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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------- --------
Commission Registrant; State of Incorporation; IRS Employer
File Number Address; and Telephone Number Identification No.
- ------------------------------------------------------------------------------------------
1-9513 CMS ENERGY CORPORATION 38-2726431
(A Michigan Corporation)
Fairlane Plaza South, Suite 1100
330 Town Center Drive, Dearborn, Michigan 48126
(313)436-9200
1-5611 CONSUMERS ENERGY COMPANY 38-0442310
(A Michigan Corporation)
212 West Michigan Avenue, Jackson, Michigan 49201
(517)788-0550
1-2921 PANHANDLE EASTERN PIPE LINE COMPANY 44-0382470
(A Delaware Corporation)
5444 Westheimer Road, P.O. Box 4967, Houston, Texas 77210-4967
(713)989-7000
Indicate by check mark whether the Registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes X* No
--- ---
Panhandle Eastern Pipe Line Company meets the conditions set forth in General
Instructions H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q
with the reduced disclosure format. In accordance with Instruction H, Part I,
Item 2 has been reduced and Part II, Items 2, 3 and 4 have been omitted.
Number of shares outstanding of each of the issuer's classes of common stock at
October 31, 2002:
CMS ENERGY CORPORATION:
CMS ENERGY Common Stock, $.01 par value 144,086,749
CONSUMERS ENERGY COMPANY, $10 par value, privately held by CMS Energy 84,108,789
PANHANDLE EASTERN PIPE LINE COMPANY, no par value,
indirectly privately held by CMS Energy 1,000
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* While this Form 10-Q has been filed on the specified due date, it does not
contain the certification required by the Sarbanes-Oxley Act of 2002 and Rule
13a-14. The Securities and Exchange Commission thus will not consider this
Form 10-Q to be timely.
Explanatory Note
Pending Restatement
As a result of certain events previously disclosed regarding round-trip trading,
CMS Energy has engaged Ernst & Young to re-audit its financial statements for
the fiscal years ended December 31, 2001 and 2000. During the course of the
re-audit, in consultation with its new auditors, CMS Energy has determined that
certain adjustments discussed below (unrelated to the round-trip trades) by CMS
Energy, Consumers, and Panhandle to their consolidated financial statements for
the fiscal years ended December 31, 2001 and December 31, 2000 are required. At
the time it adopted the accounting treatments for the items, CMS Energy believed
that such treatments were appropriate under generally accepted accounting
principles, and Arthur Andersen concurred. CMS Energy has now determined it will
adopt different accounting for certain transactions, upon the recommendation of
Ernst & Young, as discussed below. As a result, following completion of the
re-audit, CMS Energy, Consumers and Panhandle intend to file an amended Form
10-K for the fiscal year ended December 31, 2001. In addition, CMS Energy,
Consumers and Panhandle will file amended Form 10-Qs for the quarters ended
March 31, 2002, June 30, 2002 and September 30, 2002 following completion of
Ernst & Young's review of the interim financial statements for these periods. As
a result of these reviews and re-audits, there may be revisions to the financial
statements contained in the above-referenced reports, including this Form 10-Q,
which are in addition to the known revisions described below, some of which
could be material. CMS Energy has advised the staff of the SEC about the pending
restatements. CMS Energy is working with Ernst & Young to resolve these issues
and expects it will file all restated results by the end of January 2003.
The following table sets forth the estimated effects of the restatement
based on CMS Energy's knowledge to date:
NET INCOME IMPACT (MILLIONS)
Increase (Decrease)
2000 2001
MCV Partnership PPA Reserve -- $110
DIG Charge Reversal -- 130
CMS MST Changes/Reconciliations $43 (112)
---- -----
TOTAL $43 $128
ADDITIONS TO CONSOLIDATED DEBT (MILLIONS)
2000 2001
LNG Business $ 0 $215
Methanol Plant 125 125
---- ----
TOTAL $125 $340
The principal accounting restatement items include:
- - A change in the accounting treatment for reserves associated with
Consumers' PPA with the MCV Partnership. This change in accounting is
expected to result in a $110 million increase to net income in 2001 for CMS
Energy and Consumers. However, a determination as to the preferred
accounting method has not yet been completed and these adjustments are
subject to change;
- - Reversing a 2001 charge associated with the DIG complex. This is expected
to result in an increase to net income of $130 million in 2001 for CMS
Energy;
- - Changes to mark-to-market accounting and account reconciliations at CMS
MST. These are expected to result in an increase of $43 million in net
income for 2000 and a net charge of $112 million in 2001. This
reconciliation has not yet been completed and these adjustments are subject
to change for CMS Energy;
- - A change in the accounting treatment for CMS Energy's and Panhandle's
interest in the LNG business which was described in CMS Energy's and
Panhandle's 2001 Annual Report on Form 10-K. This will result in an
additional $215 million of debt on CMS Energy's and Panhandle's
consolidated balance sheet in 2001; and
- - A change in the accounting treatment for CMS Energy's financing of its
methanol plant previously disclosed in CMS Energy's 1999 Annual Report on
Form 10-K. This change will result in an increase in both debt and equity
of $125 million each to CMS Energy's 2000 and 2001 financial statements.
This debt was retired in January 2002.
Additional details of these transactions will be available in the amended
quarterly and annual reports to be filed upon completion of the re-audit and in
the restatements. See the "Round-Trip Trades" and "Change in Auditors and
Pending Restatements" sections of this Form 10-Q's MD&A and Condensed Notes to
the Consolidated Financial Statements for further discussion of these matters.
THE ACCOUNTING CONSEQUENCES OF THE RESTATEMENT ITEMS REFERENCED ABOVE ARE NOT
REFLECTED IN THE FINANCIAL INFORMATION INCLUDED IN THIS FORM 10-Q, OTHER THAN IN
THE "CHANGE IN AUDITORS AND PENDING RESTATEMENTS" SECTION OF CMS ENERGY'S MD&A.
ALL STATEMENTS IN THIS FORM 10-Q ARE QUALIFIED BY REFERENCE TO THIS EXPLANATORY
NOTE.
2
Certifications; Financial Review
As a result of the fact that the re-audit has not been completed and CMS Energy,
Consumers and Panhandle are not in a position to restate their financial
statements at this time, this Form 10-Q is not accompanied by the certifications
required by the Sarbanes-Oxley Act of 2002 and Rule 13(a)-14 of the Securities
Exchange Act of 1934, as amended. These certifications will be filed by
amendment to this Form 10-Q upon completion of the re-audit and the restatement
of the financial statements contained in this Form 10-Q.
This quarterly report includes financial statements which have not been reviewed
by an independent accountant under Rule 10-01(d) of Regulation S-X. We expect
that Ernst & Young will complete the quarterly review required by Rule 10-01(d)
of Regulation S-X following its re-audit of our historical financial statements
for the two-year period ended December 31, 2001.
3
CMS ENERGY CORPORATION
AND
CONSUMERS ENERGY COMPANY
AND
PANHANDLE EASTERN PIPE LINE COMPANY
QUARTERLY REPORTS ON FORM 10-Q TO THE
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
This combined Form 10-Q is separately filed by each of CMS Energy Corporation,
Consumers Energy Company and Panhandle Eastern Pipe Line Company. Information
contained herein relating to each individual registrant is filed by such
registrant on its own behalf. Accordingly, except for their respective
subsidiaries, Consumers Energy Company and Panhandle Eastern Pipe Line Company
make no representation as to information relating to any other companies
affiliated with CMS Energy Corporation.
TABLE OF CONTENTS
Page
----
Glossary.................................................................................................. 6
PART I: FINANCIAL INFORMATION
CMS Energy Corporation
Management's Discussion and Analysis
Forward-Looking Statements and Risk Factors..................................................... CMS-1
Round-Trip Trades............................................................................... CMS-2
Change in Auditors and Pending Restatement...................................................... CMS-3
Other Matters................................................................................... CMS-8
Results of Operations........................................................................... CMS-9
Critical Accounting Policies.................................................................... CMS-16
Capital Resources and Liquidity................................................................. CMS-23
Market Risk Information......................................................................... CMS-29
Outlook......................................................................................... CMS-31
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CMS-43
Consolidated Statements of Cash Flows........................................................... CMS-44
Consolidated Balance Sheets..................................................................... CMS-46
Consolidated Statements of Common Stockholders' Equity.......................................... CMS-48
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Basis of Presentation.............................................. CMS-49
2. Discontinued Operations.................................................................... CMS-54
3. Asset Disposition.......................................................................... CMS-56
4. Goodwill................................................................................... CMS-57
5. Uncertainties.............................................................................. CMS-58
6. Short-Term and Long-Term Financings, and Capitalization.................................... CMS-84
7. Earnings Per Share and Dividends........................................................... CMS-87
8. Risk Management Activities and Financial Instruments....................................... CMS-89
9. Reportable Segments........................................................................ CMS-94
4
TABLE OF CONTENTS
(CONTINUED)
Page
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Consumers Energy Company
Management's Discussion and Analysis
Forward-Looking Statements and Risk Factors..................................................... CE - 1
Change in Auditors and Pending Restatement...................................................... CE - 2
Critical Accounting Policies.................................................................... CE - 5
Results of Operations........................................................................... CE - 12
Capital Resources and Liquidity................................................................. CE - 15
Outlook......................................................................................... CE - 19
Other Matters................................................................................... CE - 27
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CE - 30
Consolidated Statements of Cash Flows........................................................... CE - 31
Consolidated Balance Sheets..................................................................... CE - 32
Consolidated Statements of Common Stockholder's Equity.......................................... CE - 34
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Summary of Significant Accounting Policies......................... CE - 35
2. Uncertainties.............................................................................. CE - 38
3. Short-Term Financings and Capitalization................................................... CE - 52
Panhandle Eastern Pipe Line Company
Management's Discussion and Analysis
Forward-Looking Statements and Risk Factors..................................................... PE - 1
Change in Auditors and Pending Restatements..................................................... PE - 3
Results of Operations........................................................................... PE - 6
Critical Accounting Policies.................................................................... PE - 8
Liquidity....................................................................................... PE - 11
Outlook......................................................................................... PE - 13
Other Matters................................................................................... PE - 15
Consolidated Financial Statements
Consolidated Statements of Income............................................................... PE - 18
Consolidated Statements of Cash Flows........................................................... PE - 19
Consolidated Balance Sheets..................................................................... PE - 20
Consolidated Statements of Common Stockholder's Equity.......................................... PE - 22
Condensed Notes to Consolidated Financial Statements:
1. Corporate Structure and Basis of Presentation.............................................. PE - 23
2. Regulatory Matters......................................................................... PE - 26
3. Goodwill Impairment........................................................................ PE - 27
4. Related Party Transactions................................................................. PE - 28
5. Commitments and Contingencies.............................................................. PE - 29
6. Debt Rating Downgrades .................................................................... PE - 33
7. System Gas ................................................................................ PE - 34
8. Possible Sale of Panhandle ................................................................ PE - 34
9. Pending Restatements ...................................................................... PE - 34
Quantitative and Qualitative Disclosures about Market Risk................................................ CO - 1
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................................................ CO - 1
Item 5. Other Information............................................................................ CO - 3
Item 6. Exhibits and Reports on Form 8-K............................................................. CO - 3
Signatures........................................................................................... CO - 5
5
GLOSSARY
Certain terms used in the text and financial statements are defined below.
