================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission Registrant; State of Incorporation; IRS Employer
File Number Address; and Telephone Number Identification No.
- ----------- ------------------------------------------ ------------------
1-9513 CMS ENERGY CORPORATION 38-2726431
(A Michigan Corporation)
One Energy Plaza, Jackson, Michigan 49201
(517) 788-0550
1-5611 CONSUMERS ENERGY COMPANY 38-0442310
(A Michigan Corporation)
One Energy Plaza, Jackson, Michigan 49201
(517) 788-0550
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 [ ]
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
CMS ENERGY CORPORATION: Large accelerated filer [X] Accelerated filer [ ]
Non-Accelerated filer [ ]
CONSUMERS ENERGY COMPANY: Large accelerated filer [ ] Accelerated filer [ ]
Non-Accelerated filer [X]
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
CMS ENERGY CORPORATION: Yes [ ] No [X]
CONSUMERS ENERGY COMPANY: Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock at August 1, 2006:
CMS ENERGY CORPORATION:
CMS Energy Common Stock, $.01 par value 221,587,738
CONSUMERS ENERGY COMPANY, $10 par value,
privately held by CMS Energy Corporation 84,108,789
================================================================================
CMS ENERGY CORPORATION
AND
CONSUMERS ENERGY COMPANY
QUARTERLY REPORTS ON FORM 10-Q TO THE
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FOR THE QUARTER ENDED JUNE 30, 2006
This combined Form 10-Q is separately filed by CMS Energy Corporation and
Consumers Energy Company. Information contained herein relating to each
individual registrant is filed by such registrant on its own behalf.
Accordingly, except for its subsidiaries, Consumers Energy Company makes no
representation as to information relating to any other companies affiliated with
CMS Energy Corporation.
TABLE OF CONTENTS
Page
--------
Glossary.................................................................................................. 3
PART I: FINANCIAL INFORMATION
CMS Energy Corporation
Management's Discussion and Analysis
Executive Overview.............................................................................. CMS - 1
Forward-Looking Statements and Information...................................................... CMS - 2
Results of Operations........................................................................... CMS - 5
Critical Accounting Policies.................................................................... CMS - 13
Capital Resources and Liquidity................................................................. CMS - 18
Outlook......................................................................................... CMS - 20
Implementation of New Accounting Standards...................................................... CMS - 30
New Accounting Standards Not Yet Effective...................................................... CMS - 30
Consolidated Financial Statements
Consolidated Statements of Income .............................................................. CMS - 32
Consolidated Statements of Cash Flows........................................................... CMS - 35
Consolidated Balance Sheets..................................................................... CMS - 36
Consolidated Statements of Common Stockholders' Equity.......................................... CMS - 38
Condensed Notes to Consolidated Financial Statements (Unaudited):
1. Corporate Structure and Accounting Policies................................................ CMS - 39
2. Contingencies.............................................................................. CMS - 41
3. Financings and Capitalization.............................................................. CMS - 59
4. Earnings Per Share......................................................................... CMS - 61
5. Financial and Derivative Instruments....................................................... CMS - 63
6. Retirement Benefits........................................................................ CMS - 70
7. Asset Retirement Obligations............................................................... CMS - 72
8. Executive Incentive Compensation........................................................... CMS - 73
9. Equity Method Investments.................................................................. CMS - 75
10. Reportable Segments ....................................................................... CMS - 76
1
TABLE OF CONTENTS
(CONTINUED)
Page
--------
Consumers Energy Company
Management's Discussion and Analysis
Executive Overview.............................................................................. CE - 1
Forward-Looking Statements and Information...................................................... CE - 2
Results of Operations........................................................................... CE - 5
Critical Accounting Policies.................................................................... CE - 10
Capital Resources and Liquidity................................................................. CE - 14
Outlook......................................................................................... CE - 16
Implementation of New Accounting Standards...................................................... CE - 24
New Accounting Standards Not Yet Effective...................................................... CE - 25
Consolidated Financial Statements
Consolidated Statements of Income............................................................... CE - 26
Consolidated Statements of Cash Flows........................................................... CE - 27
Consolidated Balance Sheets..................................................................... CE - 28
Consolidated Statements of Common Stockholder's Equity.......................................... CE - 30
Condensed Notes to Consolidated Financial Statements (Unaudited):
1. Corporate Structure and Accounting Policies................................................. CE - 33
2. Contingencies............................................................................... CE - 35
3. Financings and Capitalization............................................................... CE - 48
4. Financial and Derivative Instruments........................................................ CE - 50
5. Retirement Benefits......................................................................... CE - 56
6. Asset Retirement Obligations................................................................ CE - 58
7. Executive Incentive Compensation............................................................ CE - 59
8. Reportable Segments......................................................................... CE - 62
Quantitative and Qualitative Disclosures about Market Risk................................................ CO - 1
Controls and Procedures................................................................................... CO - 1
PART II: OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... CO - 2
Item 1A. Risk Factors.............................................................................. CO - 5
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds............................... CO - 8
Item 3. Defaults Upon Senior Securities........................................................... CO - 8
Item 4. Submission of Matters to a Vote of Security Holders....................................... CO - 8
Item 5. Other Information......................................................................... CO - 9
Item 6. Exhibits.................................................................................. CO - 9
Signatures........................................................................................... CO - 11
2
GLOSSARY
Certain terms used in the text and financial statements are defined below
AFUDC............................. Allowance for Funds Used During Construction
ALJ............................... Administrative Law Judge
APB............................... Accounting Principles Board
APB Opinion No. 18................ APB Opinion No. 18, "The Equity Method of Accounting for Investments in
Common Stock"
ARO............................... Asset retirement obligation
Bay Harbor........................ a residential/commercial real estate area located near Petoskey,
Michigan. In 2002, CMS Energy sold its interest in Bay Harbor.
bcf............................... One billion cubic feet of gas
Big Rock.......................... Big Rock Point nuclear power plant, owned by Consumers
Board of Directors................ Board of Directors of CMS Energy
CEO............................... Chief Executive Officer
CFO............................... Chief Financial Officer
CFTC.............................. Commodity Futures Trading Commission
Clean Air Act..................... Federal Clean Air Act, as amended
CMS Energy........................ CMS Energy Corporation, the parent of Consumers and Enterprises
CMS Energy Common Stock or
common stock.................... Common stock of CMS Energy, par value $.01 per share
CMS ERM........................... CMS Energy Resource Management Company, formerly CMS MST, a subsidiary
of Enterprises
CMS Field Services................ CMS Field Services Inc., formerly a wholly owned subsidiary of CMS Gas
Transmission. The sale of this subsidiary closed in July 2003.
CMS Gas Transmission.............. CMS Gas Transmission Company, a subsidiary of Enterprises
CMS Midland....................... CMS Midland Inc., a subsidiary of Consumers that has a 49 percent
ownership interest in the MCV Partnership
CMS Midland Holdings Company...... CMS Midland Holdings Company, a subsidiary of Consumers that has a 46
percent ownership interest in First Midland Limited Partnership and a 35
percent lessor interest in the MCV Facility
CMS MST........................... CMS Marketing, Services and Trading Company, a wholly owned subsidiary
of Enterprises, whose name was changed to CMS ERM effective January 2004
CMS Oil and Gas................... CMS Oil and Gas Company, formerly a subsidiary of Enterprises
Consumers......................... Consumers Energy Company, a subsidiary of CMS Energy
CPEE.............................. Companhia Paulista de Energia Eletrica, a subsidiary of Enterprises
Customer Choice Act............... Customer Choice and Electricity Reliability Act, a Michigan statute
enacted in June 2000
DCCP.............................. Defined Company Contribution Plan
Detroit Edison.................... The Detroit Edison Company, a non-affiliated company
3
DIG............................... Dearborn Industrial Generation, LLC, an indirect wholly owned subsidiary of CMS
Energy
DOE............................... U.S. Department of Energy
DOJ............................... U.S. Department of Justice
Dow............................... The Dow Chemical Company, a non-affiliated company
EISP.............................. Executive Incentive Separation Plan
EITF.............................. Emerging Issues Task Force
EITF Issue No. 02-03.............. Issues Involved in Accounting for Derivative Contracts Held for Trading
Purposes and Contracts Involved in Energy Trading and Risk Management
Activities
Entergy........................... Entergy Corporation, a non-affiliated company
Enterprises....................... CMS Enterprises Company, a subsidiary of CMS Energy
EPA............................... U. S. Environmental Protection Agency
EPS............................... Earnings per share
ERISA............................. Employee Retirement Income Security Act
Exchange Act...................... Securities Exchange Act of 1934, as amended
FASB.............................. Financial Accounting Standards Board
FASB Interpretation No. 46(R)..... Revised FASB Interpretation No. 46, Consolidation of Variable Interest
Entities
FERC.............................. Federal Energy Regulatory Commission
FIN 47............................ FASB Interpretation No. 47, Accounting for Conditional Asset Retirement
Obligations
FIN 48............................ FASB Interpretation No. 48, Uncertainty in Income Taxes
FMB............................... First Mortgage Bonds
FMLP.............................. First Midland Limited Partnership, a partnership that holds a lessor
interest in the MCV Facility and an indirect subsidiary of Consumers
FTR............................... Financial transmission right
GAAP.............................. Generally Accepted Accounting Principles
GasAtacama........................ An integrated natural gas pipeline and electric generating plant located
in Argentina and Chile, which includes 702 miles of natural gas pipeline
and a 720 MW gross capacity power plant
GCR............................... Gas cost recovery
GVK............................... GVK Facility, a 250 MW gas fired power plant located in South Central
India, in which CMS Generation formerly held a 33 percent interest
ISFSI............................. Independent Spent Fuel Storage Installation
IRS............................... Internal Revenue Service
ITC............................... ITC Holdings Corporation
Jorf Lasfar....................... The 1,356 MW coal-fueled power plant in Morocco, jointly owned by CMS
Generation and ABB Energy Ventures, Inc.
Jubail............................ A 240 MW natural gas cogeneration power plant located in Saudi Arabia,
in which CMS Generation owns a 25 percent interest
4
kWh............................... Kilowatt-hour (a unit of power equal to one thousand watt hours)
Ludington......................... Ludington pumped storage plant, jointly owned by Consumers and Detroit
Edison
mcf............................... One thousand cubic feet of gas
MCV Facility...................... A natural gas-fueled, combined-cycle cogeneration facility operated by
the MCV Partnership
MCV Partnership................... Midland Cogeneration Venture Limited Partnership in which Consumers has
a 49 percent interest through CMS Midland
MCV PPA........................... The Power Purchase Agreement between Consumers and the MCV Partnership
with a 35-year term commencing in March 1990, as amended, and as
interpreted by the Settlement Agreement dated as of January 1, 1999
between the MCV Partnership and Consumers.
MD&A.............................. Management's Discussion and Analysis
MDEQ.............................. Michigan Department of Environmental Quality
METC.............................. Michigan Electric Transmission Company, LLC
Midwest Energy Market............. An energy market developed by the MISO to provide day-ahead and
real-time market information and centralized dispatch for market
participants
MISO.............................. Midwest Independent Transmission System Operator, Inc.
MMBtu............................. Million British Thermal Units
MPSC.............................. Michigan Public Service Commission
MRV............................... Market-Related Value of Plan assets
MSBT.............................. Michigan Single Business Tax
MW................................ Megawatt (a unit of power equal to one million watts)
NEIL.............................. Nuclear Electric Insurance Limited, an industry mutual insurance company
owned by member utility companies
Neyveli........................... CMS Generation Neyveli Ltd, a 250 MW lignite-fired power station located
in Neyveli, Tamil Nadu, India, in which CMS International Ventures holds
a 50 percent interest
NMC............................... Nuclear Management Company, LLC, formed in 1999 by Northern States Power
Company (now Xcel Energy Inc.), Alliant Energy, Wisconsin Electric Power
Company, and Wisconsin Public Service Company to operate and manage
nuclear generating facilities owned by the four utilities
NOL............................... Net Operating Loss
NRC............................... Nuclear Regulatory Commission
NYMEX............................. New York Mercantile Exchange
OPEB.............................. Postretirement benefit plans other than pensions for retired employees
Palisades......................... Palisades nuclear power plant, which is owned by Consumers
5
Panhandle......................... Panhandle Eastern Pipe Line Company, including its subsidiaries
Trunkline, Pan Gas Storage, Panhandle Storage, and Panhandle Holdings.
