
- You are not distributing and do not intend to
distribute the new bonds.
When you tender the old bonds we will ask you to
represent to us that:
- You are not our affiliate.
- You will acquire the new bonds in the ordinary
course of business.
- When the Exchange Offer begins you are not
distributing and you do not plan to distribute
with anyone else the new bonds.
If you are unable to make these representations, you
will be required to comply with the registration and
prospectus delivery requirements under the Securities
Act in connection with any secondary resale
transaction.
If you are a broker-dealer and receive new bonds for
your own account, you must acknowledge that you will
deliver a prospectus if you resell the new bonds. By
acknowledging your intent and delivering a prospectus
you will not be deemed to admit that you are an
"underwriter" under the Securities Act. You may use
this prospectus as it is amended from time to time
when you resell new bonds which were acquired from
market-making or trading activities. For a year after
the Expiration Date we will make this prospectus
available to any broker-dealer in connection with
such a resale. See "Plan of Distribution."
If necessary, we will cooperate with you to register
and qualify the new bonds for offer or sale without
any restrictions or limitations under state "blue
sky" laws.
Consequences of Failure
to Exchange Old Bonds If you do not exchange your old bonds during the
Exchange Offer you will no longer be entitled to
registration rights. You will not be able to offer or
sell the old bonds unless they are later registered,
sold pursuant to an exemption from registration or
sold in a transaction not subject to the Securities
Act or state securities laws. See "The Exchange
Offer--Consequences of Failure to Exchange."
Expiration Date 5:00 p.m., EST on _________ __, 2004 (the "EXPIRATION
DATE"). We may extend the exchange offer.
12
Conditions to the
Exchange Offer No minimum principal amount of old bonds must be
tendered to complete the Exchange Offer. However, the
Exchange Offer is subject to certain customary
conditions which we may waive. See "The Exchange
Offer--Conditions." Other than United States federal
and state securities laws we do not need to satisfy
any regulatory requirements or obtain any regulatory
approval to conduct the Exchange Offer.
Procedures for Tendering
Old Bonds If you wish to participate in the Exchange Offer you
must complete, sign and date the letter of
Transmittal (the "LETTER OF TRANSMITTAL") or a
facsimile copy and mail it or deliver it to the
Exchange Agent along with any necessary
documentation. Instructions and the address of the
Exchange Agent will be on the Letter of Transmittal
and can be found in this prospectus. See "The
Exchange Offer--Procedures for Tendering" and;
"--Exchange Agent." You must also effect a tender of
old bonds pursuant to the procedures for book-entry
transfer as described in this prospectus. See "The
Exchange Offer--Procedures for Tendering."
Guaranteed Delivery
Procedures If you cannot tender the old bonds, complete the
Letter of Transmittal or provide the necessary
documentation prior to the termination of the
Exchange Offer, you may tender your old bonds
according to the guaranteed delivery procedures set
forth in "The Exchange Offer--Guaranteed Delivery
Procedures."
Withdrawal Rights You may withdraw tendered old bonds at any time prior
to the 5:00 p.m. EST on the Expiration Date. You must
send a written or facsimile withdrawal notice to the
Exchange Agent prior to 5:00 p.m. EST on the
Expiration Date.
Acceptance of Old Bonds
and Delivery of New
Bonds All old bonds properly tendered to the Exchange Agent
by 5:00 p.m. EST on the Expiration Date will be
accepted for exchange. The new bonds will be
delivered promptly after the Expiration Date. See
"The Exchange Offer - Acceptance of Old Bonds for
Exchange; Delivery of New Bonds."
Certain United States
Tax Consequences Exchanging old bonds for the new bonds will not be a
taxable exchange for United States federal income tax
purposes. See "Certain United States Federal Income
Tax Consequences."
13
Exchange Agent JP Morgan Chase Bank is the exchange agent (the
"EXCHANGE AGENT") for the Exchange Offer.
Fees and Expenses We will pay all fees and expenses associated with the
Exchange Offer and compliance with the Registration
Rights Agreements.
Use of Proceeds We will receive no cash proceeds in connection with
the issuance of the new bonds pursuant to the
Exchange Offer. See "Use of Proceeds."
THE NEW BONDS
Issuer Consumers Energy Company.
Securities Offered - $250 million aggregate principal amount of 4.25%
First Mortgage Bonds due 2008, Series C (the
"SERIES C BONDS");
- $375 million aggregate principal amount of 5.375%
First Mortgage Bonds due 2013, Series D (the
"SERIES D BONDS");
- $250 million aggregate principal amount of 4.00%
First Mortgage Bonds due 2010, Series F (the
"SERIES F BONDS");
- $200 million aggregate principal amount of 4.80%
First Mortgage Bonds due 2009, Series H (the
"SERIES H BONDS"); and
- $200 million aggregate principal amount of 6.00%
First Mortgage Bonds due 2014, Series J (the
"SERIES J BONDS")
to be issued under the indenture dated as of
September 1, 1945 between us and JPMorgan Chase Bank
(ultimate successor to City Bank Farmers Trust
Company), as Trustee, and as amended and supplemented
from time to time (the "INDENTURE").
Maturity The Series C Bonds will mature on April 15, 2008. The
Series D Bonds will mature on April 15, 2013. The
Series F Bonds will mature on May 15, 2010. The
Series H Bonds will mature on February 17, 2009. The
Series J Bonds will mature on February 15, 2014.
14
Interest Rate The Series C Bonds will bear interest at 4.25% per
annum. The Series D Bonds will bear interest at
5.375% per annum. The Series F Bonds will bear
interest at 4.00% per annum. The Series H bonds will
bear interest at 4.80% per annum. The Series J Bonds
will bear interest at 6.00% per annum.
Interest Payment Dates We will pay interest on the Series C Bonds and Series
D Bonds on April 15 and October 15 of each year,
beginning April 15, 2004, and at maturity. We will
pay interest on the Series F Bonds on May 15 and
November 15 of each year, beginning May 15, 2004, and
at maturity. We will pay interest on the Series H
Bonds and the Series J Bonds on February 15 and
August 15 of each year, beginning on February 15,
2004, and at maturity.
Record Date for Interest
Payments The first calendar day of the month in which an
Interest Payment Date occurs.
Ratings BBB- by Standard & Poor's Ratings Group, a division
of The McGraw Hill Companies, Inc. ("S&P"), Baa3 by
Moody's Investors Service, Inc. ("MOODY'S") and BB+
by Fitch, Inc. ("FITCH").
Ranking The new bonds will rank equally in right of payment
with our other existing or future first mortgage
bonds issued either independently or as collateral
for outstanding or future securities or loans. See
"Rankings."
Mandatory Redemption None.
Optional Redemption Each series of new bonds will be redeemable at our
option, in whole or in part, at any time, on not less
than 30 days' notice at the applicable redemption
prices described herein, plus any accrued interest to
the date fixed for redemption. See "Description of
the New Bonds - Optional Redemption."
Form of New Bonds One or more global securities held in the name of DTC
in a minimum denomination of $1,000 and any integral
multiple thereof for each series of new bonds.
Settlement and Payment Same-day immediately available funds.
Trustee and Paying
Agent JPMorgan Chase Bank.
15
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial data for the fiscal years ended
December 31, 1998 through December 31, 2002 have been derived from our audited
consolidated financial statements, which have been audited by Ernst & Young LLP,
independent auditors, except for the consolidated financial statements of the
MCV Partnership, an equity method investee, which were audited by other
independent auditors, PricewaterhouseCoopers LLP for the fiscal year ended
December 31, 2002, and Arthur Andersen LLP, independent accountants (who have
ceased operations), for the fiscal years ended December 31, 2001 and 2000, and
by Arthur Andersen LLP (who have ceased operations)for the fiscal years ended
December 31, 1999 and 1998. The following selected financial data for the nine
months ended September 30, 2003 and 2002 have been derived from our unaudited
consolidated financial statements. Please refer to our consolidated financial
statements for the quarter ended September 30, 2003 that are found on pages F-2
through F-8 of this prospectus. Please refer to our financial statements for the
fiscal year ended December 31, 2002 that are found on pages F-35 through F-41 of
this prospectus. The financial information set forth below should be read in
conjunction with our consolidated financial statements, related notes and other
financial information that can be found on pages F-2 through F-86 of this
prospectus. Operating results for the nine months ended September 30, 2003 are
not necessarily indicative of the results that may be expected for the entire
year ending December 31, 2003. See "Where You Can Find More Information."
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------ ----------------------------------------
2003 2002 2002 2001 2000 1999 1998
-------------------------------------------------------------------------------------------------------------
(IN MILLIONS) (IN MILLIONS)
Operating revenue ($) 3,223 3,020 4,169 3,976 3,878 3,824 3,659
Income before cumulative effect of change
in accounting principle ($) 206 283 363 199 284 340 306
Net income ($) 206 301 381 188 284 340 349
Net income available to common
stockholder ($) 172 267 335 145 248 313 312
Total assets ($) 9,269 8,206 8,700 8,321 7,776 7,170 7,163
Long-term debt, excluding current
maturities ($) 3,531 2,701 2,442 2,472 2,110 2,006 2,007
Non-current portion of capital leases ($) 116 110 116 72 49 85 100
Total preferred stock ($) 44 44 44 44 44 44 238
Total preferred securities ($) 490 490 490 520 395 395 220
16
RISK FACTORS
In considering whether to exchange the old bonds for new bonds, you
should carefully consider all the information we have included in this
prospectus. In particular, you should carefully consider the risk factors
described below. In addition, please read the information in "Forward-Looking
Statements and Information" beginning on page 2 of this prospectus and see
"Managements Discussion and Analysis of Financial Condition and Results of
Operations for the Nine Months Ended September 30, 2003" and "Managements
Discussion and Analysis of Financial Condition and Results of Operations for the
Fiscal Year Ended December 31, 2002." Also see "Condensed Notes to Consolidated
Financial Statements For the Nine Months Ended September 30, 2003 (Unaudited )
-- Note 2 Uncertainties" and "Notes to Consolidated Financial Statements For the
Fiscal Year Ended December 31, 2002 -- Note 2 Uncertainties" where we describe
additional uncertainties associated with our business and the forward-looking
statements in this prospectus.
IF YOU FAIL TO EXCHANGE YOUR OLD BONDS, YOU MAY BE UNABLE TO SELL THEM.
Because we did not register the old bonds under the Securities Act or
any state securities laws, and we do not intend to do so after the Exchange
Offer, the old bonds may only be transferred in limited circumstances under
applicable securities laws. If the holders of the old bonds do not exchange
their old bonds in the Exchange Offer, they may lose their right to have their
old bonds registered under the Securities Act, subject to some limitations. As a
holder of old bonds after the Exchange Offer, you may be unable to sell your old
bonds.
THERE IS NO PUBLIC MARKET FOR THE NEW BONDS, SO YOU MAY BE UNABLE TO SELL THEM.
The new bonds are new securities for which there is currently no
market. Consequently, the new bonds will be relatively illiquid, and you may be
unable to sell them. We do not intend to apply for listing of the new bonds on
any securities exchange or for the inclusion of the new bonds in any automated
quotation system. Accordingly, we cannot assure you that a liquid market for the
new bonds will develop.
REGULATORY CHANGES AND OTHER DEVELOPMENTS HAVE RESULTED AND WILL CONTINUE TO
RESULT IN INCREASED COMPETITION IN OUR DOMESTIC ENERGY BUSINESS. GENERALLY,
INCREASED COMPETITION THREATENS OUR MARKET SHARE IN CERTAIN SEGMENTS OF OUR
BUSINESS AND CAN REDUCE OUR PROFITABILITY.
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 open access in the State of Michigan.
Pursuant to the Customer Choice Act, as of January 1, 2002, all electric
customers have the choice of buying electric generation service from an
alternative electric supplier. We have noticed an upward trend over the last 18
months in the total volume of electric supply load lost to competitor suppliers.
However, we cannot predict the total amount of electric supply load that we may
lose to competitor suppliers in the future.
ELECTRIC INDUSTRY REGULATION COULD ADVERSELY AFFECT OUR BUSINESS INCLUDING OUR
ABILITY TO RECOVER OUR EXPENSES FROM OUR CUSTOMERS.
Federal and state regulation of electric utilities has changed
dramatically in the last two decades and could continue to change over the next
several years. These changes could adversely affect our business, financial
condition and profitability.
17
In June 2000, the Michigan Legislature enacted the Customer Choice Act
that became effective June 5, 2000. Pursuant to the Customer Choice Act:
- all electric rates were frozen through December 31, 2003;
- residential rates were reduced by five percent and then capped
through at least December 31, 2005; and
- small commercial and industrial customer rates were capped
through at least December 31, 2004.
Ultimately, the rate caps could extend until December 31, 2013
depending upon whether or not Consumers exceeds the market power supply test
established by the legislation (a requirement with which Consumers believes
itself to be in compliance with at this time). Under circumstances specified in
the Customer Choice Act, certain costs can be deferred for future recovery after
the expiration of the rate cap period. The rate caps could, however, result in
Consumers being unable to collect customer rates sufficient to fully recover its
cost of conducting business. Some of these costs may be beyond Consumers'
ability to control. In particular, if Consumers needs to purchase power supply
from wholesale suppliers during the period when retail rates are frozen or
capped, the rate restrictions imposed by the Customer Choice Act may make it
impossible for Consumers to fully recover the cost of purchased power and
associated transmission costs through the rates it charges its customers. As a
result, it is not certain that Consumers can maintain its profit margins in its
electric utility business during the period of the rate freeze or rate caps.
There are multiple proceedings pending before FERC involving
transmission rates, regional transmission organizations and standard market
design for electric bulk power markets and transmission. We cannot predict the
impact of these electric industry-restructuring proceedings on our financial
position, liquidity or results of operations.
OUR ABILITY TO RECOVER OUR "NET" STRANDED COSTS IS UNCERTAIN AND MAY AFFECT OUR
FINANCIAL RESULTS.
The Customer Choice Act allows for the recovery, by an electric
utility, of the cost of implementing that act's requirements and "net" Stranded
Costs, without defining the term. According to the MPSC, "net" Stranded Costs
are to be recovered from retail open access customers through a Stranded Cost
transition charge.
In March 2003, Consumers filed an application with the MPSC seeking
approval of "net" Stranded Costs incurred in 2002, and for approval of a "net"
Stranded Cost recovery charge. In the application, Consumers indicated that if
Consumers' proposal to securitize Clean Air Act expenditures and previously
unsecuritized Palisades nuclear power plant expenditures were approved as
proposed in its securitization case as discussed above in "Summary -- Recent
Developments -- Michigan's Customer Choice and Electric Reliability Act," then
Consumers' "net" Stranded Costs incurred in 2002 would be approximately $35
million. If the proposal to securitize those costs is not approved, then
Consumers indicated that the costs would be properly included in the 2002 "net"
Stranded Cost calculation, which would increase Consumers' 2002 "net" Stranded
Costs to approximately $103 million. In June 2003, the MPSC issued a financing
order in the securitization case authorizing the issuance of securitization
bonds in the amount of approximately $554 million. Included in this amount were
Clean Air expenditures. However, the MPSC rejected previously unsecuritized
Palisades nuclear power plant expenditures as eligible securitized costs. As a
result, the previously unsecuritized Palisades nuclear power plant expenditures
should be included as a component of "net" Stranded Costs and will be included
as a
18
component of a future electric rate case proceeding with the MPSC. With the
inclusion of the previously unsecuritized Palisades nuclear power plant
expenditures, Consumers' "net" Stranded Costs in 2002 are estimated to be
approximately $50 million. In July 2003, Consumers filed a petition for
rehearing and clarification on a number of features in the MPSC financing order
on securitization. Once a final financing order by the MPSC is issued, the
amount of Consumers' request for "net" Stranded Costs will be known. We cannot
predict the outcome of Consumers' rehearing request or our ability to recover
our "net" Stranded Costs, including our costs related to electric utility
restructuring. The MPSC staff has scheduled a collaborative process to discuss
"net" Stranded Costs and related issues and to identify and make recommendations
to the MPSC. Consumers has participated in this collaborative process. In July
2003, the MPSC staff suspended further discussion while it considers possible
conclusions and recommendations.
WE COULD INCUR SIGNIFICANT CAPITAL EXPENDITURES TO COMPLY WITH ENVIRONMENTAL
STANDARDS AND FACE DIFFICULTY IN RECOVERING THESE COSTS ON A CURRENT BASIS.
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 1998, the Environmental Protection Agency ("EPA") issued regulations
requiring the State of Michigan to further limit nitrogen oxide emissions. The
Michigan Department of Environmental Quality finalized rules to comply with the
EPA regulations in December 2002 and submitted these rules for approval to the
EPA in the first quarter of 2003. In addition, the EPA has also issued
additional regulations regarding nitrogen oxide emissions that require certain
generators, including some of Consumers' electric generating facilities, to
achieve the same emissions rate as that required by the 1998 regulations. The
EPA and the State of Michigan regulations will require Consumers to make
significant capital expenditures estimated to be $770 million. As of September
30, 2003, Consumers has incurred $437 million in capital expenditures to comply
with the EPA regulations and anticipates that the remaining capital expenditures
will be incurred between the remainder of 2003 and 2009. Additionally, Consumers
currently expects it will supplement its compliance plan with the purchase of
nitrogen oxide emissions credits in the years 2005 through 2008. The cost of
these credits based on the current market is estimated to average $6 million per
year, however, the market for nitrogen oxide emissions credits and their price
could change substantially. At some point, if new environmental standards become
effective, Consumers will need to make additional capital expenditures to comply
with the standards.
Based on the Customer Choice Act, beginning January 2004, an annual
return of and on these types of capital expenditures, including deferred
amounts, to the extent they are above depreciation levels, is expected to be
recoverable from customers, subject to an MPSC prudency hearing.
These and other required environmental expenditures, if not recovered
from customers in Consumers' rates, may require us to seek significant
additional financing to fund such expenditures and could strain our cash
resources.
OUR REVENUES AND RESULTS OF OPERATIONS ARE SUBJECT TO RISKS THAT ARE BEYOND OUR
CONTROL, INCLUDING BUT NOT LIMITED TO FUTURE TERRORIST ATTACKS OR RELATED ACTS
OF WAR.
The cost of repairing damage to our facilities due to storms, natural
disasters, wars, terrorist acts and other catastrophic events, in excess of
reserves established for such repairs, may adversely impact our results of
operations, financial condition and cash flows. The occurrence or
19
risk of occurrence of future terrorist activity and the high cost or potential
unavailability of insurance to cover such terrorist activity may impact our
results of operations and financial condition in unpredictable ways. These
actions could also result in disruptions of power and fuel markets. In addition,
our natural gas distribution system and pipelines could be directly or
indirectly harmed by future terrorist activity.
WE HAVE FINANCING NEEDS IN 2004 AND WE MAY BE UNABLE TO SUCCESSFULLY ACCESS BANK
FINANCING OR THE CAPITAL MARKETS.
We rely on access to bank financing and the capital markets as a source
of liquidity for capital requirements not satisfied by the cash flow from our
operations. We may seek new financing in 2004 as required for our ongoing
operations and construction program, including construction expenditures for
federal Clean Air Act compliance. See "We could incur significant capital
expenditures to comply with environmental standards and face difficulty in
recovering these costs on a current basis" above. In addition, the amount we pay
for natural gas stored as inventory will require additional financing due to
timing of cost recoveries. We also plan to contribute approximately $280 million
in 2004 to our pension funds. We currently plan to seek funds through one or
more of the capital markets, commercial lenders, gas inventory financing and
securitization bonds issued pursuant to the Customer Choice Act. Entering into
new financings is subject in part to capital market receptivity to utility
industry securities in general and to Consumers' securities issuances in
particular. We are partially addressing our near-to-mid-term liquidity and
capital requirements through reduced capital expenditures and cost reduction. We
believe, but can make no assurances, that our current level of cash and
borrowing capacity, along with anticipated cash flows from operating and
investing activities, will be sufficient to meet our liquidity needs through
2005. We also have a pending request before the MPSC for authorization to issue
securitization bonds. See "Our ability to recover our "net" Stranded Costs is
uncertain and may affect our financial results" above. The proceeds from
securitization bonds will be used to refinance existing debt. We cannot predict
whether, or to what extent, the MPSC will approve this request. Consumers cannot
guarantee the capital markets' acceptance of its securities or predict the
impact of factors beyond its control, such as actions of rating agencies and
regulators, on such acceptance. If we are unable to access bank financing or the
capital markets to incur or refinance indebtedness, there could be a material
adverse effect upon our liquidity and operations.
Our current credit ratings are discussed in "Ratings." We cannot assure
you that these credit ratings will remain in effect for any given period of time
or that one or more of these ratings will not be lowered or withdrawn entirely
by a rating agency. We note that these credit ratings are not recommendations to
buy, sell or hold our securities. Each rating should be evaluated independently
of any other rating. Any future reduction or withdrawal of one or more of our
credit ratings could have a material adverse impact on our ability to access
capital on acceptable terms. We cannot assure you that any of our current
ratings or those of our affiliates, including CMS Energy, will remain in effect
for any given period of time or that a rating will not be lowered or withdrawn
entirely by a rating agency. Further, any adverse developments relating to CMS
Energy that resulted in a lowering of CMS Energy's credit ratings could have an
adverse effect on our credit ratings. Any lowering of the ratings of our first
mortgage bonds would likely reduce the market value of the new bonds.
WE ARE SUBJECT TO COVENANTS IN OUR FINANCING AGREEMENTS THAT COULD LIMIT OUR
ABILITY TO INCUR ADDITIONAL INDEBTEDNESS.
We have agreed in several of our financing agreements to maintain
specified levels of cash coverage of our interest requirements and to not allow
indebtedness to exceed specified levels of our consolidated capitalization (the
"DEBT PERCENTAGE TESTS"). We are in compliance with these
20
requirements as of the most recent measurement date, September 30, 2003. These
covenants make use of both generally accepted accounting principles and defined
contractual terms in specifying how the relevant calculations are made. However,
it is possible that if we fail to be in compliance with some of the Debt
Percentage Tests such failure could constrain our ability to access our
revolving credit or accounts receivable sales facilities, or to incur additional
indebtedness, and could also result in defaults under one or more of these
agreements.
THE UNDERFUNDING OF OUR RETIREMENT PLANS MAY REQUIRE ADDITIONAL SIGNIFICANT
CONTRIBUTIONS AND WE MAY BE NEGATIVELY IMPACTED BY THE RESULTS OF AN EMPLOYEE
BENEFIT PLAN LAWSUIT.
Consumers, along with CMS Energy, participate in a defined pension plan
("PENSION PLAN") for their employees. In addition, Consumers, along with CMS
Energy, participate in postretirement plans for retired employees other than
pensions. The recent significant downturn in the equities markets has affected
the value of the Pension Plan assets. The Pension Plan's liabilities based on
service and pay to date ("ACCUMULATED BENEFIT OBLIGATION") exceeded the value of
these assets at December 31, 2002, and as a result, Consumers and the other
participants were required to recognize an additional minimum liability for this
excess. The fair value of the Pension Plan assets at December 31, 2002 was $607
million. As of December 31, 2002, the Accumulated Benefit Obligation was
estimated at $1.055 billion and the additional minimum liability was $426
million. Consumers was allocated $325 million of the additional minimum
liability.
During 2002, Consumers' portion of contributions made to the plans'
trust accounts was $120 million. This amount represents $47 million of pension
related benefits and $73 million of postretirement health care and life
insurance benefits. Consumers expects similar contributions for postretirement
health care and life insurance benefits will be made in 2003, 2004, and 2005.
The investment performance returns and declining discount rates have increased
the underfunding of the Pension Plan, net of benefit obligations, from $350
million at December 31, 2001 to $649 million at December 31, 2002. Because of
the recent rise in the underfunded status of the Pension Plan, Consumers
contributed $172 million to the Pension Plan in August 2003. Based on actuarial
assumptions, Consumers also expects to make cash contributions to the Pension
Plan that approximate $280 million and $42 million in 2004 and 2005,
respectively.
Consumers is a defendant, along with CMS Energy, CMS MST, a subsidiary
of CMS Energy, and certain named and unnamed officers and directors, in two
lawsuits brought as purported class actions on behalf of participants and
beneficiaries of our 401(k) plan. The two cases, filed in July 2002 in the
United States District Court for the Eastern District of Michigan, were
consolidated by the trial judge and an amended and consolidated complaint has
been filed. Plaintiffs allege breaches of fiduciary duties under the Employee
Retirement Income Security Act ("ERISA") and seek restitution on behalf of the
plan with respect to a decline in value of the shares of CMS Energy common stock
held in the plan.
In 2003, a large majority of retiring employees elected the lump sum
payment option instead of receiving pension benefits as an annuity over time. As
a result, Consumers may be required to record a settlement loss in accordance
with SFAS No. 88 Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and Termination Benefits, which requires a
settlement loss to be recognized when the cost of all settlements paid during
the year exceeds the sum of the service and interest costs for the same year.
Consumers cannot yet determine if the amount of lump sum payments for 2003 will
exceed the threshold, but estimates that, if the threshold is exceeded, between
$55 million and $65 million could be recognized as a loss in the fourth quarter
of 2003.
Consumers cannot predict the future performance of the equity markets.
A continued
21
downturn in the equity markets could have a material negative impact on the net
asset value of the plans' trust accounts and increase the underfunding of the
Pension Plan, net of benefit obligations. This may necessitate significant cash
contributions to the Pension Plan that could negatively affect our liquidity.
Consumers also cannot predict the outcome of the ERISA litigation and
it is possible that an adverse outcome in this lawsuit could adversely affect
our financial condition and results of operations.
THE FINANCIAL DIFFICULTIES OF OUR PARENT COMPANY, CMS ENERGY, COULD ADVERSELY
AFFECT OUR ABILITY TO OBTAIN COMMON EQUITY CAPITAL, OUR CREDIT RATINGS AND OUR
ABILITY TO ACCESS THE CAPITAL MARKETS.
CMS Energy is subject to uncertainties in accessing the capital markets
that are similar to, if not more pronounced than, those discussed above in
respect of Consumers, and faces additional uncertainties associated with
successfully completing its planned asset sales. As the sole holder of our
common stock, CMS Energy is currently our only source of common equity capital.
We engage in transactions with other subsidiaries and affiliates of CMS Energy
in the ordinary course of business, including the MCV Partnership, and paid
overhead costs to CMS Energy that totaled $18 million in 2002. Any inability of
CMS Energy to successfully execute its strategy for liquidity improvement and
stabilization could have an adverse effect on our credit ratings or our ability
to access the capital markets. Dividends from Consumers are a major contribution
to CMS Energy's cash resources and significantly affect the ability of CMS
Energy to service its debt.
WE MAY BE ADVERSELY AFFECTED BY REGULATORY INVESTIGATIONS AND LAWSUITS REGARDING
"ROUND TRIP" TRADING BY OUR AFFILIATE AS WELL AS CIVIL LAWSUITS REGARDING
PRICING INFORMATION THAT TWO OF OUR AFFILIATES PROVIDED TO MARKET PUBLICATIONS.
We are a direct subsidiary of CMS Energy. As a result of round trip
trading transactions at CMS MST, CMS Energy is under investigation by the SEC
and the United States Department of Justice. CMS Energy has also received
subpoenas from U.S. Attorneys Offices regarding investigations of those trades.
CMS Energy and Consumers have also been named in numerous class action lawsuits
by individuals who allege that they purchased CMS Energy securities during a
purported class period. The cases were consolidated into a single lawsuit and an
amended and consolidated class action complaint was filed on May 1, 2003. The
consolidated complaint contains a purported class period beginning on May 1,
2000 and running through March 31, 2003. It generally seeks unspecified damages
based on allegations that the defendants violated United States securities laws
and regulations by making allegedly false and misleading statements about the
company's business and financial condition.
In May of 2002, the Board of Directors of CMS Energy received a demand
from a shareholder to commence civil actions (i) to remedy alleged breaches of
fiduciary duties by CMS Energy officers and directors in connection with round
trip trading at CMS MST, and (ii) to recover damages sustained by CMS Energy as
a result of alleged insider trades alleged to have been made by certain current
and former officers of CMS Energy and its subsidiaries. In December 2002, two
new directors were appointed to the CMS Energy Board of Directors. A special
litigation committee was formed by the Board in January 2003 to determine
whether it is in the best interest of CMS Energy to bring the action demanded by
the shareholder. The disinterested members of the Board appointed the two new
directors to serve on the committee.
On December 2, 2003, during the continuing review by the special
litigation committee, CMS Energy was served with a derivative complaint filed by
the shareholder in the Circuit Court of Jackson County, Michigan in furtherance
of his demands. CMS Energy intends to seek an
22
extension of time to answer or otherwise respond to the complaint in order for
the special litigation committee to complete its review.
CMS Energy notified appropriate regulatory and governmental agencies
that some employees at CMS MST and CMS Field Services, Inc., a former indirect
subsidiary of CMS Energy, appeared to have provided inaccurate information
regarding natural gas trades to various energy industry publications which
compile and report index prices. CMS Energy is cooperating with investigations
by the United States Department of Justice and the FERC regarding this matter.
The FERC issued an order on April 30, 2003 directing eight companies, including
CMS MST, to submit written demonstrations within forty-five days that they have
taken certain specified remedial measures with respect to the reporting of
natural gas trading data to publications that compile and publish price indices.
CMS MST made a written submission to the FERC in compliance with the FERC's
directive. On July 29, 2003, the FERC issued an order stating that CMS MST met
the requirements of the FERC's April 2003 order. On November 25, 2003, the CFTC
issued a settlement order regarding this matter. CMS MST and CMS Field Services,
Inc. agreed to pay a fine to the CFTC totaling $16 million. In the settlement,
CMS Energy neither admits nor denies the findings of the CFTC in the settlement
order.
CMS Energy has also been named as a defendant in several gas industry
civil lawsuits regarding inaccurate gas trade reporting that include a lawsuit
alleging violation of the Commodities Exchange Act and certain antitrust laws.
Other than as described above concerning the FERC and CFTC
investigations, Consumers cannot predict the outcome of these investigations and
lawsuits. It is possible that an adverse outcome in one or more of these
investigations or lawsuits could adversely affect CMS Energy's and our financial
condition and results of operations.
OUR OWNERSHIP OF A NUCLEAR GENERATING FACILITY CREATES RISKS RELATING TO NUCLEAR
ENERGY.
We own the Palisades nuclear power plant and are, therefore, subject to
the risks of nuclear generation and the storage and disposal of spent fuel and
other radioactive waste. The Nuclear Regulatory Commission ("NRC") has broad
authority under federal law to impose licensing and safety-related requirements
for the operation of nuclear generation facilities. In the event of
non-compliance, the NRC has the authority to impose fines or shut down a unit,
or both, depending upon its assessment of the severity of the situation, until
compliance is achieved. In addition, although we have no reason to anticipate a
serious nuclear incident at our plant, if an incident did occur, it could harm
our results of operations or financial condition. A major incident at a nuclear
facility anywhere in the world could cause the NRC to limit or prohibit the
operation or licensing of any domestic nuclear unit.
THE RECENT ADOPTION OF FINANCIAL ACCOUNTING STANDARDS BOARD INTERPRETATION NO.
46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES, REQUIRES US TO CONSOLIDATE
CERTAIN VARIABLE INTEREST ENTITIES IN OUR FINANCIAL STATEMENTS WHEN WE ARE THE
PRIMARY BENEFICIARY, AS DEFINED; THIS COULD AFFECT NEGATIVELY CERTAIN FINANCIAL
COVENANT RATIOS WE HAVE IN OUR FINANCING AGREEMENTS IF THE CONSOLIDATION RESULTS
IN ADDITIONAL DEBT ON OUR BALANCE SHEET.
Issued by the Financial Accounting Standards Board ("FASB") in January
2003, FASB Interpretation No. 46 requires the primary beneficiary of a variable
interest entity's activities to consolidate the variable interest entity. The
primary beneficiary is the party that absorbs a majority of the expected losses
and/or receives a majority of the expected residual returns of the variable
interest entity's activities. The consolidation requirements of FASB
Interpretation No. 46 apply immediately to variable interest entities created
after January 31, 2003. We have not created any variable interest entities in
2003. Therefore, this portion of FASB Interpretation No.
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46 has no impact on our consolidated financial statements. Public companies,
whose fiscal year is a calendar year, were required originally to implement the
guidance in this FASB Interpretation No. 46 by the third quarter of 2003.
However, on October 9, 2003 the FASB issued FASB Staff Position No. 46-6,
Effective Date of FASB Interpretation No. 46, which defers implementation of
FASB Interpretation No. 46 until the fourth quarter of 2003 for variable
interest entities and potential variable interest entities created before
February 1, 2003.
We are evaluating all of our interests in entities that are not
currently consolidated. If the completed analysis were to require us to disclose
information about or consolidate in our financial statements, the assets,
liabilities and activities of the MCV Partnership and the First Midland
Partnership, including the recognition of approximately $700 million of debt of
the MCV Limited Partnership and the First Midland Limited Partnership on our
financial statements, this could impact negatively our various financial
covenants under our financing agreements. As a result, we may have to seek
amendments to the relevant financing agreements to modify the terms of certain
of these covenants in order to remove the effect of this potential consolidation
or refinance the relevant debt. As of September 30, 2003, our investments in the
MCV Partnership and in the First Midland Limited Partnership were $404 million
and $222 million, respectively.
WE CURRENTLY UNDERRECOVER IN OUR RATES OUR PAYMENTS TO THE MCV PARTNERSHIP FOR
CAPACITY AND ENERGY, AND ARE ALSO EXPOSED TO FUTURE CHANGES IN THE MCV
PARTNERSHIP'S FINANCIAL CONDITION THROUGH OUR EQUITY AND LESSOR INVESTMENTS.
Our power purchase agreement with the MCV Partnership, which expires in
2025, provided 15.1% of our owned and contracted electric generating capacity in
2002. We estimate that we will incur estimated cash underrecoveries of payments
under the MCV Partnership power purchase agreement aggregating $263 million
through 2007. For availability payments billed by the MCV Partnership after
September 15, 2007, and not recovered from customers, we would expect to claim a
"regulatory out" under the MCV Partnership power purchase agreement. The effect
of any such action would be to reduce cash flow to the MCV Partnership, which
could in turn have an adverse effect on our equity and lessor interests in the
MCV Partnership facility. The book value of our investments in the MCV
Partnership and facility aggregated $626 million at September 30, 2003.
Further, under the MCV Partnership power purchase agreement, energy
payments to the MCV Partnership are based on the cost of coal burned at
Consumers' coal plants and costs associated with fuel inventory, operations and
maintenance, and administrative and general expenses associated with Consumers'
coal plants. However, the MCV Partnership's costs of producing electricity are
tied, in large part, to the cost of natural gas. Because natural gas prices have
increased substantially in recent years, while energy charge payments to the MCV
Partnership have not, the MCV Partnership's financial performance has been
impacted negatively.
We cannot estimate, at this time, the impact of these issues on our
future earnings or cash flow from our interest in the MCV Partnership. The
forward price of natural gas for the next 22 years and the MPSC decision in 2007
or later related to our recovery of capacity payments are the two most
significant variables in the analysis of the MCV Partnership's future financial
performance. Natural gas prices have historically been volatile and presently
there is no consensus in the marketplace on the price or range of prices of
natural gas beyond the next few years. Further, it is not presently possible for
us to predict the actions of the MPSC in 2007 or later. For reasons, at this
time we cannot predict the impact of these issues on our future earnings, cash
flows, or on the value of our equity interest in the MCV Partnership.
24
USE OF PROCEEDS
The Exchange Offer is intended to satisfy our obligations under the
Registration Rights Agreements. We will not receive any cash proceeds from the
issuance of the new bonds. The old bonds that are surrendered in exchange for
the new bonds will be retired and canceled and cannot be reissued. As a result,
the issuance of the new bonds will not result in any increase or decrease in our
indebtedness. We have agreed to bear the expenses of the Exchange Offer to the
extent indicated in the Registration Rights Agreements. No underwriter is being
used in connection with the Exchange Offer. We used the net proceeds from the
sale of the old bonds of approximately $1,262 billion, after deducting offering
discounts and expenses, as follows:
- $260.5 million to redeem the aggregate outstanding balance of
$250 million of our Senior Notes, 6.20% Reset Put Securities
due 2008, plus proceeds necessary to pay accrued interest to
the redemption date;
- approximately $32 million to pay an associated option call
payment regarding our Senior Notes, 6.20% Reset Put Securities
due 2008;
- approximately $300 million to prepay a $300 million term loan
that would have matured on July 11, 2004 with a then current
interest rate of between 5.85% and 5.92%;
- $150 million to prepay a $150 million term loan that would
have matured on March 28, 2006 with a then current interest
rate of 5.62%; and
- the remaining proceeds for general corporate purposes
including the financing of natural gas inventory to be held in
storage.
RATIO OF EARNINGS TO FIXED CHARGES
The ratios of earnings to fixed charges for the nine months ended
September 30, 2003 and for each of the years ended December 31, 1998 through
2002 are as follows:
NINE MONTHS
ENDED YEAR ENDED DECEMBER 31,
SEPTEMBER 30, PRO FORMA ----------------------------
2003 2002 2002 2001 2000 1999 1998
------------- --------- ---- ---- ---- ---- ---
Ratio of earnings to fixed charges(a)...................... 2.57 2.57(b) 2.88 1.87 2.44 2.99 2.52
----------
(a) For purposes of computing the ratios of earnings to fixed charges,
earnings represent income before income taxes and cumulative effect of
change-in-accounting principle, net interest charges and the estimated
interest portions of lease rentals, plus distributed income of equity
investees less earnings from minority interests of equity investees.
(b) The pro forma calculation assumes the new bonds were all issued on
January 1, 2002 and the related net proceeds were applied as described
under "Use of Proceeds".
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DESCRIPTION OF THE NEW BONDS
GENERAL
The new bonds are to be issued under an Indenture dated as of September
1, 1945, between Consumers and JPMorgan Chase Bank (ultimate successor to City
Bank Farmers Trust Company), as trustee (the "TRUSTEE"), as amended and
supplemented by various supplemental indentures. In connection with the change
of the state of incorporation from Maine to Michigan in 1968, Consumers
succeeded to, and was substituted for, the Maine corporation under the
Indenture. At September 30, 2003, six series of first mortgage bonds in an
aggregate principal amount of approximately $1,482 million were outstanding
under the Indenture, excluding eight series of first mortgage bonds in an
approximate aggregate principal amount of $1,794 million to secure outstanding
senior notes and credit facilities and three series of first mortgage bonds in
an approximate aggregate principal amount of $126 million to secure outstanding
pollution control revenue bonds.
The statements herein concerning the new bonds and the Indenture are a
summary and do not purport to be complete and are subject to, and qualified in
their entirety by, all of the provisions of the Indenture, which is incorporated
herein by this reference. They make use of defined terms and are qualified in
their entirety by express reference to the Indenture, including the supplements
thereto, copy of which will be available upon request to the Trustee.
PRINCIPAL, MATURITY AND INTEREST
The Indenture permits us to "re-open" this offering of each series of
new bonds without the consent of the holders of the new bonds of such series.
Accordingly, the principal amount of each series of new bonds may be increased
in the future on the same terms and conditions and with the same CUSIP numbers
as the new bonds of such series being offered by this prospectus. The Series C
Bonds will mature on April 15, 2008 and the Series D Bonds will mature on April
15, 2013. The Series F Bonds will mature on May 15, 2010. The Series H Bonds
will mature on February 17, 2009 and the Series J Bonds will mature on February
15, 2014, unless earlier redeemed or otherwise repaid. The Series C Bonds will
bear interest at 4.25% per year and the Series D Bonds will bear interest at a
rate of 5.375% per year, payable semi-annually in arrears on April 15 and
October 15 of each year, beginning April 15, 2004 and at maturity. The Series F
Bonds will bear interest at 4.00% per year, payable semi-annually in arrears on
May 15 and November 15 of each year, beginning May 15, 2004 and at maturity. The
Series H Bonds will bear interest at a rate of 4.80% per year and the Series J
Bonds will bear interest at a rate of 6.00% per year, payable semi-annually in
arrears on February 15 and August 15 of each year, beginning February 15, 2004
and at maturity. Interest will be paid to the person in whose name the new bonds
are registered at the close of business on the first calendar day of the month
in which the interest payment date occurs. Interest payable on any interest
payment date or on the date of maturity will be the amount of interest accrued
from and including the date of original issuance or from and including the most
recent interest payment date on which interest has been paid or duly made
available for payment to but excluding such interest payment date or the date of
maturity, as the case may be. So long as the new bonds are in book-entry form,
principal of and interest on the new bonds will be payable, and the new bonds
may be transferred, only through the facilities of DTC. If any interest payment
date falls on a day that is not a business day, the interest payment date will
be the next succeeding business day (and without any interest or other payment
in respect of any such delay). Interest will be computed on the basis of a
360-day year consisting of twelve 30-day months.
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REGISTRATION, TRANSFER AND EXCHANGE
Each series of new bonds will be initially issued in the form of one or
more global new bonds, in registered form, without coupons, in denominations of
$1,000 and any integral multiple thereof as described under "Book-Entry Only
Issuance -- The Depository Trust Company." The global new bonds will be
registered in the name of the nominee of DTC. Except as described under
"Book-Entry Only Issuance -- The Depository Trust Company," owners of beneficial
interests in a global new bond will not be entitled to have new bonds registered
in their names, will not receive or be entitled to receive physical delivery of
any such new bond and will not be considered the registered holder thereof under
the Indenture.
OPTIONAL REDEMPTION
Each series of new bonds will be redeemable as a whole or in part, at
our option, at any time upon at least 30 days' notice, at a redemption price
equal to the greater of (1) 100% of the principal amount of such new bonds and
(2) the sum of the present values of the Remaining Scheduled Payments (as
defined below) of principal and interest on such new bonds discounted to the
redemption date semi-annually (assuming a 360-day year consisting of twelve
30-day months) at the Treasury Rate (as defined below), plus 20 basis point for
the Series C Bonds and the Series F Bonds and plus 25 basis points for the
Series D Bonds, the Series H Bonds and the Series J Bonds, plus in any case
accrued interest on the new bonds to the date of redemption.
"TREASURY RATE" means, with respect to any redemption date, the rate per annum
equal to the semi-annual equivalent yield to maturity of the Comparable Treasury
Issue (as defined below), assuming a price for the Comparable Treasury Issue
(expressed as a percentage of its principal amount) equal to the Comparable
Treasury Price (as defined below) for such redemption date.
"COMPARABLE TREASURY ISSUE" means the United States Treasury security selected
by an Independent Investment Banker (as defined below) as having a maturity
comparable to the remaining term of the applicable new bonds to be redeemed that
would be used, at the time of selection and in accordance with customary
financial practice, in pricing new issues of corporate debt securities of
comparable maturity to the remaining term of such new bonds.
"INDEPENDENT INVESTMENT BANKER" means either Banc One Capital Markets, Inc.,
Barclays Capital Inc., J.P. Morgan Securities Inc., or Wachovia Securities, Inc.
for the Series C Bonds and the Series D Bonds, and either Banc One Capital
Markets, Inc., Barclays Capital Inc., or J.P. Morgan Securities Inc. for the
Series F Bonds, the Series H Bonds, and the Series J Bonds or, if such firms are
unwilling or unable to select the Comparable Treasury Issues, an independent
banking institution of national standing selected by us.
"COMPARABLE TREASURY PRICE" means, with respect to any redemption date, (1) the
average of the bid and asked prices for the Comparable Treasury Issue (expressed
in each case as a percentage of its principal amount) on the third business day
preceding such redemption date, as set forth in the daily statistical release
(or any successor release) published by the Federal Reserve Bank of New York and
designated "H.15(519)" or (2) if such release (or any successor release) is not
published or does not contain such prices on such business day, (a) the average
of the Reference Treasury Dealer Quotations (as defined below) for such
redemption date, after excluding the highest and lowest of such Reference
Treasury Dealer Quotations, or (b) if the Company obtains fewer than four such
Reference Treasury Dealer Quotations, the average of all such quotations.
27
"REFERENCE TREASURY DEALER QUOTATIONS" means, with respect to each Reference
Treasury Dealer (as defined below) and any redemption date, the average, as
determined by the Company, of the bid and asked prices for the Comparable
Treasury Issue (expressed in each case as a percentage of its principal amount)
quoted in writing to the Company by such Reference Treasury Dealer at 5:00 p.m.
on the third business day preceding such redemption date.
"REFERENCE TREASURY DEALER" means (1) each of Banc One Capital Markets, Inc.,
Barclays Capital Inc., J.P. Morgan Securities Inc. and Wachovia Securities, Inc.
for the Series C Bonds, and the Series D Bonds and either Banc One Capital
Markets, Inc., Barclays Capital Inc., or J.P. Morgan Securities Inc. for the
Series F Bonds, the Series H Bonds and the Series J Bonds and their respective
successors; provided, however, that if any of the foregoing shall cease to be a
primary U.S. government securities dealer in New York City (a "PRIMARY TREASURY
DEALER"), we shall replace that former dealer with another Primary Treasury
Dealer and (2) up to four other Primary Treasury Dealers selected by us.
"REMAINING SCHEDULED PAYMENTS" means, with respect to each new bond to be
redeemed, the remaining scheduled payments of the principal thereof and interest
thereon that would be due after the related redemption date but for such
redemption; provided, however, that, if that redemption date is prior to an
interest payment date with respect to such new bond, the amount of the next
succeeding scheduled interest payment thereon will be reduced by the amount of
interest accrued thereon to that redemption date.
We will mail notice of any redemption between 30 days and 60 days
before the redemption date to each holder of the debt securities to be redeemed.
SINKING FUND REQUIREMENT
The new bonds will not have the benefit of any sinking fund.
ISSUANCE OF ADDITIONAL FIRST MORTGAGE BONDS
Additional first mortgage bonds may be issued under the Indenture for
up to 60% of unfunded net property additions or against the deposit of an equal
amount of cash, if, for any period of twelve consecutive months within the
fifteen preceding calendar months, the net earnings of Consumers (before income
or excess profit taxes) shall have been at least twice the interest requirement
for one year on all first mortgage bonds outstanding and to be issued and on
indebtedness of prior or equal rank. Additional first mortgage bonds may also be
issued to refund first mortgage bonds outstanding under the Indenture. Deposited
cash may be applied to the retirement of first mortgage bonds or be withdrawn in
an amount equal to the principal amount of first mortgage bonds which may be
issued on the basis of unfunded net property additions. As of October 31, 2003,
unfunded net property additions were $2.592 billion. Consumers could issue
$1.555 billion of additional first mortgage bonds on the basis of such property
additions. In addition, as of December 1, 2003, Consumers could issue $260.7
million of additional first mortgage bonds on the basis of first mortgage bonds
previously retired.
LIMITATIONS ON DIVIDENDS
The Indenture does not restrict Consumers' ability to pay dividends on
its common stock.
28
CONCERNING THE TRUSTEE
JPMorgan Chase Bank is the Trustee and Paying Agent. Consumers and its
affiliates maintain lending, depository and other normal banking relationships
with JPMorgan Chase Bank. JPMorgan Chase Bank is also a lender to Consumers and
its affiliates.
The Indenture provides that Consumers' obligations to compensate the
Trustee and reimburse the Trustee for expenses, disbursements and advances will
constitute indebtedness which will be secured by a lien generally prior to that
of the first mortgage bonds upon all property and funds held or collected by the
Trustee as such.
The Trustee or the holders of 20% in total principal amount of the
first mortgage bonds may declare the principal due on default, but the holders
of a majority in total principal amount may rescind such declaration and waive
the default if the default has been cured. Subject to certain limitations, the
holders of a majority in total principal amount of the first mortgage bonds may
generally direct the time, method and place of conducting any proceeding for the
enforcement of the Indenture. No first mortgage bondholder has the right to
institute any proceedings for the enforcement of the Indenture unless that
holder has given the Trustee written notice of a default, the holders of 20% of
total principal amount of outstanding first mortgage bonds shall have tendered
to the Trustee reasonable security or indemnity against costs, expenses and
liabilities and requested the Trustee to take action, the Trustee shall have
declined to take action or failed to do so within 60 days and no inconsistent
directions shall have been given by the holders of a majority in total principal
amount of the first mortgage bonds.
PRIORITY AND SECURITY
The new bonds are ranked equally with all other series of first
mortgage bonds now outstanding or issued later under the Indenture. The
Indenture is a direct first lien on substantially all of Consumers' property and
franchises (other than certain property expressly excluded from the lien (such
as cash, bonds, stock and certain other securities, contracts, accounts and
bills receivables, judgments and other evidences of indebtedness, stock in
trade, materials or supplies manufactured or acquired for the purpose of sale
and/or resale in the usual course of business or consumable in the operation of
any of the properties of Consumers, natural gas, oil and minerals, motor
vehicles and certain real property listed in Schedule A to the Indenture)). This
lien is subject to excepted encumbrances (and certain other limitations) as
defined and described in the Indenture. The new bonds are also subject to
certain provisions of Michigan law which provide that, under certain
circumstances, the State of Michigan's lien against property on which it has
incurred costs related to any environmental response activity that is
subordinate to prior recorded liens can become superior to such prior liens
pursuant to court order. The Indenture permits, with certain limitations, the
acquisition of property subject to prior liens and, under certain conditions,
permits the issuance of additional indebtedness under such prior liens to the
extent of 60% of net property additions made by Consumers to the property
subject to such prior liens.
RELEASE AND SUBSTITUTION OF PROPERTY
The Indenture provides that, subject to various limitations, property
may be released from the lien thereof when sold or exchanged, or contracted to
be sold or exchanged, upon the basis of:
- cash deposited with the Trustee;
- bonds or purchase money obligations delivered to the Trustee;
29
- prior lien bonds delivered to the Trustee or reduced or
assumed by the purchaser;
- property additions acquired in exchange for the property
released; or
- a showing that unfunded net property additions exist.
The Indenture also permits the withdrawal of cash upon a showing that unfunded
net property additions exist or against the deposit of bonds or the application
thereof to the retirement of bonds.
MODIFICATION OF INDENTURE
The Indenture, the rights and obligations of Consumers and the rights
of the holders of first mortgage bonds may be modified by Consumers with the
consent of the holders of 75% in principal amount of the first mortgage bonds
and of not less than 60% of the principal amount of each series affected. In
general, however, no modification of the terms of payment of principal or
interest and no modification affecting the lien or reducing the percentage
required for modification is effective against any first mortgage bonds without
the first mortgage bondholders' consent. Consumers has reserved the right
without any consent or other action by the holders of first mortgage bonds of
any series created after September 15, 1993 or by the holder of any senior note
or exchange note that is secured by first mortgage bonds to amend the Indenture
in order to substitute a majority in principal amount of first mortgage bonds
outstanding under the Indenture for the 75% requirement set forth above (and
then only in respect of such series of outstanding bonds as shall be affected by
the proposed action) and to eliminate the requirement for a series-by-series
consent requirement.
DEFAULTS
The Indenture defines the following as "defaults":
- failure to pay principal when due;
- failure to pay interest for sixty days;
- failure to pay any installment of any sinking or other
purchase fund for ninety days;
- certain events in bankruptcy, insolvency or reorganization;
and
- failure to perform any other covenant for ninety days
following written demand by the Trustee for Consumers to cure
such failure.
Consumers has covenanted to pay interest on any overdue principal and
(to the extent permitted by law) on overdue installments of interest, if any, on
the first mortgage bonds under the Indenture at the rate of 6% per year. The
Indenture does not contain a provision requiring any periodic evidence to be
furnished as to the absence of default or as to compliance with the terms
thereof. However, Consumers is required by law to furnish annually to the
Trustee a certificate as to compliance with all conditions and covenants under
the Indenture.
BOOK-ENTRY ONLY ISSUANCE -- THE DEPOSITORY TRUST COMPANY
The new bonds that are exchanged for old bonds that were sold to QIBs
will be in the form of one or more bonds in registered, global form without
interest coupons (the "GLOBAL NEW BONDS").
30
Upon issuance, the global new bonds will be deposited with the Trustee, as
custodian for DTC, and registered in the name of DTC or its nominee, in each
case for credit to the accounts of DTC's Direct Participants and Indirect
Participants (each as defined below).
Beneficial interests in all global new bonds and all new bonds in
certificated form ("CERTIFICATED NEW BONDS"), if any, will be subject to the
applicable rules and procedures of DTC and its Direct Participants or Indirect
Participants, which may change from time to time.
The global new bonds may be transferred, in whole and not in part, only
to another nominee of DTC or to a successor of DTC or its nominee in certain
limited circumstances. Beneficial interests in the global new bonds may be
exchanged for certificated new bonds in certain limited circumstances. See "--
Exchange of Interests in Global New Bonds for Certificated New Bonds."
DEPOSITARY PROCEDURES
DTC has advised Consumers that DTC is a limited-purpose trust company
created to hold securities for its participating organizations (collectively,
the "DIRECT PARTICIPANTS") and to facilitate the clearance and settlement of
transactions in those securities between Direct Participants through electronic
book-entry changes in accounts of Direct Participants. The Direct Participants
include securities brokers and dealers (including the Initial Purchasers),
banks, trust companies, clearing corporations and certain other organizations.
Access to DTC's system is also available to other entities that clear through or
maintain a direct or indirect, custodial relationship with a Direct Participant
(collectively, the "INDIRECT PARTICIPANTS"). DTC may hold securities
beneficially owned by other persons only through the Direct Participants or
Indirect Participants, and such other persons' ownership interest and transfer
of ownership interest will be recorded only on the records of the appropriate
Direct Participant and/or Indirect Participant, and not on the records
maintained by DTC.
DTC has also advised Consumers that, pursuant to DTC's procedures, (1)
upon deposit of the global new bonds, DTC will credit the accounts of the Direct
Participants designated by the Initial Purchasers with portions of the principal
amount of the global new bonds allocated by the Initial Purchasers to such
Direct Participants and (2) DTC will maintain records of the ownership interests
of such Direct Participants in the global new bonds and the transfer of
ownership interests by and between Direct Participants. DTC will not maintain
records of the ownership interests of, or the transfer of ownership interests by
and between, Indirect Participants or other owners of beneficial interests in
the global new bonds. Direct Participants and Indirect Participants must
maintain their own records of the ownership interests of, and the transfer of
ownership interests by and between, Indirect Participants and other owners of
beneficial interests in the global new bonds. Investors in the global new bonds
may hold their interests therein directly through DTC if they are Direct
Participants in DTC or indirectly through organizations that are Direct
Participants in DTC. All ownership interests in any global new bonds will be
subject to the procedures and requirements of DTC.
The laws of some states require that certain persons take physical
delivery in definitive, certificated form, of securities that they own. This may
limit or curtail the ability to transfer beneficial interests in a global new
bond to such persons. Because DTC can act only on behalf of Direct Participants,
which in turn act on behalf of Indirect Participants and others, the ability of
a person having a beneficial interest in a global new bond to pledge such
interest to persons or entities that are not Direct Participants in DTC, or to
otherwise take actions in respect of such interests, may be affected by the lack
of physical certificates evidencing such interests. For certain other
restrictions on the transferability of the new bonds, see "-- Exchange of
Interests in Global New Bonds for Certificated New Bonds."
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EXCEPT AS DESCRIBED IN "-- EXCHANGE OF INTERESTS IN GLOBAL NEW BONDS
FOR CERTIFICATED NEW BONDS", OWNERS OF BENEFICIAL INTERESTS IN THE GLOBAL NEW
BONDS WILL NOT HAVE NEW BONDS REGISTERED IN THEIR NAMES, WILL NOT RECEIVE
PHYSICAL DELIVERY OF CERTIFICATED NEW BONDS IN CERTIFICATED FORM AND WILL NOT BE
CONSIDERED THE REGISTERED OWNERS OR HOLDERS THEREOF UNDER THE INDENTURE FOR ANY
PURPOSE.
Under the terms of the Indenture, Consumers and the Trustee will treat
the persons in whose names the new bonds are registered (including new bonds
represented by global new bonds) as the owners thereof for the purpose of
receiving payments and for any and all other purposes whatsoever. Payments in
respect of the principal, premium, liquidated damages, if any, and interest on
global new bonds registered in the name of DTC or its nominee will be payable by
the Trustee to DTC or its nominee as the registered holder under the Indenture.
Consequently, neither Consumers, the Trustee nor any agent of Consumers or the
Trustee has or will have any responsibility or liability for (1) any aspect of
DTC's records or any Direct Participant's or Indirect Participant's records
relating to or payments made on account of beneficial ownership interests in the
global new bonds or for maintaining, supervising or reviewing any of DTC's
records or any Direct Participant's or Indirect Participant's records relating
to the beneficial ownership interests in any global new bond or (2) any other
matter relating to the actions and practices of DTC or any of its Direct
Participants or Indirect Participants.
DTC has advised Consumers that its current payment practice (for
payments of principal, interest and the like) with respect to securities such as
the new bonds is to credit the accounts of the relevant Direct Participants with
such payment on the payment date in amounts proportionate to such Direct
Participant's respective ownership interests in the applicable global new bonds
as shown on DTC's records. Payments by Direct Participants and Indirect
Participants to the beneficial owners of the new bonds will be governed by
standing instructions and customary practices between them and will not be the
responsibility of DTC, the Trustee or Consumers. Neither Consumers nor the
Trustee will be liable for any delay by DTC or its Direct Participants or
Indirect Participants in identifying the beneficial owners of the new bonds, and
Consumers and the Trustee may conclusively rely on and will be protected in
relying on instructions from DTC or its nominee as the registered owner of the
new bonds for all purposes.
The global new bonds will trade in DTC's Same-Day Funds Settlement
System and, therefore, transfers between Direct Participants in DTC will be
effected in accordance with DTC's procedures, and will be settled in immediately
available funds. Transfers between Indirect Participants who hold an interest
through a Direct Participant will be effected in accordance with the procedures
of such Direct Participant but generally will settle in immediately available
funds.
DTC has advised Consumers that it will take any action permitted to be
taken by a holder of new bonds of a series only at the direction of one or more
Direct Participants to whose account interests in the related global new bonds
are credited and only in respect of such portion of the aggregate principal
amount of such new bonds as to which such Direct Participant or Direct
Participants has or have given direction. However, if there is an event of
default with respect to the new bonds, DTC reserves the right to exchange the
related global new bonds (without the direction of one or more of its Direct
Participants) for legended certificated new bonds, and to distribute such
certificated new bonds to its Direct Participants. See "-- Exchange of Interests
in Global New Bonds for Certificated New Bonds."
Although DTC has agreed to the foregoing procedures to facilitate
transfers of interests in the global new bonds among Direct Participants, it is
under no obligation to perform or to continue to perform such procedures, and
such procedures may be discontinued at any time. None of Consumers, the Initial
Purchasers or the Trustee will have any responsibility for the performance
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by DTC, or its respective Direct Participants and Indirect Participants, of
their respective obligations under the rules and procedures governing any of
their operations.
The information in this section concerning DTC and its book-entry
system has been obtained from DTC, and Consumers takes no responsibility for the
accuracy thereof.
EXCHANGE OF INTERESTS IN GLOBAL NEW BONDS FOR CERTIFICATED NEW BONDS
Global new bonds may be exchanged for certificated new bonds if (1) (a)
DTC notifies Consumers that it is unwilling or unable to continue as depositary
for the global new bonds or Consumers determines that DTC is unable to act as
such depositary and Consumers thereupon fails to appoint a successor depositary
within 90 days or (b) DTC has ceased to be a clearing agency registered under
the Exchange Act, (2) Consumers, at its option, notifies the Trustee in writing
that it elects to cause the issuance of certificated new bonds or (3) there
shall have occurred and be continuing a default or an event of default with
respect to the new bonds. In any such case, Consumers will notify the Trustee in
writing that, upon surrender by the Direct Participants and Indirect
Participants of their interest in such global new bond, certificated new bonds
will be issued to each person that such Direct Participants and Indirect
Participants and DTC identify as being the beneficial owner of the related new
bonds.
Beneficial interests in global new bonds held by any Direct Participant
or Indirect Participant may be exchanged for certificated new bonds upon request
to DTC, or by such Direct Participant (for itself or on behalf of an Indirect
Participant), to the Trustee in accordance with customary DTC procedures.
Certificated new bonds delivered in exchange for any beneficial interest in any
global new bond will be registered in the names, and issued in any approved
denominations, requested by DTC on behalf of such Direct Participants or
Indirect Participants (in accordance with DTC's customary procedures).
Neither Consumers nor the Trustee will be liable for any delay by the
holder of global new bonds or DTC in identifying the beneficial owners of the
related new bonds, and Consumers and the Trustee may conclusively rely on, and
will be protected in relying on, instructions from the holder of the global new
bond or DTC for all purposes.
CERTIFICATED NEW BONDS
Certificated new bonds may be exchangeable for other certificated new
bonds of any authorized denominations and of a like aggregate principal amount
and tenor. Certificated new bonds may be presented for exchange, and may be
presented for registration of transfer (duly endorsed, or accompanied by a duly
executed written instrument of transfer), at the designated office of the
Trustee in Detroit, Michigan (the "SECURITY REGISTRAR"). The Security Registrar
will not charge a service charge for any registration of transfer or exchange of
new bonds; however, Consumers may require payment by a holder of a sum
sufficient to cover any tax, assessment or other governmental charge payable in
connection therewith, as described in the Indenture. Such transfer or exchange
will be effected upon the Security Registrar being satisfied with the documents
of title and identity of the person making the request. Consumers may at any
time designate additional transfer agents with respect to the new bonds.
Consumers shall not be required to (a) issue, exchange or register the
transfer of any certificated new bond for a period of 15 days next preceding the
mailing of notice of redemption of such new bond or (b) exchange or register the
transfer of any certificated new bond or portion thereof selected, called or
being called for redemption, except, in the case of any certificated new bond to
be redeemed in part, the portion thereof not so to be redeemed.
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If a certificated new bond is mutilated, destroyed, lost or stolen, it
may be replaced at the office of the Security Registrar upon payment by the
holder of such expenses as may be incurred by Consumers and the Security
Registrar in connection therewith and the furnishing of such evidence and
indemnity as Consumers and the Security Registrar may require. Mutilated new
bonds must be surrendered before substitute new bonds will be issued.
SAME DAY SETTLEMENT
Payments in respect of the new bonds represented by the global new
bonds (including principal, premium, if any, and interest) will be made by wire
transfer of immediately available same day funds to the accounts specified by
DTC as the holder of the global new bonds. Principal, premium, if any, and
interest and liquidated damages, if any, on all certificated new bonds in
registered form will be payable at the office or agency of the Trustee in The
City of New York, except that, at the option of Consumers, payment of any
interest and liquidated damages, if any, may be made except for DTC (1) by check
mailed to the address of the person entitled thereto as such address shall
appear in the security register or (2) by wire transfer to an account maintained
by the person entitled thereto as specified in the security register.
RATINGS
S&P has assigned each series of old bonds a rating of BBB-, Moody's has
assigned each series of old bonds a rating of Baa3 and Fitch has assigned each
series of old bonds a rating of BB+. The terms of the new bonds will be
identical in all material respects to the terms of the old bonds, except that
the registration rights and related liquidated damages provisions and the
transfer restrictions applicable to the old bonds will not be applicable to the
new bonds. The new bonds will have the same financial terms and covenants as the
old bonds, and will be subject to the same business and financial risks. The
ratings mentioned above reflect only the views of such ratings agencies, and do
not constitute a recommendation to buy, sell or hold securities. In general,
ratings address credit risk. Each rating should be evaluated independently of
any other rating. An explanation of the significance of such ratings may be
obtained only from such rating agencies at the following addresses: Standard &
Poor's, 25 Broadway, New York, New York 10004; Moody's Investors Service, Inc.,
99 Church Street, New York, New York 10007; and Fitch, Inc., 1 State Street
Plaza, New York, New York 10004. The security rating may be subject to revision
or withdrawal at any time by the assigning rating organization, and,
accordingly, there can be no assurance that such ratings will remain in effect
for any period of time or that they will not be revised downward or withdrawn
entirely by the rating agencies if, in their judgment, circumstances warrant.
Neither Consumers nor the Initial Purchasers have undertaken any responsibility
to oppose any proposed downward revision or withdrawal of a rating on the old
bonds. Any such downward revision or withdrawal of such ratings may have an
adverse effect on the market price of the new bonds.
THE EXCHANGE OFFER
PURPOSE OF THE EXCHANGE OFFER
We initially sold the old bonds in private offerings to Banc One
Capital Markets, Inc., Barclays Capital Inc., J.P. Morgan Securities Inc.,
Comerica Securities, Inc., Wachovia Securities, Inc., ABN AMRO Incorporated,
Huntington Capital Corp., Tokyo-Mitsubishi International plc, and Fifth Third
Securities, Inc. (the "INITIAL PURCHASERS") pursuant to various purchase
agreements between us and them. The Initial Purchasers resold the old bonds to
34
qualified institutional buyers in reliance on, and subject to the restrictions
imposed under, Rule 144A under the Securities Act. As of the date of this
prospectus, $1.275 billion of the old bonds are outstanding.
EXCHANGE OFFER REGISTRATION
In connection with the private offering of the old bonds, we entered
into various Registration Rights Agreements with the Initial Purchasers pursuant
to which we agreed, for the benefit of the holders of the old bonds, at our cost
to:
- within either 217 days for the Series F Bonds or 240 days for
the Series C Bonds, the Series D Bonds, the Series H Bonds and
the Series J Bonds following the original issue date of such
old bonds, prepare and file with the SEC an exchange offer
registration statement with respect to a proposed Exchange
Offer and the issuance and delivery to the holders, in
exchange for the old bonds of each series, of new bonds, which
will have terms identical in all material respects to the old
bonds of such series, except that the new bonds will not
contain terms with respect to transfer restrictions and will
not provide for the payment of additional interest under the
circumstances described below;
- use our reasonable best efforts to cause the exchange offer
registration statement to be declared effective under the
Securities Act within either 307 days for the Series F Bonds
or 330 days for the Series C Bonds, the Series D Bonds, the
Series H Bonds, and the Series J Bonds after the original
issue date of such old bonds;
- use our reasonable best efforts to keep the exchange offer
registration statement effective until the closing of the
Exchange Offer; and
- use our reasonable best efforts to cause the Exchange Offer to
be consummated not later than 30 days following the
effectiveness of the exchange offer registration statement.
The new bonds will be issued under the Indenture. Upon the
effectiveness of the exchange offer registration statement, we will offer the
new bonds in exchange for surrender of the old bonds of the related series. We
will keep the Exchange Offer open for not less than 20 business days after the
date notice of the Exchange Offer is mailed to the holders of the old bonds of
the related series, or longer if required by applicable law.
For each old bond surrendered to us pursuant to the Exchange Offer and
not withdrawn by the holder, the holder of the old bond will receive a new bond
having a principal amount equal to that of the surrendered old bond. Interest on
each new bond will accrue from the last date on which interest was paid on the
old bond surrendered in exchange or, if no interest has been paid on that old
bond, from the original issue date of the new bonds.
ADDITIONAL INTEREST
We are making this Exchange Offer to satisfy our obligations and your
registration rights under the Registration Rights Agreements. If a registration
default occurs, which means one of the following events occurs:
- the exchange offer registration statement is not filed with
the SEC on or prior to the either the 217th calendar day for
the Series F Bonds or the 240th calendar day for the Series C
Bonds, the Series D Bonds, the Series H Bonds and the Series J
Bonds following the original issue date of such old bonds;
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- the exchange offer registration statement is not declared
effective on or prior to the either the 307th calendar day for
the Series F Bonds or the 330th calendar day for the Series C
Bonds, the Series D Bonds, the Series H Bonds and the Series J
Bonds following the original issue date of such old bonds;
- the Exchange Offer is not consummated on or prior to the 30th
calendar day following effectiveness of the exchange offer
registration statement;
- if required, a shelf registration statement with respect to
the old bonds is not filed with the SEC on or prior to the
date specified above;
- if required, a shelf registration statement with respect to
the old bonds is not declared effective on or prior to such
date specified above; or
- either the exchange offer registration statement or a shelf
registration statement has been filed and declared effective
but after its effective date ceases to be effective or is
unusable for its intended purpose without being succeeded
within 15 business days by a post-effective amendment to such
registration statement that cures such failure and that is
itself declared effective by the SEC within five business
days;
then additional interest will accrue on the old bonds, from and
including the date on which any such registration default shall occur to, but
excluding, the date on which the registration default has been cured, at the
rate of 0.50% per year. We will have no other liabilities for monetary damages
with respect to our registration obligations. The receipt of additional interest
will be the sole monetary remedy available to a holder if we fail to meet these
obligations.
SEC INTERPRETATIONS
Based on existing interpretations of the Securities Act by the staff of
the SEC in several no-action letters to third parties, and subject to the
immediately following sentence, we believe that the new bonds issued pursuant to
the Exchange Offer may be offered for resale, resold or otherwise transferred by
the holders, other than holders who are broker-dealers, without further
compliance with the registration and prospectus delivery provisions of the
Securities Act. Any purchaser of the old bonds, however, who is our affiliate or
who intends to participate in the Exchange Offer for the purpose of distributing
the new bonds, or any participating broker-dealer who purchased the old bonds
for its own account, other than as a result of market-making activities or other
trading activities, to resell pursuant to Rule 144A or any other available
exemption under the Securities Act:
- will not be able to rely on the interpretations by the staff
of the SEC;
- will not be able to tender its old bonds in the Exchange
Offer; and
- must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any sale
or transfer of the new bonds, unless the sale or transfer is
made under an exemption from those requirements.
We do not intend to seek our own interpretation regarding the Exchange
Offer, and we cannot assure you that the staff of the SEC would make a similar
determination with respect to the new bonds as it has in other interpretations
to third parties.
Each holder of the old bonds of a series, other than specified holders,
who wishes to exchange such old bonds for the related new bonds in the Exchange
Offer will be required to make representations that:
36
- it is not our affiliate;
- the old bonds being exchanged, and any new bonds to be
received by it, have been or will be acquired in the ordinary
course of its business; and
- it has no arrangement or understanding with any person to
participate in the distribution, within the meaning of the
Securities Act, of the new bonds.
In addition, in connection with resales of the new bonds, any
participating broker-dealer must deliver a prospectus meeting the requirements
of the Securities Act. The staff of the SEC has taken the position that
participating broker-dealers may fulfill their prospectus delivery requirements
with respect to the new bonds, other than a resale of an unsold allotment from
the original sale of the old bonds, with the prospectus contained in the
exchange offer registration statement. Under the Registration Rights Agreements,
we have agreed, for a period of one year following the consummation of the
Exchange Offer, to make available a prospectus meeting the requirements of the
Securities Act to any participating broker-dealer for use in connection with any
resale of any new bonds acquired in the Exchange Offer.
SHELF REGISTRATION
If:
(1) we are not permitted to consummate the Exchange Offer because
the Exchange Offer is not permitted by applicable law or SEC
policy; or
(2) upon notice to us by any holder in specified circumstances,
and
(3) we are eligible to use Securities Act Form S-3
we will, in addition to or instead of effecting the registration of the new
bonds pursuant to the exchange offer registration statement, as the case may be,
(1) on or prior to 90 days for the Series H Bonds and the Series J
Bonds and 180 days for the Series C Bonds, the Series D Bonds
and the Series F Bonds after the earlier of any event in (1)
or (2) above, file with the SEC a shelf registration statement
covering resales of the old bonds;
(2) use our reasonable best efforts to cause the shelf
registration statement to be declared effective under the
Securities Act not later than 180 days for the Series H Bonds
and the Series J Bonds and 270 days for the Series C Bonds,
the Series D Bonds and the Series F Bonds after the date of
any event in (1) or (2) above;
(3) use our reasonable best efforts to keep the shelf registration
statement effective for two years; and
(4) use our reasonable best efforts to ensure that the shelf
registration statement and any amendment to the shelf
registration statement and any prospectus included in the
shelf registration statement conforms with the requirements of
the Securities Act.
We will, in the event of the filing of a shelf registration statement,
provide to each holder of the old bonds that are covered by the shelf
registration statement copies of the prospectus that is a part of the shelf
registration statement and notify each holder when the shelf registration
statement has become effective. A holder of the old bonds that sells the old
bonds pursuant to
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the shelf registration statement generally will be required to be named as a
selling security holder in the related prospectus, to deliver information to be
used in connection with the shelf registration, and to deliver a prospectus to
purchasers, will be subject to the civil liability provisions under the
Securities Act in connection with the sales and will be bound by the provisions
of the Registration Rights Agreements that are applicable to the holder,
including indemnification obligations.
EXPIRATION DATE; EXTENSIONS; AMENDMENTS; TERMINATION
The term "EXPIRATION DATE" shall mean ________ __, 2004 unless we, in
our sole discretion, extend the Exchange Offer, in which case the term
"EXPIRATION DATE" shall mean the latest date to which the Exchange Offer is
extended.
To extend the Expiration Date, we will notify the Exchange Agent of any
extension by oral or written notice and will notify the holders of the old bonds
by means of a press release or other public announcement prior to 9:00 a.m., New
York City time, on the next business day after the previously scheduled
Expiration Date. Such announcement may state that we are extending the Exchange
Offer for a specified period of time.
We reserve the right:
- to delay acceptance of any old bonds, extend the Exchange
Offer or terminate the Exchange Offer and not permit
acceptance of the old bonds not previously accepted if any of
the conditions set forth herein under "--Conditions" shall
have occurred and shall not have been waived by us, by giving
oral or written notice of such delay, extension or termination
to the Exchange Agent, or
- to amend the terms of the Exchange Offer in any manner deemed
by it to be advantageous to the holders of the old bonds.
Any such delay in acceptance, extension, termination or amendment will be
followed as promptly as practicable by oral or written notice thereof to the
Exchange Agent. If the Exchange Offer is amended in a manner determined by us to
constitute a material change, we will promptly disclose such amendment in a
manner reasonably calculated to inform the holders of the old bonds of such
amendment.
Without limiting the manner in which we may choose to make public
announcement of any delay, extension, amendment or termination of the Exchange
Offer, we shall have no obligations to publish, advertise, or otherwise
communicate any such public announcement, other than by making a timely release
to an appropriate news agency.
INTEREST ON THE NEW BONDS
Interest on the new bonds will accrue from the last date on which
interest was paid on the old bonds, or, if no interest has been paid on a series
of old bonds, from the date of issuance of each series of old bonds for which
the Exchange Offer is being made. Relevant interest information for each series
of the new bonds is as follows:
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Interest Date of
Semiannual Commencement Issuance
Issuance Rate Dates Payable Date of New Bonds of Old Bonds
-------- ---- ------------- ----------------- ------------
Series C Bonds 4.25% April 15 and October 15 April 15, 2004 April 30, 2003
Series D Bonds 5.375% April 15 and October 15 April 15, 2004 April 30, 2003
Series F Bonds 4.00% May 15 and November 15 May 15, 2004 May 23, 2003
Series H Bonds 4.80% February 15 and August 15 February 15, 2004 August 26, 2003
Series J Bonds 6.00% February 15 and August 15 February 15, 2004 August 26, 2003
PROCEDURES FOR TENDERING
To tender in the Exchange Offer, a holder must complete, sign and date
the Letter of Transmittal, or a facsimile thereof, have the signatures thereon
medallion guaranteed if required by the Letter of Transmittal, and mail or
otherwise deliver such Letter of Transmittal or such facsimile, together with
any other required documents, to the Exchange Agent prior to 5:00 p.m., New York
City time, on the Expiration Date. In addition, either (i) a timely confirmation
of a book-entry transfer (a "BOOK-ENTRY CONFIRMATION") of such old bonds into
the Exchange Agent's account at The Depositary (the "BOOK-ENTRY TRANSFER
FACILITY") pursuant to the procedure for book-entry transfer described below,
must be received by the Exchange Agent prior to the Expiration Date or (ii) the
holder must comply with the guaranteed delivery procedures described below. THE
METHOD OF DELIVERY OF LETTERS OF TRANSMITTAL AND ALL OTHER REQUIRED DOCUMENTS TO
THE EXCHANGE AGENT IS AT THE ELECTION AND RISK OF THE HOLDERS. IF SUCH DELIVERY
IS BY MAIL, IT IS RECOMMENDED THAT REGISTERED MAIL, PROPERLY INSURED, WITH
RETURN RECEIPT REQUESTED, BE USED. IN ALL CASES, SUFFICIENT TIME SHOULD BE
ALLOWED TO ASSURE TIMELY DELIVERY TO THE EXCHANGE AGENT BEFORE THE EXPIRATION
DATE. NO LETTERS OF TRANSMITTAL OR OTHER REQUIRED DOCUMENTS SHOULD BE SENT TO
CONSUMERS. Delivery of all documents must be made to the Exchange Agent at its
address set forth below. Holders may also request their respective brokers,
dealers, commercial banks, trust companies or nominees to effect such tender for
such holders.
The tender by a holder of old bonds will constitute an agreement
between such holder and Consumers in accordance with the terms and subject to
the conditions set forth herein and in the Letter of Transmittal. Any beneficial
owner whose old bonds are registered in the name of a broker, dealer, commercial
bank, trust company or other nominee and who wishes to tender should contact
such registered holder promptly and instruct such registered holder to tender on
his behalf.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the
case may be, must be medallion guaranteed by any member firm of a registered
national securities exchange or of the National Association of Securities
Dealers, Inc., a commercial bank or trust company having an office or
correspondent in the United States or an "eligible guarantor" institution within
the meaning of Rule 17Ad-15 under the Exchange Act (each an "ELIGIBLE
INSTITUTION") unless the old bonds tendered pursuant thereto are tendered for
the account of an Eligible Institution.
If the Letter of Transmittal is signed by trustees, executors,
administrators, guardians,attorneys-in-fact, officers of corporations, or others
acting in a fiduciary or representative capacity, such person should so indicate
when signing, and unless waived by Consumers, evidence satisfactory to Consumers
of their authority to so act must be submitted with the Letter of Transmittal.
