DTE Energy - 10-Q quarterly report FY

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarter Ended June 30, 2000

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 [   ]

At July 31, 2000, 142,658,064 shares of DTE Energy’s Common Stock, substantially all held by non-affiliates, were outstanding.

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DTE ENERGY COMPANY
and
THE DETROIT EDISON COMPANY
FORM 10-Q
For The Quarter Ended June 30, 2000

This document contains the Quarterly Reports on Form 10-Q for the quarter ended June 30, 2000 for each of DTE Energy Company and The Detroit Edison Company. Information contained herein relating to an individual registrant is filed by such registrant on its own behalf. Accordingly, except for its subsidiaries, The Detroit Edison Company makes no representation as to information relating to any other companies affiliated with DTE Energy Company.

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DEFINITIONS

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PART I — FINANCIAL INFORMATION" -->

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DTE Energy Company
Condensed Consolidated Statement of Income (Unaudited)
(Millions, Except Per Share Amounts)

See Notes to Condensed Consolidated Financial Statements (Unaudited)

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DTE Energy Company
Condensed Consolidated Balance Sheet (Unaudited)
(Millions, Except Per Share Amounts and Shares)

See Notes to Condensed Consolidated Financial Statements (Unaudited)

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See Notes to Condensed Consolidated Financial Statements (Unaudited)

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DTE Energy Company
Condensed Consolidated Statement of Cash Flows (Unaudited)
(Millions)

See Notes to Condensed Consolidated Financial Statements (Unaudited)

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DTE Energy Company
Condensed Consolidated Statement of Changes in Shareholders’ Equity
(Unaudited)
(Millions, Except Per Share Amounts; Shares in Thousands)

See Notes to Condensed Consolidated Financial Statements (Unaudited).

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The Detroit Edison Company
Condensed Consolidated Statement of Income (Unaudited)
(Millions)

See Notes to Condensed Consolidated Financial Statements (Unaudited).

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The Detroit Edison Company
Condensed Consolidated Balance Sheet (Unaudited)
(Millions, Except Per Share Amounts and Shares)

See Notes to Condensed Consolidated Financial Statements (Unaudited).

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See Notes to Condensed Consolidated Financial Statements (Unaudited).

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The Detroit Edison Company
Condensed Consolidated Statement of Cash Flows (Unaudited)
(Millions)

See Notes to Condensed Consolidated Financial Statements (Unaudited).

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The Detroit Edison Company
Condensed Consolidated Statement of Changes in Shareholder’s Equity (Unaudited)
(Millions, Except Per Share Amounts; Shares in Thousands)

See Notes to Condensed Consolidated Financial Statements (Unaudited).

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DTE Energy Company and The Detroit Edison Company
Notes to Condensed Consolidated Financial Statements (Unaudited)

NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES

These condensed consolidated financial statements (unaudited) should be read in conjunction with the Annual Report Notes and the Quarterly Report Notes. The Notes contained herein update and supplement matters discussed in the Annual Report Notes and the Quarterly Report Notes.

The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The condensed consolidated financial statements are unaudited, but in the opinion of the Company and Detroit Edison, with respect to its own financial statements, include all adjustments necessary for a fair statement of the results for the interim periods. Financial results for this interim period are not necessarily indicative of results that may be expected for any other interim period or for the fiscal year.

Certain prior year balances have been reclassified to conform to the current year’s presentation.

The Securities and Exchange Commission Staff (“staff”) issued Staff Accounting Bulletin (“SAB”) No. 101 in December 1999. This staff accounting bulletin summarizes certain of the staff’s views in applying generally accepted accounting principles to revenue recognition in financial statements. The effective date of SAB No. 101 has been delayed until the fourth quarter ended December 31, 2000. At June 30, 2000, the Company and Detroit Edison have not yet determined the impact the adoption of SAB No. 101 will have on the Company’s and Detroit Edison’s financial statements.

NOTE 2 – MERGER AGREEMENT

As discussed in Note 2 of the Annual Report Notes, the Company has entered into a definitive merger agreement with MCN. The proposed merger is being reviewed by the Federal Trade Commission (FTC) pursuant to the Hart-Scott-Rodino Act. The FTC staff has focused primarily on possible competition between the Company and MCN for cogeneration load and other gas/electric displacement technologies in the companies’ coincident retail distribution areas. The Company and MCN are taking action to address issues raised by the FTC staff, including consideration of the potential sale of capacity on the Michigan Consolidated Gas Co. system. Because of the length of the FTC review, it appears unlikely that the transaction can be completed before the fourth quarter of this year.