Panhandle was a wholly owned subsidiary of CMS Gas Transmission. The
sale of this subsidiary closed in June 2003.
PCB............................... Polychlorinated biphenyl
Pension Plan...................... The trusteed, non-contributory, defined benefit pension plan of
Panhandle, Consumers and CMS Energy
PJM RTO........................... Pennsylvania-Jersey-Maryland Regional Transmission Organization
Price-Anderson Act................ Price Anderson Act, enacted in 1957 as an amendment to the Atomic Energy
Act of 1954, as revised and extended over the years. This act
stipulates between nuclear licensees and the U.S. government the
insurance, financial responsibility, and legal liability for nuclear
accidents.
PSCR.............................. Power supply cost recovery
PURPA............................. Public Utility Regulatory Policies Act of 1978
RCP............................... Resource Conservation Plan
ROA............................... Retail Open Access
SAB No. 107....................... Staff Accounting Bulletin No. 107, Share-Based Payment
SEC............................... U.S. Securities and Exchange Commission
Section 10d(4) Regulatory Asset... Regulatory asset as described in Section 10d(4) of the Customer Choice
Act, as amended
Securitization.................... A financing method authorized by statute and approved by the MPSC which
allows a utility to sell its right to receive a portion of the rate
payments received from its customers for the repayment of Securitization
bonds issued by a special purpose entity affiliated with such utility
SENECA............................ Sistema Electrico del Estado Nueva Esparta C.S., a subsidiary of
Enterprises
SERP.............................. Supplemental Executive Retirement Plan
SFAS.............................. Statement of Financial Accounting Standards
SFAS No. 5........................ SFAS No. 5, "Accounting for Contingencies"
SFAS No. 71....................... SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation"
SFAS No. 87........................ SFAS No. 87, "Employers' Accounting for Pensions"
SFAS No. 88........................ SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits"
SFAS No. 98........................ SFAS No. 98, "Accounting for Leases"
SFAS No. 106....................... SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions"
SFAS No. 115....................... SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities"
SFAS No. 123(R).................... SFAS No. 123 (revised 2004), "Share-Based Payment"
SFAS No. 132(R).................... SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions and
Other Postretirement Benefits"
6
SFAS No. 133....................... SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities, as amended and interpreted"
SFAS No. 143....................... SFAS No. 143, "Accounting for Asset Retirement Obligations"
Shuweihat........................... A power and desalination plant of Emirates CMS Power Company, in which
CMS Generation holds a 20 percent interest
SLAP............................... Scudder Latin American Power Fund
Special Committee.................. A special committee of independent directors, established by CMS
Energy's Board of Directors, to investigate matters surrounding
round-trip trading
Stranded Costs..................... Costs incurred by utilities in order to serve their customers in a
regulated monopoly environment, which may not be recoverable in a
competitive environment because of customers leaving their systems and
ceasing to pay for their costs. These costs could include owned and
purchased generation and regulatory assets.
Superfund.......................... Comprehensive Environmental Response, Compensation and Liability Act
Takoradi........................... A 200 MW open-cycle combustion turbine crude oil power plant located in
Ghana, in which CMS Generation owns a 90 percent interest
Taweelah........................... Al Taweelah A2, a power and desalination plant of Emirates CMS Power
Company, in which CMS Generation holds a 40 percent interest
7
(This page intentionally left blank)
8
CMS Energy Corporation
CMS ENERGY CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
This MD&A is a consolidated report of CMS Energy and Consumers. The terms "we"
and "our" as used in this report refer to CMS Energy and its subsidiaries as a
consolidated entity, except where it is clear that such term means only CMS
Energy. This MD&A has been prepared in accordance with the instructions to Form
10-Q and Item 303 of Regulation S-K. This MD&A should be read in conjunction
with the MD&A contained in CMS Energy's Form 10-K/A Amendment No. 1 for the year
ended December 31, 2005.
EXECUTIVE OVERVIEW
CMS Energy is an energy company operating primarily in Michigan. We are the
parent holding company of Consumers and Enterprises. Consumers is a combination
electric and gas utility company serving Michigan's Lower Peninsula.
Enterprises, through various subsidiaries and equity investments, is engaged in
domestic and international diversified energy businesses including independent
power production, electric distribution, and natural gas transmission, storage,
and processing. We manage our businesses by the nature of services each provides
and operate principally in three business segments: electric utility, gas
utility, and enterprises.
We earn our revenue and generate cash from operations by providing electric and
natural gas utility services, electric power generation, and gas distribution,
transmission, storage, and processing. Our businesses are affected primarily by:
- weather, especially during the traditional heating and cooling
seasons,
- economic conditions, primarily in Michigan,
- regulation and regulatory issues that affect our electric and gas
utility operations,
- energy commodity prices,
- interest rates, and
- our debt credit rating.
During the past several years, our business strategy has involved improving our
balance sheet and maintaining focus on our core strength: utility operations and
service. Our primary focus with respect to our non-utility businesses has been
to optimize cash flow and further reduce our business risk and leverage through
the sale of selected assets, and to improve earnings and cash flow from the
businesses we retain.
In July 2006, we reached an agreement to sell the Palisades nuclear plant to
Entergy for $380 million. We also signed a 15-year power purchase agreement for
100 percent of the plant's current electric output. We are targeting to close
the sale in the first quarter of 2007. The sale will result in an immediate
improvement in our cash flow, a reduction in our nuclear operating and
decommissioning risk, and an improvement in our financial flexibility to support
other utility investments. We expect that a portion of the proceeds will benefit
our customers. We plan to use the cash that we retain from the sale to reduce
debt.
We are working to reduce Parent debt. During the first six months of 2006, we
retired $76 million of CMS Energy senior notes. We also invested $200 million in
Consumers, and Consumers extinguished, through a legal defeasance, $129 million
of 9 percent related party notes.
Working capital and cash flow continue to be a challenge for us. Natural gas
prices continue to be volatile and remain at high levels. Although our natural
gas purchases are recoverable from our utility customers, higher priced natural
gas stored as inventory requires additional liquidity due to the lag in cost
recovery.
CMS-1
CMS Energy Corporation
In addition to causing working capital issues for us, historically high natural
gas prices caused the MCV Partnership to reevaluate the economics of operating
the MCV Facility and to record an impairment charge in 2005. High gas prices
could result in a further impairment of our interest in the MCV Partnership.
Due to the impairment of the MCV Facility and operating losses from
mark-to-market adjustments on derivative instruments, the equity held by a
Consumers' subsidiary and the other minority interest owners in the MCV
Partnership has decreased significantly and is now negative. As the MCV
Partnership recognizes future losses, we will assume an additional 7 percent of
the MCV Partnership's negative equity, which is a portion of the limited
partners' negative equity, in addition to our proportionate share. In July 2006,
we reached an agreement to sell our interests in the MCV Partnership and the
FMLP. The sale is subject to various regulatory approvals including the MPSC. If
the sale closes by the end of 2006, as expected, it will have a $56 million
positive impact on our 2006 cash flow. The sale will reduce our exposure to
sustained high natural gas prices. We will use the proceeds to reduce utility
debt. If the sale is not completed, the viability of the MCV Facility is still
in question.
Going forward, our strategy will continue to focus on:
- managing cash flow issues,
- reducing parent company debt,
- maintaining and growing earnings,
- reducing risk, and
- positioning us to make investments that complement our strengths.
As we execute our strategy, we will need to overcome a sluggish Michigan economy
that has been further hampered by recent negative developments in Michigan's
automotive industry and limited growth in the non-automotive sectors of our
economy.
These negative effects will be offset somewhat by the reduction we are
experiencing in ROA load in our service territory. At June 30, 2006, alternative
electric suppliers were providing 311 MW of generation service to ROA customers.
This is 4 percent of our total distribution load and represents a decrease of 62
percent of ROA load compared to June 30, 2005. It is, however, difficult to
predict future ROA customer trends.
Finally, successful execution of our strategy will require continuing earnings
and cash flow contributions from our Enterprises businesses.
FORWARD-LOOKING STATEMENTS AND INFORMATION
This Form 10-Q and other written and oral statements that we make contain
forward-looking statements as defined in Rule 3b-6 under the Securities Exchange
Act of 1934, as amended, Rule 175 under the Securities Act of 1933, as amended,
and relevant legal decisions. Our intention with the use of such words as "may,"
"could," "anticipates," "believes," "estimates," "expects," "intends," "plans,"
and other similar words is to identify forward-looking statements that involve
risk and uncertainty. We designed this discussion of potential risks and
uncertainties to highlight important factors that may impact our business and
financial outlook. We have 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 our
actual results to differ materially from the results anticipated in these
statements. Such factors include our inability to predict and (or) control:
CMS-2
CMS Energy Corporation
- capital and financial market conditions, including the price of CMS
Energy Common Stock, and the effect of such market conditions on the
Pension Plan, interest rates, and access to the capital markets,
including availability of financing to CMS Energy, Consumers, or any
of their affiliates, and the energy industry,
- market perception of the energy industry, CMS Energy, Consumers, or
any of their affiliates,
- credit ratings of CMS Energy, Consumers, or any of their affiliates,
- currency fluctuations, transfer restrictions, and exchange controls,
- factors affecting utility and diversified energy operations, such as
unusual weather conditions, catastrophic weather-related damage,
unscheduled generation outages, maintenance or repairs,
environmental incidents, or electric transmission or gas pipeline
system constraints,
- international, national, regional, and local economic, competitive,
and regulatory policies, conditions and developments,
- adverse regulatory or legal decisions, including those related to
environmental laws and regulations, and potential environmental
remediation costs associated with such decisions, including but not
limited to Bay Harbor,
- potentially adverse regulatory treatment and (or) regulatory lag
concerning a number of significant questions presently before the
MPSC including:
- recovery of Clean Air Act costs and other environmental
and safety-related expenditures,
- power supply and natural gas supply costs when oil
prices and other fuel prices are increasing rapidly,
- timely recognition in rates of additional equity
investments in Consumers,
- adequate and timely recovery of additional electric and
gas rate-based investments,
- adequate and timely recovery of higher MISO energy
costs, and
- recovery of Stranded Costs incurred due to customers
choosing alternative energy suppliers,
- the impact of adverse natural gas prices on the MCV Partnership and
the FMLP investments, regulatory decisions that limit recovery of
capacity and fixed energy payments, and our ability to complete the
sale of our interests in the MCV Partnership and the FMLP,
- if Consumers is successful in exercising the regulatory out clause
of the MCV PPA, and if the sale of our interests in the MCV
Partnership and the FMLP is not completed, the negative impact on
the MCV Partnership's financial performance,
- if Consumers exercises its regulatory out rights causing the MCV
Partnership to terminate the MCV PPA, the effects on our ability to
purchase capacity to serve our customers and recover the cost of
these purchases,
- federal regulation of electric sales and transmission of
electricity, including periodic re-examination by federal regulators
of the market-based sales authorizations in wholesale power markets
without price restrictions,
CMS-3
CMS Energy Corporation
- energy markets, including availability of capacity and the timing
and extent of changes in commodity prices for oil, coal, natural
gas, natural gas liquids, electricity and certain related products
due to lower or higher demand, shortages, transportation problems,
or other developments,
- our ability to collect accounts receivable from our customers,
- potential for the Midwest Energy Market to develop into an active
energy market in the state of Michigan, which may lead us to account
for certain electric energy contracts as derivatives,
- the GAAP requirement that we utilize mark-to-market accounting on
certain energy commodity contracts and interest rate swaps, which
may have, in any given period, a significant positive or negative
effect on earnings, which could change dramatically or be eliminated
in subsequent periods and could add to earnings volatility,
- the effect on our electric utility of the direct and indirect
impacts of the continued economic downturn experienced by our
automotive and automotive parts manufacturing customers,
- potential disruption, expropriation or interruption of facilities or
operations due to accidents, war, terrorism, or changing political
conditions, and the ability to obtain or maintain insurance coverage
for such events,
- changes in available gas supplies or Argentine government
regulations that could restrict natural gas exports to our
GasAtacama electric generating plant and the operating and financial
effects of the restrictions,
- nuclear power plant performance, decommissioning, policies,
procedures, incidents, and regulation, including the availability of
spent nuclear fuel storage,
- technological developments in energy production, delivery, and
usage,
- achievement of capital expenditure and operating expense goals,
- changes in financial or regulatory accounting principles or
policies,
- changes in tax laws or new IRS interpretations of existing tax laws,
- outcome, cost, and other effects of legal and administrative
proceedings, settlements, investigations and claims, including
particularly claims, damages, and fines resulting from round-trip
trading and inaccurate commodity price reporting, including
investigations by the DOJ regarding round-trip trading and price
reporting,
- limitations on our ability to control the development or operation
of projects in which our subsidiaries have a minority interest,
- disruptions in the normal commercial insurance and surety bond
markets that may increase costs or reduce traditional insurance
coverage, particularly terrorism and sabotage insurance and
performance bonds,
CMS-4
CMS Energy Corporation
- the efficient sale of non-strategic or under-performing domestic or
international assets and discontinuation of certain operations,
- other business or investment considerations that may be disclosed
from time to time in CMS Energy's or Consumers' SEC filings, or in
other publicly issued written documents, and
- other uncertainties that are difficult to predict, many of which are
beyond our control.