All questions as to the validity, form, eligibility (including time of
receipt) and withdrawal of the tendered old bonds will be determined by
Consumers, in its sole discretion, which
39
determination will be final and binding. Consumers reserves the absolute right
to reject any and all old bonds not properly tendered or any old bonds which, if
accepted, would, in the opinion of counsel for Consumers, be unlawful. Consumers
also reserves the absolute right to waive any irregularities or conditions of
tender as to particular old bonds. Consumers' interpretation of the terms and
conditions of the Exchange Offer (including the instructions in the Letter of
Transmittal) will be final and binding on all parties. Unless waived, any
defects or irregularities in connection with tenders of old bonds must be cured
within such time as Consumers shall determine. Neither Consumers, the Exchange
Agent nor any other person shall be under any duty to give notification of
defects or irregularities with respect to tenders of old bonds, nor shall any of
them incur any liability for failure to give such notification. Tenders of old
bonds will not be deemed to have been made until such irregularities have been
cured or waived. Any old bonds received by the Exchange Agent that are not
properly tendered and as to which the defects or irregularities have not been
cured or waived will be returned without cost to such holder by the Exchange
Agent, unless otherwise provided in the Letter of Transmittal, as soon as
practicable following the Expiration Date.
In addition, Consumers reserves the right, in its sole discretion,
subject to the provisions of the Indenture, to purchase or make offers for any
old bonds that remain outstanding subsequent to the Expiration Date or, as set
forth under "--Conditions," to terminate the Exchange Offer in accordance with
the terms of the Registration Rights Agreements, and to the extent permitted by
applicable law, purchase old bonds in the open market, in privately negotiated
transactions or otherwise. The terms of any such purchases or offers could
differ from the terms of the Exchange Offer.
ACCEPTANCE OF OLD BONDS FOR EXCHANGE; DELIVERY OF NEW BONDS
Upon satisfaction or waiver of all of the conditions to the Exchange
Offer, all old bonds properly tendered will be accepted promptly after the
Expiration Date, and the new bonds will be issued promptly after acceptance of
the old bonds. See "--Conditions." For purposes of the Exchange Offer, the old
bonds shall be deemed to have been accepted as validly tendered for exchange
when Consumers gives oral or written notice to the Exchange Agent.
In all cases, issuance of new bonds for old bonds that are accepted for
exchange pursuant to the Exchange Offer will be made only after the Exchange
Agent has timely received a Book-Entry Confirmation of such old bonds into its
account at the Book-Entry Transfer Facility and a properly completed and duly
executed Letter of Transmittal and all other required documents. If any tendered
old bonds are not accepted for any reason set forth in the terms and conditions
of the Exchange Offer, such unaccepted or such nonexchanged old bonds will be
credited to an account maintained with such Book- Entry Transfer Facility as
promptly as practicable after the expiration or termination of the Exchange
Offer.
BOOK-ENTRY TRANSFER
The Exchange Agent will make a request to establish an account with
respect to the old bonds at the Book-Entry Transfer Facility for purposes of the
Exchange Offer within two business days after the date of this prospectus. Any
financial institution that is a participant in the Book-Entry Transfer
Facility's systems may make book-entry delivery of old bonds by causing the
Book-Entry Transfer Facility to transfer such old bonds into the Exchange
Agent's account at the Book-Entry Transfer Facility in accordance with such
Book-Entry Transfer Facility's procedures for transfer. However, the Letter of
Transmittal (or facsimile) thereof with any required signature guarantees and
any other required documents must, in any case, be transmitted to and received
by the Exchange Agent at one of the addresses set forth under "--Exchange Agent"
on or prior to the Expiration Date or the guaranteed delivery procedures
described below must be complied with.
40
GUARANTEED DELIVERY PROCEDURES
If the procedures for book-entry transfer cannot be completed on a
timely basis, a tender may be effected if:
- the tender is made through an Eligible Institution,
- prior to the Expiration Date, the Exchange Agent receives from
such Eligible Institution a properly completed and duly
executed Letter of Transmittal (or a facsimile thereof) and
Notice of Guaranteed Delivery, substantially in the form
provided by Consumers (by facsimile transmission, mail or hand
delivery), setting forth the name and address of the holder of
old bonds and the amount of old bonds tendered, stating that
the tender is being made thereby and guaranteeing that within
three New York Stock Exchange, Inc. ("NYSE") trading days
after the date of execution of the Notice of Guaranteed
Delivery, a Book-Entry Confirmation and any other documents
required by the Letter of Transmittal will be deposited by the
Eligible Institution with the Exchange Agent, and
- a Book-Entry Confirmation and all other documents required by
the Letter of Transmittal are received by the Exchange Agent
within three NYSE trading days after the date of execution of
the Notice of Guaranteed Delivery.
WITHDRAWAL OF TENDERS
Tenders of old bonds may be withdrawn at any time prior to 5:00 p.m.,
New York City time, on the Expiration Date.
For a withdrawal to be effective, a written notice of withdrawal must
be received by the Exchange Agent prior to 5:00 p.m., New York City time, on the
Expiration Date at one of the addresses set forth under "--Exchange Agent." Any
such notice of withdrawal must:
- specify the name and number of the account at the Book-Entry
Transfer Facility from which the old bonds were tendered,
- identify the principal amount of the old bonds to be
withdrawn, and
- specify the name and number of the account at the Book-Entry
Transfer Facility to be credited with the withdrawn old bonds
and otherwise comply with the procedures of such Book-Entry
Transfer Facility.
All questions as to the validity, form and eligibility (including time of
receipt) of such notice will be determined by Consumers, whose determination
shall be final and binding on all parties. Any old bonds so withdrawn will be
deemed not to have been validly tendered for exchange for purposes of the
Exchange Offer. Any old bonds which have been tendered for exchange but which
are not exchanged for any reason will be credited to an account maintained with
such Book-Entry Transfer Facility for the old bonds as soon as practicable after
withdrawal, rejection of tender or termination of the Exchange Offer. Properly
withdrawn old bonds may be retendered by following one of the procedures
described under "--Procedures for Tendering" and "--Book-Entry Transfer" at any
time on or prior to the Expiration Date.
41
CONDITIONS
Notwithstanding any other term of the Exchange Offer, old bonds will
not be required to be accepted for exchange, nor will new bonds be issued in
exchange for any old bonds, and Consumers may terminate or amend the Exchange
Offer as provided herein before the acceptance of such old bonds, if, because of
any change in law, or applicable interpretations thereof by the SEC, Consumers
determines that it is not permitted to effect the Exchange Offer. Consumers has
no obligation to, and will not knowingly, permit acceptance of tenders of old
bonds from affiliates of Consumers or from any other holder or holders who are
not eligible to participate in the Exchange Offer under applicable law or
interpretations thereof by the staff of the SEC, or if the new bonds to be
received by such holder or holders of old bonds in the Exchange Offer, upon
receipt, will not be tradable by such holder without restriction under the
Securities Act and the Exchange Act and without material restrictions under the
"blue sky" or securities laws of substantially all of the states of the United
States. Other than the United States federal and state securities laws we do not
need to satisfy any regulatory requirements or obtain any regulatory approvals
to conduct the Exchange Offer.
EXCHANGE AGENT
JPMorgan Chase Bank has been appointed as Exchange Agent for the
Exchange Offer. Questions and requests for assistance and requests for
additional copies of this prospectus or of the Letter of Transmittal should be
directed to the Exchange Agent addressed as follows:
By Certified or Registered Mail: By Overnight Courier or Hand:
JPMorgan Chase Bank JPMorgan Chase Bank
Institutional Trust Services Institutional Trust Services
P.O. Box 2320 2001 Bryan Street, 9th Floor
Dallas, Texas 75221-2320 Dallas, Texas 75201
Attention: Beth Mullin Attention: Beth Mullin
Facsimile Transmission Number:
(214)468-6494
(Eligible Institutions Only)
Confirm By Telephone:
(214)468-6464
FEES AND EXPENSES
The expenses of soliciting tenders pursuant to the Exchange Offer will
be borne by Consumers. The principal solicitation for tenders pursuant to the
Exchange Offer is being made by mail; however, additional solicitations may be
made by telephone, facsimile or in person by officers and regular employees of
Consumers.
Consumers will not make any payments to brokers, dealers or other
persons soliciting acceptances of the Exchange Offer. Consumers, however, will
pay the Exchange Agent reasonable and customary fees for its services and will
reimburse the Exchange Agent for its reasonable out-of-pocket expenses in
connection therewith.
The expenses to be incurred in connection with the Exchange Offer will
be paid by Consumers, including fees and expenses of the Exchange Agent and the
Trustee, and accounting, legal, printing and related fees and expenses.
42
Consumers will pay all transfer taxes, if any, applicable to the
exchange of old bonds pursuant to the Exchange Offer. If, however, new bonds or
old bonds for principal amounts not tendered or accepted for exchange are to be
registered or issued in the name of any person other than the registered holder
of the old bonds tendered, or if tendered old bonds are registered in the name
of any person other than the person signing the Letter of Transmittal, or if a
transfer tax is imposed for any reason other than the exchange of old bonds
pursuant to the Exchange Offer, then the amount of any such transfer taxes
(whether imposed on the registered holder or any other persons) will be payable
by the tendering holder. If satisfactory evidence of payment of such taxes or
exemption therefrom is not submitted with the Letter of Transmittal, the amount
of such transfer taxes will be billed directly to such tendering holder.
RESALE OF NEW BONDS
Based on an interpretation by the staff of the SEC set forth in
no-action letters issued to third parties, Consumers believes that new bonds
issued pursuant to the Exchange Offer in exchange for old bonds may be offered
for resale, resold and otherwise transferred by any owner of such new bonds
(other than any such owner which is an "affiliate" of Consumers within the
meaning of Rule 405 under the Securities Act) without compliance with the
registration and prospectus delivery provisions of the Securities Act, provided
that such new bonds are acquired in the ordinary course of such owner's business
and such owner does not intend to participate, and has no arrangement or
understanding with any person to participate, in the distribution of such new
bonds. Any owner of old bonds who tenders in the Exchange Offer with the
intention to participate, or for the purpose of participating, in a distribution
of the new bonds may not rely on the position of the staff of the SEC enunciated
in Exxon Capital Holdings Corporation (available May 13, 1988, as interpreted in
the SEC's letter to Shearman & Sterling dated July 2, 1993), Morgan Stanley &
Co., Incorporated(available June 5, 1991), Warnaco, Inc. (available June 5,
1991), and Epic Properties, Inc. (available October 21, 1991) or similar
no-action letters (collectively the "NO-ACTION LETTERS") but rather must comply
with the registration and prospectus delivery requirements of the Securities Act
in connection with any resale transaction. In addition, any such resale
transaction should be covered by an effective registration statement containing
the selling security holders information required by Item 507 of Regulation S-K
of the Securities Act. Each broker-dealer that receives new bonds for its own
account in exchange for old bonds, where such old bonds were acquired by such
broker-dealer as a result of market-making activities or other trading
activities, may be a statutory underwriter and must acknowledge that it will
deliver a prospectus meeting the requirements of the Securities Act in
connection with any resale of such new bonds.
By tendering in the Exchange Offer, each holder (or DTC participant, in
the case of tenders of interests in the global old bonds s held by DTC) will
represent to Consumers (which representation may be contained the Letter of
Transmittal) to the effect that:
- it is not an affiliate of Consumers,
- it is not engaged in, and does not intend to engage in, and
has no arrangement or understanding with any person to
participate in, a distribution of the new bonds to be issued
in the Exchange Offer and
- it is acquiring the new bonds in its ordinary course of
business.
Each holder will acknowledge and agree that any broker-dealer and any such
holder using the Exchange Offer to participate in a distribution of the new
bonds acquired in the Exchange Offer:
43
- could not under SEC policy as in effect on the date of the
Registration Rights Agreements rely on the position of the SEC
enunciated in the No-Action Letters, and
- must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with a
secondary resale transaction and that such a secondary resale
transaction must be covered by an effective registration
statement containing the selling security holder information
required by Item 507 or 508, as applicable, of Regulation S-K
if the resales are of new bonds obtained by such holder in
exchange for old bonds acquired by such holder directly from
Consumers or an affiliate thereof.
To comply with the securities laws of certain jurisdictions, it may be
necessary to qualify for sale or to register the new bonds prior to offering or
selling such new bonds. Consumers has agreed, pursuant to the Registration
Rights Agreements and subject to certain specified limitations therein, to
cooperate with selling holders or underwriters in connection with the
registration and qualification of the new bonds for offer or sale under the
securities or "blue sky" laws of such jurisdictions as may be necessary to
permit the holders of new bonds to trade the new bonds without any restrictions
or limitations under the securities laws of the several states of the United
States.
CONSEQUENCES OF FAILURE TO EXCHANGE
Holders of old bonds who do not exchange their old bonds for new bonds
pursuant to the Exchange Offer will continue to be subject to the restrictions
on transfer of such old bonds as set forth in the legend thereon as a
consequence of the issuance of the old bonds pursuant to exemptions from, or in
transactions not subject to, the registration requirements of the Securities Act
and applicable state securities laws. In general, the old bonds may not be
registered under the Securities Act, except pursuant a transaction not subject
to, the Securities Act and applicable state securities laws. Consumers does not
currently anticipate that it will register the old bonds under the Securities
Act. To the extent that old bonds are tendered and accepted in the Exchange
Offer, the trading market for untendered and tendered but unaccepted old bonds
could be adversely affected.
44
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
This Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Nine Months Ended September 30, 2003 (the "10-Q
MD&A") refers to Consumers' Condensed Notes to Consolidated Financial Statements
for the nine months ended September 30, 2003 and should be read in conjunction
with such September 30, 2003 Financial Statements (the "SEPTEMBER 30, 2003
FINANCIAL STATEMENTS") beginning on page F-2. They contain detailed information
that should be referred to in conjunction with the following 10-Q MD&A. The 10-Q
MD&A also describes material contingencies in Consumers' Condensed Notes to the
September 30, 2003 Financial Statements, and Consumers encourages readers to
review these Notes. All Note references within the 10-Q MD&A refer to Consumers'
Condensed Notes to the September 30, 2003 Financial Statements. Please refer to
the Glossary beginning on page 130 of this prospectus for definitions of certain
capitalized terms used in the 10-Q MD&A.
CRITICAL ACCOUNTING POLICIES
Consumers' consolidated financial statements are based on the
application of accounting principles generally accepted in the United States.
The application of these principles often requires management to make certain
judgments, assumptions and estimates that may result in different financial
presentations. Consumers believes that certain accounting principles are
critical in terms of understanding its consolidated financial statements. These
principles include the use of estimates in accounting for contingencies and
long-lived assets, accounting for derivatives and financial instruments,
regulatory accounting, and pension and postretirement benefits.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
judgments, estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Certain accounting principles require subjective
and complex judgments used in the preparation of financial statements.
Accordingly, a different financial presentation could result depending on the
judgment, estimates or assumptions that are used. Such estimates and assumptions
include, but are not specifically limited to: depreciation, amortization,
interest rates, discount rates, future commodity prices, mark-to-market
valuations, investment returns, impact of new accounting standards, future costs
associated with long-term contractual obligations, future compliance costs
associated with environmental regulations and continuing creditworthiness of
counterparties. Actual results could differ materially from those estimates.
The recording of estimated liabilities for contingencies within the
financial statements is guided by the principles in SFAS No. 5. SFAS No. 5
requires a company to record estimated liabilities in the financial statements
when it is probable that a loss payment will be made in the future as a result
of a current event, and when that amount can be reasonably estimated. Consumers
has used this accounting principle to record estimated liabilities for the
following significant events.
ELECTRIC ENVIRONMENTAL ESTIMATES: Consumers is subject to costly and
increasingly
45
stringent environmental regulations. Consumers expects to incur significant
costs for future environmental compliance, especially compliance with clean air
laws.
The EPA has issued regulations regarding nitrogen oxide emissions from
certain generators, including some of Consumers' electric generating facilities.
These regulations require Consumers to make significant capital expenditures
estimated to be $770 million. As of September 30, 2003, Consumers has incurred
$437 million in capital expenditures to comply with these regulations and
anticipates that the remaining capital expenditures will be incurred between
2003 and 2009. Additionally, Consumers expects to supplement its compliance plan
with the purchase of nitrogen oxide emissions credits in the years 2005 through
2008. The cost of these credits based on the current market is estimated to
average $6 million per year; however, the market for nitrogen oxide emissions
credits and their cost can change substantially. As new environmental standards
become effective, Consumers will need additional capital expenditures to comply
with the standards. Capital expenditures will depend upon the composition of the
final regulations.
The EPA has proposed changes to the rules that govern generating plant
cooling water intake systems. The proposed rules will require significant
abatement of fish mortality. The proposed rules are scheduled to become final in
the first quarter of 2004 and some of Consumers' facilities would be required to
comply by 2006. Consumers is studying the proposed rules to determine the most
cost-effective solutions for compliance. Until the method of compliance is
determined, Consumers is unable to estimate the cost of compliance with the
proposed rules.
The EPA has alleged that some utilities have incorrectly classified
plant modifications as "routine maintenance" rather than seek permits from the
EPA. Consumers has received and responded to information requests from the EPA
on this subject. Consumers believes that it has properly interpreted the
requirements of "routine maintenance". If Consumers' interpretation is
eventually found to be incorrect, it may be required to install additional
pollution controls at some or all of its coal-fired plants and could call into
question the viability of certain plants remaining in operation.
For further information on electric environmental matters see Note 2,
Uncertainties, "Electric Contingencies - Electric Environmental Matters."
GAS ENVIRONMENTAL ESTIMATES: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will incur investigation
and remedial action costs at a number of sites. Consumers estimates the costs
for 23 former manufactured gas plant sites using the Gas Research
Institute-Manufactured Gas Plant Probabilistic Cost Model. A revised cost
estimate, completed in September 2003, estimated remaining costs to be between
$37 million and $90 million. The range reflects multiple alternatives with
various assumptions for resolving the environmental issues at each site. The
estimates are based on discounted 2003 costs using a discount rate of three
percent. The discount rate represents a ten-year average of U.S. Treasury bond
rates reduced for increases in the consumer price index. Any significant change
in assumptions, such as remediation techniques, nature and extent of
contamination, and legal and regulatory requirements, could change the remedial
action costs for the sites. For further information see Note 2, Uncertainties,
"Gas Contingencies - Gas Environmental Matters."
MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the
MCV Facility, contracted to sell electricity to Consumers for a 35-year period
beginning in 1990 and to supply electricity and steam to Dow. Consumers, through
two wholly owned subsidiaries, holds a 49 percent partnership interest in the
MCV Partnership, and a 35 percent lessor interest in the MCV Facility.
46
Consumers' annual obligation to purchase capacity from the MCV
Partnership is 1,240 MW through the term of the PPA ending in 2025. The PPA
requires Consumers to pay, based on the MCV Facility's availability, a levelized
average capacity charge of 3.77 cents per kWh and a fixed energy charge, and
also to pay a variable energy charge based primarily on Consumers' average cost
of coal consumed for all kWh delivered. Consumers has not been allowed full
recovery of the capacity and fixed energy charges in rates. After September
2007, the PPA's regulatory out terms obligate Consumers to pay the MCV
Partnership only those capacity and energy charges that the MPSC has authorized
for recovery from electric customers.
In 1992, Consumers recognized a loss and established a PPA liability
for the present value of the estimated future underrecoveries of power supply
costs under the PPA based on MPSC cost recovery orders. Primarily as a result of
the MCV Facility's actual availability being greater than management's original
estimates, the PPA liability has been reduced at a faster rate than originally
anticipated. The remaining estimated future PPA liability associated with the
loss totaled $34 million at September 30, 2003 and $59 million at September 30,
2002. The PPA liability is expected to be depleted in late 2004.
In March 1999, Consumers and the MCV Partnership reached a settlement
agreement effective January 1, 1999, that addressed, among other things, the
ability of the MCV Partnership to count modifications increasing the capacity of
the existing MCV Facility for purposes of computing the availability of contract
capacity under the PPA for billing purposes. That settlement agreement capped
payments made on the basis of availability that may be billed by the MCV
Partnership at a maximum 98.5 percent availability level.
Under Michigan's electric restructuring law, Consumers will return to
unfrozen rates for large industrial customers beginning January 1, 2004,
including the resumption of the PSCR process. Under the PSCR process, Consumers
will recover from customers capacity and fixed energy charges on the basis of
availability, to the extent that availability does not exceed 88.7 percent
availability established in previous MPSC orders. Recovery of capacity and fixed
energy charges will be subject to certain rate caps as discussed in Note 2,
Uncertainties, "Electric Rate Matters - Electric Restructuring." For capacity
and energy payments billed by the MCV Partnership after September 15, 2007, and
not recovered from customers, Consumers would expect to claim a regulatory out
under the PPA. The regulatory out provision relieves Consumers of the obligation
to pay more for capacity and energy payments than the MPSC allows Consumers to
collect from its customers. Consumers estimates that 51 percent of the actual
cash underrecoveries for the years 2003 and 2004 will be charged to the PPA
liability, with the remaining portion charged to operating expense as a result
of Consumers' 49 percent ownership in the MCV Partnership. All cash
underrecoveries will be expensed directly to income once the PPA liability is
depleted. If the MCV Facility's generating availability remains at the maximum
98.5 percent level, Consumers' cash underrecoveries associated with the PPA
could be as follows:
In Millions
--------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
--------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5% (a) $57 $56 $56 $55 $39
Amount to be charged to operating expense $28 $27 $56 $55 $39
Amount to be charged to PPA liability $29 $29 $ - $ - $ -
============================================================================================
(a) For the nine months ended September 30, 2003, Consumers' cash
underrecoveries associated with the PPA were $43 million.
As previously noted, until September 2007, the PPA and settlement
require Consumers to pay
47
capacity costs based on the MCV Facility's actual availability up to the 98.5
percent cap. After September 2007, Consumers expects to exercise the "regulatory
out" clause in the PPA, limiting its capacity payments to the MCV Partnership to
the amount collected from its customers. Depending on the MPSC's future actions
with respect to the capacity payments recoverable from its customers subsequent
to September 2007, the earnings of the MCV Partnership and the value of
Consumers' equity interest in the MCV Partnership, may be affected negatively.
Further, under the PPA, energy payments to the MCV Partnership are
based on the cost of coal burned in Consumers' coal plants and costs associated
with fuel inventory, operations and maintenance, and administrative and general
expenses associated with Consumers' coal plants. However, the MCV Partnership's
costs of producing electricity are tied, in large part, to the cost of natural
gas. Because natural gas prices have increased substantially in recent years,
while energy charge payments to the MCV Partnership have not, the MCV
Partnership's financial performance has been impacted negatively.
As of January 1, 2004, Consumers intends to return to forced
(uneconomic) dispatch of the MCV Facility in order to maximize recovery of its
capacity payments. As such, if the spread between MCV Facility's variable
electricity production costs and its energy payment revenues stays constant or
widens, the negative impacts on MCV Partnership's financial performance, and on
the value of Consumers' equity interest in the MCV Partnership, will be worse.
Consumers cannot estimate, at this time, the impact of these issues on
its future earnings or cash flow from its interest in the MCV Partnership. The
forward price of natural gas for the next 22 years and the MPSC decision in 2007
or later related to Consumers' recovery of capacity payments are the two most
significant variables in the analysis of MCV Partnership's future financial
performance. Natural gas prices have historically been volatile and presently
there is no consensus in the marketplace on the price or range of prices of
natural gas beyond the next five years. Further, it is not presently possible
for Consumers to predict the actions of the MPSC in 2007 or later. For these
reasons, at this time Consumers cannot predict the impact of these issues on its
future earnings, cash flows, or on the value of its $404 million equity interest
in the MCV Partnership.
Consumers is exploring possible alternatives for utilizing the MCV
Facility without increasing costs to customers. Any changes regarding the
recovery of MCV capacity costs would require MPSC approval. Consumers cannot
predict the outcome of this matter.
For further information see Note 2, Uncertainties, "Other Electric
Uncertainties - The Midland Cogeneration Venture."
ACCOUNTING FOR DERIVATIVE AND FINANCIAL INSTRUMENTS AND MARKET RISK INFORMATION
DERIVATIVE INSTRUMENTS: Consumers uses the criteria in SFAS No. 133, as
amended and interpreted, to determine if certain contracts must be accounted for
as derivative instruments. The rules for determining whether a contract meets
the criteria for derivative accounting are numerous and complex. As a result,
significant judgment is required to determine whether a contract requires
derivative accounting, and similar contracts can sometimes be accounted for
differently.
The types of contracts Consumers typically classifies as derivative
instruments are interest rate swaps, certain electric call options, gas fuel
options, fixed priced weather-based gas supply call options and fixed price gas
supply call and put options. Consumers does not account for electric capacity
and energy contracts, gas supply contracts, coal and nuclear fuel supply
contracts, or purchase orders for numerous supply items as derivatives.
48
Certain of Consumers' electric capacity and energy contracts are not
derivatives due to the lack of an active energy market in the state of Michigan,
as defined by SFAS No. 133, and the transportation cost to deliver the power
under the contracts to the closest active energy market at the Cinergy hub in
Ohio. If a market develops in the future, Consumers may be required to account
for these contracts as derivatives. The mark-to-market impact on earnings
related to these contracts, particularly related to the PPA, could be material
to the financial statements.
If a contract is accounted for as a derivative instrument, it is
recorded in the financial statements as an asset or a liability, at the fair
value of the contract. Any difference between the recorded book value and the
fair value is reported either in earnings or accumulated other comprehensive
income, depending on certain qualifying criteria. The recorded fair value of the
contract is then adjusted quarterly to reflect any change in the market value of
the contract.
In order to determine the fair value of contracts that are accounted
for as derivative instruments, Consumers uses a combination of quoted market
prices and mathematical valuation models. Valuation models require various
inputs, including forward prices, volatilities, interest rates and exercise
periods. Changes in forward prices or volatilities could significantly change
the calculated fair value of certain contracts. At September 30, 2003, Consumers
assumed a market-based interest rate of one percent (six-month U.S. Treasury)
and an average volatility rate of 55 percent to calculate the fair value of its
gas call options.
In order for derivative instruments to qualify for hedge accounting
under SFAS No. 133, the hedging relationship must be formally documented at
inception and be highly effective in achieving offsetting cash flows or
offsetting changes in fair value, attributable to the risk being hedged. If
hedging a forecasted transaction, the forecasted transaction must be probable.
If a derivative instrument, used as a cash flow hedge, is terminated early
because it is probable that a forecasted transaction will not occur, any gain or
loss as of such date is immediately recognized in earnings. If a derivative
instrument, used as a cash flow hedge, is terminated early for other economic
reasons, any gain or loss as of the termination date is deferred and recorded
when the forecasted transaction affects earnings.
FINANCIAL INSTRUMENTS: Consumers accounts for its investments in debt
and equity securities in accordance with SFAS No. 115. As such, debt and equity
securities can be classified into one of three categories: held-to-maturity,
trading, or available-for-sale securities. Consumers' investments in equity
securities, including its investment in CMS Energy Common Stock, are classified
as available-for-sale securities. They are reported at fair value, with any
unrealized gains or losses resulting from changes in fair value reported in
equity as part of accumulated other comprehensive income and are excluded from
earnings unless such changes in fair value are other than temporary. In 2002,
Consumers determined that the decline in value related to its investment in CMS
Energy Common Stock was other than temporary as the fair value was below the
cost basis for a period greater than six months. As a result, Consumers
recognized a loss on its investment in CMS Energy Common Stock through earnings
of $12 million in the fourth quarter of 2002, and an additional $12 million in
the first quarter of 2003. As of September 30, 2003, Consumers held 2.4 million
shares of CMS Energy Common Stock with a fair value of $17 million. Consumers
believes that any further adverse change in the market price of this investment
would not have a material effect on its consolidated financial position, results
of operation or cash flows. Unrealized gains or losses resulting from changes in
the fair value of Consumers' nuclear decommissioning investments are reported as
regulatory liabilities. The fair value of these investments is determined from
quoted market prices.
MARKET RISK INFORMATION: Consumers is exposed to market risks
including, but not limited to, changes in interest rates, commodity prices, and
equity security prices. Consumers' market
49
risk, and activities designed to minimize this risk, are subject to the
direction of an executive oversight committee consisting of designated members
of senior management and a risk committee, consisting of certain business unit
managers. Established policies and procedures are used to manage the risks
associated with market fluctuations.
Consumers may use various contracts, including swaps, options, and
forward contracts to manage its risks associated with the variability in
expected future cash flows attributable to fluctuations in interest rates and
commodity prices. When management uses these instruments, it intends that an
opposite movement in the value of the at-risk item would offset any losses
incurred on the contracts. Contracts used to manage interest rate and commodity
price risk may be considered derivative instruments that are subject to
derivative and hedge accounting pursuant to SFAS No. 133. Consumers enters into
all risk management contracts for purposes other than trading.
These instruments contain credit risk if the counterparties, including
financial institutions and energy marketers, fail to perform under the
agreements. Consumers minimizes such risk by performing financial credit reviews
using, among other things, publicly available credit ratings of such
counterparties.
In accordance with SEC disclosure requirements, Consumers performs
sensitivity analyses to assess the potential loss in fair value, cash flows and
earnings based upon a hypothetical 10 percent adverse change in market rates or
prices. Management does not believe that sensitivity analyses alone provide an
accurate or reliable method for monitoring and controlling risks. Therefore,
Consumers relies on the experience and judgment of its senior management to
revise strategies and adjust positions, as they deem necessary. Changes in
excess of the amounts determined in sensitivity analyses could occur if market
rates or prices exceed the 10 percent shift used for the analyses.
INTEREST RATE RISK: Consumers is exposed to interest rate risk
resulting from the issuance of fixed-rate and variable-rate financing, and from
interest rate swap agreements. Consumers uses a combination of these instruments
to manage and mitigate interest rate risk exposure when deemed appropriate,
based upon market conditions. These strategies are designed to provide and
maintain a balance between risk and the lowest cost of capital.
As of September 30, 2003, Consumers had no outstanding interest rate
swap agreements. As of September 30, 2003, Consumers had outstanding
variable-rate financing of $628 million, a $640 million decrease (50 percent)
from the December 31, 2002 balance of $1.268 billion. The decline in
variable-rate financing is primarily due to a shift toward fixed-rate financing.
As of September 30, 2003, assuming a hypothetical 10 percent adverse change in
market interest rates, Consumers' before tax annual earnings exposure on its
variable-rate financing would be $1 million.
As of September 30, 2003, Consumers had outstanding fixed-rate
financing of $3.694 billion, a $934 million increase (34 percent) over the
December 31, 2002 balance of $2.760 billion. As of September 30, 2003, the fair
value of Consumers' fixed-rate financing was $3.804 billion, a $1.127 billion
increase (42 percent) over the December 31, 2002 fair value of $2.677 billion.
The change in the fair value of the fixed-rate financing is due to both an
increase in outstanding fixed-rate debt obligations as well as a decline in
market interest rates. As of September 30, 2003, assuming a hypothetical 10
percent adverse change in market interest rates, the fair value of Consumers'
fixed-rate financing would increase by $155 million.
As discussed below in Electric Business Outlook - Securitization,
Consumers has filed an application with the MPSC to securitize certain costs.
Upon final approval, Consumers intends to
50
use the proceeds from the securitization to retire higher cost debt, which could
include a portion of its current fixed-rate debt. Consumers does not believe
that any adverse change in debt price and interest rates would have a material
adverse effect on either its consolidated financial position, results of
operation or cash flows.
COMMODITY MARKET RISK: For purposes other than trading, Consumers
entered into electric call options, fixed priced weather-based gas supply call
options and fixed priced gas supply call and put options. The electric call
options are used to protect against risk due to fluctuations in the market price
of electricity and to ensure a reliable source of capacity to meet customers'
electric needs. The weather-based gas supply call options, and the gas supply
call and put options are used to purchase reasonably priced gas supply. Call
options allow Consumers the right but not the obligation to purchase gas supply
at predetermined fixed prices. Put options allow third-party suppliers the right
but not the obligation to sell Consumers gas supply at predetermined fixed
prices.
As of September 30, 2003 and December 31, 2002, the fair value of
electricity-related call option contracts, based on quoted market prices and
mathematical valuation models using current and historical pricing data, was $3
million and $9 million, respectively. As of September 30, 2003 assuming a
hypothetical 10 percent adverse change in market prices, the potential reduction
in fair value associated with these contracts would be $1 million. As of
September 30, 2003 and December 31, 2002, Consumers had an asset of $21 million
and $30 million, respectively, related to premiums incurred for electric call
option contracts. Consumers' maximum exposure associated with the call option
contracts is limited to the premiums incurred. As of September 30, 2003, the
fair value of the fixed priced weather-based gas supply call options and fixed
priced gas supply call and put options, based on quoted market prices and
mathematical valuation models, was less than $1 million. As of September 30,
2003, assuming a hypothetical 10 percent adverse change in market prices, the
potential reduction in fair value associated with these contracts would be $1
million.
For further information on market risk and derivative activities, see
Note 4, Financial and Derivative Instruments.
ACCOUNTING FOR THE EFFECTS OF INDUSTRY REGULATION
Because Consumers is involved in a regulated industry, regulatory
decisions affect the timing and recognition of revenues and expenses. Consumers
uses SFAS No. 71 to account for the effects of these regulatory decisions. As a
result, Consumers may defer or recognize revenues and expenses differently than
a non-regulated entity.
For example, items that a non-regulated entity normally would expense,
Consumers may capitalize as regulatory assets if the actions of the regulator
indicate such expenses will be recovered in future rates. Conversely, items that
non-regulated entities may normally recognize as revenues, Consumers may record
as regulatory liabilities if the actions of the regulator indicate they will
require such revenues to be refunded to customers. Judgment is required to
discern the recoverability of items recorded as regulatory assets and
liabilities. As of September 30, 2003, Consumers had $1.113 billion recorded as
regulatory assets and $461 million recorded as regulatory liabilities.
In 1999, Consumers received MPSC electric restructuring orders, which,
among other things, identified the terms and timing for implementing electric
restructuring in Michigan. Consistent with these orders and EITF No. 97-4,
Consumers discontinued the application of SFAS No. 71 for the energy supply
portion of its business because Consumers expected to implement retail
51
open access at competitive market-based rates for its electric customers.
However, since 1999, there has been a significant legislative and regulatory
change in Michigan that has resulted in: 1) electric supply customers of
utilities remaining on cost-based rates and 2) utilities being given the ability
to recover Stranded Costs associated with electric restructuring, from customers
who choose an alternative electric supplier. During 2002, Consumers re-evaluated
the criteria used to determine if an entity or a segment of an entity meets the
requirements to apply regulated utility accounting, and determined that the
energy supply portion of its business could meet the criteria if certain
regulatory events occurred. In December 2002, Consumers received a MPSC Stranded
Cost order that allowed Consumers to re-apply regulatory accounting standard
SFAS No. 71 to the energy supply portion of its business. Re-application of SFAS
No. 71 had no effect on the prior discontinuation accounting, but allowed
Consumers to apply regulatory accounting treatment to the energy supply portion
of its business beginning in the fourth quarter of 2002, including regulatory
accounting treatment of costs required to be recognized in accordance with SFAS
No. 143. See Note 5, Implementation of New Accounting Standards, "SFAS No. 143,
Accounting for Asset Retirement Obligations."
For further information on industry regulation, see Note 1, Corporate
Structure and Summary of Significant Accounting Policies, "Utility Regulation".
ACCOUNTING FOR PENSION AND OPEB
Consumers provides postretirement benefits under its Pension Plan, and
postretirement health and life benefits under its OPEB plans to substantially
all its retired employees. Consumers uses SFAS No. 87 to account for pension
costs and uses SFAS No. 106 to account for other postretirement benefit costs.
These statements require liabilities to be recorded on the balance sheet at the
present value of these future obligations to employees net of any plan assets.
The calculation of these liabilities and associated expenses requires the
expertise of actuaries and is subject to many assumptions including life
expectancies, present value discount rates, expected long-term rate of return on
plan assets, rate of compensation increase and anticipated health care costs.
Any change in these assumptions can significantly change the liability and
associated expenses recognized in any given year.
The Pension Plan includes amounts for employees of CMS Energy and
non-utility affiliates, including Panhandle, which are not distinguishable from
the Pension Plan's total assets. In June 2003, CMS Energy completed the sale of
Panhandle to Southern Union Panhandle Corp. No portion of the Pension Plan was
transferred with the sale. Panhandle employees are no longer eligible to accrue
additional benefits. The Pension Plan retained pension payment obligations for
Panhandle employees that were vested under the Pension Plan. Because of the
significant change in the makeup of the plan, SFAS No. 87 required a
remeasurement of the obligation at the date of sale. The estimated remeasurement
resulted in an increase in pension expense of approximately $3 million and OPEB
expense of approximately $5 million for 2003, as well as an additional charge to
accumulated other comprehensive income of approximately $27 million ($17 million
after tax) as a result of the increase in the additional minimum pension
liability. The actuary is in the process of finalizing the effects of the
mid-year remeasurement. Although actual results may differ from the estimates
recorded, Consumers does not expect those differences to be material.
Consumers estimates OPEB expense will approximate $54 million in 2003,
$62 million in 2004, and $60 million in 2005. Consumers estimates pension
expense will approximate $38 million in 2003, $46 million in 2004, and $47
million in 2005. Future actual pension expense will depend on future investment
performance, changes in future discount rates and various other factors related
to the populations participating in the Pension Plan. In August 2003, Consumers
made its planned contribution of $172 million to the Pension Plan.
52
Consumers has announced amendments to the Pension Plan for salaried
employees, whereby, the method used to convert an employee's benefit to a lump
sum payment is being changed. Employees who elect the lump sum payment option
will not earn an additional early retirement subsidy. As a result, employees who
choose the lump sum payment option, and retire before age 65, will receive lower
lump sum payments. In addition, Consumers has implemented a cash balance plan
for employees hired on or after July 1, 2003. Under a cash balance plan, an
employees' retirement account is credited annually with a percentage of their
base pay. Accounts will be valued at the end of each year, using an annual
variable interest rate to determine growth. Employees who leave the company and
are vested in the cash balance version of the pension plan can either start
receiving their benefit immediately, postpone receiving benefits until a future
date while receiving an earnings credit on their account (payment cannot be
deferred beyond age 70-1/2), or roll 100 percent of the cash balance account
into an IRA or another qualified plan. If a participant is not vested (less than
five years of service under the terms of the plan), the cash balance account is
forfeited.
In 2003, a large majority of retiring employees elected the lump sum
payment option instead of receiving pension benefits as an annuity over time. As
a result, Consumers may be required to record a settlement loss in accordance
with SFAS No. 88, which requires a settlement loss to be recognized when the
cost of all settlements paid during the year exceeds the sum of the service and
interest costs for the same year. Consumers cannot yet determine if the amount
of lump sum payments for 2003 will exceed the threshold, but estimates that if
the threshold is exceeded, between $55 million and $65 million could be
recognized as a loss in the fourth quarter of 2003.
ACCOUNTING FOR NUCLEAR DECOMMISSIONING COSTS
Consumers' decommissioning cost estimates for the Big Rock and
Palisades plants assume that each plant site will eventually be restored to
conform to the adjacent landscape with all contaminated equipment and material
removed and disposed of in a licensed burial facility and the site released for
unrestricted use. The MPSC orders received in March and December of 1999 for Big
Rock and Palisades plants, respectively, provided for fully funding the
decommissioning trust funds for both sites. The December 1999 order set the
annual decommissioning surcharge for the Palisades decommissioning at $6
million. Consumers estimates that at the time of the decommissioning of
Palisades, its decommissioning trust fund will be fully funded. This conclusion
assumes that the trust funds are invested in equities and fixed income
investments, equities will be converted to fixed income investments during
decommissioning and fixed income investments are converted to cash as needed.
Decommissioning costs have been developed, in part, by independent contractors
with expertise in decommissioning. These cost estimates use various inflation
rates for labor, non-labor, and contaminated equipment disposal costs.
In December 2000, funding of the Big Rock trust fund was stopped since
it was considered fully funded, subject to further review. A portion of future
decommissioning cost will result from the failure of the DOE to remove fuel from
the site. These costs, and similar costs incurred at Palisades, would not be
necessary if the DOE took possession of the spent fuel as required by the
Nuclear Waste Policy Act of 1982. A number of utilities, including Consumers,
which filed its complaint in December 2002, have commenced litigation in the
Court of Claims. The Chief Judge of the Court of Claims identified six lead
cases to be used as vehicles for resolving dispositive motions. Consumers' case
is not a lead case. It is unclear what impact this decision by the Chief Judge
will have on the outcome of Consumers' litigation. If the litigation that was
commenced in the fourth quarter of 2002 against the DOE is successful, Consumers
anticipates future recoveries from the DOE to defray the significant costs it
will incur for the storage of spent fuel until the DOE takes possession as
required by law. However, there is no assurance that the
53
litigation against the DOE will be successful.
The funds provided by the trusts and additional potential funds from
DOE litigation are expected to fully fund the decommissioning costs. Variance
from trust earnings, a lesser recovery of costs from the DOE, changes in
decommissioning technology, regulations, estimates or assumptions could affect
the cost of decommissioning these sites and the adequacy of the decommissioning
trust funds. For further information see Note 2, Uncertainties, "Other Electric
Uncertainties - Nuclear Matters."
In March 2003, the Michigan Environmental Council, the Public Interest
Research Group in Michigan, and the Michigan Consumer Federation submitted a
complaint to the MPSC, which was served on Consumers by the MPSC in April 2003.
The complaint asks the MPSC to commence a generic investigation and contested
case to review all facts and issues concerning costs associated with spent
nuclear fuel storage and disposal. The complaint seeks a variety of relief with
respect to Consumers, Detroit Edison, Indiana & Michigan Electric Company,
Wisconsin Electric Power Company and Wisconsin Public Service Corporation,
including establishing external trusts to which amounts collected in electric
rates for spent nuclear fuel storage and disposal should be transferred, and the
adoption of additional measures related to the storage and disposal of spent
nuclear fuel. In May 2003, Consumers and the other named utilities each filed a
motion to dismiss the complaint. Consumers is unable to predict the outcome of
this matter.
RELATED PARTY TRANSACTIONS
Consumers enters into a number of significant transactions with related
parties. These transactions include the purchase of capacity and energy from the
MCV Partnership and from affiliates of Enterprises, the purchase of electricity
and gas for generation from CMS MST, the sale of electricity to CMS MST, the
purchase of gas transportation from CMS Bay Area Pipeline, L.L.C., the payment
of parent company overhead costs to CMS Energy, the sale of storage and
transportation of natural gas and other services to the MCV Partnership, and an
investment in CMS Energy Common Stock.
Transactions involving CMS Energy and its affiliates and the sale of
storage and transportation of natural gas and other services to the MCV
Partnership are generally based on regulated prices, market prices or
competitive bidding. Transactions involving the power supply purchases from the
MCV Partnership, and certain affiliates of Enterprises, are based upon avoided
costs under PURPA and competitive bidding; and the payment of parent company
overhead costs to CMS Energy are based upon use or accepted industry allocation
methodologies.
In 2002, Consumers sold its transmission facilities to MTH, a
non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect, Inc., an independent company, whose management includes former
executive employees of Consumers. The transaction was based on competitive
bidding. Consumers continues to use the transmission facilities now owned by
MTH, and a director of Consumers is currently a stockholder of Trans-Elect, Inc.
For detailed information about related party transactions see Note 2,
Uncertainties, "Electric Rate Matters - Transmission", and "Other Electric
Uncertainties - The Midland Cogeneration Venture".
54
RESULTS OF OPERATIONS
CONSUMERS' NET INCOME AVAILABLE TO COMMON STOCKHOLDER
In Millions
--------------------------------------------------------------------------------------------------------
September 30 2003 2002 Change
--------------------------------------------------------------------------------------------------------
Three months ended $ 33 $ 74 $(41)
Nine months ended $172 $267 $(95)
========================================================================================================
2003 COMPARED TO 2002: For the three months ended September 30, 2003,
Consumers' net income available to common stockholder totaled $33 million, a
decrease of $41 million from the previous year.
A decrease in electric delivery revenues reduced earnings by $22
million after-tax. This decrease was primarily due to reduced deliveries to the
higher margin residential sector resulting from milder summer weather compared
to the same period in 2002, which included record setting monthly sendout and
monthly hourly peak demand volumes. Commercial and industrial customers
switching to alternative electric suppliers as allowed by the Customer Choice
Act further reduced electric delivery revenues. Lower gas deliveries reduced
after-tax earnings by $9 million. Earnings were also reduced $10 million
after-tax due to a decrease in the fair value of certain long-term gas contracts
held by the MCV Partnership. The earnings decrease also reflects increased costs
of borrowing that reduced earnings by $4 million after-tax, and increased
general tax expense of $3 million after-tax. Offsetting the earnings decrease is
an after-tax benefit of $3 million due to the final gas rate order issued in
2002 authorizing Consumers to increase its gas tariff rates.
For the nine months ended September 30, 2003, Consumers' net income
available to common stockholder totaled $172 million, a decrease of $95 million
from the previous year.
This decrease in earnings reflects the absence of the nonrecurring
benefits from 2002, including the $31 million after-tax gain on asset sales, and
the $18 million of after-tax earnings related to an adjustment to the fair value
of certain long-term gas contracts held by the MCV Partnership. Reduced earnings
also reflect a $12 million charge to non-utility expense in order to recognize a
decline in market value of CMS Energy Common Stock held by Consumers.
Decreased electric deliveries reduced after tax earnings by $25
million. This decrease can be attributed to the continuing switch by commercial
and industrial customers to alternative electric suppliers allowed by the
Customer Choice Act. A reduction in residential consumption also contributed to
the decrease in electric deliveries. This decrease was due to milder summer
temperatures in 2003 compared to the same period in 2002, which included record
setting monthly send out and monthly hourly peak demand volumes.
Increased electric and gas operating expenses reduced after-tax
earnings by $32 million. Increased costs of borrowings reduced after-tax
earnings by $16 million, and a $7 million after-tax charge at CMS Midland
Holdings reflecting the loss of certain tax credits also contributed to the
earnings decrease.
Offsetting these decreases is an after-tax benefit of $9 million due to
increased gas deliveries reflecting colder winter weather in early 2003, a $23
million after-tax benefit due to the final gas rate order issued in 2002
authorizing Consumers to increase its gas tariff rates, and the $13 million
after-tax benefit relating to the reduction in MSBT expenses relating to years
2000 and
55
2001. The reduction in MSBT expense is a result of CMS Energy receiving approval
to file consolidated tax returns for years 2000 and 2001. These returns were
filed in the second quarter of 2003.
Finally, earnings for the three and nine month period ended September
30, 2003, were reduced by $1 million after-tax as a result of the Northeast
United States blackout that commenced August 14, 2003.
For further information, see the Electric and Gas Utility Results of
Operations sections and Note 2, Uncertainties.
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
----------------------------------------------------------------------------------------------------------
September 30 2003 2002 Change
----------------------------------------------------------------------------------------------------------
Three months ended $ 59 $ 88 $(29)
Nine months ended $145 $222 $(77)
==========================================================================================================
Three Months Ended Nine Months Ended
Reasons for change September 30, 2003 vs. 2002 September 30, 2003 vs. 2002
-----------------------------------------------------------------------------------------------------------
Electric deliveries $ (34) $ (38)
Power supply costs and related revenue 2 14
Other operating expenses and
non-commodity revenue (5) (43)
Asset sales - (38)
General taxes (3) 12
Fixed charges (5) (18)
Income taxes 16 34
------------------------------------------------
Total change $ (29) $ (77)
==========================================================================================================
ELECTRIC DELIVERIES: For the three months ended September 30, 2003,
electric delivery revenues decreased by $34 million from the previous year.
Electric deliveries, including transactions with other wholesale market
participants and other electric utilities, were 10.3 billion kWh, a decrease of
0.6 billion kWh or 4.9 percent from 2002. The decrease in revenue is primarily
the result of decreased deliveries to the higher margin residential sector due
to milder summer temperatures in 2003 compared to the same period in 2002, which
included record setting monthly sendout and monthly hourly peak demand volumes.
Commercial and industrial customers switching to alternative electric suppliers
as allowed by the Customer Choice Act further reduced electric delivery
revenues.
For the nine months ended September 30, 2003, electric delivery
revenues decreased by $38 million from the previous year. Electric deliveries,
including transactions with other wholesale market participants and other
electric utilities, were 29.3 billion kWh, a decrease of 0.2 billion kWh or 0.6
percent from 2002. The decrease in delivery revenues can be attributed to the
continuing switch by commercial and industrial customers to alternative electric
suppliers allowed by the Customer Choice Act. Also contributing to decreased
electric deliveries was a reduction in residential consumption due to milder
summer temperatures in 2003 compared to the same period in 2002, which included
record setting monthly send out and monthly hourly peak demand volumes.
POWER SUPPLY COSTS AND RELATED REVENUE: For the three months ended
September 30, 2003,
56
power supply costs and related revenues increased electric net income by $2
million from 2002.
For the nine months ended September 30, 2003, power supply costs and
related revenues increased electric net income by $14 million from 2002. This
increase is primarily the result of increased intersystem revenues due to higher
market prices and sales made from additional surplus capacity.
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUE: For the three
months ended September 30, 2003, net operating expenses and non-commodity
revenue decreased operating income by $5 million compared to 2002. This decrease
relates primarily to increased amortization expense from securitized assets and
reduced miscellaneous electric service revenues.
For the nine months ended September 30, 2003, operating expenses
increased compared to 2002. This increase can be attributed to storm restoration
expenses, a scheduled refueling outage at Palisades, which began on March 16,
2003 and ended on April 20, 2003, and higher transmission costs due to the loss
of a financial return on the Consumers' transmission system asset sold in May
2002. Slightly offsetting these increased operating expenses were increased
non-commodity revenues associated with miscellaneous service revenues.
ASSET SALES: For the nine months ended September 30, 2003, pretax
income from asset sales decreased $38 million from the comparable period in
2002. This is the result of the $31 million pretax gain associated with the May
2002 sale of Consumers' electric transmission system and the $7 million pretax
gain associated with the June 2002 sale of nuclear equipment from the cancelled
Midland project.
GENERAL TAXES: For the three months ended September 30, 2003, general
taxes increased $3 million compared to 2002 primarily due to larger property tax
expense from increased investment.
For the nine months ended September 30, 2003, general taxes decreased
$12 million from the comparable period in 2002. This decrease is due to reduced
MSBT expenses related to the years 2000 and 2001. This is the result of CMS
Energy receiving approval to file consolidated tax returns for the years 2000
and 2001. These returns were filed during the second quarter of 2003.
FIXED CHARGES: For the three and nine months ended September 30, 2003,
fixed charges increased $5 million and $18 million, respectively, from the
comparable period in 2002. These increases can be attributed to increased
financing activities.
INCOME TAXES: For the three and nine months ended September 30, 2003,
income tax expense decreased $16 million and $34 million, primarily due to a
decrease in earnings by the electric utility compared to 2002.
GAS UTILITY RESULTS OF OPERATIONS
In Millions
----------------------------------------------------------------------------------------------------------
September 30 2003 2002 Change
----------------------------------------------------------------------------------------------------------
Three months ended $(19) $(18) $(1)
Nine months ended $ 40 $ 13 $27
==========================================================================================================
57
Three Months Ended Nine Months Ended
Reasons for change September 30, 2003 vs. 2002 September 30, 2003 vs. 2002
----------------------------------------------------------------------------------------------------------------
Gas deliveries $(14) $ 14
Gas rate increase 5 35
Gas wholesales and retail services 1 4
Operation and maintenance 8 (6)
General taxes, depreciation, and other income (1) (2)
Fixed charges (1) (4)
Income taxes 1 (14)
-----------------------------------------------
Total change $ (1) $ 27
================================================================================================================
GAS DELIVERIES: For the three months ended September 30, 2003, gas
delivery revenues decreased by $14 million from the previous year. The decrease
primarily reflects $7 million of increased expense associated with Consumers'
annual analysis of gas losses related to the gas transmission and distribution
system. The adjustment is recorded as a reduction to accrued gas revenues.
System deliveries, including miscellaneous transportation, totaled 38.2 bcf, a
decrease of 1.9 bcf or 4.8 percent compared with 2002.
For the nine months ended September 30, 2003, gas delivery revenues
increased by $14 million from the previous year. System deliveries, including
miscellaneous transportation, totaled 272.7 bcf, an increase of 18 bcf or 7.1
percent compared with 2002. This increase is primarily due to colder weather
during the first quarter that resulted in increased deliveries to the
residential and commercial sectors in 2003.
GAS RATE INCREASE: In November 2002, the MPSC issued a final gas rate
order authorizing a $56 million annual increase in Consumers' gas tariff rates.
As a result of this order, for the three and nine months ended September 30,
2003, Consumers recognized increased gas revenues of $5 million and $35 million,
respectively.
OPERATION AND MAINTENANCE: For the three months ended September 30,
2003, operation and maintenance expenses decreased $8 million when compared to
2002. This decrease reflects the absence of gas storage inventory losses
recorded in 2002.
For the nine months ended September 30, 2003, operation and maintenance
expenses increased $6 million when compared to 2002. This increase reflects the
recognition of additional expenditures on safety, reliability and customer
service.
INCOME TAXES: For the three months ended September 30, 2003, income tax
expense decreased primarily due to decreased earnings of the gas utility
compared to 2002.
For the nine months ended September 30, 2003, income tax expense
increased primarily due to improved earnings of the gas utility.
CAPITAL RESOURCES AND LIQUIDITY
CASH POSITION, INVESTING, AND FINANCING
The following discussion of operating, investing and financing
activities summarizes Consumers' consolidated statements of cash flows found in
Consumers' consolidated financial statements.
Operating Activities: Consumers' principal source of liquidity is cash
from the sale and transportation of natural gas and the generation, delivery and
sale of electricity. For the nine months ended September 30, cash from
operations totaled $130 million in 2003 and $420 million in 2002. The $290
million decrease in cash from operations resulted primarily from an increase in
a depleted natural gas inventory due to colder weather and higher gas prices, an
increase in the
58
pension contribution for 2003, and an increase in accounts receivable and
accrued revenues. Consumers primarily uses cash derived from operating
activities to operate, maintain, expand and construct its electric and gas
systems, to retire portions of long-term debt, and to pay dividends. A decrease
in cash from operations could reduce the availability of funds and result in
additional short-term financings, see Note 3, Financings and Capitalization for
additional details about this source of funds.
Investing Activities: For the nine months ended September 30, cash used
for investing activities totaled $326 million in 2003 and $144 million in 2002.
The change of $182 million is primarily due to the absence of $283 million of
proceeds from the sale of METC and other asset sales, partially offset by a $94
million decrease in capital expenditures.
Financing Activities: For the nine months ended September 30, cash
provided by financing activities totaled $103 million in 2003 and cash used for
financing activities totaled $182 million in 2002. The change of $285 million is
primarily due to an increase of $941 million in proceeds from senior notes and
bank loans, offset partially by $371 million of payments for retirement of bonds
and other long-term debt and a $271 million additional payment of notes payable.
Refer below to discussion of Consumers' refinancing.
Contractual Obligations and Commercial Commitments: The following
schedule of material contractual obligations and commercial commitments is
provided to aggregate information in a single location so that a picture of
liquidity and capital resources is readily available. For further information
see Note 2, Uncertainties, and Note 3, Financings and Capitalization.
Contractual Obligations In Millions
----------------------------------------------------------------------------------------------------------
Payments Due
----------------------------------------------------
2008 and
September 30 Total 2003 2004 2005 2006 2007 beyond
----------------------------------------------------------------------------------------------------------
On-balance sheet:
Long-term debt $ 3,531 $ - $ 8 $ 329 $361 $ 31 $ 2,802
Current portion of long-
term debt 28 8 20 - - - -
Notes payable 4 1 3 - - - -
Capital lease obligations 127 4 15 14 13 12 69
----------------------------------------------------------------------------------------------------------
Total on-balance sheet $ 3,690 $ 13 $ 46 $ 343 $374 $ 43 $ 2,871
----------------------------------------------------------------------------------------------------------
Off-balance sheet:
Operating leases $ 76 $ 6 $ 11 $ 9 $ 9 $ 8 $ 33
Non-recourse debt of FMLP 194 - 57 41 26 13 57
Sale of accounts receivable 254 254 - - - - -
Unconditional purchase
obligations 17,897 601 1,577 1,197 905 743 12,874
----------------------------------------------------------------------------------------------------------
Total off-balance sheet $18,421 $861 $1,645 $1,247 $940 $764 $12,964
==========================================================================================================
59
LONG-TERM FINANCINGS:
The following is a summary of Consumers' Long-Term debt issuances
during 2003:
-----------------------------------------------------------------------------------------------------------------
Facility Principal Use of
Type (millions) Issue Rate Issue Date Maturity Date Proceeds Collateral
-----------------------------------------------------------------------------------------------------------------
Term Loan $ 140 LIBOR + March 2003 March 2009 GCP FMB (f)
475 bps
Term Loan 150 LIBOR + March 2003 March 2006 (c) GCP FMB (f)
450 bps
FMB (a) 375 5.375% April 2003 April 2013 (c) -
FMB (a) 250 4.250% April 2003 April 2008 (c) -
FMB (a) 250 4.000% May 2003 May 2010 (d) -
FMB (b) 200 4.800% August 2003 February 2009 (e) -
FMB (b) 200 6.000% August 2003 February 2014 (e) -
--------
Total $ 1,565
=================================================================================================================
(GCP - General Corporate Purposes) (bps - basis points)
(FMB - First Mortgage Bonds)
(a) Consumers has agreed to file a registration statement with the SEC
by December 26, 2003 to permit holders of these first mortgage bonds to exchange
the bonds for new bonds that will be registered under the Securities Act of
1933.
(b) Consumers has agreed to file a registration statement with the SEC
by April 14, 2004 to permit holders of these first mortgage bonds to exchange
the bonds for new bonds that will be registered under the Securities Act of
1933.
(c) Consumers used the net proceeds to replace a $250 million senior
reset put bond that matured in May 2003, to pay an associated $32 million option
call payment and for general corporate purposes that included paying down
additional debt.
(d) Consumers used the net proceeds to prepay a portion of a term loan
that was due to mature in July 2004.
(e) Consumers used the net proceeds to pay off the $150 million term
loan negotiated in March 2003 that was due to mature in March 2006 as well as
the remaining $50 million balance on a term loan that was due to mature in March
2004, and for general corporate purposes.
(f) Refer to "Regulatory Authorization for Financings" below for
information about Consumers' remaining FERC debt authorization.
As part of Consumers' ongoing cost reduction measures in an attempt to
reduce its financing costs, Consumers will continue to monitor financial markets
REGULATORY AUTHORIZATION FOR FINANCINGS: At September 30, 2003,
Consumers had FERC authorization, through June 2004, to issue or guarantee up to
$1.1 billion of short-term securities outstanding at any one time. As of
September 30, 2003, Consumers had $400 million outstanding as collateral for the
revolving credit facility (discussed below) and had an additional $700 million
available for future issuances of short-term securities. At September 30, 2003,
Consumers also had remaining FERC authorization, through June 2004, to issue up
to $800 million of long-term securities for refinancing or refunding purposes,
$560.3 million of long-term securities for general corporate purposes, and $2.06
billion of long-term first mortgage bonds to be issued solely as collateral for
other long-term securities. Also, FERC has granted waivers of its
60
competitive bid/negotiated placement requirements applicable to the long-term
securities authorization indicated above.
SHORT-TERM FINANCINGS: In March 2003, Consumers obtained a replacement
revolving credit facility in the amount of $250 million secured by first
mortgage bonds. In September 2003, this facility was amended and restated as a
$400 million revolving credit facility. The interest rate of the facility was
reduced from LIBOR plus 350 to LIBOR plus 175 basis points. The new credit
facility matures in March 2004 with two annual extensions at Consumers' option,
which would extend the maturity to March 2006. At September 30, 2003, all of the
$400 million is available for general corporate purposes.
The revolving credit facility mentioned above has contractual
restrictions that require Consumers to maintain, as of the last day of each
fiscal quarter, the following:
Limitation Ratio at September 30, 2003
----------------------------------------------------------------------------------------------------------
Debt to Capital Ratio (a)(b) Not more than 0.65 to 1.00 0.58 to 1.00
Interest Coverage Ratio - Revolver (a) Not less than 2.00 to 1.00 3.34 to 1.00
==========================================================================================================
(a) Violation of this ratio would constitute an event of default under
the facility that provides the lender, among other remedies, the right to
declare the principal and interest immediately due and payable.
(b) The terms of the credit facility provide for the exclusion of
securitization bonds in the calculation of the debt to capital ratio.
Consumers is subject to covenants in its financing agreements that
could limit its ability to incur additional indebtedness. Consumers has agreed
in several of its financing agreements to maintain specified levels of cash
coverage of its interest requirements and to not allow its indebtedness to
exceed specified levels of its consolidated capitalization (the "Debt Percentage
Tests"). Consumers is in compliance with these requirements as of the most
recent measurement date, September 30, 2003. These covenants make use of both
generally accepted accounting principles and defined contractual terms in
specifying how the relevant calculations are made. Consumers sought and received
amendments to certain of its financing agreements to modify the terms of the
Debt Percentage Tests in order to, among other things, remove the effect of the
adoption of SFAS No. 150, portions of which have now been deferred indefinitely,
regarding Trust Preferred Securities on the calculations.
Under the provisions of its articles of incorporation, Consumers had
$412 million of unrestricted retained earnings available to pay common dividends
at September 30, 2003. However, covenants in Consumers' debt facilities cap
common stock dividend payments at $300 million in a calendar year. Through
September 30, 2003, Consumers paid $162 million in common dividends. In October
2003, Consumers declared a $57 million common dividend payable in November 2003.
For information on the potential cap on common dividends payable
included in the MPSC Securitization order see Electric Business Outlook,
"Competition and Regulatory Restructuring - Securitization." Also, for
information on the potential cap on common dividends payable included in the
MPSC Staff's recommendation in Consumers' 2003 gas rate case see Gas Business
Outlook, "2003 Gas Rate Case."
LEASES: Consumers' capital leases are predominately for leased service
vehicles and the new headquarters building. On November 7, 2003, Consumers
closed a three-year $60 million term loan at an interest rate of LIBOR plus 135
basis points. The term loan is secured by first
61
mortgage bonds. The proceeds of the loan were used to purchase Consumers'
headquarters building lease from the lessor, resulting in cost savings to
Consumers. Operating leases are predominately for railroad coal cars.
OFF-BALANCE SHEET ARRANGEMENTS: Consumers' use of long-term contracts
for the purchase of commodities and services, the sale of its accounts
receivable, and operating leases are considered to be off-balance sheet
arrangements. Consumers has responsibility for the collectability of the
accounts receivable sold, and the full obligation of its leases become due in
case of lease payment default. Consumers uses these off-balance sheet
arrangements in its normal business operations.
SALE OF ACCOUNTS RECEIVABLE: Under a revolving accounts receivable
sales program, Consumers currently sells certain accounts receivable to a wholly
owned, consolidated, bankruptcy remote special purpose entity, Consumers
Receivables Funding II. In turn, Consumers Receivables Funding II may sell an
undivided interest in up to $325 million of the receivables to a bank-sponsored
commercial paper conduit. The amount sold to the conduit was $254 million at
September 30, 2003 and $325 million at September 30, 2002. These amounts are
excluded from accounts receivable in Consumers' consolidated balance sheets.
Consumers continues to service the receivables sold; however, the purchaser of
the receivables has no recourse against Consumers' other assets for failure of a
debtor to pay when due and the purchaser has no right to any receivables not
sold. No gain or loss has been recorded on the receivables sold and Consumers
retains no interest in the receivables sold.
UNCONDITIONAL PURCHASE OBLIGATIONS: Unconditional purchase obligations
include natural gas, electricity, and coal purchase contracts and their
associated cost of transportation. These obligations represent normal business
operating contracts used to assure adequate supply and to minimize exposure to
market price fluctuations.
Included in unconditional purchase obligations are long-term power
purchase agreements with various generating plants including the MCV Facility.
These contracts require monthly capacity payments based on the plants'
availability or deliverability. These payments are approximately $47 million per
month for the remaining three months of 2003, including $34 million related to
the MCV Facility. For the period that a plant is not available to deliver
electricity to Consumers, Consumers is not obligated to make the capacity
payments to the plant. See Electric Utility Results of Operations above and Note
2, Uncertainties, "Electric Rate Matters - Power Supply Costs" and "Other
Electric Uncertainties - The Midland Cogeneration Venture" for further
information concerning power supply costs.
COMMERCIAL COMMITMENTS: Indemnities are agreements by Consumers to
reimburse other companies, such as an insurance company, if those companies have
to complete Consumers' performance involving a third party contract. Letters of
credit are issued by a bank on behalf of Consumers, guaranteeing payment to a
third party. Letters of credit substitute the bank's credit for Consumers' and
reduce credit risk for the third party beneficiary. The amount and time period
for drawing on a letter of credit is limited.
Commercial Commitments In Millions
----------------------------------------------------------------------------------------------------------
Commitment Expiration
-------------------------------------------------------------
2008 and
September 30 Total 2003 2004 2005 2006 2007 beyond
----------------------------------------------------------------------------------------------------------
Off-balance sheet:
Indemnities $8 $- $- $- $- $- $8
Letters of credit 7 - 7 - - - -
==========================================================================================================
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OUTLOOK
LIQUIDITY AND CAPITAL RESOURCES
Consumers' liquidity and capital requirements generally are a function
of its results of operations, capital expenditures, contractual obligations,
debt maturities, working capital needs and collateral requirements. During the
summer months, Consumers purchases natural gas and stores it for resale
primarily during the winter heating season. Recently, the market price for
natural gas has increased. Although Consumers' natural gas purchases are
recoverable from its customers, the amount paid for natural gas stored as
inventory could require additional liquidity due to the timing of the cost
recoveries. In addition, certain commodity suppliers to Consumers have requested
advance payments or other forms of assurances, including margin calls, in
connection with maintenance of ongoing deliveries of gas and electricity. This
will also affect Consumers' liquidity position.
Historically, Consumers has met its consolidated cash needs through its
operating and financing activities and access to bank financing and the capital
markets. In 2003, Consumers has contractual obligations and planned capital
expenditures that would require substantial amounts of cash. Consumers may also
become subject to liquidity demands pursuant to commercial commitments under
guarantees, indemnities and letters of credit as indicated above. Consumers
plans to meet its liquidity and capital requirements in 2003 through a
combination of borrowings, reduced capital expenditures, cash flow generated
from operations, and other measures. Refer to "Capital Resources and
Liquidity-"Long Term Financings" above for information about Consumers' 2003
debt financings.
Consumers believes that its present level of cash and borrowing
capacity (assuming access to capital markets), along with anticipated cash flows
from operating and investing activities, will be sufficient to meet its
liquidity needs through 2004.
ELECTRIC BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects electric kWh volume
deliveries (including both full service sales and delivery service to customers
who choose to buy generation service from an alternative electric supplier, but
excluding transactions with other wholesale market participants including other
electric utilities) to grow at an average rate of approximately two percent per
year based primarily on a steadily growing customer base. This growth rate
reflects a long-range expected trend of growth. Growth from year to year may
vary from this trend due to customer response to abnormal weather conditions and
changes in economic conditions including utilization and expansion of
manufacturing facilities. Consumers experienced higher electric deliveries in
2002 as a result of warmer than normal summer weather. For 2003, a slight
decline in electric deliveries from 2002 is anticipated. This short-term outlook
for 2003 assumes higher levels of manufacturing activity than in 2002 and normal
weather conditions in the last three months of the year.
COMPETITION AND REGULATORY RESTRUCTURING: The enactment in 2000 of
Michigan's Customer Choice Act and other developments will continue to result in
increased competition in the electric business. Generally, increased competition
can reduce profitability and threatens Consumers' market share for generation
services. The Customer Choice Act allowed all of Consumers' electric customers
to buy electric generation service from Consumers or from an alternative
electric supplier as of January 1, 2002. As a result, alternative electric
suppliers for generation services have entered Consumers' market. As of October
2003, alternative electric
63
suppliers are providing 603 MW of generation supply to retail open access
customers. To the extent Consumers experiences "net" Stranded Costs as
determined by the MPSC, the Customer Choice Act allows for the company to
recover such "net" Stranded Costs by collecting a transition surcharge from
those customers who switch to an alternative electric supplier. Consumers cannot
predict the total amount of electric supply load that may be lost to competitor
suppliers, nor whether the stranded cost recovery method adopted by the MPSC
will be applied in a manner that will fully offset any associated margin loss.
STRANDED COSTS: The Customer Choice Act allows electric utilities to
recover the act's implementation costs and "net" Stranded Costs (without
defining the term). The act directs the MPSC to establish a method of
calculating "net" Stranded Costs and of conducting related true-up adjustments.
In December 2001, the MPSC adopted a methodology which calculated "net" Stranded
Costs as the shortfall between: (a) the revenue required to cover the costs
associated with fixed generation assets, generation-related regulatory assets,
and capacity payments associated with purchase power agreements, and (b) the
revenues received from customers under existing rates available to cover the
revenue requirement. The MPSC authorized Consumers to use deferred accounting to
recognize the future recovery of costs determined to be stranded. According to
the MPSC, "net" Stranded Costs are to be recovered from retail open access
customers through a Stranded Cost transition charge.
In April 2002, Consumers made "net" Stranded Cost filings with the MPSC
for $22 million for 2000 and $43 million for 2001. Consumers in its hearing
brief, filed in August 2002, revised its request for Stranded Costs to $7
million for 2000 and $4 million for 2001. The single largest reason for the
difference in the filing was the exclusion, as ordered by the MPSC, of all costs
associated with expenditures required by the Clean Air Act. As discussed below
in "Securitization", Consumers filed a request with the MPSC for authority to
issue Securitization bonds that would allow recovery of the Clean Air Act
expenditures that were excluded from the Stranded Cost calculation.
In December 2002, the MPSC issued an order finding that Consumers
experienced zero "net" Stranded Costs in 2000 and 2001, but declined to resolve
numerous issues regarding the "net" Stranded Cost methodology in a way that
would allow a reliable prediction of the level of Stranded Costs for 2002 and
future years. In January 2003, Consumers filed a petition for rehearing of the
December 2002 Stranded Cost order in which it asked the MPSC to grant a
rehearing and revise certain features of the order. Several other parties have
also filed rehearing petitions with the MPSC. Consumers has also initiated an
appeal at the Michigan Court of Appeals related to the MPSC's December 2001
"net" Stranded Cost order.
In March 2003, Consumers filed an application with the MPSC seeking
approval of "net" Stranded Costs incurred in 2002, and for approval of a "net"
Stranded Cost recovery charge. In the application, Consumers indicated that if
Consumers' proposal to securitize Clean Air Act expenditures and Palisades
expenditures previously not securitized were approved as proposed in its
securitization case as discussed below in "Securitization", then Consumers'
"net" Stranded Costs incurred in 2002 would be approximately $35 million. If the
proposal to securitize those costs is not approved, then Consumers indicated
that the costs would be properly included in the 2002 "net" Stranded Cost
calculation, which would increase Consumers' 2002 "net" Stranded Costs to
approximately $103 million.
In June 2003, the MPSC issued a financing order in the securitization
case, authorizing the issuance of Securitization bonds in the amount of
approximately $554 million. Included in this amount were Clean Air Act
expenditures. However, the MPSC rejected Palisades expenditures previously not
securitized as eligible securitized costs. As a result, the Palisades
expenditures previously not securitized should be included as a component of
"net" Stranded Costs and will be
64
included as a component of a future electric rate case proceeding with the MPSC.
With the inclusion of the Palisades expenditures previously not securitized,
Consumers' "net" Stranded Costs incurred in 2002 are estimated to be
approximately $50 million.
In July 2003, Consumers filed a petition for rehearing and
clarification on a number of features in the MPSC's financing order on
securitization. Once a final financing order by the MPSC on securitization is
issued, the amount of Consumers' request for "net" Stranded Cost recovery for
2002 will be known. Consumers cannot predict how the MPSC will rule on its
request for the recoverability of Stranded Costs, and therefore Consumers has
not recorded any regulatory assets to recognize the future recovery of such
costs.
The MPSC staff has scheduled a collaborative process to discuss
Stranded Costs and related issues and to identify and make recommendations to
the MPSC. Consumers has participated in this collaborative process. In July
2003, the staff suspended formal discussion while it considers possible
conclusions and recommendations.
IMPLEMENTATION COSTS: Since 1997, Consumers has incurred significant
electric utility restructuring implementation costs. The following table
outlines the applications filed by Consumers with the MPSC and the status of
recovery for these costs.
In Millions
----------------------------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
----------------------------------------------------------------------------------------------------------
1999 1997 & 1998 $20 $ - $15 $5
2000 1999 30 - 25 5
2001 2000 25 - 20 5
2002 2001 8 - 8 -
2003 2002 2 2 Pending Pending
==========================================================================================================
The MPSC disallowed certain costs based upon a conclusion that these
amounts did not represent costs incremental to costs already reflected in
electric rates. In the order received for the year 2001, the MPSC also reserved
the right to review again the implementation costs depending upon the progress
and success of the retail open access program, and ruled that due to the rate
freeze imposed by the Customer Choice Act, it was premature to establish a cost
recovery method for the allowable implementation costs. In addition to the
amounts shown above, as of September 30, 2003, Consumers incurred and deferred
as a regulatory asset, $2 million of additional implementation costs and has
also recorded a regulatory asset of $16 million for the cost of money associated
with total implementation costs. Consumers believes the implementation costs and
the associated cost of money are fully recoverable in accordance with the
Customer Choice Act. Cash recovery from customers is expected to begin after the
rate freeze or rate cap period has expired. As discussed below, Consumers has
asked to include implementation costs through December 31, 2000 in the pending
securitization case. If approved, the sale of Securitization bonds will allow
for the recovery of these costs. Consumers cannot predict the amounts the MPSC
will approve as allowable costs.
Also, Consumers is pursuing authorization at the FERC for MISO to
reimburse Consumers for approximately $8 million in certain electric utility
restructuring implementation costs related to its former participation in the
development of the Alliance RTO, a portion of which has been expensed. In May
2003, the FERC issued an order denying MISO's request for authorization to
reimburse Consumers. In June 2003, Consumers and MISO filed a joint petition for
rehearing with the FERC. In September 2003, the FERC denied Consumers' and
MISO's joint request. Consumers plans to appeal the FERC ruling at the United
States Court of Appeals for the District of Columbia and pursue other potential
means of recovery. In November 2003, in conjunction
65
with Consumers' appeal of the September Order denying recovery, Consumers
persuaded MISO to file a request with the FERC seeking authority to reimburse
METC, the legal successor in interest to the Alliance RTO start-up costs. As
part of the contract for sale of Consumers' former transmission system, should
the Commission approve the new MISO filing, METC is contractually obligated to
flow-through to Consumers the full amount of any Alliance RTO start-up costs
that it is authorized to recover through FERC. Consumers cannot predict the
outcome of the appeal process, the MISO request, or the amount of implementation
costs, if any; the FERC ultimately will allow to be collected.
SECURITIZATION: In March 2003, Consumers filed an application with the
MPSC seeking approval to issue Securitization bonds in the amount of
approximately $1.084 billion. The application sought recovery of costs
associated with Clean Air Act expenditures, Palisades expenditures previously
not securitized, retail open access implementation costs through December 31,
2003, certain pension fund costs, and expenses associated with the issuance of
the bonds. In June 2003, the MPSC issued a financing order authorizing the
issuance of Securitization bonds in the amount of approximately $554 million.
This amount relates to Clean Air Act expenditures and associated return on those
expenditures through December 31, 2002, retail open access implementation costs
and previously authorized return on those expenditures through December 31,
2000, and the "up front" other qualified costs related to issuance of the
Securitization bonds. The MPSC rejected Palisades expenditures previously not
securitized as eligible securitized costs. Therefore, Palisades expenditures
previously not securitized should be included as a component of "net" Stranded
Costs and will be included as a component of a future electric rate case
proceeding with the MPSC.
In the June 2003 financing order, the MPSC also adopted a rate design
that would allow retail open access customers to pay a securitization charge
(and related tax charge) that are a small fraction of the amounts paid by full
service bundled sales customers and special contract customers of the utility.
The financing order provides that the securitization charges (and related tax
charges) for the full service and bundled sales customers are increased under
the rate design in the financing order in order to be sufficient to repay the
principal, interest and all other "ongoing" qualified costs related to servicing
the Securitization bonds. The financing order also restricts the amount of
common dividends payable by Consumers to its "earnings." In July 2003, Consumers
filed for rehearing and clarification on a number of features in the financing
order, including the rate design, accounting treatment of unsecuritized
qualified costs and dividend restriction. Also in July 2003, the Attorney
General filed a claim of appeal related to the financing order and the Attorney
General indicated it would challenge the lawfulness of the rate design. In
October 2003, the Court of Appeals dismissed the appeal and indicated that the
Attorney General could resubmit the appeal after the MPSC acted on Consumers'
rehearing request. Subsequently, the Attorney General filed a motion of
rehearing asking for reconsideration of the Court of Appeals' dismissal. The
financing order will become effective after rehearing, resolution of appeals and
upon acceptance by Consumers.
RATE CAPS: The Customer Choice Act imposes certain limitations on
electric rates that could result in Consumers being unable to collect from
electric customers its full cost of conducting business. Some of these costs are
beyond Consumers' control. In particular, if Consumers needs to purchase power
supply from wholesale suppliers while retail rates are frozen or capped, the
rate restrictions may make it impossible for Consumers to fully recover
purchased power and associated transmission costs from its customers. As a
result, Consumers may be unable to maintain its profit margins in its electric
utility business during the rate freeze or rate cap periods. The rate freeze is
in effect through December 31, 2003. The rate caps are in effect through at
least December 31, 2004 for small commercial and industrial customers, and at
least through December 31, 2005 for residential customers. After December 31,
2003, the statute would allow customers to petition the MPSC for rate reductions
below the cap. Consumers would have the
66
opportunity to respond to such a petition before rates could be reduced.
As a result of Consumers meeting the transmission capability expansion
requirements and the market power test, as discussed in Note 2, Uncertainties,
"Electric Rate Matters - Electric Restructuring", Consumers has met the
requirements under Public Act 141 to return to the PSCR process. On September
30, 2003, Consumers submitted a PSCR filing to the MPSC that would reinstate the
PSCR process for customers whose rates will no longer be frozen or capped as of
January 1, 2004. The proposed PSCR charge allows Consumers to recover a portion
of its increased power supply costs from large commercial and industrial
customers effective January 1, 2004. This is the first customer class for which
the rate freeze and cap expire. Consumers will, pursuant to its right under
applicable law, self-implement the proposed PSCR charge on January 1, 2004,
unless the MPSC issues an order before that date establishing a different
charge. The charge is subject to subsequent change by the MPSC during the PSCR
period (calendar-year 2004). The revenues received pursuant to the PSCR charge
by statute are also subject to subsequent reconciliation when the year is
finished and actual costs have been reviewed for reasonableness and prudence.
Consumers cannot predict the outcome of this filing.
Included in Consumers' retail electric customers' frozen rates is a
nuclear decommissioning surcharge related to the decommissioning of Big Rock.
The MPSC authorized collection of the surcharge through December 2000. Consumers
has continued to collect the Big Rock nuclear decommissioning surcharge
consistent with the provisions of the Customer Choice Act rate freeze in effect
through December 31, 2003. Beginning in January 2004, the Big Rock
decommissioning surcharge will be eliminated, reducing Consumers' annual
electric revenues by approximately $35 million in 2004. A portion of this
reduction is expected to be offset by the collection of increased PSCR revenues.
INDUSTRIAL CONTRACTS: In response to industry restructuring efforts, in
1995 and 1996, Consumers entered into multi-year electric supply contracts with
certain large industrial customers to provide electricity at specially
negotiated prices, usually at a discount from tariff prices. The MPSC approved
these special contracts, totaling a maximum of approximately 685 MW of load, as
part of its phased introduction to competition. Unless terminated or
restructured, the majority of these contracts are in effect through 2005. As of
September 30, 2003, contracts for 200 MW of load have terminated. Of the
contracts that have terminated, contracts for 64 MW have gone to an alternative
electric supplier, and contracts for 136 MW have returned to bundled tariff
rates. Consumers cannot predict the ultimate financial impact of changes related
to these power supply contracts, or whether additional special contracts will be
necessary or advisable.
CODE OF CONDUCT: In December 2000, as a result of the passage of the
Customer Choice Act, the MPSC issued a new code of conduct that applies to
electric utilities and alternative electric suppliers. The code of conduct seeks
to prevent cross-subsidization, information sharing, and preferential treatment
between a utility's regulated and unregulated services. The new code of conduct
is broadly written, and as a result, could affect Consumers' retail gas
business, the marketing of unregulated services and equipment to Michigan
customers, and transfer pricing between Consumers' departments and affiliates.
In October 2001, the new code of conduct was reaffirmed by the MPSC without
substantial modification. Consumers appealed the MPSC orders related to the code
of conduct and sought a stay of the orders until the appeal was complete;
however, the request for a stay was denied. Consumers filed a compliance plan in
accordance with the code of conduct. It also sought waivers to the code of
conduct in order to continue utility activities that provide approximately $50
million in annual electric and gas revenues. In October 2002, the MPSC denied
waivers for three programs that provided approximately $32 million in gas
revenues in 2001, of which $30 million relates to the appliance service plan.
The waivers denied included all waivers associated with the appliance service
plan program that has been offered by Consumers for many years. Consumers filed
a renewed motion for a stay of the
67
effectiveness of the code of conduct and an appeal of the waiver denials with
the Michigan Court of Appeals. In November 2002, the Michigan Court of Appeals
denied Consumers' request for a stay. Consumers filed an application for leave
to appeal with the Michigan Supreme Court with respect to the Michigan Court of
Appeals' November ruling denying the stay. In February 2003, the Michigan
Supreme Court denied the application. In December 2002, Consumers filed a
renewed request with the MPSC for a temporary waiver until April 2004 for the
appliance service plan, which generated $33 million in gas revenues in 2002. In
February 2003, the MPSC granted an extension of the temporary waiver until
December 31, 2003. The full impact of the new code of conduct on Consumers'
business will remain uncertain until the appellate courts issue definitive
rulings. Recently, in an appeal involving affiliate pricing guidelines, the
Michigan Court of Appeals struck down the guidelines because of a procedurally
defective manner of enactment by the MPSC. A similar procedure was used by the
MPSC in enacting the new code of conduct. In July 2003, legislation was
introduced in the Michigan legislature that, if enacted, would clarify the
application of the code of conduct in a manner that would allow Consumers to
continue to offer the appliance service plan. In October 2003, the Michigan
Senate passed legislation to preserve the appliance service plan. The House of
Representatives of Michigan is scheduled to review the legislation in early
2004; however, in the interim they passed a bill to extend the MPSC's waiver for
the program to July 1, 2004.
ENERGY POLICY: Uncertainty exists regarding the enactment of a national
comprehensive energy policy, specifically federal electric industry
restructuring legislation. A variety of bills that have been introduced in the
United States Congress in recent years were designed to change existing federal
regulation of the industry. If the federal government enacts a comprehensive
energy policy, then that legislation could potentially affect company operations
and financial requirements.
TRANSMISSION: In May 2002, Consumers sold its electric transmission
system for approximately $290 million to MTH, a non-affiliated limited
partnership whose general partner is a subsidiary of Trans-Elect, Inc. The
pretax gain was $31 million ($26 million, net of tax). Remaining open issues are
not expected to substantially impact the amount of the gain.
As a result of the sale, Consumers anticipates its after-tax earnings
will decrease by $15 million in 2003, and decrease by approximately $14 million
annually for the next three years due to a loss of revenue from wholesale and
retail open access customers who will buy services directly from MTH and the
loss of a return on the sold electric transmission system.
Under an agreement with MTH, and subject to certain additional RTO
surcharges, transmission rates charged to Consumers are fixed by contract at
current levels through December 31, 2005, and subject to FERC ratemaking
thereafter. MTH has completed the capital program to expand the transmission
system's capability to import electricity into Michigan, as required by the
Customer Choice Act, and Consumers will continue to maintain the system until
May 1, 2007 under a contract with MTH.
There are multiple proceedings and a proposed rulemaking pending before
the FERC regarding transmission pricing mechanisms and standard market design
for electric bulk power markets and transmission. The results of these
proceedings and proposed rulemaking could significantly affect the trend of
transmission costs and increase the delivered power costs to Consumers and the
retail electric customers it serves. The specific financial impact on Consumers
of such proceedings, rulemaking and trends are not currently quantifiable.
In addition, Consumers is evaluating whether or not there may be
impacts on electric reliability associated with the outcomes of these various
transmission related proceedings. Consumers cannot assure that all risks to
reliability can be avoided.
68
AUGUST 14, 2003 BLACKOUT: On August 14, 2003, the electric transmission
grid serving parts of the Midwest and the Northeast experienced a significant
disturbance, which impacted electric service to millions of homes and businesses
throughout a vast region. In Michigan, more than 2 million electric customers
were without electricity. Consumers had five fossil-fueled generating unit
outages and, of Consumers' 1.7 million electric customers, approximately 100,000
were without power for approximately 24 hours as a result of the disturbance.
The impact was felt most heavily in the southeastern part of Consumers' service
territory.
As discussed above in "Transmission", Consumers sold its electric
transmission system in May 2002 to MTH, with Consumers providing transmission
system maintenance under a five-year contract with MTH. MTH now owns, controls,
and plans for the transmission system that serves Consumers. Consumers incurred
approximately $1 million of immediate financial impact as a result of the
blackout. Consumers continues to cooperate with investigations of the blackout
by several federal and state agencies. Consumers cannot predict the outcome of
these investigations.
In November 2003, the MPSC released its report on the August 14, 2003
blackout, which found no evidence to suggest that the events in Michigan or
actions taken by the Michigan utilities or transmission operators were factors
contributing to the cause of the blackout. As a result of its investigation, the
MPSC is recommending that Congress pass legislation that would empower the FERC,
where necessary, to order membership into a RTO and that Congress should provide
the FERC with the authority to develop and enforce mandatory transmission
reliability standards with penalties for noncompliance.
Consumers cannot predict the impact of these electric
industry-restructuring issues on its financial position, liquidity, or results
of operations.
PERFORMANCE STANDARDS: In July 2001, the MPSC proposed electric
distribution performance standards for Consumers and other Michigan electric
distribution utilities. The proposal would establish standards related to
restoration after an outage, safety, and customer relations. Failure to meet the
standards would result in customer bill credits. Consumers submitted comments to
the MPSC. In December 2001, the MPSC issued an order stating its intent to
initiate a formal rulemaking proceeding to develop and adopt performance
standards. In November 2002, the MPSC issued an order initiating the formal
rulemaking proceeding. Consumers has filed comments on the proposed rules and
will continue to participate in this process. Consumers cannot predict the
nature of the proposed standards or the likely effect, if any, on Consumers.
For further information and material changes relating to the rate
matters and restructuring of the electric utility industry, see Note 1,
Corporate Structure and Summary of Significant Accounting Policies, and Note 2,
Uncertainties, "Electric Rate Matters - Electric Restructuring" and "Electric
Rate Matters - Electric Proceedings."
UNCERTAINTIES: Several electric business trends or uncertainties may
affect Consumers' financial results and condition. These trends or uncertainties
have, or Consumers reasonably expects could have, a material impact on net
sales, revenues, or income from continuing electric operations. Such trends and
uncertainties include: 1) pending litigation and government investigations; 2)
the need to make additional capital expenditures and increase operating expenses
for Clean Air Act compliance; 3) environmental liabilities arising from various
federal, state and local environmental laws and regulations, including potential
liability or expenses relating to the Michigan Natural Resources and
Environmental Protection Acts and Superfund; 4) pending litigation filed by
PURPA qualifying facilities; 5) uncertainties relating to the storage and
ultimate disposal of spent nuclear fuel; 6) electric industry restructuring
issues, including
69
those described above; 7) Consumers' ability to meet peak electric demand
requirements at a reasonable cost, without market disruption, and successfully
implement initiatives to reduce exposure to purchased power price increases; 8)
the recovery of electric restructuring implementation costs; 9) Consumers'
status as an electric transmission customer and not as an electric transmission
owner/operator; 10) sufficient reserves for transmission rate refunds; 11) the
effects of derivative accounting and potential earnings volatility; 12)
increased costs for safety and homeland security initiatives that are not
recoverable on a timely basis from customers; 13) potentially rising pension
costs due to market losses and lump sum payments (as discussed above in
Accounting for Pension and OPEB); 14) Consumers' ability to recover any of its
"net" Stranded costs under the regulatory policies being followed by the MPSC;
15) the effects of lost electric supply load from retail open access and the
recovery of associated margin loss; 16) the uncertain effects, including
exposure to liability, increased regulatory requirement and new legislation, due
to the future conclusions about the causes of the August 14, 2003 blackout. For
further information about these trends or uncertainties, see Note 2,
Uncertainties.
GAS BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects gas bcf volume
deliveries, including gas full service and customer choice deliveries (excluding
transportation to the MCV Facility and off-system deliveries), to grow at an
average rate of less than one percent per year based primarily on a steadily
growing customer base. Actual gas deliveries in future periods may be affected
by abnormal weather, use of gas by independent power producers, changes in
competitive and economic conditions, the level of natural gas consumption per
customer, and the recent significant increases in gas commodity prices.
GAS COST RECOVERY: As part of the on-going GCR process, which includes
an annual reconciliation case with the MPSC, Consumers expects to recover all of
its gas costs. In June 2003, Consumers filed a reconciliation of GCR costs and
revenues for the 12-months ended March 2003. Consumers proposes to recover from
its customers a net under-recovery of approximately $6 million using a roll-in
methodology. The roll-in methodology incorporates the under-recovery in the GCR
factor charged in the next GCR year. The roll-in tariff provision was approved
by the MPSC in a November 2002 order.
In July 2003, the MPSC approved a settlement agreement authorizing
Consumers to increase its gas cost recovery factor for the remainder of the
current GCR plan year (August 2003 through March 2004) and to implement a
quarterly ceiling price adjustment mechanism, based on a formula that tracks
changes in NYMEX natural gas prices. Consistent with the terms of the
settlement, the ceiling price is $6.11 per mcf. However, Consumers will utilize
a GCR factor of $5.41 per mcf commencing in November 2003 bills. All recoveries
pursuant to such factors are subject to final reconciliation by the MPSC.
2001 GAS RATE CASE: In June 2001, Consumers filed an application with
the MPSC seeking a distribution service rate increase. In November 2002, the
MPSC issued a final order approving a $56 million annual distribution service
rate increase, which includes the $15 million interim increase, with an 11.4
percent authorized return on equity, for service effective November 2002. As
part of this order, the MPSC approved Consumers' proposal to absorb the assets
and liabilities of Michigan Gas Storage Company into Consumers' rate base and
rates. This has occurred through a statutory merger of Michigan Gas Storage
Company into Consumers and this is not expected to have an impact on Consumers'
consolidated financial statements.
2003 GAS RATE CASE: In March 2003, Consumers filed an application with
the MPSC seeking a $156 million increase in its gas delivery and transportation
rates, which includes a 13.5 percent
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return on equity, based on a 2004 test year. Contemporaneously with this filing,
Consumers has requested interim rate relief in the same amount. In August 2003,
the MPSC Staff recommended interim rate relief of $80 million be granted in this
proceeding, subject to Consumers voluntarily agreeing to limit its dividends to
its parent, CMS Energy, to a maximum of $190 million in any calendar year.
In September 2003, Consumers filed an update to its gas rate case that
lowered the requested revenue increase from $156 million to $139 million and
revised the return on common equity from 13.5 percent to 12.75 percent. The
majority of the reduction is related to lower debt costs and changes in the
projected capital structure. The MPSC Staff and ABATE filed their cases in early
October. The Staff made no change to its interim position of $80 million and
continued to propose the same dividend limitation. ABATE did not make a specific
recommendation for a final rate increase, but did discuss the rate design used
to recover any rate increase granted. A proposal for decision is expected from
the administrative law judge in January 2004.
ENERGY-RELATED SERVICES: Consumers offers a variety of energy-related
services to retail customers that focus on appliance maintenance, home safety,
commodity choice, and assistance to customers purchasing heating, ventilation
and air conditioning equipment. Consumers continues to look for additional
growth opportunities in providing energy-related services to its customers. The
ability to offer all or some of these services and other utility related
revenue-generating services, which provide approximately $36 million in annual
gas revenues, may be restricted by the new code of conduct issued by the MPSC,
as discussed above in Electric Business Outlook, "Competition and Regulatory
Restructuring - Code of Conduct."
UNCERTAINTIES: Several gas business trends or uncertainties may affect
Consumers' financial results and conditions. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing gas operations. Such trends and
uncertainties include: 1) pending litigation and government investigations; 2)
potential environmental costs at a number of sites, including sites formerly
housing manufactured gas plant facilities; 3) future gas industry restructuring
initiatives; 4) an inadequate regulatory response to applications for requested
rate increases; 5) market and regulatory responses to increases in gas costs,
including a reduced average consumption per residential customer; 6) increase in
costs for pipeline integrity, safety, and homeland security initiatives that are
not recoverable on a timely basis from customers; 7) potentially rising pension
costs due to market losses and lump sum payments (as discussed above in
Accounting for Pension and OPEB); and 8) potential adverse appliance service
plan ruling or related legislation. For further information about these
uncertainties, see Note 2, Uncertainties.
OTHER OUTLOOK
SECURITY COSTS: Since the September 11, 2001 terrorist attacks in the
United States, Consumers has increased security at all critical facilities and
over its critical infrastructure, and will continue to evaluate security on an
ongoing basis. Consumers may be required to comply with federal and state
regulatory security measures promulgated in the future. Through September 30,
2003, Consumers has incurred approximately $7 million in incremental security
costs, including operating, capital, and decommissioning and removal costs,
mainly relating to its nuclear facilities. Consumers estimates it may incur
additional incremental security costs for the last three months of 2003 of
approximately $3 million, of which $2 million relates to nuclear security costs.
Consumers will attempt to seek recovery of these costs from its customers. In
December 2002, the Michigan legislature passed, and the governor signed, a bill
that would allow Consumers to seek recovery of additional nuclear electric
division security costs incurred during the rate freeze and cap periods imposed
by the Customer Choice Act. In February 2003, the
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MPSC adopted filing requirements for the recovery of enhanced security costs.
LITIGATION AND REGULATORY INVESTIGATIONS
SEC AND OTHER INVESTIGATIONS: As a result of round-trip trading
transactions by CMS MST, CMS Energy's Board of Directors established a Special
Committee to investigate matters surrounding the transactions and retained
outside counsel to assist in the investigation. The Special Committee completed
its investigation and reported its findings to the Board of Directors in October
2002. The Special Committee concluded, based on an extensive investigation, that
the round-trip trades were undertaken to raise CMS MST's profile as an energy
marketer with the goal of enhancing its ability to promote its services to new
customers. The Special Committee found no effort to manipulate the price of CMS
Energy Common Stock or affect energy prices. The Special Committee also made
recommendations designed to prevent any reoccurrence of this practice.
Previously, CMS Energy terminated its speculative trading business and revised
its risk management policy. The Board of Directors adopted, and CMS Energy has
implemented the recommendations of the Special Committee.
CMS Energy is cooperating with other investigations concerning
round-trip trading, including an investigation by the SEC regarding round-trip
trades and CMS Energy's financial statements, accounting policies and controls,
and investigations by the United States Department of Justice, the Commodity
Futures Trading Commission and the FERC. The FERC issued an order on April 30,
2003 directing eight companies, including CMS MST, to submit written
demonstrations within 45 days that they have taken certain specified remedial
measures with respect to the reporting of natural gas trading data to
publications that compile and publish price indices. CMS MST made a written
submission to the FERC on June 11, 2003 in compliance with the FERC's
directives. On July 29, 2003, the FERC issued an order stating that CMS MST met
the requirements of the FERC's April 30, 2003 order. Other than the FERC
investigation, CMS Energy is unable to predict the outcome of these matters, and
Consumers is unable to predict what effect, if any, these investigations will
have on its business.
SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number
of securities class action complaints were filed against CMS Energy, Consumers,
and certain officers and directors of CMS Energy and its affiliates. The
complaints were filed as purported class actions in the United States District
Court for the Eastern District of Michigan by shareholders who allege that they
purchased CMS Energy's securities during a purported class period. The cases
were consolidated into a single lawsuit and an amended and a consolidated class
action complaint was filed on May 1, 2003. The consolidated complaint contains a
purported class period beginning on May 1, 2000 and running through March 31,
2003. It generally seeks unspecified damages based on allegations that the
defendants violated United States securities laws and regulations by making
allegedly false and misleading statements about CMS Energy's business and
financial condition, particularly with respect to revenues and expenses recorded
in connection with round-trip trading by CMS MST. The companies intend to defend
vigorously against this action but cannot predict the outcome of this
litigation.
ERISA LAWSUITS: Consumers is a named defendant, along with CMS Energy,
CMS MST and certain named and unnamed officers and directors, in two lawsuits
brought as purported class actions on behalf of participants and beneficiaries
of the 401(k) Plan. The two cases, filed in July 2002 in the United States
District Court for the Eastern District of Michigan, were consolidated by the
trial judge and an amended and consolidated complaint was filed. Plaintiffs
allege breaches of fiduciary duties under ERISA and seek restitution on behalf
of the plan with respect to a decline in value of the shares of CMS Energy
Common Stock held in the plan. Plaintiffs also
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seek other equitable relief and legal fees. These cases will be defended
vigorously. Consumers cannot predict the outcome of this litigation.
OTHER MATTERS
CASH MANAGEMENT
In August 2002, FERC issued a NOPR concerning the management of funds
by certain FERC-regulated companies. The proposed rule could establish limits on
the amount of funds that may be swept from a regulated subsidiary to a
non-regulated parent under cash management programs. The proposed rule would
require written cash management arrangements that would specify the duties and
restrictions of the participants, the methods of calculating interest and
allocating interest income and expenses, and the restrictions on deposits or
borrowings by money pool members. These cash management agreements also may
require participants to provide documentation of certain transactions. In the
NOPR, FERC proposed that to participate in a cash management or money pool
arrangement, FERC-regulated entities would be required to maintain a minimum
proprietary capital balance (stockholder's equity) of 30 percent and both the
FERC-regulated entity and its parent would be required to maintain investment
grade credit ratings. In October 2003, a final rule was issued by FERC. The rule
will require Consumers, as a FERC-regulated company, to file its cash management
agreements with the FERC and to notify the FERC within 45 days after the end of
each calendar quarter when their proprietary capital ratio drops below 30
percent, and when it subsequently returns to or exceeds 30 percent. The rule
also requires certain information about cash management agreements and
transactions to be maintained. The rule becomes effective in late November 2003.
Consumers operates its cash management program independent of CMS Energy and,
therefore, does not anticipate additional reporting requirements as a result of
this final rule.
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS
SFAS NO. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES: Issued by the FASB in April 2003, this statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement is effective for contracts
entered into or modified after June 30, 2003. Implementation of this statement
has not had an impact on Consumers' consolidated financial statements.
SFAS NO. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH
CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY: Issued by the FASB in May 2003,
this statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. The statement requires an issuer to classify financial instruments
within its scope as liabilities. Those instruments were previously classified as
mezzanine equity. SFAS No. 150 became effective July 1, 2003.
Consumers has four trust preferred securities outstanding as of
September 30, 2003. The trust preferred securities are issued by consolidated
subsidiaries of Consumers. Each trust holds a subordinated debenture from
Consumers. The terms of the debentures are identical to those of the trust
preferred securities, except that the debenture has an explicit maturity date.
The trust documents, in turn, require that the trust be liquidated upon the
repayment of the debenture. The trust preferred securities are redeemable upon
the liquidation of the subsidiary; and therefore, are considered equity in the
financial statements of the subsidiary.
At their October 29, 2003 Board meeting, the FASB deferred the
implementation of the
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portion of SFAS No. 150 relating to mandatorily redeemable noncontrolling
interests in subsidiaries when the noncontrolling interests are classified as
equity in the financial statements of the subsidiary. Consumers' trust preferred
securities are included under the deferral. As such, the Consumers trust
preferred securities continue to be accounted for under existing accounting
guidance and are included in mezzanine equity. Consumers continues to study the
FASB developments regarding the SFAS No. 150 deferral.
EITF ISSUE NO. 01-08, DETERMINING WHETHER AN ARRANGEMENT CONTAINS A
LEASE: In May 2003, the EITF reached consensus in EITF Issue No. 01-08 to
clarify the requirements of identifying whether an arrangement should be
accounted for as a lease at its inception. The guidance in the consensus is
designed to mandate reporting revenue as rental or leasing income that otherwise
would be reported as part of product sales or service revenue. EITF Issue No.
01-08 requires both parties to an arrangement to determine whether a service
contract or similar arrangement is or includes a lease within the scope of SFAS
No. 13, Accounting for Leases.
Historically, Consumers has entered into power purchase and similar
service arrangements. Prospective accounting under EITF Issue No. 01-08, could
affect the timing and classification of revenue and expense recognition. Certain
product sales and service revenue and expenses may be required to be reported as
rental or leasing income and/or expenses. The consensus is to be applied
prospectively to arrangements agreed to, modified, or acquired in business
combinations in fiscal periods beginning July 1, 2003. The adoption of EITF
Issue No. 01-08 has not impacted Consumers' results of operations, cash flows,
or financial position. Consumers will evaluate new or modified contracts under
EITF Issue No. 01-08 prospectively.
ACCOUNTING STANDARDS NOT YET EFFECTIVE
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST
ENTITIES: Issued by the FASB in January 2003, this Interpretation requires the
primary beneficiary of a variable interest entity's activities to consolidate
the variable interest entity. The primary beneficiary is the party that absorbs
a majority of the expected losses and/or receives a majority of the expected
residual returns of the variable interest entity's activities. The consolidation
requirements of the interpretation apply immediately to variable interest
entities created after January 31, 2003. Consumers has not created any variable
interest entities in 2003. Therefore, this portion of the interpretation has no
impact on its consolidated financial statements. Public companies, whose fiscal
year is a calendar year, were originally required to implement the guidance in
this interpretation by the third quarter of 2003. However, on October 9, 2003,
the FASB issued FASB Staff Position No. 46-6, Effective Date of FASB
Interpretation No. 46, which defers implementation of FIN 46 until the fourth
quarter of 2003, for variable interest entities and potential variable interest
entities created before February 1, 2003.
If the completed analysis were to require Consumers to disclose
information about or consolidate in its financial statements, the assets,
liabilities and activities of the MCV Partnership and the First Midland Limited
Partnership, including the recognition of the debt of the MCV Partnership on
Consumers' financial statements, this could impact negatively Consumers' various
financial covenants under its financing agreements. As a result, Consumers may
have to seek amendments to the relevant financing agreements to modify the terms
of certain of these covenants in order to remove the effect of this potential
consolidation or refinance the relevant debt. As of September 30, 2003,
Consumers' investments in the MCV Partnership and in the FMLP were $404 million
and $222 million, respectively. For a further description of the nature,
purpose, size and activities of the MCV Partnership, see Note 2, Uncertainties,
Other Electric Uncertainties, "The Midland Cogeneration Venture." Consumers is
continuing to study the implementation of this interpretation and has yet to
determine the effects, if any, on its
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consolidated financial statements.
EITF ISSUE 03-04, ACCOUNTING FOR CASH BALANCE PENSION PLANS: In May
2003, the EITF reached consensus in EITF Issue No. 03-04 to specifically address
the accounting for certain cash balance pension plans. EITF Issue No. 03-04
concluded that certain cash balance plans be accounted for as defined benefit
plans under SFAS No. 87, Employers' Accounting for Pensions. EITF No. 03-04
requires the use of the traditional unit credit method for the purposes of
measuring the benefit obligation and annual cost of benefits earned as opposed
to the projected unit credit method. The EITF concluded that the requirements of
this Issue be applied as of the next plan measurement date, which is December
31, 2003 for Consumers. Consumers commenced a cash balance pension plan that
covers employees hired after June 30, 2003. Consumers does account for this plan
as a defined benefit plan under SFAS No. 87. Consumers continues to evaluate the
impact, if any, this Issue will have upon adoption.
STATEMENT OF POSITION, ACCOUNTING FOR CERTAIN COSTS AND ACTIVITIES
RELATED TO PROPERTY, PLANT, AND EQUIPMENT: At its September 9, 2003 meeting, the
Accounting Standards Executive Committee voted to approve the Statement of
Position, Accounting for Certain Costs and Activities Related to Property,
Plant, and Equipment. The Statement of Position is expected to be presented for
FASB clearance late in the fourth quarter of 2003 and would be applicable for
fiscal years beginning after December 15, 2004. The Accounting Standards
Executive Committee concluded that at transition, a company would have the
flexibility to adopt a property, plant and equipment component accounting policy
for transition-date property, plant and equipment accounts. The property, plant
and equipment component policy may differ from the componentization policy, if
any, previously used by the enterprise. Selecting a policy that differs from the
company's prior level of componentization at the date of adoption of the
Statement of Position would not result in any cumulative effect difference for
adopting such a policy. A company would not have to restate its pre-adoption
assets to conform with its post-adoption componentization policy. The Accounting
Standards Executive Committee concluded that companies would be required to
disclose meaningful ranges with respect to property, plant and equipment
depreciable lives. Consumers continues to evaluate the impact, if any, this
Issue will have upon adoption.
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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR THE FISCAL
YEAR ENDED DECEMBER 31, 2002
This Management, Discussion and Analysis of Financial Condition and
Results of Operations for the Fiscal Year Ended December 31, 2002 (the "10-K
MD&A") refers to, and in some sections specifically incorporates by reference,
Consumers' Notes to Consolidated Financial Statements and Notes for the fiscal
year ended December 31, 2002 (the "DECEMBER 31, 2002 FINANCIAL STATEMENTS")
beginning on page F-34. They contain detailed information that should be
referred to in conjunction with the following 10-K MD&A. The 10-K MD&A also
describes material contingencies in Consumers' Notes to the December 31, 2002
Financial Statements, and Consumers encourages readers to review these Notes.
All note references within the 10-K MD&A refer to Consumers' Notes to the
December 31, 2002 Financial Statements. Please refer to the Glossary beginning
on page 130 of this prospectus for definitions of certain capitalized terms used
in the 10-K MD&A.
CRITICAL ACCOUNTING POLICIES
Presenting financial statements in accordance with accounting
principles generally accepted in the United States requires using estimates,
assumptions, and accounting methods that are often subject to judgment.
Presented below, are the accounting policies and assumptions that Consumers
believes are most critical to both the presentation and understanding of its
financial statements. Applying these accounting policies to financial statements
can involve very complex judgments. Accordingly, applying different judgments,
estimates or assumptions could result in a different financial presentation.
USE OF ESTIMATES IN ACCOUNTING FOR CONTINGENCIES
The principles in SFAS No. 5 guide the recording of estimated
liabilities for contingencies within the financial statements. SFAS No. 5
requires a company to record estimated liabilities in the financial statements
when a current event has caused a probable future loss payment of an amount that
can be reasonably estimated. Consumers has used this accounting principle to
record estimated liabilities for the following significant events.
ELECTRIC ENVIRONMENTAL ESTIMATES: Consumers is subject to costly and
increasingly stringent environmental regulations. Consumers expects to incur
significant costs for future environmental compliance, especially compliance
with clean air laws.
The EPA has issued final regulations regarding nitrogen oxide emissions
from certain generators, including some of Consumers' electric generating
facilities. These regulations will require Consumers to make significant capital
expenditures estimated to be $770 million. As of December 31, 2002, Consumers
has incurred $405 million in capital expenditures to comply with these
regulations and anticipates that the remaining capital expenditures will be
incurred between 2003 and 2009. Additionally, Consumers expects to supplement
its compliance plan with the purchase of nitrogen oxide emissions credits in the
years 2005 through 2008. The cost of these credits based on the current market
is estimated to average $6 million per year; however, the market for nitrogen
oxide emissions credits is volatile and the price could change significantly. At
some point, if new environmental standards become effective, Consumers may need
additional capital expenditures to comply with the standards. These and other
required environmental expenditures, if not recovered in Consumers' rates, may
have a material adverse effect upon Consumers' financial condition and results
of operations. For further information see Note 2, Uncertainties, "Electric
Contingencies - Electric Environmental Matters."
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GAS ENVIRONMENTAL ESTIMATES: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will incur investigation
and remedial action costs at a number of sites. Consumers estimates the costs
for 23 former manufactured gas plant sites will be between $82 million and $113
million, using the Gas Research Institute-Manufactured Gas Plant Probabilistic
Cost Model. These estimates are based on discounted 2001 costs and follow EPA
recommended use of discount rates between three and seven percent. Consumers
expects to recover a significant portion of these costs through MPSC-approved
rates charged to its customers. Any significant change in assumptions, such as
remediation techniques, nature and extent of contamination, and legal and
regulatory requirements, could change the remedial action costs for the sites.
For further information see Note 2, Uncertainties, "Gas Contingencies - Gas
Environmental Matters."
MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the
MCV Facility, contracted to sell electricity to Consumers for a 35-year period
beginning in 1990 and to supply electricity and steam to Dow. Consumers, through
two wholly owned subsidiaries, holds a 49 percent partnership interest in the
MCV Partnership, and a 35 percent lessor interest in the MCV Facility.
Consumers' annual obligation to purchase capacity from the MCV
Partnership is 1,240 MW through 2025. The PPA requires Consumers to pay, based
on the MCV Facility's availability, a levelized average capacity charge of 3.77
cents per kWh, a fixed energy charge, and a variable energy charge based
primarily on Consumers' average cost of coal consumed for all kWh delivered.
Consumers has not been allowed full recovery of the capacity charges in rates.
After September 2007, the PPA's terms obligate Consumers to pay the MCV
Partnership only those capacity and energy charges that the MPSC has authorized
for recovery from electric customers.
In 1992, Consumers recognized a loss and established a PPA liability
for the present value of the estimated future underrecoveries of power supply
costs under the PPA based on MPSC cost recovery orders. Primarily as a result of
the MCV Facility's actual availability being greater than management's original
estimates, the PPA liability has been reduced at a faster rate than originally
anticipated. At December 31, 2002, 2001 and 2000, the remaining after-tax
present value of the estimated future PPA liability associated with the loss
totaled $34 million, $50 million and $64 million, respectively. The PPA
liability is expected to be depleted in late 2004.
In March 1999, Consumers and the MCV Partnership reached a settlement
agreement effective January 1, 1999, that addressed, among other things, the
ability of the MCV Partnership to count modifications increasing the capacity of
the existing MCV Facility for purposes of computing the availability of contract
capacity under the PPA for billing purposes. That settlement agreement capped
availability payments that may be billed by the MCV Partnership at a 98.5
percent level.
When Consumers returns, as expected, to unfrozen rates beginning in
2004, Consumers will recover from customers, on-peak and off-peak capacity, so
long as availability does not exceed an average 88.7 percent established in
previous MPSC orders. For availability payments billed by the MCV Partnership
after September 15, 2007, and not recovered from customers, Consumers would
expect to claim a regulatory out under the PPA. If the MCV Facility's generating
availability remains at the maximum 98.5 percent level during the next five
years, Consumers' after-tax cash underrecoveries associated with the PPA could
be as follows:
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In Millions
----------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
----------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $25
==========================================================================================================
It is currently estimated that 51 percent of the actual cash
underrecoveries for the years 2003 and 2004 will be charged to the PPA
liability, with the remaining portion charged to operating expense as a result
of Consumers' 49 percent ownership in the MCV Partnership. All cash
underrecoveries will be expensed directly to income once the PPA liability is
depleted.
For further information see Note 2, Uncertainties, "Other Electric
Uncertainties - The Midland Cogeneration Venture."
ACCOUNTING FOR DERIVATIVE AND FINANCIAL INSTRUMENTS AND MARKET RISK INFORMATION
DERIVATIVE INSTRUMENTS: Consumers uses SFAS No. 133 criteria to
determine which contracts must be accounted for as derivative instruments. These
rules, however, are numerous and complex. As a result, significant judgment is
required, and similar contracts can sometimes be accounted for differently.
Consumers currently accounts for the following contracts as derivative
instruments: interest rate swaps, certain electric call options, fixed priced
weather-based gas supply call options and fixed price gas supply put options.
Consumers does not account for the following contracts as derivative
instruments: electric capacity and energy contracts, gas supply contracts
without embedded options, coal and nuclear fuel supply contracts, and purchase
orders for numerous supply items.
Consumers believes that certain of its electric capacity and energy
contracts are not derivatives due to the lack of an active energy market in the
state of Michigan, as defined by SFAS No. 133, and the transportation cost to
deliver the power under the contracts to the closest active energy market at the
Cinergy hub in Ohio. If a market develops in the future, Consumers may be
required to account for these contracts as derivatives. The mark-to-market
impact on earnings related to these contracts, particularly related to the PPA,
could be material to the financial statements.
If a contract is accounted for as a derivative instrument, it is
recorded in the financial statements as an asset or a liability, at the fair
value of the contract. Any difference between the recorded book value and the
fair value is reported either in earnings or other comprehensive income,
depending on certain qualifying criteria. The recorded fair value of the
contract is then adjusted quarterly to reflect any change in the market value of
the contract.
In order to fair value the contracts that are accounted for as
derivative instruments, Consumers uses a combination of market quoted prices and
mathematical models. Option models require various inputs, including forward
prices, volatilities, interest rates and exercise periods. Changes in forward
prices or volatilities could significantly change the calculated fair value of
the call option contracts. At December 31, 2002, Consumers assumed a
market-based interest rate of 4.5 percent and a volatility rate of 70 percent in
calculating the fair value of its electric call options.
In order for derivative instruments to qualify for hedge accounting
under SFAS No. 133, the hedging relationship must be formally documented at
inception and be highly effective in achieving offsetting cash flows or
offsetting changes in fair value, attributable to the risk being hedged. If
hedging a forecasted transaction, the forecasted transaction must be probable.
If a derivative instrument, used as a cash flow hedge, is terminated early
because it is probable that a
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forecasted transaction will not occur, any gain or loss as of such date is
immediately recognized in earnings. If a derivative instrument, used as a cash
flow hedge, is terminated early for other economic reasons, any gain or loss as
of the termination date is deferred and recorded when the forecasted transaction
affects earnings.
FINANCIAL INSTRUMENTS: Consumers accounts for its debt and equity
investment securities in accordance with SFAS No. 115. As such, debt and equity
securities can be classified into one of three categories: held-to-maturity,
trading, or available-for-sale securities. Consumers' investments in equity
securities, including its investment in CMS Energy Common Stock, are classified
as available-for-sale securities. They are reported at fair value, with any
unrealized gains or losses from changes in fair value reported in equity as part
of other comprehensive income and excluded from earnings unless such changes in
fair value are other than temporary. In 2002, Consumers determined that the
decline in value related to its investment in CMS Energy Common Stock was other
than temporary as the fair value was below the cost basis for a period greater
than six months. As a result, Consumers recognized a loss on its investment in
CMS Energy Common Stock through earnings of $12 million in the fourth quarter of
2002. As of December 31, 2002, Consumers held 2.4 million shares of CMS Energy
Common Stock with a fair value of $22 million; as of March 14, 2003 the fair
value was $8 million. Unrealized gains or losses from changes in the fair value
of Consumers' nuclear decommissioning investments are reported in accumulated
depreciation. The fair value of these investments is determined from quoted
market prices.
MARKET RISK INFORMATION: Consumers is exposed to market risks
including, but not limited to, changes in interest rates, commodity prices, and
equity security prices. Consumers' market risk, and activities designed to
minimize this risk, are subject to the direction of an executive oversight
committee consisting of designated members of senior management and a risk
committee, consisting of certain business unit managers. The role of the risk
committee is to review the corporate commodity position and ensure that net
corporate exposures are within the economic risk tolerance levels established by
Consumers' Board of Directors. Established policies and procedures are used to
manage the risks associated with market fluctuations.
Consumers uses various contracts, including swaps, options, and forward
contracts to manage its risks associated with the variability in expected future
cash flows attributable to fluctuations in interest rates and commodity prices.
When management uses these instruments, it intends that an opposite movement in
the value of the at-risk item would offset any losses incurred on the contracts.
Contracts used to manage interest rate and commodity price risk may be
considered derivative instruments that are subject to derivative and hedge
accounting pursuant to SFAS No. 133. Consumers enters into all risk management
contracts for purposes other than trading.
These instruments contain credit risk if the counterparties, including
financial institutions and energy marketers, fail to perform under the
agreements. Consumers minimizes such risk by performing financial credit reviews
using, among other things, publicly available credit ratings of such
counterparties.
In accordance with SEC disclosure requirements, Consumers performs
sensitivity analyses to assess the potential loss in fair value, cash flows and
earnings based upon a hypothetical 10 percent adverse change in market rates or
prices. Management does not believe that sensitivity analyses alone provide an
accurate or reliable method for monitoring and controlling risks. Therefore,
Consumers relies on the experience and judgment of its senior management to
revise strategies and adjust positions, as it deems necessary. Losses in excess
of the amounts determined in sensitivity analyses could occur if market rates or
prices exceed the 10 percent shift used for the analyses.
79
INTEREST RATE RISK: Consumers is exposed to interest rate risk
resulting from the issuance of fixed-rate financing and variable-rate financing,
and from interest rate swap agreements. Consumers uses a combination of these
instruments to manage and mitigate interest rate risk exposure when it deems it
appropriate, based upon market conditions. These strategies attempt to provide
and maintain the lowest cost of capital. As of December 31, 2002, Consumers had
outstanding $1.268 billion of variable-rate financing, including variable-rate
swaps. At December 31, 2002, assuming a hypothetical 10 percent adverse change
in market interest rates, Consumers' before tax earnings exposure on its
variable-rate financing would be $2 million. As of December 31, 2002, Consumers
had entered into floating-to-fixed interest rate swap agreements for a notional
amount of $75 million. These swaps exchange variable-rate interest payment
obligations for fixed-rate interest payment obligations in order to minimize the
impact of potential adverse interest rate changes. As of December 31, 2002,
Consumers had outstanding fixed-rate financing, including fixed-rate swaps, of
$2.760 billion, with a fair value of $2.677 billion. As of December 31, 2002,
assuming a hypothetical 10 percent adverse change in market rates, Consumers
would have an exposure of $137 million to the fair value of these instruments if
it had to refinance all of its fixed-rate financing. As discussed below in
Electric Business Outlook - Securitization, Consumers has filed an application
with the MPSC to securitize certain costs. If approved, Consumers will use the
proceeds from the securitization for refinancing or retirement of debt, which
could include a portion of its current fixed-rate debt. Consumers does not
believe that any adverse change in debt price and interest rates would have a
material adverse effect on either its consolidated financial position, results
of operation or cash flows.
COMMODITY MARKET RISK: For purposes other than trading, Consumers
enters into electric call options, fixed price gas supply contracts containing
embedded put options, fixed priced weather-based gas supply call options and
fixed priced gas supply put options. The electric call options are used to
protect against risk due to fluctuations in the market price of electricity and
to ensure a reliable source of capacity to meet customers' electric needs. The
gas supply contracts containing embedded put options, the weather-based gas
supply call options, and the gas supply put options are used to purchase
reasonably priced gas supply.
As of December 31, 2002, the fair value based on quoted future market
prices of electricity-related call option contracts was $9 million. At December
31, 2002, assuming a hypothetical 10 percent adverse change in market prices,
the potential reduction in fair value associated with these contracts would be
$2 million. As of December 31, 2002, Consumers had an asset of $37 million,
related to premiums incurred for electric call option contracts. Consumers'
maximum exposure associated with the call option contracts is limited to the
premiums incurred. As of December 31, 2002, the fair value based on quoted
future market prices of gas supply-related call and put option contracts was $1
million. At December 31, 2002, a hypothetical 10 percent adverse change in
market prices would be immaterial.
EQUITY SECURITY PRICE RISK: Consumers owns less than 20 percent of the
outstanding shares of CMS Energy Common Stock. Consumers recognized a loss on
this investment through earnings of $12 million in the fourth quarter of 2002,
because the loss was other than temporary as the fair value was below the cost
basis for a period greater than six months. As of December 31, 2002, Consumers
held 2.4 million shares of CMS Energy Common stock at a fair value of $22
million, as of March 14, 2003 the fair value was $8 million. Consumers believes
that any further adverse change in the market price of this investment would not
have a material effect on its consolidated financial position, results of
operation or cash flows.
For further information on market risk and derivative activities, see
Note 5, Financial and Derivative Instruments.
80
ACCOUNTING FOR THE EFFECTS OF INDUSTRY REGULATION
Because Consumers is involved in a regulated industry, regulatory
decisions affect the timing and recognition of revenues and expenses. Consumers
uses SFAS No. 71 to account for the effects of these regulatory decisions. As a
result, Consumers may defer or recognize revenues and expenses differently than
a non-regulated entity.
For example, items that a non-regulated entity would normally expense,
Consumers may capitalize as regulatory assets if the actions of the regulator
indicate such expenses will be recovered in future rates. Conversely, items that
non-regulated entities may normally recognize as revenues, Consumers may record
as regulatory liabilities if the actions of the regulator indicate they will
require such revenues to later be refunded to customers. Judgment is required to
discern the recoverability of items recorded as regulatory assets and
liabilities. As of December 31, 2002, Consumers had $1.072 billion recorded as
regulatory assets and $313 million recorded as regulatory liabilities.
In March 1999, Consumers received MPSC electric restructuring orders,
which, among other things, identified the terms and timing for implementing
electric restructuring in Michigan. Consistent with these orders and EITF No.
97-4, Consumers discontinued the application of SFAS No. 71 for the energy
supply portion of its business because Consumers expected to implement retail
open access at competitive market-based rates for its electric customers. Since
1999, there has been a significant legislative and regulatory change in Michigan
that has resulted in: 1) electric supply customers of utilities remaining on
cost-based rates and 2) utilities being given the ability to recover Stranded
Costs associated with electric restructuring, from customers who choose an
alternative electric supplier. During 2002, Consumers re-evaluated the criteria
used to determine if an entity or a segment of an entity meets the requirements
to apply regulated utility accounting, and determined that the energy supply
portion of its business could meet the criteria if certain regulatory events
occurred. In December 2002, Consumers received a MPSC Stranded Cost order that
allowed Consumers to re-apply regulatory accounting standard SFAS No. 71 to the
energy supply portion of its business. Re-application of SFAS No. 71 had no
effect on the prior discontinuation accounting, but will allow Consumers to
apply regulatory accounting treatment to the energy supply portion of its
business on a prospective basis, including regulatory accounting treatment of
costs required to be recognized in accordance with SFAS No. 143.
ACCOUNTING FOR PENSION AND OPEB
Consumers provides postretirement benefits under its Pension Plan, and
postretirement health and life benefits under its OPEB plans to substantially
all its retired employees. Consumers uses SFAS No. 87 to account for pension
costs and uses SFAS No. 106 to account for other postretirement benefit costs.
These statements require liabilities to be recorded on the balance sheet at the
present value of these future obligations to employees net of any plan assets.
The calculation of these liabilities and associated expenses require the
expertise of actuaries and are subject to many assumptions including life
expectancies, present value discount rates, expected long-term rate of return on
plan assets, rate of compensation increase and anticipated health care costs.
Any change in these assumptions can significantly change the liability and
associated expenses recognized in any given year. The Pension Plan includes
amounts for employees of CMS Energy and non-utility affiliates, including
Panhandle, which were not distinguishable from the Pension Plan's total assets.
On December 21, 2002, a definitive agreement was executed to sell Panhandle. The
sale is expected to close in 2003. No portion of the Pension Plan will be
transferred with the sale of Panhandle. At the closing of the sale, none of the
employees of Panhandle will be eligible to accrue additional benefits. The
Pension Plan will retain pension payment obligations for Panhandle employees
that are vested under the Pension Plan. Consumers does not expect the impact to
be material.
81
Pension and OPEB plan assets, net of contributions, have been reduced
in value from the previous year due to the downturn in the equities market, and
a decrease in the price of CMS Energy Common Stock. As a result, Consumers
expects to see an increase in pension and OPEB expense levels over the next
several years unless investment performance of plan assets improves. Consumers
anticipates its allocated share of pension expense to rise in 2003 by
approximately $11 million over 2002 expenses. OPEB expenses in 2003 are
anticipated to stay the same as 2002 expenses. For pension expense, this
increase is due to a downturn in value of pension assets during the past two
years, forecasted increases in pay and added service, and a decline in the
interest rate used to value the liability of the plan. Estimated 2003 OPEB
expenses remained the same as 2002 due to additional required contributions from
retirees and increases in mail-order prescription copays. Under the OPEB plans'
assumptions, health care costs increase at a slower rate from current levels
through 2010; however, Consumers cannot predict the impact that future health
care costs and interest rates or market returns will have on pension and OPEB
expense in the future. As of January 2002, OPEB plan claims are paid from the
VEBA Trusts.
The recent significant downturn in the equities markets has affected
the value of the Pension Plan assets. The Pension Plan's Accumulated Benefit
Obligation exceeded the value of these assets at December 31, 2002, and as a
result, Consumers and the other participants were required to recognize an
additional minimum liability for this excess in accordance with SFAS No. 87. The
fair value of the Pension Plan assets at December 31, 2002 was $607 million,
including CMS Energy Common Stock which had a market value of $49 million based
on a market price of $9.44. As of March 14, 2003, the market value of CMS Energy
Common Stock in the Pension Plan was $18 million based on a share price of
$3.52. As of December 31, 2002, the Accumulated Benefit Obligation was estimated
at $1.055 billion and the additional minimum liability was $426 million.
Consumers was allocated $325 million of the additional minimum liability, of
which $40 million was recorded as an intangible asset, and $285 million was
charged to other comprehensive income ($185 million after-tax).
At December 31, 2002, the balance of the OPEB plans' assets was $465
million. This amount consists primarily of stocks and bonds, including CMS
Energy Common Stock of $1.3 million, based on a share price of $9.44. As of
March 14, 2003, the market value of CMS Energy Common Stock in the OPEB plans'
assets was $0.5 million, based on a share price of $3.52.
During 2002, Consumers' portion of contributions made to the plans'
trust accounts was $120 million. This amount represents $47 million of pension
related benefits and $73 million of postretirement health care and life
insurance benefits. Consumers expects similar contributions for postretirement
health care and life insurance benefits will be made in 2003, 2004, and 2005.
The investment performance returns and declining discount rates have increased
the underfunding of the Pension Plan, net of benefit obligations, from $350
million at December 31, 2001 to $649 million at December 31, 2002. Because of
the recent rise in the underfunded status of the Pension Plan, based on
actuarial assumptions, Consumers expects to make cash contributions to the
Pension Plan which approximates $158 million, $209 million, and $24 million in
2003, 2004, and 2005, respectively. However, if necessary to increase liquidity,
Consumers would postpone the 2003 contribution.
Consumers' expense for the Pension Plan approximated $25 million and
$17 million for the years ended December 31, 2002 and December 31, 2001,
respectively, and is calculated based upon a number of actuarial assumptions,
including an expected long-term rate of return on the Pension Plan assets of
8.75 percent in 2002 and 9.75 percent in 2001.
Lowering the expected long-term rate of return on the Pension Plan
assets by 0.25 percent (from 8.75 percent to 8.5 percent) would have increased
pension expense for fiscal 2002 by
82
approximately $3 million. Lowering the discount rate by 0.25 percent would have
increased pension expense for fiscal 2002 by approximately $2 million.
Consumers estimates pension expense will approximate $36 million, $42
million and $48 million in fiscal 2003, fiscal 2004 and fiscal 2005,
respectively. Future actual pension expense will depend on future investment
performance, changes in future discount rates and various other factors related
to the populations participating in the Pension Plan.
Consumers bases the determination of pension expense on a
market-related valuation of assets, which reduces year-to-year volatility. This
market-related valuation recognizes investment gains or losses over a 5-year
period from the year in which they occur. Investment gains or losses for this
purpose are the difference between the expected return calculated using the
market-related value of assets and the actual return based on the market-related
value of assets. Since the market-related value of assets recognizes gains or
losses over a 5-year period, the future value of assets will be impacted as
previously deferred gains or losses are recorded.
Due to the unfavorable performance of the equity markets, as of
December 31, 2002, Consumers had cumulative losses of approximately $205 million
that remain to be recognized in the calculation of the market-related value of
assets. These unrecognized net actuarial losses result in increases in future
pension expense depending on several factors, including whether such losses at
each measurement date exceed the corridor in accordance with SFAS No. 87.
Consumers has announced changes to the Pension Plan. Employees hired on
or after July 1, 2003 will be covered by the cash balance plan section of the
plan currently being used. Under the cash balance plan, an employee's retirement
account is credited annually with a percentage of their salary and any amounts
that are vested are portable when an employee leaves the company. In addition,
the method used to convert an employee's benefit to a lump sum payment is being
changed. Employees who elect the lump sum payment option will no longer receive
an early retirement subsidy. As a result, employees who choose the lump sum
payment option, and retire before age 65, will receive lower lump sum payments.
Consumers also provides retirement benefits under a defined
contribution 401(k) plan. Consumers previously offered an employer's
contribution match of 50 percent of the employee's contribution up to six
percent (three percent maximum), as well as an incentive match in years when
Consumers' financial performance exceeded targeted levels. Effective September
1, 2002, the employer's match was suspended until January 1, 2005, and the
incentive match was permanently eliminated. The amount charged to expense for
the employer's match for 2002 was $8 million. Amounts charged to expense for the
employer's match and incentive match during 2001 were $12 million and $8
million, respectively.
In order to keep health care benefits and costs competitive, Consumers
has announced several changes to the Health Care Plan. These changes were
effective January 1, 2003. The most significant change is that Consumers' future
increases in health care costs will be shared with salaried employees. The
salaried retirees health care plan has also been amended. Pre-Medicare retirees
now elect coverage from four different levels of coverage, with the two best
coverage options requiring premium contributions. These plans also coordinate
benefits under a maintenance of benefits provision to reduce claim costs for
Consumers. Mail-order prescription copays have also been increased for all
salaried retirees.
For detailed information on postretirement benefits see Note 7,
Retirement Benefits.
83
ACCOUNTING FOR NUCLEAR DECOMMISSIONING COSTS
Consumers' decommissioning cost estimates for the Big Rock and
Palisades plants assume that each plant site will eventually be restored to
conform to the adjacent landscape with all contaminated equipment and material
removed and disposed of in a licensed burial facility and the site released for
unrestricted use. A March 1999 MPSC order provided for fully funding the
decommissioning trust funds for both sites. The order set the annual
decommissioning surcharge for the Palisades decommissioning at $6 million a
year. Consumers estimates that at the time of the decommissioning of Palisades,
its decommissioning trust fund will be fully funded. Earnings assumptions are
that the trust funds are invested in equities and fixed income investments,
equities will be converted to fixed income investments during decommissioning
and fixed income investments are converted to cash as needed. Decommissioning
costs have been developed, in part, by independent contractors with expertise in
decommissioning. These costs estimates use various inflation rates for labor,
non-labor, and contaminated equipment disposal costs.
On December 31, 2000, the Big Rock trust fund was considered fully
funded. A portion of its current decommissioning cost is due to the failure of
the DOE to remove fuel from the site. These costs, and similar costs incurred at
Palisades, would not be necessary but for the failure of the DOE to take
possession of the spent fuel as required by the Nuclear Waste Policy Act of
1982. If the litigation that was commenced in the fourth quarter of 2002,
against the DOE is successful, Consumers anticipates future recoveries from the
DOE to defray the significant costs it will incur for the storage of spent fuel
until the DOE takes possession as required by law.
On March 26, 2003, the Michigan Environmental Council, the Public
Interest Research Group in Michigan, and the Michigan Consumer Federation filed
a complaint with the MPSC that asks the MPSC to commence a generic investigation
and contested case to review all facts and issues concerning the recovery of
costs associated with spent nuclear fuel storage and disposal. The complaint
alleges that the rates of Consumers Energy, The Detroit Edison Company, Indiana
& Michigan Electric Company, Wisconsin Electric Power Company and Wisconsin
Public Service Corporation are unjust and unreasonable with respect to the
recovery of costs associated with spent nuclear fuel storage and disposal. The
complaint seeks a variety of relief, including the establishing of external
trusts to which amounts collected in electric rates for spent nuclear fuel
storage and disposal should be transferred, and the adoption of additional
measures to assure that adequate funds are available for the storage and
disposal of spent nuclear fuel. Consumers has not had an opportunity to review
the complaint in detail.
The funds provided by the trusts and additional funds from DOE
litigation are expected to fully fund the decommissioning costs. Variance from
trust earnings, a lesser recovery of costs from the DOE, changes in
decommissioning technology, regulations, estimates or assumptions could affect
the cost of decommissioning these sites.
RELATED PARTY TRANSACTIONS
Consumers enters into a number of significant transactions with related
parties. These transactions include the purchase of capacity and energy from the
MCV Partnership and from affiliates of Enterprises, the purchase of electricity
and gas supply from CMS MST, the sale of electricity to CMS MST, the purchase of
gas transportation from CMS Bay Area Pipeline, L.L.C., the purchase of gas
transportation from Trunkline, a subsidiary of Panhandle, the payment of parent
company overhead costs to CMS Energy, the sale, storage and transportation of
natural gas and other services to the MCV Partnership, and an investment in CMS
Energy Common Stock.
84
Transactions involving CMS Energy and its affiliates and the sale,
storage and transportation of natural gas and other services to the MCV
Partnership are based on regulated prices, market prices or competitive bidding.
Transactions involving the power supply purchases from the MCV Partnership, and
certain affiliates of Enterprises, are based upon avoided costs under PURPA and
competitive bidding; and the payment of parent company overhead costs to CMS
Energy are based upon use or accepted industry allocation methodologies.
In 2002, Consumers also sold its transmission facilities to MTH, a
non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect, Inc., an independent company, whose management includes former
executive employees of Consumers. The transaction was based on competitive
bidding.
For detailed information about related party transactions see Note 2,
Uncertainties, "Electric Rate Matters - Transmission", and "Other Electric
Uncertainties - The Midland Cogeneration Venture".
RESULTS OF OPERATIONS
CONSUMERS CONSOLIDATED EARNINGS
In Millions
----------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 Change 2001 2000 Change
----------------------------------------------------------------------------------------------------------
Net income available to common stockholder $335 $145 $190 $145 $248 $(103)
==========================================================================================================
2002 COMPARED TO 2001: For 2002, Consumers' net income available to the
common stockholder totaled $335 million, an increase of $190 million from the
previous year. The earnings increase reflects the after-tax benefit of decreased
electric power costs of $85 million from 2001. This reduction in power costs was
primarily due to the need to purchase higher replacement power resulting from a
refueling outage and an unscheduled forced outage at Palisades in 2001. This
reduction in power costs also can be attributed to the lower price of power
options and dispatchable capacity contracts purchased for 2002. The increase in
earnings also reflects the after-tax $26 million gain from the May 2002 sale of
Consumers' electric transmission system to MTH, an after-tax $5 million gain
from the sale of an unused nuclear plant reactor head, along with a $25 million
benefit, which includes an after-tax cumulative effect of accounting change of
$18 million, associated with the fair value of certain long-term gas contracts
held by the MCV Partnership. The fair value of these contracts is adjusted,
through earnings, on a quarterly basis in accordance with SFAS No. 133. Earnings
also increased as a result of an after-tax $11 million adjustment to its
electric call option and option like contracts that was booked in 2001, as a
result of the implementation of SFAS No. 133. For further information on SFAS
No. 133, see Note 5, Financial and Derivative Instruments. Increased electric
deliveries to the higher margin residential and commercial sectors contributed
an additional after-tax benefit of $27 million. Also, contributing to the
earnings increase is an after-tax benefit of $16 million due to the interim and
final gas rate orders issued in 2001 and 2002. Offsetting these increases is a
$9 million decrease resulting from the recognition of a historic, cumulative 4
bcf loss of natural gas from inventory.
2001 COMPARED TO 2000: For 2001, Consumers' net income available to the
common stockholder totaled $145 million, a decrease of $103 million from the
previous year. The earnings decrease reflects significantly increased operating
expense in 2001, primarily $59 million of after-tax costs for replacement power
supply costs due to a six month unscheduled outage at the Palisades Plant. Net
income in 2001 was also adversely impacted by $11 million to reflect a change in
accounting for certain electric call option contracts under SFAS No. 133. In
addition, 2001 earnings decreased due to the impact of reduced gas deliveries
resulting from
85
milder temperatures during both the first quarter and fourth quarter heating
seasons. Gas delivery revenues were also adversely impacted as a result of
warmer temperatures compared to the 2000 heating season and a reduction due to
the year-long impact of an economic slowdown in 2001, throughout Michigan. Also
contributing to this earnings decrease is the fact that 2001 reflects a full
year impact of a five percent electric residential rate decrease that was
implemented to comply with the Customer Choice Act.
For further information, see the Electric and Gas Utility Results of
Operations sections and Note 2, Uncertainties.
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
----------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 Change 2001 2000 Change
----------------------------------------------------------------------------------------------------------
Net income available to common stockholder $264 $109 $155 $109 $199 $ (90)
==========================================================================================================
Reasons for the change:
Electric deliveries $ 41 $ 19
Power supply costs and related revenue 120 (109)
Rate decrease - (35)
Other operating expenses and non-commodity revenue 5 17
Implementation of accounting standard (SFAS No. 133) 17 (17)
Gain on asset sales 38 -
Fixed charges 9 (6)
Income taxes (75) 41
--------------------------------
Total change $155 $ (90)
==========================================================================================================
ELECTRIC DELIVERIES: For the year 2002, electric delivery revenues
increased by $41 million from the previous year. Electric deliveries, including
transactions with other wholesale market participants and other electric
utilities, were 39.3 billion kWh, a decrease of 0.3 billion kWh or 0.7 percent
from 2001. This reduction in electric deliveries is primarily due to reduced
transactions with other utilities and the expiration of wholesale power sales
contracts with certain Michigan municipal utilities. Although total deliveries
were below the 2001 level, increased deliveries to the higher margin residential
and commercial sectors, along with the growth in retail deliveries, more than
offset the impact of reduced deliveries to lower margin customers. For the year,
Consumers set an all-time monthly sendout record during the month of July, and
new monthly hourly peak demand records were set on April 16, 2002, June 25,
2002, September 9, 2002, and October 1, 2002. For the year 2001, electric
delivery revenues increased by $19 million from the previous year. Electric
deliveries, including transactions with other wholesale market participants and
other electric utilities, were 39.6 billion kWh, a decrease of 1.4 billion kWh
or 3.5 percent from 2000.
POWER SUPPLY COSTS AND RELATED REVENUE: For the year 2002, power supply
costs and related revenues provided a net increase of $120 million from 2001.
This net increase was primarily due to reduced purchased power costs resulting
from the Palisades plant being returned to service in 2002. In 2001, Consumers
purchased higher cost replacement power during the refueling outage that began
in March and ended in May and the unscheduled forced outage at Palisades that
began in June and ended in January 2002. Also contributing to this decrease in
power costs is lower priced power options and dispatchable capacity contracts
that were purchased for 2002. For the year 2001, power supply costs and related
revenues resulted in a net decrease of $109 million from 2000. This net decrease
was primarily due to the need to purchase greater quantities of higher-priced
electricity to offset the loss of generation resulting from the Palisades
outages mentioned above.
86
For the years 2002 and 2001 respectively, Consumers purchased and
expensed $23 million and $65 million of electric call options to ensure a
reliable source of power supply during the summer months. As a result of
periodic excess daily capacity, certain call options were sold and the remaining
call options were either exercised or expired. Consumers accounted for the costs
relating to the expired call options and the income received from the sale of
call options, as purchased power supply costs.
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUE: For the year 2002,
non-commodity revenues increased primarily resulting from increased
miscellaneous service revenues. Partially offsetting this increase in revenues,
are increased other operating expenses compared to 2001. This increase can be
attributed to higher depreciation expense resulting from higher plant in service
along with increased operating costs resulting from higher health care expenses,
storm restoration expenses, and increased contracted maintenance expenses. For
the year 2001, other operating expenses and non-commodity revenues provided a
net benefit when compared to 2000. This benefit is primarily due to reduced
amortization expense, as permitted by MPSC orders resulting from the Customer
Choice Act. Consumers temporarily suspended amortization of the securitized
assets pending the issuance of Securitization bonds in November 2001.
IMPLEMENTATION OF ACCOUNTING STANDARD (SFAS NO. 133): In 2001,
Consumers implemented SFAS No. 133 which provides for derivative and hedge
accounting for certain utility industry contracts, particularly electric call
option contracts and option-like contracts. After receiving guidance from the
FASB, Consumers re-evaluated its electric call option and option-like contracts
and determined that these contracts require derivative accounting, and therefore
recorded a $17 million pre-tax cumulative effect adjustment as a decrease to
earnings. This adjustment relates to the difference between the fair value and
the recorded book value of these electric call option contracts.
GAIN ON ASSET SALES: For the year 2002, asset sales resulted in a $31
million pretax gain associated with the sale of Consumers' electric transmission
system and a $7 million pretax gain on the sale of nuclear equipment from the
cancelled Midland project.
INCOME TAXES: For the year 2002, income tax expense increased primarily
due to an increase in earnings by the electric utility. Income taxes associated
with the transmission system sale reflect a $5 million benefit due to the
recognition of the remaining unutilized investment tax credit related to the
assets sold.
87
GAS UTILITY RESULTS OF OPERATIONS
In Millions
----------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 Change 2001 2000 Change
----------------------------------------------------------------------------------------------------------
Net income available to common stockholder $46 $21 $ 25 $21 $18 $ 3
==========================================================================================================
Reasons for the change:
Gas deliveries $ 21 $(21)
Gas commodity and related revenue - 44
Gas rate increase 25 -
Gas wholesales and retail services 1 8
Operation and maintenance (14) (30)
General taxes and depreciation (3) -
Fixed charges 3 1
Income taxes (8) 1
----------------------------------
Total change $ 25 $ 3
==========================================================================================================
GAS DELIVERIES: For the year 2002, gas delivery revenues increased by
$21 million from the previous year. System deliveries, including miscellaneous
transportation, totaled 376.4 bcf, an increase of 9.4 bcf or 2.6 percent
compared with 2001. This increase is primarily due to colder weather that
resulted in increased deliveries to the residential and commercial sectors in
2002. For the year 2001, gas delivery revenues decreased by $21 million from the
previous year. System deliveries, including miscellaneous transportation,
totaled 367 bcf, a decrease of 43 bcf or 10 percent compared with 2000. This
decrease is primarily due to warmer temperatures compared to the 2000 heating
season and a reduction due to the economic slowdown in 2001.
GAS RATE INCREASE: In 2001, the MPSC issued an interim order in
Consumers' gas rate filing. In November 2002, the MPSC issued a final gas rate
order authorizing a $56 million annual increase in Consumers gas tariff rates.
As a result of these orders, Consumers recognized increased gas revenues of $25
million.
OPERATION AND MAINTENANCE: For the year 2002, operation and maintenance
expenses increased $14 million compared to 2001. This increase reflects the
recognition of gas storage inventory losses, and additional expenditures on
customer reliability and service.
INCOME TAXES: For the year 2002, income tax expense increased,
primarily due to improved earnings of the gas utility.
CAPITAL RESOURCES AND LIQUIDITY
CASH POSITION, INVESTING AND FINANCING
OPERATING ACTIVITIES: Consumers' principal source of liquidity is from
cash derived from operating activities involving the sale and transportation of
natural gas and the generation, delivery and sale of electricity. For 2002 and
2001, cash from operations totaled $769 million and $518 million, respectively.
The $251 million increase resulted primarily from an increase in cash due to
lower expenditures for natural gas and increased tax refunds provided by the Job
Creation and Worker Assistance Act of 2002, a gas rate increase and lower
electric power purchase costs as discussed in the results of operations also
contributed to the increase. Partially offsetting the cash increase was a
decrease in cash collected from customers and related parties.
88
Consumers primarily uses cash derived from operating activities to operate,
maintain, expand and construct its electric and gas systems, to retire portions
of long-term debt, and to pay dividends. A decrease in cash from operations
could reduce the availability of funds and result in additional short-term
financings, see Note 3, Financings and Capitalization for additional details
about this source of funds.
INVESTING ACTIVITIES: For 2002 and 2001, cash used for investing
activities totaled $311 million and $803 million, respectively. The change of
$492 million is primarily the result of $298 million cash proceeds from the sale
of METC and other assets, and lower capital expenditures to comply with the
Clean Air Act.
FINANCING ACTIVITIES: Cash used for financing activities totaled $204
million for 2002 compared to $281 million provided in 2001. The change of $485
million is primarily due to $173 million additional retirement of bonds and
other long-term debt, and a net reduction in proceeds from new borrowings of
$334 million for 2002 compared to 2001.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS: The following
schedule of material contractual obligations and commercial commitments is
provided to aggregate information in a single location so that a picture of
liquidity and capital resources is readily available. For further information
see Note 2, Uncertainties, and Note 3, Financings and Capitalization.
Contractual Obligation In Millions
----------------------------------------------------------------------------------------------------------
Payments Due
-----------------------------------------------------------
2008 and
December 31 Total 2003 2004 2005 2006 2007 beyond
----------------------------------------------------------------------------------------------------------
On-balance sheet:
Long-term debt $ 2,442 $ - $328 $470 $362 $ 31 $ 1,251
Current portion of long-
term debt 305 305 - - - - -
Notes payable 457 457 - - - - -
Capital lease obligations (a) 157 21 20 18 17 16 65
Off-balance sheet:
Headquarters building lease (a) 6 - - - - - 6
Operating leases 78 13 10 8 8 6 33
Non-recourse debt of FMLP 208 8 54 41 26 13 66
Sale of accounts receivable 325 325 - - - - -
Unconditional purchase
obligations 17,344 1,368 975 877 727 727 12,670
==========================================================================================================
(a) The headquarters building capital lease is estimated to be $60 million of
which a $54 million construction obligation has been incurred and recorded on
Consumers' balance sheet as of December 31, 2002.
REGULATORY AUTHORIZATION FOR FINANCINGS: At December 31, 2002,
Consumers had FERC authorization to issue or guarantee through June 2004, up to
$1.1 billion of short-term securities outstanding at any one time. Consumers
also had remaining FERC authorization to issue through June 2004 up to $500
million of long-term securities for refinancing or refunding purposes, $677
million for general corporate purposes, and $900 million of first mortgage bonds
to be issued solely as security for the long-term securities. On October 10,
2002, FERC granted a waiver of its competitive bid/negotiated placement
requirements applicable to the remaining long-term securities authorization
indicated above.
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LONG TERM DEBT: Consumers' current portion of long-term debt maturing
in 2003 is $305 million. Refer to Outlook, "Liquidity and Capital Resources"
below for information about Consumers strategic measures addressing its future
liquidity and capital requirements.
SHORT TERM FINANCINGS: On July 12, 2002, Consumers entered into two
credit facilities as follows: a $250 million revolving credit facility maturing
July 11, 2003 and a $300 million term loan maturing July 11, 2003. In March
2003, Consumers obtained a replacement revolving credit facility in the amount
of $250 million. The new credit facility matures in March 2004 with two annual
extensions at Consumers' option, which would extend the maturity to March 2006.
In September 2002, the term loan maturity was extended by one year at Consumers'
option and now has a maturity date of July 11, 2004. These two facilities
aggregating $550 million replaced a $300 million revolving credit facility that
matured July 14, 2002, as well as various credit lines aggregating $200 million.
At December 31, 2002, a total of $550 million was outstanding under the revolver
and term loan, of which $250 million was included in notes payable and $300
million was included in long-term debt maturing in 2004. The prior credit
facilities and lines were unsecured. The two new credit facilities are secured
with Consumers' first mortgage bonds and are available to finance seasonal
working capital requirements and to pay for capital expenditures between
long-term financings.
Consumers' $250 million revolving credit facility had, as of December
31, 2002, an effective interest rate of 5.9 percent, although the rate may
fluctuate depending on the rating of Consumers' first mortgage bonds or changes
in the base LIBOR rate. The effective interest rate on the $300 million term
loan was 8.9 percent as of December 31, 2002. The rate may fluctuate depending
on the rating of Consumers' first mortgage bonds or changes in the base LIBOR
rate. Consumers' bank and legal fees associated with arranging the facilities in
July 2002 were $6 million.
The two credit facilities have contractual restrictions that require
Consumers to maintain, as of the last day of each fiscal quarter, the following:
Limitation Ratio at December 31, 2002
----------------------------------------------------------------------------------------------------------
Debt to Capital Ratio (a)(b) Not more than 0.65 to 1.00 0.55 to 1.00
Interest Coverage Ratio (a)(b) Not less than 2.0 to 1.0 4.00 to 1.0
==========================================================================================================
(a) Violation of this ratio would constitute an event of default under the
facility which provides the lender, among other remedies, the right to declare
the principal and interest immediately due and payable.
(b) The terms of the credit facilities provide for the exclusion of
securitization bonds in the calculation of the debt to capital ratio.
Also, pursuant to restrictive covenants in the new facilities,
Consumers is limited to common stock dividend payments that will not exceed $300
million in any calendar year. Consumers paid $231 million and $190 million in
common stock dividends to CMS Energy in 2002 and 2001, respectively. In January
2003, Consumers declared and paid a $78 million common dividend.
In October 2002, Consumers simultaneously entered into a new term loan
agreement collateralized by first mortgage bonds and a new gas inventory term
loan agreement collateralized by Consumers' natural gas in storage. These
agreements contain complementary collateral packages that provide Consumers, as
additional first mortgage bonds become available, borrowing capacity of up to
$225 million, of which $207 million was outstanding at December 31, 2002 with an
effective interest rate of 6.3 percent. The bank and legal fees associated with
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the agreements were $2 million. The first amortization payment under these
agreements occurred in December 2002 with monthly amortization payments
scheduled until full repayment is completed in mid-April of 2003. The loan
amortization also reduces the bank's loan commitment to the amount of loan
outstanding, which was $207 million as of December 31, 2002.
LEASES: Consumers' capital leases are predominately for leased service
vehicles and the new headquarters building. Operating leases are predominately
railroad coal car leases.
OFF-BALANCE SHEET ARRANGEMENTS: Consumers' use of long-term contracts
for the purchase of commodities and services, the sale of its accounts
receivable, and operating leases are considered to be off-balance sheet
arrangements. Consumers has responsibility for the collectability of the
accounts receivable sold, and the full obligation of its leases become due in
case of lease payment default. Consumers uses these off-balance sheet
arrangements in its normal business operations.
SALE OF ACCOUNTS RECEIVABLE: Consumers had, through its wholly owned
subsidiary Consumers Receivables Funding, a $325 million trade receivable sale
program in place as an anticipated source of funds for general corporate
purposes and currently expected capital expenditures at December 31, 2002. At
December 31, 2001, prior to the establishment of its new subsidiary, Consumers
Receivables Funding, Consumers had a $450 million trade receivables sale program
in place as an anticipated source of funds for general corporate purposes and
currently expected capital expenditures. At December 31, 2002 and 2001, the
receivable sold totaled $325 million and $334 million, respectively. Accounts
receivable and accrued revenue in the Consolidated Balance Sheets have been
reduced to reflect receivables sold.
UNCONDITIONAL PURCHASE OBLIGATIONS: Unconditional purchase obligations
include natural gas, electricity, and coal purchase contracts and their
associated cost of transportation. These obligations represent normal business
operating contracts used to assure adequate supply and to minimize exposure to
market price fluctuations.
Included in unconditional purchase obligations are long-term power
purchase agreements with various generating plants including the MCV Facility.
These contracts require monthly capacity payments based on the plants'
availability or deliverability. These payments are approximately $45 million per
month for year 2003, including $33 million related to the MCV Facility. For the
period that a plant is not available to deliver electricity to Consumers,
Consumers is not obligated to make the capacity payments to the plant. See
Electric Utility Results of Operations above and Note 2, Uncertainties,
"Electric Rate Matters - Power Supply Costs" and "Other Electric Uncertainties -
The Midland Cogeneration Venture" for further information concerning power
supply costs.
Commercial Commitments In Millions
----------------------------------------------------------------------------------------------------------
Commitment Expiration
-----------------------------------------------------------
2008 and
December 31 Total 2003 2004 2005 2006 2007 beyond
----------------------------------------------------------------------------------------------------------
Off-balance sheet:
Indemnities $11 $- - - - - $11
Letters of credit 7 7 - - - - -
==========================================================================================================
Indemnities are agreements by Consumers to reimburse other companies,
such as an insurance company, if those companies have to complete Consumers'
performance involving a third party contract. Letters of credit are issued by a
bank on behalf of Consumers, guaranteeing payment to a third party. Letters of
credit substitute the bank's credit for Consumers' and reduce credit risk for
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the third party beneficiary. The amount and time period for drawing on a letter
of credit is limited.
OUTLOOK
LIQUIDITY AND CAPITAL RESOURCES
Consumers' liquidity and capital requirements are generally a function
of its results of operations, capital expenditures, contractual obligations,
debt maturities, working capital needs and collateral requirements. Consumers
has historically met its consolidated cash needs through its operating and
financing activities and access to bank financing and the capital markets. As
discussed above, during 2003, Consumers has contractual obligations and planned
capital expenditures that would require substantial amounts of cash. Consumers
also has approximately $727 million of publicly issued and credit facility debt
maturing in 2003, including the Consumers' credit facilities described above.
However, in March 2003, a $250 million revolving credit facility was replaced,
as discussed below. In addition, Consumers may also become subject to liquidity
demands pursuant to commercial commitments under guarantees, indemnities and
letters of credit as indicated above.
Consumers is partially addressing its near-to-mid-term liquidity and
capital requirements through reduced capital expenditures and cost reduction.
Consumers believes that its current level of cash and borrowing capacity, along
with anticipated cash flows from operating and investing activities, will be
sufficient to meet its liquidity needs through 2003, including debt maturities
in 2003. Consumers expects to borrow approximately $1.1 billion in total in
2003, which includes an amount to refinance the majority of the maturing debt
above.
During the summer months, Consumers purchases natural gas and stores it
for resale primarily during the winter heating season. Recently the market price
for natural gas has increased. If continued, this price increase could impose
liquidity needs beyond what is anticipated for 2003. Although Consumers' natural
gas purchases are recoverable from its customers, the amount paid for natural
gas stored as inventory could require additional liquidity due to the timing of
the cost recoveries.
In July 2002, the credit rating of the publicly traded securities of
Consumers was downgraded by the major rating agencies. As a result of certain of
these rating agency downgrades, certain commodity suppliers to Consumers have
requested advance payments or other forms of assurances in connection with
maintenance of ongoing deliveries of gas and electricity. Consumers is
addressing these issues as required.
As a result of the ratings downgrades and related changes in its
financial situation, Consumers' access to bank financing and the capital markets
and its ability to incur additional indebtedness may be restricted. Consumers
continues to explore the full range of strategic measures to provide adequate
liquidity. These measures include refinancing its bank credit facilities,
entering into leasing arrangements, inventory financing, vendor financing,
refinancing and issuing new capital markets debt, and preferred equity, and
negotiating private placement debt, and preferred equity. Consumers believes
that these measures will also supplement its cash balances in 2003.
Consumers plans to meet its liquidity and capital requirements in 2003
through a combination of approximately $229 million from operations and
approximately $513 million of new debt along with reduced capital expenditures,
cost reductions and other measures. As of March 14, 2003, Consumers planned to
refinance $727 million of debt in 2003. To that end, Consumers has initiated
several transactions with various financial institutions, regulators, banks,
lenders,
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and others that are designed to provide liquidity:
- Consumers has obtained a replacement revolving credit facility
in the amount of $250 million secured by first mortgage bonds.
The cost of the facility is LIBOR plus 350 basis points. The
new credit facility matures in March 2004 with two annual
extensions at Consumers' option, which would extend the
maturity to March 2006. The prior facility was due to expire
in July 2003.
