SECURITIES AND EXCHANGE COMMISSIONWashington, 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 March 31, 2001
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 No
At April 30, 2001, 135,803,708 shares of DTE Energy’s Common Stock, substantially all held by non-affiliates, were outstanding.
TABLE OF CONTENTS
DTE ENERGY COMPANYandTHE DETROIT EDISON COMPANYFORM 10-QFor The Quarter Ended March 31, 2001
This document contains the Quarterly Reports on Form 10-Q for the quarter ended March 31, 2001 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.
2
3
Item 1 — Condensed Consolidated Financial Statements (Unaudited).
The following condensed consolidated financial statements (unaudited) are included herein.
4
DTE Energy CompanyCondensed Consolidated Statement of Income (Unaudited)(Millions, Except Per Share Amounts; Shares in Thousands)
See Notes to Condensed Consolidated Financial Statements (Unaudited).
5
DTE Energy CompanyCondensed Consolidated Balance Sheet (Unaudited)(Millions, Except Shares)
6
7
DTE Energy CompanyCondensed Consolidated Statement of Cash Flows (Unaudited)(Millions)
8
DTE Energy CompanyCondensed Consolidated Statement of Changes in Shareholders’ Equity (Unaudited)(Millions, Except Per Share Amounts; Shares in Thousands)
9
[ This page intentionally left blank. ]
10
The Detroit Edison CompanyCondensed Consolidated Statement of Income (Unaudited)(Millions)
11
The Detroit Edison CompanyCondensed Consolidated Balance Sheet (Unaudited)(Millions, Except Per Share Amounts and Shares)
12
13
The Detroit Edison CompanyCondensed Consolidated Statement of Cash Flows (Unaudited)(Millions)
14
The Detroit Edison CompanyCondensed Consolidated Statement of Changes in Shareholder’s Equity (Unaudited)(Millions, Except Per Share Amounts; Shares in Thousands)
15
DTE Energy Company and The Detroit Edison CompanyNotes to Condensed Consolidated Financial Statements (Unaudited)
NOTE 1 – ANNUAL REPORT NOTES
These condensed consolidated financial statements (unaudited) should be read in conjunction with the Annual Report Notes. The Notes contained herein update and supplement matters discussed in the Annual Report Notes.
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America 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.
NOTE 2 – MERGER AGREEMENT
As discussed in Notes 2 and 17 of the Annual Report Notes, on February 28, 2001, the Company and MCN announced a revised merger agreement that provides that the Company will acquire all outstanding shares of MCN for $24.00 per share in cash, or 0.715 shares of Company common stock for each share of MCN common stock. Certain allocation and proration procedures provided for in the original agreement continue to apply and will be used to ensure that the aggregate number of shares of MCN common stock that will be converted into cash and the Company’s common stock will be equal to 55% and 45%, respectively, of the total number of shares of MCN common stock outstanding immediately prior to the pending merger. MCN’s common shareholders have been asked to approve the revised merger agreement at a special meeting scheduled for May 15, 2001. The Company is currently awaiting approval of the merger from the Securities and Exchange Commission under the Public Utility Holding Company Act of 1935, as amended. Although no assurances can be given, and the merger may be completed later, the Company currently expects that the merger will be completed on May 31, 2001. If this expectation does not change by May 24, 2001, the Company will publicly announce May 31, 2001 as the closing date. Even then, the closing could be delayed if SEC approval is not received prior to May 31, 2001.
Effective March 21, 2001, the Federal Trade Commission accepted a proposed consent order and easement agreement and granted DTE and MCN early termination of the Hart-Scott-Rodino Anti-trust Improvements Act of 1976 pre-merger waiting period. The easement agreement, which addresses the FTC’s competitive concerns, conveys an easement to Exelon Corp., an unaffiliated company, over the Michigan Consolidated Gas Company’s (“MichCon’s”) local natural gas distribution system that will allow Exelon Corp. to engage in the distribution, storage and sale of natural gas in MichCon’s and Detroit Edison’s overlapping distribution areas. MichCon, a natural gas utility
16
serving 1.2 million customers in more than 530 communities throughout Michigan, is MCN’s largest subsidiary.
The revised merger agreement expires December 31, 2001, in order to allow for sufficient time to obtain necessary regulatory approvals. The value of the revised transaction is approximately $4.1 billion, including the assumption of approximately $1.8 billion of MCN’s debt. The Company estimates that closing on the merger will occur in second quarter 2001.
NOTE 3 – SECURITIZATION
On June 5, 2000, Michigan Public Acts 141 and 142 became effective, providing Detroit Edison with the right to recover certain stranded costs through securitization, assuming such recovery was authorized by an appropriate order of the MPSC.
In an order issued on November 2, 2000, and clarified on January 4, 2001, the MPSC approved the issuance of up to $1.774 billion of securitization bonds for the benefit of Detroit Edison. Detroit Edison formed The Detroit Edison Securitization Funding LLC (“Securitization LLC”), a wholly owned single member Michigan limited liability corporation, for the purpose of securitizing its stranded costs (referred to as qualified costs and securitization property in the Michigan statutes). The securitization property created by the MPSC’s order consists of certain of Detroit Edison’s qualified costs (primarily unamortized costs related to Detroit Edison’s Fermi 2 nuclear power plant), an irrevocable right to recover amounts sufficient to pay the principal of and interest on the securitization bonds, as well as amounts sufficient to pay ongoing costs associated with the securitization bond transaction and the Securitization LLC.
On March 9, 2001, the Securitization LLC issued $1.750 billion of its Securitization Bonds, Series 2001-1 and Detroit Edison sold $1.750 billion of stranded costs to its Securitization LLC. The Securitization Bonds mature over a period of up to fifteen years and have an average interest rate of 6.3%. Detroit Edison has implemented a non-bypassable surcharge on its customer bills, effective March 26, 2001. The MPSC’s securitization order also permits Detroit Edison to recover taxes associated with securitization.
The Securitization LLC is independent of the Company and Detroit Edison, as is its ownership of the securitization property. Due to principles of consolidation, stranded costs sold by Detroit Edison to the Securitization LLC and the $1.750 billion of its securitization bonds appear on the Company’s and Detroit Edison’s balance sheets. Neither the Company nor Detroit Edison make claim to these assets and ownership of such assets has vested in the Securitization LLC and been assigned to the trustee for the Securitization Bonds. Funds collected by Detroit Edison, acting in the capacity of a servicer for the Securitization LLC, are remitted to the trustee for the Securitization Bonds. Neither the securitization property nor funds collected from Detroit Edison’s customers for the payment of costs related to the Securitization LLC and Securitization Bonds are available to the Company’s or Detroit Edison’s creditors.
17
NOTE 4 – SHORT-TERM CREDIT ARRANGEMENTS AND BORROWINGS
At March 31, 2001, Detroit Edison had total short-term credit arrangements of approximately $518 million, under which no amounts were outstanding. Additionally, Detroit Edison had a $200 million short-term financing agreement secured by its customer accounts receivable and unbilled revenues portfolios, under which no amounts were outstanding at March 31, 2001.
On April 9, 2001, DTE Capital was merged into the Company, with the Company assuming all of DTE Capital’s assets and liabilities. The Company has assumed DTE Capital’s $400 million commercial paper program, as well as direct liability for $400 million of remarketed notes originally issued by DTE Capital. At March 31, 2001, $35 million in commercial paper was outstanding, and the Company assumed direct liability for this commercial paper. Support agreements for the benefit of DTE Capital have been terminated. Guarantees of non-regulated affiliate obligations, of which $296 million were outstanding and $700 million were authorized at March 31, 2001, will now be issued solely by the Company.