For additional information regarding these and other uncertainties, see the
"Outlook" section included in this MD&A, Note 2, Contingencies, and Part II,
Item 1A. Risk Factors.
RESULTS OF OPERATIONS
CMS ENERGY CONSOLIDATED RESULTS OF OPERATIONS
<Table>
<Caption>
In Millions (except for
per share amounts)
--------------------------------
Three months ended June 30 2006 2005 Change
- -------------------------- -------- -------- --------
Net Income Available to Common Stockholders $ 72 $ 27 $ 45
Basic Earnings Per Share $ 0.33 $ 0.12 $ 0.21
Diluted Earnings Per Share $ 0.31 $ 0.12 $ 0.19
-------- -------- --------
Electric Utility $ 37 $ 46 $ (9)
Gas Utility (3) (3) -
Enterprises (Includes the MCV Partnership and the FMLP interests) 4 29 (25)
Corporate Interest and Other 32 (45) 77
Discontinued Operations 2 - 2
-------- -------- --------
Net Income Available to Common Stockholders $ 72 $ 27 $ 45
======== ======== ========
</Table>
For the three months ended June 30, 2006, net income available to common
stockholders was $72 million compared to $27 million for 2005. The increase
primarily reflects a $62 million impact from the resolution of an IRS income tax
audit. The audit resolution resulted in an increase to net income of $46 million
at our corporate interest and other segment, $8 million at Enterprises, $4
million at the electric utility, $3 million at the gas utility, and $1 million
in discontinued operations. Also contributing to the increase was an insurance
reimbursement for previously incurred legal expenses and a reduction in
corporate interest and other expenses. At our electric utility, the positive
effects of recent regulatory activities and the return to full service-rates of
customers previously using alternative energy suppliers were more than offset by
increased operating and maintenance expenses.
Specific changes to net income available to common stockholders for the three
months ended June 30, 2006 versus 2005 are:
CMS-5
CMS Energy Corporation
<Table>
<Caption>
In Millions
-----------
- - effects of the resolution of an IRS income tax audit on corporate and Enterprises income
taxes, primarily for the utilization or restoration of income tax credits, $ 54
- - additional decrease in corporate interest and other expenses due to a $15 million insurance
reimbursement received in June 2006 for previously incurred legal expenses, and an
additional $16 million reduction in other expenses primarily due to lower interest
expenses, lower legal expenses, and a decrease in general taxes, 31
- - effects from other Enterprises operations, including equity method investments, 5
- - absence of income tax benefits recorded in 2005 at Enterprises resulting from the
American Jobs Creation Act of 2004, (24)
- - mark-to-market losses recorded at CMS ERM in 2006, and (12)
- - decrease in net income from our electric utility primarily due to increased operating
expenses, primarily driven by a planned refueling outage at Palisades, and a reduction
in income from the regulatory return on capital expenditures, offset partially by
an increase in revenue from an electric rate order, the return to full service-rates
of customers previously using alternative energy suppliers, and the effects
of the resolution of an IRS income tax audit. (9)
-----
Total Change $ 45
=====
</Table>
<Table>
<Caption>
In Millions (except for
per share amounts)
---------------------------------
Six months ended June 30 2006 2005 Change
- ------------------------ -------- -------- --------
Net Income Available to Common Stockholders $ 45 $ 177 $ (132)
Basic Earnings Per Share $ 0.21 $ 0.86 $ (0.65)
Diluted Earnings Per Share $ 0.20 $ 0.82 $ (0.62)
-------- -------- --------
Electric Utility $ 66 $ 79 $ (13)
Gas Utility 34 55 (21)
Enterprises (Includes the MCV Partnership and
the FMLP interests) (45) 134 (179)
Corporate Interest and Other (13) (91) 78
Discontinued Operations 3 - 3
-------- -------- --------
Net Income Available to Common Stockholders $ 45 $ 177 $ (132)
======== ======== ========
</Table>
For the six months ended June 30, 2006, net income available to common
stockholders was $45 million compared to $177 million for 2005. The decrease
reflects the impact of gas prices on the market value of certain long-term gas
contracts and financial hedges. In order to reflect the market value of these
contracts and hedges, mark-to-market losses were recorded in 2006 to reverse
partially gains recorded on these assets in 2005. Further contributing to the
decrease in net income were increased operating expenses at Enterprises, and
decreases in net income at our electric and gas utilities. At our electric
utility, the positive effects of recent regulatory activities, and the return to
full service-rates of customers previously using alternative energy suppliers
were more than offset by increased operating and maintenance expenses. At our
gas utility, warmer weather and customer conservation efforts negatively
impacted results. These decreases were offset partially by the $62 million
impact from the resolution of an IRS income tax audit, an insurance
reimbursement for previously incurred legal expenses and additional reductions
in corporate interest and other expenses.
CMS-6
CMS Energy Corporation
Specific changes to net income available to common stockholders for the six
months ended June 30, 2006 versus 2005 are:
<Table>
<Caption>
In Millions
-----------
- - decrease in earnings from our ownership interest in the MCV Partnership primarily due to
mark-to-market losses on certain long-term gas contracts and financial hedges, which
reduced partially gains recorded in 2005, $ (122)
- - mark-to-market losses recorded at CMS ERM in 2006 versus gains recorded in 2005, (40)
- - absence of income tax benefits recorded in 2005 at Enterprises resulting from the
American Jobs Creation Act of 2004, (24)
- - decrease in net income from our gas utility primarily due to a reduction in deliveries
resulting from increased customer conservation efforts and warmer weather in 2006, (21)
- - decrease in net income from our electric utility primarily due to increased operating
expenses, and a reduction in income from the regulatory return on capital expenditures,
offset partially by an increase in revenue from an electric rate order, the return to
full service-rates of customers previously using alternative energy suppliers,
and the effects of the resolution of an IRS income tax audit, (13)
- - decrease in equity earnings from Enterprises investments, (3)
- - effects of the resolution of an IRS income tax audit on corporate and Enterprises income
taxes, primarily for the utilization or the restoration of income tax credits, 54
- - additional decrease in corporate interest and other expenses due to a $15 million insurance
reimbursement received in June 2006 for previously incurred legal expenses, and an
additional $17 million reduction in other expenses primarily due to lower interest
expenses, lower legal expenses, and a decrease in general taxes, and 32
- - effects from other Enterprises operations. 5
------
Total Change $ (132)
======
</Table>
CMS-7
CMS Energy Corporation
ELECTRIC UTILITY RESULTS OF OPERATIONS
<Table>
<Caption>
In Millions
--------------------
June 30 2006 2005 Change
- ------- ---- ---- ------
Three months ended $ 37 $ 46 $ (9)
Six months ended $ 66 $ 79 $ (13)
==== ==== ======
</Table>
<Table>
<Caption>
Three Months Ended Six Months Ended
Reasons for the change: June 30, 2006 vs. 2005 June 30, 2006 vs. 2005
- ----------------------- ---------------------- ----------------------
Electric deliveries $ 60 $ 119
Power supply costs and related revenue 3 12
Other operating expenses, other income, and
non-commodity revenue (71) (130)
Regulatory return on capital expenditures (8) (21)
General taxes (1) (1)
Interest charges (3) (2)
Income taxes 11 10
---------- ---------
Total change $ (9) $ (13)
========== ==========
</Table>
ELECTRIC DELIVERIES: For the three months ended June 30, 2006, electric
deliveries, excluding intersystem sales, decreased 0.2 billion kWh or 2.1
percent versus 2005. For the six months ended June 30, 2006, electric
deliveries, excluding intersystem sales, decreased 0.3 billion kWh or 1.8
percent versus 2005. The decrease in electric deliveries for both periods is
primarily due to weather. Despite lower electric deliveries, electric delivery
revenue increased primarily due to an electric rate order, increased surcharge
revenue, and the return to full-service rates of customers previously using
alternative energy suppliers.
In December 2005, the MPSC issued an order authorizing an annual rate increase
of $86 million for service rendered on and after January 11, 2006. As a result
of this order, electric delivery revenues increased $23 million for the three
months ended June 30, 2006 and $43 million for the six months ended June 30,
2006 versus the same periods in 2005.
Effective January 1, 2006, we started collecting a surcharge that the MPSC
authorized under Section 10d(4) of the Customer Choice Act. This surcharge
increased electric delivery revenue by $12 million for the three months ended
June 30, 2006 and $23 million for the six months ended June 30, 2006 versus the
same periods in 2005. In addition, on January 1, 2006, we began recovering
customer choice transition costs from our residential customers, thereby
increasing electric delivery revenue by another $2 million for the three months
ended June 30, 2006 and $5 million for the six months ended June 30, 2006 versus
the same periods in 2005.
The Customer Choice Act allows all of our electric customers to buy electric
generation service from us or from an alternative electric supplier. At June 30,
2006, alternative electric suppliers were providing 311 MW of generation service
to ROA customers. This amount represents a decrease of 62 percent of ROA load
compared to June 30, 2005. The return of former ROA customers to full-service
rates increased electric revenues $15 million for the three months ended June
30, 2006 and $28 million for the six months ended June 30, 2006 versus the same
periods in 2005.
CMS-8
CMS Energy Corporation
POWER SUPPLY COSTS AND RELATED REVENUE: In 2005, power supply costs exceeded
power supply revenue due to rate caps for our residential customers. Rate caps
for our residential customers expired on December 31, 2005. In 2006, the absence
of rate caps allows us to record power supply revenue to offset fully our power
supply costs. Our ability to recover fully these power supply costs resulted in
a $3 million increase to electric revenue for the three months ended June 30,
2006 and $12 million for the six months ended June 30, 2006 versus the same
periods in 2005.
OTHER OPERATING EXPENSES, OTHER INCOME AND NON-COMMODITY REVENUE: For the three
months ended June 30, 2006, other operating expenses increased $73 million,
other income increased $3 million, and non-commodity revenue decreased $1
million versus 2005. For the six months ended June 30, 2006, other operating
expenses increased $135 million, other income increased $8 million, and
non-commodity revenue decreased $3 million versus 2005.
The increase in other operating expenses reflects higher operating and
maintenance expense, customer service expense, depreciation and amortization
expense, and pension and benefit expense. Operating and maintenance expense
increased primarily due to costs related to a planned refueling outage at our
Palisades nuclear plant, and higher tree trimming and storm restoration costs.
Higher customer service expense reflects contributions, which started in January
2006 pursuant to a December 2005 MPSC order, to a fund that provides energy
assistance to low-income customers. Depreciation and amortization expense
increased due to higher plant in service and greater amortization of certain
regulatory assets. Pension and benefit expense reflects changes in actuarial
assumptions in 2005, and the latest collective bargaining agreement between the
Utility Workers Union of America and Consumers.
The increase in other income is primarily due to higher interest income and the
absence, in 2006, of expenses recorded in 2005 associated with the early
retirement of debt. The decrease in non-commodity revenue is primarily due to a
decrease in capital-related services provided to METC in 2006 versus 2005.