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NOTE 3 – REGULATORY MATTERS

On June 3, 2000, Michigan Governor John Engler signed Enrolled Senate Bill No. 937, Public Act 141 of 2000 (PA 141), which provides Detroit Edison with the right to recover stranded costs, codifies and establishes a date certain for the MPSC’s existing electric customer choice program, and requires the MPSC to reduce electric residential rates by 5%.

On that same date, the Governor signed Enrolled Senate Bill No. 1253, Public Act 142 of 2000 (PA 142). PA 142 provides for the recovery through securitization of “qualified costs,” which consist of an electric utility’s regulatory assets plus various costs associated with, or resulting from, the establishment of a competitive electric market and the issuance of securitization bonds. In order to recover its “qualified costs,” Detroit Edison must apply to the MPSC for authority to issue the securitization bonds, which may not exceed 15 years in term. Before the bonds may be issued, the MPSC is required to make findings that recovery of the qualified costs will provide tangible and quantifiable benefits to customers. PA 142 requires Detroit Edison to retire debt and equity with the proceeds of securitization bonds. An annual reconciliation of securitization charges is also required by statute.

In an Application for a Financing Order filed July 5, 2000, Detroit Edison requested that the MPSC, as permitted by PA 142, make the necessary statutory findings and rulings to permit Detroit Edison to securitize certain qualified costs in the amount of $1.850 billion. These qualified costs include Fermi 2 costs, MPSC-approved restructuring costs, costs of certain regulatory assets, and electric choice implementation costs. In addition, the initial and periodic costs of issuance associated with securitization bonds, as well as the costs of retiring and refunding securities with the proceeds of securitization, are qualified costs. Buyout or buydown of power purchase contract costs, and employee retraining and transition costs, are also qualified costs, and may be included in a future filing.

By statute, the Application for a Financing Order is to be treated as an expedited contested case proceeding and the MPSC is to act upon such Application no later than 90 days after the electric utility filed its application.

The issuance of securitization bonds is expected to result in an overall revenue requirement reduction for Detroit Edison. Acting pursuant to PA 141, in an order issued June 5, 2000, the MPSC immediately reduced Detroit Edison’s residential electric rates by 5%, or approximately $65 million on an annual basis, and imposed a rate freeze for all classes of customers through 2003. Since rate reductions will be funded through securitization savings, Detroit Edison deferred $9 million for the residential rate reduction in the second quarter of 2000. Detroit Edison anticipates that a total of approximately $42 million will be deferred until securitization bonds are issued, which is expected to occur

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by December 31, 2000. Savings resulting from securitization are, by statute, to be utilized as available in the following priority order: the 5% residential rate reduction, rate reductions for other customers up to 5%, funding of the low income/energy efficiency fund, and to pay for stranded and transition costs.

The legislation also contains provisions preventing rate increases for residential customers through 2005, for small business customers through 2004 and remaining business customers through 2003. Certain costs may be deferred after 2003 and during the period that rate increases are impermissible. This rate cap may be lifted when certain market test provisions are met, namely, an electric utility has no more than 30% of generation capacity in its market, with allowance for capacity needed to meet a utility’s responsibility to serve its customers. Statewide, multi-utility transmission system improvements are also required. If these market conditions and transmission improvements conditions are not met, the rate freeze may continue through 2013.

In addition, as a result of the legislation the Company must:

As a result of the legislation discussed above, in several orders issued on June 19, 2000, the MPSC determined that adjusting rates for changes in PSCR expenses through continuance of the PSCR clause would be inconsistent with the new statutes. Therefore, the MPSC dismissed Detroit Edison’s application for reconciliation of its 1999 PSCR revenues and expenses, its application for approval of its 2000 PSCR plan, and did not allow Detroit Edison to collect the 1998 PSCR underrecovery of $8.6 million plus accrued interest of $3.0 million. Detroit Edison reversed approximately $55 million of liabilities associated with the PSCR clause as of the effective date of the legislation. Parties have filed Claims of Appeal regarding the 1999 and 2000 PSCR issues with the Michigan Court of Appeals. The Company is not able to determine the timing or outcome of these proceedings.

Detroit Edison is unable to predict the outcome of the matters discussed herein. Resolution of these matters is dependent upon future MPSC orders which may impact the financial position of Detroit Edision.

NOTE 4 – SHAREHOLDERS’ EQUITY

The Company’s board of directors has authorized the repurchase of up to 10 million common shares, with the current program tentatively set to not exceed $100 million. Stock purchases are made from time to time on the open market or through negotiated transactions. All common stock repurchased will be canceled. During the six month period ended June 30, 2000, the Company repurchased approximately 2.3 million shares at an aggregate cost of approximately $70 million.