ABATE..................................... Association of Businesses Advocating Tariff Equity
ALJ....................................... Administrative Law Judge
AMT....................................... Alternative Minimum Tax
APB....................................... Accounting Principles Board
APB Opinion No. 18....................... APB Opinion No. 18, "The Equity Method of Accounting for Investments
in Common Stock"
APB Opinion No. 30........................ APB Opinion No. 30, "Reporting Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business"
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
Alliance.................................. Alliance Regional Transmission Organization
Arthur Andersen........................... Arthur Andersen LLP
Articles.................................. Articles of Incorporation
Attorney General.......................... Michigan Attorney General
bcf....................................... Billion cubic feet
BG LNG Services........................... BG LNG Services, Inc., a subsidiary of BG Group of the
........................................... United Kingdom
Big Rock.................................. Big Rock Point nuclear power plant, owned by Consumers
Board of Directors........................ Board of Directors of CMS Energy
Bookouts.................................. Unplanned netting of transactions from multiple contracts
Centennial................................ Centennial Pipeline, LLC, in which Panhandle owns a one-third interest
CEO....................................... Chief Executive Officer
CFO....................................... Chief Financial Officer
Clean Air Act............................. Federal Clean Air Act, as amended
CMS Capital............................... CMS Capital Corp., a subsidiary of Enterprises
CMS Electric and Gas...................... CMS Electric and Gas Company, a subsidiary of Enterprises
CMS Energy................................ CMS Energy Corporation, the parent of Consumers and Enterprises
CMS Energy Common Stock................... Common stock of CMS Energy, par value $.01 per share
CMS Gas Transmission...................... CMS Gas Transmission Company, a subsidiary of Enterprises
CMS Generation............................ CMS Generation Co., a subsidiary of Enterprises
CMS Holdings.............................. CMS Midland Holdings Company, a subsidiary of Consumers
CMS Land.................................. CMS Land, a subsidiary of Enterprises
CMS Midland............................... CMS Midland Inc., a subsidiary of Consumers
CMS MST................................... CMS Marketing, Services and Trading Company, a subsidiary of
Enterprises
CMS Oil and Gas .......................... CMS Oil and Gas Company, a subsidiary of Enterprises
CMS Panhandle Holdings, LLC .............. A subsidiary of Panhandle Eastern Pipe Line
CMS Trunkline ............................ CMS Trunkline Gas Company, LLC, a subsidiary of CMS Panhandle
Holdings, LLC
CMS Trunkline LNG ........................ CMS Trunkline LNG Company, LLC, a subsidiary of LNG Holdings, LLC
CMS Viron................................. CMS Viron Energy Services, a wholly owned subsidiary of CMS MST
Consumers................................. Consumers Energy Company, a subsidiary of CMS Energy
6
Consumers Campus Holdings................. Consumers Campus Holdings, L.L.C., a wholly owned subsidiary of
Consumers
Court of Appeals.......................... Michigan Court of Appeals
Customer Choice Act....................... Customer Choice and Electricity Reliability Act, a Michigan statute
enacted in June 2000 that allows all retail customers choice of
alternative electric suppliers as of January 1, 2002, provides for
full recovery of net stranded costs and implementation costs,
establishes a five percent reduction in residential rates, establishes
rate freeze and rate cap, and allows for Securitization
Detroit Edison............................ The Detroit Edison Company, a non-affiliated company
DIG....................................... Dearborn Industrial Generation, L.L.C., a wholly owned subsidiary of
CMS Generation
DIG Statement No. C16..................... Derivatives Implementation Group, Statement 133 Implementation Issue
No. C16, "Scope Exceptions: Applying the Normal Purchases and Normal
Sales Exception to Contracts That Combine a Forward Contract and a
Purchased Option Contract"
DOE....................................... U.S. Department of Energy
Dow....................................... The Dow Chemical Company, a non-affiliated company
Duke Energy............................... Duke Energy Corporation, a non-affiliated company
EITF...................................... Emerging Issues Task Force
Energy Michigan........................... Energy Michigan is a trade association for the cogeneration,
independent power and waste to energy industries in Michigan.
Enterprises............................... CMS Enterprises Company, a subsidiary of CMS Energy
EPA....................................... U. S. Environmental Protection Agency
EPS....................................... Earnings per share
ERISA..................................... Employee Retirement Income Security Act
Ernst & Young............................. Ernst & Young LLP
FASB...................................... Financial Accounting Standards Board
FERC...................................... Federal Energy Regulatory Commission
FMLP...................................... First Midland Limited Partnership, a partnership that holds a lessor
interest in the MCV facility
GCR....................................... Gas cost recovery
GTNs...................................... CMS Energy General Term Notes(R), $200 million Series D, $400 million
Series E and $300 million Series F
Guardian ................................. Guardian Pipeline, LLC, in which Panhandle owns a one-third interest
GWh....................................... Gigawatt-hour
Health Care Plan.......................... The medical, dental, and prescription drug programs offered to
eligible employees of Panhandle, Consumers and CMS Energy
INGAA..................................... Interstate Natural Gas Association of America
IPP....................................... Independent Power Producer
ISO....................................... Independent System Operator
Jorf Lasfar............................... The 1,356 MW coal-fueled power plant in Morocco, jointly owned by CMS
Generation and ABB Energy Venture, Inc.
kWh....................................... Kilowatt-hour
7
LIBOR..................................... London Inter-Bank Offered Rate
Loy Yang.................................. The 2,000 MW brown coal fueled Loy Yang A power plant and an
associated coal mine in Victoria, Australia, in which CMS Generation
holds a 50 percent ownership interest
LNG....................................... Liquefied natural gas
LNG Holdings.............................. CMS Trunkline LNG Holdings, LLC, jointly owned by CMS Panhandle
Holdings, LLC and Dekatherm Investor Trust
Ludington................................. Ludington pumped storage plant, jointly owned by Consumers and Detroit
Edison
MACT...................................... Maximum Achievable Control Technology
mcf....................................... Thousand cubic feet
MCV Facility.............................. A natural gas-fueled, combined-cycle cogeneration facility operated by
the MCV Partnership
MCV Partnership........................... Midland Cogeneration Venture Limited Partnership in which Consumers
has a 49 percent interest through CMS Midland
MD&A...................................... Management's Discussion and Analysis
MEPCC..................................... Michigan Electric Power Coordination Center
METC...................................... Michigan Electric Transmission Company, formally a subsidiary of
Consumers Energy and now an indirect subsidiary of Trans-Elect
Michigan Gas Storage...................... Michigan Gas Storage Company, a subsidiary of Consumers
MISO...................................... Midwest Independent System Operator
Moody's .................................. Moody's Investors Service, Inc.