REGULATORY RETURN ON CAPITAL EXPENDITURES: The $8 million decrease for the three
months ended June 30, 2006 and $21 million decrease for the six months ended
June 30, 2006 versus the same periods in 2005, is due to lower income associated
with recording a return on capital expenditures in excess of our depreciation
base as allowed by the Customer Choice Act. In December 2005, the MPSC issued an
order that authorized us to recover $333 million of Section 10d(4) costs. The
order authorized recovery of a lower level of costs versus the level used to
record 2005 income.
GENERAL TAXES: For the three and six months ended June 30, 2006, the increase in
general taxes reflect higher MSBT expense, offset partially by lower property
tax expense.
INTEREST CHARGES: For the three and six months ended June 30, 2006, interest
charges increased primarily due to adjustments made in connection with an IRS
income tax audit. The settlement recognized that Consumers' taxable income for
prior years was higher than originally filed, resulting in the accrual of
interest on the additional tax liability for these prior years.
INCOME TAXES: For the three and six months ended June 30, 2006, income taxes
decreased versus 2005 primarily due to lower earnings by the electric utility
and the resolution of an IRS income tax audit, which resulted in a $4 million
income tax benefit primarily for the utilization or restoration of income tax
credits.
CMS-9
CMS Energy Corporation
GAS UTILITY RESULTS OF OPERATIONS
<Table>
<Caption>
In Millions
----------------------
June 30 2006 2005 Change
- ------- ---- ---- ------
Three months ended $ (3) $ (3) $ -
Six months ended $ 34 $ 55 $ (21)
==== ==== ======
</Table>
<Table>
<Caption>
Three Months Ended Six Months Ended
Reasons for the change: June 30, 2006 vs. 2005 June 30, 2006 vs. 2005
- ----------------------- ---------------------- ----------------------
Gas deliveries $ (5) $ (36)
Gas wholesale and retail services, other gas
revenues and other income 6 11
Operation and maintenance 1 (2)
General taxes and depreciation (2) (5)
Interest charges (3) (3)
Income taxes 3 14
-------- --------
Total change $ - $ (21)
======== ========
GAS DELIVERIES: For the three months ended June 30, 2006, gas deliveries,
including miscellaneous transportation to end-use customers, decreased 6 bcf or
12 percent. The decrease in gas deliveries is due to increased customer
conservation efforts in response to higher gas prices and warmer than normal
weather.
For the six months ended June 30, 2006, gas deliveries, including miscellaneous
transportation to end-use customers, decreased 28 bcf or 14.4 percent. The
decrease in gas deliveries is primarily due to warmer weather in 2006 versus
2005 and increased customer conservation efforts in response to higher gas
prices. Average temperatures during the six-month period in 2006 were 4.3
percent warmer than 2005.
GAS WHOLESALE AND RETAIL SERVICES, OTHER GAS REVENUES AND OTHER INCOME: For the
three and six months ended June 30, 2006, the increase is related primarily to
increased gas wholesale and retail services revenue.
OPERATION AND MAINTENANCE: For the three months ended June 30, 2006, operation
and maintenance expenses decreased versus 2005 primarily due to a reduction in
our injuries and damages expense, offset partially by higher pension and benefit
expense and customer service expense. Pension and benefit expense reflects
changes in actuarial assumptions, and the latest collective bargaining agreement
between the Utility Workers Union of America and Consumers. Customer service
expense increased primarily due to higher uncollectible accounts expense.
For the six months ended June 30, 2006, operation and maintenance expenses
increased versus 2005 primarily due to higher pension and benefit expense and
customer service expense. Pension and benefit expense reflects changes in
actuarial assumptions, and the latest collective bargaining agreement between
the Utility Workers Union of America and Consumers. Customer service expense
increased primarily due to higher uncollectible accounts expense.
GENERAL TAXES AND DEPRECIATION: For the three and six months ended June 30,
2006, depreciation expense increased versus 2005 primarily due to higher plant
in service. The increase in general taxes reflects higher MSBT expense,
partially offset by lower property tax expense.
CMS-10
CMS Energy Corporation
INTEREST CHARGES: For the three and six months ended June 30, 2006, interest
charges increased primarily due to adjustments made in connection with an IRS
income tax audit.
INCOME TAXES: For the three and six months ended June 30, 2006, income taxes
decreased versus 2005 primarily due to lower earnings by the gas utility and the
resolution of an IRS income tax audit, which resulted in a $3 million income tax
benefit primarily for the utilization or restoration of income tax credits.
ENTERPRISES RESULTS OF OPERATIONS
<Table>
<Caption>
In Millions
-------------------------
June 30 2006 2005 Change
- ------- ------ ------ ------
Three months ended $ 4 $ 29 $ (25)
Six months ended $ (45) $ 134 $ (179)
====== ====== ======
</Table>
<Table>
<Caption>
Three Months Ended Six Months Ended
Reasons for the change: June 30, 2006 vs. 2005 June 30, 2006 vs. 2005
- ----------------------- ---------------------- ----------------------
Operating revenues $ 84 $ 121
Cost of gas and purchased power (95) (197)
Fuel costs mark-to-market at the MCV Partnership (3) (368)
Earnings from equity method investees (14) (9)
Gain on sale of assets (2) (5)
Operation and maintenance - (17)
General taxes, depreciation, and other income, net 15 47
Fixed charges 14 3
Minority interest (14) 167
Income taxes (10) 79
-------- --------
Total change $ (25) $ (179)
======== ========
</Table>
OPERATING REVENUES: For the three and six months ended June 30, 2006, operating
revenues increased versus 2005 due to the impact of increased production at our
Takoradi plant, which is contracted to provide power when local hydro-generating
plants are unable to meet demand. Also contributing to the increase was
increased customer demand at our South American facilities and increased
third-party gas sales at CMS ERM. These increases were offset partially by
mark-to-market losses on gas contracts at CMS ERM compared to gains in 2005.
COST OF GAS AND PURCHASED POWER: For the three and six months ended June 30,
2006, cost of gas and purchased power increased versus 2005. The increase in
expense is primarily due to increased fuel costs related to increased production
at Takoradi. Also contributing to the increase are higher gas prices and an
increase in fuel and power purchases in order to meet customer demand, primarily
in South America.
FUEL COSTS MARK-TO-MARKET AT THE MCV PARTNERSHIP: For the three months ended
June 30, 2006, the fuel costs mark-to-market adjustments of certain long-term
gas contracts and financial hedges at the MCV Partnership decreased operating
earnings due to decreased gas prices versus smaller losses in 2005.
For the six months ended June 30, 2006, the fuel costs mark-to-market
adjustments at the MCV Partnership
CMS-11
CMS Energy Corporation
decreased operating earnings due to the impact of gas prices on the market value
of certain long-term gas contracts and financial hedges. In order to reflect the
market value of these contracts and hedges, mark-to-market losses were recorded
in 2006 to reduce partially gains recorded on these assets in 2005. The 2005
gains were primarily due to the marking-to-market of certain long term gas
contracts and financial hedges that, as a result of the implementation of the
RCP, no longer qualified as normal purchases or cash flow hedges.
EARNINGS FROM EQUITY METHOD INVESTEES: For the three months ended June 30, 2006,
equity earnings decreased by $14 million versus 2005. Contributing to this
decrease was the establishment of a tax reserve related to some of our foreign
investments and lower earnings at GasAtacama. These decreases were offset
partially by mark-to-market gains on interest rate swaps associated with our
investment in Taweelah, compared to losses recorded on these instruments in the
same period of 2005.
For the six months ended June 30, 2006, equity earnings decreased $9 million
versus 2005. This decrease was due to the establishment of a tax reserve related
to some of our foreign investments and lower earnings at GasAtacama. These
decreases were offset partially by mark-to-market gains on interest rate swaps
associated with our investment in Taweelah, compared to losses recorded on these
instruments in the same period of 2005. The decreases were also reduced
partially by higher earnings at Neyveli, due to the absence in 2006 of expenses
related to a forced outage and a penalty on coal purchase commitments, which
were recorded in 2005.
GAIN ON SALE OF ASSETS: For the three months ended June 30, 2006, there were no
gains or losses on asset sales versus a $2 million gain on the sale of SLAP in
2005.
For the six months ended June 30, 2006, there were no gains or losses on asset
sales versus a $3 million gain on the sale of GVK and a $2 million gain on the
sale of SLAP in 2005.
OPERATION AND MAINTENANCE: For the six months ended June 30, 2006, operation and
maintenance expenses increased due to higher salaries and benefits, primarily at
South American subsidiaries, and increased expenditures related to prospecting
initiatives.
GENERAL TAXES, DEPRECIATION AND OTHER INCOME, NET: For the three and six months
ended June 30, 2006, the net of general tax expense, depreciation and other
income increased operating income compared to 2005. This is primarily due to
lower depreciation expense at the MCV Partnership resulting from the impairment
of property, plant, and equipment and higher interest income. These increases
were offset partially by higher general taxes, primarily at South American
subsidiaries.
FIXED CHARGES: For the three and six months ended June 30, 2006, fixed charges
decreased due to lower interest expense at the MCV Partnership as the result of
lower debt levels, offset partially by higher interest expense from an increase
in subsidiary debt and interest rates.
MINORITY INTEREST: For the three months ended June 30, 2006, minority owners
shared in a portion of the losses at our subsidiaries. The allocation of losses
to minority owners increased our net income for the period. For the three months
ended June 30, 2005, minority interest owners shared in a portion of larger
losses at our subsidiaries. The losses in 2006 and 2005 were primarily due to
activities at the MCV Partnership.
For the six months ended June 30, 2006, minority owners shared in a portion of
the losses at our subsidiaries versus sharing in the profits of these
subsidiaries in 2005. The losses in 2006 and the profits in 2005 were primarily
due to activities at the MCV Partnership.
CMS-12
CMS Energy Corporation
INCOME TAXES: For the three months ended June 30, 2006, the income tax benefit
was lower versus 2005. The benefit in 2006 was due to the resolution of an IRS
income tax audit, which resulted in an $8 million income tax benefit primarily
for the utilization or restoration of income tax credits. The 2005 benefit was
due to income tax benefits related to the American Jobs Creation Act of 2004,
offset partially by higher earnings.
For the six months ended June 30, 2006, we recognized income tax benefits versus
income tax expense in 2005. The benefit in 2006 was due to the resolution of an
IRS income tax audit, which resulted in an $8 million income tax benefit
primarily for the utilization or restoration of income tax credits. The income
tax expense in 2005 was due to higher earnings offset partially by the income
tax benefits related to the American Jobs Creation Act of 2004.
CORPORATE INTEREST AND OTHER RESULTS OF OPERATIONS
<Table>
<Caption>
In Millions
----------------------
June 30 2006 2005 Change
- ------- ---- ---- ------
Three months ended $ 32 $(45) $ 77
Six months ended $(13) $(91) $ 78
==== ==== ======
</Table>
For the three months ended June 30, 2006, net income from corporate interest and
other was $32 million versus net expenses of $45 million in 2005. The $77
million change reflects the resolution of an IRS income tax audit, which
resulted in a $46 million income tax benefit primarily for the utilization or
restoration of income tax credits. Also contributing to the change was an
insurance reimbursement received in June 2006 for previously incurred legal
expenses.
For the six months ended June 30, 2006, net expense from corporate interest and
other was $13 million versus net expenses of $91 million in 2005. The decrease
reflects the resolution of an IRS income tax audit, which resulted in a $46
million income tax benefit primarily for the utilization or restoration of
income tax credits. Also contributing to the change was an insurance
reimbursement received in June 2006 for previously incurred legal expenses.
CRITICAL ACCOUNTING POLICIES
The following accounting policies are important to an understanding of our
results of operations and financial condition and should be considered an
integral part of our MD&A.
USE OF ESTIMATES AND ASSUMPTIONS
In preparing our financial statements, we use estimates and assumptions that may
affect reported amounts and disclosures. We use accounting estimates for asset
valuations, depreciation, amortization, financial and derivative instruments,
employee benefits, and contingencies. For example, we estimate the rate of
return on plan assets and the cost of future health-care benefits to determine
our annual pension and other postretirement benefit costs. There are risks and
uncertainties that may cause actual results to differ from estimated results,
such as changes in the regulatory environment, competition, foreign exchange,
regulatory decisions, and lawsuits.