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NOTE 5 – SHORT-TERM CREDIT ARRANGEMENTS AND BORROWINGS

At June 30, 2000, Detroit Edison had total short-term credit arrangements of approximately $506 million under which $182 million of commercial paper was outstanding. Additionally, Detroit Edison had a $200 million trade receivables sales agreement under which $200 million was outstanding at June 30, 2000.

At June 30, 2000, DTE Capital had $240 million of commercial paper outstanding. A $400 million short-term credit arrangement, backed by a Support Agreement from the Company, provided credit support for this commercial paper.

During the first quarter of 2000, plans were announced to terminate DTE Capital’s operations. Subsequently, the Company assumed all of DTE Capital’s outstanding guarantees. Currently the Company is authorized to issue up to $350 million of new guarantees. At June 30, 2000, the Company had assumed and/or issued guarantees of various consolidated affiliate obligations of $225 million.

NOTE 6 – FINANCIAL INSTRUMENTS

The Company has entered into a series of forward starting interest rate swaps and Treasury locks in order to limit the Company’s sensitivity to interest rate fluctuations associated with its anticipated issuance of long-term debt to be used to finance the merger with MCN. The Company has designated these instruments as hedges. The Company expects to issue this debt subsequent to the merger. The forward starting swaps, which include notional amounts of $250 million and $450 million in 5 and 10-year maturities, respectively, have a weighted average interest rate of 7.55% and 7.61%, respectively. The Treasury locks, which include notional amounts of $50 million and $150 million in 10 and 30-year maturities, respectively, have a weighted average interest rate of 6.01% and 6.26%, respectively. At June 30, 2000, the fair value of these derivative financial instruments indicated an unrealized loss of approximately $17 million. The unrealized loss is not reflected in the financial statements at June 30, 2000, but would be recognized as a deferred item upon issuance of the anticipated long-term debt. The deferred item would be amortized through interest expense over the life of the associated long-term debt as a yield adjustment.

Trading activities of DTE Energy Trading, Inc. (DTE ET) are accounted for using the mark to market method of accounting. Net unrealized gains from such contracts were $18 million and $2 million at June 30, 2000 and June 30, 1999, respectively.

The Company’s non regulated energy marketing subsidiary enters into commitments to deliver electricity to retail customers outside southeast Michigan. To limit its exposure to price volatility on the electricity it purchases to fulfill its commitments, it enters into forward purchase commitments with DTE ET. DTE ET also enters into forward purchase commitments with third parties to cover its commitments to deliver electricity to the energy marketing subsidiary. All such contracts have been designated as hedges of the anticipated sale of electricity to the energy marketing company and the retail customer, respectively. As such, unrealized gains on these contracts of $15 million have not been reflected in the consolidated financial statements at June 30, 2000.

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NOTE 7 – COMMITMENTS AND CONTINGENCIES

As discussed in the Annual Report, in July 1999, ABATE made a filing with the MPSC indicating that Detroit Edison’s retail rates produce approximately $333 million of excess revenues. Of this amount, approximately $202 million is related to ABATE’s proposed reversal of the December 28, 1998 MPSC Order authorizing the accelerated amortization of Fermi 2. On June 19, 2000, the MPSC dismissed with prejudice the complaint filed initially by ABATE in 1997 alleging that Detroit Edison’s rates produced excessive revenues. A Proposal for Decision issued in March 2000 by an administrative law judge had recommended that Detroit Edison’s electric rates be reduced by approximately $101.6 million. In dismissing the complaint, the MPSC indicated that adjusting rates would be inconsistent with PA 141. ABATE has filed a motion with the MPSC requesting rehearing, asking that the parties be allowed to address whether excess earnings can be used as an offset against, at least, electric choice implementation costs. The MPSC has not acted on the motion. The Company is unable to predict the outcome of this proceeding.

As discussed in the Annual Report, the EPA has issued ozone transport regulations, final new air quality standards relating to ozone and particulate air pollution and a SIP (State Implementation Plan) call giving states a year to develop new regulations to limit nitrogen oxide (NOx) emissions because of their contribution to ozone formation. In June 2000, the U.S. Court of Appeals refused to rehear a decision upholding the SIP call. The State of Michigan has indicated its intention to appeal the decision to the U.S. Supreme Court. Unless it is reversed, it is estimated that Detroit Edison will incur approximately $400 million in capital expenditures to comply. Under the recently enacted Michigan electric restructuring legislation, beginning January 1, 2004, annual return of and on this capital expenditure would be deferred until after the expiration of the rate cap period presently expected to end December 31, 2005.