NOTE 5 – FINANCIAL AND OTHER DERIVATIVE INSTRUMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that all derivative instruments be recognized as either assets or liabilities, measured at fair value. The accounting for changes in fair value depends upon the purpose of the derivative instrument and whether it is designated as a hedge and qualifies for hedge accounting. To the extent derivative instruments qualify as hedges and are designated as hedges of the variability of cash flows associated with forecasted transactions, the effective portion of the gain or loss on such derivative instruments is generally reported in other comprehensive income. The ineffective portion, if any, is reported in net income. Such amounts reported in other comprehensive income are reclassified into net income when the forecasted transaction affects earnings. If a cash flow hedge is discontinued because it is probable that the forecasted transaction will not occur, the net gain or loss is immediately reclassified into earnings. To the extent derivative instruments qualify as hedges and are designated as hedges of changes in fair value of an existing asset, liability or firm commitment, the gain or loss on the hedging instrument is recognized in earnings along with the changes in fair value of the hedged asset, liability or firm commitment attributable to the hedged risk.
SFAS No. 133 requires that as of the date of initial adoption, the difference between the fair market value of derivative instruments recorded on the balance sheet and the previous carrying amount of those derivatives be reported in net income or other comprehensive income, as appropriate, as the cumulative effect of a change in accounting principle in accordance with Accounting Principles Board Opinion 20, “Accounting Changes.”
18
THE COMPANY
As of January 1, 2001, the Company adopted SFAS No. 133, as required. The cumulative effect of the adoption of SFAS No. 133 was an after-tax increase in net income of $3 million, and an after-tax increase in other comprehensive loss of $42 million. The financial statement impact of recording the various SFAS 133 transactions for the Company at January 1, 2001 was as follows:
The Company’s primary market risk exposures are associated with interest rates and commodity prices. The Company has risk management policies to monitor and assist in mitigating these market risks and uses derivative instruments to manage some of the exposures. Except for the activities of DTE Energy Trading (DTE ET), the Company does not hold or issue derivative instruments for trading purposes.
Interest Rate Risk
Hedge of Anticipated Issuance of Long-Term Debt
In accordance with its risk management policy, the Company entered into a series of forward-starting interest rate swaps and Treasury locks in order to limit its sensitivity to market interest rate risk associated with its forecasted issuance of long-term debt to be used to finance the pending merger with MCN. Such instruments have been formally designated as cash flow hedges for accounting purposes, are measured at fair market value and are recorded as liabilities in the Company’s consolidated balance sheet. Losses on these instruments are included in other comprehensive loss. At March 31, 2001, the Company recorded $63 million, net of tax in other comprehensive loss for this hedge. Amounts recorded in other comprehensive loss will be reclassified to interest expense as the forecasted interest payments associated with the debt issuance affect earnings. The maximum length of time over which the Company is hedging its exposure to the variability of future cash flows for this forecasted transaction is 30 years.
During the three-month period ended March 31, 2001, no amounts were recognized in earnings due to hedge ineffectiveness of this hedging relationship. However, a loss of approximately $6 million was reclassified from accumulated other comprehensive loss into earnings since management determined it was probable that certain forecasted transactions within a series of interest payments associated with this issuance of long-term debt would not occur within the time frame originally anticipated. This loss was reported as a component of interest expense within the consolidated statement of
19
income. The estimated net amount of existing losses at March 31, 2001 that is expected to be reclassified into earnings within the next 12 months is approximately $6 million.
Interest Rate Swap
PCI Enterprises Company (PCI), a wholly owned coal pulverizing subsidiary of the Company, entered into a seven-year interest rate swap agreement beginning June 30, 1997, with the intent of reducing the impact of certain cash flows due to changes in LIBOR associated with its variable rate non-recourse debt. The swap has been formally designated as a cash flow hedge for accounting purposes, is measured at fair market value and is recorded as a liability in the Company’s consolidated balance sheet. The holding loss on the swap is included in other comprehensive loss. At March 31, 2001, the Company recorded $0.7 million, net of tax in other comprehensive loss for this hedge. During the three-month period ended March 31, 2001, no amounts were recognized in earnings due to ineffectiveness of this hedging relationship. No amounts are expected to be reclassified into earnings within the next 12 months.