CONTINGENCIES: We are involved in various regulatory and legal proceedings that
arise in the ordinary course of our business. We record a liability for
contingencies based upon our assessment that a loss is
CMS-13
CMS Energy Corporation
probable and the amount of loss can be reasonably estimated. The recording of
estimated liabilities for contingencies is guided by the principles in SFAS No.
5. We consider many factors in making these assessments, including the history
and specifics of each matter.
The amount of income taxes we pay is subject to ongoing audits by federal,
state, and foreign tax authorities, which can result in proposed assessments.
Our estimate for the potential outcome for any uncertain tax issue is highly
judgmental. We believe we have provided adequately for any likely outcome
related to these matters. However, our future results may include favorable or
unfavorable adjustments to our estimated tax liabilities in the period the
assessments are made or resolved or when statutes of limitation on potential
assessments expire. As a result, our effective tax rate may fluctuate
significantly on a quarterly basis. In July 2006, the FASB issued a new
interpretation on the recognition and measurement of uncertain tax positions.
For additional details, see the "New Accounting Standards Not Yet Effective"
section included in this MD&A.
ACCOUNTING FOR FINANCIAL AND DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES, AND
MARKET RISK INFORMATION
FINANCIAL INSTRUMENTS: We account for investments in debt and equity securities
using SFAS No. 115. For additional details on accounting for financial
instruments, see Note 5, Financial and Derivative Instruments.
DERIVATIVE INSTRUMENTS: We account for derivative instruments in accordance with
SFAS No. 133. Except as noted within this section, there have been no material
changes to the accounting for derivative instruments since the year ended
December 31, 2005. For additional details on accounting for derivatives, see
Note 5, Financial and Derivative Instruments.
To determine the fair value of our derivatives, we use information from external
sources (i.e., quoted market prices and third-party valuations), if available.
For certain contracts, this information is not available and we use mathematical
valuation models to value our derivatives. These models require various inputs
and assumptions, including commodity market prices and volatilities, as well as
interest rates and contract maturity dates. Changes in forward prices or
volatilities could significantly change the calculated fair value of our
derivative contracts. The cash returns we actually realize on these contracts
may vary, either positively or negatively, from the results that we estimate
using these models. As part of valuing our derivatives at market, we maintain
reserves, if necessary, for credit risks arising from the financial condition of
our counterparties.
The following table summarizes the interest rate and volatility rate assumptions
we used to value these contracts at June 30, 2006:
<Table>
<Caption>
Interest Rates (%) Volatility Rates (%)
------------------ --------------------
Long-term gas contracts associated with the MCV
Partnership 5.33 - 5.68 31 - 69
Gas-related option contracts 4.90 59
Electricity-related option contracts 4.90 119 - 158
Establishment of the Midwest Energy Market: In 2005, the MISO began operating
the Midwest Energy Market. As a result, the MISO now centrally dispatches
electricity and transmission service throughout much of the Midwest and provides
day-ahead and real-time energy market information. At this time, we believe that
the establishment of this market does not represent the development of an active
energy market in Michigan, as defined by SFAS No. 133. However, as the Midwest
Energy Market matures, we will
CMS-14
CMS Energy Corporation
continue to monitor its activity level and evaluate whether or not an active
energy market may exist in Michigan. If an active market develops in the future,
some of our electric purchase and sale contracts may qualify as derivatives.
However, we believe that we would be able to apply the normal purchases and
sales exception of SFAS No. 133 to these contracts and, therefore, would not be
required to mark these contracts to market.
Implementation of the RCP: As a result of implementing the RCP in 2005, a
significant portion of the MCV Partnership's long-term gas contracts no longer
qualify as normal purchases because the gas will not be used to generate
electricity or steam. Accordingly, these contracts are accounted for as
derivatives, with changes in fair value recorded in earnings each quarter.
Additionally, certain of the MCV Partnership's natural gas futures and swap
contracts, which are used to hedge variable-priced long-term gas contracts, no
longer qualify for cash flow hedge accounting and we record any changes in their
fair value in earnings each quarter. As a result of recording the changes in
fair value of these long-term gas contracts and the related futures, options,
and swaps to earnings, the MCV Partnership has recognized the following losses
in 2006:
<Table>
<Caption>
In Millions
-------------------------------------
2006
-------------------------------------
First Second Year to
Quarter Quarter Date
--------- --------- ---------
Long-term gas contracts $ (111) $ (34) $ (145)
Related futures, options, and swaps (45) (8) (53)
--------- --------- ---------
Total $ (156) $ (42) $ (198)
========= ========= =========
</Table>
These losses, shown before consideration of tax effects and minority interest,
are included in the total Fuel costs mark-to-market at the MCV Partnership on
our Consolidated Statements of Income. Because of the volatility of the natural
gas market, the MCV Partnership expects future earnings volatility on both its
long-term gas contracts and its futures, options, and swap contracts, since
gains and losses will be recorded each quarter. We will continue to record these
gains and losses in our consolidated financial statements until we close the
sale of our interest in the MCV Partnership.
We have recorded derivative assets totaling $58 million associated with the fair
value of these contracts on our Consolidated Balance Sheets at June 30, 2006.
The MCV Partnership expects almost all of these assets, which represent
cumulative net mark-to-market gains, to reverse as losses through earnings
during 2006 and 2007 as the gas is purchased and the futures, options, and swaps
settle, with the remainder reversing between 2008 and 2011. Due to the
impairment of the MCV Facility and subsequent losses, the value of the equity
held by all of the owners of the MCV Partnership has decreased significantly and
is now negative. Since we are one of the general partners of the MCV
Partnership, we have recognized a portion of the limited partners' negative
equity. As the MCV Partnership recognizes future losses from the reversal of
these derivative assets, we will continue to assume a portion of the limited
partners' share of those losses, in addition to our proportionate share, but
only until we close the sale of our interest in the MCV Partnership.
At the closing of this sale, these assets, which represent cumulative net
mark-to-market gains, will be sold in conjunction with the sale of our ownership
interest. As a result, we will no longer record the fair value of these
long-term gas contracts or the related futures, options, and swaps on our
Consolidated Balance Sheets and will not be required to recognize gains or
losses related to changes in the fair value of these contracts on our
Consolidated Statements of Income. Additionally, at June 30, 2006, we have
recorded a cumulative net gain of $39 million, net of tax and minority interest,
in Accumulated other comprehensive loss representing our proportionate share of
the cash flow hedges held by the MCV
CMS-15
CMS Energy Corporation
Partnership. At the closing of the sale of our interest, this amount, adjusted
for any additional changes in fair value, will be reclassified and recognized in
earnings.
Any changes in the fair value of these contracts recognized before the closing
will not affect the purchase price of our ownership interest in the MCV
Partnership. For additional details on the sale of our interest in the MCV
Partnership, see the "Other Electric Utility Business Uncertainties - MCV
Underrecoveries" section in this MD&A and Note 2, Contingencies, "Other
Consumers' Electric Utility Contingencies - The Midland Cogeneration Venture."
CMS ERM CONTRACTS: CMS ERM enters into and owns energy contracts as a part of
activities considered to be an integral part of CMS Energy's ongoing operations.
There have been no material changes to the accounting for CMS ERM's contracts
since the year ended December 31, 2005.
We include the fair value of the derivative contracts held by CMS ERM in either
Price risk management assets or Price risk management liabilities on our
Consolidated Balance Sheets. The following tables provide a summary of these
contracts at June 30, 2006:
<Table>
<Caption>
In Millions
-------------------------------
Non-
Trading Trading Total
------- ------- -------
Fair value of contracts outstanding at December 31, 2005 $ (63) $ 100 $ 37
Fair value of new contracts when entered into during the period (a) - (1) (1)
Contracts realized or otherwise settled during the period 7 (13) (6)
Other changes in fair value (b) (8) (42) (50)
------- ------- -------
Fair value of contracts outstanding at June 30, 2006 $ (64) $ 44 $ (20)
======= ======= =======
</Table>
(a) Reflects only the initial premium payments (receipts) for new contracts. No
unrealized gains or losses were recognized at the inception of any new
contracts.
(b) Reflects changes in price and net increase (decrease) of forward positions
as well as changes to present value and credit reserves.
<Table>
<Caption>
Fair Value of Non-Trading Contracts at June 30, 2006 In Millions
- --------------------------------------------------------------------------------------------------------
Maturity (in years)
Total ----------------------------------------------
Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5
- -------------------- ---------- ----------- ------ ------ --------------
Prices actively quoted $ - $ - $ - $ - $ -
Prices obtained from external
sources or based on models and
other valuation methods (64) (12) (21) (31) -
----- ----- ----- ----- -----
Total $ (64) $ (12) $ (21) $ (31) $ -
===== ===== ===== ===== =====
</Table>
<Table>
<Caption>
Fair Value of Trading Contracts at June 30, 2006 In Millions
- --------------------------------------------------------------------------------------------------------
Maturity (in years)
Total ----------------------------------------------
Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5
- -------------------- ---------- ----------- ------ ------- --------------
Prices actively quoted $ (54) $ (18) $ (36) $ - $ -
Prices obtained from external
sources or based on models and
other valuation methods 98 22 45 31 -
----- ----- ----- ------ -----
Total $ 44 $ 4 $ 9 $ 31 $ -
===== ===== ===== ====== =====
</Table>
CMS-16
CMS Energy Corporation
MARKET RISK INFORMATION: The following is an update of our risk sensitivities
since December 31, 2005. These sensitivities indicate the potential loss in fair
value, cash flows, or future earnings from our financial instruments, including
our derivative contracts, assuming a hypothetical adverse change in market rates
or prices of 10 percent. Changes in excess of the amounts shown in the
sensitivity analyses could occur if changes in market rates or prices exceed the
10 percent shift used for the analyses.
Interest Rate Risk Sensitivity Analysis (assuming an adverse change in market
interest rates of 10 percent):
<Table>
<Caption>
In Millions
----------------------------------
June 30, 2006 December 31, 2005
------------- -----------------
Variable-rate financing -- before-tax annual earnings exposure $ 2 $ 4
Fixed-rate financing -- potential REDUCTION in fair value (a) 222 223
</Table>
(a) Fair value exposure could only be realized if we repurchased all of our
fixed-rate financing.
Certain equity method investees have entered into interest rate swaps. These
instruments are not required to be included in the sensitivity analysis, but can
have an impact on financial results.
Commodity Price Risk Sensitivity Analysis (assuming an adverse change in market
prices of 10 percent):
<Table>
<Caption>
In Millions
-----------------------------------
June 30, 2006 December 31, 2005
------------- -----------------
Potential REDUCTION in fair value:
Non-trading contracts
Gas supply option contracts $ - $ 1
CMS ERM gas forward contracts 1 -
Derivative contracts associated with the MCV Partnership:
Long-term gas contracts 19 39
Gas futures, options, and swaps 34 48
Trading contracts
Electricity-related option contracts - 2
Electricity-related swaps 11 13
Gas-related option contracts 1 1
Gas-related swaps and futures 2 4
</Table>
Investment Securities Price Risk Sensitivity Analysis (assuming an adverse
change in market prices of 10 percent):
<Table>
<Caption>
In Millions
-----------------------------------
June 30, 2006 December 31, 2005
------------- -----------------
Potential REDUCTION in fair value of available-for-sale equity
securities (primarily SERP investments): $ 5 $ 5
</Table>
Consumers maintains trust funds, as required by the NRC, for the purpose of
funding certain costs of nuclear plant decommissioning. At June 30, 2006 and
December 31, 2005, these funds were invested primarily in equity securities,
fixed-rate, fixed-income debt securities, and cash and cash equivalents, and
CMS-17
CMS Energy Corporation
are recorded at fair value on our Consolidated Balance Sheets. These investments
are exposed to price fluctuations in equity markets and changes in interest
rates. Because the accounting for nuclear plant decommissioning recognizes that
costs are recovered through Consumers' electric rates, fluctuations in equity
prices or interest rates do not affect our earnings or cash flows.
For additional details on market risk and derivative activities, see Note 5,
Financial and Derivative Instruments. For additional details on nuclear plant
decommissioning at Big Rock and Palisades, see the "Other Electric Utility
Business Uncertainties - Nuclear Matters" section included in this MD&A.
OTHER
Other accounting policies important to an understanding of our results of
operations and financial condition include:
- accounting for long-lived assets and equity method investments,
- accounting for the effects of industry regulation,
- accounting for pension and OPEB,
- accounting for asset retirement obligations, and
- accounting for nuclear decommissioning costs.
These accounting policies were disclosed in our 2005 Form 10-K/A and there have
been no subsequent material changes.
CAPITAL RESOURCES AND LIQUIDITY
Factors affecting our liquidity and capital requirements are:
- results of operations,
- capital expenditures,
- energy commodity costs,
- contractual obligations,
- regulatory decisions,
- debt maturities,
- credit ratings,
- working capital needs, and
- collateral requirements.
During the summer months, we purchase natural gas and store it for resale
primarily during the winter heating season. Although our prudent natural gas
purchases are recoverable from our customers, the amount paid for natural gas
stored as inventory requires additional liquidity due to the timing of the cost
recoveries. We have credit agreements with our commodity suppliers and those
agreements contain terms that have resulted in margin calls. Additional margin
calls or other credit support may be required if agency ratings are lowered or
if market conditions remain unfavorable relative to our obligations to those
parties.
Our current financial plan includes controlling operating expenses and capital
expenditures and evaluating market conditions for financing opportunities. Due
to the adverse impact of the MCV Partnership asset impairment charge recorded in
2005 and the MCV Partnership fuel cost mark-to-market charges during 2006,
Consumers' ability to issue FMB as primary obligations or as collateral for
financing is expected to be limited to $298 million through December 31, 2006.
After December 31, 2006, Consumers' ability to
CMS-18
CMS Energy Corporation
issue FMB in excess of $298 million is based on achieving a two-times FMB
interest coverage ratio.
We believe the following items will be sufficient to meet our liquidity needs:
- our current level of cash and revolving credit facilities,
- our ability to access junior secured and unsecured borrowing
capacity in the capital markets, and
- our anticipated cash flows from operating and investing activities.
We have not made a specific determination concerning the reinstatement of common
stock dividends. The Board of Directors may reconsider or revise its dividend
policy based upon certain conditions, including our results of operations,
financial condition, and capital requirements, as well as other relevant
factors.
CASH POSITION, INVESTING, AND FINANCING
Our operating, investing, and financing activities meet consolidated cash needs.
At June 30, 2006, $918 million consolidated cash was on hand, which includes $67
million of restricted cash and $273 million from entities consolidated pursuant
to FASB Interpretation No. 46(R).
Our primary ongoing source of cash is dividends and other distributions from our
subsidiaries. For the six months ended June 30, 2006, Consumers paid $40 million
in common stock dividends to CMS Energy.
SUMMARY OF CONSOLIDATED STATEMENTS OF CASH FLOWS:
In Millions
--------------
Six months ended June 30 2006 2005
- ------------------------ ----- -----
Net cash provided by (used in):
Operating activities $ 489 $ 480
Investing activities (250) (110)
----- -----
Net cash provided by operating and investing activities 239 370
Financing activities (236) (27)
Effect of exchange rates on cash 1 1
----- -----
Net Increase in Cash and Cash Equivalents $ 4 $ 344
===== =====
</Table>
OPERATING ACTIVITIES: For the six months ended June 30, 2006, net cash provided
by operating activities was $489 million, an increase of $9 million versus 2005.
This was the result of a decrease in accounts receivable, cash proceeds from the
sale of excess sulfur dioxide allowances, and a return of funds formerly held as
collateral under certain gas hedging arrangements. This activity was offset by
decreases in accounts payable and the MCV Partnership gas supplier funds on
deposit. The decrease in accounts receivable was primarily due to the expiration
of emergency rules initiated by the MPSC, which delayed customer payments during
the heating season. The decrease in the MCV Partnership gas supplier funds on
deposit was the result of refunds to suppliers from decreased exposure due to
declining gas prices in 2006. The decrease in accounts payable was mainly due to
payments for higher priced gas that were accrued as of December 31, 2005.
INVESTING ACTIVITIES: For the six months ended June 30, 2006, net cash used in
investing activities was $250 million, an increase of $140 million versus 2005.
This was primarily due to the absence of short-term investment proceeds, the
absence of proceeds from asset sales, an increase in capital expenditures, and
an increase in notes receivable. This activity was offset by a release of
restricted cash in February 2006, which we used to extinguish long-term
debt-related parties.
CMS-19
CMS Energy Corporation
FINANCING ACTIVITIES: For the six months ended June 30, 2006, net cash used in
financing activities was $236 million, an increase of $209 million versus 2005.
This was primarily due to a decrease in proceeds from common stock issuances of
$271 million.
For additional details on long-term debt activity, see Note 3, Financings and
Capitalization.
OBLIGATIONS AND COMMITMENTS
DIVIDEND RESTRICTIONS: For details on dividend restrictions, see Note 3,
Financings and Capitalization.
DEBT CREDIT RATINGS: In June 2006, Moody's placed the debt ratings of CMS Energy
under review for possible upgrade. Moody's also affirmed CMS Energy's liquidity
rating and revised the debt rating outlook for Consumers to stable from
negative.
OFF-BALANCE SHEET ARRANGEMENTS: CMS Energy and certain of its subsidiaries enter
into various arrangements in the normal course of business to facilitate
commercial transactions with third-parties. These arrangements include
indemnifications, letters of credit, surety bonds, and financial and performance
guarantees. For details on guarantee arrangements, see Note 2, Contingencies,
"Other Contingencies - FASB Interpretation No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others."
REVOLVING CREDIT FACILITIES: For details on revolving credit facilities, see
Note 3, Financings and Capitalization.
SALE OF ACCOUNTS RECEIVABLE: For details on the sale of accounts receivable, see
Note 3, Financings and Capitalization.
OUTLOOK
CORPORATE OUTLOOK
Over the next few years, our business strategy will focus on managing cash flow
issues, reducing parent company debt, maintaining and growing earnings, reducing
risk, and positioning us to make new investments that complement our strengths.
ELECTRIC UTILITY BUSINESS OUTLOOK
GROWTH: Summer 2005 temperatures were higher than historical averages, leading
to increased demand from electric customers. In 2006, we project electric
deliveries will decline less than one percent from 2005 levels. This short-term
outlook assumes a stabilizing economy and normal weather conditions throughout
the remainder of the year.
Over the next five years, we expect electric deliveries to grow at an average
rate of about one and one-half percent per year. However, such growth is
dependent on a modestly growing customer base and a stabilizing Michigan
economy. This growth rate includes both full-service sales and delivery service
to customers who choose to buy generation service from an alternative electric
supplier, but excludes transactions with other wholesale market participants and
other electric utilities. This growth rate reflects a long-range expected trend
of growth. Growth from year to year may vary from this trend due to customer
response to fluctuations in weather conditions and changes in economic
conditions, including utilization and expansion or contraction of manufacturing
facilities.
CMS-20
CMS Energy Corporation
ELECTRIC RESERVE MARGIN: We have a reserve margin of approximately 11 percent
for summer 2006, or supply resources equal to 111 percent of projected firm
summer peak load. The 2006 supply resources of 111 percent come from our
electric generating plants, long-term power purchase contracts, and other
contractual arrangements. We have purchased capacity and energy contracts
covering the reserve margin requirements for 2006 and covering partially the
estimated reserve margin requirements for 2007 through 2010. As a result, we
recognized an asset of $75 million for unexpired capacity and energy contracts
at June 30, 2006. Upon the completion of the sale of the Palisades plant, the
power purchase agreement will offset, for the term of the agreement, the
reduction in the owned capacity represented by the Palisades plant.
The MCV PPA is not affected by our agreement to sell our interest in the MCV
Partnership. After September 15, 2007, we expect to exercise our claim for
relief under the regulatory out provision in the MCV PPA. If we are successful
in exercising our claim, the MCV Partnership has the right to terminate the MCV
PPA, which could impact our reserve margin status.
ELECTRIC TRANSMISSION EXPENSES: METC, which provides electric transmission
service to us, increased substantially the transmission rates it charges us in
2006. The increased rates are subject to refund and to reduction based on the
outcome of hearings at the FERC scheduled for December 2006. We are attempting
to recover these costs through our 2006 PSCR plan case. The PSCR process allows
recovery of all reasonable and prudent power supply costs. However, we cannot
predict when recovery of these transmission costs will commence. To the extent
that we incur and are unable to collect these increased costs in a timely
manner, our cash flows from electric utility operations will be affected
negatively. For additional details, see Note 2, Contingencies, "Consumers'
Electric Utility Rate Matters - Power Supply Costs."
In May 2006, ITC, a company that operates electric transmission facilities
through a wholly owned subsidiary, including the transmission system within
Detroit Edison's territory, filed an application with the FERC to acquire METC.
The FERC subsequently delayed hearings concerning the METC transmission rates.
We will continue to participate in the FERC proceeding concerning the METC
transmission rates and the FERC proceeding concerning ITC's proposed acquisition
of METC. We are unable to predict the nature and timing of any action by the
FERC on transmission rates or if and when the ITC's purchase of METC will be
completed.
INDUSTRIAL REVENUE OUTLOOK: Our electric utility customer base includes a mix of
residential, commercial, and diversified industrial customers. In November 2005,
General Motors Corporation, a large industrial customer of Consumers, announced
plans to reduce certain manufacturing operations in Michigan. However, since the
targeted operations are outside of our service territory, we do not anticipate a
significant impact on electric utility revenue. In March 2006, Delphi
Corporation, also a large industrial customer of Consumers with six facilities
in our service territory, announced plans to sell or close all but one of their
manufacturing operations in Michigan as part of their bankruptcy restructuring.
Our electric utility operations are not dependent upon a single customer, or
even a few customers, and customers in the automotive sector constitute 4
percent of our total electric revenue. In addition, returning former ROA
industrial customers will benefit our electric utility revenue. However, we
cannot predict the impact of these restructuring plans or possible future
actions by other industrial customers.
THE ELECTRIC CAPACITY NEED FORUM: In January 2006, the MPSC Staff issued a
report on future electric capacity in the state of Michigan. The report
indicated that existing generation resources are adequate in the short term, but
could be insufficient to maintain reliability standards by 2009. The report also
indicated that new coal-fired baseload generation may be needed by 2011. The
MPSC Staff recommended an approval and bid process for new power plants. To
address revenue stability risks, the Staff also proposed a special reliability
charge that a utility would assess on all electric distribution customers. In
April 2006, the governor of Michigan issued an executive directive calling for
the development of a comprehensive energy plan for the state of Michigan. The
directive calls for the Chairman of the MPSC, working in cooperation
CMS-21
CMS Energy Corporation
with representatives from the public and private sectors, to make
recommendations on Michigan's energy policy by the end of 2006. We will continue
to participate as the MPSC addresses future electric capacity needs.
BURIAL OF OVERHEAD POWER LINES: The City of Taylor, a municipality located in
Wayne county, Michigan, passed an ordinance that required Detroit Edison to bury
a section of overhead power lines at Detroit Edison's expense. In September
2004, the Michigan Court of Appeals upheld a lower court decision affirming the
legality of the ordinance over Detroit Edison's objections. Other municipalities
in our service territory adopted, or proposed the adoption of, similar
ordinances. Detroit Edison appealed the Michigan Court of Appeals ruling to the
Michigan Supreme Court. In May 2006, the Michigan Supreme Court ruled in favor
of Detroit Edison. The Court found that the MPSC has primary jurisdiction over
this issue and accordingly, the Taylor ordinance is subject to any applicable
rules and regulations of the MPSC, including issues concerning who should bear
the expense of underground facilities. If incurred, we would seek recovery of
these costs from the municipality, or from our customers located in the
municipality, subject to MPSC approval.
ELECTRIC UTILITY BUSINESS UNCERTAINTIES
Several electric business trends or uncertainties may affect our financial
results and condition. These trends or uncertainties have, or we reasonably
expect could have, a material impact on revenues or income from continuing
electric operations.