NOTE 8 – SEGMENT AND RELATED INFORMATION

The Company’s reportable business segment is its electric utility, Detroit Edison, which is engaged in the generation, purchase, transmission, distribution and sale of electric energy in a 7,600 square mile area in Southeastern Michigan. All Other includes non-regulated energy-related businesses and services, which develop and manage electricity and other energy-related projects, and engage in domestic energy trading and marketing. Inter-segment revenues are not material. Income taxes are allocated based on intercompany tax sharing agreements, which generally allocate the tax benefit of alternate fuels tax credits and accelerated depreciation to the respective subsidiary, without regard to the subsidiary’s own net income or whether such tax benefits are realized by the Company. Financial data for business segments are as follows:

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      This Quarterly Report on Form 10-Q, including the report of Deloitte & Touche LLP (on page 22) will automatically be incorporated by reference in the Prospectuses constituting part of the Registration Statements on Form S-3 (Registration Nos. 33-53207, 33-64296 and 333-65765) of The Detroit Edison Company and Form S-8 (Registration No. 333-00023), Form S-4 (Registration No. 333-89175) and Form S-3 (Registration No. 33-57545) of DTE Energy Company, filed under the Securities Act of 1933. Such report of Deloitte & Touche LLP, however, is not a “report” or “part of the Registration Statement” within the meaning of Sections 7 and 11 of the Securities Act of 1933 and the liability provisions of Section 11(a) of such Act do not apply.

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Independent Accountants’ Report

      To the Board of Directors and Shareholders of DTE Energy Company and The Detroit Edison Company

      We have reviewed the accompanying condensed consolidated balance sheets of DTE Energy Company and subsidiaries and of The Detroit Edison Company and subsidiaries as of June 30, 2000, and the related condensed consolidated statements of income for the three-month and six-month periods ended June 30, 2000 and 1999, the condensed consolidated statements of cash flows for the six-month periods ended June 30, 2000 and 1999, and the condensed consolidated statements of changes in shareholders’ equity for the six-month period ended June 30, 2000. These financial statements are the responsibility of DTE Energy Company’s management and of The Detroit Edison Company’s management.

      We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

      Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

      We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheets of DTE Energy Company and subsidiaries and of The Detroit Edison Company and subsidiaries as of December 31, 1999, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated January 26, 2000, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheets as of December 31, 1999 is fairly stated, in all material respects, in relation to the consolidated balance sheets from which it has been derived.

DELOITTE & TOUCHE LLP

Detroit, Michigan
August 9, 2000

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Item 2 – Management’s Discussion and Analysis of Financial Condition and
Results of Operations.

This analysis for the three and six months ended June 30, 2000, as compared to the same periods in 1999, should be read in conjunction with the condensed consolidated financial statements (unaudited), the accompanying Notes, the Quarterly Report Notes and the Annual Report Notes.

Detroit Edison is the principal operating subsidiary of the Company and, as such, unless otherwise identified, this discussion explains material changes in results of operations of both the Company and Detroit Edison and identifies recent trends and events affecting both the Company and Detroit Edison.

GROWTH

As discussed in the Annual Report, in order to sustain earnings growth with an objective of 6% growth annually, the Company and Detroit Edison have developed a business strategy focused on core competencies, consisting of expertise in developing, managing and operating energy assets, including coal sourcing, blending and transportation skills.

As discussed in Note 2, the Company and MCN have entered into a merger agreement. The Company expects that completion of the merger will result in the issuance of approximately 30 million shares of its common stock and approximately $1.4 billion in external financing. The merger is expected to create a fully integrated electric and natural gas company that is expected to strongly support the Company’s commitment to a long-term earnings growth rate of 6%. The merger is expected to permit the Company to be responsive to competitive pressures. The external financing needs of the merger may create a sensitivity to interest rate changes; and the Company will need to successfully integrate the two operations in order to be able to service the expected debt requirements and achieve aggregate operating cost reductions. The delay in the receipt of regulatory approvals may impact the accretive effect on earnings in 2001 resulting from the proposed transaction. See Note 2 and 6 for further discussion of the pending DTE/MCN merger and the financial instruments used to hedge the interest rate risk associated with financing the merger.

The Company’s earnings are largely dependent upon the earnings of Detroit Edison and the utilization of alternate fuels tax credits generated from non-regulated businesses. Securitization, discussed in Note 3, is expected to reduce Detroit Edison’s earnings, which may impact the Company’s ability to utilize all future available alternate fuels tax credits.

