10-Q 1 k72366e10vq.txt QUARTERLY REPORT FOR PERIOD END SEPTEMBER 30, 2002 United States Securities and Exchange Commission Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the quarter ended September 30, 2002 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from __________ to __________

Securities registered pursuant to Section 12 (b) of the Act: None. Securities registered pursuant to Section 12 (g) of the Act: None. Indicate by check mark whether the Registrant (1) has 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 Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X]* NO [ ] Consumers Funding LLC meets the conditions set forth in General Instruction H(1)(a) and (b) of the 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 Parts III, Items 2, 3 and 4 have been omitted. The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant: None. Documents incorporated by reference: Not applicable. * 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. 1 CONSUMERS FUNDING, LLC FORM 10-Q QUARTERLY REPORT TO THE SECURITIES AND EXCHANGE COMMISSION FOR THE QUARTER ENDED SEPTEMBER 30, 2002 TABLE OF CONTENTS

2 CONSUMERS FUNDING LLC MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATION This Management's Narrative Analysis (MNA) of the results of operation of Consumers Funding LLC (Consumers Funding) is an abbreviated format pursuant to Instruction H of Form 10-Q. The MNA refers to Consumers Funding's Notes to Financial Statements and should be read in conjunction with such Financial Statements and Notes. This Form 10-Q and other written and oral statements from Consumers Funding may contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to various factors that could cause Consumers Funding's actual results to differ materially from the results anticipated in such statements. Consumers Funding 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. Consumers Funding does, however, discuss certain risk factors, uncertainties and assumptions in this MNA, and in various public filings it periodically makes with the Securities and Exchange Commission. Consumers Funding designed this discussion of potential risks and uncertainties, which is by no means comprehensive, to highlight important factors that may impact Consumers Funding's outlook. Consumers Funding, a Delaware limited liability company, whose sole member is Consumers Energy Company (Consumers), was formed by Consumers on October 11, 2000. Consumers is an electric and gas utility and is a wholly owned subsidiary of CMS Energy Corporation. Consumers Funding was organized for the sole purpose of purchasing and owning securitization property (see below), issuing securitization bonds, pledging its interest in securitization property and other collateral to the trustee to collateralize the securitization bonds, and performing activities that are necessary, suitable or convenient to accomplish these purposes. On November 8, 2001, Consumers Funding issued $468.6 million of securitization bonds. Consumers Funding used the proceeds from the securitization bond issuance to purchase securitization property from Consumers. As discussed in Note 1 to the Financial Statements, securitization property represents the irrevocable right of Consumers to collect a nonbypassable Securitization Charge (Securitization Charge) from customers in accordance with a financing order issued by the Michigan Public Service Commission (MPSC). The securitization property, which is classified as a securitization receivable, along with earnings on cash deposited with the trustee, resulted in the recording of $5.7 million of interest income for the three months ended September 30, 2002. Interest expense associated with the securitization bonds totaled $5.7 million for the same three-month period. For the nine months ended September 30, 2002, interest income totaled $17.2 million and interest expense totaled $17.2 million. Consumers, as servicer, began billing a Securitization Charge to electric customers beginning with its December 2001 billing cycle. The surcharge currently totals $.001427 per kilowatt-hour. In the servicing agreement between Consumers Funding and Consumers, Consumers is required to remit its Securitization Charge collections to the trustee each business day. Through September 30, 2002, Consumers had remitted approximately $40.4 million of Securitization Charge collections to the trustee, which was sufficient for the first and second payments of securitization bond principal, interest and related expenses, which were completed July 20, 2002, in the amount of $25.4 million. An additional payment was made on October 20, 2002, in the amount of $13.4 million which was recorded in the fourth quarter. Under the servicing agreement, Consumers is required to request periodic Securitization Charge adjustments from the MPSC. The request for an adjustment must be submitted at least 45 days before the 3 adjustment may take place. Adjustments will be made annually, and then quarterly beginning approximately one year before the expected final payment date of the last maturing class of securitization bonds. Adjustments to the Securitization Charge are based, among other things, on actual Securitization Charge revenue collections and updated assumptions by Consumers as to projected future deliveries of electricity to customers. A request for adjustment was submitted on October 15, 2002 and approval by the MPSC was granted on November 7, 2002. The new surcharge becomes effective with the December 2002 billing cycle and will be $0.001328 per kilowatt-hour. CHANGE IN AUDITORS On April 22, 2002 the Board of Directors of Consumers, upon the recommendation of the Audit Committee of the Board, voted to discontinue using Arthur Andersen, LLP to audit Consumers' financial statements, including the financial statements for Consumers Funding, for the year ending December 31, 2002. Consumers Funding previously retained Arthur Andersen to review its financial statements for the quarter ended March 31, 2002. On May 23, 2002, Consumers' Board of Directors engaged Ernst & Young to audit its financial statements, including the financial statements of Consumers Funding, for the year ending December 31, 2002. Ernst & Young has hired some of Arthur Andersen's Detroit office employees, including some of the former auditors from the Consumers Funding audit engagement team. As a result of certain financial reporting issues surrounding round trip trading transactions at CMS MST, Arthur Andersen notified CMS Energy that Arthur Andersen's historical opinions on CMS Energy's financial statements for the fiscal years ended December 31, 2001 and December 31, 2000 cannot be relied upon. However, this is not the case for Consumers Funding. Arthur Andersen's reports on Consumers Funding's financial statements for the fiscal year ended December 31, 2001 contained no adverse or disclaimer of opinion. Nor were the reports qualified or modified regarding uncertainty, audit scope or accounting principles. During the fiscal year ended December 31, 2001 and through the date of their opinion for the quarter ended March 31, 2002, Consumers Funding and Arthur Andersen did not disagree on any matter of accounting principle or practice, financial statement disclosure, or auditing scope or procedure. If Arthur Andersen and Consumers Funding had disagreed on these matters and they were not resolved to Arthur Andersen's satisfaction, Arthur Andersen would have noted this in its report on Consumers Funding's financial statements. During Consumers Funding's most recent fiscal year ended December 31, 2001 and the subsequent interim period through June 10, 2002, Consumers did not consult with Ernst & Young regarding any matter or event identified by SEC laws and regulations. However, as a result of certain financial reporting issues surrounding "round trip" trading transactions at CMS MST, 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, and includes audit work at Consumers Funding for the year ended 2001. In light of the foregoing circumstances, we cannot issue a certification to accompany the Report pursuant to 18 U.S.C 1350, as adopted pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. 4 CONSUMERS FUNDING LLC STATEMENTS OF INCOME (UNAUDITED)