- Consumers has entered into a $140 million term loan secured by
first mortgage bonds with a private investor bank. This loan
has a term of six years at a cost of LIBOR plus 475 basis
points. Proceeds from this loan would be used to retire a debt
or for general corporate purposes.
- Consumers has entered into a $150 million term loan secured by
first mortgage bonds. This term loan has a three-year maturity
at a cost of LIBOR plus 450 basis points. Proceeds from this
loan would be used to retire debt or for general corporate
purposes.
- Consumers filed a general rate case for its gas utility
business on March 14, 2003. Consumers requested rate relief in
the amount of approximately $156 million. In its filing,
Consumers requested immediate interim relief. If interim
relief of $156 million were granted, Consumers expects that
the rate relief will be in place by the fourth quarter of
2003.
- Consumers has filed an application with the MPSC seeking
authorization to issue $1.084 billion of securitization bonds.
These bonds would provide liquidity to Consumers at interest
rates reflective of high quality credit. Consumers would
utilize these proceeds to retire higher cost debt and in turn
would realize significant interest expense savings over the
life of the bonds. If the MPSC approves a financing in the
amount requested, and there are no delays in the offering
process, Consumers anticipates that bonds would be issued by
year-end, 2003.
If necessary for liquidity purposes, Consumers would also postpone the
planned $158 million pension contribution expected to be made in September 2003.
In the event Consumers is unable to access bank financing or the
capital markets to incur or refinance indebtedness, there could be a material
adverse effect on Consumers' liquidity and operations. There is no assurance
that the pending securitization bond issuance transaction noted above will be
completed. Further, there is no assurance that the MPSC will grant either
interim or final gas utility rate relief.
SEC AND OTHER INVESTIGATIONS
As a result of round-trip trading transactions at CMS MST, CMS Energy's
Board of Directors established a Special Committee of independent directors to
investigate matters surrounding the transactions and retained outside counsel to
assist in the investigation. The Special Committee completed its investigation
and reported its findings to the Board of Directors in October 2002. The Special
Committee concluded, based on an extensive investigation, that the round-trip
trades were undertaken to raise CMS MST's profile as an energy marketer with the
goal of enhancing its ability to promote its services to new customers. The
Special Committee found no apparent effort to manipulate the price of CMS Energy
Common Stock or affect energy prices. The Special Committee also made
recommendations designed to prevent any reoccurrence of this practice, most of
which have already been implemented. Previously, CMS Energy terminated its
speculative trading business and revised its risk management policy. The Board
of Directors adopted, and CMS
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Energy has begun implementing, the remaining recommendations of the Special
Committee.
CMS Energy is cooperating with other investigations concerning
round-trip trading, including an investigation by the SEC regarding round-trip
trades and CMS Energy's financial statements, accounting policies and controls,
and investigations by the United States Department of Justice, the Commodity
Futures Trading Commission and the FERC. CMS Energy has also received subpoenas
from U.S. Attorneys Offices regarding investigations of those trades. CMS Energy
is unable to predict the outcome of these matters, and Consumers is unable to
predict what effect, if any, these investigations will have on its business.
SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of
securities class action complaints have been filed against CMS Energy,
Consumers, and certain officers and directors of CMS Energy and its affiliates.
The complaints have been filed in the United States District Court for the
Eastern District of Michigan as purported class actions by individuals who
allege that they purchased CMS Energy's securities during a purported class
period. At least two of the complaints contain purported class periods beginning
on August 3, 2000 and running through May 10, 2002 or May 14, 2002. These
complaints generally seek unspecified damages based on allegations that the
defendants violated United States securities laws and regulations by making
allegedly false and misleading statements about the company's business and
financial condition. The cases have been consolidated into a single lawsuit and
an amended and consolidated complaint is due to be filed by May 1, 2003. CMS
Energy and Consumers intend to vigorously defend against this action. Consumers
cannot predict the outcome of this litigation.
ERISA CASES: Consumers is a named defendant, along with CMS Energy, CMS
MST and certain named and unnamed officers and directors, in two lawsuits
brought as purported class actions on behalf of participants and beneficiaries
of the 401(k) plan. The two cases, filed in July 2002 in the United States
District Court for the Eastern District of Michigan, were consolidated by the
trial judge and an amended and consolidated complaint has been filed. Plaintiffs
allege breaches of fiduciary duties under ERISA and seek restitution on behalf
of the plan with respect to a decline in value of the shares of CMS Energy
Common Stock held in the plan. Plaintiffs also seek other equitable relief and
legal fees. These cases will be vigorously defended. Consumers cannot predict
the outcome of this litigation.
CAPITAL EXPENDITURES OUTLOOK
Consumers estimates the following capital expenditures, including new
lease commitments, by expenditure type and by business segments during 2003
through 2005. Consumers prepares these estimates for planning purposes and may
revise them.
In Millions
----------------------------------------------------------------------------------------------------------
Years Ended December 31 2003 2004 2005
----------------------------------------------------------------------------------------------------------
Construction $424 $520 $585
Nuclear fuel 33 32 -
Other capital leases 28 23 25
---------------------------------
$485 $575 $610
==========================================================================================================
Electric utility operations (a)(b) $341 $408 $385
Gas utility operations (a) 144 167 225
---------------------------------
$485 $575 $610
==========================================================================================================
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(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.
ELECTRIC BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects electric kWh volume
deliveries (including both full service sales and delivery service to customers
who choose to buy generation service from an alternative electric supplier, but
excluding transactions with other wholesale market participants including other
electric utilities) to grow at an average rate of approximately two percent per
year based primarily on a steadily growing customer base. This growth rate
reflects a long-range expected trend of growth. Growth from year to year may
vary from this trend due to customer response to abnormal weather conditions and
changes in economic conditions including, utilization and expansion of
manufacturing facilities. Consumers has experienced much stronger than expected
growth in 2002 as a result of warmer than normal summer weather. Assuming that
normal weather conditions will occur in 2003, electric deliveries are expected
to grow less than one percent over the strong 2002 electric deliveries.
COMPETITION AND REGULATORY RESTRUCTURING: The enactment in 2000 of
Michigan's Customer Choice Act and other developments will continue to result in
increased competition in the electric business. Generally, increased competition
can reduce profitability and threatens Consumers' market share for generation
services. The Customer Choice Act allowed all of the company's electric
customers to buy electric generation service from Consumers or from an
alternative electric supplier as of January 1, 2002. As a result, alternative
electric suppliers for generation services have entered Consumers' market. As of
mid-March 2003, alternative electric suppliers are providing 516 MW of
generation supply to customers. To the extent Consumers experiences "net"
Stranded Costs as determined by the MPSC, the Customer Choice Act allows for the
company to recover such "net" Stranded Costs by collecting a transition
surcharge from those customers who switch to an alternative electric supplier.
Consumers cannot predict the total amount of electric supply load that may be
lost to competitor suppliers, nor whether the stranded cost recovery method
adopted by the MPSC will be applied in a manner that will fully offset any
associated margin loss.
Stranded and Implementation Costs: The Customer Choice Act allows
electric utilities to recover the act's implementation costs and "net" Stranded
Costs (without defining the term). The act directs the MPSC to establish a
method of calculating "net" Stranded Costs and of conducting related true-up
adjustments. In December 2001, the MPSC adopted a methodology which calculated
"net" Stranded Costs as the shortfall between: (a) the revenue required to cover
the costs associated with fixed generation assets, generation-related regulatory
assets, and capacity payments associated with purchase power agreements, and (b)
the revenues received from customers under existing rates available to cover the
revenue requirement. The MPSC authorized Consumers to use deferred accounting to
recognize the future recovery of costs determined to be stranded. Consumers has
initiated an appeal at the Michigan Court of Appeals related to the MPSC's
December 2001 "net" Stranded Cost order.
According to the MPSC, "net" Stranded Costs were to be recovered from
retail open access customers through a Stranded Cost transition charge. In April
2002, Consumers made "net" Stranded Cost filings with the MPSC for $22 million
and $43 million for 2000 and 2001, respectively. In the same filing, Consumers
estimated that it would experience "net" Stranded Costs of $126 million for
2002. Consumers, in its hearing brief, filed in August 2002, revised its request
for "net" Stranded Costs to $7 million and $4 million for 2000 and 2001,
respectively,
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and an estimated $73 million for 2002. The single largest reason for the
difference was the exclusion, as ordered by the MPSC, of all costs associated
with expenditures required by the Clean Air Act.
In December 2002, the MPSC issued an order finding that Consumers
experienced zero "net" Stranded Costs in 2000 and 2001, but declined to
establish a defined methodology that would allow a reliable prediction of the
level of Stranded Costs for 2002 and future years. In January 2003, Consumers
filed a petition for rehearing of the December 2002 Stranded Cost order in which
it asked the MPSC to grant rehearing and revise certain features of the order.
Several other parties also filed rehearing petitions with the MPSC. As discussed
below, Consumers has filed a request with the MPSC for authority to issue
securitization bonds that would allow recovery of the Clean Air Act expenditures
and post-2000 Palisades expenditures that were excluded from the Stranded Cost
calculation.
On March 4, 2003, Consumers filed an application with the MPSC seeking
approval of "net" Stranded Costs incurred in 2002, and for approval of a "net"
Stranded Cost recovery charge. In the application, Consumers indicated that if
Consumers' proposal to securitize Clean Air Act expenditures and post-2000
Palisades expenditures were approved as proposed in its securitization case as
discussed below, then Consumers' "net" Stranded Costs incurred in 2002 are
approximately $35 million. If the proposal to securitize those costs is not
approved, then Consumers indicated that the costs would be properly included in
the 2002 "net" Stranded Cost calculation, which would increase Consumers' 2002
"net" Stranded Costs to approximately $103 million. Consumers cannot predict the
recoverability of Stranded Costs, and therefore has not recorded any regulatory
assets to recognize the future recovery of such costs.
The MPSC staff has scheduled a collaborative process to discuss
Stranded Costs and related issues and to identify and make recommendations to
the MPSC. Consumers intends to participate in this collaborative process.
Since 1997, Consumers has incurred significant electric utility
restructuring implementation costs. The following table outlines the
applications filed by Consumers with the MPSC and the status of recovery for
these costs.
In Millions
----------------------------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
----------------------------------------------------------------------------------------------------------
1999 1997 & 1998 $20 $ - $15 $5
2000 1999 30 - 25 5
2001 2000 25 - 20 5
2002 2001 8 8 - -
2003 2002 2 2 - -
The MPSC disallowed certain costs based upon a conclusion that these
amounts did not represent costs incremental to costs already reflected in
electric rates. In the orders received for the years 1997 through 2000, the MPSC
also reserved the right to review again the total implementation costs depending
upon the progress and success of the retail open access program, and ruled that
due to the rate freeze imposed by the Customer Choice Act, it was premature to
establish a cost recovery method for the allowable implementation costs. In
addition to the amounts shown above, as of December 2002, Consumers incurred and
deferred as a regulatory asset, $1 million of additional implementation costs
and has also recorded as a regulatory asset $13 million for the cost of money
associated with total implementation costs. Consumers believes the
implementation costs and the associated cost of money are fully recoverable in
96
accordance with the Customer Choice Act. Cash recovery from customers will
probably begin after the rate freeze or rate cap period has expired. Consumers
cannot predict the amounts the MPSC will approve as allowable costs.
Consumers is also pursuing authorization at the FERC for MISO to
reimburse Consumers for approximately $8 million in certain electric utility
restructuring implementation costs related to its former participation in the
development of the Alliance RTO, a portion of which has been expensed. However,
Consumers cannot predict the amount the FERC will ultimately order to be
reimbursed by the MISO.
Securitization: On March 4, 2003, Consumers filed an application with
the MPSC seeking approval to issue Securitization bonds in the amount of
approximately $1.084 billion. If approved, this would allow the recovery of
costs associated with Clean Air Act expenditures, post-2000 Palisades
expenditures, and retail open access implementation costs through December 31,
2003, and certain pension fund expenses, and expenses associated with the
issuance of the bonds.
Rate Caps: The Customer Choice Act imposes certain limitations on
electric rates that could result in Consumers being unable to collect from
electric customers its full cost of conducting business. Some of these costs are
beyond Consumers' control. In particular, if Consumers needs to purchase power
supply from wholesale suppliers while retail rates are frozen or capped, the
rate restrictions may make it impossible for Consumers to fully recover
purchased power and associated transmission costs from its customers. As a
result, Consumers may be unable to maintain its profit margins in its electric
utility business during the rate freeze or rate cap periods. The rate freeze is
in effect through December 31, 2003. The rate caps are in effect through at
least December 31, 2004 for small commercial and industrial customers, and at
least through December 31, 2005 for residential customers.
Industrial Contracts: In response to industry restructuring efforts, in
1995 and 1996, Consumers entered into multi-year electric supply contracts with
certain large industrial customers to provide electricity at specially
negotiated prices, usually at a discount from tariff prices. The MPSC approved
these special contracts as part of its phased introduction to competition.
Unless terminated or restructured, the majority of these contracts are in effect
through 2005. As of December 2002, some contracts have expired, but outstanding
contracts involve approximately 500 MW. Consumers cannot predict the ultimate
financial impact of changes related to these power supply contracts, or whether
additional contracts will be necessary or advisable.
Code of Conduct: In December 2000, as a result of the passage of the
Customer Choice Act, the MPSC issued a new code of conduct that applies to
electric utilities and alternative electric suppliers. The code of conduct seeks
to prevent cross-subsidization, information sharing, and preferential treatment
between a utility's regulated and unregulated services. The new code of conduct
is broadly written, and as a result, could affect Consumers' retail gas
business, the marketing of unregulated services and equipment to Michigan
customers, and internal transfer pricing between Consumers' departments and
affiliates. In October 2001, the new code of conduct was reaffirmed by the MPSC
without substantial modification. Consumers appealed the MPSC orders related to
the code of conduct and sought a stay of the orders until the appeal was
complete; however, the request for a stay was denied. Consumers filed a
compliance plan in accordance with the code of conduct. It also sought waivers
to the code of conduct in order to continue utility activities that provide
approximately $50 million in annual revenues. In October 2002, the MPSC denied
waivers for three programs that provide approximately $32 million in revenues in
2001, of which $30 million relates to the appliance service plan. The waivers
denied included all waivers associated with the appliance service plan program
that has been offered by
97
Consumers for many years. Consumers filed a renewed motion for a stay of the
effectiveness of the code of conduct and an appeal of the waiver denials with
the Michigan Court of Appeals. On November 8, 2002, the Michigan Court of
Appeals denied Consumers' request for a stay. Consumers has filed an application
for leave to appeal with the Michigan Supreme Court with respect to the Michigan
Court of Appeals' November ruling denying the stay. In February 2003, the
Michigan Supreme Court denied the application. In December 2002, Consumers filed
a renewed request with the MPSC for a temporary waiver until April 2004 for the
appliance service plan, which generated $33 million in revenues in 2002. In
February 2003, the MPSC granted an extension of the temporary waiver until
December 31, 2003. The full impact of the new code of conduct on Consumers'
business will remain uncertain until the appellate courts issue definitive
rulings. Recently, in an appeal involving affiliate pricing guidelines, the
Michigan Court of Appeals struck the guidelines down because of a procedurally
defective manner of enactment by the MPSC. A similar procedure was used by the
MPSC in enacting the new code of conduct. Consumers is also exploring seeking
legislative clarification of the scope of the code of conduct.
Energy Policy: Uncertainty exists regarding the enactment of a national
comprehensive energy policy, specifically federal electric industry
restructuring legislation. A variety of bills introduced in the United States
Congress in recent years aimed to change existing federal regulation of the
industry. If the federal government enacts a comprehensive energy policy or
electric restructuring legislation, then that legislation could potentially
affect company operations and financial requirements.
Transmission: In 1999, the FERC issued Order No. 2000, strongly
encouraging electric utilities to transfer operating control of their electric
transmission system to an RTO, or sell the facilities to an independent company.
In addition, in June 2000, the Michigan legislature passed Michigan's Customer
Choice Act, which also requires utilities to divest or transfer the operating
authority of transmission facilities to an independent company. Consumers chose
to offer its electric transmission system (METC) for sale rather than own and
invest in an asset it could not control. In May 2002, Consumers sold its
electric transmission system for approximately $290 million in cash to MTH, a
non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect, Inc.
Trans-Elect, Inc. submitted the winning bid through a competitive
bidding process, and various federal agencies approved the transaction.
Consumers did not provide any financial or credit support to Trans-Elect, Inc.
Certain of Trans-Elect's officers and directors are former officers and
directors of CMS Energy, Consumers and their subsidiaries. None of them were
employed by CMS Energy, Consumers, or their affiliates when the transaction was
discussed internally and negotiated with purchasers. As a result of the sale,
Consumers experienced an after-tax earnings increase of approximately $17
million in 2002, due to the recognition of a $26 million gain on the sale of the
electric transmission system. This gain from the sale is offset by a loss of
revenue from wholesale and retail open access customers who will buy services
directly from MTH, including the loss of a return on the sold electric
transmission system. Consumers anticipates that the future impact of the loss of
revenue from wholesale and retail open access customers who will buy services
directly from MTH and the loss of a return on the sold electric transmission
system on its after-tax earnings will be a decrease of $15 million in 2003, and
a decrease of approximately $14 million annually for the next three years.
Under the agreement with MTH, and subject to certain additional RTO
surcharges, transmission rates charged to Consumers are fixed by contract at
current levels through December 31, 2005, and subject to FERC ratemaking
thereafter. MTH has completed the capital program to expand the transmission
system's capability to import electricity into Michigan, as required by the
Customer Choice Act, and Consumers will continue to maintain the system under a
five-year
98
contract with MTH. Effective April 30, 2002, Consumers and METC
withdrew from the Alliance RTO, and MTH (METC) has joined the MISO RTO. For
further information, see Note 2, Uncertainties, "Electric Rate Matters -
Transmission."
Consumers is a customer of AEP, holding 500 MW of long-term
transmission service reservations through the AEP transmission system. AEP
recently indicated its intent to turn control of its transmission system over to
the PJM RTO and become part of the PJM market sometime after May 1, 2003, which
requires approval by FERC. This will require current AEP customers to become
members of, and resubmit reservation requests to, PJM. Consumers filed an
intervention requesting clarification in January 2003. Upon FERC's approval of
this transfer, Consumers will complete the application process to join PJM. Of
the 500 MW of long-term transmission service reservations held, 200 MW will
expire on April 1, 2003. Effective June 1, 2003, Consumers will have an
additional 100 MW of long-term transmission, resulting in a total of 400 MW of
long-term transmission for summer 2003.
In July 2002, the FERC issued a 600-page notice of proposed rulemaking
on standard market design for electric bulk power markets and transmission. Its
stated purpose is to remedy undue discrimination in the use of the interstate
transmission system and give the nation the benefits of a competitive bulk power
system. The proposed rulemaking is primarily designed to correct perceived
problems in the electric transmission industry. Consumers sold its electric
transmission system in 2002, but is a transmission customer. The financial
impact to Consumers is uncertain, but the final standard market design rules
could significantly increase delivered power costs to Consumers and the retail
electric customers it serves. Consumers has filed comments with the FERC in
general opposition to the proposal.
There are multiple proceedings pending before the FERC regarding
transitional transmission pricing mechanisms intended to mitigate the revenue
impact on transmission owners resulting from the elimination of "Rate
Pancaking". "Rate Pancaking" represents the application of the transmission rate
of each individual transmission owner whose system is utilized on the scheduled
path of an energy delivery and its elimination has been alleged to result in
"lost revenues" for transmission owners. It is unknown what mechanism(s) may
result from the proceedings currently pending before the FERC, and as such, it
is not possible at this time to identify the specific effect on Consumers. It
should be noted, however, that Consumers believes the results of these
proceedings could also significantly increase the delivered power costs to
Consumers and the retail electric customers it serves.
Similarly, other proceedings before the FERC involving rates of
transmission providers of Consumers could increase Consumers' cost of
transmitting power to its customers in Michigan. As RTOs develop and mature in
Consumers' area of electrical operation, and those RTOs respond to FERC
initiatives concerning the services they must provide and the systems they
maintain, Consumers believes that there is likely to be an upward cost trend in
transmission used by Consumers, ultimately increasing the delivered cost of
power to Consumers and the retail electric customers it serves. The specific
financial impact on Consumers of such proceedings and trends are not currently
quantifiable.
In addition to the potential cost impacts identified above, Consumers
is evaluating whether or not there may be impacts on electric reliability
associated with the outcomes of these various transmission related proceedings.
Consumers cannot assure that all risks to reliability can be avoided.
Consumers cannot predict the impact of these electric
industry-restructuring issues on its financial position, liquidity, or results
of operations.
PERFORMANCE STANDARDS: In July 2001, the MPSC proposed electric
distribution performance
99
standards for Consumers and other Michigan electric distribution utilities. The
proposal would establish standards related to restoration after an outage,
safety, and customer relations. Failure to meet the standards would result in
customer bill credits. Consumers submitted comments to the MPSC. In December
2001, the MPSC issued an order stating its intent to initiate a formal
rulemaking proceeding to develop and adopt performance standards. In November
2002, the MPSC issued an order initiating the formal rulemaking proceeding.
Consumers has filed comments on the proposed rules and will continue to
participate in this process. Consumers cannot predict the nature of the proposed
standards or the likely effect, if any, on Consumers.
For further information and material changes relating to the rate
matters and restructuring of the electric utility industry, see Note 1,
Corporate Structure and Summary of Significant Accounting Policies, and Note 2,
Uncertainties, "Electric Rate Matters - Electric Restructuring" and "Electric
Rate Matters - Electric Proceedings."
UNCERTAINTIES: Several electric business trends or uncertainties may
affect Consumers' financial results and condition. These trends or uncertainties
have, or Consumers reasonably expects could have, a material impact on net
sales, revenues, or income from continuing electric operations. Such trends and
uncertainties include: 1) pending litigation and government investigations; 2)
the need to make additional capital expenditures and increase operating expenses
for Clean Air Act compliance; 3) environmental liabilities arising from various
federal, state and local environmental laws and regulations, including potential
liability or expenses relating to the Michigan Natural Resources and
Environmental Protection Acts and Superfund; 4) uncertainties relating to the
storage and ultimate disposal of spent nuclear fuel and the successful operation
of Palisades by NMC; 5) electric industry restructuring issues, including those
described above; 6) Consumers' ability to meet peak electric demand requirements
at a reasonable cost, without market disruption, and successfully implement
initiatives to reduce exposure to purchased power price increases; 7) the
recovery of electric restructuring implementation costs; 8) Consumers new status
as an electric transmission customer and not as an electric transmission
owner/operator; 9) sufficient reserves for OATT rate refunds; 10) the effects of
derivative accounting and potential earnings volatility; 11) increased costs for
safety and homeland security initiatives that are not recoverable on a timely
basis from customers; 12) Consumers' continuing ability to raise funds at
reasonable rates in order to meet the cash requirements of its electric business
and to pay maturing debt in the short-term, and 13) potentially rising pension
costs due to market losses. For further information about these trends or
uncertainties, see Note 2, Uncertainties.
GAS BUSINESS OUTLOOK
GROWTH: Over the next five years, Consumers expects gas bcf volume
deliveries, including gas full service and customer choice deliveries (excluding
transportation to the MCV Facility and off-system deliveries), to grow at an
average rate of less than one percent per year based primarily on a steadily
growing customer base. Actual gas deliveries in future periods may be affected
by abnormal weather, use of gas by independent power producers, changes in
competitive and economic conditions, and the level of natural gas consumption
per customer.
2001 GAS RATE CASE: In June 2001, Consumers filed an application with
the MPSC seeking a distribution service rate increase. On November 7, 2002, the
MPSC issued a final order approving a $56 million annual distribution service
rate increase, which includes the $15 million interim increase, with an 11.4
percent authorized return on equity, for service effective November 8, 2002. As
part of this order, the MPSC approved Consumers' proposal to absorb the assets
and liabilities of Michigan Gas Storage Company into Consumers' rate base and
rates. This has occurred through a statutory merger of Michigan Gas Storage
Company into Consumers and this is not expected to have an impact on Consumers'
consolidated financial statements. See Note 2,
100
Uncertainties, "Gas Rate Matters - 2001 Gas Rate Case" for further information.
2003 GAS RATE CASE: On March 14, 2003, Consumers filed an application
with the MPSC seeking a $156 million increase in its gas delivery and
transportation rates, which includes a 13.5 percent authorized return on equity,
based on a 2004 test year. If approved, the request would add about $6.40 per
month, or about 9 percent, to the typical residential customer's average monthly
distribution bill. Contemporaneously with this filing, Consumers has requested
interim rate relief in the same amount.
UNBUNDLING STUDY: In July 2001, the MPSC directed gas utilities under
its jurisdiction to prepare and file an unbundled cost of service study. The
purpose of the study is to allow parties to advocate or oppose the unbundling of
the following services: metering, billing information, transmission, balancing,
storage, backup and peaking, and customer turn-on and turn-off services.
Unbundled services could be separately priced in the future and made subject to
competition by other providers. The MPSC addressed Consumers' study in the
November 2002 gas distribution rate case order and indicated that it makes
little sense to set rates for unbundled services before the details of those
services are known. Unbundled services may continue to be an issue in future
proceedings.
In September 2002, the FERC issued an order rejecting a filing by
Consumers to assess certain rates for non-physical gas title tracking services
offered by Consumers. Despite Consumers' arguments to the contrary, the FERC
asserted jurisdiction over such activities and allowed Consumers to refile and
justify a title transfer fee not based on volumes as Consumers proposed. Because
the order was issued six years after Consumers made its original filing
initiating the proceeding, over $3 million in non-title transfer tracking fees
had been collected. No refunds have been ordered, and Consumers sought rehearing
of the September order. If refunds were ordered they may include interest which
would increase the refund liability to more than the $3 million collected. In
December 2002, Consumers established a $3.6 million reserve related to this
matter. Consumers is unable to say with certainty what the final outcome of this
proceeding might be.
UNCERTAINTIES: Several gas business trends or uncertainties may affect
Consumers' financial results and conditions. These trends or uncertainties have,
or Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing gas operations. Such trends and
uncertainties include: 1) pending litigation and government investigations; 2)
potential environmental costs at a number of sites, including sites formerly
housing manufactured gas plant facilities; 3) future gas industry restructuring
initiatives; 4) any initiatives undertaken to protect customers against gas
price increases; 5) an inadequate regulatory response to applications for
requested rate increases; 6) market and regulatory responses to increases in gas
costs, including a reduced average use per residential customer; 7) increased
costs for pipeline integrity and safety and homeland security initiatives that
are not recoverable on a timely basis from customers; 8) Consumers' continuing
ability to raise funds at reasonable rates in order to meet the cash
requirements of its gas business; and 9) potentially rising pension costs due to
market losses. For further information about these uncertainties, see Note 2,
Uncertainties.
OTHER OUTLOOK
See Outlook, "Liquidity and Capital Resources," "SEC and Other
Investigations," "Securities Class Action Lawsuits," and "ERISA Cases" above.
TERRORIST ATTACKS: Since the September 11, 2001 terrorist attacks in
the United States, Consumers has increased security at all critical facilities
and over its critical infrastructure, and will continue to evaluate security on
an ongoing basis. Consumers may be required to comply
101
with federal and state regulatory security measures promulgated in the future.
Through December 31, 2002, Consumers has incurred approximately $4 million in
incremental security costs, including operating, capital, and decommissioning
and removal costs. Consumers estimates it may incur additional incremental
security costs in 2003 of approximately $6 million. Consumers will attempt to
seek recovery of these costs from its customers. In December 2002, the Michigan
legislature passed, and the governor signed, a bill that would allow Consumers
to seek recovery of additional electric division security costs incurred during
the rate freeze and cap periods imposed by the Customer Choice Act. On February
5, 2003, the MPSC adopted filing requirements for the recovery of enhanced
security costs.
ENERGY-RELATED SERVICES: Consumers offers a variety of energy-related
services to retail customers that focus on appliance maintenance, home safety,
commodity choice, and assistance to customers purchasing heating, ventilation
and air conditioning equipment. Consumers continues to look for additional
growth opportunities in providing energy-related services to its customers. The
ability to offer all or some of these services and other utility related
revenue-generating services, which provide approximately $50 million in annual
revenues, may be restricted by the new code of conduct issued by the MPSC, as
discussed above in Electric Business Outlook, "Competition and Regulatory
Restructuring - Code of Conduct."
OTHER MATTERS
NEW ACCOUNTING STANDARDS
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Beginning
January 1, 2003, companies must comply with SFAS No. 143. The standard requires
companies to record the fair value of the legal obligations related to an asset
retirement in the period in which it is incurred. Consumers has determined that
it has legal asset retirement obligations, particularly in regard to its nuclear
plants, but has not yet finalized its assessment of the obligation. However,
upon initial adoption of the standard, Consumers expects to record a regulatory
liability, as well as an asset retirement obligation, as required by SFAS No.71.
The regulatory liability recognizes the difference between the cost of removal
included in the reserve for accumulated depreciation for assets within the scope
of SFAS No. 143 and the accretion expense of the asset retirement obligation and
the depreciation expense of the asset retirement obligation asset from when the
obligation was initially incurred through December 2002. When the asset
retirement obligation liability is initially recorded, the company would
capitalize an offsetting amount by increasing the carrying amount of the related
long-lived asset. Over time, the initial liability would be accreted to its
present value each period and the capitalized cost would be depreciated over the
related asset's useful life.
SFAS NO. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44 AND 64, AMENDMENT
OF FASB STATEMENT NO. 13, AND TECHNICAL CORRECTIONS: Issued by the FASB in April
2002, this standard rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishment of Debt Made to Satisfy
Sinking-Fund Requirements. As a result, any gain or loss on extinguishment of
debt should be classified as an extraordinary item only if it meets the criteria
set forth in APB Opinion No. 30. The provisions of this section are applicable
to fiscal years beginning 2003, but may be adopted early. Consumers has adopted
this provision early, with no material affect to its income statement. SFAS No.
145 amends SFAS No. 13, to require sale-leaseback accounting for certain lease
modifications that have similar economic impacts to sale-leaseback transactions.
This provision is effective for transactions occurring after May 15, 2002.
Finally, SFAS No. 145 amends other existing authoritative pronouncements to make
various technical corrections and rescinds SFAS No. 44, Accounting for
Intangible Assets of Motor Carriers. These provisions are effective for
financial statements issued on or after May
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15, 2002. Upon adoption of the standard, there was no impact on Consumers'
financial statements.
SFAS NO. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL
ACTIVITIES: Issued by the FASB in July 2002, this standard requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
This standard is effective for exit or disposal activities initiated after
December 31, 2002. Consumers does not expect the adoption of SFAS No. 146 to
have a material impact on its financial position or results of operations.
FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE
REQUIREMENT FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF
OTHERS: This interpretation, effective January 1, 2003, elaborates on the
disclosure to be made by a guarantor about its obligations under certain
guarantees that it has issued. It requires that a guarantor recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. For contracts that are within the initial
recognition and measurement provision of this interpretation, the provisions are
to be applied to guarantees issued or modified after December 31, 2002; no
cumulative effect adjustments are required. For further information see Note 1,
Corporate Structure and Summary of Significant Accounting Policies, "New
Accounting Standards To Be Adopted".
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST
ENTITIES: Issued by the FASB in January 2003, the interpretation expands upon
and strengthens existing accounting guidance that addresses when a company
should include in its financial statements the assets, liabilities and
activities of another entity. The consolidation requirements of the
interpretation apply immediately to variable interest entities created after
January 31, 2003. For Consumers, the consolidation requirements apply to
pre-existing entities beginning July 1, 2003. Certain of the disclosure
requirements apply to all financial statements initially issued after January
31, 2003. Consumers will be required to consolidate any entities that meet the
requirements of the interpretation. Consumers is in the process of studying the
interpretation, and has yet to determine the effects, if any, on its
consolidated financial statements.
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OUR BUSINESS
GENERAL
CMS ENERGY
CMS Energy, formed in Michigan in 1987, is an energy holding company
operating, through subsidiaries, in the United States and in selected markets
around the world. Its two principal subsidiaries are Consumers and Enterprises.
Consumers is a public utility that provides natural gas and/or electricity to
almost 6 million of Michigan's 10 million residents and serves customers in all
68 of the state's Lower Peninsula counties. Enterprises, through subsidiaries,
is engaged in several energy businesses in the United States and in selected
international markets.
In 2002, CMS Energy's consolidated operating revenue was approximately
$8.7 billion.
CONSUMERS
Consumers, formed in Michigan in 1968, is the successor to a
corporation organized in Maine in 1910 that conducted business in Michigan from
1915 to 1968. In 1997, Consumers, formerly named Consumers Power Company,
changed its name to Consumers Energy Company to better reflect its integrated
electricity and gas businesses.
Consumers' service areas include automotive, metal, chemical, food and
wood products and a diversified group of other industries. Consumers'
consolidated operations account for a majority of CMS Energy's total assets and
income, as well as a substantial portion of its operating revenue. At year-end
2002, Consumers' customer base and operating revenues were as follows:
Customers Operating 2002 vs. 2001
Served Revenue Operating Revenue
(millions) (millions) % Increase/(Decrease)
---------- ---------- ---------------------
Electric Utility Business.................... 1.73 $2,648 0.57%
Gas Utility Business......................... 1.65 1,519 13.53
Other........................................ --- 2 (60.00)
Total........................................ 3.38 $4,169 4.85%
Consumers' rates and certain other aspects of its business are subject
to the jurisdiction of the MPSC and FERC, as described in CONSUMERS REGULATION
below.
CONSUMERS PROPERTIES -- GENERAL: The principal properties of Consumers
and its subsidiaries are owned in fee, except that most electric lines and gas
mains are located, pursuant to easements and other rights, in public roads or on
land owned by others. Substantially all of Consumers' properties are subject to
the lien of its First Mortgage Bond Indenture. For additional information on
Consumers' properties see BUSINESS SEGMENTS -- Consumers Electric Utility
Operations -- Electric Utility Properties, and -- Consumers Gas Utility
Operations -- Gas Utility Properties, below.
For information on capital expenditures, see the 10-K MD&A -- Outlook
and Note 10 of the Notes to the December 31, 2002 Financial Statements.
104
BUSINESS SEGMENTS
For information with respect to the operating revenue, net operating
income, identifiable assets and liabilities attributable to Consumers' business
segments, see the December 31, 2002 Financial Statements and related Notes.
CONSUMERS' ELECTRIC UTILITY OPERATIONS
Based on the average number of customers, Consumers' electric utility
operations, if independent, would be the thirteenth largest electric utility
company in the United States. Consumers' electric utility operations include the
generation, purchase, distribution and sale of electricity. At year-end 2002, it
served customers in 61 of the 68 counties of Michigan's lower peninsula.
Principal cities served include Battle Creek, Flint, Grand Rapids, Jackson,
Kalamazoo, Midland, Muskegon and Saginaw. Consumers' electric utility customer
base includes a mix of residential, commercial and diversified industrial
customers, the largest segment of which is the automotive industry. Consumers'
electric utility operations are not dependent upon a single customer, or even a
few customers, and the loss of any one or even a few of such customers is not
reasonably likely to have a material adverse effect on its financial condition.
Consumers' electric utility operations are seasonal. The summer months
usually increase demand for electric energy, principally due to the use of air
conditioners and other cooling equipment, thereby affecting revenues. In 2002
and 2001, total electric deliveries were 39 billion kWh and 40 billion kWh,
respectively. In 2002, electric sales totaled 37 billion kWh and retail open
access deliveries totaled 2 billion kWh. In 2001, electric sales totaled 39
billion kWh and retail open access deliveries totaled 1 billion kWh.
Excluding retail open access loads, Consumers experienced 2002 and 2003
summer peak demand of 7,697 MW and 7,721 MW, respectively. In 2002, the winter
peak demand was 5,573 MW for the winter 2001-02 period and 5,862 MW for the
winter 2002-03 period. In 2002, based on the actual summer peak, Consumers'
power reserve, also called a reserve margin, was 20.6 percent compared to 11.1
percent in 2001. Based on its summer 2003 forecast, Consumers carried an 11.0
percent reserve margin. The reserve margin provides additional power supply
capability above Consumers' anticipated peak power supply demands. It also
allows Consumers to provide reliable service to its electric service customers
and to protect itself against unscheduled plant outages and unanticipated
demand. As it did in 2003, Consumers is currently planning for a reserve margin
of approximately 11 percent for summer 2004 or supply resources equal to 111
percent of projected summer peak load. Of the 111 percent, approximately 100
percent is expected to be met from owned options for physical deliveries and
other agreements. The ultimate use of the 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.
Including retail open access loads, Consumers experienced a 2002 summer
peak demand of 7,984 MW. Winter peak demand for 2002, including retail open
access loads, was 5,694 MW for the winter 2001-02 period and 6,140 MW for the
winter 2002-03 period.
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ELECTRIC UTILITY PROPERTIES: At December 31, 2002, Consumers' electric
generating system consists of the following:
2002 Net
2002 Summer Net Generation
Size and Year Demonstrated (Thousands
Name and Location (Michigan) Entering Service Capability (KWs) of kWHs)
-------------------- ---------------- -----------
Coal Generation
J H Campbell 1 & 2 - West Olive.............. 2 Units, 1962-1967 615,000 4,406,940
J H Campbell 3 - West Olive.................. 1 Unit, 1980 765,140(a) 4,511,713
D E Karn - Essexville........................ 2 Units, 1959-1961 515,000 3,824,249
B C Cobb - Muskegon ......................... 2 Units, 1956-1957 312,000 2,150,510
J R Whiting - Erie........................... 3 Units, 1952-1953 326,000 2,262,509
J C Weadock - Essexville..................... 2 Units, 1955-1958 310,000 2,205,575
--------- ----------
Total coal generation.......................... 2,843,140 19,361,496
--------- ----------
Oil/Gas Generation
B C Cobb - Muskegon.......................... 3 Units, 1999-2000 183,000 38,035
D E Karn - Essexville........................ 2 Units, 1975-1977 1,276,000 650,008
--------- ----------
Total oil/gas generation....................... 1,459,000 688,043
--------- ----------
Hydroelectric
Conventional Hydro Generation................ 13 Plants, 1906-1949 73,540 386,691
Ludington Pumped Storage..................... 6 Units, 1973 954,700(b) (486,322)
--------- ----------
Total Hydroelectric............................ 1,028,240 (99,631)
--------- ----------
Nuclear Generation
Palisades - South Haven...................... 1 Unit, 1971 767,000 6,357,962
--------- ----------
Gas/Oil Combustion Turbine
Generation................................... 7 Plants, 1966-1971 346,800(d) 12,743
--------- ----------
Total owned generation......................... 6,444,180 26,320,613
--------- ==========
Purchased and Interchange Power
Capacity..................................... 1,766,180(e)
Total.......................................... 8,210,360
===========
(a) Represents Consumers' share of the capacity of the J H Campbell 3, net
of 6.69 percent (ownership interests of the Michigan Public Power
Agency and Wolverine Power Supply Cooperative, Inc.).
(b) Represents Consumers' share of the capacity of Ludington. Consumers and
Detroit Edison have 51 percent and 49 percent undivided ownership,
respectively, in the plant.
(c) Represents Consumers' share of net pumped storage generation. This
facility electrically pumps water during off-peak hours for storage to
later generate electricity during peak-demand hours.
(d) Includes 1.8 MW of distributed diesel generation.
(e) Includes 1,240 MW of purchased contract capacity from the MCV Facility.
In 2002, Consumers purchased, through long-term purchase contracts,
options, spot market and other seasonal purchases, up to 2,683 MW of net
capacity from other power producers, which amounted to 34.9 percent of
Consumers' total system requirements, the largest of which was the MCV
Partnership.
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A high voltage transmission system interconnects Consumers' electric
generating plants at many locations with transmission facilities of unaffiliated
systems including those of other utilities in Michigan and Indiana. The
interconnections permit a sharing of the reserve capacity of the connected
systems. This allows mutual assistance during emergencies and substantially
reduces investment in utility plant facilities. Consumers owns: a) 338 miles of
high voltage distribution radial lines operating at 120 kilovolts and above; b)
4,159 miles of high voltage distribution overhead lines operating at 23
kilovolts and 46 kilovolts; c) 16 subsurface miles of high voltage distribution
underground lines operating at 23 kilovolts and 46 kilovolts; d) 54,681 miles of
electric distribution overhead lines; e) 8,201 subsurface miles of underground
distribution lines and f) substations having an aggregate transformer capacity
of 20,596,240 kilovoltamperes.
On April 1, 2001, Consumers transferred its investment in electric
transmission lines and substations to a wholly owned subsidiary, Michigan
Electric Transmission Company (METC). On May 1, 2002, Consumers transferred its
interest in METC to a third party, Michigan Transco Holdings, LLC (MTH), and
Consumers no longer owns or controls transmission facilities either directly or
indirectly. MTH owns the former Consumers transmission assets through a new
transmission company called Michigan Electric Transmission Company, LLC. For
additional information on the sale of the transmission assets, see -- Note 2 of
the Notes to the December 31, 2002 Financial Statements -- Electric Rate Matters
-- Transmission.
FUEL SUPPLY: Consumers has four generating plant sites that use coal as
a fuel source and that constitute 73.6 percent of its baseload supply, the
capacity used to serve a constant level of customer demand. In 2002, these
plants produced a combined total of 19,361 million kWhs of electricity and
required 9.7 million tons of coal. On December 31, 2002, Consumers' coal
inventory amounted to approximately 30 days' supply. For additional information
on future sources of coal, see Note 2 of the Notes to the December 31, 2002
Financial Statements - Other Electric Uncertainties --Coal Supply.
Consumers owns two nuclear power plants, Big Rock, located near
Charlevoix, Michigan and Palisades, located near South Haven, Michigan. In 1997,
Consumers ceased operating Big Rock. In May 2001, with the approval of the NRC,
Consumers transferred its authority to operate Palisades to the Nuclear
Management Company (NMC). The Palisades nuclear fuel supply responsibilities are
under the control of NMC acting as agent for Consumers. During 2002, Palisades'
net generation was 6,358 million kWhs, constituting 24.2 percent of Consumers'
baseload supply. New fuel contracts are being written as NMC Agreements.
Consumers/NMC currently have sufficient contracts for uranium concentrates to
provide up to 100 percent of its fuel supply requirements for the 2003 and 2004
period. Consumers/NMC also have contracts for conversion services and enrichment
services with quantity flexibility ranging up to 100 percent. If spot market
prices are below the contract price, NMC will purchase only the minimum amount
of nuclear fuel required by the contracts. Conversely, if spot market prices are
above the contract prices, Consumers will purchase the maximum amount of nuclear
fuel allowed by the contracts to meet its requirements.
NMC also has contracts for nuclear fuel services and for fabrication of
nuclear fuel assemblies. The fabrication contract for Palisades remains in
effect for the next two reloads with options to extend the contract for an
additional two reloads. The fuel contracts are with major private industrial
suppliers of nuclear fuel and related services and with uranium producers,
converters and enrichers who participate in the world nuclear fuel marketplace.
107
As shown below, Consumers generates electricity principally from coal
and nuclear fuel.
Millions of kWhs
----------------------------------------------------
Power Generated 2002 2001 2000 1999 1998
--------------------- ---------- ---------- -------- -------- --------
Coal 19,361 19,203 17,926 19,085 17,959
Nuclear 6,358 2,326(a) 5,724 5,105 5,364
Oil 347 331 645 809 520
Gas 354 670 400 441 302
Hydro 387 423 351 365 395
Net pumped storage (486) (553) (541) (476) (480)
------- ------- ------- ------- -------
Total net generation........ 26,321 22,400 24,505 25,329 24,060
======= ======= ======= ======= =======
(a) On June 20, 2001, the Palisades reactor was shut down so technicians could
inspect a small steam leak on a control rod drive assembly. The defective
components were replaced and the plant returned to service on January 21, 2002.
The cost of all fuels consumed, shown below, fluctuates with the mix of
fuel burned.
Cost per Million Btu
------------------------------------------
Fuel Consumed 2002 2001 2000 1999 1998
------------------------- ----- ----- ----- ----- -----
Coal......................................... $1.34 $1.38 $1.34 $1.38 $1.45
Oil.......................................... 3.49 4.02 3.30 2.69 2.73
Gas.......................................... 3.98 4.05 4.80 2.74 2.66
Nuclear ..................................... 0.35 0.39 0.45 0.52 0.50
All Fuels(a)................................. 1.19 1.44 1.27 1.28 1.28
(a) Weighted average fuel costs.
Pursuant to the Nuclear Waste Policy Act of 1982, the federal
government became responsible for the permanent disposal of spent nuclear fuel
and high-level radioactive waste by 1998. To date, the DOE has been unable to
arrange for storage facilities to meet this obligation and it does not expect
that in 2003 it will be able to receive spent nuclear fuel for storage. For
additional information on disposal of nuclear fuel see Note 2 of the Notes to
the December 31, 2002 and the September 30, 2003 Financial Statements. The
amount of spent nuclear fuel discharged from the reactor to date exceeds
Palisades' temporary on-site storage pool capacity, and Consumers is currently
storing spent nuclear fuel in NRC-approved steel and concrete vaults, known as
"dry casks". Currently, three dry casks are available for future storage. For a
discussion relating to the NRC approval of dry casks and Consumers' use of the
dry casks, see Note 2 of the Notes to the December 31, 2002 and the September
30, 2003 Financial Statements - Uncertainties - Other Electric Uncertainties.
CONSUMERS' GAS UTILITY OPERATIONS
Based on the average number of customers, Consumers' gas utility
operations, if independent, would be the 6th largest gas utility company in the
United States. Consumers' gas utility operations purchase, transport, store,
distribute and sell natural gas. As of December 31, 2002, it was authorized to
provide service in 54 of the 68 counties in Michigan's lower peninsula.
Principal cities served include Bay City, Flint, Jackson, Kalamazoo, Lansing,
Pontiac and Saginaw, as well as the suburban Detroit area, where nearly 900,000
of the gas customers are located. Consumers' gas utility operations are not
dependent upon a single customer, or even a few customers, and the loss of any
one or even a few of such customers is not reasonably likely to have a material
adverse effect on its financial condition.
Consumers' gas utility operations are seasonal. Consumers injects
natural gas into storage during the summer months of the year for use during the
winter months when the demand for natural gas is higher. Peak demand usually
occurs in the winter due to colder temperatures
108
and the resulting increased demand for heating fuels. In 2002, total deliveries
of natural gas sold by Consumers and by other sellers who deliver natural gas
through Consumers' pipeline and distribution network to ultimate customers,
including the MCV Partnership, totaled 376.4 bcf.
Consumers sells gas to retail customers under tariffs approved by the
MPSC. These tariffs measure the gas delivered to customers based on the volume
(ie. Mcf's) of gas delivered. However, Consumers purchases gas for resale on a
Btu basis. The Btu content (Btu's per cubic foot) of the gas available for
purchase has been increasing and may result in customers using less gas for the
same heating requirement. Consumers fully recovers what it spends to purchase
the gas through the approved GCR. However, since the customer is using less gas
on a volumetric basis, the revenue from the distribution charge (the non-gas
cost portion of the customer bill) would be reduced. This could adversely affect
Consumers' earnings from its gas utility. The amount of the earning loss in
future periods cannot be estimated at this time.
Due to prolonged colder than normal weather during the winter months of
2002-2003, Consumers' gas storage fields were drawn down to unexpected and
unusually low levels. This caused withdrawal of the entire amount of working
storage gas from some fields. As a result, some salt water has entered
Consumers' pipelines and distribution lines that may increase future maintenance
problems and costs resulting from pipe corrosion.
GAS UTILITY PROPERTIES: Consumers' gas distribution and transmission
system consists of 25,218 miles of distribution mains and 1,624 miles of
transmission lines throughout Michigan's lower peninsula. It owns and operates
seven compressor stations with a total of 162,000 installed horsepower.
Consumers has 14 gas storage fields located across Michigan with an aggregate
storage capacity of 330.8 bcf.
In February 2002, the FERC approved Michigan Gas Storage's application
for a declaration of exemption from provisions of the National Gas Act. This
allowed Consumers to file with the MPSC for approval to merge with Michigan Gas
Storage. The merger was approved and completed in November 2002.
GAS SUPPLY: Total 2002 purchases included 58 percent from United States
producers outside Michigan, 22 percent from Canadian producers and 6 percent
from Michigan producers. Authorized suppliers in the permanent gas customer
choice pilot program, which started in April 2001, supplied the remaining 14
percent of gas delivered by Consumers.
Consumers' firm transportation agreements are with ANR Pipeline
Company, Great Lakes Gas Transmission, L.P., Trunkline and Panhandle Eastern
Pipe Line. Consumers uses these agreements to deliver gas to Michigan for
ultimate deliveries to market. In total, Consumers' firm transportation and city
gate arrangements are capable of delivering over 95 percent of Consumers' total
gas supply requirements. As of December 1, 2003, Consumers' portfolio of firm
transportation from pipelines to Michigan is as follows:
Volume
(dekatherms/day) Expiration
---------------- --------------------
ANR Pipeline Company.................................... 84,054 March 2004
Great Lakes Gas Transmission, L.P....................... 85,092 April 2004
Great Lakes Gas Transmission, L.P....................... 90,000 March 2004
Trunkline............................................... 336,375 October 2005
Trunkline............................................... 40,106 March 2004
Consumers purchases the balance of its required gas supply under firm
city gate contracts and as needed, interruptible contracts. The amount of
interruptible transportation service and its use varies primarily with the price
for such service and the availability and price of the spot supplies
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being purchased and transported. Consumers' use of interruptible transportation
is generally in off-peak summer months and after Consumers has fully utilized
the services under the firm transportation agreements.
CONSUMERS REGULATION
Consumers and its subsidiaries are subject to regulation by various
federal, state and local governmental agencies, including those specifically
described below.
MICHIGAN PUBLIC SERVICE COMMISSION
Consumers is subject to the MPSC's jurisdiction, which regulates public
utilities in Michigan with respect to retail utility rates, accounting, utility
services, certain facilities and various other matters. The Attorney General,
ABATE, and the MPSC staff typically intervene in MPSC electric and gas related
proceedings concerning Consumers. For many years, almost every significant MPSC
order affecting Consumers has been appealed. Certain appeals from the MPSC
orders are pending in the Michigan Court of Appeals.
RATE PROCEEDINGS: In 1996, the MPSC issued an order that established
the electric authorized rate of return on common equity at 12.25 percent. In
2002, the MPSC issued an order that established the gas authorized rate of
return on common equity at 11.4 percent.
MPSC REGULATORY AND MICHIGAN LEGISLATIVE CHANGES: State regulation of
the retail electric and gas utility businesses is in the process of undergoing
significant changes. In 2000, the Michigan Legislature enacted the Customer
Choice Act. Pursuant to the Customer Choice Act, as of January 2002, all
electric customers have their choice of buying generation service from an
alternative electric supplier. The Customer Choice Act also imposes rate
reductions, rate freezes and rate caps. For a description and additional
information regarding the Customer Choice Act, see Note 2 of the Notes to the
December 31, 2002 and the September 30, 2003 Financial Statements.
As a result of regulatory changes in the natural gas industry,
Consumers transports the natural gas commodity that is sold to some customers by
competitors like gas producers, marketers and others. From April 1, 1998, to
March 31, 2001, Consumers' implemented a statewide experimental gas customer
choice pilot program that allowed up to 300,000 residential, commercial and
industrial retail gas sales customers to choose their gas supplier and froze the
rates Consumers was permitted to charge for the service of distributing gas to
its customers.
Beginning April 1, 2001, Consumers established a permanent gas customer
choice program that allows up to 600,000 of Consumers' gas customers to select
an alternative gas commodity supplier. Currently, all of Consumers' gas
customers are eligible to select an alternative gas commodity supplier. As of
November 30, 2003, 134,361 of Consumers' gas customers had elected an alternate
gas commodity supplier. Also on April 1, 2001, pursuant to the permanent gas
customer choice program, Consumers returned to a GCR mechanism that allows it to
recover from its customers all prudently incurred costs to purchase the natural
gas commodity and transport it to Consumers' facilities. For additional
information on gas customer choice programs see Note 2 of the Notes to the
December 31, 2002 Financial Statements.
Consumers has also recently filed requests with the MPSC for an
increase in gas delivery and transportation rates as well as entered into a
settlement with the MPSC regarding the GCR process. For additional information
on these matters see Recent Developments- Gas Rate Case
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and Gas Cost Recovery.
FEDERAL ENERGY REGULATORY COMMISSION
Some of Consumers' gas business is also subject to regulation by FERC,
including a blanket transportation tariff pursuant to which Consumers can
transport gas in interstate commerce. FERC also regulates certain aspects of
Consumers' electric operations including: compliance with FERC accounting rules;
wholesale rates; transfers of certain facilities; and corporate mergers and
issuance of securities. For a discussion of the effect of certain FERC orders on
Consumers, see the 10-K MD&A -- Outlook -- Electric Business Outlook.
NUCLEAR REGULATORY COMMISSION
Under the Atomic Energy Act of 1954, as amended, and the Energy
Reorganization Act of 1974, Consumers is subject to the jurisdiction of the NRC
with respect to the design, construction, operation and decommissioning of its
nuclear power plants. Consumers is also subject to NRC jurisdiction with respect
to certain other uses of nuclear material. These and other matters concerning
Consumers' nuclear plants are more fully discussed in Notes 1 and 2 of the Notes
to the December 31, 2002 Financial Statements.
OTHER REGULATION
The Secretary of Energy regulates the importation and exportation of
natural gas and has delegated various aspects of this jurisdiction to FERC and
the DOE's Office of Fossil Fuels. Consumers is also subject to the Hazardous
Liquid Pipeline Safety Act of 1979, which regulates oil and petroleum pipelines.
Consumers is also subject to the Pipeline Safety Improvement Act of 2002, which
regulates gas pipeline safety requirements.
CONSUMERS ENVIRONMENTAL COMPLIANCE
Consumers and its subsidiaries are subject to various federal, state
and local regulations for environmental quality, including air and water
quality, waste management, zoning and other matters. For additional information
concerning environmental matters, see Note 2 of the Notes to the December 31,
2002 and the September 30, 2003 Financial Statements --Uncertainties -- Electric
Contingencies.
Consumers has installed and is currently installing modern emission
controls at its electric generating plants and has converted and is converting
electric generating units to burn cleaner fuels. Consumers expects that the cost
of future environmental compliance, especially compliance with clean air laws,
will be significant because of EPA regulations regarding nitrogen oxide and
particulate-related emissions. These regulations will require Consumers to make
significant capital expenditures. For the estimates of these capital
expenditures to reduce nitrogen oxide-related emissions see Note 2 of the Notes
to the December 31, 2002 and September 30, 2003 Financial Statements --
Uncertainties --electric Contingencies.
Consumers is in the process of closing older ash disposal areas at two
plants. Construction, operation, and closure of a modern solid waste disposal
area for ash can be expensive, because of strict federal and state requirements.
In order to significantly reduce ash field closure costs, Consumers has worked
with others to use bottom ash and fly ash as part of temporary and final cover
for ash disposal areas instead of native materials in cases where such use of
bottom ash and fly ash is compatible with environmental standards. To reduce
disposal volumes, Consumers sells coal ash for use as a filler for asphalt, for
incorporation into concrete products and for other
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environmentally compatible uses. The EPA has announced its intention to develop
new nationwide standards for ash disposal areas. Consumers intends to work
through industry groups to help ensure that any such regulations require only
the minimum cost necessary to adhere to standards that are consistent with
protection of the environment.
Consumers has PCB in some of its electrical equipment, as do most
electric utilities. During routine maintenance activities, Consumers identified
PCB as a component in certain paint, grout and sealant materials at the
Ludington Pumped Storage facility. Consumers removed and replaced part of the
PCB material. Consumers has proposed a plan to the EPA to deal with the
remaining materials and is waiting on a response from the EPA.
Certain environmental regulations affecting Consumers include, but are
not limited to, the Clean Air Act Amendments of 1990 and Superfund. Superfund
can require any individual or entity that may have owned or operated a disposal
site, as well as transporters or generators of hazardous substances that were
sent to such site, to share in remediation costs for the site.
Consumers' current insurance coverage does not extend to certain
environmental clean-up costs, such as claims for air pollution, some past PCB
contamination and for some long-term storage or disposal of pollutants.
CONSUMERS COMPETITION
ELECTRIC COMPETITION
Consumers' electric utility business experiences competition, actual
and potential, from many sources, both in the wholesale and retail markets, and
in electric generation, electric delivery, and retail services.
In the wholesale electricity markets, Consumers competes with other
wholesale suppliers, marketers and brokers. Electric competition in the
wholesale markets increased significantly since 1996 due to FERC Order 888.
Whereas Consumers is still active in wholesale electricity markets, wholesale
for retail transactions by Consumers generated an immaterial amount of
Consumers' 2002 revenues from electric utility operations. Consumers does not
believe future loss of wholesale sales for retail sales to be significant.
A significant increase in retail electric competition is now possible
with the passage of the Customer Choice Act and the availability of retail open
access. The Customer Choice Act of June 2000 required Consumers to open
progressive tiers of its electric customer power supply requirement such that a
total of 750 MW was open to competition in 2001. As of January 1, 2002, the
Consumer Choice Act also gave all electric customers the right to buy generation
service from an alternative electric supplier. As a result, alternative electric
suppliers for generation services have entered Consumers' market. As of October
2003, alternative electric suppliers are providing 603 MW of generation supply
to retail open access customers. The Michigan Public Service Commission has
adopted a mechanism pursuant to the Customer Choice Act to provide for recovery
of stranded costs. The company cannot predict the total amount of electric
supply load that may be lost to competitor suppliers, nor whether the stranded
cost recovery method adopted by the MPSC will be applied in a manner that will
fully offset any associated margin loss.
In addition to retail electric customer choice, Consumers also has
competition or potential competition from: 1) the threat of customers relocating
outside Consumers' service territory; 2)
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the possibility of municipalities owning or operating competing electric
delivery systems; 3) customer self-generation; and 4) adjacent municipal
utilities that extend lines to customers near service territory boundaries.
Consumers addresses this competition primarily through offering rate discounts,
providing additional services and insistence upon compliance with MPSC and FERC
rules.
Consumers offers non-commodity retail services to electric customers in
an effort to offset costs. Consumers faces competition from many sources,
including energy management services companies, other utilities, contractors,
and retail merchandisers.
For additional information concerning electric competition, see the
10-Q MD&A -- Outlook -- Electric Business Outlook -- Competition and Regulatory
Resructuring.
GAS COMPETITION
Competition has existed for the past decade, and is likely to increase,
in various aspects of Consumers' gas utility business. Competition traditionally
comes from alternate fuels and energy sources, such as propane, oil, and
electricity. Competition has also been introduced through the gas customer
choice program which allows residential, commercial and industrial retail gas
sales customers to choose an alternative gas commodity supplier in direct
competition with Consumers. Consumers would continue to transport and distribute
gas to these customers.
For additional information concerning gas competition, see the 10-K
MD&A -- Outlook -- Gas Business Outlook.
INSURANCE
Consumers maintains insurance coverage similar to other comparable
companies in the same lines of business. The insurance policies are subject to
terms, conditions, limitations and exclusions that might not fully compensate
Consumers for all losses. Furthermore, as Consumers renews its policies it is
possible that full insurance coverage may not be obtainable on commercially
reasonable terms due to the recent increasingly restrictive insurance markets.
For additional information regarding Insurance, see Note 2 of the Notes
to the December 31, 2002 Financial Statements - Other Electric Uncertainties -
Insurance.
EMPLOYEES
As of December 1, 2003, Consumers and its subsidiaries had 8,548
full-time equivalent employees of whom 8,338 are full-time employees and 210
full-time equivalent employees associated with the part-time work force.
Included in the total are 3,497 full-time operating, maintenance and
construction employees of Consumers who are represented by the Utility Workers
Union of America. Consumers and the Union negotiated a collective bargaining
agreement that became effective as of June 1, 2000 and will continue in full
force and effect until June 1, 2005. Effective April 1, 2003, Consumers entered
into a collective bargaining agreement for its approximately 300 Call Center
employees that will continue in full force and effect through August 1, 2005.
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LEGAL PROCEEDINGS
Consumers and some of its subsidiaries and affiliates are parties to
certain routine lawsuits and administrative proceedings incidental to their
businesses involving, for example, claims for personal injury and property
damage, contractual matters, various taxes, and rates and licensing. Reference
is made to-- Consumers Regulation, as well as the 10-Q MD&A and the Notes to the
September 30, 2003 Financial Statements included herein for additional
information regarding various pending administrative and judicial proceedings
involving regulatory, operating and environmental matters.
EMPLOYMENT RETIREMENT INCOME SECURITY ACT CLASS ACTION LAWSUITS
Consumers is a named defendant, along with CMS Energy, CMS MST and
certain named and unnamed officers and directors, in two lawsuits brought as
purported class actions on behalf of participants and beneficiaries of the CMS
Employee's Savings and Incentive Plan (the "PLAN"). The two cases, filed in July
2002 in the U.S. District Court, were consolidated by the trial judge and an
amended consolidated complaint has been filed. Plaintiffs allege breaches of
fiduciary duties under ERISA and seek restitution on behalf of the Plan with
respect to a decline in value of the shares of CMS Energy Common Stock held in
the Plan. Plaintiffs also seek other equitable relief and legal fees. These
cases will be vigorously defended. Consumers cannot predict the outcome of this
litigation.
SECURITIES CLASS ACTION LAWSUITS
Beginning on May 17, 2002, a number of securities class action
complaints have been filed against CMS Energy, Consumers and certain officers
and directors of CMS Energy and its affiliates. The complaints have been filed
in the United States District Court for the Eastern District of Michigan as
purported class actions by individuals who allege that they purchased CMS
Energy's securities during a purported class period. The cases were consolidated
into a single lawsuit and an amended and consolidated class action complaint was
filed on May 1, 2003. The consolidated complaint contains a purported class
period beginning on May 1, 2000 and running through March 31, 2003. It generally
seek unspecified damages based on allegations that the defendants violated
United States securities laws and regulations by making allegedly false and
misleading statements about the company's business and financial condition,
particularly with respect to revenues and expenses recorded with round-trip
trading by CMS MST. The companies intend to vigorously defend against this
action but cannot predict the outcome of this litigation.
SHAREHOLDER DERIVATIVE SUIT
In May of 2002, the Board of Directors of CMS Energy received a demand
from a shareholder to commence civil actions (i) to remedy alleged breaches of
fiduciary duties by CMS Energy officers and directors in connection with round
trip trading at CMS MST, and (ii) to recover damages sustained by CMS Energy as
a result of alleged insider trades alleged to have been made by certain current
and former officers of CMS Energy and its subsidiaries. In December 2002, two
new directors were appointed to the CMS Energy Board of Directors. A special
litigation committee was formed by the Board in January 2003 to determine
whether it is in the best interest of CMS Energy to bring the action demanded by
the shareholder. The disinterested members of the Board appointed the two new
directors to serve on the committee.
On December 2, 2003, during the continuing review by the special litigation
committee, CMS
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Energy was served with a derivative complaint filed by the shareholder in the
Circuit Court of Jackson County, Michigan in furtherance of his demands. CMS
Energy intends to seek an extension of time to answer or otherwise respond to
the complaint in order for the special litigation committee to complete its
review.
ENVIRONMENTAL MATTERS
Consumers and its 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, Consumers believes that it is unlikely that
these actions, individually or in total, will have a material adverse effect on
their financial condition. See the 10-K MD&A and the Notes to the December 31,
2002 Financial Statements.
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OUR MANAGEMENT
The following table sets for the names, ages, positions and five-year
employment history of our executive officers as of December 1, 2003.
EXECUTIVE OFFICERS
NAME AGE POSITION PERIOD
-------------------------------- --- --------------------------------------------------------------- ------------
Kenneth Whipple................. 69 Chairman of the Board, Chief Executive Officer of CMS Energy 2002-Present
Chairman of the Board, Chief Executive Officer of Consumers 2002-Present
Chairman of the Board of Enterprises 2002-Present
Director of CMS Energy 1993-Present
Director of Consumers 1993-Present
Chairman and Chief Executive Officer of Ford Credit Company 1997-1999
Executive Vice President and President of Ford Financial
Services Group 1989-1999
S. Kinnie Smith, Jr. ........... 72 Vice Chairman of the Board of CMS Enterprises 2003-Present
Vice Chairman of the Board and General Counsel of CMS Energy 2002-Present
Vice Chairman of the Board of Consumers 2002-Present
Executive Vice President of Enterprises 2002-Present
Director of CMS Energy 2002-Present
Director of Consumers 2002-Present
Vice Chairman of Trans-Elect, Inc. 2002
Senior Counsel at Skadden, Arps, Slate, Meagher & Flom LLP 1995-2002
David W. Joos................... 50 Chairman of the Board and Chief Executive Officer of CMS
Enterprises 2003-Present
President and Chief Operating Officer of CMS Energy 2001-Present
President and Chief Operating Officer of Consumers 2001-Present
President and Chief Operating Officer of CMS Enterprises 2001-2003
Director of CMS Energy 2001-Present
Director of Consumers 2001-Present
Executive Vice President and Chief Operating Officer-- Electric
of Enterprises 2000-2001
Executive Vice President and Chief Operating Officer-- Electric
of CMS Energy 2000-2001
Executive Vice President and President and Chief Executive
Officer - Electric of Consumers 1997-2001
Thomas J. Webb.................. 51 Executive Vice President and Chief Financial Officer of CMS
Energy 2002-Present
Executive Vice President and Chief Financial Officer of 2002-Present
Consumers
Executive Vice President and Chief Financial Officer of 2002-Present
Enterprises
Executive Vice President and Chief Financial Officer of
Panhandle Eastern Pipe Line Company 2002-2003
Executive Vice President and Chief Financial Officer of Kellogg
Company 1999-2002
Vice President and Chief Financial Officer of Visteon , a
division of Ford Motor Company 1996-1999
Thomas W. Elward................ 55 President and Chief Operating Officer of CMS Enterprises 2003-Present
President and Chief Executive Officer of CMS Generation Company 2002-Present
Senior Vice President of CMS Enterprises 2002
Senior Vice President of CMS Generation Company 1998
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NAME AGE POSITION PERIOD
-------------------------------- --- --------------------------------------------------------------- ------------
Carl L. English................. 57 Executive Vice President and President and Chief Executive 1999-Present
Officer-- Gas of Consumers
Vice President of Consumers 1990-1999
John G. Russell**............... 45 Executive Vice President and President and Chief Executive
Officer - Electric of Consumers 2001-Present
Senior Vice President of Consumers 2000-2001
Vice President of Consumers 1999-2000
John F. Drake................... 55 Senior Vice President of CMS Enterprises 2003-Present
Senior Vice President of CMS Energy 2002-Present
Senior Vice President of Consumers 2002-Present
Vice President of CMS Energy 1997-2002
Vice President of Consumers 1998-2002
David G. Mengebier*............. 46 Senior Vice President of CMS Enterprises 2003-Present
Senior Vice President of CMS Energy 2001-Present
Senior Vice President of Consumers 2001-Present
Vice President of CMS Energy 1999-2001
Vice President of Consumers 1999-2001
Robert A. Fenech................ 56 Senior Vice President of Consumers 1997-Present
Vice President of Consumers 1994-1997
Preston D. Hopper............... 52 Senior Vice President of CMS Enterprises 2003-Present
Senior Vice President of CMS Energy 2003-Present
Senior Vice President of Consumers 2003-Present
Senior Vice President and Chief Accounting Officer of 1997-2003
Enterprises
Senior Vice President, Chief Accounting Officer and Controller
of CMS Energy 1996-2003
Senior Vice President and Controller of Enterprises 1996-1997
Frank Johnson................... 55 Senior Vice President of Consumers 2001-Present
President and Chief Executive Officer of CMS Electric and Gas 2000-2002
Vice President and Chief Operating Officer of CMS Electric and 2000
Gas
Vice President of CMS Electric and Gas 1996-2000
David A. Mikelonis.............. 55 Senior Vice President and General Counsel of Consumers 1988-Present
Paul N. Preketes................ 53 Senior Vice President of Consumers 1999-Present
Vice President of Consumers 1994-1999
Glenn P. Barba.................. 38 Vice President and Chief Accounting Officer of CMS Enterprises 2003-Present
Vice President, Controller and Chief Accounting Officer of CMS
Energy 2003-Present
Vice President, Controller and Chief Accounting Officer of
Consumers 2003-Present
Vice President and Controller of Consumers 2001-2003
Controller of CMS Generation Company 1997-2001
* Mr. Mengebier has served as Senior Vice President of CMS Energy and
Consumers since 2001, after receiving a promotion from his position in
both companies as Vice President, which he had held since 1999. From
1997 to 1999, Mr. Mengebier served as Executive Director of Federal
Governmental Affairs for CMS Enterprises.
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** Mr. Russell has served as Executive Vice President and President and
Chief Executive Officer - Electric of Consumers since October 2001.
From December 2000 until October 2001, Mr. Russell served as Senior
Vice President of Consumers. From October 1999 until December 2000, Mr.
Russell served as Vice President of Consumers. From July 1997 until
October 1999, Mr. Russell served as Manager - Electric Customer
Operations of Consumers.
There are no family relationships among executive officers and
directors of Consumers.
DIRECTORS
Set forth below is a certain biographical information regarding our
directors which includes their names, ages, positions and five-year employment
history as of December 1, 2003.
JAMES J. DUDERSTADT, 60, has been President Emeritus and University Professor of
Science and Engineering at the University of Michigan, Ann Arbor, Michigan,
since 1996. He served as the President of the University of Michigan from 1988
to 1996. He is a director of Unisys Corporation, chairs the Nuclear Energy
Research Advisory Committee of the Department of Energy, and conducts numerous
studies for the National Academy of Sciences. He has been a director of CMS and
of Consumers since 1993.
KATHLEEN R. FLAHERTY, 52, served from 1999 to 2001 as President and Chief
Operating Officer of WinStar International. Previously, she served from 1998 to
1999 as President and Chief Operating Officer of WinStar Communications, Europe,
from 1997 to 1998 as Senior Vice President, Product Architecture for MCI
Communications Corporation, and from 1995 to 1997 as National Business Marketing
Director for British Telecom. She has been a director of CMS and of Consumers
since 1995.
EARL D. HOLTON, 69, has served since 1999 as Vice Chairman of Meijer, Inc., a
Grand Rapids, Michigan based operator of food and general merchandise centers.
He is also Chairman of the Board of Steelcase, Inc. Previously, he served from
1980 to 1999 as President of Meijer, Inc. He is a director of Meijer, Inc. and
Steelcase, Inc. He has been a director of CMS and of Consumers since 1989.
DAVID W. JOOS, 50, has served since 2001 as President and Chief Operating
Officer of CMS and Consumers. Previously, he served from 2000 to 2001 as
Executive Vice President and Chief Operating Officer -- Electric of CMS and from
1997 to 2000 as President and Chief Executive Officer -- Electric of Consumers.
He is a director of Steelcase, Inc., Nuclear Management Co., the Michigan
Colleges Foundation, Michigan Economic Development Corporation, and is a
director and Vice Chairman of the Michigan Manufacturers Association. He has
been a director of CMS and of Consumers since 2001.
MICHAEL T. MONAHAN, 64, has served since 1999 as President of Monahan
Enterprises, LLC, a Bloomfield Hills, Michigan based consulting firm.
Previously, he was Chairman of Munder Capital Management, an investment
management company, from October 1999 to December 2000 and Chairman and Chief
Executive Officer of Munder from October 1999 until January 2000. Prior to that,
he was President and a director of Comerica Bank from 1992 to 1999 and President
and a director of Comerica Inc., from 1993 to 1999. He is a director of The
Munder Funds, Inc., Chairman of the Board of Guilford Mills, Inc., a member of
the board of trustees of Henry Ford Health Systems, Inc., and a member of the
board of trustees of the Community Foundation for Southeastern Michigan. He has
been a director of CMS and Consumers since December 2002.
JOSEPH F. PAQUETTE, JR., 69, served from 1988 to 1995 as Chairman of the Board
and Chief
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Executive Officer and from 1995 until his retirement in 1997 as Chairman of the
Board of PECO Energy, formerly the Philadelphia Electric Company, a major
supplier of electric and gas energy. He is a director of USEC, Inc., AAA
Mid-Atlantic, Inc., the Mid-Atlantic Insurance Company, and Mercy Health
Systems. He has been a director of CMS and Consumers since December 2002. He had
previously served as a director of CMS and Consumers and as President of CMS
from 1987 to 1988.
WILLIAM U. PARFET, 57, has served since 1999 as Chairman and Chief Executive
Officer of MPI Research, Inc., Mattawan, Michigan, a contract research
laboratory conducting risk assessment toxicology studies. Previously, he served
from 1995 to 1999 as Co-Chairman of MPI Research. He is a director of Pharmacia
Corporation, Stryker Corporation, PAREXEL International Corporation, and
Monsanto Company. He is also a commissioner of the Michigan Department of
Natural Resources. He has been a director of CMS and of Consumers since 1991.
PERCY A. PIERRE, 64, has served since 1990 as Professor of Electrical
Engineering, Michigan State University, East Lansing, Michigan. He also served
as Vice President for Research and Graduate Studies at Michigan State University
from 1990 to 1995. Dr. Pierre is a former Assistant Secretary of the Army for
Research, Development and Acquisition. He is also a former President of Prairie
View A&M University. He is a director of Fifth Third Bank (Western Michigan) and
the Whitman Education Group. He also serves as a member of the Boards of
Trustees for the University of Notre Dame and Hampshire College. He has been a
director of CMS and of Consumers since 1990.
S. KINNIE SMITH, JR., 72, has served as Vice Chairman and General Counsel of CMS
since June 2002. Previously, he served as Senior Counsel for the law firm
Skadden, Arps, Slate, Meagher & Flom from 1996 to 2002. He has been a director
of CMS and Consumers since August 2002. He had held the positions of Vice
Chairman and President of CMS and Vice Chairman of Consumers and served as a
director of CMS and Consumers from 1987 to 1996. In May and June of 2002, he
served as Vice Chairman and as a director of Trans-Elect, Inc.
KENNETH L. WAY, 64, served from 1988 through 2002 as Chairman of the Board of
Lear Corporation, a Southfield, Michigan based supplier of automotive interior
systems to the automotive industry. In addition, he served from 1988 to 2000 as
Chief Executive Officer of Lear Corporation. He is a director of Comerica, Inc.
and WESCO International, Inc. He also serves as a member of the Boards of
Trustees for Kettering University and the Henry Ford Health Systems. He has been
a director of CMS and of Consumers since 1998.
KENNETH WHIPPLE, 69, has served since May of 2002 as Chairman of the Board and
Chief Executive Officer of CMS and Consumers. Previously, he served from 1988
until his retirement in 1999 as Executive Vice President of Ford Motor Company,
Dearborn, Michigan, a world-wide automotive manufacturer, and President of the
Ford Financial Services Group. In addition, he served from 1997 to 1998 as
Chairman and Chief Executive Officer of Ford Motor Credit Company. He had
previously served as Chairman and Chief Executive Officer of Ford of Europe,
Inc. from 1986 to 1988. He is a director of AB Volvo and a trustee of 13
J.P.Morgan Chase mutual funds. He has been a director of CMS and of Consumers
since 1993.
JOHN B. YASINSKY, 64, served from 1999 until his retirement in 2000 as Chairman
of the Board and Chief Executive Officer and continued as Chairman until
February 2001 of OMNOVA Solutions Inc., Fairlawn, Ohio, a developer,
manufacturer, and marketer of emulsion polymers, specialty chemicals, and
building products. Previously, he served from 1995 to 1999 as Chairman, Chief
Executive Officer and President of GenCorp. He is a director of A. Schulman,
Inc. He has been a director of CMS and of Consumers since 1994.
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MANAGEMENT SECURITY OWNERSHIP
The following chart shows the ownership of CMS Common Stock by the
directors and executive officers:
SHARES
NAME BENEFICIALLY OWNED*
James J. Duderstadt.................... 7,801
Kathleen R. Flaherty................... 8,514
Earl D. Holton......................... 26,113
David W. Joos.......................... 209,855
Michael T. Monahan..................... 3,943
Joseph F. Paquette, Jr................. 18,138
William U. Parfet...................... 15,810
Percy A. Pierre........................ 5,810
S. Kinnie Smith, Jr.................... 156,818
Kenneth L. Way......................... 49,623
Kenneth Whipple........................ 356,021
John B. Yasinsky....................... 16,495
David A. Mikelonis..................... 35,397
All Directors and Executive Officers... 1,404,040
* All shares shown above are as of December 5, 2003. In addition to the shares
shown above, Mr. Smith, Mr. Joos, and Mr. Mikelonis, and all other executive
officers own options to acquire 165,000; 473,000; 137,000; and 1,509,560 shares,
respectively. Mr. Whipple does not own any options to acquire CMS Common Stock.
All options identified in this footnote are as of December 5, 2003.
Shares shown as beneficially owned include (1) shares to which a person
has or shares voting power and/or investment power, and (2) the number of shares
and share equivalents represented by interests in the Employee Savings Plan, the
Deferred Salary Savings Plan, the Performance Incentive Stock Plan, the
Directors' Deferred Compensation Plan, the Salaried Employee Merit Plan and
employment agreements. Mr. Duderstadt, Ms. Flaherty, Mr. Holton, Mr. Parfet, Mr.
Pierre, Mr. Smith, Mr. Way, Mr. Whipple and Mr. Yasinsky each own 10 shares of
Preferred Stock of Consumers. The directors and executive officers together own
less than 1% of the outstanding shares of CMS.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Federal securities laws require CMS directors and executive officers,
and persons who own more than 10% of CMS Common Stock, to file with the SEC
reports of ownership and changes in ownership of any securities or derivative
securities of CMS. To CMS' knowledge, during the year ended December 31, 2002,
CMS' officers and directors made all required Section 16(a) filings on a timely
basis.
COMPENSATION OF DIRECTORS
Directors who are not officers of CMS or Consumers received in 2002 an
annual retainer fee of $30,000, $1,500 for attendance at each Board meeting and
$750 for attendance at each committee meeting. Committee chairs received $1,000
for attendance at each committee meeting. These figures have remained unchanged
for several years, and are relatively low by industry standards. The Board of
Directors has set the same amounts for retainer and attendance fees to be paid
in 2003. In 2002, all directors who were not officers of CMS or Consumers were
granted 850 restricted shares of CMS Common Stock with a fair market value at
time of grant of $15,563.
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These restricted shares must be held for at least three years from the date of
grant. In 2003, the number of restricted shares to be granted to each continuing
outside director will again be 850 shares. Because of the decline in the CMS
Common Stock price, this will be a significant reduction in the dollar value of
shares granted to these directors from prior years. This reduction reflects CMS'
and Consumers' 2002 financial performance. Mr. Monahan and Mr. Paquette, the two
outside directors who joined the Boards in December 2002, will each receive a
restricted stock grant with a market value at the time of grant of $30,000.
These two new directors' stock grants reflect the fact that it is increasingly
difficult to attract highly qualified directors in today's business environment,
especially given the relatively low retainer and fees received by CMS directors
compared to comparable companies' directors. Providing these two individuals
with newly issued shares of restricted stock rather than with cash helped enable
CMS to attract two exceptional new directors while conserving much needed cash.
Directors are reimbursed for expenses incurred in attending Board or committee
meetings. Directors who are officers of CMS or Consumers do not receive
retainers or meeting fees for service on the Board or as a member of any Board
committee. Pursuant to the Directors' Deferred Compensation Plan, a director of
CMS or Consumers who is not an officer may, at any time prior to a calendar year
in which a retainer and fees are to be earned, or at any time during the year
prior to the month in which a retainer and fees are earned, irrevocably elect to
defer payment for that year, or a portion thereof, through written notice to CMS
or Consumers, of all or half of any of the retainer and fees which would
otherwise be paid to the director, to a time following the director's retirement
from the Board of Directors. Any amount deferred will either (a) accrue interest
at either the prime rate or the rate for 10-year Treasury Notes (whichever is
greater), (b) be treated as if it were invested as an optional cash payment in
CMS' Stock Purchase Plan, or (c) be treated as if it were invested in a Standard
& Poor's 500 stock index fund. Accrued amounts will be distributed in a lump sum
or in five or ten annual installments in cash. Outside directors who retire with
five years of service on the Board will receive retirement payments equal to the
retainer. These payments will continue for a period of time equal to their years
of service on the Board. All benefits will cease at the death of the retired
director. Outside directors are offered optional life insurance coverage,
business-related travel accident insurance, and optional health care insurance,
and CMS and Consumers pay the premiums associated with participation by
directors. The imputed income for the life insurance coverage in 2002 was:
Messrs. Duderstadt, $741; Holton, $2,553; Monahan, $62; Paquette, $200; Parfet,
$633; Pierre, $744; Whipple, $2,394; Yasinsky, $756; Deutch, $744; and Ms.
Flaherty, $369. The imputed income for health insurance coverage in 2002 was:
Ms. Flaherty, $5,267.
EXECUTIVE COMPENSATION
The following charts contain information concerning annual and
long-term compensation and awards of stock options and restricted stock under
CMS' Performance Incentive Stock Plan. The charts include the Chairman of the
Board and Chief Executive Officer, the next four most highly compensated
executive officers in 2002, the former Chairman of the Board and Chief Executive
Officer, the former Chief Financial Officer, and the former President and Chief
Executive Officer of CMS Oil and Gas Company.
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SUMMARY COMPENSATION TABLE
Long-Term
Compensation(1)
---------------------------------------
Awards Payouts
Annual ------------------------- -----------
Compensation Restricted Securities Long-Term
------------------------- Stock Underlying Incentive All Other
Name and Principal Position Year Salary Bonus Awards(2) Options Payouts(2) Compensation
--------------------------- ---- ------------- --------- ------------ ---------- ----------- --------------
Current Officers
KENNETH WHIPPLE............. 2002 $ 639,060(4) $ 0 $ 0 0 $ 0 $ 0
Chairman and CEO, CMS 2001 0 0 0 0 0 0
and Consumers 2000 0 0 0 0 0 0
DAVID W. JOOS............... 2002 750,000 0 406,000(5) 165,000 0 15,000(6)
President and COO, 2001 637,500 0 0 100,000 35,907 19,125(6)
CMS and Consumers 2000 508,333 326,510 0 32,000 98,233 15,250(6)
WILLIAM J. HAENER........... 2002 530,000 0 178,640(7) 82,500 0 10,600(6)
Executive Vice President 2001 509,167 0 0 40,000 26,930 15,275(6)
and COO-- Natural Gas, CMS 2000 406,667 322,459 0 22,000 83,977 12,200(6)
CHRISTOPHER A. HELMS........ 2002 400,000 0 64,960(8) 34,000 0 0
President and CEO, 2001 386,042 134,300 0 16,000 0 0
CMS Panhandle Companies 2000 297,708 202,747 0 16,000 0 0
DAVID A. MIKELONIS.......... 2002 355,000 0 56,840(9) 28,000 0 7,100(6)
Senior Vice President and 2001 355,000 0 0 14,000 17,978 10,650(6)
General Counsel, Consumers 2000 335,000 161,574 0 14,000 59,400 10,050(6)
Former Officers
WILLIAM T. MCCORMICK, JR.(10) 2002 462,500 0 0 90,000 0 1,557,700(11)
Former Chairman and CEO, 2001 1,110,000 0 0 100,000 112,271 33,300(6)
CMS and Consumers 2000 1,060,000 700,000 0 100,000 319,869 31,800(6)
ALAN M. WRIGHT(12).......... 2002 291,667 0 0 45,000 0 1,177,500(13)
Former Chief Financial
Officer, 2001 500,000 0 0 45,000 35,907 15,000(6)
CMS and Consumers 2000 417,500 249,374 0 28,000 98,233 12,525(6)
BRADLEY W. FISCHER(14)...... 2002 283,333 168,330 0 20,000 0 2,847,759(15)
Former President and CEO, 2001 383,333 257,400 0 41,000 0 11,500(6)
CMS Oil and Gas Company 2000 310,000 179,115 0 16,000 0 9,300(6)
(1) Aggregate non-performance based restricted stock granted prior to 2002
held as of December 31, 2002 by named officers was: Mr. Whipple, 1,900
shares, with year-end market value of $17,936, and Mr. Haener, 636
shares, with year-end market value of $6,004. Regular dividends were
paid on such restricted stock.
(2) 2002 restricted stock awards granted July 31, 2002. These shares vest
at a rate of 25% per year beginning July 31, 2004. The 2002 dollar
values shown below are based on the July 31, 2002 grant date closing
price of $8.12 per share.
(3) Market value of CMS Common Stock paid under CMS' Performance Incentive
Stock Plan for three-year performance periods.
(4) Mr. Whipple's 2002 salary consisted of $2,125 in cash compensation and
$636,935 in deferred compensation. The dollar value of the deferred
compensation will be based on the future price of CMS Common Stock.
Unless the stock price rises considerably from current (April 22, 2003)
levels, the cash compensation eventually received by Mr. Whipple will
be significantly below the $636,935 indicated above.
(5) 50,000 restricted shares awarded to Mr. Joos.
(6) Employer matching contribution to defined contribution plans.
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(7) 22,000 restricted shares awarded to Mr. Haener.
(8) 8,000 restricted shares awarded to Mr. Helms.
(9) 7,000 restricted shares awarded to Mr. Mikelonis.
(10) Mr. McCormick resigned as Chairman and CEO on May 24, 2002.
(11) $22,200 employer matching contribution to defined contribution plans
plus $1,535,500 in separation payments.
(12) Mr. Wright resigned as Executive Vice President, CFO and Chief
Administrative Officer on August 16, 2002.
(13) $8,750 employer matching contributions to defined contribution plans
plus $1,168,750 in separation payments.
(14) Mr. Fischer resigned as President and CEO, CMS Oil and Gas Company on
September 16, 2002.
(15) $8,000 employer matching contribution to defined contributions plans
plus $2,839,759 in incentive and change-of-control payments resulting
from the sale for over $1.3 billion in cash of substantially all of CMS
Oil and Gas Company.
EMPLOYMENT ARRANGEMENTS
Agreements with the executive officers named above provide for payments
equal to three times annual cash compensation if there is a change of control
and adverse change of responsibilities, as well as payments equal to two times
annual cash compensation if employment is terminated by the company, other than
for cause, in the absence of a change of control. CMS and Consumers also provide
long-term disability insurance policies for all executive officers which would
provide payment of up to 60% of compensation in the event of disability. CMS
does not have a "poison pill" plan and is not considering the adoption of such a
plan.
OPTION GRANTS IN 2002
Number of Securities Percentage of Total Exercise Grant Date
Underlying Options Options Granted to Price Per Expiration Present
Name Granted Employees in 2002 Share Date Value(1)
--------------------------- ------------------- ------------------ --------- ---------- ----------
Kenneth Whipple............ 0 0 -- -- $ 0
David W. Joos.............. 65,000 4.4 $ 22.20 3-21-12 249,600
David W. Joos.............. 100,000 6.7 8.12 8-30-12 144,000
William J. Haener.......... 40,000 2.7 22.20 3-21-12 153,600
William J. Haener.......... 42,500 2.8 8.12 8-30-12 61,200
Christopher A. Helms....... 18,000 1.2 22.20 3-21-12 69,170
Christopher A. Helms....... 16,000 1.1 8.12 8-30-12 23,040
David A. Mikelonis......... 14,000 0.9 22.20 3-21-12 53,760
David A. Mikelonis......... 14,000 0.9 8.12 8-30-12 20,160
William T. McCormick, Jr... 90,000 6.0 22.20 3-21-12 345,600
Alan M. Wright............. 45,000 3.0 22.20 3-21-12 172,800
Bradley W. Fischer......... 20,000 1.3 22.20 3-21-12 76,800
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(1) The present value is based on the Black-Scholes Model, a mathematical
formula used to value options traded on securities exchanges. The model
utilizes a number of assumptions, including the exercise price, the
underlying CMS Common Stock's volatility using weekly closing prices
for a four and one half year period prior to grant date, the dividend
rate, the term of the option, and the level of interest rates
equivalent to the yield of four-year Treasury Notes. However, the Model
does not take into account a significant feature of options granted to
employees under CMS' Plan, the non-transferability of options awarded.
For those options above with an expiration date of 3-21-12 (granted
2-22-02), the volatility was 32.44%, the dividend rate at the time was
$0.365 per quarter, and the interest rate was 3.95%. For those options
above with an expiration date of 8-30-12 (granted 7-31-02), the
volatility was 40.81%, the dividend rate at the time was $0.18 per
quarter, and the interest rate was 3.16%.
AGGREGATED OPTION EXERCISES IN 2002 AND YEAR-END OPTIONS VALUES
Number of Securities Value of Unexercised
Shares Acquired Value Underlying Unexercised In-the-Money Options
Name On Exercise Realized Options at Year End at Year End(1)(2)
----------------------------- ----------------- --------- ---------------------- ----------------------
Kenneth Whipple.............. 0 $ 0 0 $ 0
David W. Joos................ 0 0 373,000 132,000
William J. Haener............ 0 0 234,500 56,100
Christopher A. Helms......... 0 0 73,500 21,120
David A. Mikelonis........... 0 0 78,000 18,480
William T. McCormick, Jr..... 10,000 56,375 677,000 0
Alan M. Wright............... 0 0 161,000 0
Bradley W. Fischer........... 0 0 87,000 0
(1) All options listed in this table are exercisable. The named officers
have no unexercisable options.
(2) Based on the December 31, 2002 closing price of CMS Common Stock as
shown in the report of the NYSE Composite Transactions ($9.44).
PENSION PLAN TABLE
The following table shows the aggregate annual pension benefits at
normal retirement date presented on a straight life annuity basis under CMS'
qualified Pension Plan and non-qualified Supplemental Executive Retirement Plan
(offset by a portion of Social Security benefits).
Years of Service
-------------------------------------------------------------------------
Compensation 15 20 25 30 35
------------ ----------- ---------- ---------- ----------- ------------
$ 500,000 $ 157,500 $ 210,000 $ 247,500 $ 285,000 $ 322,500
800,000 252,000 336,000 396,000 456,000 516,000
1,100,000 346,500 462,000 544,500 627,000 709,500
1,400,000 441,000 588,000 693,000 798,000 903,000
1,700,000 535,500 714,000 891,500 969,000 1,096,500
2,000,000 630,000 840,000 990,000 1,140,000 1,290,000
"Compensation" in this table is the average of Salary plus Bonus, as
shown in the Summary Compensation Table, for the five years of highest earnings.
The estimated years of service for each named executive is: Mr. Whipple, 1.56
years; Mr. Joos, 31.33 years; Mr. Haener, 18.00 years; Mr. Helms, 16.99 years;
Mr. Mikelonis, 35.00 years; Mr. McCormick, 27.20 years; Mr. Wright, 21.76 years;
and Mr. Fischer, 10.40 years.
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AFFILIATE RELATIONSHIPS AND TRANSACTIONS
On May 1, 2002, Consumers sold its electric transmission system to
Michigan Transmission Holdings, LLP, a non-affiliated limited partnership whose
general partner is a subsidiary of Trans-Elect, Inc. A Trans-Elect, Inc.
subsidiary provides interstate electric transmission service to Consumers
pursuant to agreements entered into at the time of the sale. The rates and other
terms of the service were approved by the Federal Energy Regulatory Commission
prior to the sale and remain subject to the Commissions' jurisdiction. From May
15, 2002 until June 30, 2002, S. Kinnie Smith, Jr. served as Vice Chairman of
Trans-Elect, Inc. Mr. Smith served as a director of Trans-Elect, Inc. since its
organization in 1998. Mr. Smith resigned as Vice Chairman and director of
Trans-Elect, Inc. upon becoming Vice Chairman, General Counsel, and a director
of CMS. Mr. Smith owns 20,000 shares of Convertible Preferred A Stock of
Trans-Elect, Inc., or approximately 10% of the outstanding voting securities of
Trans-Elect, Inc. Mr. Smith also has an option to acquire an additional 250
shares of this security.
The Consumers electric transmission system was sold in a competitive
bidding process to Trans-Elect, Inc's subsidiary for approximately $290 million
in cash. Consumers did not provide any financial or credit support for the sale
to Trans-Elect, Inc. As a result of the sale, Consumers experienced an after-tax
earnings increase of approximately $17 million in 2002 due to the recognition of
a $26 million gain on the sale. For the period from May 1, 2002 to December 31,
2002, Consumers paid a total of $56 million to Trans-Elect, Inc's subsidiary for
electric transmission services.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
DESCRIPTION OF CERTAIN FEDERAL INCOME TAX CONSEQUENCES OF THE EXCHANGE OF OLD
BONDS FOR NEW BONDS
The following summary describes the principal United States federal
income tax consequences to holders who exchange old bonds for new bonds pursuant
to the Exchange Offer. This summary is intended to address the beneficial owners
of old bonds that are citizens or residents of the United States, corporations,
partnerships or other entities created or organized in or under the laws of the
United States or any State or the District of Columbia, or estates or trusts
that are not foreign estates or trusts for United States federal income tax
purposes, in each case, that hold the old bonds as capital assets.
The exchange of old bonds for new bonds pursuant to the Exchange Offer
will not constitute a taxable exchange for United States federal income tax
purposes. As a result, a holder of an old bond whose old bond is accepted in the
Exchange Offer will not recognize gain or loss on the exchange. A tendering
holder's tax basis in the new bonds received pursuant to the Exchange Offer will
be the same as such holder's tax basis in the old bonds surrendered therefor. A
tendering holder's holding period for the new bonds received pursuant to the
Exchange Offer-will include its holding period for the old bonds surrendered
therefor.
ALL HOLDERS OF OLD BONDS ARE ADVISED TO CONSULT THEIR OWN TAX ADVISORS
REGARDING THE UNITED STATES FEDERAL, STATE AND LOCAL TAX CONSEQUENCES OF THE
EXCHANGE OF OLD BONDS FOR NEW BONDS, AND OF THE OWNERSHIP AND DISPOSITION OF NEW
BONDS RECEIVED IN THE EXCHANGE OFFER IN LIGHT OF THEIR OWN PARTICULAR
CIRCUMSTANCES.
125
DESCRIPTION OF CERTAIN FEDERAL INCOME TAX CONSEQUENCES OF AN INVESTMENT IN THE
NEW BONDS
The following is a summary of the material United States federal income
tax consequences of the acquisition, ownership and disposition of the old bonds
or the new bonds by a United States Holder (as defined below). This summary
deals only with the United States Holders that will hold the old bonds or the
new bonds as capital assets. The discussion does not cover-all aspects of
federal taxation that may be relevant to, or the actual tax effect that any of
the matters described herein will have on, the acquisition, ownership or
disposition of the old bonds or the new bonds by particular investors, and does
not address state, local, foreign or other tax laws. In particular, this summary
does not discuss all of the tax considerations that may be relevant to certain
types of investors subject to special treatment under the federal income tax
laws (such as banks, insurance companies, investors liable for the alternative
minimum tax, individual retirement accounts and other tax-deferred accounts,
tax-exempt organizations, dealers in securities or currencies, investors that
will hold the old bonds or the new bonds as part of straddles, hedging
transactions or conversion transactions for federal tax purposes or investors
whose functional currency is not United States Dollars). Furthermore, the
discussion below is based on provisions of the Internal Revenue Code of 1986, as
amended (the "CODE"), and regulations, rulings, and judicial decisions
thereunder as of the date hereof, and such authorities may be repealed, revoked
or modified so as to result in U.S. federal income tax consequences different
from those discussed below.
PERSONS CONSIDERING THE PURCHASE, OWNERSHIP, OR DISPOSITION OF NEW
BONDS SHOULD CONSULT THEIR OWN TAX ADVISORS CONCERNING THE U.S. FEDERAL INCOME
TAX CONSEQUENCES IN LIGHT OF THEIR PARTICULAR SITUATIONS AS WELL AS ANY
CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE, LOCAL OR INTERNATIONAL TAXING
JURISDICTION.
As used herein, the term "UNITED STATES HOLDER" means a beneficial
owner of the old bonds or the new bonds that is (i) a citizen or resident of the
United States for United States federal income tax purposes, (ii) a corporation
created or organized under the laws of the United States or any State thereof,
(iii) a person or entity that is otherwise subject to United States federal
income tax on a net income basis in respect of income derived from the old bonds
or the new bonds, or (iv) a partnership to the extent the interest therein is
owned by a person who is described in clause (i), (ii) or (iii) of this
paragraph.
INTEREST
Interest paid on an old bond or a new bond will be taxable to a United
States Holder as ordinary income at the time it is received or accrued,
depending on the holder's method of accounting for tax purposes.
PURCHASE, SALE, EXCHANGE, RETIREMENT AND REDEMPTION OF THE NEW BONDS
In general (with certain exceptions described below) a United States
Holder's tax basis in a new bond will equal the price paid for the old bonds for
which such new bond was exchanged pursuant to the Exchange Offer. A United
States Holder generally will recognize gain or loss on the sale, exchange,
retirement, redemption or other disposition of an old bond or a new bond (or
portion thereof) equal to the difference between the amount realized on such
disposition and the United States Holder's tax basis in the old bond or the new
bond (or portion thereof). Except to the extent attributable to accrued but
unpaid interest, gain or loss recognized on such disposition of an old bond or a
new bond will be capital gain or loss. Such capital gain or loss will generally
126
be long-term capital gain or loss if the United States Holder held such bond
(including in the holding period of the new bond, the period during which the
United Stated Holder held the old bonds surrendered for it) for more than one
year immediately prior to such disposition. Long-term capital gains of
individuals are eligible for preferential rates of taxation, which have been
reduced for long-term capital gains recognized on or after May 6, 2003 and
before January 1, 2009. The deductibility of capital losses is subject to
limitations.
BOND PREMIUM
If a United States Holder acquires a new bond or has acquired an old
bond, in each case, for an amount more than its redemption price, the Unites
States Holder may elect to amortize such bond premium on a yield to maturity
basis. Once made, such an election applies to all bonds (other than bonds the
interest on which is excludable from gross income) held by the United States
Holder at the beginning of the first taxable year to which the election applies
or thereafter acquired by the United States Holder, unless the IRS consents to a
revocation of the election. The basis of a new bond will be reduced by any
amortizable bond premium taken as a deduction.
MARKET DISCOUNT
The purchase of a new bond or the purchase of an old bond other than at
original issue may be affected by the market discount provisions of the Code.
These rules generally provide that, if a United States Holder purchases a new
bond (or purchased an old bond) at a "market discount," as defined below, and
thereafter recognizes gain upon a disposition of the new bond (including
dispositions by gift or redemption), the lesser of such gain (or appreciation,
in the case of a gift) or the portion of the market discount that has accrued
("ACCRUED MARKET DISCOUNT") while the new bond (and its predecessor old bond, if
any) was held by such United States Holder will be treated as ordinary interest
income at the time of disposition rather than as capital gain. For a new bond or
an old bond, "MARKET DISCOUNT" is the excess of the stated redemption price at
maturity over the tax basis immediately after its acquisition by a United States
Holder. Market discount generally will accrue ratably during the period from the
date of acquisition to the maturity date of the new bond, unless the United
States Holder elects to accrue such discount on the basis of the constant yield
method. Such an election applies only to the new bond with respect to which it
is made and is irrevocable.
In lieu of including the accrued market discount income at the time of
disposition, a United States Holder of a new bond acquired at a market discount
(or acquired in exchange for an old bond acquired at a market discount) may
elect to include the accrued market discount in income currently either ratably
or using the constant yield method. Once made, such an election applies to all
other obligations that the United States Holder purchases at a market discount
during the taxable year for which the election is made and in all subsequent
taxable years of the United States Holder, unless the Internal Revenue Service
consents to a revocation of the election. If an election is made to include
accrued market discount in income currently, the basis of a new bond (or, where
applicable, a predecessor old bond) in the hands of the United States Holder
will be increased by the accrued market discount thereon as it is includible in
income. A United States Holder of a market discount new bond who does not elect
to include market discount in income currently generally will be required to
defer deductions for interest on borrowings allocable to such new bond, if any,
in an amount not exceeding the accrued market discount on such new bond until
the maturity or disposition of such new bond.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Payments of interest and principal on, and the proceeds of sale or
other disposition of the old
127
bonds or the new bonds payable to a United States Holder, may be subject to
information reporting requirements and backup withholding at the applicable
statutory rate will apply to such payments if the United States Holder fails to
provide an accurate taxpayer identification number or to report all interest and
dividends required to be shown on its federal income tax returns. Certain United
States Holders (including, among others, corporations) are not subject to backup
withholding. United States Holders should consult their tax advisors as to their
qualification for exemption from backup withholding and the procedure for
obtaining such an exemption.
PLAN OF DISTRIBUTION
Each broker-dealer that receives new bonds for its own account pursuant
the Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such new bonds. This prospectus, as it may be
amended or supplemented from time to time, may be used by a broker-dealer in
connections with resales of the new bonds received in exchange for the old bonds
where such old bonds were acquired as a result of market-making activities or
other trading activities. Consumers has agreed that, starting on the Expiration
Date and ending on the close of business on the first anniversary of the
Expiration Date, it will make this prospectus, as amended or supplemented,
available to any broker-dealer for use in connection with any such resale.
Consumers will not receive any proceeds from any sale of the new bonds
by broker-dealers. The new bonds received by broker-dealers for their own
account pursuant to the Exchange Offer may be sold from time to time in one or
more transactions in the over-the counter market, in negotiated transactions,
through the writing of options on the new bonds or a combination of such methods
of resale, at market prices or negotiated prices. Any such resale may be made
directly to purchasers or to or through brokers or dealers who may receive
compensation in the form of commissions or concessions from any such
broker-dealer and/or the purchasers of any such new bonds. Any broker-dealer
that resells new bonds that were received by it for its own account pursuant to
the Exchange Offer and any broker or dealer that participates in a distribution
of such new bonds may be deemed to be an "UNDERWRITER" within the meaning of the
Securities Act and any profit of any such resale of new bonds and any
commissions or concessions received by any such persons may be deemed to be
underwriting compensation under the Securities Act. The Letter of Transmittal
states that by acknowledging that it will deliver and by delivering a
prospectus, a broker-dealer will not be deemed to admit that it is an
"UNDERWRITER" within the meaning of the Securities Act.
For a period of one year after the Expiration Date, Consumers will
promptly send additional copies of this prospectus and any amendment or
supplement to this prospectus to any broker-dealer that requests such documents
in the Letter of Transmittal. Consumers has agreed to pay all expenses incident
to the Exchange Offer and will indemnify the holders of the new bonds against
certain liabilities, including liabilities under the Securities Act.
LEGAL OPINION
Robert C. Shrosbree, Assistant General Counsel for CMS Energy
Corporation, will render opinions as to the legality of the new bonds for
Consumers.
EXPERTS
The consolidated financial statements and schedule of Consumers at
December 31, 2002 and 2001, and for each of the three years in the period ended
December 31, 2002, appearing in this prospectus and registration statement have
been audited by Ernst & Young LLP, independent auditors, as set forth in their
report thereon appearing elsewhere herein which, are based in part
128
on the reports of PricewaterhouseCoopers LLP for 2002 and Arthur Andersen LLP
(who have ceased operations) for 2001 and 2000, independent auditors. The
consolidated financial statements and schedule referred to above are included in
reliance upon such reports given on the authority of such firms as experts in
accounting and auditing.
The audited consolidated financial statements of the MCV Partnership as
of and for the year ended December 31, 2002, not separately presented or
incorporated by reference in this prospectus, have been audited by
PricewaterhouseCoopers LLP, independent accountants, as stated in their report
appearing in Consumers' Annual Report on Form 10-K for the year ended December
31, 2002. Such financial statements to the extent they have been included in the
financial statements of Consumers, have been so included in reliance on the
report of such independent accountants given on the authority of said firm as
experts in auditing and accounting.
129
GLOSSARY
Certain terms used in the text of "Our Business," the 10-K MD&A and the
10-Q MD&A and the December 31, 2002 Financial Statements and the September 30,
2003 Financial Statements are defined below.
ABATE............................... Association of Business Advocating Tariff Equity
Accumulated Benefit Obligation...... The liabilities of a pension plan based on service and pay to date. This differs
from the Projected Benefit Obligation that is typically disclosed in that it does
not reflect expected future salary increases.
AEP................................. American Electric Power, a non-affiliated company
ALJ................................. Administrative Law Judge
Alliance RTO........................ Alliance Regional Transmission Organization
AMT................................. Alternative minimum tax
APB................................. Accounting Principles Board
APB Opinion No. 25.................. APB Opinion No. 25, "Accounting for Stock Issued to Employees"
APB Opinion No. 30.................. APB Opinion No. 30, "Reporting Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business"
ARO................................. Asset retirement obligation
Attorney General.................... Michigan Attorney General
bcf................................. Billion cubic feet
Big Rock............................ Big Rock Point nuclear power plant, owned by Consumers
Board of Directors.................. Board of Directors of CMS Energy
Btu................................. British thermal unit
CEO................................. Chief Executive Officer
CFO................................. Chief Financial Officer
Clean Air Act....................... Federal Clean Air Act, as amended
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 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
Common Stock........................ All classes of Common Stock of CMS Energy and each of its subsidiaries, or any of
them individually, at the time of an award or grant under the Performance
Incentive Stock Plan
Consumers........................... Consumers Energy Company, a subsidiary of CMS Energy
Consumers Campus Holdings........... Consumers Campus Holdings, L.L.C., a wholly owned subsidiary of Consumers
Consumers Funding................... Consumers Funding, L.L.C., a special consolidated subsidiary of Consumers
130
Consumers Receivables Funding....... Consumers Receivables Funding, L.L.C., a wholly owned subsidiary of Consumers
Consumers Receivables Funding II.... Consumers Receivables Funding II LLC, a wholly-owned subsidiary of Consumers
Customer Choice Act................. Customer Choice and Electricity Reliability Act, a Michigan statute enacted
in June 2000 that allows all retail customers choice of alternative electric
suppliers as of January 1, 2002, provides for full recovery of net stranded
costs and implementation costs, establishes a five percent reduction in
residential rates, establishes rate freeze and rate cap, and allows for
Securitization
Detroit Edison...................... The Detroit Edison Company, a non-affiliated company
DOE................................. U.S. Department of Energy
Dow................................. The Dow Chemical Company, a non-affiliated company
DSM................................. Demand-side management
EISP................................ Executive Incentive Separation Plan
EITF................................ Emerging Issues Task Force
EITF No. 97-4....................... EITF 97-4, "Deregulation of the Pricing of Electricity"
Enterprises......................... CMS Enterprises Company, a subsidiary of CMS Energy
EPA................................. U. S. Environmental Protection Agency
ERISA............................... Employee Retirement Income Security Act
Exchange Act........................ Securities Exchange Act of 1934, as amended
FASB................................ Financial Accounting Standards Board
FERC................................ Federal Energy Regulatory Commission
FMB................................. First Mortgage Bonds
FMLP................................ First Midland Limited Partnership, a partnership that holds a lessor interest
in the MCV facility
GCR................................. Gas cost recovery
IPP................................. Independent Power Production
ITC................................. Investment tax credit
kWh................................. Kilowatt-hour
LIBOR............................... London Inter-Bank Offered Rate
Ludington........................... Ludington pumped storage plant, jointly owned by Consumers and Detroit Edison
Massachusetts Formula............... A widely used and FERC accepted method of allocating general and administrative
expenses, based on three factors: property, sales and payroll.
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
131
METC................................ Michigan Electric Transmission Company, formerly a subsidiary of Consumers
Energy and now an indirect subsidiary of Trans-Elect
Michigan Gas Storage Company........ Michigan Gas Storage Company, a former subsidiary of Consumers that merged into
Consumers in November 2002
MISO................................ Midwest Independent System Operator
MPSC................................ Michigan Public Service Commission
MSBT................................ Michigan Single Business Tax
MTH................................. Michigan Transco Holdings, Limited Partnership
MW.................................. Megawatts
NEIL................................ Nuclear Electric Insurance Limited, an industry mutual insurance company
owned by member utility companies
NMC................................. Nuclear Management Company, LLC, formed in 1999 by Northern States Power
Company (now Xcel Energy Inc.), Alliant Energy, Wisconsin Electric Power
Company, and Wisconsin Public Service Company to operate and manage nuclear
generating facilities owned by the four utilities
NRC................................. Nuclear Regulatory Commission
NYMEX............................... New York Mercantile Exchange
OATT................................ Open Access Transmission Tariff
OPEB................................ Postretirement benefit plans other than pensions for retired employees
Palisades........................... Palisades nuclear power plant, which is owned by Consumers
Panhandle........................... Panhandle Eastern Pipe Line Company, including its subsidiaries Trunkline,
Pan Gas Storage, Panhandle Storage, and Panhandle Holdings. Panhandle was a
wholly owned subsidiary of CMS Gas Transmission. The sale of this subsidiary
closed in June 2003.
Panhandle Eastern Pipe Line......... PanhandleEastern Pipe Line Company, formerly a wholly owned subsidiary of CMS Gas
Transmission. The sale of this subsidiary closed in June 2003.
PCB................................. Polychlorinated biphenyl
Pension Plan........................ The trusteed, non-contributory, defined benefit pension plan of Panhandle,
Consumers and CMS Energy
PJM................................. PJM Interconnection, a non-affiliated company.
PPA................................. The Power Purchase Agreement between Consumers and the MCV Partnership with a
35-year term commencing in March 1990
Price Anderson Act.................. Price Anderson Act, enacted in 1957 as an amendment to the Atomic Energy Act of
1954, as revised and extended over the years. This act stipulates between nuclear
licensees and the U.S. government the insurance, financial responsibility, and
legal liability for nuclear accidents.
PSCR................................ Power supply cost recovery
Public Act 141...................... Public Act 141, Customer Choice and Electricity Reliability Act
132
Public Act 142...................... Public Act 142, Securitization Act
PURPA............................... Public Utility Regulatory Policies Act of 1978
RTO................................. Regional Transmission Organization
SEC................................. U.S. Securities and Exchange Commission
Securitization...................... A financing method authorized by statute and approved by the MPSC which
allows a utility to set aside and pledge a portion of the rate payments
received by its customers for the repayment of Securitization bonds issued by
a special purpose entity affiliated with such utility
SERP................................ Supplemental Executive Retirement Plan
SFAS................................ Statement of Financial Accounting Standards
SFAS No. 5.......................... SFAS No. 5, "Accounting for Contingencies"
SFAS No. 13......................... SFAS No. 13, "Accounting for Leases"
SFAS No. 71......................... SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation"
SFAS No. 87......................... SFAS No. 87, "Employers' Accounting for Pensions"
SFAS No. 106........................ SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions"
SFAS No. 109 ......................SFAS No. 109, " Accounting for Income Taxes"
SFAS No. 115........................ SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
SFAS No. 123........................ SFAS No. 123, "Accounting for Stock-Based Compensation"
SFAS No. 133........................ SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities, as
amended and interpreted"
SFAS No. 142........................ SFAS No. 142, "Goodwill and Other Intangible Assets"
SFAS No. 143........................ SFAS No. 143, "Accounting for Asset Retirement Obligations"
SFAS No. 144........................ SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
SFAS No. 145........................ SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections"
SFAS No. 146........................ SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
SFAS No. 148........................ SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure"
SFAS No. 149........................ SFAS No. 149, "Amendment of Statement No. 133 on Derivative Instruments and
Hedging Activities"
SFAS No. 150........................ SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of Both Liabilities and Equity"
Special Committee................... A special committee of independent directors, established by CMS Energy's Board of
Directors, to investigate matters surrounding round-trip trading
Stranded Costs...................... Costs incurred by utilities in order to serve their customers in a regulated
monopoly environment, which may not be recoverable in a competitive environment
because of customers leaving their systems and ceasing to
133
pay for their costs. These costs could include owned and purchased generation
and regulatory assets.
Superfund........................... Comprehensive Environmental Response, Compensation and Liability Act
Trunkline........................... Trunkline Gas Company, LLC, formerly a subsidiary of CMS Panhandle Holdings, LLC
Trust Preferred Securities.......... Securities representing an undivided beneficial interest in the assets of
statutory business trusts, the interests of which have a preference with
respect to certain trust distributions over the interests of either CMS
Energy or Consumers, as applicable, as owner of the common beneficial
interests of the trusts
Union............................... Utility Workers of America, AFL-CIO
VEBA Trusts......................... VEBA (voluntary employees' beneficiary association) Trusts are tax-exempt accounts
established to specifically set aside employer contributed assets to pay for
future expenses of the OPEB plan
134
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 UNAUDITED FINANCIAL STATEMENTS
Consolidated Statements of Income................................................ F-2
Consolidated Statements of Cash Flows............................................ F-3
Consolidated Balance Sheets...................................................... F-4
Consolidated Statements of Common Stockholder's Equity........................... F-5
Condensed Notes to Consolidated Financial Statements ............................ F-8
DECEMBER 31, 2002 FINANCIAL STATEMENTS
Consolidated Statements of Income............................................... F-39
Consolidated Statements of Cash Flows........................................... F-40
Consolidated Balance Sheets..................................................... F-41
Consolidated Statements of Long-Term Debt....................................... F-43
Consolidated Statements of Preferred Stock...................................... F-44
Consolidated Statements of Common Stockholder's Equity.......................... F-45
Notes to Consolidated Financial Statements...................................... F-47
Reports of Independent Auditors................................................. F-89
Quarterly Financial Information................................................. F-92
F-1
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 2003 2002 2003 2002
-----------------------------------------------------------------------------------------------------------------
In Millions
OPERATING REVENUE $879 $911 $3,223 $3,020
EARNINGS (LOSS) FROM EQUITY METHOD INVESTEES (3) 8 31 35
OPERATING EXPENSES
Operation
Fuel for electric generation 89 98 245 236
Purchased power - related parties 131 143 383 416
Purchased and interchange power 103 111 260 244
Cost of gas sold 90 20 793 528
Cost of gas sold - related parties 2 34 27 96
Other 178 182 505 487
------------------------------------------
593 588 2,213 2,007
------------------------------------------
Maintenance 41 43 149 141
Depreciation, depletion and amortization 80 77 275 256
General taxes 47 43 130 144
------------------------------------------
761 751 2,767 2,548
----------------------------------------------------------------------------------------------------------------
OPERATING INCOME 115 168 487 507
OTHER INCOME (DEDUCTIONS)
Dividends and interest from affiliates - - - 2
Accretion expense (1) (1) (5) (4)
Other, net 2 1 (3) 37
------------------------------------------
1 - (8) 35
----------------------------------------------------------------------------------------------------------------
INTEREST CHARGES
Interest on long-term debt 51 41 144 111
Other interest 2 5 10 16
Capitalized interest (2) (3) (7) (8)
------------------------------------------
51 43 147 119
----------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 65 125 332 423
INCOME TAXES 21 41 126 140
------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 44 84 206 283
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR DERIVATIVE
INSTRUMENTS, NET OF $1 AND $10 TAX EXPENSE IN 2002, RESPECTIVELY - 1 - 18
------------------------------------------
NET INCOME 44 85 206 301
PREFERRED STOCK DIVIDENDS - - 1 1
PREFERRED SECURITIES DISTRIBUTIONS 11 11 33 33
------------------------------------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 33 $ 74 $ 172 $ 267
================================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-2
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30 2003 2002
----------------------------------------------------------------------------------------------------------------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 206 $ 301
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation, depletion and amortization (includes nuclear decommissioning
of $4 and $5, respectively) 275 256
Gain on sale of METC and other assets - (38)
Deferred income taxes and investment tax credit 72 (18)
Loss on CMS Energy stock 12 -
Capital lease and other amortization 20 11
Distributions from related parties in excess of (less than) earnings 14 (20)
Cumulative effect of accounting changes - (18)
Pension contribution (172) (47)
Changes in other assets and liabilities:
Increase in inventories (335) (37)
Decrease in accounts receivable and accrued revenue 156 98
Decrease in accounts payable (39) (79)
Changes in other assets and liabilities (79) 11
----------------------
Net cash provided by operating activities 130 420
-------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (306) (400)
Cost to retire property, net (52) (50)
Investment in Electric Restructuring Implementation Plan (5) (6)
Investments in nuclear decommissioning trust funds (4) (5)
Proceeds from nuclear decommissioning trust funds 26 19
Proceeds from sale of METC and other assets 15 298
----------------------
Net cash used in investing activities (326) (144)
-------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from senior notes and bank loans, net 1,543 602
Retirement of bonds and other long-term debt (780) (409)
Decrease in notes payable, net (453) (182)
Payment of common stock dividends (162) (154)
Preferred securities distribution (33) (33)
Payment of capital lease obligations (10) (11)
Payment of preferred stock dividends (1) (1)
Restricted cash on hand (1) (14)
Redemption of preferred securities - (30)
Stockholder's contribution, net - 50
----------------------
Net cash provided by (used in) financing activities 103 (182)
-------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS (93) 94
CASH AND TEMPORARY CASH INVESTMENTS, BEGINNING OF PERIOD 253 13
----------------------
CASH AND TEMPORARY CASH INVESTMENTS, END OF PERIOD $ 160 $ 107
=============================================================================================================
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 156 $ 116
Income taxes paid (net of refunds) 32 83
Pension and OPEB cash contribution 226 101
NON-CASH TRANSACTIONS
Other assets placed under capital leases $ 11 $ 50
=============================================================================================================
F-3
CONSUMERS ENERGY COMPANY
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 SEPTEMBER 30
2003 DECEMBER 31 2002
ASSETS (UNAUDITED) 2002 (UNAUDITED)
-------------------------------------------------------------------------------------------------------------------------
In Millions
PLANT (AT ORIGINAL COST)
Electric $ 7,583 $ 7,523 $ 7,504
Gas 2,841 2,719 2,692
Other 15 23 22
-------------------------------------------
10,439 10,265 10,218
Less accumulated depreciation, depletion and amortization 5,365 5,900 5,856
-------------------------------------------
5,074 4,365 4,362
Construction work-in-progress 359 548 463
-------------------------------------------
5,433 4,913 4,825
-----------------------------------------------------------------------------------------------------------------------
INVESTMENTS
Stock of affiliates 17 22 19
First Midland Limited Partnership 222 255 250
Midland Cogeneration Venture Limited Partnership 404 388 370
Consumers Nuclear Services, LLC 2 2 2
-------------------------------------------
645 667 641
-----------------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 160 253 107
Restricted cash 19 18 18
Accounts receivable, notes receivable and accrued revenue,
less allowances of $7, $4 and $4 respectively 81 236 36
Accounts receivable - related parties 7 13 18
Inventories at average cost
Gas in underground storage 813 486 601
Materials and supplies 72 71 71
Generating plant fuel stock 44 37 49
Deferred property taxes 88 142 82
Regulatory assets 19 19 19
Other 94 38 27
-------------------------------------------
1,397 1,313 1,028
-----------------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS
Regulatory Assets
Securitized costs 659 689 699
Postretirement benefits 168 185 191
Abandoned Midland Project 10 11 11
Other 257 168 173
Nuclear decommissioning trust funds 553 536 530
Other 147 218 108
-------------------------------------------
1,794 1,807 1,712
-------------------------------------------
TOTAL ASSETS $ 9,269 $ 8,700 $ 8,206
=======================================================================================================================
F-4
STOCKHOLDER'S EQUITY AND LIABILITIES
SEPTEMBER 30 SEPTEMBER 30
2003 DECEMBER 31 2002
(UNAUDITED) 2002 (UNAUDITED)
-------------------------------------------------------------------------------------------------------------------------
In Millions
CAPITALIZATION
Common stockholder's equity
Common stock $ 841 $ 841 $ 841
Paid-in capital 682 682 682
Accumulated other comprehensive loss (191) (179) (8)
Retained earnings since December 31, 1992 555 545 525
-------------------------------------------
1,887 1,889 2,040
Preferred stock 44 44 44
Company-obligated mandatorily redeemable preferred securities
of subsidiaries 490 490 490
Long-term debt 3,531 2,442 2,701
Non-current portion of capital leases 116 116 110
-------------------------------------------
6,068 4,981 5,385
-----------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES
Current portion of long-term debt and capital leases 39 318 224
Notes payable 4 457 235
Accounts payable 241 261 212
Accrued taxes 84 214 152
Accounts payable - related parties 65 84 85
Deferred income taxes 23 25 18
Current portion of purchase power contract 26 26 29
Other 168 200 226
-------------------------------------------
650 1,585 1,181
-----------------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES
Deferred income taxes 1,009 949 762
Postretirement benefits 431 563 244
Regulatory liabilities for income taxes, net 309 297 282
Asset retirement obligations 362 - -
Other regulatory liabilities 152 4 -
Deferred investment tax credit 86 91 92
Power purchase agreement - MCV Partnerhsip 8 27 30
Other 194 203 230
-------------------------------------------
2,551 2,134 1,640
-----------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 2)
TOTAL STOCKHOLDER'S EQUITY AND LIABILITIES $ 9,269 $ 8,700 $ 8,206
=======================================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-5
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------------------------
In Millions
COMMON STOCK
At beginning and end of period (a) $ 841 $ 841 $ 841 $ 841
------------------------------------------------------------------------------------------------------------------------
OTHER PAID-IN CAPITAL
At beginning of period 682 682 682 632
Stockholders' contribution - - - 150
Return of Stockholders' contribution - - - (100)
--------------------------------------------
At end of period 682 682 682 682
------------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Minimum Pension Liability
At beginning of period (202) - (185) -
Minimum liability pension adjust (b) - - (17) -
--------------------------------------------
At end of period (202) - (202) -
--------------------------------------------
Investments
At beginning of period 8 (5) 1 16
Unrealized gain (loss) on investments (c) (2) (4) 5 (25)
--------------------------------------------
At end of period 6 (9) 6 (9)
--------------------------------------------
Derivative Instruments
At beginning of period (d) 11 (3) 5 (12)
Unrealized gain on derivative instruments (c) (4) 1 9 6
Reclassification adjustments included in consolidated
net income (loss) (c) (2) 3 (9) 7
--------------------------------------------
At end of period 5 1 5 1
------------------------------------------------------------------------------------------------------------------------
Total Accumulated Other Comprehensive Income (Loss) (191) (8) (191) (8)
------------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS
At beginning of period 522 480 545 441
Net income 44 85 206 301
Cash dividends declared - Common Stock - (29) (162) (183)
Cash dividends declared - Preferred Stock - - (1) (1)
Preferred securities distributions (11) (11) (33) (33)
--------------------------------------------
At end of period 555 525 555 525
------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKHOLDER'S EQUITY $ 1,887 $2,040 $1,887 $2,040
========================================================================================================================
F-6
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------------------------------
(a) Number of shares of common stock outstanding was 84,108,789 for all periods
presented.
(b) Because of the significant change in the makeup of the pension plan due to
the sale of Panhandle, SFAS No. 87 required a remeasurement of the obligation at
the date of sale. The remeasurement resulted in an additional charge to
Accumulated Other Comprehensive Income (Loss) of approximately $27 million ($17
million after tax) as a result of the increase in the additional minimum pension
liability.
(c) Disclosue of Comprehensive Income:
Minimum pension liability adjustment (b) $ - $ - $ (17) $ -
Investments
Unrealized gain (loss) on investments, net of tax of
$-, $3, $(3) and $14, respectively (2) (4) 5 (25)
Derivative Instruments
Unrealized gain (loss) on derivative instruments, net of tax of
$2, $(1), $(4) and $(4), respectively (4) 1 9 6
Reclassification adjustments included in net income, net of tax of
$1, $(2), $5 and $(4), respectively (2) 3 (9) 7
Net income 44 85 206 301
-----------------------------------------
Total Comprehensive Income $ 36 $ 85 $ 194 $289
=========================================
(d) Included in these amounts is Consumers' proportionate share of the effects
of derivative accounting related to its equity investment in the MCV Partnership
as follows:
At the beginning of the period $ 13 $ 1 $ 8 (8)
Unrealized gain (loss) on derivative instruments (5) 1 8 7
Reclassification adjustments included in net income (2) 2 (10) 5
-----------------------------------------
At the end of the period $ 6 $ 4 $ 6 $ 4
=========================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-7
CONSUMERS ENERGY COMPANY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
These interim Consolidated Financial Statements have been prepared by
Consumers in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. As such, certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted. Certain prior year amounts have been
reclassified to conform to the presentation in the current year. In management's
opinion, the unaudited information contained in this report reflects all
adjustments of a normal recurring nature necessary to assure the fair
presentation of financial position, results of operations and cash flows for the
periods presented. The Condensed Notes to Consolidated Financial Statements and
the related Consolidated Financial Statements should be read in conjunction with
the Consolidated Financial Statements and Notes to Consolidated Financial
Statements contained in the Consumers' Form 10-K for the year ended December 31,
2002, which includes the Reports of Independent Auditors. Due to the seasonal
nature of Consumers' operations, the results as presented for this interim
period are not necessarily indicative of results to be achieved for the fiscal
year.
1: CORPORATE STRUCTURE AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CORPORATE STRUCTURE: Consumers, a subsidiary of CMS Energy, a holding
company, is an electric and gas utility company that provides service to
customers in Michigan's Lower Peninsula. Consumers' customer base includes a mix
of residential, commercial and diversified industrial customers, the largest
segment of which is the automotive industry.
COLLECTIVE BARGAINING AGREEMENT: As of December 31, 2002, 44 percent of
Consumers' workforce was represented by the Utility Workers Union of America.
Consumers and the Union negotiated a collective bargaining agreement that became
effective as of June 1, 2000, and will continue in full force and effect until
June 1, 2005. On March 26, 2003, Consumers reached a tentative agreement with
the Union for a collective bargaining agreement for its Call Center employees.
The agreement was subsequently ratified by the membership and became effective
April 1, 2003, and covers approximately 300 employees. The agreement will
continue in full force and effect until August 1, 2005.
BASIS OF PRESENTATION: The consolidated financial statements include
Consumers and its wholly owned subsidiaries. Consumers uses the equity method of
accounting for investments in companies and partnerships where it has more than
a twenty percent but less than a majority ownership interest and includes these
results in operating income. Consumers prepared the financial statements in
conformity with accounting principles generally accepted in the United States
that include the use of management's estimates.
USE OF ESTIMATES: The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
F-8
The principles in SFAS No. 5 guide the recording of estimated
liabilities for contingencies within the financial statements. SFAS No. 5
requires a company to record estimated liabilities in the financial statements
when it is probable that a loss will be paid in the future as a result of a
current event, and when an amount can be reasonably estimated. Consumers has
used this accounting principle to record estimated liabilities as discussed in
Note 2, Uncertainties.
REPORTABLE SEGMENTS: Consumers has two reportable segments: electric
and gas. The electric segment consists of activities associated with the
generation and distribution of electricity. The gas segment consists of
activities associated with the transportation, storage and distribution of
natural gas. Consumers' reportable segments are domestic business units
organized and managed by the nature of the product and service each provides.
The accounting policies of the segments are the same as those described in
Consumers' 2002 Form 10-K. Consumers' management has changed its evaluation of
the performance of the electric and gas segments from operating income to net
income available to common stockholder. Intersegment sales and transfers are
accounted for at current market prices and are eliminated in consolidated net
income available to common stockholder by segment. The other business unit
includes Consumers' consolidated statutory business trusts, which were created
to issue preferred securities and Consumers' consolidated special purpose entity
for the sale of trade receivables. The operating revenue and net income (loss)
available to common stockholder by reportable segment are as follows:
In Millions
---------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
---------------------------------------------------------------------------------------------------------------------
Operating revenue
Electric $714 $775 $1,970 $2,015
Gas 164 135 1,252 1,002
Other 1 1 1 3
---------------------------------------------------------------------------------------------------------------------
Total Operating Revenue $879 $911 $3,223 $3,020
=====================================================================================================================
Net income available to common stockholder
Electric $ 59 $ 88 $ 145 $ 222
Gas (19) (18) 40 13
Other (7) 4 (13) 32
---------------------------------------------------------------------------------------------------------------------
Total Net Income $ 33 $ 74 $ 172 $ 267
=====================================================================================================================
FINANCIAL INSTRUMENTS: Consumers accounts for its investments in debt
and equity securities in accordance with SFAS No. 115. As such, debt and equity
securities can be classified into one of three categories: held-to-maturity,
trading, or available-for-sale securities. Consumers' investments in equity
securities, including its investment in CMS Energy Common Stock, are classified
as available-for-sale securities. They are reported at fair value, with any
unrealized gains or losses from changes in fair value reported in equity as part
of accumulated other comprehensive income and are excluded from earnings, unless
such changes in fair value are other than temporary. Unrealized gains or losses
from changes in the fair value of Consumers' nuclear decommissioning investments
are reported as regulatory liabilities. The fair value of these investments is
determined from quoted market prices. For further information regarding
financial instruments, see Note 4, Financial and Derivative Instruments -
Financial Instruments.
UTILITY REGULATION: Consumers accounts for the effects of regulation
based on the regulated utility accounting standard SFAS No. 71. As a result, the
actions of regulators affect when Consumers recognizes revenues, expenses,
assets and liabilities.
F-9
In 1999, Consumers received MPSC electric restructuring orders, which,
among other things, identified the terms and timing for implementing electric
restructuring in Michigan. Consistent with these orders and EITF No. 97-4,
Consumers discontinued the application of SFAS No. 71 for the energy supply
portion of its business because Consumers expected to implement retail open
access at competitive market based rates for its electric customers. However,
since 1999, there has been a significant legislative and regulatory change in
Michigan that has resulted in: 1) electric supply customers of utilities
remaining on cost-based rates and 2) utilities being given the ability to
recover Stranded Costs associated with electric restructuring, from customers
who choose an alternative electric supplier. During 2002, Consumers re-evaluated
the criteria used to determine if an entity or a segment of an entity meets the
requirements to apply regulated utility accounting, and determined that the
energy supply portion of its business could meet the criteria if certain
regulatory events occurred. In December 2002, Consumers received a MPSC Stranded
Cost order that allowed Consumers to re-apply regulatory accounting standard
SFAS No. 71 to the energy supply portion of its business. Re-application of SFAS
No. 71 had no effect on the prior discontinuation accounting, but allowed
Consumers to apply regulatory accounting treatment to the energy supply portion
of its business beginning in the fourth quarter of 2002, including regulatory
accounting treatment of costs required to be recognized in accordance with SFAS
No. 143. See Note 5, Implementation of New Accounting Standards, "SFAS No. 143,
Accounting for Asset Retirement Obligations."
SFAS No. 144 imposes strict criteria for retention of
regulatory-created assets by requiring that such assets be probable of future
recovery at each balance sheet date. Management believes these assets are
probable of future recovery.
RESTRICTED CASH: At September 30, 2003, Consumers' restricted cash on
hand totaled $19 million. Restricted cash primarily consists of cash dedicated
for repayment of securitization bonds. It is classified as a current asset as
the payments on the related securitization bonds occur within one year.
STOCK-BASED COMPENSATION: In December 2002, the FASB issued SFAS No.
148. This standard provides for alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In the fourth quarter of 2002, Consumers adopted the fair
value method of accounting for stock-based compensation under SFAS No. 123 as
amended by SFAS No. 148, applying the prospective method. If compensation cost
for stock option had been determined in accordance with SFAS No. 123 for the
three and nine month periods ended September 30, 2002, consolidated net income
as reported and pro forma would have been as follows:
In Millions
---------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30 2002
---------------------------------------------------------------------------------------------------------------------
Net income, as reported $85
Add: Stock-based employee compensation expense included in reported net income, net of taxes -
Deduct: Total stock-based compensation expense determined under fair value based method for all awards,
net of tax -
---
Pro forma net income $85
=====================================================================================================================
F-10
In Millions
----------------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30 2002
----------------------------------------------------------------------------------------------------------------------
Net income, as reported $301
Add: Stock-based employee compensation expense included in reported net income, net of taxes -
Deduct: Total stock-based compensation expense determined under fair value based method for all awards,
net of tax (1)
----
Pro forma net income $300
=====================================================================================================================
In the third quarter of 2003, Consumers granted 500,000 stock options
to employees. As a result, Consumers expensed approximately $3 million related
to the fair value of those stock options. Fair value is estimated using the
Black Scholes model, a mathematical formula used to value options traded on the
securities exchange.
2: UNCERTAINTIES
Several business trends or uncertainties may affect Consumers'
financial results and condition. These trends or uncertainties have, or
Consumers reasonably expects could have, a material impact on net sales,
revenues, or income from continuing electric and gas operations. Such trends and
uncertainties are discussed in detail below and include: 1) pending litigation
and government investigations; 2) the need to make additional capital
expenditures and increase operating expenses for Clean Air Act compliance; 3)
environmental liabilities arising from various federal, state and local
environmental laws and regulations, including potential liability or expenses
relating to the Michigan Natural Resources and Environmental Protection Acts and
Superfund; 4) pending litigation regarding PURPA qualifying facilities; 5)
electric industry restructuring issues; 6) Consumers' ability to meet peak
electric demand requirements at a reasonable cost, without market disruption,
and successfully implement initiatives to reduce exposure to purchased power
price increases; 7) the recovery of electric restructuring implementation costs;
8) Consumers' status as an electric transmission customer and not as an electric
transmission owner/operator; 9) sufficient reserves for transmission rate
refunds; 10) uncertainties relating to the storage and ultimate disposal of
spent nuclear fuel; 11) the effects of derivative accounting and potential
earnings volatility; 12) potential environmental costs at a number of sites,
including sites formerly housing manufactured gas plant facilities; 13) future
gas industry restructuring initiatives; 14) an inadequate regulatory response to
applications for requested rate increases; 15) market and regulatory responses
to increases in gas costs, including a reduced average use per residential
customer; 16) increased costs for pipeline integrity and safety and homeland
security initiatives that are not recoverable on a timely basis from customers;
17) Consumers' ability to recover any of its net stranded costs under the
regulatory policies being followed by the MPSC; 18) the effects of lost electric
supply load from retail open access and the recovery of associated margin loss;
and 19) the uncertain effects, including exposure to liability, increased
regulatory requirement and new legislation, due to the future conclusions about
the causes of the August 14, 2003 blackout.
SEC AND OTHER INVESTIGATIONS: As a result of round-trip trading
transactions by CMS MST, CMS Energy's Board of Directors established a Special
Committee to investigate matters surrounding the transactions and retained
outside counsel to assist in the investigation. The Special Committee completed
its investigation and reported its findings to the Board of Directors in October
2002. The Special Committee concluded, based on an extensive investigation, that
the round-trip trades were undertaken to raise CMS MST's profile as an energy
marketer with the goal of enhancing its ability to promote its services to new
customers. The Special Committee found no effort to manipulate the price of CMS
Energy Common Stock or affect energy prices. The Special Committee also made
recommendations designed to prevent any reoccurrence of this practice.
Previously, CMS Energy terminated its speculative
F-11
trading business and revised its risk management policy. The Board of Directors
adopted, and CMS Energy has implemented the recommendations of the Special
Committee.
CMS Energy is cooperating with other investigations concerning
round-trip trading, including an investigation by the SEC regarding round-trip
trades and CMS Energy's financial statements, accounting policies and controls,
and investigations by the United States Department of Justice, the Commodity
Futures Trading Commission and the FERC. The FERC issued an order on April 30,
2003 directing eight companies, including CMS MST, to submit written
demonstrations within 45 days that they have taken certain specified remedial
measures with respect to the reporting of natural gas trading data to
publications that compile and publish price indices. CMS MST made a written
submission to the FERC on June 11, 2003 in compliance with the FERC's
directives. On July 29, 2003, the FERC issued an order stating that CMS MST met
the requirements of the FERC's April 30, 2003 order. Other than the FERC
investigation, CMS Energy is unable to predict the outcome of these matters, and
Consumers is unable to predict what effect, if any, these investigations will
have on its business.
SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number
of securities class action complaints were filed against CMS Energy, Consumers,
and certain officers and directors of CMS Energy and its affiliates. The
complaints were filed as purported class actions in the United States District
Court for the Eastern District of Michigan by shareholders who allege that they
purchased CMS Energy's securities during a purported class period. The cases
were consolidated into a single lawsuit and an amended and a consolidated class
action complaint was filed on May 1, 2003. The consolidated complaint contains a
purported class period beginning on May 1, 2000 and running through March 31,
2003. It generally seeks unspecified damages based on allegations that the
defendants violated United States securities laws and regulations by making
allegedly false and misleading statements about CMS Energy's business and
financial condition, particularly with respect to revenues and expenses recorded
in connection with round-trip trading by CMS MST. The companies intend to defend
vigorously against this action but cannot predict the outcome of this
litigation.
ERISA LAWSUITS: CMS Energy is a named defendant, along with Consumers,
CMS MST and certain named and unnamed officers and directors, in two lawsuits
brought as purported class actions on behalf of participants and beneficiaries
of the 401(k) Plan. The two cases, filed in July 2002 in the United States
District Court for the Eastern District of Michigan, were consolidated by the
trial judge, and an amended and consolidated complaint was filed. Plaintiffs
allege breaches of fiduciary duties under ERISA and seek restitution on behalf
of the plan with respect to a decline in value of the shares of CMS Energy
Common Stock held in the plan. Plaintiffs also seek other equitable relief and
legal fees. These cases will be defended vigorously. Consumers cannot predict
the outcome of this litigation.
ELECTRIC CONTINGENCIES
ELECTRIC ENVIRONMENTAL MATTERS: Consumers is subject to costly and
increasingly stringent environmental regulations. Consumers expects that the
cost of future environmental compliance, especially compliance with clean air
laws, will be significant.
Clean Air - In 1998, the EPA issued regulations requiring the state of
Michigan to further limit nitrogen oxide emissions. The Michigan Department of
Environmental Quality finalized rules to comply with the EPA regulations in
December 2002 and submitted these rules for approval to the EPA in the first
quarter of 2003. The EPA has issued additional regulations regarding nitrogen
oxide emissions that require certain generators, including some of Consumers'
electric generating facilities, to achieve the same emissions rate as that
required by the 1998 regulations. The EPA and the state regulations require
Consumers to make significant capital expenditures estimated to be $770 million.
As of September 30,
F-12
2003, Consumers has incurred $437 million in capital expenditures to comply with
the EPA regulations and anticipates that the remaining capital expenditures will
be incurred between 2003 and 2009. Based on the Customer Choice Act, beginning
January 2004, an annual return of and on these types of capital expenditures, to
the extent they are above depreciation levels, is expected to be recoverable
from customers, subject to an MPSC prudency hearing.
Consumers expects to supplement its environmental regulation compliance
plan with the purchase of nitrogen oxide emissions credits for years 2005
through 2008. The cost of these credits based on the current market is estimated
to average $6 million per year; however, the market for nitrogen oxide emissions
credits and their price could change substantially.
The EPA has proposed changes to the rules which govern generating plant
cooling water intake systems. The proposed rules will require significant
abatement of fish mortality. The proposed rules are scheduled to become final in
the first quarter of 2004 and some of Consumers' facilities would be required to
comply by 2006. Consumers is studying the proposed rules to determine the most
cost-effective solutions for compliance. Until the method of compliance is
determined, Consumers is unable to estimate the cost of compliance with the
proposed rules.
The EPA has alleged that some utilities have incorrectly classified
plant modifications as "routine maintenance" rather than seek permits from the
EPA. Consumers has received and responded to information requests from the EPA
on this subject. Consumers believes that it has properly interpreted the
requirements of "routine maintenance". If Consumers' interpretation is
eventually found to be incorrect, it may be required to install additional
pollution controls at some or all of its coal-fired plants and could call into
question the viability of certain plants remaining in operation.
Cleanup and Solid Waste - Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will ultimately incur
investigation and remedial action costs at a number of sites. Consumers believes
that these costs will be recoverable in rates under current ratemaking policies.
Consumers is a potentially responsible party at several contaminated
sites administered under Superfund. Superfund liability is joint and several.
Along with Consumers, many other creditworthy, potentially responsible parties
with substantial assets cooperate with respect to the individual sites. Based
upon past negotiations, Consumers estimates that its share of the total
liability for the known Superfund sites will be between $1 million and $9
million. As of September 30, 2003, Consumers had accrued the minimum amount of
the range for its estimated Superfund liability.
In October 1998, during routine maintenance activities, Consumers
identified PCB as a component in certain paint, grout and sealant materials at
the Ludington Pumped Storage facility. Consumers removed and replaced part of
the PCB material. Consumers has proposed a plan to deal with the remaining
materials and is awaiting a response from the EPA.
LITIGATION: In October 2003, a group of eight PURPA qualifying
facilities selling power to Consumers filed a lawsuit in Ingham County Circuit
Court against Consumers. The lawsuit alleges that Consumers incorrectly
calculated the energy charge payments made pursuant to power purchase agreements
between the qualifying facilities and Consumers. More specifically, the lawsuit
alleges that Consumers should be basing the energy charge calculation on the
cost of more expensive eastern coal, rather than on the cost of the coal
actually burned by Consumers for use in its coal-fired generating plants.
Consumers believes it has been performing the calculation in the manner
prescribed by the power purchase agreements, and has filed a request with the
MPSC (as a supplement to the PSCR plan) that asks the MPSC to review this issue
and to confirm that Consumers' method of performing the calculation is correct.
Also, Consumers has filed a motion to dismiss the lawsuit in the Ingham County
Circuit Court
F-13
due to the pending request at the MPSC in regard to the PSCR plan case. Although
only eight qualifying facilities have currently raised the issue, the same
energy charge methodology is used in the PPA with the MCV Partnership and in
approximately 20 additional power purchase agreements with Consumers,
representing approximately 1,670 MW of electric capacity. Consumers cannot
predict the outcome of this litigation.
ELECTRIC RATE MATTERS
ELECTRIC RESTRUCTURING: In June 2000, the Michigan legislature passed
electric utility restructuring legislation known as the Customer Choice Act.
This act: 1) permits all customers to choose their electric generation supplier
beginning January 1, 2002; 2) cut residential electric rates by five percent; 3)
freezes all electric rates through December 31, 2003, and establishes a rate cap
for residential customers through at least December 31, 2005, and a rate cap for
small commercial and industrial customers through at least December 31, 2004; 4)
allows for the use of Securitization bonds to refinance qualified costs, as
defined by the act; 5) establishes a market power supply test that if not met
may require transferring control of generation resources in excess of that
required to serve firm retail sales requirements (In September 2003, the MPSC
issued an order finding that Consumers is in compliance with the market power
test set forth in the Customer Choice Act.); 6) requires Michigan utilities to
join a FERC-approved RTO or divest their interest in transmission facilities to
an independent transmission owner (Consumers has sold its interest in its
transmission facilities to an independent transmission owner, see "Transmission"
below); 7) requires Consumers, Detroit Edison and American Electric Power to
jointly expand their available transmission capability by at least 2,000 MW. (In
July 2002, the MPSC issued an order approving the plan to achieve the increased
transmission capacity. The MPSC found that once the planned projects were
completed and verification was submitted, a utility was in technical compliance.
Consumers has completed the transmission capacity projects identified in the
plan and has submitted verification of this fact to the MPSC. Consumers believes
it is in full compliance.); 8) allows deferred recovery of an annual return of
and on capital expenditures in excess of depreciation levels incurred during and
before the rate freeze/cap period; and 9) allows recovery of "net" Stranded
Costs and implementation costs incurred as a result of the passage of the act.
Under Public Act 141, Consumers currently offers standby generation
services to certain retail open access customers. The obligation to offer this
service does not extend beyond the later of December 31, 2001 or the date the
MPSC finds that Consumers complies with the market power test set forth in the
Customer Choice Act and has completed the projects necessary to meet Consumers',
Detroit Edison's and American Electric Power's obligation to jointly expand
their available transmission capability by at least 2,000 MW. As stated above,
in September 2003, the MPSC issued an order finding that Consumers is in
compliance with the market power test and in December 2002, Consumers filed
verification with the MPSC indicating that Consumers met the transmission
capability expansion requirements. As a result, Consumers filed a notice with
the MPSC indicating that it was terminating retail open access standby service
on December 31, 2003. Also, as a result of Consumers meeting the transmission
capability expansion requirements and the market power test, Consumers has met
the requirements under Public Act 141 to return to the PSCR process. For further
discussion on the PSCR process see, "Power Supply Costs" in this Note.
The rate-freeze imposed by Public Act 141 ends at December 31, 2003.
After that date, the statute would allow customers to petition the MPSC for rate
reductions below the cap. Consumers would have the opportunity to respond to
such a petition before rates could be reduced.
In 1998, Consumers submitted a plan for electric retail open access to
the MPSC. In March 1999, the MPSC issued orders generally supporting the plan.
The Customer Choice Act states that the MPSC
F-14
orders issued before June 2000 are in compliance with this act and enforceable
by the MPSC. Those MPSC orders: 1) allow electric customers to choose their
supplier; 2) authorize recovery of "net" Stranded Costs and implementation
costs; and 3) confirm any voluntary commitments of electric utilities. In
September 2000, as required by the MPSC, Consumers once again filed tariffs
governing its retail open access program and made revisions to comply with the
Customer Choice Act. In December 2001, the MPSC approved revised retail open
access tariffs. The revised tariffs establish the rates, terms, and conditions
under which retail customers will be permitted to choose an alternative electric
supplier. The tariffs, effective January 1, 2002, did not require significant
modifications in the existing retail open access program. The tariff terms allow
retail open access customers, upon as little as 30 days notice to Consumers, to
return to Consumers' generation service at current tariff rates. If any class of
customers' (residential, commercial, or industrial) retail open access load
reaches 10 percent of Consumers' total load for that class of customers, then
returning retail open access customers for that class must give 60 days notice
to return to Consumers' generation service at current tariff rates. However,
Consumers may not have sufficient, reasonably priced, capacity to meet the
additional demand of returning retail open access customers, and may be forced
to purchase electricity on the spot market at higher prices than it could
recover from its customers. Consumers cannot predict the total amount of
electric supply load that may be lost to competitor suppliers (as noted below in
"Power Supply Costs" in this Note, 603 MW of load is currently being served by
competitor suppliers), nor whether the stranded cost recovery method adopted by
the MPSC will be applied in a manner that will fully offset any associated
margin loss.
SECURITIZATION: The Customer Choice Act allows for the use of
Securitization bonds to refinance certain qualified costs, as defined by the
act. Securitization typically involves issuing asset-backed bonds with a higher
credit rating than conventional utility corporate financing. In 2000 and 2001,
the MPSC issued orders authorizing Consumers to issue Securitization bonds.
Consumers issued its first Securitization bonds in late 2001. Securitization
resulted in lower interest costs and a longer amortization period for the
securitized assets, and offset the impact of the required residential rate
reduction. The Securitization orders directed Consumers to apply any cost
savings in excess of the five percent residential rate reduction to rate
reductions for non-residential customers and reductions in Stranded Costs for
retail open access customers after the bonds are sold.
Consumers and Consumers Funding will recover the repayment of
principal, interest and other expenses relating to the bond issuance through a
securitization charge and a tax charge that began in December 2001. These
charges are subject to an annual true up until one year prior to the last
expected bond maturity date, and no more than quarterly thereafter. The first
true up occurred in November 2002, and prospectively modified the total
securitization and related tax charges from 1.677 mills per kWh to 1.746 mills
per kWh. Current electric rate design covers these charges, and there will be no
rate impact for most Consumers electric customers until the Customer Choice Act
rate freeze and cap period expire and an electric rate case is processed.
Securitization charge collections, $37 million for the nine months ended
September 30 2003, and $39 million for the nine months ended September 30, 2002,
are remitted to a trustee for the Securitization bonds. Securitization charge
collections are dedicated to the repayment of the principal and interest on the
Securitization bonds and payment of the ongoing expenses of Consumers Funding
and can only be used for those purposes. Consumers Funding is legally separate
from Consumers. The assets and income of Consumers Funding, including without
limitation, the securitized property, are not available to creditors of
Consumers or CMS Energy.
In March 2003, Consumers filed an application with the MPSC seeking
approval to issue Securitization bonds in the amount of approximately $1.084
billion. The application sought recovery of costs associated with Clean Air Act
expenditures, Palisades expenditures previously not securitized, retail open
access implementation costs through December 31, 2003, certain pension fund
costs, and expenses associated with the issuance of the bonds. In June 2003, the
MPSC issued a financing order authorizing the issuance of Securitization bonds
in the amount of approximately $554 million. This amount relates to
F-15
Clean Air Act expenditures and associated return on those expenditures through
December 31, 2002, retail open access implementation costs and previously
authorized return on those expenditures through December 31, 2000, and the "up
front" other qualified costs related to issuance of the Securitization bonds.
The MPSC rejected Palisades expenditures previously not securitized as eligible
securitized costs. Therefore, Palisades expenditures previously not securitized
should be included as a component of "net" Stranded Costs and will be included
as a component of a future electric rate case proceeding with the MPSC.
In the June 2003 financing order, the MPSC also adopted a rate design
that would allow retail open access customers to pay a securitization charge
(and related tax charge) that are a small fraction of the amounts paid by full
service bundled sales customers and special contract customers of the utility.
The financing order provides that the securitization charges (and related tax
charges) for the full service and bundled sales customers are increased under
the rate design in the financing order in order to be sufficient to repay the
principal, interest and all other "ongoing" qualified costs related to servicing
the Securitization bonds. The financing order also restricts the amount of
common dividends payable by Consumers to its "earnings." In July 2003, Consumers
filed for rehearing and clarification on a number of features in the financing
order, including the rate design, accounting treatment of unsecuritized
qualified costs and dividend restriction. Also in July 2003, the Attorney
General filed a claim of appeal related to the financing order and the Attorney
General indicated it would challenge the lawfulness of the rate design. In
October 2003, the Court of Appeals dismissed the appeal and indicated that the
Attorney General could resubmit the appeal after the MPSC acted on Consumers'
rehearing request. Subsequently, the Attorney General filed a motion of
rehearing asking for reconsideration of the Court of Appeals' dismissal. The
financing order will become effective after rehearing, resolution of appeals and
upon acceptance by Consumers.
ELECTRIC PROCEEDINGS: Stranded Costs - The Customer Choice Act allows
electric utilities to recover the act's implementation costs and "net" Stranded
Costs (without defining the term). The act directs the MPSC to establish a
method of calculating "net" Stranded Costs and of conducting related true-up
adjustments. In December 2001, the MPSC adopted a methodology which calculated
"net" Stranded Costs as the shortfall between: (a) the revenue required to cover
the costs associated with fixed generation assets, generation-related regulatory
assets, and capacity payments associated with purchase power agreements, and (b)
the revenues received from customers under existing rates available to cover the
revenue requirement. The MPSC authorized Consumers to use deferred accounting to
recognize the future recovery of costs determined to be stranded. According to
the MPSC, "net" Stranded Costs are to be recovered from retail open access
customers through a Stranded Cost transition charge.
In April 2002, Consumers made "net" Stranded Cost filings with the MPSC
for $22 million for 2000 and $43 million for 2001. Consumers in its hearing
brief, filed in August 2002, revised its request for Stranded Costs to $7
million for 2000 and $4 million for 2001. The single largest reason for the
difference in the filing was the exclusion, as ordered by the MPSC, of all costs
associated with expenditures required by the Clean Air Act. As discussed above
in "Securitization", Consumers filed a request with the MPSC for authority to
issue Securitization bonds that would allow recovery of the Clean Air Act
expenditures that were excluded from the Stranded Cost calculation.
In December 2002, the MPSC issued an order finding that Consumers
experienced zero "net" Stranded Costs in 2000 and 2001, but declined to resolve
numerous issues regarding the "net" Stranded Cost methodology in a way that
would allow a reliable prediction of the level of Stranded Costs for 2002 and
future years. In January 2003, Consumers filed a petition for rehearing of the
December 2002 Stranded Cost order in which it asked the MPSC to grant a
rehearing and revise certain features of the order. Several other parties have
also filed rehearing petitions with the MPSC. Consumers has also
F-16
initiated an appeal at the Michigan Court of Appeals related to the MPSC's
December 2001 "net" Stranded Cost order.
In March 2003, Consumers filed an application with the MPSC seeking
approval of "net" Stranded Costs incurred in 2002, and for approval of a "net"
Stranded Cost recovery charge. In the application, Consumers indicated that if
Consumers' proposal to securitize Clean Air Act expenditures and Palisades
expenditures, previously not securitized, were approved as proposed in its
securitization case as discussed above in "Securitization", then Consumers'
"net" Stranded Costs incurred in 2002 would be approximately $35 million. If the
proposal to securitize those costs is not approved, then Consumers indicated
that the costs would be properly included in the 2002 "net" Stranded Cost
calculation, which would increase Consumers' 2002 "net" Stranded Costs to
approximately $103 million.
In June 2003, the MPSC issued a financing order in the securitization
case, authorizing the issuance of Securitization bonds in the amount of
approximately $554 million. Included in this amount were Clean Air Act
expenditures. However, the MPSC rejected Palisades expenditures previously not
securitized as eligible securitized costs. As a result, the Palisades
expenditures previously not securitized should be included as a component of
"net" Stranded Costs and will be included as a component of a future electric
rate case proceeding with the MPSC. With the inclusion of the Palisades
expenditures previously not securitized, Consumers' "net" Stranded Costs
incurred in 2002 are estimated to be approximately $50 million.
In July 2003, Consumers filed a petition for rehearing and
clarification on a number of features in the MPSC's financing order on
securitization. Once a final financing order by the MPSC on securitization is
issued, the amount of Consumers' request for "net" Stranded Cost recovery for
2002 will be known. Consumers cannot predict how the MPSC will rule on its
request for the recoverability of Stranded Costs, and therefore Consumers has
not recorded any regulatory assets to recognize the future recovery of such
costs.
The MPSC staff has scheduled a collaborative process to discuss
Stranded Costs and related issues and to identify and make recommendations to
the MPSC. Consumers has participated in this collaborative process. In July
2003, the staff suspended formal discussion while it considers possible
conclusions and recommendations.
Implementation Costs - Since 1997, Consumers has incurred significant
electric utility restructuring implementation costs. The following table
outlines the applications filed by Consumers with the MPSC and the status of
recovery for these costs.
In Millions
----------------------------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
----------------------------------------------------------------------------------------------------------
1999 1997 & 1998 $ 20 $ - $15 $ 5
2000 1999 30 - 25 5
2001 2000 25 - 20 5
2002 2001 8 - 8 -
2003 2002 2 2 Pending Pending
==========================================================================================================
The MPSC disallowed certain costs based upon a conclusion that these
amounts did not represent costs incremental to costs already reflected in
electric rates. In the order received for the year 2001, the MPSC also reserved
the right to review again the implementation costs depending upon the progress
and success of the retail open access program, and ruled that due to the rate
freeze imposed by the Customer Choice Act, it was premature to establish a cost
recovery method for the allowable implementation costs.
F-17
In addition to the amounts shown above, as of September 30, 2003, Consumers
incurred and deferred as a regulatory asset, $2 million of additional
implementation costs and has also recorded a regulatory asset of $16 million for
the cost of money associated with total implementation costs. Consumers believes
the implementation costs and the associated cost of money are fully recoverable
in accordance with the Customer Choice Act. Cash recovery from customers is
expected to begin after the rate freeze or rate cap period has expired. As
discussed above, Consumers has asked to include implementation costs through
December 31, 2000 in the pending securitization case. If approved, the sale of
Securitization bonds will allow for the recovery of these costs. Consumers
cannot predict the amounts the MPSC will approve as allowable costs.
Also, Consumers is pursuing authorization at the FERC for MISO to
reimburse Consumers for approximately $8 million in certain electric utility
restructuring implementation costs related to its former participation in the
development of the Alliance RTO, a portion of which has been expensed. In May
2003, the FERC issued an order denying MISO's request for authorization to
reimburse Consumers. In June 2003, Consumers and MISO filed a joint petition for
rehearing with the FERC. In September 2003, the FERC denied Consumers' and
MISO's joint request. Consumers plans to appeal the FERC ruling at the United
States Court of Appeals for the District of Columbia and pursue other potential
means of recovery. In November 2003, in conjunction with Consumers' appeal of
the September Order denying recovery, Consumers persuaded MISO to file a request
with the FERC seeking authority to reimburse METC, the legal successor in
interest to the Alliance RTO start-up costs. As part of the contract for sale of
Consumers' former transmission system, should the Commission approve the new
MISO filing, METC is contractually obligated to flow-through to Consumers the
full amount of any Alliance RTO start-up costs that it is authorized to recover
through FERC. Consumers cannot predict the outcome of the appeal process, the
MISO request, or the amount of implementation costs, if any; the FERC ultimately
will allow to be collected.
Transmission Rates - In 1996, Consumers filed new OATT transmission
rates with the FERC for approval. Interveners contested these rates, and
hearings were held before an ALJ in 1998. In 1999, the ALJ made an initial
decision that was largely upheld by the FERC in March 2002, which requires
Consumers to refund, with interest, over-collections for past services as
measured by the final FERC approved OATT rates. Since the initial decision,
Consumers has been reserving a portion of revenues billed to customers under the
filed 1996 OATT rates. Consumers submitted revised rates to comply with the FERC
final order in June 2002. Those revised rates were accepted by the FERC in
August 2002 and Consumers is in the process of computing refund amounts for
individual customers. Consumers and Detroit Edison used the same rates for JOATT
transmission rates. Approval of the JOATT transmission rates application is
pending FERC approval. Consumers believes its reserve is sufficient to satisfy
its refund obligation under current rate applications. As of October 2003,
Consumers has paid $27 million in refunds. In October 2003, Consumers filed with
FERC its formal notice of cancellation of its transmission tariffs since
Consumers no longer has any transmission customers.
TRANSMISSION: In May 2002, Consumers sold its electric transmission
system for approximately $290 million to MTH, a non-affiliated limited
partnership whose general partner is a subsidiary of Trans-Elect, Inc. The
pretax gain was $31 million ($26 million, net of tax). Remaining open issues are
not expected to materially impact the amount of the gain.
As a result of the sale, Consumers anticipates its after-tax earnings
will decrease by $15 million in 2003, and decrease by approximately $14 million
annually for the next three years due to a loss of revenue from wholesale and
retail open access customers who will buy services directly from MTH and the
loss of a return on the sold electric transmission system.
F-18
Under an agreement with MTH, and subject to certain additional RTO
surcharges, transmission rates charged to Consumers are fixed by contract at
current levels through December 31, 2005, and subject to FERC ratemaking
thereafter. MTH has completed the capital program to expand the transmission
system's capability to import electricity into Michigan, as required by the
Customer Choice Act, and Consumers will continue to maintain the system until
May 1, 2007 under a contract with MTH.
AUGUST 14, 2003 BLACKOUT: On August 14, 2003, the electric transmission
grid serving parts of the Midwest and the Northeast experienced a significant
disturbance, which impacted electric service to millions of homes and businesses
throughout a vast region. In Michigan, more than 2 million electric customers
were without electricity. Consumers had five fossil-fueled generating unit
outages and, of Consumers' 1.7 million electric customers, approximately 100,000
were without power for approximately 24 hours as a result of the disturbance.
The impact was felt most heavily in the southeastern part of Consumers' service
territory.
As discussed above in "Transmission", Consumers sold its transmission
system in May 2002 to MTH, with Consumers providing transmission system
maintenance under a five-year contract with MTH. MTH now owns, controls, and
plans for the transmission system that serves Consumers. Consumers incurred
approximately $1 million of immediate financial impact as a result of the
blackout. Consumers continues to cooperate with investigations of the blackout
by several federal and state agencies. Consumers cannot predict the outcome of
these investigations.
In November 2003, the MPSC released its report on the August 14
blackout, which found no evidence to suggest that the events in Michigan or
actions taken by the Michigan utilities or transmission operators were factors
contributing to the cause of the blackout. As a result of its investigation, the
MPSC is recommending that Congress pass legislation that would empower the FERC,
where necessary, to order membership into a RTO and that Congress should provide
the FERC with the authority to develop and enforce mandatory transmission
reliability standards with penalties for noncompliance.
POWER SUPPLY COSTS: During periods when electric demand is high, the
cost of purchasing electricity on the spot market can be substantial. To reduce
Consumers' exposure to the fluctuating cost of electricity, and to ensure
adequate supply to meet demand, Consumers intends to maintain sufficient
generation and to purchase electricity from others to create a power supply
reserve, also called a reserve margin. The reserve margin provides additional
power supply capability above Consumers' anticipated peak power supply demands.
It also allows Consumers to provide reliable service to its electric service
customers and to protect itself against unscheduled plant outages and
unanticipated demand. As it did in 2003, Consumers is currently planning for a
reserve margin of approximately 11 percent for summer 2004 or supply resources
equal to 111 percent of projected summer peak load. Of the 111 percent,
approximately 100 percent is expected to be met from owned electric generating
plants and long-term power purchase contracts and 11 percent from short-term
contracts and options for physical deliveries and other agreements. The ultimate
use of the reserve margin will depend primarily on summer weather conditions,
the level of retail open access requirements being served by others during the
summer, and any unscheduled plant outages. As of October 2003, alternative
electric suppliers are providing 603 MW of generation supply to ROA customers.
Consumers' reserve margin does not include generation being supplied by other
alternative electric suppliers under the ROA program.
Currently, Consumers is required to provide backup service to ROA
customers on a "best efforts" basis. In October 2003, Consumers provided notice
to the MPSC that it would terminate the provision of backup service in
accordance with Public Act 141, effective January 1, 2004.
To reduce the risk of high electric prices during peak demand periods
and to achieve its reserve margin target, Consumers employs a strategy of
purchasing electric call option and capacity and energy contracts
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for the physical delivery of electricity primarily in the summer months and to a
lesser degree in the winter months. As of September 30, 2003, Consumers
purchased capacity and energy contracts partially covering the estimated reserve
margin requirements for 2004 through 2007. As a result, Consumers has a
recognized asset of $21 million for unexpired capacity and energy contracts. The
total premium cost of electricity call option and capacity and energy contracts
for 2003 is expected to be approximately $10 million.
Prior to 1998, the PSCR process provided for the reconciliation of
actual power supply costs with power supply revenues. This process assured
recovery of all reasonable and prudent power supply costs actually incurred by
Consumers, including the actual cost for fuel, and purchased and interchange
power. In 1998, as part of the electric restructuring efforts, the MPSC
suspended the PSCR process, effective through 2001. As a result of the rate
freeze imposed by the Customer Choice Act, the current rates will remain in
effect until at least December 31, 2003 and, therefore, the PSCR process remains
suspended. Therefore, changes in power supply costs as a result of fluctuating
electricity prices will not be reflected in rates charged to Consumers'
customers during the rate freeze period.
On September 30, 2003, Consumers submitted a PSCR filing to the MPSC
that would reinstate the PSCR process for customers whose rates will no longer
be frozen or capped as of January 1, 2004. The proposed PSCR charge allows
Consumers to recover a portion of its increased power supply costs from large
commercial and industrial customers effective January 1, 2004. This is the first
customer class for which the rate freeze and cap expire. Consumers will,
pursuant to its right under applicable law, self-implement the proposed PSCR
charge on January 1, 2004, unless the MPSC issues an order before that date
establishing a different charge. The charge is subject to subsequent change by
the MPSC during the PSCR period (calendar-year 2004). The revenues received
pursuant to the PSCR charge by statute are also subject to subsequent
reconciliation when the year is finished and actual costs have been reviewed for
reasonableness and prudence. Consumers cannot predict the outcome of this
filing.
OTHER ELECTRIC UNCERTAINTIES
THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and
operates the MCV Facility, contracted to sell electricity to Consumers for a
35-year period beginning in 1990 and to supply electricity and steam to Dow.
Consumers, through two wholly owned subsidiaries, holds the following assets
related to the MCV Partnership and MCV Facility: 1) CMS Midland owns a 49
percent general partnership interest in the MCV Partnership; and 2) CMS Holdings
holds, through FMLP, a 35 percent lessor interest in the MCV Facility.
Consumers' consolidated retained earnings include undistributed
earnings from the MCV Partnership, which at September 30, 2003 and 2002 are $238
million and $217 million, respectively.
SUMMARIZED STATEMENTS OF INCOME FOR CMS MIDLAND AND CMS HOLDINGS
In Millions
--------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
Earnings (loss) from equity method investees $(3) $8 $31 $35
Operating taxes and other (1) 2 18 11
------------------------------------------
Income (loss) before cumulative effect of accounting change (2) 6 13 24
Cumulative effect of change in method of accounting for
derivatives, net of $1 and $10 million tax expense in 2002 (a) - 1 - 18
------------------------------------------
Net income (loss) $(2) $7 $13 $42
====================================================================================================================
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SUMMARIZED STATEMENTS OF INCOME FOR THE MCV PARTNERSHIP
In Millions
--------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
--------------------------------------------------------------------------------------------------------------------
Operating revenue $148 $156 $443 $451
Operating expenses 138 120 322 318
---- ---- ---- ----
Operating income 10 36 121 133
Other expense, net 25 27 82 86
---- ---- ---- ----
Income (loss) before cumulative effect of accounting change (15) 9 39 47
Cumulative effect of change in method of accounting for
derivative option contracts (a) - - - 58
---- ---- ---- ----
Net income (loss) $(15) $ 9 $ 39 $105
====================================================================================================================
(a) On April 1, 2002, the MCV Partnership implemented Derivative
Implementation = Group Issue C-16, an interpretation of SFAS No. 133. The MCV
Partnership began accounting for several natural gas contracts containing an
option component at fair value. As a result, a cumulative effect adjustment for
the change in accounting principle was recorded as an increase to earnings.
Power Supply Purchases from the MCV Partnership - Consumers' annual
obligation to purchase capacity from the MCV Partnership is 1,240 MW through the
term of the PPA ending in 2025. The PPA requires Consumers to pay, based on the
MCV Facility's availability, a levelized average capacity charge of 3.77 cents
per kWh and a fixed energy charge, and also to pay a variable energy charge
based primarily on Consumers' average cost of coal consumed for all kWh
delivered. Since January 1, 1993, the MPSC has permitted Consumers to recover
capacity charges averaging 3.62 cents per kWh for 915 MW, plus a substantial
portion of the fixed and variable energy charges. Since January 1, 1996, the
MPSC has also permitted Consumers to recover capacity charges for the remaining
325 MW of contract capacity with an initial average charge of 2.86 cents per kWh
increasing periodically to an eventual 3.62 cents per kWh by 2004 and
thereafter. However, due to the current freeze of Consumers' retail rates that
the Customer Choice Act requires, the capacity charge for the 325 MW is now
frozen at 3.17 cents per kWh. Recovery of both the 915 MW and 325 MW portions of
the PPA are subject to certain limitations discussed below. After September
2007, the PPA's regulatory out terms obligate Consumers to pay the MCV
Partnership only those capacity and energy charges that the MPSC has authorized
for recovery from electric customers.
In 1992, Consumers recognized a loss and established a PPA liability
for the present value of the estimated future underrecoveries of power supply
costs under the PPA based on MPSC cost recovery orders. Primarily as a result of
the MCV Facility's actual availability being greater than management's original
estimates, the PPA liability has been reduced at a faster rate than originally
anticipated. The remaining estimated future PPA liability associated with the
loss totaled $34 million at September 30, 2003 and $59 million at September 30,
2002. The PPA liability is expected to be depleted in late 2004. For further
discussion on the impact of the frozen PSCR, see "Electric Rate Matters" in this
Note.
In March 1999, Consumers and the MCV Partnership reached a settlement
agreement effective January 1, 1999, that addressed, among other things, the
ability of the MCV Partnership to count modifications increasing the capacity of
the existing MCV Facility for purposes of computing the availability of contract
capacity under the PPA for billing purposes. That settlement agreement capped
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payments made on the basis of availability that may be billed by the MCV
Partnership at a maximum 98.5 percent availability level.
Under Michigan's electric restructuring law, Consumers will return to
unfrozen rates for large industrial customers beginning January 1, 2004,
including the resumption of the PSCR process. Under the process, Consumers will
recover from customers capacity and fixed energy charges on the basis of
availability, to the extent that availability does not exceed 88.7 percent
availability established in previous MPSC orders. Recovery of capacity and fixed
energy charges will be subject to certain rate caps as discussed in Note 2,
Uncertainties, "Electric Rate Matters - Electric Restructuring." For capacity
and energy payments billed by the MCV Partnership after September 15, 2007, and
not recovered from customers, Consumers would expect to claim a regulatory out
under the PPA. The regulatory out provision relieves Consumers of the obligation
to pay more for capacity and energy payments than the MPSC allows Consumers to
collect from its customers. Consumers estimates that 51 percent of the actual
cash underrecoveries for the years 2003 and 2004 will be charged to the PPA
liability, with the remaining portion charged to operating expense as a result
of Consumers' 49 percent ownership in the MCV Partnership. All cash
underrecoveries will be expensed directly to income once the PPA liability is
depleted. If the MCV Facility's generating availability remains at the maximum
98.5 percent level, Consumers' cash underrecoveries associated with the PPA
could be as follows:
In Millions
----------------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
----------------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5% (a) $57 $56 $56 $55 $39
Amount to be charged to operating expense $28 $27 $56 $55 $39
Amount to be charged to PPA liability $29 $29 $ - $ - $ -
======================================================================================================================
(a) For the nine months ended September 30, 2003, Consumers' cash
underrecoveries associated with the PPA were $43 million.
As previously noted, until September 2007, the PPA and settlement
require Consumers to pay capacity costs based on the MCV Facility's actual
availability up to the 98.5 percent cap. After September 2007, Consumers expects
to exercise the "regulatory out" clause in the PPA, limiting its capacity
payments to the MCV Partnership to the amount collected from its customers.
Depending on the MPSC's future actions with respect to the capacity payments
recoverable from its customers subsequent to September 2007, the earnings of the
MCV Partnership and the value of Consumers' equity interest in the MCV
Partnership, may be affected negatively.
Further, under the PPA, energy payments to the MCV Partnership are
based on the cost of coal burned at Consumers' coal plants and costs associated
with fuel inventory, operations and maintenance, and administrative and general
expenses associated with Consumers' coal plants. However, the MCV Partnership's
costs of producing electricity are tied, in large part, to the cost of natural
gas. Because natural gas prices have increased substantially in recent years,
while energy charge payments to the MCV Partnership have not, the MCV
Partnership's financial performance has been impacted negatively.
As of January 1, 2004, Consumers intends to return to forced
(uneconomic) dispatch of the MCV Facility in order to maximize recovery of its
capacity payments. As such, if the spread between MCV Facility's variable
electricity production costs and its energy payment revenues stays constant or
widens, the negative impacts on MCV Partnership's financial performance, and on
the value of Consumers' equity interest in the MCV Partnership, will be worse.
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Consumers cannot estimate, at this time, the impact of these issues on
its future earnings or cash flow from its interest in the MCV Partnership. The
forward price of natural gas for the next 22 years and the MPSC decision in 2007
or later related to Consumers' recovery of capacity payments are the two most
significant variables in the analysis of MCV Partnership's future financial
performance. Natural gas prices have historically been volatile and presently
there is no consensus in the marketplace on the price or range of prices of
natural gas beyond the next five years. Further, it is not presently possible
for Consumers to predict the actions of the MPSC in 2007 or later. For these
reasons, at this time Consumers cannot predict the impact of these issues on its
future earnings, cash flows, or on the value of its $404 million equity interest
in the MCV Partnership.
Consumers is exploring possible alternatives for utilizing the MCV
Facility without increasing costs to customers. Any changes regarding the
recovery of MCV capacity costs would require MPSC approval. Consumers cannot
predict the outcome of this matter.
In February 1998, the MCV Partnership appealed the January 1998 and
February 1998 MPSC orders related to electric utility restructuring. At the same
time, MCV Partnership filed suit in the United States District Court in Grand
Rapids seeking a declaration that the MPSC's failure to provide Consumers and
MCV Partnership a certain source of recovery of capacity payments after 2007
deprived MCV Partnership of its rights under PURPA. In July 1999, the district
court granted MCV Partnership's motion for summary judgment. The district court
permanently prohibited enforcement of the restructuring orders in any manner
that denies any utility the ability to recover amounts paid to qualifying
facilities such as the MCV Facility or that precludes the MCV Partnership from
recovering the avoided cost rate. The MPSC appealed the court's order to the 6th
Circuit Court of Appeals in Cincinnati. In June 2001, the 6th Circuit overturned
the lower court's order and dismissed the case against the MPSC. The appellate
court determined that the case was premature and concluded that the qualifying
facilities needed to wait until 2008 for an actual factual record to develop
before bringing claims against the MPSC in federal court.
NUCLEAR MATTERS: Significant progress continues to be made in the
decommissioning of Big Rock. Following the successful loading of spent fuel into
dry storage (see below under "Spent Nuclear Fuel Storage"), the spent fuel
storage racks were removed and disposed of and the spent fuel pool cleaned and
drained. The reactor vessel closure head was shipped for disposal in May 2003
and in August 2003, the reactor vessel was moved from the plant and sealed into
a specially designed shipping container. In October 2003, the shipping container
was transported to the licensed disposal facility in Barnwell, South Carolina.
The License Termination Plan was submitted to the NRC staff for review in April
2003. System dismantlement and building demolition continue on a schedule to
return the 560-acre site to a natural setting for unrestricted use in early
2006. The NRC and Michigan Department of Environmental Quality continue to find
that all decommissioning activities at Big Rock are being performed in
accordance with applicable regulatory and license requirements.
In July 2003, the NRC completed its mid-cycle plant performance
assessment of Palisades. The mid-cycle review for Palisades covered the period
from January 1, 2003 through the end of July 2003. The NRC determined that
Palisades was operated in a manner that preserved public health and safety and
fully met all cornerstone objectives. Based on the plant's performance, only
regularly scheduled inspections are planned through September 2004.
Spent Nuclear Fuel Storage: During the fourth quarter of 2002,
equipment fabrication, assembly and testing was completed at Big Rock on
NRC-approved transportable steel and concrete canisters or vaults, commonly
known as "dry casks." Spent fuel was then loaded into the dry casks from the
fuel pool and transported to the temporary onsite storage pad. A total of seven
dry casks have been loaded with spent fuel. An additional eighth cask,
containing high-level radioactive waste material, was also loaded. This
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radioactive material was made up of reactor vessel components that could not be
shipped or stored with the reactor vessel. These transportable dry casks will
remain onsite until the DOE moves the material to a national fuel repository.
At Palisades, the amount of spent nuclear fuel discharged from the
reactor to date exceeds Palisades' temporary onsite storage pool capacity.
Consequently, Consumers is using dry casks for temporary onsite storage. As of
September 30, 2003, Consumers had loaded 18 dry casks with spent nuclear fuel at
Palisades. Palisades will need to load additional dry casks by the fall of 2004
in order to continue operation. Palisades currently has three empty storage-only
dry casks onsite, with storage pad capacity for up to seven additional loaded
dry casks. Consumers anticipates that licensed transportable dry casks for
additional storage, along with more storage pad capacity, will be available
prior to 2004.
As of September 30, 2003, Consumers has a recorded liability to the DOE
of $139 million, including interest, which is payable upon the first delivery of
spent nuclear fuel to the DOE. Consumers recovered through electric rates the
amount of this liability, excluding a portion of the interest.
In 1997, a U.S. Court of Appeals decision confirmed that the DOE was to
begin accepting deliveries of spent nuclear fuel for disposal by January 31,
1998. Subsequent U.S. Court of Appeals litigation in which Consumers and certain
other utilities participated has not been successful in producing more specific
relief for the DOE's failure to comply.
In July 2000, the DOE reached a settlement agreement with one utility
to address the DOE's delay in accepting spent fuel. The DOE may use that
settlement agreement as a framework that it could apply to other nuclear power
plants. However, certain other utilities challenged the validity of the
mechanism for funding the settlement in an appeal, and the reviewing court
sustained their challenge. Additionally, there are two court decisions that
support the right of utilities to pursue damage claims in the United States
Court of Claims against the DOE for failure to take delivery of spent fuel. A
number of utilities, including Consumers, which filed its complaint in December
2002, have commenced litigation in the Court of Claims. The Chief Judge of the
Court of Claims identified six lead cases to be used as vehicles for resolving
dispositive motions. Consumers' case is not a lead case. It is unclear what
impact this decision by the Chief Judge will have on the outcome of Consumers'
litigation. If the litigation that was commenced in the fourth quarter of 2002
against the DOE is successful, Consumers anticipates future recoveries from the
DOE to defray the significant costs it will incur for the storage of spent fuel
until the DOE takes possession as required by law. However, there is no
assurance that the litigation against the DOE will be successful.
In July 2002, Congress approved and the President signed a bill
designating the site at Yucca Mountain, Nevada, for the development of a
repository for the disposal of high-level radioactive waste and spent nuclear
fuel. The next step will be for the DOE to submit an application to the NRC for
a license to begin construction of the repository. The application and review
process is estimated to take several years.
In March 2003, the Michigan Environmental Council, the Public Interest
Research Group in Michigan, and the Michigan Consumer Federation submitted a
complaint to the MPSC, which was served on Consumers by the MPSC in April 2003.
The complaint asks the MPSC to commence a generic investigation and contested
case to review all facts and issues concerning costs associated with spent
nuclear fuel storage and disposal. The complaint seeks a variety of relief with
respect to Consumers, Detroit Edison, Indiana & Michigan Electric Company,
Wisconsin Electric Power Company and Wisconsin Public Service Corporation,
including establishing external trusts to which amounts collected in electric
rates for spent nuclear fuel storage and disposal should be transferred, and the
adoption of additional measures related to the storage and disposal of spent
nuclear fuel. In May 2003, Consumers
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and the other named utilities each filed a motion to dismiss the complaint.
Consumers is unable to predict the outcome of this matter.
Palisades Plant Operations: In March 2002, corrosion problems were
discovered in the reactor head at an unaffiliated nuclear power plant in Ohio.
As a result, the NRC requested that all United States nuclear plants utilizing
pressurized water reactors provide reports detailing their reactor head
inspection histories, design capabilities and future inspection plans. In
response to the issues identified at this and other nuclear plants worldwide, a
bare metal visual inspection was completed on the Palisades reactor vessel head
during the spring 2003 refueling outage. No indication of leakage was detected
on any of the 54 penetrations of the reactor head. Consumers will continue to
comply with the more aggressive reactor head inspection requirements in future
planned outages at Palisades.
Insurance: Consumers maintains primary and excess nuclear property
insurance from NEIL, totaling $2.750 billion in recoverable limits for the
Palisades nuclear plant. Consumers also procures coverage from NEIL that would
partially cover the cost of replacement power during certain prolonged
accidental outages at Palisades. NEIL's policies include coverage for acts of
terrorism.
Consumers retains the risk of loss to the extent of the insurance
deductibles and to the extent that its loss exceeds its policy limits. Because
NEIL is a mutual insurance company, Consumers could be subject to assessments
from NEIL up to $26 million in any policy year if insured losses in excess of
NEIL's maximum policyholders surplus occur at its, or any other member's,
nuclear facility.
Consumers maintains nuclear liability insurance for injuries and
off-site property damage resulting from the nuclear hazard at Palisades for up
to approximately $10.862 billion, the maximum insurance liability limits
established by the Price-Anderson Act. Congress enacted the Price-Anderson Act
to provide financial protection for persons who may be liable for a nuclear
accident or incident and persons who may be injured by a nuclear incident. The
Price-Anderson Act was extended to December 31, 2003. Part of the Price-Anderson
Act's financial protection consists of a mandatory industry-wide program under
which owners of nuclear generating facilities could be assessed if a nuclear
incident occurs at any of such facilities. The maximum assessment against
Consumers could be $101 million per occurrence, limited to maximum annual
installment payments of $10 million. Consumers also maintains insurance under a
master worker program that covers tort claims for bodily injury to workers
caused by nuclear hazards. The policy contains a $300 million nuclear industry
aggregate limit. Under a previous insurance program providing coverage for
claims brought by nuclear workers, Consumers remains responsible for a maximum
assessment of up to $6 million. The Big Rock plant remains insured for nuclear
liability by a combination of insurance and United States government indemnity
totaling $544 million.
Insurance policy terms, limits and conditions are subject to change
during the year as Consumers renews its policies.
GAS CONTINGENCIES
GAS ENVIRONMENTAL MATTERS: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will ultimately incur
investigation and remedial action costs at a number of sites. These include 23
former manufactured gas plant facilities, which were operated by Consumers for
some part of their operating lives, including sites in which it has a partial or
no current ownership interest. Consumers has completed initial investigations at
the 23 sites. For sites where Consumers has received site-wide study plan
approvals, it will continue to implement these plans. It will also work toward
resolution of environmental issues at sites as studies are completed. Consumers
has estimated its costs related to investigation and remedial action for all 23
sites using the Gas Research Institute-Manufactured
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Gas Plant Probabilistic Cost Model. A revised cost estimate, completed in
September 2003, estimated remaining costs to be between $37 million and $90
million. The range reflects multiple alternatives with various assumptions for
resolving the environmental issues at each site. The estimates are based on
discounted 2003 costs using a discount rate of three percent. The discount rate
represents a ten-year average of U.S. Treasury bond rates reduced for increases
in the consumer price index. Consumers expects to fund a significant portion of
these costs through insurance proceeds and through MPSC approved rates charged
to its customers. As of September 30, 2003, Consumers has an accrued liability
of $47 million, net of $35 million of expenditures incurred to date, and a
regulatory asset of $68 million. Any significant change in assumptions, such as
an increase in the number of sites, different remediation techniques, nature and
extent of contamination, and legal and regulatory requirements, could affect
Consumers' estimate of remedial action costs.
The MPSC, in its November 2002, gas distribution rate order, authorized
Consumers to continue to recover approximately $1 million of manufactured gas
plant facilities environmental clean-up costs annually. Consumers defers and
amortizes, over a period of 10 years, manufactured gas plant facilities
environmental clean-up costs above the amount currently being recovered in
rates. Additional rate recognition of amortization expense cannot begin until
after a prudency review in a gas rate case. The annual amount that the MPSC
authorized Consumers to recover in rates will continue to be offset by $2
million to reflect amounts recovered from all other sources.
GAS RATE MATTERS
GAS COST RECOVERY: As part of the on-going GCR process, which includes
an annual reconciliation case with the MPSC, Consumers expects to recover all of
its gas costs. In June 2003, Consumers filed a reconciliation of GCR costs and
revenues for the 12-months ended March 2003. Consumers proposes to recover from
its customers a net under-recovery of approximately $6 million using a roll-in
methodology. The roll-in methodology incorporates the under-recovery in the GCR
factor charged in the next GCR year. The roll-in tariff provision was approved
by the MPSC in a November 2002 order.
In July 2003, the MPSC approved a settlement agreement authorizing
Consumers to increase its gas cost recovery factor for the remainder of the
current GCR plan year (August 2003 through March 2004) and to implement a
quarterly ceiling price adjustment mechanism, based on a formula that tracks
changes in NYMEX natural gas prices. Consistent with the terms of the
settlement, the ceiling price is $6.11 per mcf. However, Consumers will utilize
a GCR factor of $5.41 per mcf commencing in November 2003 bills. All recoveries
pursuant to such factors are subject to final reconciliation by the MPSC.
2003 GAS RATE CASE: In March 2003, Consumers filed an application with
the MPSC seeking a $156 million increase in its gas delivery and transportation
rates, which included a 13.5 percent return on equity, based on a 2004 test
year. Contemporaneously with this filing, Consumers requested interim rate
relief in the same amount. In August 2003, the MPSC Staff recommended interim
rate relief of $80 million be granted in this proceeding, subject to Consumers
voluntarily agreeing to limit its dividends to its parent, CMS Energy, to a
maximum of $190 million in any calendar year.
In September 2003, Consumers filed an update to its gas rate case that
lowered the requested revenue increase from $156 million to $139 million and
revised the return on common equity from 13.5 percent to 12.75 percent. The
majority of the reduction is related to lower debt costs and changes in the
projected capital structure. The MPSC Staff and ABATE filed their cases in early
October. The Staff made no change to its interim position of $80 million and
continued to propose the same dividend limitation. ABATE did not make a specific
recommendation for a final rate increase, but did discuss the rate design
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used to recover any rate increase granted. A proposal for decision is expected
from the administrative law judge in January 2004.
OTHER UNCERTAINTIES
SECURITY COSTS: Since the September 11, 2001 terrorist attacks in the
United States, Consumers has increased security at all critical facilities and
over its critical infrastructure, and will continue to evaluate security on an
ongoing basis. Consumers may be required to comply with federal and state
regulatory security measures promulgated in the future. Through September 30,
2003, Consumers has incurred approximately $7 million in incremental security
costs, including operating, capital, and decommissioning and removal costs,
mainly relating to its nuclear facilities. Consumers estimates it may incur
additional incremental security costs for the last three months of 2003 of
approximately $3 million, of which $2 million relates to nuclear security costs.
Consumers will attempt to seek recovery of these costs from its customers. In
December 2002, the Michigan legislature passed, and the governor signed, a bill
that would allow Consumers to seek recovery of additional nuclear electric
division security costs incurred during the rate freeze and cap periods imposed
by the Customer Choice Act. In February 2003, the MPSC adopted filing
requirements for the recovery of enhanced security costs.
DERIVATIVE ACTIVITIES: Consumers may use a variety of contracts to
protect against commodity price and interest rate risk. Some of these contracts
may be subject to derivative accounting, which requires that the value of the
contracts be adjusted to fair value through earnings or equity depending upon
certain criteria. Such adjustments to fair value could cause earnings
volatility. For further information about derivative activities, see Note 4,
Financial and Derivative Instruments.
OTHER: In addition to the matters disclosed in this note, Consumers and
certain of its subsidiaries are parties to certain lawsuits and administrative
proceedings before various courts and governmental agencies arising from the
ordinary course of business. These lawsuits and proceedings may involve personal
injury, property damage, contractual matters, environmental issues, federal and
state taxes, rates, licensing and other matters.
Consumers has accrued estimated losses for certain contingencies
discussed in this note. Resolution of these contingencies is not expected to
have a material adverse impact on Consumers' financial position, liquidity, or
results of operations.
3: FINANCINGS AND CAPITALIZATION
REGULATORY AUTHORIZATION FOR FINANCINGS: At September 30, 2003,
Consumers had FERC authorization, through June 2004, to issue or guarantee up to
$1.1 billion of short-term securities outstanding at any one time. As of
September 30, 2003, Consumers had $400 million outstanding as collateral for the
revolving credit facility (discussed below) and had an additional $700 million
available for future issuances of short-term securities. At September 30, 2003,
Consumers also had remaining FERC authorization, through June 2004, to issue up
to $800 million of long-term securities for refinancing or refunding purposes,
$560.3 million of long-term securities for general corporate purposes, and $2.06
billion of long-term first mortgage bonds to be issued solely as collateral for
other long-term securities. Also, FERC has granted waivers of its competitive
bid/negotiated placement requirements applicable to the long-term securities
authorization indicated above.
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SHORT-TERM FINANCINGS: In March 2003, Consumers obtained a replacement
revolving credit facility in the amount of $250 million secured by first
mortgage bonds. In September 2003, this facility was amended and restated as a
$400 million revolving credit facility. The interest rate of the facility was
reduced from LIBOR plus 350 to LIBOR plus 175 basis points. The new credit
facility matures in March 2004 with two annual extensions at Consumers' option,
which would extend the maturity to March 2006. At September 30, 2003, all of the
$400 million is available for general corporate purposes. At September 30, 2003,
a total of $4 million was outstanding on all short-term financings at a weighted
average interest rate of 2.79 percent, compared with $235 million outstanding at
September 30, 2002 at a weighted average interest rate of 3.7 percent.
LONG-TERM DEBT: The following is a summary of Consumers' Long-Term Debt
as of September 30, 2003 and December 31, 2002:
In Millions
-----------------------------------------------------------------------------------------------------------
September 30 December 31
Interest Rate(%) Maturity 2003 2002
-----------------------------------------------------------------------------------------------------------
Senior Notes 6.000 2005 $ 300 $ 300
6.250 2006 332 332
6.375 2008 159 159
6.200(a) 2008 - 250
6.875 2018 180 180
6.500(b) 2018 141 141
6.500(c) 2028 142 142
-------------------------
1,254 1,504
-------------------------
Securitization Bonds 5.075(d) 2005-2015 434 453
First Mortgage Bonds 5.240(d) 2008-2023 1,482 208
Long-Term Bank Debt Floating 2009 140 328
Nuclear Fuel Disposal Liability (e) 139 138
Pollution Control Revenue Bonds Various 2010-2018 126 126
Other 6 8
-------------------------
2,327 1,261
-------------------------
Principal Amount Outstanding 3,581 2,765
Current Amounts (28) (305)
Net Unamortized Discount (22) (18)
-------------------------
Total Long-Term Debt $ 3,531 $ 2,442
===========================================================================================================
(a) These notes were subject to a call option by the callholder or a mandatory
put on May 1, 2003.
(b) Senior remarketed notes subject to optional redemption by Consumers after
June 15, 2005.
(c) Callable at par on or after October 1, 2003.
(d) Represents the weighted average interest rate at September 30, 2003.
(e) Maturity date uncertain.
F-28
FIRST MORTGAGE BONDS: In April 2003, Consumers sold $625 million
principal amount of first mortgage bonds in a private offering to institutional
investors; $250 million were issued at an interest rate of 4.25 percent,
maturing in April 2008, and net proceeds were approximately $248 million; $375
million were issued at an interest rate 5.375 percent, maturing in April 2013,
and net proceeds were approximately $371 million. Consumers used the net
proceeds to replace a $250 million senior reset put bond that matured in May
2003, to pay an associated $32 million option call payment, and for general
corporate purposes that included paying down additional debt. The $32 million
option call payment was deferred and is being amortized to interest expense over
the term of the replacement debt in accordance with SFAS No. 71. Consumers
agreed to file a registration statement with the SEC by December 26, 2003 to
permit holders of the first mortgage bonds to exchange the bonds for new bonds
that will be registered under the Securities Act of 1933.
In May 2003, Consumers sold $250 million principal amount of first
mortgage bonds in a private offering to institutional investors; the bonds were
issued at an interest rate of 4.00 percent, maturing May 2010, and net proceeds
were approximately $247 million. Consumers used the net proceeds to pay down
existing debt. Consumers agreed to file a registration statement with the SEC by
December 26, 2003 to permit holders of the first mortgage bonds to exchange the
bonds for new bonds that will be registered under the Securities Act of 1933.
In August 2003, Consumers sold $400 million principal amount of first
mortgage bonds in a private offering to institutional investors; $200 million
were issued at an interest rate of 4.80 percent, maturing in February 2009, and
net proceeds were approximately $198 million and $200 million were issued at an
interest rate of 6.00 percent, maturing in February 2014, and net proceeds were
approximately $198 million. Consumers used the net proceeds to pay down existing
debt and for general corporate purposes. Consumers agreed to file a registration
statement with the SEC by April 14, 2004 to permit holders of the first mortgage
bonds to exchange the bonds for new bonds that will be registered under the
Securities Act of 1933.
SENIOR NOTES: In March 2003, Consumers entered into a $140 million term
loan secured by first mortgage bonds with a private investor bank. This loan has
a term of six years at a cost of LIBOR plus 475 basis points. Proceeds from this
loan were used for general corporate purposes.
In March 2003, Consumers entered into a $150 million term loan secured
by first mortgage bonds. This term loan had a three-year maturity expiring in
March 2006. This term loan was paid in full with the proceeds of first mortgage
bonds issued in August 2003.
COMPANY-OBLIGATED PREFERRED SECURITIES: Consumers has wholly-owned
statutory business trusts that are consolidated within its financial statements.
Consumers created these trusts for the sole purpose of issuing trust preferred
securities. In each case, the primary asset of the trust is a note or debenture
of Consumers. The terms of the trust preferred security parallel the terms of
the related Consumers' note or debenture. The terms, rights and obligations of
the trust preferred security and related note or debenture are also defined in
the related indenture through which the note or debenture was issued, Consumers'
guarantee of the related trust preferred security and the declaration of trust
for the particular trust. All of these documents together with their related
note or debenture and trust preferred security constitute a full and
unconditional guarantee by Consumers of the trust's obligations under the trust
preferred security. In addition to the similar provisions previously discussed,
specific terms of the securities follow. For further information, see Note 5,
Implementation of New Accounting Standards.
F-29
In Millions
------------------------------------------------------------------------------------------------
Amount Earliest
Trust and Securities Rate Outstanding Maturity Redemption
------------------------------------------------------------------------------------------------
September 30 2003 2002
------------------------------------------------------------------------------------------------
Consumers Power Company Financing I,
Trust Originated Preferred Securities (a) 8.36% $ 70 $ 70 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities (a) 8.20% 120 120 2027 2002
Consumers Energy Company Financing III,
Trust Originated Preferred Securities (b) 9.25% 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities (c) 9.00% 125 125 2031 2006
---------------
Total Amount Outstanding $ 490 $ 490
================================================================================================
(a) Consumers can currently redeem these securities at par value.
(b) Consumers cannot redeem these securities until 2004. If Consumers were
to redeem these securities as of September 30, 2003, they would be
required to pay market value, which is approximately $180 million.
(c) Consumers cannot redeem these securities until 2006. If Consumers were
to redeem these securities, as of September 30, 2003, they would be
required to pay market value, which is approximately $128 million.
REQUIRED RATIOS: The revolving credit facility has contractual
restrictions that require Consumers to maintain, as of the last day of each
fiscal quarter, the following:
Limitation Ratio at September 30, 2003
====================================================================================================
Debt to Capital Ratio (a)(b) Not more than 0.65 to 1.00 0.58 to 1.00
Interest Coverage Ratio - Revolver (a) Not less than 2.00 to 1.00 3.34 to 1.00
(a) Violation of this ratio would constitute an event of default under
the facility that provides the lender, among other remedies, the right to
declare the principal and interest immediately due and payable.
(b) The terms of the credit facility provide for the exclusion of
securitization bonds in the calculation of the debt to capital ratio.
Consumers is subject to covenants in its financing agreements that
could limit its ability to incur additional indebtedness. Consumers has agreed
in several of its financing agreements to maintain specified levels of cash
coverage of its interest requirements and to not allow its indebtedness to
exceed specified levels of its consolidated capitalization (the "Debt Percentage
Tests"). Consumers is in compliance with these requirements as of the most
recent measurement date, September 30, 2003. These covenants make use of both
generally accepted accounting principles and defined contractual terms in
specifying how the relevant calculations are made. Consumers sought and received
amendments to certain of its relevant financing agreements to modify the terms
of the Debt Percentage Tests in order to, among other things, remove the effect
of the adoption of SFAS No. 150, portions of which have now been deferred
indefinitely, regarding Trust Preferred Securities on the calculations.
F-30
OTHER: Under a revolving accounts receivable sales program, Consumers
currently sells certain accounts receivable to a wholly owned, consolidated,
bankruptcy remote special purpose entity, Consumers Receivables Funding II. In
turn, Consumers Receivables Funding II may sell an undivided interest in up to
$325 million of the receivables to a bank-sponsored commercial paper conduit.
The amount sold to the conduit was $254 million at September 30, 2003 and $325
million at September 30, 2002. These amounts are excluded from accounts
receivable in Consumers' consolidated balance sheets. Consumers continues to
service the receivables sold, however, the purchaser of the receivables has no
recourse against Consumers' other assets for failure of a debtor to pay when due
and the purchaser has no right to any receivables not sold. No gain or loss has
been recorded on the receivables sold and Consumers retains no interest in the
receivables sold.
Certain cash flows received from and paid to Consumers under its
accounts receivable sales program are shown below:
In Millions
--------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 2003 2002 2003 2002
--------------------------------------------------------------------------------------------------------
Proceeds from sales (remittance of collections)
under the program $ 204 $ 14 $ (71) $ (9)
Collections reinvested under the program 920 918 3,379 3,141
========================================================================================================
DIVIDEND RESTRICTIONS: Under the provisions of its articles of
incorporation, Consumers had $412 million of unrestricted retained earnings
available to pay common dividends at September 30, 2003. However, covenants in
Consumers' debt facilities cap common stock dividend payments at $300 million in
a calendar year. Through September 30, 2003, Consumers paid $162 million in
common dividends. In October 2003, Consumers declared a $57 million common
dividend payable in November 2003.
For information on the potential cap on common dividends payable
included in the MPSC Securitization order see Note 2, Uncertainties, Electric
Rate Matters, "Securitization." Also, for information on the potential cap on
common dividends payable included in the MPSC Staff's recommendation in
Consumers' gas rate case see Note 2, Uncertainties, "Gas Rate Matters - 2003 Gas
Rate Case."
FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE
REQUIREMENT FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF
OTHERS: Effective January 2003, this interpretation elaborates on the disclosure
to be made by a guarantor about its obligations under certain guarantees that it
has issued. It also requires that a guarantor recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and measurement provision of this
interpretation does not apply to certain guarantee contracts, such as
warranties, derivatives, or guarantees between either parent and subsidiaries or
corporations under common control, although disclosure of such guarantees is
required. For contracts that are within the initial recognition and measurement
provision of this interpretation, the provisions are to be applied to guarantees
issued or modified after December 31, 2002; no cumulative effect adjustments are
required.
F-31
Following is a general description of Consumers' guarantees as required
by this Interpretation:
September 30, 2003 In Millions
---------------------------------------------------------------------------------------------------------------
Expiration Maximum Carrying Recourse
Guarantee Description Issue Date Date Obligation Amount Provision(a)
---------------------------------------------------------------------------------------------------------------
Standby letters of credit Various Various $ 7 $ - $ -
Surety bonds Various Various 8 - -
Nuclear insurance retrospective premiums Various Various 133 - -
===============================================================================================================
(a) Recourse provision indicates the approximate recovery from third
parties including assets held as collateral.
Following is additional information regarding Consumers' guarantees:
September 30, 2003
Events That Would Require
Guarantee Description How Guarantee Arose Performance
------------------------------------------------------------------------------------------------------------------
Standby letters of credit Normal operations of coal power plants Noncompliance with environmental
Self-insurance requirement regulations
Nonperformance
Surety bonds Normal operating activity, permits and Nonperformance
license
Nuclear insurance retrospective Normal operations of nuclear plants Call by NEIL and Price Anderson Act
premiums for nuclear incident
4: FINANCIAL AND DERIVATIVE INSTRUMENTS
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term
investments and current liabilities approximate their fair values due to their
short-term nature. Consumers estimates the fair values of long-term investments
based on quoted market prices or, in the absence of specific market prices, on
quoted market prices of similar investments or other valuation techniques. The
carrying amounts of all long-term financial instruments, except as shown below,
approximate fair value. For held-to-maturity securities and related-party
financial instruments, see Note 1.
In Millions
----------------------------------------------------------------------------------------------------------------------
September 30 2003 2002
----------------------------------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized
Cost Value Gain (Loss) Cost Value Gain (Loss)
---------------------------------------------------------------------------------------------------------------------
Long-Term Debt (a) $3,531 $3,633 $(102) $2,701 $2,694 $ 7
Trust Preferred Securities 490 497 (7) 490 439 51
Preferred Stock 44 33 11 44 23 21
Available for sale securities:
Common stock of CMS Energy (b) 10 17 7 35 19 (16)
SERP 17 20 3 18 19 1
Nuclear decommissioning investments (c) 450 553 103 464 530 66
=====================================================================================================================
(a) Settlement of long-term debt is generally not expected until
maturity.
(b) Consumers recognized a $12 million loss on this investment in 2002
and an additional $12 million loss in the first quarter of 2003 because the loss
was other than temporary, as the fair value was below the cost basis for a
period greater than six months. As of September 30, 2003, Consumers held 2.4
million shares of CMS Energy Common Stock.
F-32
(c) On January 1, 2003, Consumers adopted SFAS No. 143 and began
classifying its unrealized gains and losses on nuclear decommissioning
investments as regulatory liabilities. Consumers previously classified these
investments in accumulated depreciation.
RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS: Consumers is
exposed to market risks including, but not limited to, changes in interest
rates, commodity prices, and equity security prices. Consumers' market risk, and
activities designed to minimize this risk, are subject to the direction of an
executive oversight committee consisting of designated members of senior
management and a risk committee, consisting of certain business unit managers.
Established policies and procedures are used to manage the risks associated with
market fluctuations.
Consumers may use various contracts, including swaps, options, and
forward contracts to manage its risks associated with the variability in
expected future cash flows attributable to fluctuations in interest rates and
commodity prices. When management uses these instruments, it intends that an
opposite movement in the value of the at-risk item would offset any losses
incurred on the contracts. Consumers enters into all risk management contracts
for purposes other than trading.
These instruments contain credit risk if the counterparties, including
financial institutions and energy marketers, fail to perform under the
agreements. Consumers minimizes such risk by performing financial credit reviews
using, among other things, publicly available credit ratings of such
counterparties.
Contracts used to manage interest rate and commodity price risk may be
considered derivative instruments that are subject to derivative and hedge
accounting pursuant to SFAS No. 133. If a contract is accounted for as a
derivative instrument, it is recorded in the financial statements as an asset or
a liability, at the fair value of the contract. Any difference between the
recorded book value and the fair value is reported either in earnings or
accumulated other comprehensive income, depending on certain qualifying
criteria. The recorded fair value of the contract is then adjusted quarterly to
reflect any change in the market value of the contract.
In order for derivative instruments to qualify for hedge accounting
under SFAS No. 133, the hedging relationship must be formally documented at
inception and be highly effective in achieving offsetting cash flows or
offsetting changes in fair value attributable to the risk being hedged. If
hedging a forecasted transaction, the forecasted transaction must be probable.
If a derivative instrument, used as a cash flow hedge, is terminated early
because it is probable that a forecasted transaction will not occur, any gain or
loss as of such date is immediately recognized in earnings. If a derivative
instrument, used as a cash flow hedge, is terminated early for other economic
reasons, any gain or loss as of the termination date is deferred and recorded
when the forecasted transaction affects earnings. Consumers uses a combination
of quoted market prices and mathematical valuation models to determine fair
value of those contracts requiring derivative accounting. The ineffective
portion, if any, of all hedges is recognized in earnings.
The majority of Consumers' contracts are not subject to derivative
accounting because they qualify for the normal purchases and sales exception of
SFAS No. 133. Derivative accounting is required, however, for certain contracts
used to limit Consumers' exposure to electricity and gas commodity price risk
and interest rate risk.
F-33
The following table reflects the fair value of contracts requiring
derivative accounting:
In Millions
--------------------------------------------------------------------------------------------------------
September 30 2003 2002
--------------------------------------------------------------------------------------------------------
Fair Fair
Derivative Instruments Cost Value Cost Value
--------------------------------------------------------------------------------------------------------
Electric - related contracts $ - $ - $ 8 $ 1
Gas contracts 3 - - 1
Interest rate risk contracts - - - (2)
Derivative contracts associated with Consumers'
equity investment in the MCV Partnership - 10 - 7
========================================================================================================
The fair value of all derivative contracts, except the fair value of
derivative contracts associated with Consumers' equity investment in the MCV
Partnership, is included in either Other Assets or Other Liabilities on the
Balance Sheet. The fair value of derivative contracts associated with Consumers'
equity investment in the MCV Partnership is included in Investments - Midland
Cogeneration Venture Limited Partnership on the Balance Sheet. Effective April
1, 2002, the MCV Partnership changed its accounting for derivatives, see Note 2,
Uncertainties, Other Electric Uncertainties, The Midland Cogeneration Venture.
ELECTRIC CONTRACTS: Consumers' electric business uses purchased
electric call option contracts to meet, in part, its regulatory obligation to
serve. This obligation requires Consumers to provide a physical supply of
electricity to customers, to manage electric costs and to ensure a reliable
source of capacity during peak demand periods. As of September 30, 2003,
Consumers did not have any unexpired purchased electric call option contracts
subject to derivative accounting. All remaining purchased electric call option
contracts subject to derivative accounting as of June 2003, expired in the third
quarter of 2003. As of September 30, 2002, Consumers recorded on the balance
sheet all of its unexpired purchased electric call option contracts subject to
derivative accounting at a fair value of $1 million.
Consumers believes that certain of its electric capacity and energy
contracts are not derivatives due to the lack of an active energy market in the
state of Michigan, as defined by SFAS No. 133, and the transportation cost to
deliver the power under the contracts to the closest active energy market at the
Cinergy hub in Ohio. If a market develops in the future, Consumers may be
required to account for these contracts as derivatives. The mark-to-market
impact in earnings related to these contracts, particularly related to the PPA
could be material to the financial statements.
Consumers' electric business also uses gas option and swap contracts to
protect against price risk due to the fluctuations in the market price of gas
used as fuel for generation of electricity. These contracts are financial
contracts that are used to offset increases in the price of potential gas
purchases. These contracts do not qualify for hedge accounting. Therefore,
Consumers records any change in the fair value of these contracts directly in
earnings as part of power supply costs. As of September 30, 2003, gas fuel for
generation call option contracts entered into in the second quarter of 2003 had
expired. As of September 30, 2002, gas fuel for generation swap contracts had a
fair value of less than $1 million. These contracts expired in December 2002.
For the three months ended September 30, 2003, Consumers recorded an
unrealized loss in accumulated other comprehensive income related to its
proportionate share of the effects of derivative accounting related to its
equity investment in the MCV Partnership of $5 million, net of tax. For the nine
months ended September 30, 2003, Consumers recorded an unrealized gain in
accumulated other comprehensive income related to its proportionate share of the
effects of derivative accounting related to its equity investment in the MCV
Partnership of $8 million, net of tax. As of September 30, 2003, the
F-34
cumulative total of unrealized gains recorded in other accumulated comprehensive
income related to Consumers' proportionate share of the effects of derivative
accounting related to its equity investment in the MCV Partnership is $6
million, net of tax. Consumers expects to reclassify this gain, if this value
remains, as an increase to earnings from equity method investees during the next
12 months.
GAS CONTRACTS: Consumers' gas business uses fixed price gas supply
contracts, and fixed price weather-based gas supply call options and fixed price
gas supply call and put options, and other types of contracts, to meet its
regulatory obligation to provide gas to its customers at a reasonable and
prudent cost. As of September 30, 2003, weather-based gas call options and gas
call and put options requiring derivative accounting had a net fair value that
was less than $1 million. The original cost of the options was a net $3 million.
Consumers recorded an unrealized loss of $3 million associated with these
options directly in earnings as part of other income, and then directly offset
this loss and recorded it on the balance sheet as a regulatory asset. Any
subsequent changes in fair value will be recorded in a similar manner.
As of September 30, 2002, Consumers' gas supply contracts and
weather-based gas call options and gas put options requiring derivative
accounting had a fair value of $1 million, representing a fair value gain on the
contracts since the date of inception. Changes in fair value were recorded in a
similar manner as stated above for weather-based gas call options and gas call
and put options.
INTEREST RATE RISK CONTRACTS: Consumers uses interest rate swaps to
hedge the risk associated with forecasted interest payments on variable-rate
debt. These interest rate swaps are designated as cash flow hedges. As such,
Consumers records any change in the fair value of these contracts in accumulated
other comprehensive income unless the swaps are sold. As of September 30, 2003,
Consumers did not have any interest rate swaps outstanding. As of September 30,
2002, Consumers had entered into a swap to fix the interest rate on $75 million
of variable-rate debt. This swap expired in June 2003. As of September 30, 2002,
this interest rate swap had a negative fair value of $2 million.
Consumers was able to apply the shortcut method to all interest rate
hedges; therefore, there was no ineffectiveness associated with these hedges.
5: IMPLEMENTATION OF NEW ACCOUNTING STANDARDS
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Beginning
January 2003, companies must comply with SFAS No. 143. The standard requires
companies to record the fair value of the legal obligations related to an asset
retirement in the period in which it is incurred. Consumers has determined that
it has legal asset retirement obligations, particularly in regard to its nuclear
plants.
Prior to adoption of SFAS No. 143, Consumers classified the removal
cost liability of assets included in the scope of SFAS No. 143 as part of the
reserve for accumulated depreciation. For these assets, the removal cost of $448
million which was classified as part of the reserve at December 31, 2002, was
reclassified in January 2003, in part, as: 1) a $364 million ARO liability; 2) a
$134 million regulatory liability; 3) a $42 million regulatory asset; and 4) a
$7 million net increase to property, plant, and equipment as prescribed by SFAS
No. 143. As required by SFAS No. 71 for regulated entities, Consumers is
reflecting a regulatory asset and liability instead of a cumulative effect of a
change in accounting principle.
F-35
The fair value of ARO liabilities has been calculated using an expected
present value technique. This technique reflects assumptions, such as costs,
inflation, and profit margin that third parties would consider in order to take
on the settlement of the obligation. Fair value, to the extent possible, should
include a market risk premium for unforeseeable circumstances. No market risk
premium was included in Consumers' ARO fair value estimate since a reasonable
estimate could not be made. If a five percent market risk premium were assumed,
Consumers' ARO liability would be $381 million.
If a reasonable estimate of fair value cannot be made in the period the
asset retirement obligation is incurred, such as assets with an indeterminate
life, the liability is to be recognized when a reasonable estimate of fair value
can be made. Generally, transmission and distribution assets have an
indeterminate life, retirement cash flows cannot be determined and there is a
low probability of a retirement date, therefore no liability has been recorded
for these assets. No liability has been recorded for assets that have an
insignificant cumulative disposal cost, such as substation batteries. The
initial measurement of the ARO liability for Consumers' Palisades Nuclear Plant
and Big Rock Nuclear Plant is based on decommissioning studies, which are based
largely on third party cost estimates.
The following table is a general description of the AROs and their
associated long-lived assets.
September 30, 2003 In Millions
-------------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
-------------------------------------------------------------------------------------------------------------------
Palisades - decommission plant site 1972 Palisades nuclear plant $ 462
Big Rock - decommission plant site 1962 Big Rock nuclear plant 90
JHCampbell intake/discharge water line 1980 Plant intake/discharge water line
Closure of coal ash disposal areas Various Generating plants coal ash areas
Closure of wells at gas storage fields Various Gas storage fields
Indoor gas services equipment relocations Various Gas meters located inside structures
The following table is a reconciliation of the carrying amount of the
AROs.
September 30, 2003 In Millions
-------------------------------------------------------------------------------------------------------------------
pro forma ARO Liability ARO
ARO liability---------------------------- Cash flow liability
ARO 1/1/02 1/1/03 Incurred Settled Accretion Revisions 9/30/03
------------------------------------------------------------------------------------------------------------------
Palisades - decommission $232 $249 $ - $ - $ 14 $ - $ 263
Big Rock - decommission 94 61 - (28) 10 - 43
JHCampbell intake line - - - - - - -
Coal ash disposal areas 46 51 - (2) 4 - 53
Wells at gas storage fields 2 2 - - - - 2
Indoor gas services relocations 1 1 - - - - 1
---------------------------------------------------------------------------------
Total $375 $364 $ - $(30) $ 28 $ - $ 362
===================================================================================================================
SFAS NO. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES: Issued by the FASB in April 2003, this statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement is effective for contracts
entered into or modified after June 30, 2003. Implementation of this statement
has not had an impact on Consumers' Consolidated Financial Statements.
F-36
SFAS NO. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH
CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY: Issued by the FASB in May 2003,
this statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. The statement requires an issuer to classify financial instruments
within its scope as liabilities. Those instruments were previously classified as
mezzanine equity. SFAS No. 150 became effective July 1, 2003.
Consumers has four trust preferred securities outstanding as of
September 30, 2003. The trust preferred securities are issued by consolidated
subsidiaries of Consumers. Each trust holds a subordinated debenture from
Consumers. The terms of the debentures are identical to those of the trust
preferred securities, except that the debenture has an explicit maturity date.
The trust documents, in turn, require that the trust be liquidated upon the
repayment of the debenture. The trust preferred securities are redeemable upon
the liquidation of the subsidiary; and therefore, are considered equity in the
financial statements of the subsidiary.
At their October 29, 2003 Board meeting, the FASB deferred the
implementation of the portion of SFAS No. 150 relating to mandatorily redeemable
noncontrolling interests in subsidiaries when the noncontrolling interests are
classified as equity in the financial statements of the subsidiary. Consumers'
trust preferred securities are included under the deferral. As such, the
Consumers trust preferred securities continue to be accounted for under existing
accounting guidance and are included in mezzanine equity. Consumers continues to
study the FASB developments regarding the SFAS No. 150 deferral.
EITF ISSUE NO. 01-08, DETERMINING WHETHER AN ARRANGEMENT CONTAINS A
LEASE: In May 2003, the EITF reached consensus in EITF Issue No. 01-08 to
clarify the requirements of identifying whether an arrangement should be
accounted for as a lease at its inception. The guidance in the consensus is
designed to mandate reporting revenue as rental or leasing income that otherwise
would be reported as part of product sales or service revenue. EITF Issue No.
01-08 requires both parties to an arrangement to determine whether a service
contract or similar arrangement is or includes a lease within the scope of SFAS
No. 13, Accounting for Leases.
Historically, Consumers has entered into power purchase and similar
service arrangements. Prospective accounting under EITF Issue No. 01-08, could
affect the timing and classification of revenue and expense recognition. Certain
product sales and services revenue and expenses may be required to be reported
as rental or leasing income and/or expenses. The consensus is to be applied
prospectively to arrangements agreed to, modified, or acquired in business
combinations in fiscal periods beginning July 1, 2003. The adoption of EITF
Issue No. 01-08 has not impacted Consumers' results of operations, cash flows,
or financial position. Consumers will evaluate new or modified contracts under
EITF Issue No. 01-08 prospectively.
NEW ACCOUNTING STANDARDS NOT YET EFFECTIVE
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST
ENTITIES: Issued by the FASB in January 2003, FIN 46 requires the primary
beneficiary of a variable interest entity's activities to consolidate the
variable interest entity. The primary beneficiary is the party that absorbs a
majority of the expected losses and/or receives a majority of the expected
residual returns of the variable interest entity's activities. The consolidation
requirements of the interpretation apply immediately to variable interest
entities created after January 31, 2003. Consumers has not created any variable
interest entities in 2003. Therefore, this portion of the interpretation has no
impact on its consolidated financial statements. Public companies, whose fiscal
year is a calendar year, were originally required to implement the guidance in
this interpretation by the third quarter of 2003. However, on October 9, 2003,
the FASB issued FASB Staff Position No. 46-6, Effective Date of FASB
Interpretation No. 46, which defers implementation of
F-37
FIN 46 until the fourth quarter of 2003 for variable interest entities and
potential variable interest entities created before February 1, 2003.
If the completed analysis were to require Consumers to disclose
information about or consolidate in its financial statements, the assets,
liabilities and activities of the MCV Partnership and the First Midland Limited
Partnership, including the recognition of the debt of the MCV Partnership on its
financial statements, this could impact negatively Consumers' various financial
covenants under its financing agreements. As a result, Consumers may have to
seek amendments to the relevant financing agreements to modify the terms of
certain of these covenants in order to remove the effect of this potential
consolidation or refinance the relevant debt. As of September 30, 2003,
Consumers' investments in the MCV Partnership and in the FMLP were $404 million
and $222 million, respectively. For further description of the nature, purpose,
size and activities of the MCV Partnership, see Note 2, Uncertainties, Other
Electric Uncertainties, "The Midland Cogeneration Venture." Consumers is
continuing to study the implementation of this interpretation and has yet to
determine the effects, if any, on its consolidated financial statements.
EITF ISSUE 03-04, ACCOUNTING FOR CASH BALANCE PENSION PLANS: In May
2003, the EITF reached consensus in EITF Issue No. 03-04 to specifically address
the accounting for certain cash balance pension plans. EITF Issue No. 03-04
concluded that certain cash balance plans be accounted for as defined benefit
plans under SFAS No. 87, Employers' Accounting for Pensions. EITF No. 03-04
requires the use of the traditional unit credit method for the purposes of
measuring the benefit obligation and annual cost of benefits earned as opposed
to the projected unit credit method. The EITF concluded that the requirements of
this Issue be applied as of the next plan measurement date, which is December
31, 2003 for Consumers. Consumers commenced a cash balance pension plan that
covers employees hired after June 30, 2003. Consumers does account for this plan
as a defined benefit plan under SFAS No. 87. Consumers continues to evaluate the
impact, if any, this Issue will have upon adoption.
STATEMENT OF POSITION, ACCOUNTING FOR CERTAIN COSTS AND ACTIVITIES
RELATED TO PROPERTY, PLANT, AND EQUIPMENT: At its September 9, 2003 meeting, the
Accounting Standards Executive Committee voted to approve the Statement of
Position, Accounting for Certain Costs and Activities Related to Property,
Plant, and Equipment. The Statement of Position is expected to be presented for
FASB clearance late in the fourth quarter of 2003 and would be applicable for
fiscal years beginning after December 15, 2004. The Accounting Standards
Executive Committee concluded that at transition, a company would have the
flexibility to adopt a property, plant and equipment component accounting policy
for transition-date property, plant and equipment accounts. The property, plant
and equipment component policy may differ from the componentization policy, if
any, previously used by the enterprise. Selecting a policy that differs from the
company's prior level of componentization at the date of adoption of the
Statement of Position would not result in any cumulative effect difference for
adopting such a policy. A company would not have to restate its pre-adoption
assets to conform with its post-adoption componentization policy. The Accounting
Standards Executive Committee concluded that companies would be required to
disclose meaningful ranges with respect to property, plant and equipment
depreciable lives. Consumers continues to evaluate the impact, if any, this
Issue will have upon adoption.
F-38
CONSOLIDATED STATEMENTS OF INCOME CONSUMERS ENERGY COMPANY
In Millions
Years Ended December 31 2002 2001 2000
-------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE Electric $ 2,648 $ 2,633 $ 2,676
Gas 1,519 1,338 1,196
Other 2 5 6
------------------------------------
4,169 3,976 3,878
EARNINGS FROM EQUITY METHOD INVESTEES 53 38 57
OPERATING EXPENSES Operation
Fuel for electric generation 320 330 324
Purchased power - related parties 546 543 534
Purchased and interchange power 314 476 402
Cost of gas sold 831 707 616
Cost of gas sold - related parties 131 123 103
Other 660 625 555
------------------------------------
2,802 2,804 2,534
Maintenance 190 203 172
Depreciation 300 309 322
Amortization 48 30 104
General taxes 193 187 197
------------------------------------
3,533 3,533 3,329
-------------------------------------------------------------------------------------------------------------------
OPERATING Electric 512 349 454
INCOME Gas 127 97 96
Other 50 35 56
------------------------------------
689 481 606
-------------------------------------------------------------------------------------------------------------------
OTHER INCOME Dividends and interest from affiliates 3 6 10
(DEDUCTIONS) Accretion income (Note 1) - - 2
Accretion expense (Note 1) (6) (11) (9)
Other, net 25 6 (5)
------------------------------------
22 1 (2)
-------------------------------------------------------------------------------------------------------------------
INTEREST CHARGES Interest on long-term debt 153 151 141
Other interest 27 41 44
Capitalized interest (12) (6) (2)
------------------------------------
168 186 183
-------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 543 296 421
INCOME TAXES 180 97 137
------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 363 199 284
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR DERIVATIVE INSTRUMENTS,
NET OF $10 TAX EXPENSE IN 2002 (NOTE 11) AND $6 TAX BENEFIT IN 2001 (NOTE 5) 18 (11) -
------------------------------------
NET INCOME 381 188 284
PREFERRED STOCK DIVIDENDS 2 2 2
PREFERRED SECURITIES DISTRIBUTIONS 44 41 34
------------------------------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 335 $ 145 $ 248
===================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-39
CONSOLIDATED STATEMENTS OF CASH FLOWS CONSUMERS ENERGY COMPANY
In Millions
Years Ended December 31 2002 2001 2000
---------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM Net income $ 381 $ 188 $ 284
OPERATING ACTIVITIES Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $6, $6 and $39, respectively) 348 339 426
Deferred income taxes and investment tax credit 280 136 (21)
Capital lease and other amortization 15 20 32
Gain on sale of METC and other assets (38) - -
Loss on CMS Energy stock 12 - -
Cumulative effect of accounting change (18) 11 -
Undistributed earnings of related parties (net
of dividends, $15, $8 and $8, respectively) (38) (30) (49)
Changes in assets and liabilities
Decrease (increase) in accounts receivable
and accrued revenue (98) 149 (178)
Increase (decrease) in accounts payable (30) 53 19
Decrease (increase) in inventories 90 (307) (59)
Changes in other assets and liabilities (135) (41) 61
-------------------------------
Net cash provided by operating activities 769 518 515
---------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM Capital expenditures (excludes assets placed under capital
INVESTING ACTIVITIES lease) (559) (745) (498)
Cost to retire property, net (66) (118) (125)
Investment in Electric Restructuring Implementation Plan (8) (13) (29)
Investments in nuclear decommissioning trust funds (6) (6) (39)
Associated company preferred stock redemption - 50 50
Proceeds from nuclear decommissioning trust funds 30 29 37
Cash proceeds from sale of METC and other assets 298 - -
-------------------------------
Net cash used in investing activities (311) (803) (604)
---------------------------------------------------------------------------------- -------------------------------
CASH FLOWS FROM Retirement of bonds and other long-term debt (574) (401) (9)
FINANCING ACTIVITIES Payment of common stock dividends (231) (190) (245)
Preferred securities distributions (44) (41) (34)
Redemption of preferred securities (30) - -
Payment of capital lease obligations (15) (20) (32)
Contribution from (return of equity to) stockholder, net 50 (14) -
Payment of preferred stock dividends (2) (1) (2)
Increase (decrease) in notes payable, net 41 13 189
Proceeds from preferred securities, net - 121 -
Restricted cash on hand (14) (4) -
Proceeds from senior notes and bank loans 601 355 225
Proceeds from securitization bonds, net - 459 -
-------------------------------
Net cash provided by (used in) financing activities (218) 277 92
---------------------------------------------------------------------------------------- -------------------------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENT 240 (8) 3
Cash and temporary cash investments - Beginning of year 13 21 18
-------------------------------
End of year $ 253 $ 13 $ 21
===========================================================================================================================
OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
CASH TRANSACTIONS
Interest paid (net of amounts capitalized) $ 147 $ 169 $ 165
Income taxes paid (net of refunds, $205, $53 and $15, respectively) (78) 3 133
Pension and OPEB cash contribution 120 96 -
NON-CASH TRANSACTIONS
Nuclear fuel placed under capital lease $ - $ 13 $ 4
Other assets placed under capital lease 62 37 15
===========================================================================================================================
All highly liquid investments with an original maturity of three months or less
are considered cash equivalents.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-40
CONSOLIDATED BALANCE SHEETS CONSUMERS ENERGY COMPANY
ASSETS In Millions
December 31 2002 2001
-------------------------------------------------------------------------------------------------------------
PLANT (AT ORIGINAL COST) Electric $ 7,523 $ 7,661
Gas 2,719 2,593
Other 23 23
--------------------
$10,265 $10,277
Less accumulated depreciation, depletion
and amortization 5,900 5,934
--------------------
4,365 4,343
Construction work-in-progress 548 480
---------------------
4,913 4,823
-------------------------------------------------------------------------------------------------------------
INVESTMENTS Stock of affiliates 22 57
First Midland Limited Partnership 255 253
Midland Cogeneration Venture Limited Partnership 388 300
Consumers Nuclear Services, LLC 2 2
---------------------
667 612
-------------------------------------------------------------------------------------------------------------
CURRENT ASSETS Cash and temporary cash investments at cost, which
approximates market 253 13
Restricted cash 18 4
Accounts receivable and accrued revenue, less allowances
of $5 in 2002 and $4 in 2001 236 125
Accounts receivable - related parties 13 18
Inventories at average cost
Gas in underground storage 486 569
Materials and supplies 71 69
Generating plant fuel stock 37 52
Deferred property taxes 142 144
Regulatory assets 19 19
Other 38 14
---------------------
1,313 1,027
-------------------------------------------------------------------------------------------------------------
NON-CURRENT ASSETS Regulatory Assets
Securitized costs 689 717
Postretirement benefits 185 209
Abandoned Midland project 11 12
Other 168 167
Nuclear decommissioning trust funds 536 581
Other 218 173
---------------------
1,807 1,859
-------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 8,700 $ 8,321
=============================================================================================================
F-41
CONSUMERS ENERGY COMPANY
STOCKHOLDERS' INVESTMENT AND LIABILITIES
In Millions
December 31 2002 2001
-------------------------------------------------------------------------------------------------------------------
CAPITALIZATION (NOTE 3) Common stockholder's equity
Common stock, authorized - 125.0 shares; $ 841 $ 841
outstanding 84.1 shares for all periods
Paid-in capital 682 632
Other comprehensive income (loss) (179) 4
Retained earnings since December 31, 1992 545 441
-----------------------------
1,889 1,918
Preferred stock 44 44
Company-obligated mandatorily redeemable
preferred securities of subsidiaries (a) 490 520
Long-term debt 2,442 2,472
Non-current portion of capital leases 116 72
-----------------------------
4,981 5,026
-------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES Current portion of long-term debt and capital leases 318 257
Notes payable 457 416
Accounts payable 261 282
Accrued taxes 214 214
Accounts payable - related parties 84 96
Current portion of purchase power contracts 26 24
Deferred income taxes 25 12
Other 200 233
-----------------------------
1,585 1,534
-------------------------------------------------------------------------------------------------------------------
NON-CURRENT LIABILITIES Deferred income taxes 949 784
Postretirement benefits 563 290
Regulatory liabilities for income taxes, net 297 276
Power purchase agreement - MCV Partnership 27 52
Deferred investment tax credit 91 102
Other 207 257
-----------------------------
2,134 1,761
-------------------------------------------------------------------------------------------------------------------
Commitments and Contingencies (Notes 1, 2, 8, and 11)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $ 8,700 $ 8,321
===================================================================================================================
(a) See Note 3, Short-Term Financings and Capitalization
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-42
CONSOLIDATED STATEMENTS OF LONG-TERM DEBT CONSUMERS ENERGY COMPANY
In Millions
December 31 Series(%) Due 2002 2001
---------------------------------------------------------------------------------------
FIRST MORTGAGE BONDS
6-3/8 2003 $ - $ 300
7-3/8 2023 208 208
-----------------------
208 508
SENIOR NOTES Floating 2002 - 100
6-3/8 2008 159 159
6-7/8 2018 180 180
6-1/5 2008 (a) 250 250
6-1/2 2018 (b) 141 141
6-1/2 2028 142 143
6-1/4 2006 332 332
6-0/0 2005 300 -
-----------------------
1,504 1,305
LONG-TERM BANK DEBT 328 184
POLLUTION CONTROL REVENUE BONDS 126 126
SECURITIZATION BONDS 453 469
OTHER 8 8
NUCLEAR FUEL DISPOSAL (C) 138 135
-----------------------
1,053 922
TOTAL PRINCIPAL AMOUNT OUTSTANDING 2,765 2,735
CURRENT AMOUNTS (305) (244)
NET UNAMORTIZED DISCOUNT (18) (19)
-----------------------
TOTAL LONG-TERM DEBT $ 2,442 $ 2,472
=======================================================================================
LONG-TERM DEBT MATURITIES
In Millions
First Mortgage Senior Long-Term Securitization
Bonds Notes Bank Debt Bonds Other Total
------------------------------------------------------------------------------------------------
2003 $ - $ 250(a) $ 28 $ 27 $ - $ 305
2004 - - 300 28 - 328
2005 - 441(b) - 29 - 470
2006 - 332 - 30 - 362
2007 - - - 31 - 31
Thereafter 208 481 - 308 272 1,269
---------------------------------------------------------------------------------
Total $208 $1,504 $ 328 $ 453 $ 272 $ 2,765
================================================================================================
(a) These Notes are subject to a Call Option by the Callholder or a Mandatory
Put on May 1, 2003
(b) Includes $141 Senior Remarketed Notes subject to optional redemption by
Consumers after June 15, 2005
(c) Due date uncertain (see Note 1)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-43
CONSOLIDATED STATEMENTS OF PREFERRED STOCK CONSUMERS ENERGY COMPANY
Optional
Redemption Number of Shares In Millions
December 31 Series Price 2002 2001 2002 2001
-------------------------------------------------------------------------------------------------------
PREFERRED STOCK
Cumulative, $100 par value,
authorized 7,500,000 shares,
with no mandatory redemption $4.16 $ 103.25 68,451 68,451 $ 7 $ 7
4.50 110.00 373,148 373,148 37 37
-------------
TOTAL PREFERRED STOCK $ 44 $ 44
=======================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-44
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY CONSUMERS ENERGY COMPANY
In Millions
Years Ended December 31 2002 2001 2000
----------------------------------------------------------------------------------------------------------------------
COMMON STOCK At beginning and end of period (a) $ 841 $ 841 $ 841
----------------------------------------------------------------------------------------------------------------------
OTHER PAID-IN CAPITAL At beginning of period 632 646 645
Stockholder's contribution 150 150 -
Return of stockholder's contribution (100) (164) -
Miscellaneous - - 1
--------------------------------
At end of period 682 632 646
----------------------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE INCOME (LOSS)
Minimum Pension Liability
At beginning of period - - -
Minimum pension liability adjustments (b) (185) - -
--------------------------------
At end of period (185) - -
Investments
At beginning of period 16 33 37
Unrealized gain (loss) on investments (b) (16) (16) (4)
Reclassification adjustments included in net income (b) 1 (1) -
--------------------------------
At end of period 1 16 33
Derivative Instruments (d)
At beginning of period (c) (12) 18 -
Unrealized gain (loss) on derivative instruments (b) 10 (30) -
Reclassification adjustments included in net income (b) 7 - -
--------------------------------
At end of period 5 (12) -
----------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS At beginning of period 441 486 485
Net income (b) 381 188 284
Cash dividends declared - Common Stock (231) (190) (247)
Cash dividends declared - Preferred Stock (2) (2) (2)
Preferred securities distributions (44) (41) (34)
--------------------------------
At end of period 545 441 486
----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKHOLDER'S EQUITY $ 1,889 $ 1,918 $ 2,006
======================================================================================================================
F-45
(a) Number of shares of common stock outstanding was 84,108,789 for all periods
presented
(b) Disclosure of Comprehensive Income:
Other comprehensive income
Minimum Pension Liability
Minimum pension liability adjustments, net of tax of
$100, $- and $-, respectively $ (185) $ - $ -
Investments
Unrealized loss on investments, net of tax of
$9, $9 and $2, respectively (16) (16) (4)
Reclassification adjustments included in net income, net of tax of
$1, $1 and $-, respectively 1 (1) -
Derivative Instruments
Unrealized gain (loss) on derivative instruments, net of tax of
$6, $15 and $-, respectively 10 (30) -
Reclassification adjustments included in net income, net of tax of
$4, $- and $-, respectively 7 - -
Net income 381 188 284
-----------------------------
Total Comprehensive Income $ 198 $ 141 $ 280
=============================
(c) Cumulative effect of change in accounting principle, as of 1/1/01 and
7/1/01, net of $(9) tax (Note 5)
(d) Included in these amounts is Consumers' proportionate share of the effects
of derivative accounting related to its equity investment in the MCV
Partnership as follows:
At the beginning of the period $ (8) $ 5 $ -
Unrealized gain (loss) on derivative instruments 12 (15) -
Reclassification adjustments included in net income 4 2 -
-------------------------------
At the end of period $ 8 $ (8) $ -
===============================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-46
CONSUMERS ENERGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1: CORPORATE STRUCTURE AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CORPORATE STRUCTURE: Consumers, a subsidiary of CMS Energy, a holding company,
is an electric and gas utility company that provides service to customers in
Michigan's Lower Peninsula. Consumers' customer base includes a mix of
residential, commercial and diversified industrial customers, the largest
segment of which is the automotive industry.
BASIS OF PRESENTATION: The consolidated financial statements include Consumers
and its wholly owned subsidiaries. Consumers uses the equity method of
accounting for investments in companies and partnerships where it has more than
a twenty percent but less than a majority ownership interest and includes these
results in operating income. Consumers prepared the financial statements in
conformity with accounting principles generally accepted in the United States
that include the use of management's estimates.
USE OF ESTIMATES: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements. Estimates and
assumptions are also used in the disclosure of contingent assets and liabilities
and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The principles in SFAS No. 5 guide the recording of estimated liabilities for
contingencies within the financial statements. SFAS No. 5 requires a company to
record estimated liabilities in the financial statements when a current event
has caused a probable future payment of an amount that can be reasonably
estimated. Consumers has used this accounting principle to record estimated
liabilities discussed in Note 2, Uncertainties.
REVENUE RECOGNITION POLICY: Revenues from deliveries of electricity and natural
gas, and the storage of natural gas, are recognized as services are provided.
Therefore, revenues include the accrual of electricity or gas consumed and/or
delivered, but not billed at month-end.
ACCRETION INCOME AND EXPENSE: In 1991, the MPSC allowed Consumers to recover a
portion of its abandoned Midland investment over a 10-year period, but did not
allow Consumers to earn a return on that amount. Consumers reduced the
recoverable investment to the present value of the future recoveries. During the
recovery period, Consumers adjusts the unrecovered asset to its present value.
It reflects this adjustment as accretion income. In 1992, Consumers recorded a
loss for the present value of its estimated future underrecoveries of power
supply costs resulting from purchases from the MCV Partnership (see Note 2). It
now recognizes accretion expense annually to reflect the time value of money on
the recorded loss. Accretion expense is also recognized for some non-interest
bearing long-term electric option contracts for which Consumers has recorded a
liability at the present value of the contracts.
GAS INVENTORY: Consumers uses the weighted average cost method for valuing
working gas inventory. Beginning October 2000, gas inventory also includes
recoverable cushion gas. Consumers records non-recoverable cushion gas in the
appropriate gas utility plant account. Consumers stores gas inventory in its
underground storage facilities.
F-47
Property, Plant and Equipment: Additions to property, plant and equipment are
recorded at cost when first placed into service. When regulated assets are
retired, or otherwise disposed of in the ordinary course of the business, the
original cost and cost of removal, less salvage, is charged to accumulated
depreciation. With respect to the retirement or disposal of non-regulated assets
the resulting gains or losses are recognized as a component of income. Consumers
is permitted to capitalize an allowance for funds used during construction on
regulated construction projects and to include such amounts in plant in service.
Property, plant and equipment at December 31, 2002 and 2001, was as follows:
In Millions
-------------------------------------------------------------------------------------------------------------------
Estimated
Depreciable
Years Ended December 31 Life in Years 2002 2001
-------------------------------------------------------------------------------------------------------------------
Electric:
Generation 13-75 $3,489 $3,368
Transmission 40-75 - 450
Distribution 12-85 3,619 3,448
Other 5-50 300 288
Capital Leases (b) 115 107
Gas:
Underground storage facilities (a) 25-55 217 210
Transmission 15-68 310 303
Distribution 35-70 1,899 1,807
Other 5-45 237 220
Capital Leases (b) 56 53
Other:
Non-utility property 7-71 23 23
Construction work-in-progress (c) 548 480
Less accumulated depreciation, depletion and amortization 5,900 5,934
-------------------------------------------------------------------------------------------------------------------
Net property, plant and equipment $4,913 $4,823
===================================================================================================================
(a) Includes unrecoverable base natural gas in underground storage of $23
million and $14 million at December 31, 2002 and 2001, respectively, which
is not subject to depreciation.
(b) Capital leases presented in this chart are gross amounts. Amortization of
capital leases in 2002 and 2001 was $96 million and $91 million,
respectively. Capital leases are amortized over the lease term or the
service life of the assets in accordance with SFAS No. 13.
(c) Amount includes construction costs at December 31, 2002 and 2001 of $54
million and $16 million, respectively, relating to the capital lease of
Consumers main headquarters.
MAINTENANCE, DEPRECIATION, DEPLETION AND AMORTIZATION: Consumers charges
property repairs and minor property replacements to maintenance expense.
Depreciable property retired or sold, plus cost of removal (net of salvage
credits), is charged to accumulated depreciation. Consumers bases depreciation
provisions for utility property on straight-line and units-of-production rates
approved by the MPSC. For 2002, 2001 and 2000, the composite depreciation rate
for electric utility property was 3.1 percent annually. For 2002, 2001 and 2000,
the composite rate for gas utility property was 4.5 percent, 4.4 percent and 4.4
percent, respectively. For 2002, 2001 and 2000, the composite rate for other
property was 7.2 percent, 11.2 percent and 10.7 percent, respectively.
F-48
FINANCIAL INSTRUMENTS: Consumers accounts for its debt and equity investment
securities in accordance with SFAS No. 115. As such, debt and equity securities
can be classified into one of three categories: held-to-maturity, trading, or
available-for-sale securities. Consumers' investments in equity securities,
including its investment in CMS Energy Common Stock, are classified as
available-for-sale securities. They are reported at fair value, with any
unrealized gains or losses from changes in fair value reported in equity as part
of other comprehensive income and excluded from earnings, unless such changes in
fair value are other than temporary. In 2002, Consumers determined that the
decline in value related to its investment in CMS Energy Common Stock was other
than temporary as the fair value was below the cost basis for a period greater
than six months. As a result, Consumers recognized a loss on its investment in
CMS Energy Common Stock through earnings of $12 million in the fourth quarter of
2002. As of December 31, 2002, Consumers held 2.4 million shares of CMS Energy
Common Stock with a fair value of $22 million; as of March 14, 2003 the value
was $8 million. Unrealized gains or losses from changes in the fair value of
Consumers' nuclear decommissioning investments are reported in accumulated
depreciation. The fair value of these investments is determined from quoted
market prices.
NUCLEAR FUEL COST: Consumers amortizes nuclear fuel cost to fuel expense based
on the quantity of heat produced for electric generation. Through November 2001,
Consumers expensed the interest on leased nuclear fuel as it was incurred.
Effective December 2001, Consumers no longer leases its nuclear fuel.
For nuclear fuel used after April 6, 1983, Consumers charges disposal costs to
nuclear fuel expense, recovers these costs through electric rates, and then
remits them to the DOE quarterly. Consumers elected to defer payment for
disposal of spent nuclear fuel burned before April 7, 1983. As of December 31,
2002, Consumers has a recorded liability to the DOE of $138 million, including
interest, which is payable upon the first delivery of spent nuclear fuel to the
DOE. Consumers recovered through electric rates the amount of this liability,
excluding a portion of interest.
NUCLEAR PLANT DECOMMISSIONING: In 2002, Consumers collected $6 million from its
electric customers for the decommissioning of its Palisades nuclear plant.
Amounts collected from electric retail customers and deposited in trusts
(including trust earnings) are credited to accumulated depreciation. In March
2001, Consumers filed updated decommissioning cost estimates for Big Rock and
Palisades that were $349 million and $739 million in 2000 dollars, respectively.
Using the inflation factors presented in the filing to the MPSC, the Palisades
estimated decommissioning cost in 2002 dollars is $809 million. The Big Rock
decommissioning cost in 2002 dollars is $327 million. Consumers' site-specific
decommissioning cost estimates for Big Rock and Palisades assume that each plant
site will eventually be restored to conform to the adjacent landscape, and all
contaminated equipment will be disassembled and disposed of in a licensed burial
facility. On December 31, 2000, Big Rock trusts were fully funded per the March
22, 1999 MPSC order and Consumers discontinued depositing funds in the trust. In
December 2000, the NRC extended the Palisades operating license to March 2011
and the impact of this extension was included as part of Consumers' March 2001
filing with the MPSC. Consumers is required to file the next "Report on the
Adequacy of the Existing Annual Provision for Nuclear Plant Decommissioning"
(Report) with the MPSC by March 31, 2004.
In 1997, Big Rock closed permanently and plant decommissioning began. Consumers
estimates that the Big Rock site will be returned to a natural state by the end
of 2012 if the DOE begins removing the spent nuclear fuel by 2010. In 2002,
Consumers incurred costs of $28 million that were charged to the accumulated
depreciation reserve for decommissioning and withdrew $30 million from the Big
Rock nuclear decommissioning trust fund. In total, Consumers has incurred costs
of $218 million that have been charged to the accumulated depreciation reserve
for decommissioning and withdrew $209 million from the Big Rock nuclear
decommissioning trust fund. These activities had no material impact on net
income. At December 31, 2002, Consumers is the beneficiary of the investment in
nuclear decommissioning trust funds of $110 million for Big Rock.
F-49
After retirement of Palisades, Consumers plans to maintain the facility in
protective storage if radioactive waste disposal facilities are not available.
Consumers will incur most of the Palisades decommissioning costs after the
plant's NRC operating license expires. Palisades' current NRC license will
expire in 2011 and the trust funds were estimated to have accumulated $921
million by that time, assuming currently approved MPSC surcharge levels.
Consumers estimates that at the time Palisades is fully decommissioned in the
year 2049, the trust funds will have provided $2.5 billion, including trust
earnings, to pay for the anticipated expenditures over the entire
decommissioning period. At December 31, 2002, Consumers is the beneficiary of
the investment in the MPSC nuclear decommissioning trust funds of $416 million
for Palisades. In addition, at December 31, 2002, Consumers has a FERC
decommissioning trust fund with a balance of approximately $9 million.
UNAMORTIZED DEBT PREMIUM, DISCOUNT AND EXPENSE: Consumers amortizes premiums,
discounts and expenses incurred in connection with the issuance of presently
outstanding long-term debt over the terms of the respective issues. For the
regulated portions of our businesses, if debt is refinanced, Consumers amortizes
any unamortized premiums, discounts and expenses over the term of the new debt,
as allowed under regulated utility accounting.
RECLASSIFICATIONS: Consumers reclassified certain prior year amounts for
comparative purposes. These reclassifications did not affect consolidated net
income for the years presented.
RELATED-PARTY TRANSACTIONS: Consumers completed a five-year redemption of its
investment of $250 million in ten shares of Enterprises' preferred stock in
2001. The balances as of December 31, 2002, 2001 and 2000 were $0, $0 and $50
million, respectively. Consumers has an investment in 2.4 million shares of CMS
Energy Common Stock with a fair value totaling $22 million at December 31, 2002,
see Note 5. In 2002, 2001 and 2000, Consumers received dividends from these two
investments totaling $3 million, $6 million, and $10 million, respectively. In
2002, 2001, and 2000, Consumers paid parent company overhead costs to CMS Energy
of $18 million, $11 million and $1 million, respectively. Such overhead costs
were allocated to Consumers using the Massachusetts Formula.
In 2002, 2001 and 2000, Consumers paid $49 million, $55 million and $51 million,
respectively, for electric generating capacity and energy from affiliates of
Enterprises. From time to time, Consumers purchased a portion of its gas from
CMS Oil and Gas and CMS MST. In both 2002 and 2001, Consumers did not make a
purchase from CMS Oil and Gas. In 2000, Consumers purchased $3 million. In 2002,
2001 and 2000, Consumers' gas purchases from CMS MST were $127 million, $120
million and $95 million, respectively. Consumers pays a portion of its gas
transportation costs to Panhandle and its subsidiary Trunkline. In 2002, 2001
and 2000 transportation fees paid were $22 million, $21 million and $38 million,
respectively. In 2002, 2001, and 2000, Consumers paid $4 million, $4 million and
$1 million, respectively, for gas transportation from CMS Bay Area Pipeline,
L.L.C.. In 2002, 2001 and 2000, Consumers and its subsidiaries sold, stored and
transported natural gas and provided other services to the MCV Partnership
totaling $27 million, $27 million and $26 million, respectively. For additional
discussion of related-party transactions with the MCV Partnership and the FMLP,
see Notes 2 and 11. Other related-party transactions are immaterial.
UTILITY REGULATION: Consumers accounts for the effects of regulation based on
the regulated utility accounting standard SFAS No. 71. As a result, the actions
of regulators affect when Consumers recognizes revenues, expenses, assets and
liabilities.
In March 1999, Consumers received MPSC electric restructuring orders, which,
among other things, identified the terms and timing for implementing electric
restructuring in Michigan. Consistent with these orders and EITF No. 97-4,
Consumers discontinued the application of SFAS No. 71 for the energy supply
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portion of its business because Consumers expected to implement retail open
access at competitive market based rates for its electric customers.
Discontinuation of SFAS No. 71 for the energy supply portion of Consumers'
business resulted in Consumers reducing the carrying value of its Palisades
plant-related assets, in 1999, by approximately $535 million and establishing a
regulatory asset for a corresponding amount. As of December 31, 2002, Consumers
had a net investment in energy supply facilities of $1.475 billion included in
electric plant and property.
Since 1999, there has been a significant legislative and regulatory change in
Michigan that has resulted in: 1) electric supply customers of utilities
remaining on cost-based rates and 2) utilities being given the ability to
recover Stranded Costs associated with electric restructuring, from customers
who choose an alternative electric supplier. During 2002, Consumers re-evaluated
the criteria used to determine if an entity or a segment of an entity meets the
requirements to apply regulated utility accounting, and determined that the
energy supply portion of its business could meet the criteria if certain
regulatory events occurred. In December 2002, Consumers received a MPSC Stranded
Cost order that allowed Consumers to re-apply regulatory accounting standard
SFAS No. 71 to the energy supply portion of its business. Re-application of SFAS
No. 71 had no effect on the prior discontinuation accounting, but will allow
Consumers to apply regulatory accounting treatment to the energy supply portion
of its business on a prospective basis, including regulatory accounting
treatment of costs required to be recognized in accordance with SFAS No. 143.
See Note 2, Uncertainties, "Electric Rate Matters - Electric Restructuring."
SFAS No. 144 imposes strict criteria for retention of regulatory-created assets
by requiring that such assets be probable of future recovery at each balance
sheet date. Management believes these assets are probable of future recovery.
The following regulatory assets (liabilities), which include both current and
non-current amounts, are reflected in the Consolidated Balance Sheets. These
costs are expected to be recovered through rates over periods of up to 14 years.
Consumers recognized an OPEB transition obligation in accordance with SFAS No.
106 and established a regulatory asset for this amount, which it expects to
recover in rates over the next ten years.
In Millions
----------------------------------------------------------------------------------------------------------------
December 31 2002 2001
----------------------------------------------------------------------------------------------------------------
Securitized costs (Note 2) $ 689 $ 717
Postretirement benefits (Note 7) 204 228
Electric Restructuring Implementation Plan (Note 2) 83 82
Manufactured gas plant sites (Note 2) 69 70
Abandoned Midland project 11 12
Income taxes (Note 4) - 6
Other 16 15
--------------------------
Total regulatory assets $ 1,072 $ 1,130
================================================================================================================
Income taxes (Note 4) $ (297) $ (282)
GCR over recovery (11) (9)
Other (5) -
--------------------------
Total regulatory liabilities $ (313) $ (291)
================================================================================================================
In October 2000, Consumers received an MPSC order authorizing Consumers to
securitize certain regulatory assets up to $469 million, net of tax, see Note 2,
Uncertainties, "Electric Rate Matters -
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Electric Restructuring". Accordingly, in December 2000, Consumers established a
regulatory asset for securitized costs of $709 million, before tax, that had
previously been recorded in other regulatory asset accounts. In order to prepare
for the financing of the securitized assets and the subsequent retirement of
debt with Securitization proceeds, issuance fees of $1 million, $10 million and
$1 million were incurred in 2002, 2001 and 2000, respectively, and capitalized
as a part of Securitization costs. These issuance costs are amortized each month
for up to fourteen years. Amortization of the Securitized assets approximated
$29 million and $2 million in 2002 and 2001, respectively, for accumulated
securitized cost amortization of $31 million. The components of the unamortized
securitized costs are illustrated below.
In Millions
----------------------------------------------------------------------------------------------------------------
December 31 2002 2001
----------------------------------------------------------------------------------------------------------------
Unamortized nuclear costs $ 405 $ 405
Postretirement benefits 84 84
Income taxes 203 203
Uranium enrichment facility 16 16
Accumulated Securitization cost amortization (31) (2)
Other 12 11
---------------------------
Total unamortized securitized costs $ 689 $ 717
================================================================================================================
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS
SFAS NO. 142, GOODWILL AND OTHER INTANGIBLE ASSETS: This standard issued in July
2001, requires that goodwill no longer be amortized to earnings, but instead be
reviewed for impairment. Effective January 1, 2002, the provisions of SFAS No.
142 had no impact on Consumers' consolidated results of operations or financial
position.
SFAS NO. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS:
This new standard was issued by the FASB in October 2001, and supersedes SFAS
No. 121, and APB Opinion No. 30. SFAS No. 144 requires long-lived assets to be
measured at the lower of either the carrying amount or of the fair value less
the cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable value or include amounts for operating losses that have not yet
occurred. SFAS No. 144 also broadens the reporting of discontinued operations to
include all components of an entity with operations that can be distinguished
from the rest of the entity and that will be eliminated from the ongoing
operations of the entity in a disposal transaction. The adoption of SFAS No.
144, effective January 1, 2002, results in Consumers accounting for any
impairment or disposal of long-lived assets under the provisions of SFAS No. 144
subsequent to January 1, 2002, but will not change the accounting used for
previous asset impairments or disposals.
SFAS NO. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS: Issued by the FASB in April 2002,
this standard rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishment of Debt Made to Satisfy
Sinking-Fund Requirements. As a result, any gain or loss on extinguishment of
debt should be classified as an extraordinary item only if it meets the criteria
set forth in APB Opinion No. 30. The provisions of this section are applicable
to fiscal years beginning 2003, but may be adopted early. Consumers has adopted
this provision early, with no material affect to its income statement. SFAS No.
145 amends SFAS No. 13, Accounting for Leases, to require sale-leaseback
accounting for certain lease modifications that have similar economic impacts to
sale-leaseback transactions. This provision is effective for transactions
occurring after May 15, 2002. Finally, SFAS No. 145 amends other existing
authoritative pronouncements to make various technical corrections and rescinds
SFAS No. 44,
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Accounting for Intangible Assets of Motor Carriers. These provisions are
effective for financial statements issued on or after May 15, 2002. Upon
adoption of the standard, there was no impact on Consumers' financial
statements.
SFAS NO. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND
DISCLOSURE: Issued by the FASB in December 2002, this standard provides for
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, the
statement amends the disclosure requirements of SFAS No. 123 to require more
prominent and more frequent disclosures in financial statements about the
effects of stock-based compensation. The transition guidance and annual
disclosure provisions of the statement are effective as of December 31, 2002 and
interim disclosure provisions are effective for interim financial reports
starting in 2003. Consumers decided to voluntarily adopt the fair value based
method of accounting for stock-based employee compensation effective December
31, 2002, applying the prospective method of adoption which requires recognition
of all employee awards granted, modified, or settled after the beginning of the
year in which the recognition provisions are first applied. Therefore, Consumers
recorded $1.7 million in expense for the fair value of stock options issued in
2002.
NEW ACCOUNTING STANDARDS TO BE ADOPTED
SFAS NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS: Beginning January 1,
2003, companies must comply with SFAS No. 143. The standard requires companies
to record the fair value of the legal obligations related to an asset retirement
in the period in which it is incurred. Consumers has determined that it has
legal asset retirement obligations, particularly in regard to its nuclear
plants, but has not yet finalized its assessment of the obligation. However,
upon initial adoption of the standard, Consumers expects to record a regulatory
liability, as well as an asset retirement obligation, as required by SFAS No.
71. The regulatory liability recognizes the difference between the cost of
removal included in the reserve for accumulated depreciation for assets within
the scope of SFAS No. 143 and the accretion expense of the asset retirement
obligation and the depreciation expense of the asset retirement obligation asset
from when the obligation was initially incurred through December 2002. When the
asset retirement obligation liability is initially recorded, the company would
capitalize an offsetting amount by increasing the carrying amount of the related
long-lived asset. Over time, the initial liability would be accreted to its
present value each period and the capitalized cost would be depreciated over the
related asset's useful life.
SFAS NO. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES:
Issued by the FASB in July 2002, this standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. This standard is
effective for exit or disposal activities initiated after December 31, 2002.
Consumers does not expect the adoption of SFAS No. 146 to have a material impact
on its financial position or results of operations.
FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENT
FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS:
Effective January 2003, this interpretation elaborates on the disclosure to be
made by a guarantor about its obligations under certain guarantees that it has
issued. It also requires that a guarantor recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and measurement provision of this
interpretation does not apply to certain guarantee contracts, such as
warranties, derivatives, or guarantees between either parent and subsidiaries or
corporations under common control, although disclosure of such guarantees is
required. For contracts that are within the initial recognition and measurement
provision of this interpretation, the provisions are to be applied to guarantees
issued or modified after December 31, 2002; no cumulative effect adjustments are
required.
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Following is a general description of Consumers' guarantees as required by this
Interpretation:
December 31, 2002 In Millions
-------------------------------------------------------------------------------------------------------------------
Issue Expiration Maximum Carrying Recourse
Guarantee Description Date Date Obligation Amount Provision(a)
Standby letters of credit Various Various $ 7 $ - $ -
Surety bonds Various Various 9 - -
Nuclear insurance retrospective premiums Various Various 120 - -
===================================================================================================================
(a) Recourse provision indicates the approximate recovery from third parties
including assets held as collateral.
Following is additional information regarding Consumers' guarantees:
December 31, 2002
--------------------------------------------------------------------------------------------------------------------
Events That Would
Guarantee Description How Guarantee Arose Require Performance
--------------------------------------------------------------------------------------------------------------------
Standby letters of credit Normal operations of Non-compliance with
coal power plants environmental regulations
Self insurance requirement Non-performance
Surety bonds Normal operating activity, Non-performance
permits and license
Nuclear insurance retrospective premiums Normal operations of Call by NEIL and
nuclear plants Price-Anderson Act
for nuclear incident
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Issued
by the FASB in January 2003, the interpretation expands upon and strengthens
existing accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
The consolidation requirements of the interpretation apply immediately to
variable interest entities created after January 31, 2003. For Consumers, the
consolidation requirements apply to pre-existing entities beginning July 1,
2003. Certain of the disclosure requirements apply to all financial statements
initially issued after January 31, 2003. Consumers will be required to
consolidate any entities that meet the requirements of the interpretation.
Consumers is in the process of studying the interpretation, and has yet to
determine the effects, if any, on its consolidated financial statements.
OTHER: For significant accounting policies regarding income taxes, see Note 4;
for derivatives , see Note 5; for executive incentive compensation, see Note 6;
for pensions and other postretirement benefits, see Note 7; and for leases, see
Note 8.
2: UNCERTAINTIES
Several business trends or uncertainties may affect Consumers' financial results
and condition. These trends or uncertainties have, or Consumers reasonably
expects could have, a material impact on net sales, revenues, or income from
continuing electric operations. Such trends and uncertainties are discussed in
detail below and include: 1) pending litigation and government investigations;
2) the need to make additional capital expenditures and increase operating
expenses for Clean Air Act compliance; 3) environmental liabilities arising from
various federal, state and local environmental laws and regulations, including
potential liability or expenses relating to the Michigan Natural Resources and
Environmental Protection Acts and Superfund; 4) electric industry restructuring
issues; 5) Consumers' ability to meet
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peak electric demand requirements at a reasonable cost, without market
disruption, and successfully implement initiatives to reduce exposure to
purchased power price increases; 6) the recovery of electric restructuring
implementation costs; 7) Consumers new status as an electric transmission
customer and not as an electric transmission owner/operator; 8) sufficient
reserves for OATT rate refunds; 9) uncertainties relating to the storage and
ultimate disposal of spent nuclear fuel and the successful operation of
Palisades by NMC; 10) the effects of derivative accounting and potential
earnings volatility; 11) potential environmental costs at a number of sites,
including sites formerly housing manufactured gas plant facilities; 12) future
gas industry restructuring initiatives; 13) any initiatives undertaken to
protect customers against gas price increases; 14) an inadequate regulatory
response to applications for requested rate increases; 15) market and regulatory
responses to increases in gas costs, including a reduced average use per
residential customer; and 16) Consumers' continuing ability to raise funds at
reasonable rates in order to meet the cash requirements of its electric and gas
business.
SEC AND OTHER INVESTIGATIONS: As a result of the round-trip trading transactions
at CMS MST, CMS Energy's Board of Directors established a Special Committee of
independent directors to investigate matters surrounding the transactions and
retained outside counsel to assist in the investigation. The Special Committee
completed its investigation and reported its findings to the Board of Directors
in October 2002. The Special Committee concluded, based on an extensive
investigation, that the round-trip trades were undertaken to raise CMS MST's
profile as an energy marketer with the goal of enhancing its ability to promote
its services to new customers. The Special Committee found no apparent effort to
manipulate the price of CMS Energy Common Stock or affect energy prices. The
Special Committee also made recommendations designed to prevent any reoccurrence
of this practice, most of which have already been implemented. Previously, CMS
Energy terminated its speculative trading business and revised its risk
management policy. The Board of Directors adopted, and CMS Energy has begun
implementing, the remaining recommendations of the Special Committee.
CMS Energy is cooperating with other investigations concerning round-trip
trading, including an investigation by the SEC regarding round-trip trades and
CMS Energy's financial statements, accounting policies and controls, and
investigations by the United States Department of Justice, the Commodity Futures
Trading Commission and the FERC.CMS Energy has also received subpoenas from U.S.
Attorneys Offices regarding investigations of those trades. CMS Energy is unable
to predict the outcome of these matters, and Consumers is unable to predict what
effect, if any, these investigations will have on its business.
SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of
securities class action complaints have been filed against CMS Energy,
Consumers, and certain officers and directors of CMS Energy and its affiliates.
The complaints have been filed in the United States District Court for the
Eastern District of Michigan as purported class actions by individuals who
allege that they purchased CMS Energy's securities during a purported class
period. At least two of the complaints contain purported class periods beginning
on August 3, 2000 and running through May 10, 2002 or May 14, 2002. These
complaints generally seek unspecified damages based on allegations that the
defendants violated United States securities laws and regulations by making
allegedly false and misleading statements about the company's business and
financial condition. The cases have been consolidated into a single lawsuit and
an amended and consolidated complaint is due to be filed by May 1, 2003. CMS
Energy and Consumers intend to vigorously defend against this action. Consumers
cannot predict the outcome of this litigation.
ERISA CASES: Consumers is a named defendant, along with CMS Energy, CMS MST and
certain named and unnamed officers and directors in two lawsuits brought as
purported class actions on behalf of participants and beneficiaries of the
401(k) plan. The two cases, filed in July 2002 in the United States District
Court for the Eastern District of Michigan, were consolidated by the trial judge
and an amended
F-55
and consolidated complaint has been filed. Plaintiffs allege breaches of
fiduciary duties under ERISA and seek restitution on behalf of the plan with
respect to a decline in value of the shares of CMS Energy Common Stock held in
the plan. Plaintiffs also seek other equitable relief and legal fees. These
cases will be vigorously defended. Consumers cannot predict the outcome of this
litigation.
ELECTRIC CONTINGENCIES
ELECTRIC ENVIRONMENTAL MATTERS: Consumers is subject to costly and increasingly
stringent environmental regulations. Consumers expects that the cost of future
environmental compliance, especially compliance with clean air laws, will be
significant.
Clean Air - In 1998, the EPA issued final regulations requiring the state of
Michigan to further limit nitrogen oxide emissions. The Michigan Department of
Environmental Quality finalized rules to comply with the EPA final regulations
in December 2002 and submitted these rules for approval to the EPA in the first
quarter of 2003. In addition, 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 regulations. The EPA and the state
final regulations will require Consumers to make significant capital
expenditures estimated to be $770 million. As of December 31, 2002, Consumers
has incurred $405 million in capital expenditures to comply with the EPA final
regulations and anticipates that the remaining capital expenditures will be
incurred between 2003 and 2009. Additionally, Consumers currently expects to
supplement its compliance plan with the purchase of nitrogen oxide emissions
credits for years 2005 through 2008. The cost of these credits based on the
current market is estimated to average $6 million per year, however, the market
for nitrogen oxide emissions credits is volatile and the price could change
significantly. At some point, if new environmental standards become effective,
Consumers may need additional capital expenditures to comply with the future
standards. Based on the Customer Choice Act, beginning January 2004, an annual
return of and on these types of capital expenditures, to the extent they are
above depreciation levels, is expected to be recoverable from customers, subject
to an MPSC prudency hearing.
These and other required environmental expenditures, if not recovered from
customers in Consumers' rates, may have a material adverse effect upon
Consumers' financial condition and results of operations.
Cleanup and Solid Waste - Under the Michigan Natural Resources and Environmental
Protection Act, Consumers expects that it will ultimately incur investigation
and remedial action costs at a number of sites. Consumers believes that these
costs will be recoverable in rates under current ratemaking policies.
Consumers is a potentially responsible party at several contaminated sites
administered under Superfund. Superfund liability is joint and several. Along
with Consumers, many other creditworthy, potentially responsible parties with
substantial assets cooperate with respect to the individual sites. Based upon
past negotiations, Consumers estimates that its share of the total liability for
the known Superfund sites will be between $1 million and $9 million. As of
December 31, 2002, Consumers had accrued the minimum amount of the range for its
estimated Superfund liability.
During routine maintenance activities, Consumers identified PCB as a component
in certain paint, grout and sealant materials at the Ludington Pumped Storage
facility. Consumers removed and replaced part of the PCB material. Consumers has
proposed a plan to deal with the remaining materials and is awaiting a response
from the EPA.
F-56
ELECTRIC RATE MATTERS
ELECTRIC RESTRUCTURING: In June 2000, the Michigan legislature passed electric
utility restructuring legislation known as the Customer Choice Act. This act: 1)
permits all customers to choose their electric generation supplier beginning
January 1, 2002; 2) cut residential electric rates by five percent; 3) freezes
all electric rates through December 31, 2003, and establishes a rate cap for
residential customers through at least December 31, 2005, and a rate cap for
small commercial and industrial customers through at least December 31, 2004; 4)
allows for the use of low-cost Securitization bonds to refinance qualified
costs, as defined by the act; 5) establishes a market power supply test that may
require transferring control of generation resources in excess of that required
to serve firm retail sales requirements (a requirement Consumers believes itself
to be in compliance with at this time); 6) requires Michigan utilities to join a
FERC-approved RTO or divest their interest in transmission facilities to an
independent transmission owner (Consumers has sold its interest in its
transmission facilities to an independent transmission owner, see "Transmission"
below); 7) requires Consumers, Detroit Edison and American Electric Power to
jointly expand their available transmission capability by at least 2,000 MW; 8)
allows deferred recovery of an annual return of and on capital expenditures in
excess of depreciation levels incurred during and before the rate freeze/cap
period; and 9) allows recovery of "net" Stranded Costs and implementation costs
incurred as a result of the passage of the act. In July 2002, the MPSC issued an
order approving the plan to achieve the increased transmission capacity.
Consumers has completed the transmission capacity projects identified in the
plan and has submitted verification of this fact to the MPSC. Consumers believes
it is in full compliance with item 7 above. Consumers is also highly confident
that it will meet the conditions contained in item 5 above, prior to the
earliest rate cap termination dates specified in the act. Failure to do so,
however, could result in an extension of the rate caps to as late as December
31, 2013.
In 1998, Consumers submitted a plan for electric retail open access to the MPSC.
In March 1999, the MPSC issued orders generally supporting the plan. The
Customer Choice Act states that the MPSC orders issued before June 2000 are in
compliance with this act and enforceable by the MPSC. Those MPSC orders: 1)
allow electric customers to choose their supplier; 2) authorize recovery of
"net" Stranded Costs and implementation costs; and 3) confirm any voluntary
commitments of electric utilities. In September 2000, as required by the MPSC,
Consumers once again filed tariffs governing its retail open access program and
made revisions to comply with the Customer Choice Act. In December 2001, the
MPSC approved revised retail open access tariffs. The revised tariffs establish
the rates, terms, and conditions under which retail customers will be permitted
to choose an alternative electric supplier. The tariffs, effective January 1,
2002, did not require significant modifications in the existing retail open
access program. The tariff terms allow retail open access customers, upon as
little as 30 days notice to Consumers, to return to Consumers' generation
service at current tariff rates. If any class of customers' (residential,
commercial, or industrial) retail open access load reaches 10 percent of
Consumers' total load for that class of customers, then returning retail open
access customers for that class must give 60 days notice to return to Consumers'
generation service at current tariff rates. However, Consumers may not have
sufficient, reasonably priced, capacity to meet the additional demand of
returning retail open access customers, and may be forced to purchase
electricity on the spot market at higher prices than it could recover from its
customers. Consumers cannot predict the total amount of electric supply load
that may be lost to competitor suppliers, nor whether the stranded cost recovery
method adopted by the MPSC will be applied in a manner that will fully offset
any associated margin loss.
SECURITIZATION: In October 2000 and January 2001, the MPSC issued orders
authorizing Consumers to issue Securitization bonds. Securitization typically
involves issuing asset-backed bonds with a higher credit rating than
conventional utility corporate financing. The orders authorized Consumers to
securitize approximately $469 million in qualified costs, which were primarily
regulatory assets plus recovery of the Securitization expenses. Securitization
resulted in lower interest costs and a longer amortization period
F-57
for the securitized assets, and offset the majority of the impact of the
required residential rate reduction (approximately $22 million in 2000 and $49
million annually thereafter). The orders directed Consumers to apply any cost
savings in excess of the five percent residential rate reduction to rate
reductions for non-residential customers and reductions in Stranded Costs for
retail open access customers after the bonds are sold. Excess savings are
approximately $12 million annually.
In November 2001, Consumers Funding issued $469 million of Securitization bonds,
Series 2001-1. The Securitization bonds mature at different times over a period
of up to 14 years, with an average interest rate of 5.3 percent. The last
expected maturity date is October 20, 2015. Net proceeds from the sale of the
Securitization bonds, after issuance expenses, were approximately $460 million.
Consumers used the net proceeds to retire $164 million of its common equity from
its parent, CMS Energy. CMS Energy used the $164 million from Consumers to pay
down its own short-term debt. From December 2001 through March 2002, the
remainder of these proceeds were used to pay down Consumers' long-term debt and
Trust Preferred Securities. CMS Energy used the $164 million from Consumers to
pay down its own short-term debt.
Consumers and Consumers Funding will recover the repayment of principal,
interest and other expenses relating to the bond issuance through a
securitization charge and a tax charge that began in December 2001. These
charges are subject to an annual true-up until one year prior to the last
expected bond maturity date, and no more than quarterly thereafter. The first
true-up occurred in November 2002, and prospectively modified the total
securitization and related tax charges from 1.677 mills per kWh to 1.746 mills
per kWh. Current electric rate design covers these charges, and there will be no
rate impact for most Consumers electric customers until the Customer Choice Act
rate freeze expires. Securitization charge collections, $52 million in 2002, are
remitted to a trustee for the Securitization bonds. Securitization charge
collections are dedicated for the repayment of the principle and interest on the
Securitization bonds and payment of the ongoing expenses of Consumers Funding
and can only be used for those purposes. Consumers Funding is legally separate
from Consumers. The assets and income of Consumers Funding, including without
limitation, the securitized property, are not available to creditors of
Consumers or CMS Energy.
Regulatory assets are normally amortized over their period of regulated
recovery. Beginning January 1, 2001, the amortization was deferred for the
approved regulatory assets being securitized, which effectively offset the loss
in revenue in 2001 resulting from the five percent residential rate reduction.
In December 2001, after the Securitization bonds were sold, the amortization was
re-established, based on a schedule that is the same as the recovery of the
principal amounts of the securitized qualified costs. In 2002, the accumulated
amortization amount was approximately $31 million and the securitized assets
will be fully amortized by the end of 2015.
On March 4, 2003, Consumers filed an application with the MPSC seeking approval
to issue Securitization bonds in the amount of approximately $1.084 billion. If
approved, this would allow the recovery of costs associated with Clean Air Act
expenditures, post-2000 Palisades expenditures, and retail open access
implementation costs through December 31, 2003, and certain pension fund
expenses, and expenses associated with the issuance of the bonds.
TRANSMISSION: In 1999, the FERC issued Order No. 2000, strongly encouraging
electric utilities to transfer operating control of their electric transmission
system to an RTO, or sell the facilities to an independent company. In addition,
in June 2000, the Michigan legislature passed Michigan's Customer Choice Act,
which also requires utilities to divest or transfer the operating authority of
transmission facilities to an independent company. Consumers chose to offer its
electric transmission system for sale rather than own and invest in an asset
that it could not control. In May 2002, Consumers sold its electric
F-58
transmission system (METC) for approximately $290 million in cash to MTH, a
non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect Inc.
Trans-Elect, Inc. submitted the winning bid through a competitive bidding
process, and various federal agencies approved the transaction. Consumers did
not provide any financial or credit support to Trans-Elect, Inc. Certain of
Trans-Elect's officers and directors are former officers and directors of CMS
Energy, Consumers and their subsidiaries. None of them were employed by CMS
Energy, Consumers, or their affiliates when the transaction was discussed
internally and negotiated with purchasers. As a result of the sale, Consumers
experienced an after-tax earnings increase of approximately $17 million in 2002,
due to the recognition of a $26 million gain on the sale of the electric
transmission system. This gain from the sale is offset by a loss of revenue from
wholesale and retail open access customers who will buy services directly from
MTH, including the loss of a return on the sold electric transmission system.
Consumers anticipates that the future impact of the loss of revenue from
wholesale and retail open access customers who will buy services directly from
MTH and the loss of a return on the sold electric transmission system on its
after-tax earnings will be a decrease of $15 million in 2003, and a decrease of
approximately $14 million annually for the next three years.
Under the agreement with MTH, and subject to certain additional RTO surcharges,
transmission rates charged to Consumers are fixed by contract at current levels
through December 31, 2005, and subject to FERC ratemaking thereafter. MTH has
completed the capital program to expand the transmission system's capability to
import electricity into Michigan, as required by the Customer Choice Act, and
Consumers will continue to maintain the system under a five-year contract with
MTH. Effective April 30, 2002, Consumers and METC withdrew from the Alliance
RTO, and MTH (METC) has joined the MISO RTO.
When IPPs connect to transmission systems, they pay transmission companies the
capital costs incurred to connect the IPP to the transmission system and make
system upgrades needed for the interconnection. It is the FERC's policy that the
system upgrade portion of these IPP payments be credited against transmission
service charges over time as transmission service is taken. METC recorded a $35
million liability for IPP credits. Subsequently, MTH assumed this liability as
part of its purchase of the electric transmission system. Several months after
METC started operation, the FERC changed its policy to provide for interest on
IPP payments that are to be credited. The $35 million liability for IPP credits
does not include interest since the associated interconnection agreements do not
at this time provide for interest. MTH has asserted that Consumers may be liable
for interest on the IPP payments to be credited if interest provisions are added
to these agreements. Consumers believes that any potential liability would not
have a material adverse affect on its financial condition.
POWER SUPPLY COSTS: During periods when electric demand is high, the cost of
purchasing electricity on the spot market can be substantial. To reduce
Consumers' exposure to the fluctuating cost of electricity, and to ensure
adequate supply to meet demand, Consumers intends to maintain sufficient
generation and to purchase electricity from others to create a power supply
reserve, also called a reserve margin. The reserve margin provides additional
power supply capability above Consumers' anticipated peak power supply demands.
It also allows Consumers to provide reliable service to its electric service
customers and to protect itself against unscheduled plant outages and
unanticipated demand. In recent years, Consumers has planned for a reserve
margin of approximately 15 percent from a combination of its owned electric
generating plants and electricity purchase contracts or options, as well as
other arrangements. However, in light of various factors, including the addition
of new generating capacity in Michigan and throughout the Midwest region and
additional transmission import capability, Consumers is continuing to evaluate
the appropriate reserve margin for 2003 and beyond. Currently, Consumers has an
estimated reserve margin of approximately 11 percent for summer 2003 or 111
percent of projected summer peak load. Of the 111 percent, approximately 101
percent is met from owned electric generating plants and long-term
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power purchase contracts and 10 percent from short-term contracts and options
for physical deliveries and other agreements. The ultimate use of the reserve
margin needed will depend primarily on summer weather conditions, the level of
retail open access requirements being served by others during the summer, and
any unscheduled plant outages. As of mid-March 2003, alternative electric
suppliers are providing 516 MW of generation supply to ROA customers. Consumers'
reserve margin does not include generation being supplied by other alternative
electric suppliers under the ROA program.
To reduce the risk of high electric prices during peak demand periods and to
achieve its reserve margin target, Consumers employs a strategy of purchasing
electric call option and capacity contracts for the physical delivery of
electricity primarily in the summer months and to a lesser degree in the winter
months. As of December 31, 2002, Consumers had purchased or had commitments to
purchase electric call option and capacity contracts partially covering the
estimated reserve margin requirements for 2003 through 2007. As a result
Consumers has a recognized asset of $30 million for unexpired call options and
capacity contracts. The total cost of electricity call option and capacity
contracts for 2002 was $13 million.
Prior to 1998, the PSCR process provided for the reconciliation of actual power
supply costs with power supply revenues. This process assured recovery of all
reasonable and prudent power supply costs actually incurred by Consumers,
including the actual cost for fuel, and purchased and interchange power. In
1998, as part of the electric restructuring efforts, the MPSC suspended the PSCR
process, and would not grant adjustment of customer rates through 2001. As a
result of the rate freeze imposed by the Customer Choice Act, the current rates
will remain in effect until at least December 31, 2003 and, therefore, the PSCR
process remains suspended. Therefore, changes in power supply costs as a result
of fluctuating electricity prices will not be reflected in rates charged to
Consumers' customers during the rate freeze period.
ELECTRIC PROCEEDINGS: The Customer Choice Act allows electric utilities to
recover the act's implementation costs and "net" Stranded Costs (without
defining the term). The act directs the MPSC to establish a method of
calculating "net" Stranded Costs and of conducting related true-up adjustments.
In December 2001, the MPSC adopted a methodology which calculated "net" Stranded
Costs as the shortfall between: (a) the revenue required to cover the costs
associated with fixed generation assets, generation-related regulatory assets,
and capacity payments associated with purchase power agreements, and (b) the
revenues received from customers under existing rates available to cover the
revenue requirement. The MPSC authorized Consumers to use deferred accounting to
recognize the future recovery of costs determined to be stranded. Consumers has
initiated an appeal at the Michigan Court of Appeals related to the MPSC's
December 2001 "net" Stranded Cost order.
According to the MPSC, "net" Stranded Costs were to be recovered from retail
open access customers through a Stranded Cost transition charge. In April 2002,
Consumers made "net" Stranded Cost filings with the MPSC for $22 million and $43
million for 2000 and 2001, respectively. In the same filing, Consumers estimated
that it would experience "net" Stranded Costs of $126 million for 2002.
Consumers in its hearing brief, filed in August 2002, revised its request for
Stranded Costs to $7 million and $4 million for 2000 and 2001, respectively, and
an estimated $73 million for 2002. The single largest reason for the difference
in the filing was the exclusion, as ordered by the MPSC, of all costs associated
with expenditures required by the Clean Air Act.
In December 2002, the MPSC issued an order finding that Consumers experienced
zero "net" Stranded Costs in 2000 and 2001, but declined to establish a defined
methodology that would allow a reliable prediction of the level of Stranded
Costs for 2002 and future years. In January 2003, Consumers filed a petition for
rehearing of the December 2002 Stranded Cost order in which it asked the MPSC to
grant a rehearing and revise certain features of the order. Several other
parties also filed rehearing petitions with
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the MPSC. As noted above, Consumers has filed a request with the MPSC for
authority to issue securitization bonds that would allow recovery of the Clean
Air Act expenditures and post-2000 Palisades expenditures that were excluded
from the Stranded Cost calculation.
On March 4, 2003, Consumers filed an application with the MPSC seeking approval
of "net" Stranded Costs incurred in 2002, and for approval of a "net" Stranded
Cost recovery charge. In the application, Consumers indicated that if Consumers'
proposal to securitize Clean Air Act expenditures and post-2000 Palisades'
expenditures were approved as proposed in its securitization case as discussed
above, then Consumers' "net" Stranded Costs incurred in 2002 are approximately
$35 million. If the proposal to securitize those costs is not approved, then
Consumers indicated that the costs would be properly included in the 2002 "net"
Stranded Cost calculation, which would increase Consumers' 2002 "net" Stranded
Costs to approximately $103 million. Consumers cannot predict the recoverability
of Stranded Costs, and therefore has not recorded any regulatory assets to
recognize the future recovery of such costs.
The MPSC staff has scheduled a collaborative process to discuss Stranded Costs
and related issues and to identify and make recommendations to the MPSC.
Consumers intends to participate in this collaborative process.
Since 1997, Consumers has incurred significant electric utility restructuring
implementation costs. The following table outlines the applications filed by
Consumers with the MPSC and the status of recovery for these costs.
In Millions
-------------------------------------------------------------------------------------------------------------------
Year Filed Year Incurred Requested Pending Allowed Disallowed
-------------------------------------------------------------------------------------------------------------------
1999 1997 & 1998 $ 20 $ - $ 15 $ 5
2000 1999 30 - 25 5
2001 2000 25 - 20 5
2002 2001 8 8 - -
2003 2002 2 2 - -
===================================================================================================================
The MPSC disallowed certain costs based upon a conclusion that these amounts did
not represent costs incremental to costs already reflected in electric rates. In
the orders received for the years 1997 through 2000, the MPSC also reserved the
right to review again the total implementation costs depending upon the progress
and success of the retail open access program, and ruled that due to the rate
freeze imposed by the Customer Choice Act, it was premature to establish a cost
recovery method for the allowable implementation costs. In addition to the
amounts shown above, as of December 2002, Consumers incurred and deferred as a
regulatory asset, $1 million of additional implementation costs and has also
recorded as a regulatory asset $13 million for the cost of money associated with
total implementation costs. Consumers believes the implementation costs and the
associated cost of money are fully recoverable in accordance with the Customer
Choice Act. Cash recovery from customers will probably begin after the rate
freeze or rate cap period has expired. Consumers cannot predict the amounts the
MPSC will approve as allowable costs.
Consumers is also pursuing authorization at the FERC for MISO to reimburse
Consumers for approximately $8 million in certain electric utility restructuring
implementation costs related to its former participation in the development of
the Alliance RTO, a portion of which has been expensed. However, Consumers
cannot predict the amount the FERC will ultimately order to be reimbursed by the
MISO.
In 1996, Consumers filed new OATT transmission rates with the FERC for approval.
Interveners contested these rates, and hearings were held before an ALJ in 1998.
In 1999, the ALJ made an initial
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decision that was largely upheld by the FERC in March 2002, which requires
Consumers to refund, with interest, over-collections for past services as
measured by the FERC's finally approved OATT rates. Since the initial decision,
Consumers has been reserving a portion of revenues billed to customers under the
filed 1996 OATT rates. Consumers submitted revised rates to comply with the FERC
final order in June 2002. Those revised rates were accepted by the FERC in
August 2002 and Consumers is in the process of computing refund amounts for
individual customers. Consumers believes its reserve is sufficient to satisfy
its refund obligation. As of December 2002, Consumers had paid $17 million in
refunds.
In November 2002, the MPSC, upon its own motion, commenced a contested
proceeding requiring each utility to give reason as to why its rates should not
be reduced to reflect new personal property multiplier tables, and why it should
not refund any amounts that it receives as refunds from local governments as
they implement the new multiplier tables. Consumers responded to the MPSC that
it believes that refunds would be inconsistent with the electric rate freeze
that is currently in effect, and may otherwise be unlawful. Consumers is unable
to predict the outcome of this matter.
OTHER ELECTRIC UNCERTAINTIES
THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and operates
the MCV Facility, contracted to sell electricity to Consumers for a 35-year
period beginning in 1990 and to supply electricity and steam to Dow. Consumers,
through two wholly owned subsidiaries, holds the following assets related to the
MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general
partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through
FMLP, a 35 percent lessor interest in the MCV Facility.
Consumers' consolidated retained earnings include undistributed earnings from
the MCV Partnership for the years 2002, 2001 and 2000 of $226 million, $184
million, and $168 million, respectively.
Summarized Statements of Income for CMS Midland and CMS Holdings
In Millions
-------------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 2000
-------------------------------------------------------------------------------------------------------------------
Earnings from Equity Method Investees $52 $38 $ 57
Operating taxes and other 18 13 19
Cumulative effect of a change in accounting for
derivatives, net of $10 million tax expense (Note 11) 18 - -
-------------------------------------------------------------------------------------------------------------------
Net income $52 $25 $ 38
===================================================================================================================
Power Supply Purchases from the MCV Partnership - Consumers' annual obligation
to purchase capacity from the MCV Partnership is 1,240 MW through the
termination of the PPA in 2025. The PPA requires Consumers to pay, based on the
MCV Facility's availability, a levelized average capacity charge of 3.77 cents
per kWh, a fixed energy charge, and a variable energy charge based primarily on
Consumers' average cost of coal consumed for all kWh delivered. Since January 1,
1993, the MPSC has permitted Consumers to recover capacity charges averaging
3.62 cents per kWh for 915 MW, plus a substantial portion of the fixed and
variable energy charges. Since January 1, 1996, the MPSC has also permitted
Consumers to recover capacity charges for the remaining 325 MW of contract
capacity with an initial average charge of 2.86 cents per kWh increasing
periodically to an eventual 3.62 cents per kWh by 2004 and thereafter. However,
due to the current freeze of Consumers' retail rates that the Customer Choice
Act requires, the capacity charge for the 325 MW is now frozen at 3.17 cents per
kWh. Recovery of both
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the 915 MW and 325 MW portions of the PPA are subject to certain limitations
discussed below. After September 2007, the PPA's terms obligate Consumers to pay
the MCV Partnership only those capacity and energy charges that the MPSC has
authorized for recovery from electric customers.
In 1992, Consumers recognized a loss and established a PPA liability for the
present value of the estimated future underrecoveries of power supply costs
under the PPA based on MPSC cost recovery orders. Primarily as a result of the
MCV Facility's actual availability being greater than management's original
estimates, the PPA liability has been reduced at a faster rate than originally
anticipated. At December 31, 2002, 2001 and 2000, the remaining after-tax
present value of the estimated future PPA liability associated with the loss
totaled $34 million, $50 million and $64 respectively. The PPA liability is
expected to be depleted in late 2004. For further discussion on the impact of
the frozen PSCR, see "Electric Rate Matters" in this Note.
In March 1999, Consumers and the MCV Partnership reached a settlement agreement
effective January 1, 1999, that addressed, among other things, the ability of
the MCV Partnership to count modifications increasing the capacity of the
existing MCV Facility for purposes of computing the availability of contract
capacity under the PPA for billing purposes. That settlement agreement capped
availability payments that may be billed by the MCV Partnership at a 98.5
percent level.
When Consumers returns, as expected, to unfrozen rates beginning in 2004,
Consumers will recover from customers, on-peak and off-peak capacity, so long as
availability does not exceed an average 88.7 percent established in previous
MPSC orders. For availability payments billed by the MCV Partnership after
September 15, 2007, and not recovered from customers, Consumers would expect to
claim a regulatory out under the PPA. If the MCV Facility's generating
availability remains at the maximum 98.5 percent level during the next five
years, Consumers' after-tax cash underrecoveries associated with the PPA could
be as follows:
In Millions
-------------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
-------------------------------------------------------------------------------------------------------------------
Estimated cash underrecoveries at 98.5%, net of tax $37 $36 $36 $36 $ 25
===================================================================================================================
It is currently estimated that 51 percent of the actual cash underrecoveries for
the years 2003 and 2004 will be charged to the PPA liability, with the remaining
portion charged to operating expense as a result of Consumers' 49 percent
ownership in the MCV Partnership. All cash underrecoveries will be expensed
directly to income once the PPA liability is depleted.
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.
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NUCLEAR MATTERS: Throughout 2002, Big Rock, currently in decommissioning,
progressed on plan with building and equipment dismantlement to return the site
to a natural setting free for any future use. Periodic NRC inspection reports
continued to reflect positively on Big Rock project performance. The NRC found
all decommissioning activities were performed in accordance with applicable
regulatory and license conditions.
In February 2003, the NRC completed its end-of-cycle plant performance
assessment of Palisades. The end-of-cycle review for Palisades covered the 2002
calendar year. The NRC determined that Palisades was operated in a manner that
preserved public health and safety and fully met all cornerstone objectives.
Based on the plant's performance, only regularly scheduled inspections are
planned through March 2004. The NRC noted that they are planning inspections of
the new independent spent fuel storage facility as needed during construction
activities along with routine inspections for the new security requirements.
Spent Nuclear Fuel Storage: During the fourth quarter of 2002, equipment
fabrication, assembly and testing was completed at Big Rock on NRC approved
transportable steel and concrete canisters or vaults, commonly known as
"dry-casks" for temporary onsite storage of spent fuel and movement of fuel from
the fuel pool to dry casks began. As of March 2003, all of the seven dry casks
had been loaded with spent fuel. These transportable dry casks will remain
onsite until the DOE moves the material to a permanent national fuel repository.
At Palisades, the amount of spent nuclear fuel discharged from the reactor to
date exceeds Palisades' temporary on-site storage pool capacity. Consequently,
Consumers is using NRC-approved steel and concrete vaults, "dry casks", for
temporary on-site storage. As of December 31, 2002, Consumers had loaded 18 dry
casks with spent nuclear fuel at Palisades. Palisades will need to load
additional dry casks by the fall of 2004 in order to continue operation.
Palisades currently has three empty storage-only dry casks on-site, with storage
pad capacity for up to seven additional loaded dry casks. Consumers anticipates
that licensed transportable dry casks for additional storage, along with more
storage pad capacity, will be available prior to 2004.
In 1997, a federal court decision has confirmed that the DOE was to begin
accepting deliveries of spent nuclear fuel for disposal by January 31, 1998.
Subsequent litigation in which Consumers and certain other utilities
participated has not been successful in producing more specific relief for the
DOE's failure to comply.
In July 2000, the DOE reached a settlement agreement with one utility to address
the DOE's delay in accepting spent fuel. The DOE may use that settlement
agreement as a framework that it could apply to other nuclear power plants.
However, certain other utilities challenged the validity of the mechanism for
funding the settlement in an appeal, and recently the reviewing court sustained
their challenge. Additionally, there are two court decisions that support the
right of utilities to pursue damage claims in the United States Court of Claims
against the DOE for failure to take delivery of spent fuel. A number of
utilities have commenced litigation in the Court of Claims. If the litigation
that was commenced in the fourth quarter of 2002, against the DOE is successful,
Consumers anticipates future recoveries from the DOE to defray the significant
costs it will incur for the storage of spent fuel until the DOE takes possession
as required by law.
On March 26, 2003, the Michigan Environmental Council, the Public Interest
Research Group in Michigan, and the Michigan Consumer Federation filed a
complaint with the MPSC that asks the MPSC to commence a generic investigation
and contested case to review all facts and issues concerning the recovery of
costs associated with spent nuclear fuel storage and disposal. The complaint
alleges that the rates of Consumers Energy, The Detroit Edison Company, Indiana
& Michigan Electric Company,
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Wisconsin Electric Power Company and Wisconsin Public Service Corporation are
unjust and unreasonable with respect to the recovery of costs associated with
spent nuclear fuel storage and disposal. The complaint seeks a variety of
relief, including the establishing of external trusts to which amounts collected
in electric rates for spent nuclear fuel storage and disposal should be
transferred, and the adoption of additional measures to assure that adequate
funds are available for the storage and disposal of spent nuclear fuel.
Consumers has not had an opportunity to review the complaint in detail.
In July 2002, Congress approved and the President signed a bill designating the
site at Yucca Mountain, Nevada, for the development of a repository for the
disposal of high-level radioactive waste and spent nuclear fuel. The next step
will be for the DOE to submit an application to the NRC for a license to begin
construction of the repository. The application and review process is estimated
to take several years.
Palisades Plant Operations: In December 2000, the NRC issued an amendment
revising the operating license for Palisades to extend its expiration date to
March 2011, with no restrictions related to reactor vessel embrittlement.
In 2000, Consumers made an equity investment and entered into an operating
agreement with NMC. NMC was formed in 1999 by four utilities to operate and
manage the nuclear generating plants owned by these utilities. Consumers
benefits by consolidating expertise, cost control and resources among all of the
nuclear plants being operated on behalf of the NMC member companies.
In November 2000, Consumers requested approval from the NRC to transfer
operating authority for Palisades to NMC and the request was granted in April
2001. The formal transfer of authority from Consumers to NMC took place in May
2001. Consumers retains ownership of Palisades, its 789 MW output, the current
and future spent fuel on-site, and ultimate responsibility for the safe
operation, maintenance and decommissioning of the plant. Under the agreement
that transferred operating authority of the plant to NMC, salaried Palisades'
employees became NMC employees on July 1, 2001. Union employees work under the
supervision of NMC pursuant to their existing labor contract as Consumers'
employees. NMC currently has responsibility for operating eight units with 4,500
MW of generating capacity in Wisconsin, Minnesota, Iowa and Michigan.
Following a refueling outage in April 2001, the Palisades reactor was shut down
on June 20, 2001 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 all the components.
Installation of the new components was completed in December 2001. The plant was
returned to service on January 21, 2002 and has been in continuous operation
with the exception of three days in December 2002 when there was a transmission
line related outage. Consumers' capital expenditures for the components and
their installation was approximately $31 million.
From the start of the June 20th outage through the end of 2001, the impact on
net income of replacement power supply costs associated with the outage was
approximately $59 million. Subsequently, in January 2002, the impact on 2002 net
income was $5 million.
Insurance: Consumers maintains primary and excess nuclear property insurance
from NEIL, totaling $2.7 billion in recoverable limits for the Palisades nuclear
plant. Consumers also procures coverage from NEIL that would partially cover the
cost of replacement power during certain prolonged accidental outages at
Palisades. NEIL's policies include coverage for acts of terrorism.
Consumers retains the risk of loss to the extent of the insurance deductibles
and to the extent that its loss exceeds its policy limits. Because NEIL is a
mutual insurance company, Consumers could be subject to
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assessments from NEIL up to $25.8 million in any policy year if insured losses
in excess of NEIL's maximum policyholders surplus occur at its, or any other
member's nuclear facility.
Consumers maintains nuclear liability insurance for injuries and off-site
property damage resulting from the nuclear hazard at Palisades for up to
approximately $9.5 billion, the maximum insurance liability limits established
by the Price-Anderson Act. Congress enacted the Price-Anderson Act to provide
financial protection for persons who may be liable for a nuclear accident or
incident and persons who may be injured by a nuclear incident. The
Price-Anderson Act was recently extended to December 31, 2003. Part of the
Price-Anderson Act's financial protection consists of a mandatory industry-wide
program under which owners of nuclear generating facilities could be assessed if
a nuclear incident occurs at any of such facilities. The maximum assessment
against Consumers could be $88 million per occurrence, limited to maximum annual
installment payments of $10 million. Consumers also maintains insurance under a
master worker program that covers tort claims for bodily injury to workers
caused by nuclear hazards. The policy contains a $300 million nuclear industry
aggregate limit. Under a previous insurance program providing coverage for
claims brought by nuclear workers, Consumers remains responsible for a maximum
assessment of up to $6.3 million. The Big Rock plant remains insured for nuclear
liability by a combination of insurance and United States government indemnity
totaling $544 million.
Insurance policy terms, limits and conditions are subject to change during the
year as Consumers renews its policies.
CAPITAL EXPENDITURES: In 2003, 2004, and 2005, Consumers estimates electric
capital expenditures, including new lease commitments and environmental costs
under the Clean Air Act, of $341 million, $408 million, and $385 million,
respectively.
COMMITMENTS FOR FUTURE PURCHASES: Consumers enters into a number of
unconditional purchase obligations that represent normal business operating
contracts. These contracts are used to assure an adequate supply of goods and
services necessary for the operation of its business and to minimize exposure to
market price fluctuations. Consumers believes that these future costs are
prudent and reasonably assured of recovery in future rates.
Coal Supply: Consumers has entered into coal supply contracts with various
suppliers for its coal-fired generating stations. Under the terms of these
agreements, Consumers is obligated to take physical delivery of the coal and
make payment based upon the contract terms. Consumers' current contracts have
expiration dates that range from 2003 to 2005, and total an estimated $276
million. Long-term coal supply contracts account for approximately 60 to 90
percent of Consumers annual coal requirements. In 2002, coal purchases totaled
$247 million of which $224 million (88 percent of the tonnage requirement) was
under long-term contract. Consumers supplements its long-term contracts with
spot-market purchases.
Power Supply, Capacity and Transmission: As of December 31, 2001, Consumers had
future unrecognized commitments to purchase power supply and transmission
services under fixed price forward contracts for the years 2003 and 2004
totaling $15 million. Consumers also had commitments to purchase capacity and
energy under long-term power purchase agreements with various generating plants
including the MCV Facility. These contracts require monthly capacity payments
based on the plants' availability or deliverability. These payments for the
years 2003 through 2030 total an estimated $16 billion, undiscounted, which
includes $12 billion related to the MCV Facility. This amount may vary depending
upon plant availability and fuel costs. If a plant were not available to deliver
electricity to Consumers, then Consumers would not be obligated to make the
capacity payment until the plant could deliver. For further information, see
Note 2, Uncertainties, "The Midland Cogeneration Venture" for information
concerning power purchases from the MCV Facility.
F-66
GAS CONTINGENCIES
GAS ENVIRONMENTAL MATTERS: Under the Michigan Natural Resources and
Environmental Protection Act, Consumers expects that it will ultimately incur
investigation and remedial action costs at a number of sites. These include 23
former manufactured gas plant facilities, which were operated by Consumers for
some part of their operating lives, including sites in which it has a partial or
no current ownership interest. Consumers has completed initial investigations at
the 23 sites. For sites where Consumers has received site-wide study plan
approvals, it will continue to implement these plans. It will also work toward
closure of environmental issues at sites as studies are completed. Consumers has
estimated its costs related to further investigation and remedial action for all
23 sites using the Gas Research Institute-Manufactured Gas Plant Probabilistic
Cost Model. The estimated total costs are between $82 million and $113 million;
these estimates are based on discounted 2001 costs and follow EPA recommended
use of discount rates between 3 and 7 percent for this type of activity.
Consumers expects to recover a significant portion of these costs through
insurance proceeds and through MPSC approved rates charged to its customers. As
of December 31, 2002, Consumers has an accrued liability of $51 million, net of
$31 million of expenditures incurred to date, and a regulatory asset of $70
million. Any significant change in assumptions, such as an increase in the
number of sites, different remediation techniques, nature and extent of
contamination, and legal and regulatory requirements, could affect Consumers'
estimate of remedial action costs.
The MPSC, in its November 7, 2002, gas distribution rate order, authorized
Consumers to continue to recover approximately $1 million of manufactured gas
plant facilities environmental clean-up costs annually. Consumers defers and
amortizes, over a period of 10 years, manufactured gas plant facilities
environmental clean-up costs above the amount currently being recovered in
rates. Additional rate recognition of amortization expense cannot begin until
after a prudency review in a gas rate case. The annual amount that the MPSC
authorized Consumers to recover in rates will continue to be offset by $2
million to reflect amounts recovered from all other sources.
GAS RATE MATTERS
GAS RESTRUCTURING: From April 1, 1998 to March 31, 2001, Consumers conducted an
experimental gas customer choice pilot program that froze gas distribution and
GCR rates through the period. On April 1, 2001, a permanent gas customer choice
program commenced under which Consumers returned to a GCR mechanism that allows
it to recover from its bundled sales customers all prudently incurred costs to
purchase the natural gas commodity and transport it to Consumers for ultimate
distribution to customers.
GAS COST RECOVERY: As part of the on-going GCR process, which includes an annual
reconciliation process with the MPSC, Consumers expects to collect all of its
incurred gas costs. Under an order issued by the MPSC on March 12, 2003,
Consumers is allowed to increase its maximum GCR factor in May 2003, based on a
formula that tracks increases in NYMEX prices.
2001 GAS RATE CASE: In June 2001, Consumers filed an application with the MPSC
seeking a distribution service rate increase. On November 7, 2002, the MPSC
issued a final order approving a $56 million annual gas distribution service
rate increase, which includes the $15 million interim increase, with an 11.4
percent authorized return on equity, effective for service November 8, 2002. As
part of this order, the MPSC approved Consumers' proposal to absorb the assets
and liabilities of Michigan Gas Storage Company into Consumers' rate base and
rates. This has occurred through a statutory merger of Michigan Gas Storage
Company into Consumers and this is not expected to have an impact on Consumers'
consolidated financial statements.
F-67
2003 GAS RATE CASE: On March 14, 2003, Consumers filed an application with the
MPSC seeking a $156 million increase in its gas delivery and transportation
rates, which includes a 13.5 percent authorized return on equity, based on a
2004 test year. If approved, the request would add about $6.40 per month, or
about 9 percent, to the typical residential customer's average monthly
distribution bill. Contemporaneously with this filing, Consumers has requested
interim rate relief in the same amount.
In September 2002, the FERC issued an order rejecting a filing by Consumers to
assess certain rates for non-physical gas title tracking services offered by
Consumers. Despite Consumers' arguments to the contrary, the FERC asserted
jurisdiction over such activities and allowed Consumers to refile and justify a
title transfer fee not based on volumes as Consumers proposed. Because the order
was issued six years after Consumers made its original filing initiating the
proceeding, over $3 million in non-title transfer tracking fees had been
collected. No refunds have been ordered, and Consumers sought rehearing of the
September order. If refunds were ordered they may include interest which would
increase the refund liability to more than the $3 million collected. In December
2002, Consumers established a $3.6 million reserve related to this matter.
Consumers is unable to say with certainty what the final outcome of this
proceeding might be.
In November 2002, the MPSC upon its own motion commenced a contested proceeding
requiring each utility to give reason as to why its rates should not be reduced
to reflect new personal property multiplier tables, and why it should not refund
any amounts that it receives as refunds from local governments as they implement
the new multiplier tables. Consumers responded to the MPSC that it believes that
refunds would be inconsistent with the November 7, 2002 gas rate order in case
U-13000, with the Customer Choice Act, and may otherwise be unlawful. Consumers
is unable to predict the outcome of this matter.
OTHER GAS UNCERTAINTIES
CAPITAL EXPENDITURES: In 2003, 2004, and 2005, Consumers estimates gas capital
expenditures, including new lease commitments, of $144 million, $167 million,
and $225 million, respectively.
COMMITMENTS FOR GAS SUPPLIES: Consumers contracts to purchase gas and
transportation from various suppliers for its natural gas business. These
contracts have expiration dates that range from 2003 to 2005. Consumers' 2002
gas requirements totaled 199 bcf at a cost of $727 million. As of the end of
2002, Consumers' expected gas requirements for 2003 are 231 bcf of which 38
percent is covered by existing contracts.
OTHER UNCERTAINTIES
COLLECTIVE BARGAINING AGREEMENT: As of December 31, 2002, 44 percent of
Consumers workforce was represented by the Utility Workers Union of America.
Consumers and the Union negotiated a collective bargaining agreement that became
effective as of June 1, 2000, and will continue in full force and effect until
June 1, 2005. Consumers is currently negotiating with the Union for a collective
bargaining agreement for its Call Center employees.
DERIVATIVE ACTIVITIES: Consumers uses a variety of contracts to protect against
commodity price and interest rate risk. Some of these contracts may be subject
to derivative accounting, which requires that the value of the contracts to be
adjusted fair value through earnings or equity depending upon certain criteria.
Such adjustments to fair value could cause earnings volatility. For further
information about derivative activities, see Note 5, Financial and Derivative
Instruments.
In addition to the matters disclosed in this note, Consumers and certain of its
subsidiaries are parties to certain lawsuits and administrative proceedings
before various courts and governmental agencies arising
F-68
from the ordinary course of business. These lawsuits and proceedings may involve
personal injury, property damage, contractual matters, environmental issues,
federal and state taxes, rates, licensing and other matters.
Consumers has accrued estimated losses for certain contingencies discussed in
this note. Resolution of these contingencies is not expected to have a material
adverse impact on Consumers' financial position, liquidity, or results of
operations.
3: FINANCINGS AND CAPITALIZATION
REGULATORY AUTHORIZATION FOR FINANCINGS: At December 31, 2002, Consumers had
FERC authorization to issue or guarantee through June 2004, up to $1.1 billion
of short-term securities outstanding at any one time. Consumers also had
remaining FERC authorization to issue through June 2004 up to $500 million of
long-term securities for refinancing or refunding purposes, $677 million for
general corporate purposes, and $900 million of first mortgage bonds to be
issued solely as security for the long-term securities. On October 10, 2002,
FERC granted a waiver of its competitive bid/negotiated placement requirements
applicable to the remaining long-term securities authorization indicated above.
SHORT-TERM FINANCINGS: At December 31, 2002, a total of $457 million was
outstanding at a weighted average interest rate of 4.5 percent, compared with
$416 million outstanding on a revolving credit facility and unsecured lines of
credit at December 31, 2001, at a weighted average interest rate of 2.7 percent.
On July 12, 2002, Consumers entered into two credit facilities as follows: a
$250 million revolving credit facility maturing July 11, 2003 and a $300 million
term loan maturing July 11, 2003. In September 2002, the term loan maturity was
extended by one year at Consumers' option and now has a maturity date of July
11, 2004. These two facilities aggregating $550 million replace a $300 million
revolving credit facility that matured July 14, 2002 as well as various credit
lines aggregating $200 million. At December 31, 2002, a total of $550 million
was outstanding under the revolver and term loan, of which $250 million was
included in notes payable and $300 million was included in long-term debt
maturing in 2004. The prior credit facilities and lines were unsecured. The two
new credit facilities are secured with Consumers' first mortgage bonds and are
available to finance seasonal working capital requirements and to pay for
capital expenditures between long-term financings.
Consumers $250 million revolving credit facility had, as of December 31, 2002,
an effective interest rate of 5.9 percent, although the rate may fluctuate
depending on the rating of Consumers' first mortgage bonds or changes in the
base LIBOR rate. The effective interest rate on the $300 million term loan was
8.9 percent as of December 31, 2002. The rate may fluctuate depending on the
rating of Consumers' first mortgage bonds or changes in the base LIBOR rate.
Consumers bank and legal fees associated with arranging the facilities in July
2002 was $6 million.
The two credit facilities have contractual restrictions that require Consumers
to maintain, as of the last day of each fiscal quarter, the following:
Limitation Ratio at December 31, 2002
------------------------------------------------------------------------------------------------------------------
Debt to Capital Ratio (a)(b) Not more than 0.65 to 1.00 0.55 to 1.00
Interest Coverage Ratio (a)(b) Not less than 2.0 to 1.0 4.00 to 1.0
==================================================================================================================
(a) Violation of this ratio would constitute an event of default under the
facility which provides the lender, among other remedies, the right to declare
the principal and interest immediately due and payable.
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(b) The terms of the credit facilities provide for the exclusion of
securitization bonds in the calculation of the debt to capital ratio.
In March 2003, Consumers obtained a replacement revolving credit facility in the
amount of $250 million, secured by first mortgage bonds. The cost of the
facility is LIBOR plus 350 basis points. The new credit facility matures in
March 2004 with two annual extensions at Consumers' option, which would extend
the maturity to March 2006. The prior facility was due to expire in July 2003.
Under the provisions of its articles of incorporation, Consumers had $394
million of unrestricted retained earnings available to pay common dividends at
December 31, 2002. However, pursuant to restrictive covenants in its facilities,
Consumers is limited to common stock dividend payments that will not exceed $300
million in any calendar year. Consumers paid $231 million and $190 million in
common stock dividends to CMS Energy in 2002 and 2001, respectively. In January
2003, Consumers declared and paid a $78 million common dividend.
In July 2002, the credit rating of the publicly traded securities of Consumers
was downgraded by the major rating agencies. As a result of certain of these
downgrades, certain commodity suppliers to Consumers have requested advance
payments or other forms of assurances in connection with maintenance of ongoing
deliveries of gas and electricity. Consumers is addressing these issues as
required.
In October 2002, Consumers simultaneously entered into a new term loan agreement
collateralized by first mortgage bonds and a new gas inventory term loan
agreement collateralized by Consumers' natural gas in storage. These agreements
contain complementary collateral packages that provide Consumers, as additional
first mortgage bonds become available, borrowing capacity of up to $225 million,
of which $207 million was outstanding at December 31, 2002 with an effective
interest rate of 6.3 percent. The bank and legal fees associated with the
agreements were $2 million. The first amortization payment under these
agreements occurred in December 2002 with monthly amortization payments
scheduled until full repayment is completed in mid-April of 2003. The loan
amortization also reduces the bank's loan commitment to the amount of loan
outstanding which was $207 million as of December 31, 2002.
LONG-TERM FINANCINGS: In March 2002, Consumers sold $300 million principal
amount of 6 percent senior notes, maturing in March 2005. Net proceeds from the
sale were $299 million. Consumers used the net proceeds to replace a first
mortgage bond that was to mature in 2003.
In March 2003, Consumers entered into a $140 million term loan, secured by first
mortgage bonds, with a private investor bank. This loan has a term of six years,
at a cost of LIBOR plus 475 basis points. Also in March 2003, Consumers entered
into a $150 million term loan, secured by first mortgage bonds. This term loan
has a three-year maturity, at a cost of LIBOR plus 450 basis points.
FIRST MORTGAGE BONDS: Consumers secures its first mortgage bonds by a mortgage
and lien on substantially all of its property. Consumers' ability to issue and
sell securities is restricted by certain provisions in its first mortgage bond
Indenture, its articles of incorporation and the need for regulatory approvals
to meet appropriate federal law.
MANDATORILY REDEEMABLE PREFERRED SECURITIES: Consumers has wholly owned
statutory business trusts that are consolidated within its financial statements.
Consumers created these trusts for the sole purpose of issuing Trust Preferred
Securities. The primary asset of the trusts is a note or debenture of Consumers.
The terms of the Trust Preferred Security parallel the terms of the related
Consumers' note or debenture. The term, rights and obligations of the Trust
Preferred Security and related note or debenture are also defined in the related
indenture through which the note or debenture was issued, Consumers' guarantee
of
F-70
the related Trust Preferred Security and the declaration of trust for the
particular trust. All of these documents together with their related note or
debenture and Trust Preferred Security constitute a full and unconditional
guarantee by Consumers of the trust's obligations under the Trust Preferred
Security. In addition to the similar provisions previously discussed, specific
terms of the securities follow.
In Millions
---------------------------------------------------------------------------------------------------------------
Earliest
Trust and Securities Rate Amount Outstanding Maturity Redemption
---------------------------------------------------------------------------------------------------------------
December 31 2002 2001 2000 Year
---------------------------------------------------------------------------------------------------------------
Consumers Power Company Financing I,
Trust Originated Preferred Securities 8.36% $ 70 $100 $100 2015 2000
Consumers Energy Company Financing II,
Trust Originated Preferred Securities 8.20% 120 120 120 2027 2002
Consumers Energy Company Financing III,
Trust Originated Preferred Securities 9.25% 175 175 175 2029 2004
Consumers Energy Company Financing IV,
Trust Preferred Securities 9.00% 125 125 - 2031 2006
------------------------
Total $490 $520 $395
===============================================================================================================
In March 2002, Consumers reduced its' outstanding debt to Consumers Power
Company Financing I, Trust Originated Preferred Securities by $30 million.
OTHER: Consumers has a total of $126 million of long-term pollution control
revenue bonds outstanding, secured by first mortgage bonds and insurance
policies. These bonds had a weighted average interest rate of 2.7 percent at
December 31, 2002.
On April 1, 2002, Consumers established a new subsidiary, Consumers Receivables
Funding. This consolidated subsidiary was established as a special purpose
entity to properly reflect the sale of trade receivables from Consumers to the
purchaser, an unrelated third party under a trade receivables sale agreement.
Prior to the establishment of Consumers Receivables Funding, Consumers sold its
accounts receivable directly to the purchaser. At December 31, 2002 and 2001,
the receivables sold under the program were $325 million and $334 million,
respectively. Accounts receivable and accrued revenue in the Consolidated
Balance Sheets have been reduced to reflect receivables sold.
Under the program discussed above, during 2002 and 2001, Consumers sold accounts
receivable but retained servicing responsibility. Consumers is responsible for
the collectability of the accounts receivable sold, however, the purchaser of
sale of accounts receivable have no recourse to Consumers' other assets for
failure of debtors to pay when due and there are no restrictions on accounts
receivables not sold. No gain or loss has been recorded on the sale of accounts
receivable and Consumers retains no interest in the receivables sold. The
average annual discount rate was 2.05 percent and 4.37 percent for 2002 and
2001, respectively.
4: INCOME TAXES
Consumers and its subsidiaries file a consolidated federal income tax return
with CMS Energy. Income taxes are generally allocated based on each company's
separate taxable income. As of December 31, 2002, 2001 and 2000, Consumers had
tax related receivables (payables) from CMS Energy of $44 million, $27 million
and ($12) million, respectively.
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The Job Creation and Worker Assistance Act of 2002 provided to corporate
taxpayers a 5-year carryback of tax losses incurred in 2001 and 2002. As a
result of this legislation, CMS Energy was able to carry back consolidated 2001
and 2002 tax losses to tax years 1996 through 1999 to obtain refunds of prior
years tax payments totaling $250 million. The tax loss carryback, however,
resulted in a reduction in AMT credit carryforwards that previously had been
recorded by CMS Energy as deferred tax assets in the amount of $47 million. This
non-cash reduction in AMT credit carryforwards has been reflected in the tax
provisions of CMS Energy and allocated to each of its consolidated subsidiaries,
according to their contributions to the consolidated CMS Energy tax loss, under
the CMS Energy tax sharing agreement. Based on the final allocation, Consumers'
allocable share, $25 million, has been reflected as a dividend paid by Consumers
to CMS Energy.
Consumers practices deferred tax accounting for temporary differences in
accordance with SFAS No. 109. Consumers uses ITC to reduce current income taxes
payable, and defers and amortizes ITC over the life of the related property. AMT
paid generally becomes a tax credit that Consumers can carry forward
indefinitely to reduce regular tax liabilities in future periods when regular
taxes paid exceed the tax calculated for AMT. At December 31, 2002, Consumers
had tax loss carryforwards in the amount of $43 million that expire in 2021.
The significant components of income tax expense (benefit) consisted of:
In Millions
-------------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 2000
-------------------------------------------------------------------------------------------------------------------
Current federal income taxes $(97) $(39) $149
Deferred income taxes 283 143 (4)
Deferred ITC, net (6) (7) (8)
-----------------------------------------------
$180 $97 $137
===================================================================================================================
F-72
The principal components of Consumers' deferred tax assets (liabilities)
recognized in the balance sheet are as follows:
In Millions
-------------------------------------------------------------------------------------------------------------------
December 31 2002 2001
-------------------------------------------------------------------------------------------------------------------
Property $ (789) $ (557)
Unconsolidated investments (223) (211)
Securitization costs (Note 2) (192) (194)
Postretirement benefits (Note 7) (72) (76)
Gas inventories (74) (57)
Employee benefit obligations, includes OPEB of $94 and $103
and 2002 includes $100 for minimum pension liability (Note 7) 208 123
SFAS No.109 regulatory liability 115 117
Power purchases (Note 2) 18 28
Tax loss carryforward 15 -
AMT credit carryforward 7 30
Other, net 13 1
-----------------------------------
$ (974) $ (796)
====================================================================================================================
Deferred tax liabilities $ (1,528) $ (1,270)
Deferred tax assets 554 474
-----------------------------------
$ (974) $ (796)
===================================================================================================================
The actual income tax expense differs from the amount computed by applying the
statutory federal tax rate to income before income taxes as follows:
In Millions
-------------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 2000
-------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of change in
accounting principle $ 363 $ 199 $ 284
Income taxes 180 97 137
Preferred securities distributions (44) (41) (34)
-----------------------------------------------
Pretax income 499 255 387
Statutory federal income tax rate x 35% x 35% x 35%
-----------------------------------------------
Expected income tax expense 174 89 136
Increase (decrease) in taxes from:
Property differences not previously deferred 14 17 16
Loss on investment in CMS Energy Common Stock 4 - -
Gain on sale of METC (5) - -
ITC amortization/adjustments (6) (7) (9)
Affiliated companies' dividends (1) (2) (3)
Other, net - - (3)
------------------------------------------------
Actual income tax expense $ 180 $ 97 $ 137
===================================================================================================================
Effective tax rate 36.0% 38.0% 35.4%
===================================================================================================================
F-73
5: FINANCIAL AND DERIVATIVE INSTRUMENTS
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments and
current liabilities approximate their fair values due to their short-term
nature. Consumers estimates the fair values of long-term investments based on
quoted market prices or, in the absence of specific market prices, on quoted
market prices of similar investments or other valuation techniques. The carrying
amounts of all long-term investments, except as shown below, approximate fair
value.
In Millions
-------------------------------------------------------------------------------------------------------------------
December 31 2002 2001
-------------------------------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized
Available-for-sale securities Cost Value Gain Cost Value Gain
-------------------------------------------------------------------------------------------------------------------
Common stock of CMS Energy (a) $ 22 $ 22 $ - $ 35 $ 57 $ 22
SERP 18 19 1 22 24 2
Nuclear decommissioning
investments (b) 458 536 78 467 581 114
===================================================================================================================
Consumers recognized a $12 million loss on this investment in 2002 because the
loss was other than temporary, as the fair value was below the cost basis for a
period greater than six months. As of December 31, 2002, Consumers held 2.4
million shares of CMS Energy Common Stock with a fair value of $22 million; as
of March 14, 2003 the fair value was $8 million.
(b) Consumers classifies its unrealized gains and losses on nuclear
decommissioning investments in accumulated depreciation.
At December 31, 2002, the carrying amount of long-term debt was $2.4 billion and
at December 31, 2001, $2.5 billion, and the fair values were $2.2 billion and
$2.5 billion, respectively. For held-to-maturity securities and related-party
financial instruments, see Note 1.
RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS: Consumers is exposed to
market risks including, but not limited to, changes in interest rates, commodity
prices, and equity security prices. Consumers' market risk, and activities
designed to minimize this risk, are subject to the direction of an executive
oversight committee consisting of designated members of senior management and a
risk committee, consisting of certain business unit managers. The role of the
risk committee is to review the corporate commodity position and ensure that net
corporate exposures are within the economic risk tolerance levels established by
Consumers' Board of Directors. Established policies and procedures are used to
manage the risks associated with market fluctuations.
Consumers uses various contracts, including swaps, options, and forward
contracts to manage its risks associated with the variability in expected future
cash flows attributable to fluctuations in interest rates and commodity prices.
When management uses these instruments, it intends that an opposite movement in
the value of the at-risk item would offset any losses incurred on the contracts.
Consumers enters into all risk management contracts for purposes other than
trading.
Contracts used to manage interest rate and commodity price risk may be
considered derivative instruments that are subject to derivative and hedge
accounting pursuant to SFAS No. 133. In order for derivative instruments to
qualify for hedge accounting under SFAS No. 133, the hedging relationship must
be formally documented at inception and be highly effective in achieving
offsetting cash flows or offsetting changes in fair value attributable to the
risk being hedged. If hedging a forecasted transaction, the forecasted
transaction must be probable. If a derivative instrument, used as a cash flow
hedge, is
F-74
terminated early because it is probable that a forecasted transaction will not
occur, any gain or loss as of such date is immediately recognized in earnings.
If a derivative instrument, used as a cash flow hedge, is terminated early for
other economic reasons, any gain or loss as of the termination date is deferred
and recorded when the forecasted transaction affects earnings.
Consumers adopted SFAS No. 133 on January 1, 2001. This standard requires
Consumers to recognize at fair value all contracts that meet the definition of a
derivative instrument on the balance sheet as either assets or liabilities. The
standard also requires Consumers to record all changes in fair value directly in
earnings, or other comprehensive income if the derivative meets certain
qualifying hedge criteria. Consumers determines fair value based upon quoted
market prices and mathematical models using current and historical pricing data.
Option models require various inputs, including forward prices, volatilities,
interest rates and exercise periods. Changes in forward prices or volatilities
could significantly change the calculated fair value of the call option
contracts. At December 31, 2002, Consumers assumed a market-based interest rate
of 4.5 percent and a volatility rate of 70 percent in calculating the fair value
of its electric call options. The ineffective portion, if any, of all hedges is
recognized in earnings.
The majority of Consumers' contracts are not subject to derivative accounting
because they qualify for the normal purchases and sales exception of SFAS No.
133. Derivative accounting is required, however, for certain contracts used to
limit Consumers' exposure to electricity and gas commodity price risk and
interest rate risk.
On January 1, 2001, upon initial adoption of the standard, Consumers recorded a
$21 million, net of tax, ($32 million, pretax) cumulative effect transition
adjustment as an unrealized gain increasing accumulated other comprehensive
income. Consumers then reclassified to earnings $12 million as a reduction to
the cost of gas, $1 million as a reduction to the cost of power supply, $2
million as an increase in interest expense, and $8 million as an increase in
other revenue for the twelve months ended December 31, 2001. The remaining $9
million difference between the initial transition adjustment and the amounts
reclassified to earnings has been reduced to zero, decreasing other
comprehensive income, and represents an unrealized loss in the fair value of the
derivative instruments since January 1, 2001. As a result, as of December 31,
2001, there were no amounts remaining in accumulated other comprehensive income
related to the initial transition adjustment.
On January 1, 2001, upon initial adoption of SFAS No. 133, derivative and hedge
accounting for certain utility industry contracts, particularly electric call
option contracts and option-like contracts, and contracts subject to Bookouts
was uncertain. Consumers did not record these contracts on the balance sheet at
fair value, but instead accounted for these types of contracts as derivatives
that qualified for the normal purchase exception of SFAS No. 133. In June and
December 2001, the FASB issued guidance that resolved the accounting for these
contracts. As a result, on July 1, 2001, Consumers recorded a $3 million, net of
tax, cumulative effect adjustment as an unrealized loss, decreasing accumulated
other comprehensive income, and on December 31, 2001, recorded an $11 million,
net of tax, cumulative effect adjustment as a decrease to earnings. These
adjustments relate to the difference between the fair value and the recorded
book value of certain electric call option contracts.
F-75
In Millions
-------------------------------------------------------------------------------------------------------------------
December 31 2002 2001
-------------------------------------------------------------------------------------------------------------------
Fair Fair
Derivative Instruments Cost Value Cost Value
-------------------------------------------------------------------------------------------------------------------
Electric contracts $8 $ 1 $21 $ 2
Gas contracts - 1 - -
Interest rate risk contracts - (1) - (3)
Derivative contracts associated with Consumers'
equity investment in the MCV Partnership - 13 - (12)
====================================================================================================================
The fair value of all derivative contracts, except the fair value of derivative
contracts associated with Consumers' equity investment in the MCV Partnership,
is included in either Other Assets or Other Liabilities on the Balance Sheet.
The fair value of derivative contracts associated with Consumers' equity
investment in the MCV Partnership is included in Investments - Midland
Cogeneration Venture Limited Partnership on the Balance Sheet. April 1, 2002,
the MCV Partnership changed its accounting for derivatives, see Note 11.
Consumers' ownership share of the cumulative effect adjustment to earnings is
reflected as a change in accounting principle on Consumers' Income Statement.
ELECTRIC CONTRACTS: Consumers' electric business uses purchased electric call
option contracts to meet, in part, its regulatory obligation to serve. This
obligation requires Consumers to provide a physical supply of electricity to
customers, to manage electric costs and to ensure a reliable source of capacity
during peak demand periods. On July 1, 2001, upon initial adoption of the
standard for these contracts, Consumers recorded a $3 million, net of tax,
cumulative effect adjustment as an unrealized loss, decreasing accumulated other
comprehensive income. This adjustment relates to the difference between the fair
value and the recorded book value of these electric call option contracts. The
adjustment to accumulated other comprehensive income relates to electric call
option contracts that qualified for cash flow hedge accounting prior to the
initial adoption of SFAS No. 133. After July 1, 2001, these contracts did not
qualify for hedge accounting under SFAS No. 133 and, therefore, Consumers
records any change in fair value subsequent to July 1, 2001 directly in
earnings, which can cause earnings volatility. The initial amount recorded in
other comprehensive income was reclassified to earnings as the forecasted future
transactions occurred or the call options expired. The majority of these
contracts expired in the third quarter 2001 and the remaining contracts expired
in the third quarter of 2002. As of December 31, 2001, Consumers reclassified
from other comprehensive income to earnings, $2 million, net of tax, as part of
the cost of power supply, and the remainder, $1 million, net of tax, was
reclassified from other comprehensive income to earnings in the third quarter of
2002.
In December 2001, the FASB issued revised guidance regarding derivative
accounting for electric call option contracts and option-like contracts. The
revised guidance amended the criteria used to determine if derivative accounting
is required. In light of the amended criteria, Consumers re-evaluated its
electric call option and option-like contracts, and determined that additional
contracts require derivative accounting. Therefore, as of December 31, 2001,
upon initial adoption of the revised guidance for these contracts, Consumers
recorded an $11 million, net of tax, cumulative effect adjustment as a decrease
to earnings. This adjustment relates to the difference between the fair value
and the recorded book value of these electric call option contracts. Consumers
records any change in fair value subsequent to December 31, 2001, directly in
earnings, which could cause earnings volatility. During 2002, Consumers
recorded, as part of power costs, a $245 thousand unrecognized gain on its
unexpired electric call options contracts. As of December 31, 2002, Consumers
recorded on the balance sheet all of its unexpired purchased electric call
option contracts subject to derivative accounting at a fair value of $1 million.
Consumers believes that certain of its electric capacity and energy contracts
are not derivatives due to the lack of an active energy market, as defined by
SFAS No. 133, in the state of Michigan and the
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transportation cost to deliver the power under the contracts to the closest
active energy market at the Cinergy hub in Ohio. If a market develops in the
future, Consumers may be required to account for these contracts as derivatives.
The mark-to-market impact in earnings related to these contracts, particularly
related to the PPA could be material to the financial statements.
During 2002, Consumers' electric business also used gas swap contracts to
protect against price risk due to the fluctuations in the market price of gas
used as fuel for generation of electricity. These gas swaps were financial
contracts that were used to offset increases in the price of probable forecasted
gas purchases. These contracts did not qualify for hedge accounting. Therefore,
Consumers recorded any change in the fair value of these contracts directly in
earnings as part of power supply costs. These contracts expired in December
2002.
As of December 31, 2002, Consumers recorded a total of $8 million, net of tax,
as an unrealized gain 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 gain, if this value
remains, as an increase to other operating revenue during the next 12 months.
GAS CONTRACTS: Consumers' gas business uses fixed price gas supply contracts,
and fixed price weather-based gas supply call options and fixed price gas supply
put options, and other types of contracts, to meet its regulatory obligation to
provide gas to its customers at a reasonable and prudent cost. During 2002, some
of the fixed price gas supply contracts required derivative accounting because
they contained embedded put options that disqualified the contracts from the
normal purchase exception of SFAS No. 133. These contracts expired in October
2002.
As of December 31, 2002, weather-based gas call options and gas put options
requiring derivative accounting had a net fair value of $1 million, of which
$600,000, represents a fair value gain on the contracts since the date of
inception. This gain was recorded directly in earnings as part of other income,
and then directly offset and recorded on the balance sheet as a regulatory
liability. Any subsequent changes in fair value will be recorded in a similar
manner.
INTEREST RATE RISK CONTRACTS: Consumers uses interest rate swaps to hedge the
risk associated with forecasted interest payments on variable-rate debt. These
interest rate swaps are designated as cash flow hedges. As such, Consumers will
record any change in the fair value of these contracts in other comprehensive
income unless the swaps are sold. As of December 31, 2002, Consumers had entered
into a swap to fix the interest rate on $75 million of variable-rate debt. This
swap will expire in June 2003. As of December 31, 2002, this interest rate swap
had a negative fair value of $1 million. This amount, if sustained, will be
reclassified to earnings, increasing interest expense when the swap is settled
on a monthly basis. As of December 31, 2001, this interest rate swap had a
negative fair value of $3 million.
Consumers also uses interest rate swaps to hedge the risk associated with the
fair value of its debt. These interest rate swaps are designated as fair value
hedges. In March 2002, Consumers entered into a fair value hedge to hedge the
risk associated with the fair value of $300 million of fixed-rate debt, issued
in March 2002. In June 2002, this swap was terminated and resulted in a $7
million gain that is deferred and recorded as part of the debt. It is
anticipated that this gain will be recognized over the remaining life of the
debt.
In 2001, Consumers had entered into interest rate swaps to hedge the risk
associated with the fair value of $400 million of fixed-rate debt, which expire
in May 2003 and December 2006. In November 2001, these swaps were terminated and
resulted in a $4 million gain that was deferred and recorded as part of the
debt. This gain is being recognized over the remaining life of the debt.
F-77
In 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. This gain is being recognized over the remaining
life of the debt.
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 was recorded in other
comprehensive income and will be amortized to interest expense over the life of
the debt using the effective interest method.
Consumers was able to apply the shortcut method to all interest rate hedges,
therefore there was no ineffectiveness associated with these hedges.
6: EXECUTIVE INCENTIVE COMPENSATION
Consumers participates in CMS Energy's Performance Incentive Stock Plan. Under
the plan, restricted shares of Common Stock of CMS Energy, stock options and
stock appreciation rights related to Common Stock may be granted to key
Consumers' employees based on their contributions to the successful management
of Consumers. The plan reserves for award not more than five percent, as amended
January 1, 1999, of CMS Energy's Common Stock outstanding on January 1 each
year, less (1) the number of shares of restricted Common Stock awarded and (2)
Common Stock subject to options granted under the plan during the immediately
preceding four calendar years. The number of shares of restricted Common Stock
awarded under this plan cannot exceed 20 percent of the aggregate number of
shares reserved for award. Any forfeiture of shares previously awarded will
increase the number of shares available to be awarded under the plan. As of
December 31, 2002, under the plan, awards of up to 1,716,856 shares of CMS
Energy Common Stock may be issued.
Restricted shares of Common Stock are outstanding shares with full voting and
dividend rights. These awards vest over five years at the rate of 25 percent per
year after two years. Some restricted shares are subject to achievement of
specified levels of total shareholder return and are subject to forfeiture if
employment terminates before vesting. If performance objectives are exceeded,
the plan provides for additional awards. Restricted shares vest fully if control
of CMS Energy changes, as defined by the plan. At December 31, 2002, 113,960 of
the 320,720 shares of restricted CMS Energy Common Stock outstanding are subject
to performance objectives.
The plan grants stock options and stock appreciation rights relating to Common
Stock with an exercise price equal to the closing market price on each grant
date. All options may be exercised upon grant. All options expire up to ten
years and one month from date of grant. The status of the restricted stock and
options granted to Consumers' key employees under the Performance Incentive
Stock Plan follows.
F-78
Restricted
Stock Options
-------------------------------------------------------------------------------------------------------------------
Number Number Weighted Average
CMS ENERGY COMMON STOCK of Shares of Shares Exercise Price
-------------------------------------------------------------------------------------------------------------------
Outstanding at January 1, 2000 283,057 693,670 $34.37
Granted 81,030 221,900 $17.00
Exercised or Issued (48,979) (43,368) $17.48
Forfeited (55,731) -
Expired - (30,083) $31.87
--------------------------------------------------------------
Outstanding at December 31, 2000 259,377 842,119 $30.75
Granted 71,930 294,150 $30.04
Exercised or Issued (34,704) (35,317) $19.34
Forfeited (56,938) -
Expired - -
--------------------------------------------------------------
Outstanding at December 31, 2001 239,665 1,100,952 $30.93
Granted 163,890 490,600 $14.32
Exercised or Issued (26,663) (6,083) $17.13
Forfeited (56,172) -
Expired - (65,080) $32.03
--------------------------------------------------------------
Outstanding at December 31, 2002 320,720 1,520,389 $25.58
==============================================================
The following table summarizes information about CMS Energy Common Stock options
outstanding at December 31, 2002:
Number Weighted Weighted
Range of of Shares Average Average
Exercise Prices Outstanding Remaining Life Exercise Price
-------------------------------------------------------------------------------------------------------------------
CMS Energy Common Stock:
$ 8.12 - $17.00 445,532 8.73 years $11.53
$20.00 - $30.63 419,426 6.47 years $24.05
$31.04 - $39.06 552,949 6.93 years $34.75
$43.38 - $43.38 102,482 5.57 years $43.38
------------------------------------------------------------------------------------------------------------------
$8.12 - $43.38 1,520,389 7.24 years $25.58
===================================================================================================================
The weighted average fair value of options granted for CMS Energy Common Stock
in February 2002 was $3.79, and in July 2002, $1.40. In 2001 and 2000, the
weighted average fair value of options granted for CMS Energy Common Stock were
$6.37 and $1.91, respectively. Fair value is estimated using the Black-Scholes
model, a mathematical formula used to value options traded on securities
exchanges, with the following assumptions. For 2002 the assumptions listed are
for the February grant, followed by the July grant:
F-79
Years Ended December 31 2002 2001 2000
------------------------------------------------------------------------------------------------------------------
CMS ENERGY COMMON STOCK OPTIONS
Risk-free interest rate 4.02%, 3.28% 4.80% 6.56%
Expected stock price volatility 31.64%, 39.67% 29.48% 26.53%
Expected dividend rate $ .365, $.1825 $ .365 $ .365
Expected option life (years) 4.5 4.6 4.4
==================================================================================================================
In December 2002, Consumers voluntarily adopted the fair value method of
accounting for stock-based employee compensation, in accordance with SFAS No.
123. To adopt this change, Consumers, in accordance with SFAS No. 148, is
applying the prospective method, which requires fair value treatment of all
awards granted, modified, or settled after the beginning of the fiscal year in
which the recognition provisions are first applied. As a result of these
changes, $1.7 million was recorded as stock-based employee compensation cost for
2002. Previously, Consumers accounted for stock-based compensation under APB
Opinion No. 25, and no stock-based employee compensation cost was reflected in
net income. In 2002, 2001, and 2000, the compensation cost charged against
income for restricted stock was less than $1 million, $3 million, and $1
million, respectively.
In Millions
--------------------------------------------------------------------------------------------------------------
Years ended December 31 2002 2001 2000
--------------------------------------------------------------------------------------------------------------
Net income, as reported $381 $ 188 $284
Add: Stock-based employee
compensation expense included in
reported net income, net of related taxes 1 - -
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related taxes (1) (1) -
------------------------------------------
Pro forma net income $381 $ 187 $284
-------------------------------------------------------------------------------------------------------------
7: RETIREMENT BENEFITS
Consumers provides retirement benefits under a number of different plans,
including certain health care and life insurance benefits under OPEB, benefits
to certain management employees under SERP and EISP, and benefits to
substantially all its employees under a trusteed, non-contributory, defined
benefit Pension Plan, and a defined contribution 401(k) plan.
Weighted-Average Assumptions
-----------------------------------------------------------------------------------------------------------
Pension & SERP OPEB
Years Ended December 31 2002 2001 2000 2002 2001 2000
------------------------------------------------------------------------------------------------------------
Discount rate 6.75% 7.25% 7.75% 6.75% 7.25% 7.75%
Expected long-term
rate of return on
plan assets 8.75% 9.75% 9.75% 7.60% 8.30% 7.00%
Rate of compensation increase:
Pension - to age 45 3.50% 5.25% 5.25%
- age 45 to
assumed retirement 3.50% 3.75% 3.75%
SERP 5.50% 5.50% 5.50%
===========================================================================================================
Retiree health care costs at December 31, 2002 are based on the assumption that
costs would increase at a slower rate from the 2002 trend rate of 8.5 percent to
5.5 percent in 2010 and thereafter.
F-80
Consumers Energy's Net Pension Plan, Consumers' SERP, Consumers' EISP, and OPEB
benefit costs are shown below:
Amounts presented below for the Pension Plan include amounts for employees of
CMS Energy and non-utility affiliates, which were not distinguishable from the
plan's total assets.
In Millions
-------------------------------------------------------------------------------------------------------------------------
Pension, SERP & EISP OPEB
Years Ended December 31 2002 2001 2000 2002 2001 2000
-------------------------------------------------------------------------------------------------------------------------
Service cost $ 40 $ 37 $ 31 $ 16 $ 13 $ 11
Interest expense 86 84 79 63 57 52
Expected return on plan assets (103) (99) (92) (40) (40) (34)
Amortization of unrecognized transition (asset) - (5) (5) - - -
Plan amendments 4 - - - - -
Amortization of:
Net (gain) or loss - - - 8 - (1)
Prior service cost 8 8 4 (1) (1) -
----------------------------------------------------------------
Net periodic pension and
postretirement benefit cost $ 35 $ 25 $ 17 $ 46 $ 29 $ 28
=========================================================================================================================
The health care cost trend rate assumption significantly affects the amounts
reported. A one percentage point change in the assumed health care cost trend
assumption would have the following effects:
In Millions
-------------------------------------------------------------------------------------------------------------------
One Percentage One Percentage
Point Increase Point Decrease
-------------------------------------------------------------------------------------------------------------------
Effect on total service and interest cost component $ 13 $ (11)
Effect on postretirement benefit obligation $121 $(101)
===================================================================================================================
F-81
The funded status of the Consumers Energy Pension Plan, Consumers' SERP and OPEB
is reconciled with the liability recorded at December 31 as follows:
In Millions
-------------------------------------------------------------------------------------------------------------------
Pension Plan SERP OPEB
2002 2001 2002 2001 2002 2001
-------------------------------------------------------------------------------------------------------------------
Benefit obligation January 1 $1,195 $ 1,081 $ 19 $ 18 $ 876 $ 754
Service cost 40 36 1 1 16 13
Interest cost 84 83 2 1 63 57
Plan amendment 3 - - - (57) (16)
Actuarial loss 72 96 - - 31 102
Benefits paid (138) (101) (1) (1) (39) (34)
-------------------------------------------------------------
Benefit obligation December 31 1,256 1,195 21 19 890 876
-------------------------------------------------------------
Plan assets at fair value at January 1 845 994 - - 475 450
Actual return on plan assets (164) (113) - - (44) (23)
Company contribution 64 65 - - 73 48
Actual benefits paid (138) (101) - - (39) -
-------------------------------------------------------------
Plan assets at fair
value at December 31(a) 607 845 - - 465 475
-------------------------------------------------------------
Benefit obligation less than
(in excess of) plan assets (649) (350) (21) (21) (425) (401)
Unrecognized net loss from
experience different than assumed 573 235 3 3 282 176
Unrecognized prior service cost 60 68 - 1 (70) (15)
Panhandle adjustment (7) (7) - - - -
-------------------------------------------------------------
Net Balance Sheet Liability (23) (54) (18) (17) (213) (240)
Additional minimum liability adjustment (b) (426) - - - - -
-------------------------------------------------------------
Total Net Balance Sheet Liability $ (449) $ (54) $ (18) $(17) $(213) $(240)
===================================================================================================================
(a) Primarily stocks and bonds, including 5,241,656 and 141,000 shares of CMS
Energy Common Stock in the Pension Plan assets and OPEB plan assets,
respectively, with fair values of $49 million and $1.3 million at December 31,
2002. Fair values at December 31, 2001 were $126 million and $3 million in the
Pension Plan assets and OPEB plan assets, respectively.
(b) The Pension Plan's Accumulated Benefit Obligation of $1.055 billion exceeded
the value of the Pension Plan assets and net balance sheet liability at December
31, 2002. As a result, an additional minimum liability was recorded. The
adjustment includes $53 million of intangible asset, and $373 million of
accumulated other comprehensive income, of which $40 million and $285 million
($185 million after-tax) were allocated to Consumers.
SERP benefits are paid from a trust established in 1988. SERP is not a qualified
plan under the Internal Revenue Code, and as such, earnings of the trust are
taxable and trust assets are included in consolidated assets. At December 31,
2002 and 2001, trust assets were $19 million and $24 million, respectively, and
were classified as other non-current assets. In 2002 and 2001, the Accumulated
Benefit Obligation for SERP was $17 million and $16 million, respectively.
The Executive Incentive Separation Plan (EISP) was established to provide
flexibility in separation of employment by officers, a select group of
management, or other highly compensated employees. Terms
F-82
of the plan may include payment of a lump sum, payment of monthly benefits for
life, payment of premium for continuation of health care, or any other legally
permissible term deemed to be in the best interest of Consumers to offer. As of
December 31, 2002, the Accumulated Benefit Obligation of the EISP was $1.7
million. Consumers portion of the EISP was approximately $250,000.
The Pension Plan includes amounts for employees of CMS Energy and non-utility
affiliates, including Panhandle, which were not distinguishable from the Pension
Plan's total assets. On December 21, 2002, a definitive agreement was executed
to sell Panhandle. The sale is expected to close in 2003. No portion of the
Pension Plan will be transferred with the sale of Panhandle. At the closing of
the sale, none of the employees of Panhandle will be eligible to accrue
additional benefits. The Pension Plan will retain pension payment obligations
under the Pension Plan for Panhandle employees that are vested under the Pension
Plan. Consumers does not expect the impact to be material.
Contributions to the 40l(k) plan are invested in CMS Energy Common Stock.
Amounts charged to expense for this plan were $8 million in 2002, and $20
million in 2001. Effective September 1, 2002, the employer's match for the
401(k) plan was suspended until January 1, 2005.
In 1992, Consumers adopted the required accounting for postretirement benefits
and recorded a liability of $466 million for the accumulated transition
obligation and a corresponding regulatory asset for anticipated recovery in
utility rates (see Note 1, Corporate Structure and Summary of Significant
Accounting Policies, "Utility Regulation"). The MPSC authorized recovery of the
electric utility portion of these costs in 1994 over 18 years and the gas
utility portion in 1996 over 16 years.
8: LEASES
Consumers leases various assets, including vehicles, railcars, construction
equipment, computer equipment, and buildings. Consumers has both full-service
and net leases, the latter of which requires Consumers to pay for taxes,
maintenance, operating costs, and insurance.
Minimum rental commitments under Consumers' non-cancelable leases at December
31, 2002, were:
In Millions
----------------------------------------------------------------------------------------------------------------
Capital Leases Operating Leases
----------------------------------------------------------------------------------------------------------------
2003 $ 21 $ 13
2004 20 10
2005 18 8
2006 17 7
2007 16 6
2008 and thereafter 71 34
--------------------------------------
Total minimum lease payments 163 $ 78
===
Less imputed interest 28
------
Present value of net minimum lease payments 135
Less current portion 13
Less non-current portion of off-balance sheet lease payments 6
------
Non-current portion $ 116
================================================================================================================
Consumers recovers lease charges from customers and accordingly charges payments
for its capital and operating leases to operating expense. For the years ended
December 31, 2002, 2001 and 2000, operating lease charges, including charges to
clearing and other accounts, were $13 million, $15 million, and $16 million,
respectively. In November 2001, Consumers' nuclear fuel capital leasing
arrangement expired
F-83
upon mutual agreement by the lessor and Consumers. At termination of the lease,
Consumers paid the lessor $48 million, which was the lessor's remaining
investment at that time.
For the years ended December 31, 2002, 2001 and 2000, capital lease expenses
were $20 million, $26 million, and $41 million, respectively. Included in these
amounts, for the years ended 2002, 2001 and 2000, are nuclear fuel lease
expenses of $- million, $7 million and $22 million, respectively.
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. The new office-building lessor has committed to
fund up to $65 million for construction of the building and has appointed
Consumers the construction agent for the project. Consumers' balance sheet as of
December 31, 2002, reflects a capital lease asset and an offsetting non-current
liability equivalent to the cost of construction at that date of $54 million.
The agreement is a seven-year lease term with payments commencing upon
completion of construction, which occurred in March 2003. Total construction
costs amounted to $60 million. 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.
The estimated annual lease payments, based on the total construction cost of $60
million and LIBOR rates ranging upwards to four percent, would be $4 million
beginning on April 1, 2003 plus a termination payment of $54 million at the end
of the lease term. Actual lease payments will depend on the LIBOR rates in
effect for the period being paid.
9: JOINTLY OWNED UTILITY FACILITIES
Consumers is responsible for providing its share of financing for the jointly
owned utility facilities. Consumers includes in operating expenses the direct
expenses of the joint plants. The following table indicates the extent of
Consumers' investment in jointly owned utility facilities:
In Millions
-------------------------------------------------------------------------------------------------------------------
Net Investment Accumulated Depreciation
December 31 2002 2001 2002 2001
-------------------------------------------------------------------------------------------------------------------
Campbell Unit 3 - 93.3 percent $299 $279 $312 $312
Ludington - 51 percent 75 76 94 88
Transmission facilities - various - 37 - 40
Distribution lines - various 13 10 1 -
===================================================================================================================
10: REPORTABLE SEGMENTS
Consumers has two reportable segments: electric and gas. The electric segment
consists of regulated activities associated with the generation and distribution
of electricity. The gas segment consists of regulated activities associated with
the transportation, storage and distribution of natural gas. Consumers'
reportable segments are domestic business units organized and managed by the
nature of the product and service each provides. The accounting policies of the
segments are the same as those Consumers describes in the summary of significant
accounting policies. Where appropriate, the financial statements reflect the
assets, liabilities, revenues and expenses directly related to the electric and
gas reportable segments. However, in instances where common accounts were not
readily attributable to a single business segment, Consumers allocated the
accounts between the electric and gas segment. The allocations are based on
certain measures of business activities, such as revenue, labor dollars,
customers, other operation and maintenance and construction expense, leased
property, taxes, or functional surveys.
F-84
For example, customer receivables are allocated based on revenue; pension
provisions are allocated based on labor dollars; and common property is
allocated based on other operation and maintenance and construction expense.
Consumers' management has changed its evaluation of the performance of the
electric and gas segments from pretax operating income to net income available
to common stockholder. The Consolidated Statements of Income show operating
revenue and pretax operating income by reportable segment. For 2002, 2001 and
2000, the amounts included in earnings from investments accounted for by the
equity method of $53 million, $38 million and $57 million, respectively. For
2002, 2001 and 2000, Consumers had investments accounted for by the equity
method of $645 million, $555 million and $535 million, respectively. Consumers
accounts for intersegment sales and transfers at current market prices and
eliminates them in consolidated net income available to common stockholder by
segment. Consumers classifies its equity investments as a part of the other
business unit. The other business unit also includes Consumers' consolidated
statutory business trusts, which were created to issue preferred securities and
Consumers' consolidated special purpose entity for the sale of trade
receivables. Additional segment information follows:
F-85
In Millions
-------------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 2000
-------------------------------------------------------------------------------------------------------------------
Depreciation, depletion and amortization
Electric $ 228 $ 219 $ 311
Gas 118 118 113
Other 2 2 2
-----------------------------------------------
Total Consolidated $ 348 $ 339 $ 426
===================================================================================================================
Interest Charges
Electric $ 144 $ 153 $ 145
Gas 47 50 48
Other 21 21 27
-----------------------------------------------
Subtotal 212 224 220
Eliminations (44) (38) (37)
-----------------------------------------------
Total Consolidated $ 168 $ 186 $ 183
===================================================================================================================
Income Taxes
Electric $ 138 $ 69 $ 123
Gas 33 25 24
Other 9 3 (10)
-----------------------------------------------
Total Consolidated (a) $ 180 $ 97 $ 137
===================================================================================================================
Net Income Available to Common Stockholder
Electric $ 264 $ 109 $ 199
Gas 46 21 18
Other 25 15 31
-----------------------------------------------
Total Consolidated $ 335 $ 145 $ 248
===================================================================================================================
Total assets
Electric (b) $5,744 $ 5,454 $5,230
Gas (b) 2,002 2,194 1,776
Other 1,398 1,142 1,124
------------------------------------------------
Subtotal 9,144 8,790 8,130
Eliminations (444) (469) (354)
------------------------------------------------
Total Consolidated $8,700 $ 8,321 $7,776
===================================================================================================================
Capital expenditures (c)
Electric $ 437 $ 623 $ 430
Gas 181 145 120
------------------------------------------------
Total $ 618 $ 768 $ 550
===================================================================================================================
(a) In 2002 and 2001, amounts exclude the $10 million tax expense and $6 million
tax benefit, respectively, due to the change in accounting for derivative
instruments.
(b) Amounts include an attributed portion of Consumers' other common assets to
both the electric and gas utility businesses.
F-86
(c) Includes electric restructuring implementation plan, capital leases for
nuclear fuel, purchase of nuclear fuel and other assets and electric DSM costs.
Amounts also include an attributed portion of Consumers' capital expenditures
for plant and equipment common to both the electric and gas utility businesses.
11: SUMMARIZED FINANCIAL INFORMATION OF SIGNIFICANT RELATED ENERGY SUPPLIER
Under the PPA with the MCV Partnership discussed in Note 2, Consumers' 2002
obligation to purchase electric capacity from the MCV Partnership provided 15.1
percent of Consumers' owned and contracted electric generating capacity.
Summarized financial information of the MCV Partnership follows:
STATEMENTS OF INCOME
In Millions
-------------------------------------------------------------------------------------------------------------------
Years Ended December 31 2002 2001 2000
-------------------------------------------------------------------------------------------------------------------
Operating revenue (a) $597 $611 $604
Operating expenses 409 453 392
--------------------------------------
Operating income 188 158 212
Other expense, net 114 110 122
-------------------------------------
Net income before cumulative
effect of accounting change 74 48 90
Cumulative effect of change in method of
accounting for derivative options contracts (April 1, 2002) (b) 58 - -
--------------------------------------
Net income $132 $ 48 $ 90
===================================================================================================================
BALANCE SHEETS
In Millions
-------------------------------------------------------------------------------------------------------------------
December 31 2002 2001 2002 2001
-------------------------------------------------------------------------------------------------------------------
ASSETS LIABILITIES AND EQUITY
Current assets (c) $ 356 $ 341 Current liabilities $ 209 $ 320
Plant, net 1,550 1,610 Non-current liabilities (d) 1,155 1,245
Other assets 192 166 Partners' equity (e) 734 552
------------------- --------------------
$2,098 $ 2,117 $2,098 $2,117
===================================================================================================================
(a) For 2002, 2001, and 2000, revenue from Consumers totaled $557 million, $550
million and $569 million, respectively.
(b) On April 1, 2002, the MCV Partnership implemented Derivative Implementation
Group Issue C-16, an interpretation of SFAS No. 133. The MCV Partnership began
accounting for several natural gas contracts containing an option component at
fair value. As a result, a $58 million cumulative effect adjustment for the
change in accounting principle was recorded as an increase to earnings. CMS
Midland's 49 percent ownership share was $28 million ($18 million after-tax),
which is reflected as a change in accounting principle on Consumers' Income
Statement.
F-87
(c) At December 31, 2002 and 2001, receivables from Consumers totaled $44
million and $49 million, respectively.
(d) FMLP is the sole beneficiary of an owner trust that is the lessor in a
long-term direct finance lease with the lessee, MCV Partnership. CMS Holdings
holds a 46.4 percent ownership interest in FMLP. At December 31, 2002 and 2001,
the MCV Partnership owed lease obligations of $975 million and $1.11 billion,
respectively, to the owner trust. CMS Holdings' share of the interest and
principal portion for the 2002 lease payments was $34 million and $65 million,
respectively, and for the 2001 lease payments was $36 million and $54 million,
respectively. As of December 31, 2002 and 2001, the lease payments service $449
million and $597 million in non-recourse debt outstanding, respectively, of the
owner trust. The MCV Partnership's lease obligations, assets, and operating
revenues secures FMLP's debt. For 2002 and 2001, the owner trust made debt
payments (including interest) of $370 million and $217 million, respectively.
FMLP's earnings for 2002, 2001, and 2000 were $38 million, $30 million, and $30
million, respectively.
(e) CMS Midland's recorded investment in the MCV Partnership includes
capitalized interest, which Consumers is amortizing to expense over the life of
its investment in the MCV Partnership. Covenants contained in financing
agreements prohibit the MCV Partnership from paying distributions until it meets
certain financial test requirements. Consumers does not anticipate receiving a
cash distribution in the near future.
F-88
Report of Independent Auditors
The Board of Directors and Stockholders
Consumers Energy Company
We have audited the accompanying consolidated balance sheets and consolidated
statements of long-term debt and preferred stock of Consumers Energy Company (a
Michigan corporation and wholly-owned subsidiary of CMS Energy Corporation) and
subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of income, common stockholders' equity and cash flows for each of
three years in the period ended December 31, 2002. Our audits also included the
financial statement schedule listed in the Index at Item 15(a)(2). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits. The financial statements of Midland
Cogeneration Venture Limited Partnership (a limited partnership in which
Consumers Energy Company and subsidiaries has a 49% interest), have been audited
by other auditors (the other auditors for 2001 and 2000 for Midland Cogeneration
Venture Limited Partnership have ceased operations) whose reports have been
furnished to us; insofar as our opinion on the consolidated financial statements
relates to the amounts included for Midland Cogeneration Venture Limited
Partnership, it is based solely on their report.
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 and the reports of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the 2002
and 2001 financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Consumers Energy Company and
subsidiaries at December 31, 2002 and 2001, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002 in conformity with accounting principles generally
accepted in the United States. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
As discussed in Note 5 to the consolidated financial statements, in 2001
Consumers Energy Company, and in 2002, Midland Cogeneration Venture Limited
Partnership changed their method of accounting related to derivatives and
hedging activities. Also, in 2002 as discussed in Note 1 to the consolidated
financial statements, Consumers Energy Company changed its method of accounting
for stock-based compensation.
/s/ Ernst & Young LLP
Detroit, Michigan
March 14, 2003, except for Note 3
as to which the date is March 28, 2003
F-89
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.
/s/ PricewaterhouseCoopers LLP
Detroit, Michigan,
January 17, 2003
F-90
THIS REPORT IS A COPY OF THE PREVIOUSLY ISSUED ARTHUR
ANDERSEN REPORT AND THIS REPORT HAS NOT BEEN REISSUED
BY 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.
/s/Arthur Andersen LLP
Detroit, Michigan,
January 18, 2002
F-91
CONSUMERS ENERGY COMPANY
QUARTERLY FINANCIAL INFORMATION
2002 (UNAUDITED) 2001 (UNAUDITED)
---------------------------------------- ---------------------------------------
QUARTERS ENDED MARCH 31 JUNE 30 SEPT. 30 DEC. 31 MARCH 31 JUNE 30 SEPT. 30 DEC. 31
------------------------------------------------------------------------ ---------------------------------------
Operating revenue (a) $ 1,226 $ 883 $ 911 $ 1,149 $ 1,206 $ 864 $ 890 $ 1,016
Earnings from equity method
investees $ 10 $ 17 $ 8 $ 18 $ 13 $ 9 $ 10 $ 6
Operating income (a) $ 188 $ 152 $ 168 $ 181 $ 216 $ 112 $ 77 $ 76
Income before cumulative
effect of change in
accounting principle (a) $ 92 $ 107 $ 84 $ 80 $ 108 $ 45 $ 23 $ 23
Cumulative effect of change
in accounting for derivative
instruments, net of $10 tax
expense in 2002 and $6 tax
benefit in 2001 (a) - $ 17 $ 1 - - - - ($ 11)
Net income $ 92 $ 124 $ 85 $ 80 $ 108 $ 45 $ 23 $ 12
Preferred stock dividends - - - $ 2 - $ 1 - $ 1
Preferred securities
distributions $ 11 $ 11 $ 11 $ 11 $ 9 $ 9 $ 12 $ 11
Net income available to
common stockholder $ 81 $ 113 $ 74 $ 67 $ 99 $ 35 $ 11 $ -
(a) Consumers reclassified $28 million ($18 million after taxes) reducing June
and September 2002 operating amounts to reflect the MCV Partnership's change in
accounting for derivative instruments as a separate item. See Note 11 in the
Notes to the consolidated financial statements.
F-92
CONSUMERS ENERGY COMPANY
Schedule II - Valuation and Qualifying Accounts and Reserves
Years Ended December 31, 2002, 2001 and 2000
(In Millions)
Balance at Charged Charged to Balance
Beginning to other at End
Description of Period Expense Accounts Deductions of Period
--------------------------------------------------------------------------------------------------------------------
Accumulated provision for
uncollectible accounts:
2002 $4 $17 - $16(a) $5
2001 $3 $13 - $12(a) $4
2000 $4 $10 - $11(a) $3
=================================================================================================================
(a) Accounts receivable written off including net uncollectible amounts of $14
in 2002, $10 in 2001 and $9 in 2000 charged directly to operating expense
and credited to accounts receivable.
F-93
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS IN CONNECTION WITH THE OFFERING MADE HEREBY, AND, IF GIVEN OR
MADE, SUCH INFORMATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY
CONSUMERS, THE INITIAL PURCHASERS OR ANY OTHER PERSON. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY THE NEW BONDS
BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED, OR IN WHICH THE PERSON MAKING THE OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
--------
TABLE OF CONTENTS
PAGE
----
Important Notice about Information in this
Prospectus ........................................ 1
Where You Can Find More Information.................... 1
Forward-Looking Statements and Information............. 2
Summary................................................ 5
Risk Factors........................................... 17
Use of Proceeds........................................ 25
Ratio of Earnings to Fixed Charges..................... 25
Description of the New Bonds........................... 26
Ratings................................................ 34
The Exchange Offer .................................... 34
Managements Discussion and Analysis of
Financial Condition and Results of Operations
for the Nine Months Ended September 30, 2003 ...... 45
Managements Discussion and Analysis of
Financial Condition and Results of Operations
for the Fiscal Year Ended December 31, 2002 ....... 76
Our Business........................................... 104
Legal Proceedings...................................... 114
Our Management......................................... 116
Affiliate Relationships and Transactions............... 125
Certain United States Federal Income Tax
Consequences ...................................... 125
Plan of Distribution................................... 128
Legal Opinions......................................... 128
Experts................................................ 128
Glossary............................................... 130
Index to Consolidated Financial Statements............. F-1
OFFER TO EXCHANGE
4.25% FIRST MORTGAGE BONDS DUE 2008, SERIES C
5.375% FIRST MORTGAGE BONDS DUE 2013, SERIES D
4.00% FIRST MORTGAGE BONDS DUE 2010, SERIES F
4.80% FIRST MORTGAGE BONDS DUE 2009, SERIES H
6.00% FIRST MORTGAGE BONDS DUE 2014, SERIES J
WHICH HAVE BEEN REGISTERED
UNDER THE SECURITIES ACT OF 1933,
AS AMENDED
FOR ANY AND ALL OF THE OUTSTANDING
4.25% FIRST MORTGAGE BONDS DUE 2008, SERIES A
5.375% FIRST MORTGAGE BONDS DUE 2013, SERIES B
4.00% FIRST MORTGAGE BONDS DUE 2010, SERIES E
4.80% FIRST MORTGAGE BONDS DUE 2009, SERIES G
6.00% FIRST MORTGAGE BONDS DUE 2014, SERIES I
[CONSUMERS ENERGY LOGO]
PART II. INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The following resolution was adopted by the Board of Directors of Consumers on
May 6, 1987:
RESOLVED: That effective March 1, 1987 the Company shall indemnify to
the full extent permitted by law every person (including the estate, heirs
and legal representatives of such person in the event of the decease,
incompetency, insolvency or bankruptcy of such person) who is or was a
director, officer, partner, trustee, employee or agent of the Company, or
is or was serving at the request of the Company as a director, officer,
partner, trustee, employee or agent of another corporation, partnership,
joint venture, trust or other enterprise, against all liability, costs,
expenses, including attorneys' fees, judgments, penalties, fines and
amounts paid in settlement, incurred by or imposed upon the person in
connection with or resulting from any claim or any threatened, pending or
completed action, suit or proceeding whether civil, criminal,
administrative, investigative or of whatever nature, arising from the
person's service or capacity as, or by reason of the fact that the person
is or was, a director, officer, partner, trustee, employee or agent of the
Company or is or was serving at the request of the Company as a director,
officer, partner, trustee, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise. Such right of
indemnification shall not be deemed exclusive of any other rights to which
the person may be entitled under statute, bylaw, agreement, vote of
shareholders or otherwise.
Article XIII, Section 1 of Consumers Bylaws provides:
The Company may purchase and maintain liability insurance, to the full
extent permitted by law, on behalf of any person who is or was a director,
officer, employee or agent of the Company, or is or was serving at the
request of the Company as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise against
any liability asserted against such person and incurred by such person in
any such capacity.
Article V of Consumers Restated Articles of Incorporation, as
amended reads:
A director shall not be personally liable to the Company or its
shareholders for monetary damages for breach of duty as a director except
(i) for a breach of the director's duty of loyalty to the Company or its
shareholders, (ii) for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law, (iii) for a violation
of Section 551(1) of the Michigan Business Corporation Act, and (iv) any
transaction from which the director derived an improper personal benefit.
No amendment to or repeal of this Article V, and no modification to its
provisions by law, shall apply to, or have any effect upon, the liability
or alleged liability of any director of the Company for or with respect to
any acts or omissions of such director occurring prior to such amendment,
repeal or modification.
Article VI of Consumers Restated Articles of Incorporation, as amended
reads:
Each director and each officer of the Company shall be indemnified by
the Company to the fullest extent permitted by law against expenses
(including attorneys' fees), judgments, penalties, fines and amounts paid
in settlement actually and reasonably incurred by him or her in connection
with the defense of any proceeding in which he or she was or is a party or
is threatened to be made a party by reason of being or having been a
director or an officer of the Company. Such right of indemnification is not
exclusive of any other rights to which such director or officer may be
entitled under any now or
II-1
thereafter existing statute, any other provision of these Articles, bylaw,
agreement, vote of shareholders or otherwise. If the Business Corporation
Act of the State of Michigan is amended after approval by the shareholders
of this Article VI to authorize corporate action further eliminating or
limiting the personal liability of directors, then the liability of a
director of the Company shall be eliminated or limited to the fullest
extent permitted by the Business Corporation Act of the State of Michigan,
as so amended. Any repeal or modification of this Article VI by the
shareholders of the Company shall not adversely affect any right or
protection of a director of the Company existing at the time of such repeal
or modification.
Sections 561 through 571 of the Michigan Business Corporation Act provides
Consumers with the power to indemnify directors, officers, employees and agents
against certain expenses and payments, and to purchase and maintain insurance on
behalf of directors, officers, employees and agents.
Officers and directors are covered within specified monetary limits by
insurance against certain losses arising from claims made by reason of their
being directors or officers of Consumers or of Consumers' subsidiaries and
Consumers' officers and directors are indemnified against such losses by reason
of their being or having been directors of officers of another corporation,
partnership, joint venture, trust or other enterprise at Consumers' request. In
addition, Consumers has indemnified each of its present directors by contracts
that contain affirmative provisions essentially similar to those in sections 561
through 571 of the Michigan Business Corporation Act cited above.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
EXHIBITS
PREVIOUSLY FILED
--------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
-------- ----------- ------------ ----------------------------------------------------------------
(3)(a) 1-5611 3(c) -- Restated Articles of Incorporation dated May 26, 2000, of
Consumers (2000 Form 10-K)
(3)(b) 1-5611 (3)(d) -- By-Laws of Consumers. (1st qtr. 2003 Form 10-Q)
(4)(a) 2-65973 (b)(1)-4 -- Indenture dated as of September 1, 1945, between Consumers
and Chemical Bank (successor to Manufacturers Hanover Trust
Company), as Trustee, including therein indentures
supplemental thereto through the Forty-third Supplemental
Indenture dated as of May 1, 1979.
-- Indentures Supplemental thereto:
33-41126 (4)(c) -- 68th dated as of 06/15/93
1-5611 (4) -- 69th dated as of 09/15/93 (Form 8-K dated Sep. 21, 1993)
1-5611 (4)(a) -- 70th dated as of 02/01/98 (1997 Form 10-K)
1-5611 (4)(a) -- 71st dated as of 03/06/98 (1997 Form 10-K)
1-5611 (4)(b) -- 72nd dated as of 05/01/98 (1st qtr. 1998 Form 10-Q)
333-58943 (4)(d) -- 73rd dated as of 06/15/98 (Form S-4 dated July 13, 1998)
1-5611 (4)(b) -- 74th dated as of 10/29/98 (3rd Qtr. 1998 Form 10-Q)
1-5611 (4)(b) -- 75th dated as of 10/1/99 (1999 Form 10-K)
1-5611 (4)(d) -- 77th dated as of 10/1/99 (1999 Form 10-K)
1-5611 4(b) -- 79th dated as of 9/26/01 (3rd qtr 2001 10-Q)
1-5611 4(a)(i) -- 80th dated as of 3/22/02 (2001 Form 10-K)
1-5611 4.6 -- 81tst dated as of 7/12//02 (Form 8-K dated July 30, 2002)
1-5611 4.7 -- 82nd dated as of 7/12//02 (Form 8-K dated July 30, 2002)
1-5611 (4)(a)(i) -- 83rd dated as of 9/26/02 (2002 Form 10-K)
1-5611 (4)(a)(ii) -- 84th dated as of 12/11/02 (2002 Form 10-K)
1-5611 (4)(a)(iii) -- 85th dated as of 10/17/02 (2002 Form 10-K)
1-5611 (4)(a)(iv) -- 86th dated as of 11/25/02 (2002 Form 10-K)
1-5611 (4)(a) -- 87th dated as of 3/26/03 (1st qtr. 2003 Form 10-Q)
II-2
PREVIOUSLY FILED
--------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
-------- ------------ ----------- -----------
1-5611 (4)(b) -- 88th dated as of 3/27/03 (1st qtr. 2003 Form 10-Q)
1-5611 (4)(c) -- 89th dated as of 3/28/03 (1st qtr. 2003 Form 10-Q)
1-5611 (4)(d) -- 90th dated as of 3/30/03 (1st qtr. 2003 Form 10-Q)
1-5611 (4)(a) -- 91st dated as of 5/23/03 (3rd qtr. 2003 Form 10-Q)
1-5611 (4)(b) -- 92nd dated as of 8/26/03 (3rd qtr. 2003 Form 10-Q)
1-5611 (4)(c) -- 93rd dated as of 9/17/03 (3rd qtr. 2003 Form 10-Q)
(4)(a)(i) -- 94th dated as of 11/7/03
(4)(b) 1-5611 (4)(b) -- Indenture dated as of January 1, 1996 between Consumers and
The Bank of New York, as Trustee. (1995 Form 10-K)
-- Indentures Supplemental thereto:
1-5611 (4)(b) -- 1st dated as of 01/18/96 (1995 Form 10-K)
1-5611 (4)(a) -- 2nd dated as of 09/04/97 (3rd qtr 1997 Form 10-Q)
1-9513 (4)(a) -- 3rd 11/04/99 (3rd qtr 1999 Form 10-Q)
(4)(c) 1-5611 (4)(c) -- Indenture dated as of February 1, 1998 between Consumers
and JPMorgan Chase (formerly "The Chase Manhattan Bank), as
Trustee. (1997 Form 10-K)
1-5611 (4)(a) -- 1st dated as of 05/01/98 (1st Qtr. 1998 Form 10-Q)
333-58943 (4)(b) -- 2nd dated as of 06/15/98
1-5611 (4)(a) -- 3rd 10/29/98 (3rd qtr. 1998 Form 10-Q)
4(d) 1-5611 (4)(e) -- $140 million Term Loan Agreement dated March 26, 2003
between Consumers Energy Company and the Bank/Agent, as
defined therein (1st qtr. 2003 Form 10-Q)
(4)(e) -- Form of Series C Bonds
(4)(f) -- Form of Series D Bonds
(4)(g) -- Form of Series F Bonds
(4)(h) -- Form of Series H Bonds
(4)(i) -- Form of Series J Bonds
(4)(j) 1-5611 (4)(c) -- Registration Rights Agreement dated as of April 30, 2003
between Consumers and the Initial Purchasers, all as
defined therein (3rd qtr. 2003 Form 10-Q)
(4)(k) 1-5611 (4)(d) -- Registration Rights Agreement dated as of May 23, 2003
between Consumers and the Initial Purchasers, all as
defined therein (3rd qtr. 2003 Form 10-Q)
(4)(l) 1-5611 (4)(e) -- Registration Rights Agreement dated as of August 26, 2003
between Consumers and the Initial Purchasers, all as
defined therein (3rd qtr. 2003 Form 10-Q)
(5) -- Opinion of Robert C. Shrosbree, Assistant General Counsel
for CMS Energy
(8) -- Opinion of Jay M. Silverman, Tax Counsel for CMS Energy
regarding tax matters
(10)(a) 1-9513 (10)(b) -- Form of Employment Agreement entered into by CMS Energy's
and Consumers' executive officers. (1999 Form 10-K)
(10)(b) 1-9513 (10)(a) -- Acknowledgement of Resignation between Tamela W. Pallas and
CMS Energy Corporation (3rd qtr 2002 Form 10-Q)
(10)(c) 1-5611 (10)(g) -- Consumers' Executive Stock Option and Stock Appreciation
Rights Plan effective December 1, 1989. (1990 Form 10-K)
(10)(d) 1-9513 (10)(b) -- Employment, Separation and General Release Agreement
between William T. McCormick and CMS Energy Corporation
(3rd qtr 2002 Form 10-Q)
(10)(e) 1-9513 (10)(d) -- CMS Energy's Performance Incentive Stock Plan effective
February 3, 1988, as amended December 3, 1999. (1999 Form
10-K)
(10)(f) 1-9513 (10)(c) -- Employment, Separation and General Release Agreement
between Alan M. Wright and CMS Energy Corporation (3rd qtr
2002 Form 10-Q)
(10(g) 1-9513 (10)(g) -- Employment Agreement dated as of June 1, 2002 between
Kenneth Whipple and CMS Energy Corporation (2002 Form 10-K)
(10)(h) 1-9513 (10)(m) -- CMS Deferred Salary Savings Plan effective January 1, 1994.
(1993 Form 10-K)
II-3
PREVIOUSLY FILED
--------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
-------- ------ ------ -----------
(10)(i) 1-9513 (10)(n) -- CMS Energy and Consumers Annual Executive Incentive
Compensation Plan effective January 1, 1986, as amended
January 1995. (1995 Form 10-K)
(10)(j) 1-9513 (10)(h) -- Supplemental Executive Retirement Plan for Employees of CMS
Energy/Consumers Energy Company effective January 1, 1982,
as amended December 3, 1999. (1999 Form 10-K)
(10)(k) 33-37977 4.1 -- Senior Trust Indenture, Leasehold Mortgage and Security
Agreement dated as of June 1, 1990 between The Connecticut
National Bank and United States Trust Company of New York.
(MCV Partnership)
Indenture Supplemental thereto:
33-37977 4.2 -- Supplement No. 1 dated as of June 1, 1990. (MCV Partnership)
(10)(l) 1-9513 (28)(b) -- Collateral Trust Indenture dated as of June 1, 1990 among
Midland Funding Corporation I, MCV Partnership and United
States Trust Company of New York, Trustee. (3rd qtr 1990
Form 10-Q)
Indenture Supplemental thereto:
33-37977 4.4 -- Supplement No. 1 dated as of June 1, 1990. (MCV Partnership)
(10)(m) 1-9513 (10)(v) -- Amended and Restated Investor Partner Tax Indemnification
Agreement dated as of June 1, 1990 among Investor Partners,
CMS Midland as Indemnitor and CMS Energy as Guarantor. (1990
Form 10-K)
(10)(n) 1-9513 (19)(d)* -- Environmental Agreement dated as of June 1, 1990 made by CMS
Energy to The Connecticut National Bank and Others. (1990
Form 10-K)
(10)(o) 1-9513 (10)(z)* -- Indemnity Agreement dated as of June 1, 1990 made by CMS
Energy to Midland Cogeneration Venture Limited Partnership.
(1990 Form 10-K)
(10)(p) 1-9513 (10)(aa)* -- Environmental Agreement dated as of June 1, 1990 made by CMS
Energy to United States Trust Company of New York, Meridian
Trust Company, each Subordinated Collateral Trust Trustee
and Holders from time to time of Senior Bonds and
Subordinated Bonds and Participants from time to time in
Senior Bonds and Subordinated Bonds. (1990 Form 10-K)
(10)(q) 33-37977 10.4 -- Amended and Restated Participation Agreement dated as of
June 1, 1990 among MCV Partnership, Owner Participant, The
Connecticut National Bank, United States Trust Company,
Meridian Trust Company, Midland Funding Corporation I,
Midland Funding Corporation II, MEC Development Corporation
and Institutional Senior Bond Purchasers. (MCV Partnership)
(10)(r) 33-3797 10.4 -- Power Purchase Agreement dated as of July 17, 1986 between
MCV Partnership and Consumers. (MCV Partnership)
Amendments thereto:
33-37977 10.5 -- Amendment No. 1 dated September 10, 1987. (MCV Partnership)
33-37977 10.6 -- Amendment No. 2 dated March 18, 1988. (MCV Partnership)
33-37977 10.7 -- Amendment No. 3 dated August 28, 1989. (MCV Partnership)
33-37977 10.8 -- Amendment No. 4A dated May 25, 1989. (MCV Partnership)
(10)(s) 1-5611 (10)(y) -- Unwind Agreement dated as of December 10, 1991 by and among
CMS Energy, Midland Group, Ltd., Consumers, CMS Midland,
Inc., MEC Development Corp. and CMS Midland Holdings
Company. (1991 Form 10-K)
(10)(t) 1-5611 (10)(z) -- Stipulated AGE Release Amount Payment Agreement dated as of
June 1, 1990, among CMS Energy, Consumers and The Dow
Chemical Company. (1991 Form 10-K)
(10)(u) 1-5611 (10)(aa)* -- Parent Guaranty dated as of June 14, 1990 from CMS Energy to
II-4
PREVIOUSLY FILED
--------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
-------- ------ ------ -----------
MCV, each of the Owner Trustees, the Indenture Trustees,
the Owner Participants and the Initial Purchasers of
Senior Bonds in the MCV Sale Leaseback transaction, and
MEC Development. (1991 Form 10-K)
(10)(v) 1-8157 10.41 -- Contract for Firm Transportation of Natural Gas between
Consumers Power Company and Trunkline Gas Company, dated
November 1, 1989, and Amendment, dated November 1, 1989.
(1989 Form 10-K of PanEnergy Corp.)
(10)(w) 1-8157 10.41 -- Contract for Firm Transportation of Natural Gas between
Consumers Power Company and Trunkline Gas Company, dated
November 1, 1989. (1991 Form 10-K of PanEnergy Corp.)
(10)(x) 1-2921 10.03 -- Contract for Firm Transportation of Natural Gas between
Consumers Power Company and Trunkline Gas Company, dated
September 1, 1993. (1993 Form 10-K)
(10)(y) 1-5611 (10)(a) -- Purchase Agreement dated April 23, 2003 between Consumers
and the Initial Purchasers, as defined therein. (3rd qtr.
2003 10-Q)
(10)(z) 1-5611 (10)(b) -- Purchase Agreement dated May 20, 2003 between Consumers and
the Initial Purchasers, as defined therein. (3rd qtr. 2003
10-Q)
(10)(aa) 1-5611 (10)(c) -- Purchase Agreement dated August 19, 2003 between Consumers
and the Initial Purchasers, as defined therein. (3rd qtr.
2003 10-Q)
(10)(bb) 1-5611 10 -- First Amended and Restated Employment Agreement between
Kenneth Whipple and CMS Energy Corporation effective as of
September 1, 2003.(8-K dated October 24, 2003)
(12) -- Statement regarding computation of Consumers Ratio of
Earnings to Fixed Charges
(16) 1-5611 16.1 -- Letter from Arthur Andersen LLP to the Securities and
Exchange Commission dated April 29, 2002 regarding change
in certifying accountant (Form 8-K filed April 29, 2002)
(21) -- Subsidiaries of Consumers. (Form U-3A-2 filed February 25,
2003).
(23(a) -- Consent of Robert C. Shrosbree, Assistant General Counsel
for CMS Energy (included in Exhibit 5 above).
(23)(b) -- Consent of Jay M. Silverman, Tax Counsel for CMS Energy
(included in Exhibit 8 above).
(23)(c) -- Consent of Ernst & Young LLP
(23)(d) -- Consent of PricewaterhouseCoopers LLP
(24) -- Power of Attorney for Consumers
(25) -- Statement of Eligibility and Qualification of JPMorgan
Chase Bank.
(99)(a) -- Form of Letter of Transmittal.
(99)(b) -- Certification of Taxpayer Identification Number on
Substitute Form W-9.
(99)(c) -- Form of Notice of Guaranteed Delivery.
----------
* Obligations of only CMS Holdings and CMS Midland, second tier subsidiaries of
Consumers, and of CMS Energy but not of Consumers.
Exhibits listed above which have heretofore been filed with the Securities
and Exchange Commission pursuant to various acts administered by the Commission,
and which were designated as noted above, are hereby incorporated herein by
reference and made a part hereof with the same effect as if filed herewith.
Exhibits listed above which have been filed with the Securities and
Exchange Commission are incorporated herein by reference with the same effect as
if filed with this Registration Statement.
II-5
ITEM 22. UNDERTAKINGS.
The undersigned registrants hereby undertake:
(1) That, for purposes of determining any liability under the Securities
Act of 1933, each filing of the registrant's annual report pursuant to section
13(a) or section 15(d) of the Securities Exchange Act of 1934 that is
incorporated by reference in this registration statement shall be deemed to be a
new registration statement relating to the securities offered herein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(2) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the provisions described under Item 20 above, or
otherwise, the registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event that as
claim for indemnification against such liabilities (other than the payment by
the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
be governed by the final adjudication of such issue.
(3) To respond to requests for information that is incorporated by
reference in to the prospectus pursuant to Item 4, 10(b), 11, or 13 of this
form, within one business day of receipt of such request, and to send the
incorporated documents by first class mail or other equally prompt means. This
includes information contained in documents filed subsequent to the effective
date of the registration statement through the date of responding to the
request.
(4) To supply by means of a post-effective amendment all information
concerning a transaction, and the company being acquired involved therein, that
was not the subject of and included in the registration statement when it became
effective.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, there unto duly authorized, in the City of Jackson, and State of
Michigan, on the 15th day of December, 2003.
CONSUMERS ENERGY COMPANY
By: /s/ Thomas J. Webb
-------------------------------
Thomas J. Webb
Senior Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities indicated on December 15th, 2003.
NAME TITLE
---- -----
(I) PRINCIPAL EXECUTIVE OFFICER:
/s/ DAVID W. JOOS President
---------------------------------- and Chief Operating Officer
David W. Joos
(II) PRINCIPAL FINANCIAL OFFICER:
/s/ THOMAS J. WEBB Senior Vice President and
--------------------------------- Chief Financial Officer
Thomas J. Webb
(III) CONTROLLER OR PRINCIPAL ACCOUNTING OFFICER
/s/ GLENN P. BARBA Vice President and Controller
------------------------------------
Glenn P. Barba
*
------------------------------------
(James J. Duderstadt) Director
*
------------------------------------
(Kathleen R. Flaherty) Director
*
------------------------------------
(David W. Joos) Director
II-7
*
--------------------------------------------
(Earl D. Holton) Director
*
--------------------------------------------
(Michael T. Monahan) Director
*
--------------------------------------------
(Joseph F. Paquette, Jr.) Director
--------------------------------------------
(William U. Parfet) Director
*
--------------------------------------------
(Percy A. Pierre) Director
*
--------------------------------------------
(S. Kinnie Smith, Jr.) Director
*
--------------------------------------------
(Kenneth L. Way) Director
*
-------------------------------------------
(Kenneth Whipple) Director
*
-------------------------------------------
(John B. Yasinsky) Director
*By: /s/ THOMAS J. WEBB
------------------------
Thomas J. Webb
Attorney in-fact
II-8
EXHIBIT INDEX
PREVIOUSLY FILED
-------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
-----------------------------------------------------------------------------------------------------------------
(3)(a) 1-5611 3(c) -- Restated Articles of Incorporation dated May 26, 2000, of
Consumers (2000 Form 10-K)
(3)(b) 1-5611 (3)(d) -- By-Laws of Consumers. (1st qtr. 2003 Form 10-Q)
(4)(a) 2-65973 (b)(1)-4 -- Indenture dated as of September 1, 1945, between Consumers
And Chemical Bank (successor to Manufacturers Hanover
Trust Company), as Trustee, including therein indentures
supplemental thereto through the Forty-third Supplemental
Indenture dated as of May 1, 1979.
-- Indentures Supplemental thereto:
33-41126 (4)(c) -- 68th dated as of 06/15/93
1-5611 (4) -- 69th dated as of 09/15/93 (Form 8-K dated Sep. 21, 1993)
1-5611 (4)(a) -- 70th dated as of 02/01/98 (1997 Form 10-K)
1-5611 (4)(a) -- 71st dated as of 03/06/98 (1997 Form 10-K)
1-5611 (4)(b) -- 72nd dated as of 05/01/98 (1st qtr. 1998 Form 10-Q)
333-58943 (4)(d) -- 73rd dated as of 06/15/98 (Form S-4 dated July 13, 1998)
1-5611 (4)(b) -- 74th dated as of 10/29/98 (3rd Qtr. 1998 Form 10-Q)
1-5611 (4)(b) -- 75th dated as of 10/1/99 (1999 Form 10-K)
1-5611 (4)(d) -- 77th dated as of 10/1/99 (1999 Form 10-K)
1-5611 4(b) -- 79th dated as of 9/26/01 (3rd qtr 2001 10-Q)
1-5611 4(a)(i) -- 80th dated as of 3/22/02 (2001 Form 10-K)
1-5611 4.6 -- 81tst dated as of 7/12//02 (Form 8-K dated July 30, 2002)
1-5611 4.7 -- 82nd dated as of 7/12//02 (Form 8-K dated July 30, 2002)
1-5611 (4)(a)(i) -- 83rd dated as of 9/26/02 (2002 Form 10-K)
1-5611 (4)(a)(ii) -- 84th dated as of 12/11/02 (2002 Form 10-K)
1-5611 (4)(a)(iii) -- 85th dated as of 10/17/02 (2002 Form 10-K)
1-5611 (4)(a)(iv) -- 86th dated as of 11/25/02 (2002 Form 10-K)
1-5611 (4)(a) -- 87th dated as of 3/26/03 (1st qtr. 2003 Form 10-Q)
1-5611 (4)(b) -- 88th dated as of 3/27/03 (1st qtr. 2003 Form 10-Q)
1-5611 (4)(c) -- 89th dated as of 3/28/03 (1st qtr. 2003 Form 10-Q)
1-5611 (4)(d) -- 90th dated as of 3/30/03 (1st qtr. 2003 Form 10-Q)
1-5611 (4)(a) -- 91st dated as of 5/23/03 (3rd qtr. 2003 Form 10-Q)
1-5611 (4)(b) -- 92nd dated as of 8/26/03 (3rd qtr. 2003 Form 10-Q)
1-5611 (4)(c) -- 93rd dated as of 9/17/03 (3rd qtr. 2003 Form 10-Q)
(4)(a)(i) -- 94th dated as of 11/7/03
(4)(b) 1-5611 (4)(b) -- Indenture dated as of January 1, 1996 between Consumers and
The Bank of New York, as Trustee. (1995 Form 10-K)
-- Indentures Supplemental thereto:
1-5611 (4)(b) -- 1st dated as of 01/18/96 (1995 Form 10-K)
1-5611 (4)(a) -- 2nd dated as of 09/04/97 (3rd qtr 1997 Form 10-Q)
1-9513 (4)(a) -- 3rd 11/04/99 (3rd qtr 1999 Form 10-Q)
(4)(c) 1-5611 (4)(c) -- Indenture dated as of February 1, 1998 between Consumers
and JPMorgan Chase (formerly "The Chase Manhattan Bank), as
Trustee. (1997 Form 10-K)
1-5611 (4)(a) -- 1st dated as of 05/01/98 (1st Qtr. 1998 Form 10-Q)
333-58943 (4)(b) -- 2nd dated as of 06/15/98
1-5611 (4)(a) -- 3rd 10/29/98 (3rd qtr. 1998 Form 10-Q)
4(d) 1-5611 (4)(e) -- $140 million Term Loan Agreement dated March 26, 2003
between Consumers Energy Company and the Bank/Agent, as
defined therein (1st qtr. 2003 Form 10-Q)
(4)(e) -- Form of Series C Bonds
(4)(f) -- Form of Series D Bonds
(4)(g) -- Form of Series F Bonds
(4)(h) -- Form of Series H Bonds
II-9
PREVIOUSLY FILED
-------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
-----------------------------------------------------------------------------------------------------------------
(4)(i) -- Form of Series J Bonds
(4)(j) 1-5611 (4)(c) -- Registration Rights Agreement dated as of April 30, 2003
between Consumers and the Initial Purchasers, all as
defined therein. (3rd qtr. 2003 Form 10-Q)
(4)(k) 1-5611 (4)(d) -- Registration Rights Agreement dated as of May 23, 2003
between Consumers and the Initial Purchasers, all as
defined therein. (3rd qtr. 2003 Form 10-Q)
(4)(l) 1-5611 (4)(e) -- Registration Rights Agreement dated as of August 26, 2003
between Consumers and the Initial Purchasers, all as
defined therein. (3rd qtr. 2003 Form 10-Q)
(5) -- Opinion of Robert C. Shrosbree, Assistant General Counsel
for CMS Energy
(8) -- Opinion of Jay M. Silverman, Tax Counsel for CMS Energy
regarding tax matters
(10)(a) 1-9513 (10)(b) -- Form of Employment Agreement entered into by CMS Energy's
and Consumers' executive officers. (1999 Form 10-K)
(10)(b) 1-9513 (10)(a) -- Acknowledgement of Resignation between Tamela W. Pallas and
CMS Energy Corporation (3rd qtr 2002 Form 10-Q)
(10)(c) 1-5611 (10)(g) -- Consumers' Executive Stock Option and Stock Appreciation
Rights Plan effective December 1, 1989. (1990 Form 10-K)
(10)(d) 1-9513 (10)(b) -- Employment, Separation and General Release Agreement
between William T. McCormick and CMS Energy Corporation
(3rd qtr 2002 Form 10-Q)
(10)(e) 1-9513 (10)(d) -- CMS Energy's Performance Incentive Stock Plan effective
February 3, 1988, as amended December 3, 1999. (1999 Form
10-K)
(10)(f) 1-9513 (10)(c) -- Employment, Separation and General Release Agreement
between Alan M. Wright and CMS Energy Corporation (3rd qtr
2002 Form 10-Q)
(10(g) 1-9513 (10)(g) -- Employment Agreement dated as of June 1, 2002 between
Kenneth Whipple and CMS Energy Corporation (2002 Form 10-K)
(10)(h) 1-9513 (10)(m) -- CMS Deferred Salary Savings Plan effective January 1, 1994.
(1993 Form 10-K)
(10)(i) 1-9513 (10)(n) -- CMS Energy and Consumers Annual Executive Incentive
Compensation Plan effective January 1, 1986, as amended
January 1995. (1995 Form 10-K)
(10)(j) 1-9513 (10)(h) -- Supplemental Executive Retirement Plan for Employees of CMS
Energy/Consumers Energy Company effective January 1, 1982,
as amended December 3, 1999. (1999 Form 10-K)
(10)(k) 33-37977 4.1 -- Senior Trust Indenture, Leasehold Mortgage and Security
Agreement dated as of June 1, 1990 between The Connecticut
National Bank and United States Trust Company of New York.
(MCV Partnership)
Indenture Supplemental thereto:
33-37977 4.2 -- Supplement No. 1 dated as of June 1, 1990. (MCV Partnership)
(10)(l) 1-9513 (28)(b) -- Collateral Trust Indenture dated as of June 1, 1990 among
Midland Funding Corporation I, MCV Partnership and United
States Trust Company of New York, Trustee. (3rd qtr 1990
Form 10-Q)
Indenture Supplemental thereto:
33-37977 4.4 -- Supplement No. 1 dated as of June 1, 1990. (MCV Partnership)
(10)(m) 1-9513 (10)(v) -- Amended and Restated Investor Partner Tax Indemnification
Agreement dated as of June 1, 1990 among Investor Partners,
CMS Midland as Indemnitor and CMS Energy as Guarantor. (1990
Form 10-K)
(10)(n) 1-9513 (19)(d)* -- Environmental Agreement dated as of June 1, 1990 made by CMS
Energy to The Connecticut National Bank and Others. (1990
Form 10-K)
(10)(o) 1-9513 (10)(z)* -- Indemnity Agreement dated as of June 1, 1990 made by CMS
II-10
PREVIOUSLY FILED
-------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
-----------------------------------------------------------------------------------------------------------------
Energy to Midland Cogeneration Venture Limited Partnership.
(1990 Form 10-K)
(10)(p) 1-9513 (10)(aa)* -- Environmental Agreement dated as of June 1, 1990 made by CMS
Energy to United States Trust Company of New York, Meridian
Trust Company, each Subordinated Collateral Trust Trustee
and Holders from time to time of Senior Bonds and
Subordinated Bonds and Participants from time to time in
Senior Bonds and Subordinated Bonds. (1990 Form 10-K)
(10)(q) 33-37977 10.4 -- Amended and Restated Participation Agreement dated as of
June 1, 1990 among MCV Partnership, Owner Participant, The
Connecticut National Bank, United States Trust Company,
Meridian Trust Company, Midland Funding Corporation I,
Midland Funding Corporation II, MEC Development Corporation
and Institutional Senior Bond Purchasers. (MCV Partnership)
(10)(r) 33-3797 10.4 -- Power Purchase Agreement dated as of July 17, 1986 between
MCV Partnership and Consumers. (MCV Partnership)
Amendments thereto:
33-37977 10.5 -- Amendment No. 1 dated September 10, 1987. (MCV Partnership)
33-37977 10.6 -- Amendment No. 2 dated March 18, 1988. (MCV Partnership)
33-37977 10.7 -- Amendment No. 3 dated August 28, 1989. (MCV Partnership)
33-37977 10.8 -- Amendment No. 4A dated May 25, 1989. (MCV Partnership)
(10)(s) 1-5611 (10)(y) -- Unwind Agreement dated as of December 10, 1991 by and among
CMS Energy, Midland Group, Ltd., Consumers, CMS Midland,
Inc., MEC Development Corp. and CMS Midland Holdings
Company. (1991 Form 10-K)
(10)(t) 1-5611 (10)(z) -- Stipulated AGE Release Amount Payment Agreement dated as of
June 1, 1990, among CMS Energy, Consumers and The Dow
Chemical Company. (1991 Form 10-K)
(10)(u) 1-5611 (10)(aa)* -- Parent Guaranty dated as of June 14, 1990 from CMS Energy to
MCV, each of the Owner Trustees, the Indenture Trustees, the
Owner Participants and the Initial Purchasers of Senior Bonds
in the MCV Sale Leaseback transaction, and MEC Development.
(1991 Form 10-K)
(10)(v) 1-8157 10.41 -- Contract for Firm Transportation of Natural Gas between
Consumers Power Company and Trunkline Gas Company, dated
November 1, 1989, and Amendment, dated November 1, 1989.
(1989 Form 10-K of PanEnergy Corp.)
(10)(w) 1-8157 10.41 -- Contract for Firm Transportation of Natural Gas between
Consumers Power Company and Trunkline Gas Company, dated
November 1, 1989. (1991 Form 10-K of PanEnergy Corp.)
(10)(x) 1-2921 10.03 -- Contract for Firm Transportation of Natural Gas between
Consumers Power Company and Trunkline Gas Company, dated
September 1, 1993. (1993 Form 10-K)
(10)(y) 1-5611 (10)(a) -- Purchase Agreement dated April 23, 2003 between Consumers
and the Initial Purchasers, as defined therein. (3rd qtr.
2003 10-Q)
(10)(z) 1-5611 (10)(b) -- Purchase Agreement dated May 20, 2003 between Consumers and
the Initial Purchasers, as defined therein. (3rd qtr. 2003
10-Q)
(10)(aa) 1-5611 (10)(c) -- Purchase Agreement dated August 19, 2003 between Consumers
and the Initial Purchasers, as defined therein. (3rd qtr.
2003 10-Q)
(10)(bb) 1-5611 10 -- First Amended and Restated Employment Agreement between
Kenneth Whipple and CMS Energy Corporation effective as of
September 1, 2003.(8-K dated October 24, 2003)
(12) -- Statement regarding computation of Consumers Ratio of
Earnings to Fixed Charges
(16) 1-5611 16.1 -- Letter from Arthur Andersen LLP to the Securities and
Exchange Commission dated April 29, 2002 regarding change
in certifying
II-11
PREVIOUSLY FILED
-------------------------
WITH FILE AS EXHIBIT
EXHIBITS NUMBER NUMBER DESCRIPTION
-----------------------------------------------------------------------------------------------------------------
accountant (Form 8-K filed April 29, 2002)
(21) -- Subsidiaries of Consumers. (Form U-3A-2 filed February 25,
2003).
(23)(a) -- Consent of Robert C. Shrosbree, Assistant General Counsel
for CMS Energy (included in Exhibit 5 above).
(23)(b) -- Consent of Jay M. Silverman, Tax Counsel for CMS Energy
(included in Exhibit 8 above).
(23)(c) -- Consent of Ernst & Young LLP
(23)(d) -- Consent of PricewaterhouseCoopers LLP
(24) -- Power of Attorney for Consumers
(25) -- Statement of Eligibility and Qualification of JPMorgan
Chase Bank.
(99)(a) -- Form of Letter of Transmittal.
(99)(b) -- Certification of Taxpayer Identification Number on
Substitute Form W-9.
(99)(c) -- Form of Notice of Guaranteed Delivery.
----------
* Obligations of only CMS Holdings and CMS Midland, second tier subsidiaries
of Consumers, and of CMS Energy but not of Consumers.
Exhibits listed above which have heretofore been filed with the
Securities and Exchange Commission pursuant to various acts administered by the
Commission, and which were designated as noted above, are hereby incorporated
herein by reference and made a part hereof with the same effect as if filed
herewith.
Exhibits listed above which have been filed with the Securities and
Exchange Commission are incorporated herein by reference with the same effect
as if filed with this Registration Statement.
II-12