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ELECTRIC INDUSTRY RESTRUCTURING

Michigan’s Customer Choice and Electricity Reliability Act

See Note 3 for discussion of Public Acts 141 and 142 of 2000 (PA 141 and PA 142), new legislation signed into effect on June 3, 2000 by Michigan Governor John Engler.

Michigan Public Service Commission

The MPSC ordered Detroit Edison to file by September 20, 2000 revised tariffs governing both the experimental and the main electric choice programs, with any revisions that are appropriate to comply with PA 141 and PA 142, and to remedy problems that customers have experienced thus far. The MPSC will then conduct a contested case proceeding to resolve any issues.

Federal Energy Regulatory Commission

On May 18, 2000, the FERC issued an order in response to the filing that the Alliance RTO, which includes Detroit Edison, made on February 17, 2000. The order indicated that the compliance filing does not fully satisfy the requirements of the original order, and directed the Alliance to make additional filings, but did not set any filing deadlines. The FERC indicated that the Alliance still did not meet the independence requirements with its governance structure, and reserved the judgement on the rate design and scope and configuration until further detail is provided in future filings.

On June 29, 2000, the FERC approved Detroit Edison’s May 4, 2000 request to transfer its transmission facilities and agreements to a subsidiary, the International Transmission Company (ITC). The disposition is intended to be a first step in the Detroit Edison’s efforts to divest the transmission business to an entity qualified to join an RTO. On July 28, 2000, ITC filed an application with the FERC for transmission rate treatment, pursuant to the FERC’s Order 2000. The application proposed a rate moratorium based upon the Michigan legislative rate freeze and the transmission component of Detroit Edison’s formerly bundled retail rates. The rate would yield a revenue level of approximately $138 million annually, and is subject to refund if certain independence and RTO compliance conditions are not met.

LIQUIDITY AND CAPITAL RESOURCES

Cash From Operating Activities

Net cash from operating activities was lower for the Company due primarily to increases in accounts receivable and changes in other assets and liabilities.

Net cash from operating activities was lower for Detroit Edison due primarily to decreased net income and changes in other assets and liabilities.

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Cash Used for Investing Activities

Net cash used for investing activities was higher for the Company due to increased non-regulated plant and equipment expenditures.

Net cash used for investing activities was lower for Detroit Edison due to decreased plant and equipment expenditures.

Cash Used for Financing Activities

Net cash used for financing activities was lower for the Company due primarily to the issuance of long-term debt and increased short-term borrowings, partially offset by the redemption of common stock and long-term debt.

Net cash used for financing activities was higher for Detroit Edison due primarily to increased redemptions of long-term debt and reduced short-term borrowings, partially offset by the issuance of long-term debt.

Detroit Edison has called for redemption, on September 1, 2000, all outstanding County of Monroe, Michigan Series I-1990 Pollution Control Revenue Bonds ($50,745,000, 7.65%) at a price of 102%. These bonds are to be refinanced with an issue of tax exempt bonds by the Michigan Strategic Fund.

RESULTS OF OPERATIONS

For the three months ended June 30, 2000, the Company’s net income was $108 million or $0.76 per common share as compared to $110 million or $0.76 per common share during the same period in 1999. For the six months ended June 30, 2000, net income was $225 million or $1.57 per common share compared to $225 million or $1.55 per common share during the same period in 1999.

The 2000 three and six months earnings remained relatively stable compared to 1999 due to higher electric system sales and the effects of the June 2000 legislation and corresponding MPSC orders, offset by higher unit fuel costs and increased energy purchases. Operating expenses were higher due to a catastrophic storm in May 2000, increased generation and system maintenance and merger expenses, partially offset by Year 2000 testing and remediation expenses included last year. In addition, the Company’s non-regulated subsidiaries contributed higher earnings in the three and six months periods compared to 1999. A share repurchase program in 2000 accounted for slight differences in year over year earnings per common share amounts.

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Operating Revenues

Operating revenues were $2.61 billion, up approximately 20% from 1999 operating revenues of $2.17 billion. Operating revenues increased (decreased) due to the following:

      Detroit Edison kWh sales increased (decreased) as compared to the prior year as follows:

Operating Expenses

Fuel and Purchased Power

Fuel and purchased power expense increased for the Company due primarily to non-regulated subsidiary expenses, principally energy trading operations. Detroit Edison

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fuel and purchased power expense increased due to increased purchases of energy. The increased costs are partially offset by lower coal and nuclear generation costs.

System output and average fuel and purchased power unit costs for Detroit Edison were as follows: