10-Q 1 k86598e10vq.txt QUARTERLY REPORT FOR PERIOD ENDED JUNE 30, 2004 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 For the quarterly period ended June 30, 2004 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 of the Exchange Act). YES [ ] NO [X] 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. CONSUMERS FUNDING LLC FORM 10-Q QUARTERLY REPORT TO THE SECURITIES AND EXCHANGE COMMISSION FOR THE QUARTER ENDED June 30, 2004 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 operations 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 contain forward-looking statements as defined in Rule 3b-6 of the Securities Exchange Act of 1934, as amended and Rule 175 of the Securities Act of 1933, as amended. Consumers Funding's intention with the use of words such as "may," "could," "anticipates," "believes," "estimates," "expects," "intends," "plans," and other similar words is to identify forward-looking statements that involve risk and uncertainty. Consumers Funding designed this discussion of potential risks and uncertainties to highlight important factors that may impact its business and financial outlook. 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 the statements. 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 these statements. 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 purposes 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 Consumers Funding recording $5.3 million and $5.6 million of interest income for the three months ended June 30, 2004 and 2003, respectively. Interest expense associated with the securitization bonds totaled $5.3 million and $5.6 million for the three months ended June 30, 2004 and 2003, respectively. Interest income for the six months ended June 30, 2004 and 2003 totaled $10.8 million and $11.2 million, respectively. Interest expense for the six months ended June 30, 2004 and 2003 totaled $10.8 million and $11.2 million, respectively. Consumers, as servicer, began billing a Securitization Charge to electric customers beginning with its December 2001 billing cycle, totaling $.001427 per kilowatt-hour, per customer, per billing cycle. In the servicing agreement between Consumers Funding and Consumers, Consumers is required to remit its Securitization Charge collections to the trustee each business day. 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 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. 3 The initial request for annual adjustment was submitted on October 15, 2002 and approved by the MPSC on November 7, 2002. The new surcharge became effective with the December 2002 billing cycle and was $0.001328 per kilowatt-hour, per customer, per billing cycle. On October 16, 2003, Consumers submitted a request to the MPSC for its annual adjustment and it was approved on November 25, 2003. The approved adjustment revised the Securitization Charge to $.001299, effective with the December 2003 billing cycle. For the three months ended June 30, 2004, operating revenues totaled $5.6 million, a decrease of approximately $0.3 million compared to 2003. Included in the $5.6 million is $5.3 million of interest income and approximately $0.3 million of other operating revenue. The decrease in total operating revenues for the three-month period primarily reflects lower interest income associated with the reduction in the securitization receivable from Consumers Energy. For the three months ended June 30, 2004, Consumers Funding incurred $5.6 million of operating expenses, a decrease of approximately $0.3 million compared to 2003. Included in the $5.6 million is $5.3 million of interest expense and approximately $0.3 million of servicing, administration and other expenses. The decrease in operating expenses for the three-month period is primarily the result of reduced debt levels. For the six months ended June 30, 2004, operating revenues totaled $11.3 million, a decrease of approximately $0.5 million compared to 2003. Included in the $11.3 million is $10.8 million of interest income and approximately $0.5 of other operating revenue. The decrease in total operating revenues for the six-month period primarily reflects lower interest income associated with the reduction in the securitization receivable from Consumers Energy. For the six months ended June 30, 2004, Consumers Funding incurred $11.3 million of operating expenses, a decrease of approximately $0.5 million compared to 2003. Included in the $11.3 million is $10.8 million of interest expense and approximately $0.5 million of servicing, administration and other expenses. The decrease in operating expenses for the six-month period is primarily the result of reduced debt levels. 4 CONSUMERS FUNDING LLC STATEMENTS OF INCOME (UNAUDITED)

The accompanying notes are an integral part of these statements. 5 CONSUMERS FUNDING LLC BALANCE SHEETS

The accompanying notes are an integral part of these statements. 6 CONSUMERS FUNDING LLC STATEMENTS OF CASH FLOWS (UNAUDITED)

The accompanying notes are an integral part of these statements. 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 1. ORGANIZATION AND NATURE OF OPERATIONS Consumers Funding, a Delaware limited liability company, whose sole member is 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 purposes 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 from customers in accordance with an 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 arrangement 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 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' financial statements 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. 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 9 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 are 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 U.S. generally accepted accounting principles 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 June 30, 2004 and June 30, 2003, the General Subaccount totaled $11.5 million and $11.3 million, respectively. These funds are used by the trustee for the scheduled payments of principal and interest to bondholders and to pay expenses of Consumers Funding. 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 June 30, 2004, and June 30, 2003, the Reserve Subaccount totaled approximately $2.2 million and $2.9 million respectively. OVERCOLLATERALIZATION SUBACCOUNT: On each payment date, the trustee will deposit in the Overcollateralization Subaccount a predetermined, specified amount so that the account balance ultimately 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 June 30, 2004 and June 30, 2003, the Overcollateralization Subaccount totaled approximately $0.4 million and $0.3 million, respectively. 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 10 Funding, the trustee will draw on amounts in the Capital Subaccount to make those payments. At June 30, 2004 and June 30, 2003, the Capital Subaccount contained a balance of $2.4 million and $2.3 million, respectively. 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. As of June 30, 2004, Consumers Funding has retired all of the class A-1 securitization bonds and $30.4 million of the class A-2 securitization bonds in accordance with the bond amortization schedule. Scheduled maturities and interest rates for the remaining securitization bonds at June 30, 2004 are as follows:

The amortization schedule for the securitization bonds provided 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 during the remainder of 2004, the next five calendar years, and thereafter (in thousands).

As scheduled, on July 20, 2004, $6.2 million of securitization bonds were retired. 11 4. FAIR VALUE OF FINANCIAL INSTRUMENTS Restricted cash is on deposit with the trustee and, by definition, is carried at its fair value. At June 30, 2004, and 2003, Consumers Funding had a financial asset (representing its securitization receivable from Consumers) of approximately $402 million and $430 million, respectively, and financial liabilities (representing the securitization bonds) with a cost basis of approximately $412 million and $440 million respectively. 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. 5. SIGNIFICANT AGREEMENTS AND RELATED PARTY TRANSACTIONS Consumers Funding has a securitization receivable with Consumers in the amount of approximately $402 million and $430 million, as of June 30, 2004 and June 30, 2003, respectively. Accordingly, Consumers Funding recognized interest income totaling $5.3 million and $5.6 million for the three months ended June 30, 2004 and 2003, respectively. In addition, Consumers Funding recognized other operating revenue from Consumers totaling approximately $0.3 million for the three months ended June 30, 2004, and approximately $0.3 million for the comparable period in 2003. For the six months ended June 30, 2004, and 2003, Consumers Funding recognized interest income totaling $10.8 and $11.2 million, respectively. In addition, Consumers Funding recognized other operating income from Consumers totaling approximately $0.6 for the six months ended June 30, 2004, and approximately $0.6 million for the comparable time period in 2003. 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 months ended June 30, 2004 and 2003, Consumers Funding has recorded total expenses related to these fees of approximately $0.3 million. For the six months ended June 30, 2004, Consumers Funding has recorded total expenses associated with these fees of approximately $0.6 million, and approximately $0.6 million for the comparable time period in 2003. 12 CONSUMERS FUNDING LLC PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 5. 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 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK None. 13 SIGNATURES 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. CONSUMERS FUNDING LLC By: /s/ Laura L. Mountcastle Date: August 6, 2004 --------------------------------- Laura L. Mountcastle President, Chief Executive Officer, Chief Financial Officer and Treasurer By: /s/ Glenn P. Barba Date: August 6, 2004 -------------------------------------- Glenn P. Barba Vice President, Controller and Chief Accounting Officer 14 INDEX TO EXHIBITS

CONSUMERS FUNDING LLC 10-Q