MPSC...................................... Michigan Public Service Commission
MTH....................................... Michigan Transco Holdings, Limited Partnership
MW........................................ Megawatts
NEIL...................................... Nuclear Electric Insurance Limited, an industry mutual insurance
company owned by member utility companies
NMC....................................... Nuclear Management Company, LLC, formed in 1999 by Northern States
Power Company (now Xcel Energy Inc.), Alliant Energy, Wisconsin
Electric Power Company, and Wisconsin Public Service Company to
operate and manage nuclear generating facilities owned by the four
utilities
NRC....................................... Nuclear Regulatory Commission
OATT...................................... Open Access Transmission Tariff
OPEB...................................... Postretirement benefit plans other than pensions for retired employees
Palisades................................. Palisades nuclear power plant, which is owned by Consumers
Pan Gas Storage........................... CMS Pan Gas Storage Company, a subsidiary of Panhandle Eastern Pipe
Line Company, LLC
Panhandle................................. Panhandle Eastern Pipe Line Company, including its subsidiaries
Trunkline, Pan Gas Storage, Panhandle Storage, and Panhandle
Holdings. Panhandle is a wholly owned subsidiary of CMS Gas
Transmission
Panhandle Eastern Pipe Line............... Panhandle Eastern Pipe Line Company, a wholly owned subsidiary of CMS Gas
Transmission
Panhandle Storage......................... CMS Panhandle Storage Company, a subsidiary of Panhandle Eastern Pipe
Line Company
PCB....................................... Polychlorinated biphenyl
8
Pension Plan.............................. The trusteed, non-contributory, defined benefit pension plan of
Panhandle, Consumers and CMS Energy
Powder River.............................. CMS Oil & Gas previously owned a significant interest in coalbed
methane fields or projects developed within the Powder River Basin
which spans the border between Wyoming and Montana. The Powder River
properties have been sold and reported as a discontinued operation for
the three months ended March 31, 2002
PPA....................................... The Power Purchase Agreement between Consumers and the MCV Partnership
with a 35-year term commencing in March 1990
Price Anderson Act........................ Price Anderson Act, enacted in 1957 as an amendment to the Atomic
Energy Act of 1954, as revised and extended over the years. This act
stipulates between nuclear licensees and the U.S. government the
insurance, financial responsibility, and legal liability for nuclear
accidents
PSCR...................................... Power supply cost recovery
PUHCA..................................... Public Utility Holding Company Act of 1935
PURPA..................................... Public Utility Regulatory Policies Act of 1978
RTO....................................... Regional Transmission Organization
Sea Robin................................. Sea Robin Pipeline Company, a subsidiary of CMS Trunkline Gas Company,
LLC
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. 115.............................. SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities"
SFAS No. 121.............................. SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of"
SFAS No. 133.............................. SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities, as amended and interpreted"
SFAS No. 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. 147.............................. SFAS No. 147, "Acquisitions of Certain Financial Institutions"
SIPS...................................... State Implementation Plans
9
Special Committee......................... A special committee of independent directors, established by CMS
Energy's Board of Directors, to investigate matters surrounding
round-trip trading
Stranded Costs............................ Costs incurred by utilities in order to serve their customers in a
regulated monopoly environment, which may not be recoverable in a
competitive environment because of customers leaving their systems and
ceasing to pay for their costs. These costs could include owned and
purchased generation and regulatory assets
Superfund................................. Comprehensive Environmental Response, Compensation and Liability Act
Transition Costs.......................... Stranded Costs, as defined, plus the costs incurred in the transition
to competition
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
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
10
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11
CMS Energy Corporation
CMS ENERGY CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
CMS Energy is the parent holding company of Consumers and Enterprises. Consumers
is a combination electric and gas utility company serving Michigan's Lower
Peninsula. Enterprises, through subsidiaries, including Panhandle and its
subsidiaries, is engaged in several domestic and international diversified
energy businesses including: natural gas transmission, storage and processing;
independent power production; and energy marketing, services and trading.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
The MD&A of this Form 10-Q should be read along with the MD&A and other parts of
CMS Energy's 2001 Form 10-K. This MD&A refers to, and in some sections
specifically incorporates by reference, CMS Energy's Condensed Notes to
Consolidated Financial Statements and should be read in conjunction with such
Consolidated Financial Statements and Notes. This Form 10-Q and other written
and oral statements that CMS Energy may make contain forward-looking statements
as defined by the Private Securities Litigation Reform Act of 1995. CMS Energy's
intentions with the use of the words "anticipates," "believes," "estimates,"
"expects," "intends," and "plans," and variations of such words and similar
expressions, are solely to identify forward-looking statements that involve risk
and uncertainty. These forward-looking statements are subject to various factors
that could cause CMS Energy's actual results to differ materially from the
results anticipated in such statements. CMS Energy has no obligation to update
or revise forward-looking statements regardless of whether new information,
future events or any other factors affect the information contained in such
statements. CMS Energy does, however, discuss certain risk factors,
uncertainties and assumptions in this MD&A and in Item 1 of the 2001 Form 10-K
in the section entitled "CMS Energy, Consumers, and Panhandle Forward-Looking
Statements Cautionary Factors and Uncertainties" and in various public filings
it periodically makes with the SEC. 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:
- - Results of the re-audit of CMS Energy, Consumers, Panhandle and certain
of their subsidiaries by Ernst & Young and the subsequent restatement
of CMS Energy's, Consumers', Panhandle's and certain of their
subsidiaries' financial statements;
- - The efficient sale of non-strategic and under-performing international
assets and discontinuation of our international energy distribution
systems;
- - Achievement of operating synergies and revenue enhancements;
- - Capital and financial market conditions, including current price of CMS
Energy's Common Stock, interest rates and availability of financing to
CMS Energy, Consumers, Panhandle or any of their affiliates and the
energy industry;
- - CMS Energy, Consumers, Panhandle or any of their affiliates' securities
ratings;
- - Market perception of the energy industry, CMS Energy, Consumers,
Panhandle or any of their affiliates;
- - Ability to successfully access the capital markets;
- - Currency fluctuations and exchange controls;
- - Factors affecting utility and diversified energy operations such as
unusual weather conditions, catastrophic weather-related damage,
unscheduled generation outages, maintenance or repairs, unanticipated
changes to fossil fuel, nuclear fuel or gas supply costs or
availability due to higher demand, shortages, transportation problems
or other developments, environmental incidents, or electric
transmissions or gas pipeline system constraints;
- - International, national, regional and local economic, competitive and
regulatory conditions and developments;
CMS-1
CMS Energy Corporation
- - 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 subsidiaries participate in wholesale
power markets without price restrictions and proposals by FERC to
change the way it currently lets our subsidiaries and other public
utilities and natural gas companies interact with each other;
- - Energy markets, including the timing and extent of unanticipated
changes in commodity prices for oil, coal, natural gas liquids,
electricity and certain related products due to lower or higher demand,
shortages, transportation problems or other developments;
- - The increased competition of new pipeline and pipeline expansion
projects that transport large additional volumes of natural gas to the
Midwestern United States from Canada, which could reduce the volumes of
gas transported by our natural gas transmission business or cause them
to lower rates in order to meet competition;
- - Potential disruption, expropriation or interruption of facilities or
operations due to accidents, war and terrorism or political events and
the ability to get or maintain insurance coverage for such events;
- - 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, including
particularly claims, damages and fines resulting from those involving
round-trip trading;
- - Limitations on our ability to control the development or operation of
projects in which our subsidiaries have a minority interest;
- - 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, Consumers' or Panhandle's 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.
CMS Energy designed this discussion of potential risks and uncertainties, which
is by no means comprehensive, to highlight important factors that may impact CMS
Energy's business and financial outlook. This Form 10-Q also describes material
contingencies in CMS Energy's Condensed Notes to Consolidated Financial
Statements, and CMS Energy encourages its readers to review these Notes.
ROUND-TRIP TRADES
During the period of May 2000 through January 2002, CMS MST engaged in
simultaneous, prearranged commodity trading transactions in which energy
commodities were sold and repurchased at the same price. These transactions,
which had no impact on previously reported consolidated net income, earnings per
share or cash flows, had the effect of increasing operating revenues, operating
expenses, accounts receivable, accounts payable and reported trading volumes.
After internally concluding that cessation of these trades was in CMS Energy's
best interest, these so called round-trip trades were halted in January 2002.
CMS-2
CMS Energy Corporation
CMS Energy accounted for these trades in gross revenue and expense through the
third quarter of 2001, but subsequently concluded that these round-trip trades
should have been reflected on a net basis. In the fourth quarter of 2001, CMS
Energy ceased recording these trades in either revenues or expenses. CMS
Energy's 2001 Form 10-K, issued in March 2002, restated revenue and expense for
the first three quarters of 2001 to eliminate $4.2 billion of previously
reported revenue and expense. The 2001 Form 10-K did include $5 million of
revenue and expense for 2001 from such trades, which remained uncorrected. At
the time of the initial restatement, CMS Energy inadvertently failed to restate
2000 for round-trip trades.
CMS Energy is cooperating with an SEC investigation regarding round-trip trading
and the Company's financial statements, accounting practices and controls. CMS
Energy is also cooperating with inquiries by the Commodity Futures Trading
Commission, the FERC, and the United States Department of Justice regarding
these transactions. CMS Energy has also received subpoenas from the U.S.
Attorney's Office for the Southern District of New York and from the U.S.
Attorney's Office in Houston regarding investigations of these trades and has
received a number of shareholder class action lawsuits. In addition, CMS
Energy's Board of Directors established the Special Committee of independent
directors to investigate matters surrounding round-trip trading and the Special
Committee retained outside counsel to assist in the investigation.
On October 31, 2002, the Special Committee reported the results of its
investigation to the Board of Directors. The Special Committee discovered no new
information inconsistent with the information previously reported by CMS Energy
and as reported above. The investigation also concluded that the round-trip
trades were undertaken to raise CMS MST's profile as an energy marketer, with
the goal of enhancing CMS MST's 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 to affect energy prices.
The Special Committee also made recommendations designed to prevent any
reoccurrence of this practice, some of which have already been implemented,
including the termination of the speculative trading business and revisions to
CMS Energy's risk management policy. The Board of Directors adopted, and CMS
Energy has begun implementing, the remaining recommendations of the Special
Committee.
CHANGE IN AUDITORS AND PENDING RESTATEMENTS
In May 2002, CMS Energy stated its intention to amend, by the end of January
2003, its 2001 Form 10-K. The Form 10-K/A will reflect the elimination of the
remaining $5 million of revenue and expense related to round-trip trades in
2001, the elimination of approximately $122 million of outstanding accounts
receivable and accounts payable related to these transactions, and the
elimination of approximately $1 billion of revenue and expense from round-trip
trades in 2000. No amounts related to round-trip trades were outstanding in the
consolidated balance sheet as of December 31, 2000.