The effects of adopting SFAS No. 133 are recorded in the following line items in the accompanying Balance Sheet of the Company at March 31, 2001:
DETROIT EDISON
The cumulative effect of the adoption of SFAS No. 133 was an after-tax decrease in net income of $3 million, and an after-tax increase in other comprehensive income of $13 million. The financial statement impact of recording the various SFAS 133 transactions at January 1, 2001 was as follows:
20
Commodity Price Risk
Forward Energy Purchase Contracts
Detroit Edison uses over-the-counter (OTC) forward contracts and options to manage the risk of fluctuations in the market price of electricity. To achieve its hedging objectives, Detroit Edison chooses the time to enter into purchase and sale contracts and selects the types of instruments. The forward contracts used to financially hedge electricity price risks are relatively liquid instruments and provide Detroit Edison the flexibility to execute its hedging strategies and meet its objectives.
Certain of these contracts have been formally designated as cash flow hedges of the forecasted purchase of power for accounting purposes. Such contracts are measured at fair market value and are recorded as assets and liabilities in the consolidated balance sheets. Gains and losses on these instruments are included in other comprehensive income. At March 31, 2001, Detroit Edison recorded $3 million, net of tax in other comprehensive income for these hedges. Amounts recorded in other comprehensive income will be reclassified to fuel and purchased power expense as the forecasted purchases of electricity affect earnings. At March 31, 2001, the estimated net amount of existing gains that is expected to be reclassified into earnings within the next 12 months is approximately $3 million. The maximum length of time over which Detroit Edison is hedging its exposure to the variability of future cash flows is seventeen months. Ineffectiveness recognized in these hedging relationships was immaterial for the three months ended March 31, 2001. As forward contracts settle in the second and third quarters of 2001, existing gains and losses that are currently reported in accumulated other comprehensive income will be reclassified into earnings.
Other Derivative Instruments
Certain of Detroit Edison’s electricity forward purchase and sale contracts and purchased option contracts, entered into for the purpose of economically hedging its exposure to commodity risk, do not qualify for hedge accounting under the provisions of SFAS No. 133. Detroit Edison marks these contracts to market on its consolidated balance sheet and records an offsetting gain or loss in earnings. Such holding gains and losses are recorded in revenues or fuel and purchased power expense, depending on the type of contract.
The effects of adopting SFAS No. 133 are recorded in the following line items in the accompanying Balance Sheet of Detroit Edison at March 31, 2001:
Certain of Detroit Edison’s forward electric contracts are considered “normal purchases and sales,” as defined by SFAS No. 133, and therefore are excluded from the scope of SFAS No. 133. In April 2001, the Derivatives Implementation Group (DIG), a committee
21
of the FASB responsible for providing guidance on the implementation of SFAS No. 133, reached tentative conclusions regarding certain contracts in the power generation industry. Depending on the final decision of the FASB, certain commodity contracts currently considered “normal purchases and sales” may no longer qualify for this exclusion, and may be required to be accounted for under SFAS No. 133. In this case, Detroit Edison would follow the transition provisions for applying the implementation guidance for SFAS No. 133. Management believes such contracts would qualify as cash flow hedges and be recorded at fair value on the balance sheet, with the effective portion of the hedge recognized in accumulated other comprehensive income.
TRADING ACTIVITIES
DTE ET markets and trades electricity and natural gas physical products and financial instruments, and provides risk management services utilizing energy commodity derivative instruments, which include futures, exchange traded and over-the-counter options, and forward purchase and sales commitments.
Notional Amounts and Terms
The notional amounts and terms of DTE ET’s outstanding energy trading financial instruments as of March 31, 2001 were:
At March 31, 2001, DTE ET also had sales and purchase commitments for physical delivery of electricity associated with contracts based on fixed prices totaling 216,556 net MWh purchased with terms extending up to 2 years.
Notional amounts reflect the volume of transactions, but do not necessarily represent the amounts exchanged by the parties to the energy commodity derivative instruments. Accordingly, notional amounts do not accurately measure DTE ET’s exposure to market or credit risks. The maximum terms in years detailed above are not indicative of likely future cash flows as these positions may be offset in the markets at any time in response to DTE ET’s risk management needs.
Fair Values
The average fair values of DTE ET’s derivative assets and liabilities were $271.8 million and $263.7 million, respectively, during the first quarter ended March 31, 2001, and $80.5 million and $62.0 million, respectively, during the first quarter ended March 31, 2000. At March 31, 2001 and December 31, 2000, the fair values of the derivative assets and liabilities were approximately $228 million and $221 million, and $288.9 million and
22
$279.9 million, respectively. Net unrealized gains were $6.1 million and $9.0 million at March 31, 2001 and December 31, 2000, respectively.
NOTE 6 – SEGMENT AND RELATED INFORMATION
The Company’s reportable business segments are its electric utility, Detroit Edison, which is engaged in the generation, purchase, distribution and sale of electric energy (transmission services are performed by Detroit Edison’s wholly owned subsidiary, International Transmission Company), in a 7,600-square-mile area in Southeastern Michigan, its energy trading company, and energy services business, which develops and manages energy-related projects and services primarily concentrated in the steel industry. All Other includes businesses involved in new energy technologies. Inter-segment revenues are not material. Income taxes are allocated based on inter-company 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:
___________________________________________
This Quarterly Report on Form 10-Q, including the report of Deloitte & Touche LLP (on page 24) 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 Nos. 33-57545 and 333-58834) 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.
23
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 March 31, 2001, and the related condensed consolidated statements of income and cash flows for the three-month periods ended March 31, 2001 and 2000, and the condensed consolidated statements of changes in shareholders’ equity for the three-month period ended March 31, 2001. 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, 2000, 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 24, 2001, 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, 2000 is fairly stated, in all material respects, in relation to the consolidated balance sheets from which it has been derived.
DELOITTE & TOUCHE LLP
Detroit, MichiganMay 9, 2001
24
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This analysis for the three months ended March 31, 2001, as compared to the same period in 2000, should be read in conjunction with the condensed consolidated financial statements (unaudited), the accompanying 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
The Company is focused on prudently growing its earnings base. For the past three years, it has articulated a growth strategy that has consistently achieved its 6% growth objective (after adjustment in 2000 for one-time legislative and merger items). Given its prior successes, depth of management team and strategic asset base, the Company has increased its growth objective up to 8% over the next several years. The new anticipated growth rate is expected to be achieved by strengthening our core electric and gas (after the pending merger with MCN) utility businesses in the short term, building our non-regulated businesses in the mid term and leveraging investments in energy technology over the long term. The growth strategy, focused on the greater Midwest region, leverages and expands existing assets and skills.
As discussed in Note 2, the Company and MCN announced a revised merger agreement. The Company expects that completion of the pending merger will result in the issuance of approximately 29 million shares of its common stock and approximately $1.2 billion in external financing. The pending merger is expected to create a fully integrated electric and natural gas company that is anticipated to support the Company’s commitment to a long-term earnings growth rate of up to 8%. The merger is expected to be accretive to earnings in the first full year of operation as a combined company. In addition, it is expected that approximately $1.1 billion of cost savings will be realized over the next 10 years. See Note 5 for a discussion of the financial instruments used to hedge the interest rate risk associated with financing the pending merger.
As a result of Detroit Edison’s sale of certain of its stranded costs and the related sale of Securitization Bonds, Detroit Edison’s operating revenues and income are expected to be reduced in 2001 and future years. This revenue reduction is offset by the certainty of stranded cost recovery that resulted from the issuance of the Securitization Bonds. Earnings per share are not expected to be impacted due to the reduction in average common shares outstanding resulting from the buyback of common shares.
The Company projects that earnings (excluding the impact of goodwill and merger restructuring charges) will be approximately $3.50 to $3.60 per share in 2001 and $4.10 to $4.20 per share in 2002.
25
ELECTRIC INDUSTRY RESTRUCTURING
Pursuant to Michigan legislation and MPSC orders, on March 9, 2001, Detroit Edison sold $1.750 billion of stranded costs to its Securitization LLC subsidiary, and the Securitization LLC issued $1.750 billion of securitization bonds. Detroit Edison is in the process of using the proceeds of the bonds to retire debt and equity, as required, in a manner that will maintain its debt/equity ratio at approximately 50%. The Company will likewise retire approximately 50% debt and 50% equity with the proceeds received as the sole holder of Detroit Edison’s equity.
LIQUIDITY AND CAPITAL RESOURCES
Cash From Operating Activities
Net cash from operating activities was higher for the Company due primarily to increased net income and changes in other current assets and liabilities.
Net cash from operating activities was lower for Detroit Edison due primarily to increases in other assets.
Cash Used for Investing Activities
Net cash used for investing activities was lower due to decreased plant and equipment expenditures.
Cash From Financing Activities
Net cash from financing activities was higher due primarily to the issuance of Securitization Bonds, partially offset by the resulting redemptions of short-term borrowings and long-term debt and the buyback of common stock. Remaining proceeds from securitization will be used for additional debt redemptions and buyback of common stock.
RESULTS OF OPERATIONS
For the three months ended March 31, 2001, the Company’s net income was $138 million, or $0.98 per basic common share, compared to $117 million, or $0.81 per basic common share for the three months ended March 31, 2000.
The 2001 three-month earnings were higher than 2000 due to higher utility revenues due to the suspension of the PSCR clause and higher non-regulated income, partially offset by higher purchased power costs, higher operating expenses and the effect of the implementation of the new accounting standard for derivatives (FAS 133).
As a result of the suspension of the PSCR clause, the Company expects that the distribution of yearly earnings will shift significantly. The first and fourth quarters of the year are expected to show higher earnings, while lower earnings are expected in the second and third quarters. In addition, the fuel clause suspension will have an impact on earnings, since rates will no longer be adjusted for changes in fuel and purchased power expenses.
26
Operating Revenues
Operating revenues were $1.842 billion, up 55.8% from 2000 operating revenues of $1.182 billion. Operating revenues increased (decreased) due to the following:
In 2001, residential sales increased due to greater heating demand. Commercial sales decreased due to increased migration of customers to Electric Choice program. Industrial sales decreased due to reduced auto and steel production.
Non-regulated revenues were higher due to an increased level of operations, primarily at DTE Energy Trading, and the addition of new businesses.
27
Operating Expenses
Fuel and Purchased Power
Fuel and purchased power expense increased for the Company due primarily to non-regulated subsidiary expenses, principally DTE Energy Trading. Detroit Edison fuel and purchased power expense increased due to greater plant generation and increased market prices of purchased energy. The increased costs are partially offset by increased usage of lower cost coal and nuclear generation, decreased usage of higher cost gas and oil generation, and reduced purchased energy quantities.
System output and average delivered fuel and purchased power unit costs for Detroit Edison were as follows:
Operation and Maintenance
The Company’s operation and maintenance expenses were higher by $30 million. Higher non-regulated expenses ($14 million) were due to an increased level of operations and the addition of new businesses, partially offset by a gain on the sale of an interest in a coke battery. Higher Detroit Edison expenses ($16 million) resulted primarily from an increase in storm expense, distribution system and plant maintenance in preparation for the summer and an increase in benefit costs.
Depreciation and Amortization
Depreciation and amortization expense was lower due to an extension of the amortization period resulting from the securitization of regulatory assets in March 2001.
Income Taxes
Income tax expense for the Company increased due primarily to increased pretax income, partially offset by increased utilization of alternate fuels credits generated from non-regulated businesses. The majority of alternate fuels credits are available through 2002, while others have been extended through 2007.
28
ACCOUNTING FOR DERIVATIVES
Effective January 1, 2001, The Company adopted Statement of Financial Accounting Standards No. 133 (SFAS No. 133), as amended. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities.
In general, SFAS No. 133 requires that companies recognize all derivatives as either assets or liabilities on the balance sheet, measured at fair value. SFAS No. 133 provides an exemption for certain contracts that qualify as “normal purchases and sales.” To qualify for this exemption, certain criteria must be met, including that it must be probable that the contract will result in physical delivery.
The Company’s adoption of SFAS No. 133 on January 1, 2001 resulted in the recognition of derivative assets on the consolidated balance sheet at January 1, 2001 in the amount of $26 million, with offsetting amounts, net of tax, recorded in other comprehensive income of $13 million, and cumulative effect of a change in accounting principle of $3 million. As of January 1, 2001, derivative liabilities in the amount of $85 million were also recorded as a result of adopting SFAS No. 133, with an offsetting amount, net of tax, recorded in other comprehensive loss, of $55 million.
Detroit Edison’s adoption of SFAS No. 133 on January 1, 2001 resulted in the recognition of derivative assets on the consolidated balance sheet at January 1, 2001 in the amount of $26 million, with offsetting amounts, net of tax, recorded in other comprehensive income of $13 million, and cumulative effect of a change in accounting principle of $3 million. As of January 1, 2001, derivative liabilities in the amount of $10 million were also recorded as a result of adopting SFAS No. 133, with an offsetting amount, net of tax, recorded in cumulative effect of a change in accounting principle of $(6) million.
See “Note 5 – Financial and Other Derivative Instruments” herein for additional information.
FORWARD-LOOKING STATEMENTS
Certain information presented herein is based on the expectations of the Company and Detroit Edison, and, as such, is forward-looking. The Private Securities Litigation Reform Act of 1995 encourages reporting companies to provide analyses and estimates of future prospects and also permits reporting companies to point out that actual results may differ from those anticipated.
Actual results for the Company and Detroit Edison may differ from those expected due to a number of variables including, but not limited to, interest rates, the level of borrowings, weather, actual sales, changes in the cost of fuel and purchased power due to the suspension of the PSCR mechanism (including natural gas subsequent to the pending merger with MCN), the effects of competition and the phased-in implementation of Electric Choice, the implementation of utility restructuring in Michigan (which involves pending regulatory and related judicial proceedings, and actual and possible reductions in rates and earnings), environmental and nuclear requirements,
29
the impact of FERC proceedings and regulations, and the contributions to earnings by non-regulated businesses. In addition, expected results will be affected by the Company’s pending merger with MCN and the timing of the accretive effect of such merger. While the Company and Detroit Edison believe that estimates given accurately measure the expected outcome, actual results could vary materially due to the variables mentioned, as well as others.
Item 3 — Quantitative and Qualitative Disclosures About Market Risk.
The Company is subject to interest rate risk in conjunction with the anticipated issuance of long-term debt to be used to finance the merger with MCN. The Company’s exposure to interest rate risk arises from market fluctuations in interest rates until the date of the anticipated debt issuance. To limit the sensitivity to interest rate fluctuations, the Company has entered into a series of forward-starting interest rate swaps and Treasury locks and designated such instruments as hedges. See Note 5 for further discussion of these derivative financial instruments.
A sensitivity analysis model was used to calculate the fair values of the Company’s derivative financial instruments, utilizing applicable market interest rates in effect at March 31, 2001. The sensitivity analysis involved increasing and decreasing the market rates by a hypothetical 10% and calculating the resulting change in the fair values of the interest rate sensitive instruments. The favorable (unfavorable) changes in fair value are as follows:
Detroit Edison is subject to commodity price risk in conjunction with the anticipated purchase of electricity to meet reliability obligations during times of peak customer demand. Detroit Edison's exposure to commodity price risk arises from market fluctuations in commodity prices until the date of the anticipated purchase of electricity. To limit the sensitivity to commodity price fluctuations, Detroit Edison has entered into a series of forward electricity contracts and option contracts. See Note 5 for further discussion of these derivative instruments.
A sensitivity analysis model was used to calculate the fair values of Detroit Edison's derivative instruments, utilizing applicable commodity prices in effect at March 31, 2001. The sensitivity analysis involved increasing and decreasing the commodity prices by a hypothetical 10% and calculating the resulting change in the fair values of the commodity price sensitive instruments. The favorable (unfavorable) changes in fair value are as follows:
30
QUARTERLY REPORT ON FORM 10-Q FORDTE ENERGY COMPANY
Item 5 – Other Information.
David E. Meador was elected Senior Vice President and Chief Financial Officer of the Company and Detroit Edison, effective with the close of the pending merger with MCN. Mr. Meador was Controller, Mopar Parts Division, at Chrysler Corporation, an international automotive manufacturer, from November 1996 until February 1997. From 1986 to 1996, he held a variety of executive financial positions at Chrysler. Effective February 28, 1997, he was elected Vice President and effective March 29, 1997, he assumed the duties of Controller. Effective April 28, 1999, he was elected Vice President – Finance and Accounting and effective May 15, 2000, he was elected Senior Vice President and Treasurer.
Larry G. Garberding, current Executive Vice President and Chief Financial Officer, will continue as executive vice president and a member of the board of directors until his retirement at year-end.
Effective February 28, 2001, Daniel G. Brudzynski was elected Vice President and Controller, respectively, of the Company and Detroit Edison. Mr. Brudzynski was Manager, Product Development Finance and Manager, Forecasting Redesign and Implementation at Chrysler Corporation, an international automotive manufacturer, from 1995 until 1997. He joined Detroit Edison in 1997 as Assistant Controller. Effective April 28, 1999, he was elected Controller and Assistant Vice President.
31
Item 1 – Condensed Consolidated Financial Statements (Unaudited).
See pages 11 through 15.
See the Company’s and Detroit Edison’s “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which is incorporated herein by reference.
Item 1 – Legal Proceedings.
In April 2001, the Michigan Court of Appeals denied plaintiffs’ application for leave for an interlocutory hearing on the trial court’s denial of class certification in Coch, et al v. Detroit Edison (Circuit Court for Wayne County, Michigan). This matter, which alleges employment-related claims of discrimination, is proceeding as nine separate claims. Detroit Edison believes all claims are without merit.
On March 20, 2001, the International Transmission Company (ITC), currently a wholly owned subsidiary of Detroit Edison, along with other members of the Alliance Regional Transmission Organization (RTO), filed with FERC a settlement agreement with parties of the Midwest Independent System Operator (ISO). Both parties are developing proposals for a regional transmission organization in the Midwest. The settlement allows the business models for the Midwest ISO and the Alliance RTO to continue developing. The development of a single rate was agreed to and any eligible customer taking service under either the Midwest ISO Open Access Transmission Tariff (OATT) or the Alliance RTO OATT will be able to obtain service at this single rate. This rate will be in effect until at least December 31, 2004. The parties will also coordinate activities for transmission and transmission-related services, and plan to be operational by December 15, 2001.
The MPSC initiated a case in February 2001 to address the August 2000 request by ABATE to consider the consequences of the transfer of transmission assets from Detroit Edison to ITC. In March 2001, ABATE filed a motion to consolidate its request with the application that Detroit Edison must file by June 5, 2001, proposing to unbundle its commercial and industrial rates. Detroit Edison supported ABATE’s consolidation request, and the case has been adjourned until Detroit Edison files its case.
32
Item 6 – Exhibits and Reports on Form 8-K.
(a) Exhibits
33
34
35
36
37
38
39
40
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
41
42
Exhibit Index