The accompanying notes are an integral part of these statements. 5 CONSUMERS FUNDING LLC STATEMENTS OF CASH FLOWS (UNAUDITED)

The accompanying notes are an integral part of these statements. 6 CONSUMERS FUNDING LLC BALANCE SHEETS

The accompanying notes are an integral part of these Balance Sheets. 7 CONSUMERS FUNDING LLC STATEMENTS OF MEMBER'S EQUITY (UNAUDITED)

The accompanying notes are an integral part of these statements. 8 CONSUMERS FUNDING LLC NOTES TO FINANCIAL STATEMENTS (UNAUDITED) These interim Financial Statements have been prepared by Consumers Funding LLC (Consumers Funding) In management's opinion, the unaudited information contained in this report reflects all adjustments necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. These Notes to Financial Statements and the related Financial Statements should be read in conjunction with the Financial Statements and Notes to Financial Statements contained in Consumers Funding's Form 10-K for the year ended December 31, 2001, which includes the Report of Independent Public Accountants. 1. ORGANIZATION AND NATURE OF OPERATIONS Consumers Funding, a Delaware limited liability company, whose sole member is Consumers Energy Company (Consumers), was formed by Consumers on October 11, 2000. On January 22, 2001, Consumers completed a $1,000 equity contribution to Consumers Funding. Consumers is an electric and gas utility and is a wholly owned subsidiary of CMS Energy Corporation. Consumers Funding was organized for the sole purpose of purchasing and owning securitization property (see below), issuing securitization bonds, pledging its interest in securitization property and other collateral to the trustee to collateralize the securitization bonds, and performing activities that are necessary, suitable or convenient to accomplish these purposes. Securitization property represents the irrevocable right of Consumers, or its successor or assignee, to collect a nonbypassable Securitization Charge (Securitization Charge) from customers in accordance with the October 24, 2000 MPSC Financing Order (MPSC Financing Order). As modified by rehearing on January 4, 2001, the MPSC Financing Order authorizes the Securitization Charge to be sufficient to recover $468.6 million aggregate principal amount of securitization bonds, plus an amount sufficient to provide for any credit enhancement, to fund any reserves and to pay interest, redemption premiums, if any, servicing fees and other expenses relating to the securitization bonds. For financial reporting purposes, the purchase of the securitization property has been accounted for as a financing activity by Consumers Funding in the amount of $468.6 million. Accordingly, Consumers Funding has classified the purchase of securitization property as a securitization receivable from Consumers in the financial statements. Consumers Funding's organizational documents require it to operate in a manner so that it would not be consolidated into the bankruptcy estate of Consumers in the event Consumers becomes subject to a bankruptcy proceeding. Consumers and Consumers Funding have agreed that in the event of Consumers' bankruptcy, the parties will treat the transfer of the securitization property to Consumers Funding as a true sale. The securitization bonds are treated as debt obligations of Consumers Funding. For financial reporting, Federal income tax and State of Michigan income and franchise tax purposes, the transfer of securitization property to Consumers Funding is treated as part of a financing arrangement and not as a sale. Furthermore, the results of operations of Consumers Funding are consolidated with Consumers for financial and income tax reporting purposes. Consumers Funding is legally separate from Consumers. The assets and income of Consumers Funding, including without limitation, the securitization property, are not available to creditors of Consumers or CMS Energy Corporation. 