Following CMS Energy's announcement that it would restate its financial
statements for 2000 and 2001 to eliminate the effects of round-trip energy
trades and form the Special Committee to investigate these trades, CMS Energy
received formal notification from Arthur Andersen that it had terminated its
relationship with CMS Energy and affiliates. Arthur Andersen notified CMS Energy
that due to the investigation, Arthur Andersen's historical opinions on CMS
Energy's financial statements for the periods being restated could not be relied
upon. Arthur Andersen also notified CMS Energy that due to Arthur Andersen's
then current situation and the work of the Special Committee, it would be unable
to give an opinion on CMS Energy's restated financial statements when they are
completed. Arthur Andersen's reports on CMS Energy's, Consumers', and
Panhandle's consolidated financial statements for each of the fiscal years ended
December 31, 2001 and December 31, 2000 contained no adverse or disclaimer of
opinion, nor were the reports qualified or modified regarding uncertainty, audit
scope or accounting principles.
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CMS Energy Corporation
There were no disagreements between CMS Energy and Arthur Andersen on any matter
of accounting principle or practice, financial statement disclosure, or auditing
scope or procedure during the years 2000 and 2001 and through the date of their
review for the quarter ended March 31, 2002 which, if not resolved to Arthur
Andersen's satisfaction would have caused Arthur Andersen to make reference to
the subject matter in connection with its report to the Audit Committee of the
Board of Directors or its report on CMS Energy's consolidated financial
statements for the periods.
On April 22, 2002, the Board of Directors, upon the recommendation of the Audit
Committee of the Board, voted to discontinue using Arthur Andersen to audit CMS
Energy's financial statements for the year ending December 31, 2002. CMS Energy
previously had retained Arthur Andersen to review its financial statements for
the quarter ended March 31, 2002. On May 23, 2002, the Board of Directors
engaged Ernst & Young to audit CMS Energy's financial statements for the year
ending December 31, 2002.
During CMS Energy's two most recent fiscal years ended December 31, 2000 and
December 31, 2001 and the subsequent interim period through June 10, 2002, CMS
Energy did not consult with Ernst & Young regarding any matter or event
identified by SEC laws and regulations. However, as a result of the restatement
required with respect to the round-trip trading transactions, Ernst & Young is
in the process of re-auditing CMS Energy's consolidated financial statements for
each of the fiscal years ended December 31, 2001 and December 31, 2000, which
includes audit work at Consumers and Panhandle for these years. None of CMS
Energy's former auditors, some of whom are now employed by Ernst & Young, are
involved in the re-audit of CMS Energy's consolidated financial statements.
In connection with Ernst & Young's re-audit of the fiscal years ended December
31, 2001 and December 31, 2000, CMS Energy has determined, in consultation with
Ernst & Young, that certain adjustments (unrelated to the round-trip trades) by
CMS Energy, Consumers, and Panhandle to their consolidated financial statements
for the fiscal years ended December 31, 2001 and December 31, 2000 are required.
At the time it adopted the accounting treatment for these items, CMS Energy
believed that such accounting was appropriate under generally accepted
accounting principles and Arthur Andersen concurred. CMS Energy, Consumers and
Panhandle are in the process of advising the SEC of these adjustments before
restating their financial statements as discussed below, and intend to amend
their respective 2001 Form 10-Ks and each of the 2002 Form 10-Qs by the end of
January 2003.
MCV REGULATORY DISALLOWANCE ACCOUNTING: In 1992, Consumers established a reserve
for the difference between the amount that Consumers was paying for power in
accordance with the terms of the PPA, and the amount that Consumers was
ultimately allowed by the MPSC to recover from electric customers.
The reserve was adjusted in 1998 to reflect differences between management's
original assumptions and the MCV Facility's actual performance. In 2000,
Consumers reviewed its estimate of the economic losses it would experience with
respect to the PPA and re-evaluated all of the current facts and circumstances
used to calculate the disallowance reserve. Consumers concluded that no
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CMS Energy Corporation
adjustment to the reserve was required in 2000. However, as conditions
surrounding MCV Partnership operations evolved in 2001, Consumers concluded
that it needed to increase the reserve by $126 million (pretax) in the third
quarter of 2001, and did so.
Upon recommendations from Ernst & Young, Consumers is in the process of
reviewing its 2001 PPA accounting and related assumptions. This accounting
review is currently being discussed with Ernst & Young and the SEC. Final
conclusions have not yet been reached. At a minimum, however, the 2001
accounting will change, resulting in the reversal of the 2001 charge of $126
million. Further analysis and deliberations may produce additional accounting
changes. In addition, as a result of this accounting treatment, Consumers
expects that its ongoing operating earnings through 2007 will be reduced to
reflect higher annual purchased power expense.
DIG LOSS CONTRACT ACCOUNTING: The DIG complex, a 710 MW combined-cycle facility,
was constructed during 1998 through 2001 to fulfill contractual requirements and
to sell excess power in the wholesale power market. DIG entered into Electric
Sales Agreements (ESA) with Ford Motor Company, Rouge Industries and certain
other Ford and Rouge affiliates, that require DIG to provide up to 300 MW of
electricity at pre-determined prices for a fifteen-year term beginning in June
2000. DIG also entered into Steam Sales Agreements (SSA) with Ford and Rouge,
whereby DIG is to supply process and heating steam at a fixed price commencing
no later than June 1, 2000.
During the third quarter of 2001, CMS Energy recognized a pretax charge to
earnings of $200 million for the calculated loss on portions of the power
capacity under the ESAs. At that time CMS Energy assessed whether the DIG
facility was impaired under SFAS No. 121 and concluded that the DIG facility was
not impaired.
CMS Energy, with the concurrence of Ernst & Young has now determined that
existing accounting literature precludes the recognition of anticipated losses
on executory contracts such as those involved with the ESAs at DIG. Accordingly
CMS Energy will reverse the $200 million loss on the ESA contracts and
subsequent related transactions when it restates its 2001 financial statements
and financial statements for each of the quarters in 2002.
As a result of existing impairment indicators and the pending restatement, CMS
Energy is again assessing the recoverability of the carrying value due of its
current $358 million investment in DIG in accordance with SFAS No. 144. The
investment will be $530 million after reflecting the restatement discussed
above. This assessment is expected to result in a significant impairment charge
in the fourth quarter of 2002.
ELIMINATION OF MARK-TO-MARKET GAINS AND LOSSES ON INTER-BOOK TRANSACTIONS: CMS
MST's business activities include marketing to end users of energy commodities
such as commercial and small industrial purchasers of natural gas (CMS MST's
retail business) and trading activities with such entities as other energy
trading companies (CMS MST's wholesale business). In accordance with generally
accepted accounting principles during 2000 and 2001, CMS MST used two different
methods to account for these distinct activities: it applied the mark-to-market
method of accounting to its wholesale trading business operations, and it
accounted for its retail business operations using the accrual method. Some
other energy trading companies have taken a similar approach when their business
activities have included retail operations.
EITF Issue No. 98-10, Accounting for Contracts Involved in Energy Trading and
Risk Management Activities, applies to certain parts of CMS MST's operations.
EITF Issue No. 98-10 requires that energy-trading contracts be marked to market;
that is, measured at fair value determined as of the balance sheet date, with
the gains and losses included in the earnings. According to EITF Issue No.
98-10, the determination of whether an entity is involved in energy trading
activities is a matter of judgment that depends on the relevant facts and
circumstances. CMS MST has used the mark-to-market method of accounting for its
wholesale operations because these have been considered trading activities under
EITF Issue No. 98-10. Because CMS MST's retail
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CMS Energy Corporation
operations have not been considered trading activities, mark-to-market
accounting under EITF Issue No. 98-10 has not been applied to any retail
contracts.
During 2000 and 2001 CMS MST's wholesale business entered into certain
transactions with CMS MST's retail business (inter-book transactions). The
wholesale business marked-to-market these inter-book transactions while the
retail business did not. CMS Energy has determined that the mark-to-market
profits and losses that were recognized by the wholesale business on these
inter-book transactions should have been eliminated in consolidation. CMS Energy
will therefore recognize $54 million of pretax income and a $120 million pretax
charge to earnings in 2000 and 2001 respectively, to eliminate the effects of
mark-to-market accounting in consolidation on inter-book transactions when it
restates its financial statements.
ELIMINATION OF MARK-TO-MARKET GAINS AND LOSSES ON INTERCOMPANY TRANSACTIONS: As
explained above, during 2000 and 2001 CMS MST applied the mark-to-market method
of accounting to the energy-trading contracts of its wholesale operations. In
doing so, CMS MST did not distinguish between counterparties that were unrelated
third parties, and those that were consolidated or equity-method affiliates.
Energy-trading contracts with affiliated companies were therefore measured at
their fair values as of the balance sheet date, with the gains and losses
included in earnings. However, the affiliated counterparties accounted for these
contracts on the accrual basis, because these companies were not engaged in
energy trading activities and therefore their activities were not within the
scope of EITF Issue No. 98-10, nor were their contracts with CMS MST required to
be marked to market in 2001 under SFAS No. 133. The mark-to-market profits and
losses that CMS MST recognized on the contracts with affiliated companies were
included in the CMS Energy consolidated financial statements. CMS Energy has now
concluded that these amounts should have been eliminated in consolidation.
CMS Energy's restated consolidated financial statements for 2001 and 2000 will
eliminate the mark-to-market gains and losses on intercompany transactions which
are still being quantified and audited. Adjustments to eliminate intercompany
mark-to-market gains and losses may also be required in 2002.
CMS MST ACCOUNT RECONCILIATIONS: CMS MST's business experienced rapid growth
during 2000 and 2001. Late in 2001, CMS Energy became aware of certain control
weaknesses at CMS MST and immediately began an internal investigation. The
investigation revealed that the size and expertise of the back-office accounting
staff had not kept pace with the rapid growth and, as a result, bookkeeping
errors had occurred and account reconciliations were not prepared. Additionally,
computer interfaces of sub-ledgers to the general ledger were ineffective or
lacking. As a result, sub-ledger balances did not agree to the general ledger
and the differences were not reconciled. When Ernst & Young began its re-audit
fieldwork, an account reconstruction and reconciliation project had been under
way for some months. Most of the work has been performed by outside consultants,
although additional internal personnel have also been assigned to the task. The
effort has focused mainly on trade receivables and payables, intercompany
accounts, and cash, but other balance sheet accounts are also being reconciled
and adjusted.
The reconstruction work at CMS MST is nearing completion for December 31, 2000
and December 31, 2001 and the first three quarters of 2002. However, until all
stages of this work have been finalized, reviewed by CMS MST management, and
examined by Ernst & Young, the resulting adjustments are subject to change.
CONSOLIDATION OF LNG HOLDINGS: In late 2001, Panhandle entered into a structured
transaction to monetize a portion of the value of a long-term terminalling
contract of its LNG subsidiary. The LNG business was contributed to LNG
Holdings, which received an equity investment from an unaffiliated third party,
Dekatherm Investor Trust and obtained new loans secured by the assets. After
paying expenses, net proceeds of $235 million were distributed to Panhandle for
the contributed LNG assets, and the joint venture also loaned
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CMS Energy Corporation
$75 million to Panhandle. While the proceeds received by Panhandle were in
excess of its book basis, a gain on the transaction was not recorded. This
excess was recorded as a deferred commitment, reflecting the fact that Panhandle
was expecting to reinvest proceeds into LNG Holdings for a planned expansion.
Panhandle is the manager and operator of the joint venture and has the primary
economic interest in it. Initially, CMS Energy and Panhandle believed that
off-balance sheet treatment for the joint venture was appropriate under
generally accepted accounting principles and Arthur Andersen concurred. Upon
further analysis of these facts at this time, CMS Energy and Panhandle have now
concluded that Panhandle did not meet the conditions precedent to account for
the contribution of the LNG business as a disposition given Panhandle's
continuing involvement and the lack of sufficient participating rights by the
third-party equity holder in the joint venture. As a result, with the
concurrence of Ernst & Young, Panhandle will restate its financial statements to
reflect consolidation of LNG Holdings at December 31, 2001, and thereby
recognize a net increase of $215 million of debt, the elimination of $183
million of deferred commitment, and minority interest of $30 million. With the
exception of certain immaterial reclassifications, there will be no impact to
2001 net income resulting from this accounting treatment. In 2002, the quarterly
income recorded would be impacted due to the timing of earnings recognition from
LNG Holdings, with income generally being recognized earlier by Panhandle upon
consolidation. In addition, the gross revenues and expenses will be recorded on
a consolidated basis versus the equity income previously recorded. For the
quarterly periods in 2002 there will be an increase in net income of $4 million
for the period ending March 31, 2002 and decrease of $1 million for each of the
quarterly periods ending June and September 2002 due to equity income previously
being recognized only to the extent cash was received by Panhandle.
STRUCTURED FINANCING OF METHANOL PLANT: In 1999, CMS Gas Transmission and an
unrelated entity financed $250 million of the costs of construction of a jointly
owned methanol plant with an off-balance sheet special purpose entity (SPE) that
entered into two separate non-recourse note borrowings containing
cross-collateral provisions only with respect to a joint collection account into
which the proceeds from shared collateral were to be deposited. Plant
construction was completed in the spring of 2001. In December 2001, CMS Gas
Transmission issued an irrevocable call for $125 million of these notes (i.e.,
the A1 Notes) and they were paid off in January 2002. As part of the 1999
financing, CMS Energy guaranteed the interest payments on the A1 Notes, subject
to a $75 million limit. CMS Energy did not guarantee repayment of the A1 Notes;
however, CMS Energy issued mandatorily convertible preferred stock to a trust as
security for the A1 Notes. If an amount to repay the A1 Notes was not deposited
within 120 days of the maturity date (or earlier date caused by, for example, a
downgrade of the credit rating of CMS Energy) the holders of 25 percent of the
A1 Notes could cause the mandatorily convertible preferred shares to be sold.
The mandatorily convertible preferred stock of CMS Energy was convertible into
the number of shares of CMS Energy common stock needed to make the note holder
whole without limit. Additional security for the A1 Notes was 60 percent of the
capital stock of CMS Methanol, an entity that held a 45 percent ownership
interest in the methanol plant. The SPE's assets comprised investments in CMS
Methanol and in another subsidiary that also owned a 45 percent interest in the
methanol plant. Because the use of non-recourse debt having cross-collateral
provisions only with respect to the joint collection account effectively
segregated the cash flows and assets, in substance this financing created two
separate SPEs. CMS Energy has now concluded, and Ernst & Young concurs, that it
should have consolidated the virtual SPE created by the non-recourse borrowing.
Therefore, CMS Energy will restate its 2000 and 2001 financial statements to
increase its equity ownership interest in the methanol plant and increase debt,
each by $125 million.
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CMS Energy Corporation
The table below summarizes adjustments noted above and the estimated effects on
CMS Energy's financial statements.
Estimated Net Income Impact (Millions) 2000 2001 2000-2001
- ----------------------------------------------------------------------------------------------------------
Total
MCV Regulatory Disallowance $ - $110 $110
DIG Loss Contract Accounting - 130 130
Mark-to-Market Gains and Losses on
Inter-book Transactions 33 (75) (42)
Mark-to-Market Gains and Losses on
Intercompany Transactions 19 (30) (11)
CMS MST Account Reconciliations (9) (7) (16)
- ----------------------------------------------------------------------------------------------------------
Additions to Consolidated Debt (Millions) 2000 2001 2002
- ---------------------------------------------------------------------------------------------------------
Reconsolidation of LNG Facility $ - $215 $219
Structured Financing of Methanol Plant 125 125 -
- ---------------------------------------------------------------------------------------------------------
In addition to the above adjustments and the adjustments to reflect the
elimination of round-trip trades, CMS Energy's restated consolidated financial
statements will also include other adjustments identified in the re-audit, which
have not been completely quantified at this time. These other adjustments
include: 1) the recognition of CMS Energy's and Consumers' new headquarters
lease previously treated as an operating lease, as a capital lease; 2)
adjustments to SERP and OPEB liabilities and advertising costs; 3) adjustments
required to reconcile intercompany accounts payable and accounts receivable and
4) other immaterial items.
OTHER MATTERS
COMPLIANCE WITH THE SARBANES-OXLEY ACT OF 2002
In July 2002, the Sarbanes-Oxley Act of 2002 was enacted and requires companies
to: 1) make certain certifications related to their Form 10-Q's, including
financial statements, disclosure controls and procedures and internal controls;
and 2) make certain disclosures about its disclosure controls and procedures,
and internal controls as follows:
CEO AND CFO CERTIFICATIONS
The Sarbanes-Oxley Act of 2002 requires the CEOs and CFOs of public companies to
make certain certifications relating to their Form 10-Q, including the financial
statements. CMS Energy has not filed the certifications required by the
Sarbanes-Oxley Act of 2002 relating to this Form 10-Q for the period ended
September 30, 2002 because its 2000 and 2001 financial statements are in the
process of being restated as discussed above.
The restatement cannot be completed until Ernst & Young completes audit work at
CMS Energy, and their reviews of the quarterly statements for these years.
Therefore, CMS Energy's CEO and CFO are not able to make the statements required
by the Sarbanes-Oxley Act of 2002 with respect to this Form 10-Q for the period
ended September 30, 2002. CMS Energy expects its CEO and CFO to make the
certifications required by the Sarbanes-Oxley Act of 2002 when its restated
financial statements are available.
DISCLOSURE AND INTERNAL CONTROLS
CMS Energy's CEO and CFO are responsible for establishing and maintaining CMS
Energy's disclosure controls and procedures. Management, under the direction of
CMS Energy's principal executive and financial officers, has evaluated the
effectiveness of CMS Energy's disclosure controls and procedures as of September
30, 2002. Based on this evaluation, other than the control weaknesses at CMS MST
described below, CMS Energy's CEO and CFO have concluded that disclosure
controls and procedures are effective to ensure that material information was
presented to them and properly disclosed, particularly during the third quarter
of
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CMS Energy Corporation
2002. There have been no significant changes in CMS Energy's internal controls
or in factors, other than as discussed below, that could significantly affect
internal controls subsequent to September 30, 2002.
CONTROL WEAKNESSES AT CMS MST
During the audit cycle of 2001, it was determined that there were several
weaknesses which existed in the CMS MST accounting controls, in particular those
relating to reconciling the activity and balances in subsidiary receivable and
payable ledgers with balances reflected in the general ledger. Senior
management, the Audit Committee of the Board of Directors and the independent
auditors were all notified about the situation and a plan of remediation was
begun, including replacement of key personnel. While important changes in
control have been initiated, some elements of the remediation plans have been
unavoidably delayed by the requirement to completely re-audit the CMS Energy
financial statements for years 2000 and 2001. Management believes that
supplemental procedures and personnel currently in place, along with the
significant contraction of the trading business planned by management, have
allowed for continuing business activity while the control weaknesses are
remediated and staffing positions are filled by qualified candidates. Management
further expects controls corrections to be completed before the end of the 2002
audit cycle.
RESTRUCTURING AND OTHER COSTS
CMS Energy began a series of initiatives in the aftermath of CMS Energy's
round-trip trading disclosure and the sharp drop of the company's stock price.
Significant expenses associated with these initiatives have been incurred and
are considered restructuring and other costs. These actions include: termination
of five officers, 18 CMS Field Services employees and 37 CMS MST trading group
employees, renegotiating a number of debt agreements, responding to many
investigation and litigation matters, re-audit of the 2000 and 2001 financial
statements and plans to relocate the corporate headquarters to Jackson,
Michigan. These restructuring and other costs are being accumulated and reported
as a reconciling item when calculating net income and earnings per share before
reconciling items. These restructuring and other costs are included in
consolidated net income.
Restructuring and other costs for the year-to-date September 30, 2002, which
are reported in operating expenses ($41 million) and fixed charges ($12 million)
includes:
- - Involuntary termination benefits of $17 million for officers and
employees.
- - One-time consulting and structuring fees of $12 million to assist
CMS Energy to arrange credit facilities related to the July 2002 debt
renegotiations.
- - The $12 million of expense associated with responding to and/or
defending against investigations and lawsuits related to round-trip
trading. These expenses could ultimately total $21 million for
attorneys' fees and costs through final resolution. Potential insurance
proceeds may total $12 million, reducing these expenses to $9 million.
- - Expenses for future rentals of $7 million have been accrued in
connection with relocating the corporate headquarters to Jackson,
Michigan. The relocation is expected to be complete by June 2003.
- - Other expenses, including the cost of re-auditing 2000 and 2001 total
$5 million.
Of the above $53 million, $12 million has been paid for consulting and
structuring fees and $10 million has been paid for severance and benefits as
of September 30, 2002.
Additional restructurings and other costs are expected in the fourth quarter of
2002 of approximately $5 million related to relocating the corporate
headquarters, terminating approximately 30 employees, and additional legal
expenses for litigation issues. In the first half of 2003, restructuring and
other costs related to relocating employees and other headquarters expenses are
expected to be $3 million. The relocation is expected to occur between March
and June 2003.
RESULTS OF OPERATIONS
CMS ENERGY CONSOLIDATED EARNINGS
For the three and nine months ended September 30, 2002, and 2001, consolidated
net income included gains (losses) on asset sales, asset write-downs,
restructuring costs associated with implementing CMS Energy's new strategic
direction, AMT tax credit write-offs, and the discontinued operations of CMS Oil
and Gas, CMS
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CMS Energy Corporation
Electric & Gas, and other non-strategic businesses. The nine months ended
September 30, 2002 also reflect the adoption of SFAS No. 142 as of January 1,
2002, which required a write-down of goodwill at CMS MST and extraordinary
losses associated with early debt retirement. The following tables depict CMS
Energy's Results of Operations before and after the effects of the items
mentioned above.
In Millions, Except Per Share Amounts
- ----------------------------------------------------------------------------------------
Three months ended September 30 2002 2001
- ----------------------------------------------------------------------------------------
CONSOLIDATED NET INCOME (LOSS) OF CMS ENERGY $ 23 $ (569)
Net Asset Sales (Gain) (13) -
Net Asset Write-downs - 398
Discontinued Operations (Gain)/Loss (17) 206
Tax Credit Write-off 41 -
Restructuring and Other Costs 27 -
- ----------------------------------------------------------------------------------------
Earnings Before Reconciling Items $ 61 $ 35
============================================================================
BASIC EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY
EARNINGS (LOSS) PER SHARE $ 0.16 $ (4.29)
Net Asset Sales (Gain) (0.09) -
Net Asset Write-downs - 3.00
Discontinued Operations (Gain)/Loss (0.12) 1.55
Tax Credit Write-off 0.28 -
Restructuring and Other Costs 0.19 -
- ----------------------------------------------------------------------------------------
Earnings Per Share Before Reconciling Items $ 0.42 $ 0.26
============================================================================
DILUTED EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY
EARNINGS (LOSS) PER SHARE $ 0.16 $ (4.29)
Net Asset Sales (Gain) (0.09) -
Net Asset Write-downs - 3.00
Discontinued Operations (Gain)/Loss (0.12) 1.55
Tax Credit Write-off 0.28 -
Restructuring and Other Costs 0.19 -
- ----------------------------------------------------------------------------------------
Earnings Per Share Before Reconciling Items $ 0.42 $ 0.26
============================================================================
For the three months ended September 30, 2002, consolidated net income before
reconciling items increased by $26 million as compared to the same period in
2001. The increase primarily reflects Consumers' reduced electric power volumes
and costs due to higher replacement power supply costs in 2001 resulting from
the outage at Palisades in the third quarter of 2001. The increase was partially
offset by lower gas utility earnings and the impacts of expropriation and
devaluation issues in Argentina on the independent power production and natural
gas transmission businesses.
CMS-10
CMS Energy Corporation
In Millions, Except Per Share Amounts
- --------------------------------------------------------------------------------------------------
Nine months ended September 30 2002 2001
- --------------------------------------------------------------------------------------------------
CONSOLIDATED NET INCOME (LOSS) OF CMS ENERGY $ 337 $ (407)
Net Asset Sales (Gain)/Loss (48) 1
Net Asset Write-downs - 398
Discontinued Operations (Gain)/Loss (186) 186
Tax Credit Write-off 41 -
Restructuring and Other Costs 34 -
Goodwill Accounting Change 9 -
Extraordinary Item 8 -
----------------------------------------------------------------------------------------------
Earnings Before Reconciling Items $ 195 $ 178
==========================================================================================
BASIC EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY
EARNINGS (LOSS) PER SHARE $ 2.45 $ (3.13)
Net Asset Sales (Gain)/Loss (0.35) 0.01
Net Asset Write-downs - 3.06
Discontinued Operations (Gain)/Loss (1.35) 1.43
Tax Credit Write-off 0.30 -
Restructuring and Other Costs 0.25 -
Goodwill Accounting Change 0.07 -
Extraordinary Item 0.06 -
----------------------------------------------------------------------------------------------
Earnings Per Share Before Reconciling Items $ 1.43 $ 1.37
==========================================================================================
DILUTED EARNINGS PER AVERAGE COMMON SHARE OF CMS ENERGY
EARNINGS (LOSS) PER SHARE $ 2.42 $ (3.13)
Net Asset Sales (Gain)/Loss (0.34) 0.01
Net Asset Write-downs - 3.06
Discontinued Operations (Gain)/Loss (1.31) 1.43
Tax Credit Write-off 0.29 -
Restructuring and Other Costs 0.24 -
Goodwill Accounting Change 0.07 -
Extraordinary Item 0.05 -
----------------------------------------------------------------------------------------------
Earnings Per Share Before Reconciling Items $ 1.42 $1.37
==========================================================================================
For the nine months ended September 30, 2002, consolidated net income before
reconciling items increased by $17 million as compared to the same period in
2001. The increase primarily reflects Consumers' reduced power supply costs from
the 2001 unscheduled Palisades outage, improved earnings from the IPP business
reflecting MCV mark-to-market accounting for long-term natural gas fuel supply
contracts, and lower steam costs at DIG. These increases were partially offset
by lower LNG terminalling revenue and the impacts of the Argentina expropriation
and devaluation issues.
For further information, see the individual results of operations for each CMS
Energy business segment in this MD&A.
CONSUMERS' ELECTRIC UTILITY RESULTS OF OPERATIONS
ELECTRIC UTILITY NET INCOME:
In Millions
- ---------------------------------------------------------------------
September 30 2002 2001 Change
- ---------------------------------------------------------------------
Three months ended $ 68 $(69) $137
Nine months ended 201 22 179
=====================================================================
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CMS Energy Corporation
Three Months Nine Months
Ended September 30 Ended September 30
Reasons for change 2002 vs 2001 2002 vs 2001
- -----------------------------------------------------------------------------------------------------------------
Electric deliveries $ 25 $ 30
Power supply costs and related revenue 100 113
Other operating expenses and non-commodity revenue (12) (19)
Gain on asset sales - 38
Loss on MCV Power Purchases 126 126
Fixed charges 4 12
Income taxes (106) (121)
- -----------------------------------------------------------------------------------------------------------------
Total change $ 137 $ 179
=================================================================================================================
ELECTRIC DELIVERIES: For the three months ended September 30, 2002, electric
delivery revenues increased by $25 million from the 2001 level. Electric
deliveries, including transactions with other wholesale market participants and
other electric utilities, were 10.9 billion kWh, a decrease of 0.1 billion kWh,
or 0.9 percent from the comparable period in 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
growth in retail deliveries, more than offset the impact of reductions to the
lower-margin customers. Even though deliveries were below the 2001 level,
Consumers set an all-time monthly sendout record during the month of July, and a
monthly hourly peak demand record of 7,318 MW was set on September 9, 2002.
For the nine months ended September 30, 2002, electric delivery revenues
increased by $30 million from the 2001 level. Electric deliveries, including
transactions with other wholesale market participants and other electric
utilities, were 29.5 billion kWh, a decrease of 0.7 billion kWh, or 2.5 percent
from the comparable period in 2001. Again, 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.
Even though total deliveries were below the 2001 level, increased deliveries to
the higher-margin residential and commercial sectors, along with growth in
retail deliveries, more than offset the impact of reductions to the lower-margin
customers. For the year, Consumers has set an all-time monthly sendout record
during the month of July, and monthly hourly peak demand records were set on
April 16, 2002, June 25, 2002, and September 9, 2002.
POWER SUPPLY COSTS AND RELATED REVENUE: For the three months ended September 30,
2002, power supply costs decreased by $100 million from the comparable period in
2001. The decreased power costs in 2002 were primarily due to the higher
availability of the lower-priced Palisades plant. In the 2001 period, Consumers
was required to purchase greater quantities of higher-priced power to offset the
loss of internal generation resulting from an outage at Palisades. Also
contributing to the overall decrease in power costs was the lower volume and
lower priced power options and dispatchable capacity contracts that were
purchased for 2002.
For the nine months ended September 30, 2002, power supply costs and related
revenues decreased by a total of $113 million from the comparable period in
2001. This decrease was primarily the result of 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 is lower-priced power
options and dispatchable capacity contracts that were purchased for 2002.
OTHER OPERATING EXPENSES AND NON-COMMODITY REVENUES: For the three and nine
months ended September 30, 2002, other operating expenses increased $12 million
and $19 million, respectively from the comparable period in 2001. Both of
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CMS Energy Corporation
these increases are attributed to higher depreciation expense resulting from
higher plant in service along with increased operating costs resulting from
higher health care and storm restoration expenses.
GAIN ON ASSET SALES: For the nine months ended September 30, 2002, asset sales
increased as a result of the $31 million pretax gain associated with the May
2002 sale of Consumers' electric transmission system and a $7 million pretax
gain on the sale of nuclear equipment from the cancelled Midland project.
LOSS ON MCV POWER PURCHASES: For the three and nine months ended September 30,
2002, the earnings increase reflects a $126 million pretax loss related to the
PPA that was accounted for in September 2001. This loss is due to management's
review of the PPA liability assumptions related to increased expected long-term
dispatch of the MCV Facility and increased MCV-related costs. As a result,
Consumers increased the PPA liability in September 2001, to adequately reflect
the present value of the PPA's future effect on Consumers. For further
information see "Change in Auditors and Pending Restatement" at the beginning of
this MD&A.
INCOME TAXES: For the three and nine months ended September 30, 2002, the
earnings increase reflects the impact of a charge to income tax expense to
reflect an additional $20 million charge allocated to Consumers through CMS
Energy's consolidated Federal Income Tax return for 2001 filed in 2002.
CONSUMERS' GAS UTILITY RESULTS OF OPERATIONS
GAS UTILITY NET INCOME:
In Millions
- ----------------------------------------------------------------------------------------------------------------
September 30 2002 2001 Change
- ----------------------------------------------------------------------------------------------------------------
Three months ended $ (24) $ (10) $(14)
Nine months ended 8 20 (12)
================================================================================================================
Three Months Nine Months
Ended September 30 Ended September 30
Reasons for change 2002 vs 2001 2002 vs 2001
- ----------------------------------------------------------------------------------------------------------------
Gas deliveries $ (2) $ (2)
Gas rate increase 1 10
Gas wholesale and retail services 3 3
Operation and maintenance (17) (17)
Other operating expenses 3 (2)
Income taxes (2) (4)
- ----------------------------------------------------------------------------------------------------------------
Total change $ (14) $ (12)
================================================================================================================
For the three months ended September 30, 2002, gas revenues decreased due to
warmer temperatures compared to the third quarter 2001. Gas wholesale and retail
service revenues increased principally due to growth in the appliance service
plan. Operation and maintenance cost increases reflect recognition of gas
storage inventory losses, and additional expenditures on customer reliability
and service. System deliveries, including miscellaneous transportation volumes,
totaled 40.1 bcf, a decrease of 1.7 bcf or 4.1 percent compared with 2001. The
earnings decrease also reflects the impact of a charge to income tax expense to
reflect an additional $6 million charge allocated to Consumers through CMS
Energy's consolidated federal income tax return for 2001 filed in 2002.
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For the nine months ended September 30, 2002, gas revenues increased due to an
interim gas rate increase granted in December of 2001, partially offset by a
decrease in gas delivery revenue due to warmer temperatures and decelerated
economic demand. Operation and maintenance cost increases reflect recognition of
gas storage inventory losses, and additional expenditures on customer
reliability and service. System deliveries, including miscellaneous
transportation volumes, totaled 254.7 bcf, a decrease of 3.7 bcf or 1.4 percent
compared with 2001. The earnings decrease also reflects the impact of the $6
million income tax charge recorded in the third quarter of 2002 that is
discussed above.
NATURAL GAS TRANSMISSION RESULTS OF OPERATIONS
NET INCOME: For the three months ended September 30, 2002, net income was $12
million, an increase of $18 million from the comparable period in 2001. The
increase was primarily due to asset write-downs recorded in 2001, partially
offset by higher income taxes, and the impacts of the Argentina expropriation
and devaluation issues.
For the nine months ended September 30, 2002, net income was $64 million, an
increase of $11 million from the comparable period in 2001. The increase was
primarily due to asset write-downs recorded in 2001, the gain of $19 million on
the sale of Gas Transmission's ownership interest in Equatorial Guinea,
elimination of goodwill amortization in 2002, due to adoption of SFAS No. 142,
and lower interest expense. These increases were partially offset by a decrease
in the earnings from Panhandle, mainly LNG terminalling revenue, the impacts of
Argentine expropriation and devaluation on ongoing operations, and a decrease in
earnings from Field Services, due primarily to gas and liquids prices. In
accordance with SFAS No. 142, preliminary results of the second step of the
goodwill impairment testing indicate that most of Panhandle's goodwill is
impaired as of January 1, 2002. For further information, see Note 4, Goodwill.
INDEPENDENT POWER PRODUCTION RESULTS OF OPERATIONS
NET INCOME: For the three months ended September 30, 2002, net income was $52
million, a $302 million increase from the comparable period in 2001. The
increase was primarily due to the recognition of the DIG loss contract reserve
and reductions in asset valuations recorded in the third quarter 2001 and lower
steam costs at DIG, which had experienced construction delays in 2001 that led
to increased costs for steam generation. These increases were partially offset
by reduced earnings from international operations, including the impacts of the
Argentine expropriation and devaluation on ongoing operations.
For the nine months ended September 30, 2002, net income was $114 million, a
$320 million increase from the comparable period in 2001. The increase was
primarily due to the recognition of the DIG loss contract reserve and reductions
in asset valuations recorded in the third quarter 2001, improved earnings from
the MCV facility reflecting improved plant performance and mark-to-market
accounting for long-term natural gas fuel supply contracts and lower steam costs
at DIG. The increases were partially offset by the effects of the Argentine
expropriation and devaluation and earnings from certain domestic and
international operations.
OIL AND GAS EXPLORATION AND PRODUCTION RESULTS OF OPERATIONS
In September 2002, CMS Energy closed on the sale of the stock of CMS Oil and Gas
and the stock of a subsidiary of CMS Oil and Gas that holds property in
Venezuela. In October 2002, CMS Energy closed on the sale of CMS Oil and Gas's
properties in Colombia. As a result of these closings, CMS Energy has completed
its exit from the oil and gas exploration and production business. The proceeds
from the combined sales total approximately $212 million and have been used to
retire the remaining balance on a $150 million Enterprises term loan due in
December 2002 and a portion of a $295.8 million CMS Energy loan due March 2003.
The combined sales will result in an after-tax loss of approximately $90
million. For more information, see Note 2, Discontinued Operations, incorporated
by reference herein.
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CMS Energy Corporation
MARKETING, SERVICES AND TRADING RESULTS OF OPERATIONS
During the second quarter of 2002, CMS MST announced its intention to sell its
ownership interest in CMS Viron, resulting in a reclassification of CMS Viron's
results to discontinued operations in the consolidated statements of income. For
more information, see Note 2, Discontinued Operations, incorporated by reference
herein.
NET INCOME: For the three months ended September 30, 2002, CMS MST's net loss
was $3 million, a decrease of $15 million from the comparable period in 2001.
Credit constraints are severely limiting the overall liquidity of the energy
trading markets, reducing CMS MST's ability to actively manage and optimize its
open positions as well as impacting its ability to execute new transactions.
These constraints have placed downward pressure on trading margins for both
wholesale power and natural gas. Operating revenues increased as a result of
sales volumes on long-term power contracts that were executed during the latter
part of 2001 and early 2002.
For the nine months ended September 30, 2002, CMS MST's net loss was $29
million, a decrease of $78 million from the comparable period in 2001. The
decrease was primarily due to credit constraints as well as the adoption of SFAS
No. 142, which required the write-down of goodwill at CMS MST related to its CMS
Viron business, retroactive to January 1, 2002. For more information, see Note
4, Goodwill.
During the third quarter of 2002, power sales volumes were 22,675 GWh, an
increase of 14,232 GWh and natural gas sales volumes were 141 bcf, a decrease of
51 bcf compared to the third quarter of 2001, which have been adjusted to
exclude the round-trip trading volumes. For nine months ended September 30,
2002, power sales volumes were 54,965 GWh, an increase of 39,021 GWh and natural
gas sales volumes were 501 bcf, a decrease of 58 bcf compared to 2001, which
have been adjusted to exlude the round-trip trading volumes. The increases in
power sales volumes reflect the addition of long-term power contracts that were
executed during the latter part of 2001 and early 2002.
Due to the extreme volatility in energy trading markets and the competitive
nature of the industry, results for this interim period are not necessarily an
indication of results to be achieved for the fiscal year.
OTHER RESULTS OF OPERATIONS
TAX LOSS ALLOCATION: 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 a
consolidated 2001 tax loss to tax years 1996 through 1999 and obtain refunds of
prior years tax payments totaling $217 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 $41 million. This
one-time non-cash reduction in AMT credit carryforwards has been reflected in
the tax provisions of CMS Energy and each of its consolidated subsidiaries, as
of September 30, 2002, according to their contributions to the consolidated CMS
Energy tax loss.
OTHER: Interest expense after-tax effects for the three months ended September
30, 2002 and 2001 was $53 million and $58 million, respectively. Interest
expense after-tax effects for the nine months ended September 30, 2002 and 2001
was $163 million and $169 million, respectively. These expenses were partially
offset by the $20 million consolidating elimination in September 2002 of
intercompany losses recorded by CMS MST that result from mark-to-market
accounting for transactions with affiliates.
Discontinued Operations include, in addition to CMS Oil and Gas and CMS Viron
discussed above, a $31 million after-tax effect as a result of abandoning the
Zirconium Recovery Project after evaluating its future
CMS-15
CMS Energy Corporation
costs and risks, recorded in June 2002.
CRITICAL ACCOUNTING POLICIES
The results of operations, as presented above, are based on the application of
accounting principles generally accepted in the United States. The application
of these principles often requires management to make certain judgments,
assumptions and estimates that may result in different financial presentations.
CMS Energy believes that certain accounting principles are critical in terms of
understanding its financial statements. These principles include the use of
estimates for long-lived assets, equity method investments and long-term
obligations, accounting for derivatives and financial instruments,
mark-to-market accounting, and international operations and foreign currency.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make judgments,
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Certain accounting principles require subjective and
complex judgments used in the preparation of financial statements. Accordingly,
a different financial presentation could result depending on the judgment,
estimates or assumptions that are used. Such estimates and assumptions include,
but are not specifically limited to: depreciation, amortization, interest rates,
discount rates, currency exchange rates, future commodity prices, mark-to-market
valuations, investment returns, volatility in the price of CMS Energy Common
Stock, impact of new accounting standards, international economic policy, future
costs associated with long-term contractual obligations, future compliance costs
associated with environmental regulations and continuing creditworthiness of
counterparties. Actual results could materially differ from those estimates.
Periodically, in accordance with SFAS No. 144 and APB Opinion No. 18, long-lived
assets and equity method investments of CMS Energy and its subsidiaries are
evaluated to determine whether conditions, other than those of a temporary
nature, indicate that the carrying value of an asset may not be recoverable.
Management bases its evaluation on impairment indicators such as the nature of
the assets, future economic benefits, domestic and foreign state and federal
regulatory and political environments, historical or future profitability
measurements, as well as other external market conditions or factors that may be
present. If such indicators are present or other factors exist that indicate
that the carrying value of the asset may not be recoverable, CMS Energy
determines whether impairment has occurred through the use of an undiscounted
cash flow analysis of assets at the lowest level for which identifiable cash
flows exist. If impairment, other than a temporary nature, has occurred, CMS
Energy recognizes a loss for the difference between the carrying value and the
estimated fair value of the asset. The fair value of the asset is measured using
discounted cash flow analysis or other valuation techniques. The analysis of
each long-lived asset is unique and requires management to use certain estimates
and assumptions that are deemed prudent and reasonable for a particular set of
circumstances. Of CMS Energy's total assets, valued at $15 billion at September
30, 2002, approximately 60 to 65 percent represent the carrying value of
long-lived assets and equity method investments that are subject to this type of
analysis. If future market, political or regulatory conditions warrant, CMS
Energy and its subsidiaries may be subject to write-downs in future periods.
Conversely, if market, political or regulatory conditions improve, accounting
standards prohibit the reversal of previous write-downs.
CMS Energy has recently recorded write-downs of non-strategic or
under-performing long-lived assets as a result of implementing a new strategic
direction. CMS Energy is pursuing the sale of all of these non-strategic and
under-performing assets, including some assets that were not determined to be
impaired. Upon the sale of these assets, the proceeds realized may be materially
different from the remaining carrying value of these
CMS-16
CMS Energy Corporation
assets. Even though these assets have been identified for sale, management
cannot predict when, nor make any assurances that, these asset sales will occur,
or the amount of cash or the value of consideration to be received.
Similarly, the recording of estimated liabilities for contingent losses,
including estimated losses on long-term obligations, within the financial
statements is guided by the principles in SFAS No. 5 that require a company to
record estimated liabilities in the financial statements when it is probable
that a loss will be incurred in the future as a result of a current event, and
the amount can be reasonably estimated. Management uses cash flow valuation
techniques similar to those described above to estimate contingent losses on
long-term contracts.
ACCOUNTING FOR DERIVATIVE AND FINANCIAL INSTRUMENTS
DERIVATIVE INSTRUMENTS: CMS Energy uses the criteria in SFAS No. 133, as amended
and interpreted, to determine if certain contracts must be accounted for as
derivative instruments. The rules for determining whether a contract meets the
criteria for derivative accounting are numerous and complex. As a result,
significant judgment is required to determine whether a contract requires
derivative accounting, and similar contracts can sometimes be accounted for
differently.
The types of contracts CMS Energy currently accounts for as derivative
instruments include interest rate swaps, foreign currency exchange contracts,
certain electric call options, and gas fuel call options and swaps. CMS Energy
does not account for electric capacity and certain energy contracts, gas supply
contracts, coal supply contracts, or purchase orders for numerous supply items
as derivatives.
If a contract must be accounted for as a derivative instrument, the contract is
recorded as either an asset or a liability in the financial statements at the
fair value of the contract. Any difference between the recorded book value and
the fair value is reported either in earnings or other comprehensive income
depending on certain qualifying criteria. The recorded fair value of the
contract is then adjusted quarterly to reflect any change in the market value of
the contract.
In order to value the contracts that are accounted for as derivative
instruments, CMS Energy uses a combination of market quoted prices and
mathematical models. Option models require various inputs, including forward
prices, volatilities, interest rates and exercise periods. Changes in forward
prices or volatilities could significantly change the calculated fair value of
the call option contracts. The models used by CMS Energy have been tested
against market quotes to ensure consistency between model outputs and market
quotes. At September 30, 2002, CMS Energy assumed a market-based interest rate
of 4.5 percent in calculating the fair value of its electric call options.
In order for derivative instruments to qualify for hedge accounting under SFAS
No. 133, the hedging relationship must be formally documented at inception and
be highly effective in achieving offsetting cash flows or offsetting changes in
fair value attributable to the risk being hedged. If hedging a forecasted
transaction, the forecasted transaction must be probable. If a derivative
instrument, used as a cash flow hedge, is terminated early because it is
probable that a forecasted transaction will not occur, any gain or loss as of
such date is immediately recognized in earnings. If a derivative instrument,
used as a cash flow hedge, is terminated early for other economic reasons, any
gain or loss as of the termination date is deferred and recorded when the
forecasted transaction affects earnings.
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.
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CMS Energy Corporation
FINANCIAL INSTRUMENTS: CMS Energy accounts for its investments in debt and
equity securities in accordance with SFAS No. 115. As such, debt and equity
securities can be classified into one of three categories: held-to-maturity,
trading, or available-for-sale securities. CMS Energy's investments in equity
securities are classified as available-for-sale securities and are reported at
fair value with any unrealized gains or losses resulting from changes in fair
value excluded from earnings and reported in equity as part of other
comprehensive income. Unrealized gains or losses resulting from changes in the
fair value of Consumers' nuclear decommissioning investments are reported in
accumulated depreciation. The fair value of these investments is determined from
quoted market prices.
MARK-TO-MARKET ACCOUNTING
CMS MST's trading activities are accounted for under the mark-to-market method
of accounting. Under mark-to-market accounting, energy-trading contracts are
reflected at fair market value, net of reserves, with unrealized gains and
losses recorded as an asset or liability in the consolidated balance sheets.
These assets and liabilities are affected by the timing of settlements related
to these contracts, current-period changes from newly originated transactions
and the impact of price movements. Changes in fair value are recognized as
revenues in the consolidated statements of income in the period in which the
changes occur. Market prices used to value outstanding financial instruments
reflect management's consideration of, among other things, closing exchange and
over-the-counter quotations. In certain of these markets, long-term contract
commitments may extend beyond the period in which market quotations for such
contracts are available. The lack of long-term pricing liquidity requires the
use of mathematical models to value these commitments under the accounting
method employed. These mathematical models utilize historical market data to
forecast future elongated pricing curves, which are used to value the
commitments that reside outside of the liquid market quotations. Realized cash
returns on these commitments may vary, either positively or negatively, from the
results estimated through application of forecasted pricing curves generated
through application of the mathematical model. CMS Energy believes that its
mathematical models utilize state-of-the-art technology, pertinent industry data
and prudent discounting in order to forecast certain elongated pricing curves.
These market prices are adjusted to reflect the potential impact of liquidating
the company's position in an orderly manner over a reasonable period of time
under present market conditions.
In connection with the market valuation of its energy commodity contracts, CMS
Energy maintains reserves for credit risks based on the financial condition of
counterparties. Counterparties in its trading portfolio consist principally of
financial institutions and major energy trading companies. The creditworthiness
of these counterparties will impact overall exposure to credit risk; however,
CMS Energy maintains credit policies that management believes minimize overall
credit risk with regard to its counterparties. Determination of its
counterparties' credit quality is based upon a number of factors, including
credit ratings, financial condition, and collateral requirements. When trading
terms permit, CMS Energy employs standard agreements that allow for netting of
positive and negative exposures associated with a single counterparty. Based on
these policies, its current exposures and its credit reserves, CMS Energy does
not anticipate a material adverse effect on its financial position or results of
operations as a result of counterparty nonperformance.
The following tables provide a summary of the fair value of CMS Energy's energy
commodity contracts as of September 30, 2002.
In Millions
- ------------------------------------------------------------------------------
Fair value of contracts outstanding as of June 30, 2002 $89
Contracts realized or otherwise settled during the period (a) 7
Other changes in fair value (b) 1
- ------------------------------------------------------------------------------
Fair value of contracts outstanding as of September 30, 2002 (c) $97
==============================================================================
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Fair Value of Contracts at September 30, 2002 In Millions
- ---------------------------------------------------------------------------------------------------------------------
Total Maturity (in years)
Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5
- ---------------------------------------------------------------------------------------------------------------------
Prices actively quoted $ 32 $ 20 $ 12 $ - $ -
Prices provided by other
external sources 3 2 (2) 2 1
Prices based on models and
other valuation methods 62 8 23