9 On November 8, 2001, Consumers Funding issued $468.6 million of securitization bonds, Series 2001-1, in six different classes. Consumers Funding used the proceeds to fund the purchase of securitization property from Consumers. The principal amount of the securitization bonds, interest, fees and required overcollateralization for the securitization bonds, will be recovered through Securitization Charges collected from electric retail customers taking delivery of electricity from Consumers or its successor based on MPSC approved rate schedules and as permitted by contracts between Consumers and certain specific customers. Consumers, as servicer, collects Securitization Charges from its customers and deposits collections daily into the General Subaccount held by the trustee (The Bank of New York). The trustee is required to use these funds to make principal and interest payments on the securitization bonds and to pay certain fees and expenses of Consumers Funding. Consumers Funding has no employees. Under the servicing agreement with Consumers, Consumers is required to manage and administer the securitization property and to collect Securitization Charges on Consumers Funding's behalf. Consumers receives a monthly servicing fee of one twelfth times 0.25 percent of the principal amount of securitization bonds outstanding as of the payment date. The servicing agreement also requires Consumers to file annual Securitization Charge adjustment requests with the MPSC. These Securitization Charge adjustment requests will be based on actual Securitization Charge revenue collections and Consumers' updated assumptions as to projected future deliveries of electricity to customers, expected delinquencies and write-offs, future payments and expenses relating to securitization property and the securitization bonds, any deficiency in the Capital or Overcollateralization Subaccounts and any amounts on deposit in the Reserve Subaccount. 2. SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions. These estimates and assumptions affect the reported amount of revenues, expenses, assets, and liabilities and disclosure of contingencies. Actual results could differ from these estimates. INCOME TAXES Consumers Funding has elected not to be taxed as a corporation for Federal income tax purposes. Consumers Funding is treated as a division of Consumers, and accordingly, will not be treated as a separate taxable entity. RESTRICTED CASH The trustee has established the following subaccounts for the securitization bonds. GENERAL SUBACCOUNT: The General Subaccount is comprised of Securitization Charge collections and interest earned from short-term investments. These amounts accumulate until the trustee pays principal, interest, service and administration fees and other expenses. At September 30, 2002, the General Subaccount totaled $14.6 million. These funds are used by the trustee for the scheduled payments of principal and interest to bondholders and to pay expenses of Consumers Funding. 10 RESERVE SUBACCOUNT: The Reserve Subaccount includes any Securitization Charge collections in excess of the amounts required in the General, Overcollateralization and Capital Subaccounts. The trustee will draw funds from this subaccount if the General Subaccount is insufficient to make scheduled payments. At September 30, 2002, the Reserve Subaccount totaled approximately $463,000. OVERCOLLATERALIZATION SUBACCOUNT: On each payment date, the trustee will deposit in the Overcollateralization Subaccount a predetermined, specified amount so that the account balance reaches the required amount of $2.3 million, which represents 0.5 percent of the initial outstanding principal balance of the securitization bonds. If amounts available in the General Subaccount and the Reserve Subaccount are not sufficient on any payment date to make scheduled payments to the securitization bondholders and to pay the required expenses, fees and charges, the trustee will draw on the amounts in the Overcollateralization Subaccount to make those payments. At September 30, 2002, the Overcollateralization Subaccount totaled approximately $126,000. CAPITAL SUBACCOUNT: The Capital Subaccount was established on November 8, 2001. Consumers deposited $2.3 million into the Capital Subaccount, an amount equal to 0.5 percent of the initial principal balance of the securitization bonds. If amounts available in the General Subaccount, the Reserve Subaccount and the Overcollateralization Subaccount are not sufficient on any payment date to make scheduled payments of principal and interest to the securitization bondholders and to pay the expenses, fees and charges of Consumers Funding, the trustee will draw on amounts in the Capital Subaccount to make those payments. At September 30, 2002, the Capital Subaccount contained a balance of $2.3 million. 3. LONG-TERM DEBT On November 8, 2001, Consumers Funding issued $468.6 million of securitization bonds, in six classes at interest rates ranging from 2.59 percent to 5.76 percent. Consumers Funding used the proceeds from the securitization bonds to purchase securitization property from Consumers. 11 Scheduled maturities and interest rates for the securitization bonds at September 30, 2002 are as follows:

Current maturities are based on the expected final payment dates indicated above. The amortization schedule for the securitization bonds provides for an initial payment to bondholders on July 20, 2002 and then quarterly thereafter. The following table provides the expected principal retirement of the securitization bonds over the next five calendar years (in thousands).

As scheduled, on July 20, and October 20, 2002, approximately $8.3 million and $7.3 million of the Class A-1 securitization bonds were retired, respectively. 4. FAIR VALUE OF FINANCIAL INSTRUMENTS Restricted cash is on deposit with the trustee and, by definition, is carried at its fair value. At September 30, 2002, Consumers Funding had a financial asset (representing its securitization receivable from Consumers) of approximately $450 million, and financial liabilities (representing the securitization bonds) with a cost basis of approximately $460 million. The securitization receivable and securitization bonds are carried at cost, which approximates fair value. Fair value is estimated based on quoted market prices, or, in the absence of specific market prices, on quoted market prices of similar investments or other valuation techniques. 12 5. SIGNIFICANT AGREEMENTS AND RELATED PARTY TRANSACTIONS Consumers Funding has a securitization receivable with Consumers Energy in the amount of approximately $450 million as of September 30, 2002. Accordingly, Consumers Funding recognized interest income totaling $6 million and $17 million for the three and nine-month periods ended September 30, 2002, respectively. In addition, Consumers Funding recognized other operating income from Consumers Energy totaling $308,000 and $1,055,000 for the three and nine-month periods ended September 30, 2002, respectively. Under the servicing and administration agreements, Consumers is required to manage and administer the securitization property of Consumers Funding, and to collect the Securitization Charge on Consumers Funding's behalf. Consumers Funding pays Consumers a servicing fee (see Note 1) and an annual administrative fee. These fees are payable to Consumers on each scheduled quarterly payment date beginning July 20, 2002. For the three-month and nine month periods ending September 30, 2002, Consumers Funding has recorded total expenses associated with these fees of $308,000 and $1,055,000, respectively. 13 CONSUMERS FUNDING LLC PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS NONE ITEM 4. OTHER INFORMATION NONE ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. See Exhibit Index that appears following the Signature page to this report. (b) Reports on Form 8-K: None 14 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CONSUMERS FUNDING LLC By: /s/ Laura L. Mountcastle ---------------------------------------- Laura L. Mountcastle President, Chief Executive Officer, Chief Financial Officer and Treasurer Pursuant to the requirements of the Securities Exchange Act of 1934, this Quarterly Report has been signed below by the following persons on behalf of Consumers Funding LLC and in the capacities and on the 14th day of November 2002.

CERTIFICATIONS The Certifications of the principal executive officer and principal financial officer will not be provided as a result of the ongoing re-auditing of CMS Energy's financial statements for each of the fiscal years ended December 31, 2001 and December 2000, which includes audit work at Consumers Funding LLC for the year ended December 31, 2001. See Management's Narrative "Analysis of Results of Operation- Change in Auditors." These certifications will be filed by amendment to this Form 10-Q when the reaudit is complete. 15 INDEX TO EXHIBITS

CONSUMERS FUNDING LLC 10-Q