ELECTRIC ENVIRONMENTAL ESTIMATES: Our operations are subject to environmental
laws and regulations. Costs to operate our facilities in compliance with these
laws and regulations generally have been recovered in customer rates.
Clean Air Act: Compliance with the federal Clean Air Act and resulting
regulations has been, and will continue to be, a significant focus for us. The
Nitrogen Oxide State Implementation Plan requires significant reductions in
nitrogen oxide emissions. To comply with the regulations, we expect to incur
capital expenditures totaling $819 million. As of June 2006, we have incurred
$634 million in capital expenditures to comply with the federal Clean Air Act
and resulting regulations and anticipate that the remaining $185 million of
capital expenditures will be made in 2006 through 2011. In addition to modifying
coal-fired electric generating plants, our compliance plan includes the use of
nitrogen oxide emission allowances until all of the control equipment is
operational in 2011. The nitrogen oxide emission allowance annual expense is
projected to be $6 million per year, which we expect to recover from our
customers through the PSCR process.
Clean Air Interstate Rule: In March 2005, the EPA adopted the Clean Air
Interstate Rule that requires additional coal-fired electric generating plant
emission controls for nitrogen oxides and sulfur dioxide. We plan to meet this
rule by year round operation of our selective catalytic reduction control
technology units and installation of flue gas desulfurization scrubbers at an
estimated total cost of $960 million, to be incurred by 2014.
Clean Air Mercury Rule: Also in March 2005, the EPA issued the Clean Air Mercury
Rule, which requires initial reductions of mercury emissions from coal-fired
electric generating plants by 2010 and further reductions by 2018. We anticipate
our capital costs for mercury emissions reductions required by Phase I of the
Clean Air Mercury Rule to be less than $50 million and implemented by 2010.
Phase II requirements of the Clean Air Mercury Rule are not yet known and a cost
estimate has not been determined.
CMS-22
CMS Energy Corporation
In April 2006, Michigan's governor announced a plan that would result in mercury
emissions reductions of 90 percent by 2015. We are working with the MDEQ on the
details of these rules. We will develop a cost estimate when the details of
these rules are determined.
Greenhouse gases: Several legislative proposals have been introduced in the
United States Congress that would require reductions in emissions of greenhouse
gases, including potentially carbon dioxide. We cannot predict whether any
federal mandatory greenhouse gas emission reduction rules ultimately will be
enacted, or the specific requirements of any of these rules and their effect on
our operations and financial results.
To the extent that greenhouse gas emission reduction rules come into effect, the
mandatory emissions reduction requirements could have far-reaching and
significant implications for the energy sector. We cannot estimate the potential
effect of federal or state level greenhouse gas policy on our future
consolidated results of operations, cash flows, or financial position due to the
uncertain nature of the policies at this time. However, we stay abreast of
greenhouse gas policy developments and will continue to assess and respond to
their potential implications on our business operations.
Water: In March 2004, the EPA issued rules that govern electric generating plant
cooling water intake systems. The rules require significant reduction in fish
killed by operating equipment. Fish kill reduction studies are required to be
submitted to the EPA in 2007 and 2008. EPA compliance options in the rule are
currently being challenged in court and we will finalize our cost estimates in
2008, when a decision on the final rule is anticipated. We expect to implement
the EPA approved process from 2009 to 2011.
For additional details on electric environmental matters, see Note 2,
Contingencies, "Consumers' Electric Utility Contingencies - Electric
Environmental Matters."
COMPETITION AND REGULATORY RESTRUCTURING: The Customer Choice Act allows all of
our electric customers to buy electric generation service from us or from an
alternative electric supplier. At June 30, 2006, alternative electric suppliers
were providing 311 MW of generation service to ROA customers, which represents 4
percent of our total distribution load. It is difficult to predict future ROA
customer trends.
Section 10d(4) Regulatory Assets: In December 2005, the MPSC issued an order
that authorized us to recover $333 million in Section 10d(4) costs. Instead of
collecting these costs evenly over five years, the order instructed us to
collect 10 percent of the regulatory asset total in the first year, 15 percent
in the second year, and 25 percent in each of the third, fourth, and fifth
years. In January 2006, we filed a petition for rehearing with the MPSC that
disputed the aspect of the order dealing with the timing of our collection of
these costs. In April 2006, the MPSC issued an order that denied our petition
for rehearing.
Stranded Costs: Prior MPSC orders adopted a mechanism pursuant to the Customer
Choice Act to provide recovery of Stranded Costs that occur when customers leave
our system to purchase electricity from alternative suppliers. In November 2005,
we filed an application with the MPSC related to the determination of 2004
Stranded Costs.
In March 2006, the ALJ in our 2004 PSCR reconciliation case issued a Proposal
for Decision recommending that we use a greater portion of our net sales of
excess power into the bulk electricity market to offset our 2004 PSCR costs,
rather than 2004 Stranded Costs. In June 2006, the ALJ issued a Proposal for
Decision in our 2004 Stranded Cost case recommending that the MPSC find that we
had no Stranded Costs in 2004. If the MPSC adopts the ALJ recommendations,
earnings would be impacted adversely by $10 million. We cannot predict the
outcome of these proceedings.
CMS-23
CMS Energy Corporation
Through and Out Rates: From December 2004 to March 2006, we paid a transitional
charge pursuant to a FERC order eliminating regional "through and out" rates. In
May 2006, the FERC approved an agreement between the PJM RTO transmission owners
and Consumers concerning these transitional charges. The agreement resolves all
issues regarding transitional charges for Consumers and eliminates the potential
for refunds or additional charges to Consumers. In May 2006, Baltimore Gas &
Electric filed a notice of withdrawal from the settlement. Consumers, PJM, and
others filed responses with the FERC on this matter. The FERC has not ruled on
whether the notice of withdrawal is effective, but we do not believe this action
will have any material impact on us.
For additional details and material changes relating to the restructuring of the
electric utility industry and electric rate matters, see Note 2, Contingencies,
"Consumers' Electric Utility Restructuring Matters," and "Consumers' Electric
Utility Rate Matters."
OTHER ELECTRIC UTILITY BUSINESS UNCERTAINTIES
MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the MCV
Facility, contracted to sell electricity to Consumers for a 35-year period
beginning in 1990. We hold a 49 percent partnership interest in the MCV
Partnership, and a 35 percent lessor interest in the MCV Facility.
Sale of our Interest in the MCV Partnership and the FMLP: In July 2006, we
reached an agreement to sell 100 percent of the stock of CMS Midland, Inc. and
CMS Midland Holdings Company to an affiliate of GSO Capital Partners and
Rockland Capital Energy Investments for $60.5 million. These Consumers'
subsidiaries hold our interests in the MCV Partnership and the FMLP. The sales
agreement calls for the purchaser, an affiliate of GSO Capital Partners and
Rockland Capital Energy Investments to pay $85 million, subject to certain
conditions and reimbursement rights, if Dow terminates an agreement under which
it is provided power and steam by the MCV Partnership. The purchaser will secure
their reimbursement obligation with an irrevocable letter of credit of up to $85
million. The MCV PPA and the associated customer rates are not affected by the
sale. We are targeting to close on the sale before the end of 2006. The sale is
subject to various regulatory approvals, including the MPSC's approval and the
expiration of the waiting period under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976. The MPSC has established a contested case proceeding
schedule, which will allow for a decision from the MPSC by the end of 2006. We
cannot predict the timing or the outcome of the MPSC's decision. We further
cannot predict with certainty whether or when this transaction will be
completed.
For additional details on the sale of our interests in the MCV Partnership and
the FMLP, see Note 2, Contingencies, "Other Consumers' Electric Utility
Contingencies -- The Midland Cogeneration Venture", and the Stock Purchase
Agreement, which is attached as Exhibit 10c to this filing.
Financial Condition of the MCV Partnership: Under the MCV PPA, variable energy
payments to the MCV Partnership are based on the cost of coal burned at our coal
plants and our operation and maintenance expenses. However, the MCV
Partnership's costs of producing electricity are tied to the cost of natural
gas. Historically high natural gas prices have caused the MCV Partnership to
reevaluate the economics of operating the MCV Facility and to record an
impairment charge in 2005. If natural gas prices remain at present levels or
increase, the operations of the MCV Facility would be adversely affected and
could result in the MCV Partnership failing to meet its obligations under the
sale and leaseback transactions and other contracts.
Underrecoveries related to the MCV PPA: Further, the cost that we incur under
the MCV PPA exceeds the recovery amount allowed by the MPSC. As a result, we
estimate cash underrecoveries of capacity and fixed energy payments of $55
million in 2006 and $39 million in 2007. However, Consumers' direct savings
CMS-24
CMS Energy Corporation
from the RCP, after allocating a portion to customers, are used to offset a
portion of our capacity and fixed energy underrecoveries expense. After
September 15, 2007, we expect to claim relief under the regulatory out provision
in the MCV PPA, thereby limiting our capacity and fixed energy payments to the
MCV Partnership to the amounts that we collect from our customers. The effect of
any such action would be to:
- reduce cash flow to the MCV Partnership, which could have an adverse
effect on the MCV Partnership's financial performance, and
- eliminate our underrecoveries of capacity and fixed energy payments.
The MCV Partnership has indicated that it may take issue with our exercise of
the regulatory out clause after September 15, 2007. We believe that the clause
is valid and fully effective, but cannot assure that it will prevail in the
event of a dispute. If we are successful in exercising the regulatory out
clause, the MCV Partnership has the right to terminate the MCV PPA. The MPSC's
future actions on the capacity and fixed energy payments recoverable from
customers subsequent to September 15, 2007 may affect negatively the financial
performance of the MCV Partnership. If the MCV Partnership terminates the MCV
PPA, we would be required to replace the lost capacity to maintain an adequate
electric reserve margin. This could involve entering into a new PPA and (or)
entering into electric capacity contracts on the open market. We cannot predict
our ability to enter into such contracts at a reasonable price. We are also
unable to predict regulatory approval of the terms and conditions of such
contracts, or that the MPSC would allow full recovery of our incurred costs.
For additional details on the MCV Partnership, see Note 2, Contingencies, "Other
Consumers' Electric Utility Contingencies - The Midland Cogeneration Venture."
NUCLEAR MATTERS: Sale of Nuclear Assets: In July 2006, we reached an agreement
to sell Palisades and the Big Rock Independent Spent Fuel Storage Installation
(ISFSI) for $380 million to Entergy. The sales price reflects a $35 million
premium above the estimated Palisades asset values at the closing date after
accounting for estimated sales-related costs. This premium is expected to
benefit our customers. Entergy will assume responsibility for the future
decommissioning of the plant and for storage and disposal of spent nuclear fuel.
At the date of close, decommissioning trust assets are estimated to be $566
million. Consumers will retain $200 million of these funds at the time of close
and will be entitled to receive a return of $116 million of decommissioning
trust fund assets, pending either a favorable federal tax ruling regarding the
release of the funds or, if the funds are available, after decommissioning of
the Palisades site is complete. The disposition of the retained and receivable
nuclear decommissioning funds is subject to regulatory approval. We expect that
a portion of the proceeds will benefit our customers. We plan to use the cash
that we retain from the sale to reduce debt.
As part of the transaction, Entergy will sell us 100 percent of the plant's
output up to its current capacity of 798 MW under a 15-year power purchase
agreement. During the term of the PPA, Entergy is obligated to supply, and we
are obligated to take, all capacity and energy from the Palisades plant,
exclusive of uprates above the plant's presently specified capacity. When the
plant is not operating or is derated, under certain circumstances, Entergy can
elect to provide replacement power from another source at the rates set in the
PPA. Otherwise, we would have to obtain replacement power from the market.
However, we are only obligated to pay Entergy for capacity and energy actually
delivered by Entergy either from the plant or from an allowable replacement
source chosen by Entergy. If Entergy schedules a plant outage in June, July or
August, Entergy is required to provide replacement power at PPA rates. There are
significant penalties incurred by Entergy if the delivered energy fails to
achieve a minimum capacity factor level during July and August. Over the term of
the PPA, the pricing is structured such that Consumers' ratepayers will retain
the benefits of the Palisades plant's low-cost nuclear generation.
CMS-25
CMS Energy Corporation
The sale is subject to various regulatory approvals, including the MPSC's
approval of the power purchase agreement, the FERC's approval for Entergy to
sell power to us under the PPA and other related matters, the NRC's approval of
the transfer of the operating license to Entergy and other related matters, and
the expiration of the waiting period under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976. The final purchase price will be subject to various
closing adjustments such as working capital and capital expenditure adjustments,
adjustments for nuclear fuel usage and inventory, and the date of closing. We
are targeting to complete the sale in the first quarter of 2007. However, the
sale agreement can be terminated if the closing does not occur within 18 months
of the execution of the agreement. The closing can be extended for up to six
months to accommodate delays in receiving regulatory approval. We cannot predict
with certainty whether or when the closing conditions will be satisfied or
whether or when this transaction will be completed.
For additional details on the sale of Palisades and the Big Rock ISFSI, see the
Asset Sale Agreement and the Power Purchase Agreement, which are attached as
Exhibits 10a and 10b to this filing.
Big Rock: Decommissioning of the site is nearing completion. Demolition of the
last remaining plant structure, the containment building, and removal of
remaining underground utilities and temporary office structures is expected to
be complete by the end of the third quarter of 2006. Final radiological surveys
will then be completed to ensure that the site meets all requirements for free,
unrestricted release in accordance with the NRC approved License Termination
Plan (LTP) for the project. We anticipate NRC approval to return approximately
475 acres of the site, including the area formerly occupied by the nuclear
plant, to a natural setting for unrestricted use by early 2007. An area of
approximately 105 acres encompassing the Big Rock ISFSI, where eight casks
loaded with spent fuel and other high-level radioactive material are stored, has
been sold to Entergy. We will be required to pay Entergy $30 million for
accepting responsibility for the storage and disposal of these materials.
Palisades: The amount of spent nuclear fuel at Palisades exceeds the plant's
temporary onsite wet storage pool capacity. We are using dry casks for temporary
onsite dry storage to supplement the wet storage pool capacity. As of June 2006,
we have loaded 29 dry casks with spent nuclear fuel.
Palisades' current license from the NRC expires in 2011. In March 2005, the NMC,
which operates the Palisades plant, applied for a 20-year license renewal for
the plant on behalf of Consumers. We expect a decision from the NRC on the
license renewal application in 2007.
For additional details on nuclear plant decommissioning at Big Rock and
Palisades, see Note 2, Contingencies, "Other Consumers' Electric Utility
Contingencies -- Nuclear Plant Decommissioning."
GAS UTILITY BUSINESS OUTLOOK
GROWTH: In 2006, we project gas deliveries will decline by four percent, on a
weather-adjusted basis, from 2005 levels due to increased conservation and
overall economic conditions in the state of Michigan. Over the next five years,
we expect gas deliveries to be relatively flat. Actual gas deliveries in future
periods may be affected by:
- fluctuations in weather patterns,
- use by independent power producers,
- competition in sales and delivery,
- changes in gas commodity prices,
- Michigan economic conditions,
CMS-26
CMS Energy Corporation
- the price of competing energy sources or fuels, and
- gas consumption per customer.
GAS UTILITY BUSINESS UNCERTAINTIES
Several gas business trends or uncertainties may affect our future financial
results and financial condition. These trends or uncertainties could have a
material impact on revenues or income from gas operations.
GAS ENVIRONMENTAL ESTIMATES: We expect to incur investigation and remedial
action costs at a number of sites, including 23 former manufactured gas plant
sites. For additional details, see Note 2, Contingencies, "Consumers' Gas
Utility Contingencies - Gas Environmental Matters."
GAS COST RECOVERY: The GCR process is designed to allow us to recover all of our
purchased natural gas costs if incurred under reasonable and prudent policies
and practices. The MPSC reviews these costs, policies, and practices for
prudency in annual plan and reconciliation proceedings. For additional details
on gas cost recovery, see Note 2, Contingencies, "Consumers' Gas Utility Rate
Matters -- Gas Cost Recovery."
2001 GAS DEPRECIATION CASE: In October and December 2004, the MPSC issued
Opinions and Orders in our gas depreciation case, which:
- reaffirmed the previously-ordered $34 million reduction in our
depreciation expense,
- required us to undertake a study to determine why our plant removal
costs are in excess of other regulated Michigan natural gas
utilities, and
- required us to file a study report with the MPSC Staff on or before
December 31, 2005.
We filed the study report with the MPSC Staff on December 29, 2005.
We are also required to file our next gas depreciation case within 90 days after
the MPSC issuance of a final order in the pending case related to ARO
accounting. We cannot predict when the MPSC will issue a final order in the ARO
accounting case.
If the depreciation case order is issued after the gas general rate case order,
we proposed to incorporate its results into the gas general rates using a
surcharge mechanism, a process used to incorporate specialty items into customer
rates.
2005 GAS RATE CASE: In July 2005, we filed an application with the MPSC seeking
a 12 percent authorized return on equity along with a $132 million annual
increase in our gas delivery and transportation rates. As part of this filing,
we also requested interim rate relief of $75 million.
The MPSC Staff and intervenors filed interim rate relief testimony on October
31, 2005. In its testimony, the MPSC Staff recommended granting interim rate
relief of $38 million.
In February 2006, the MPSC Staff recommended granting final rate relief of $62
million. The MPSC Staff proposed that $17 million of this amount be contributed
to a low income and energy efficiency fund. The MPSC Staff also recommended
reducing our allowed return on common equity to 11.15 percent, from our current
11.4 percent.
In March 2006, the MPSC Staff revised its recommended final rate relief to $71
million, which includes $17 million to be contributed to a low income and energy
efficiency fund. In April 2006, we revised our request for final rate relief
downward to $118 million.
CMS-27
CMS Energy Corporation
In May 2006, the MPSC issued an order granting us interim gas rate relief of $18
million annually, which is under bond and subject to refund if final rate relief
is granted in a lesser amount. The order also extended the temporary two-year
surcharge of $58 million granted in October 2004 until the issuance of a final
order in this proceeding. The MPSC has not set a date for issuance of an order
granting final rate relief.
In July 2006, the ALJ issued a Proposal for Decision recommending final rate
relief of $74 million above current rate levels, which include interim and
temporary rate relief. The $74 million includes $17 million to be contributed to
a low income and energy efficiency fund. The Proposal for Decision also
recommended reducing our return on common equity to 11 percent, from our current
11.4 percent.
ENTERPRISES OUTLOOK
We are evaluating new development prospects outside of our current asset base to
determine whether they fit within our business strategy. These and other
investment opportunities for Enterprises will be considered for risk, rate of
return, and consistency with our business strategy. Meanwhile, we plan to
continue restructuring our Enterprises business with the objective of narrowing
the focus of our operations to primarily North America and the Middle East/North
Africa. We will continue to sell designated assets and investments that are not
consistent with this focus. The percentage of our future earnings relating to
our equity method investments may increase and our total future earnings may
depend more significantly upon the performance of those investments. For
summarized financial information of our equity method investments, see Note 9,
Equity Method Investments.
UNCERTAINTIES: The results of operations and the financial position of our
diversified energy businesses may be affected by a number of trends or
uncertainties. Those that could have a material impact on our income, cash
flows, or balance sheet and credit improvement include:
- our ability to sell or to improve the performance of assets and
businesses in accordance with our business plan,
- changes in exchange rates or in local economic or political
conditions, particularly in Argentina, Venezuela, Brazil, and the
Middle East,
- changes in foreign taxes or laws or in governmental or regulatory
policies that could reduce significantly the tariffs charged and
revenues recognized by certain foreign subsidiaries, or increase
expenses,
- imposition of stamp taxes on South American contracts that could
increase project expenses substantially,
- impact of any future rate cases, FERC actions, or orders on
regulated businesses,
- impact of ratings downgrades on our liquidity, operating costs, and
cost of capital,
- impact of changes in commodity prices and interest rates on certain
derivative contracts that do not qualify for hedge accounting and
must be marked to market through earnings,
- changes in available gas supplies or Argentine government
regulations that could restrict natural gas exports to our
GasAtacama electric generating plant, and
- impact of indemnity and environmental remediation obligations at Bay
Harbor.
GASATACAMA: On March 24, 2004, the Argentine government authorized the
restriction of exports of natural gas to Chile, giving priority to domestic
demand in Argentina. This restriction has had a detrimental effect on
GasAtacama's earnings since GasAtacama's gas-fired electric generating plant is
located in Chile and uses Argentine gas for fuel. From April through December
2004, Bolivia agreed to export 4 million
CMS-28
CMS Energy Corporation
cubic meters of gas per day to Argentina, which allowed Argentina to minimize
its curtailments to Chile. Argentina and Bolivia extended the term of that
agreement through December 31, 2006. With the Bolivian gas supply, Argentina
relaxed its export restrictions to GasAtacama, allowing GasAtacama to receive
approximately 50 percent of its contracted gas quantities at its electric
generating plant.
On May 1, 2006, the Bolivian government announced its intention to nationalize
the natural gas industry and raise prices under its existing gas export
contracts. Since May, gas flow from Bolivia has been restricted as Argentina and
Bolivia have been renegotiating the price for gas. Simultaneously, gas supply to
GasAtacama has been further curtailed. In July 2006, Argentina agreed to
increase the price it pays for gas from Bolivia through the term of the existing
contract, December 31, 2006. Concurrently, Argentina announced that it would
recover all of this price increase by a special tax on its gas exports. The
decision of Argentina to pass all of these increased costs to exports, in
addition to maintaining the current curtailment scheme, has increased the risk
and cost of GasAtacama's fuel supply. We are analyzing this situation to
determine what effect these actions may have on the value of our investment in
GasAtacama, but at this time cannot determine the effect. If an appropriate
resolution of this issue is not reached, it could result in an impairment of our
investment in GasAtacama. At June 30, 2006, the carrying value of our investment
in GasAtacama was $361 million.
SENECA: SENECA operates an electric utility on Margarita Island, Venezuela under
a Concession Agreement with the Venezuelan Ministry of Energy and Petroleum
(MEP). The Concession Agreement provides for semi-annual customer tariff
adjustments for the effects of inflation and foreign exchange variations. The
last tariff adjustment occurred in December 2003. In 2003, the MEP approved a
fuel subsidy to offset partially the lower tariff revenue. This fuel subsidy
originally expired on December 31, 2004, but has recently been approved through
December 31, 2005. SENECA has informed the MEP that for 2006, SENECA will
continue to apply the fuel subsidy as a credit against a portion of its fuel
bills from its fuel supplier, Deltaven, a governmental body regulated by the
MEP. Continued receipt of the fuel subsidy is part of SENECA's broader
discussions with the MEP for appropriate financial relief. We have been informed
that the MEP is examining other aspects of SENECA's financial relief proposal.
The outcome of these discussions is uncertain and, if not favorable, could
impact adversely SENECA's liquidity and the value of our investment.
OTHER OUTLOOK
MCV PARTNERSHIP NEGATIVE EQUITY: Due to the impairment of the MCV Facility and
operating losses from mark-to-market adjustments on derivative instruments, the
equity held by Consumers and by all of the owners of the MCV Partnership has
decreased significantly and is now negative. Since Consumers is one of the
general partners of the MCV Partnership, we have recognized a portion of the
limited partners' negative equity. As the MCV Partnership recognizes future
losses, we will continue to assume a portion of the limited partners' share of
those losses, in addition to our proportionate share.
LITIGATION AND REGULATORY INVESTIGATION: We are the subject of an investigation
by the DOJ regarding round-trip trading transactions by CMS MST. Also, we are
named as a party in various litigation matters including, but not limited to,
securities class action lawsuits, and several lawsuits regarding alleged false
natural gas price reporting and price manipulation. Additionally, the SEC is
investigating the actions of former CMS Energy subsidiaries in relation to
Equatorial Guinea. For additional details regarding these and other matters, see
Note 2, Contingencies and Part II, Item 1. Legal Proceedings.
PENSION REFORM: Both branches of Congress passed legislation aimed at reforming
pension plans in 2005. The U.S. Senate passed The Pension Security and
Transparency Act in November 2005 and The House of Representatives passed the
Pension Protection Act of 2005 in December 2005. Although the Senate and House
bills were similar, they did contain a number of differences.
CMS-29
CMS Energy Corporation
The House and Senate have passed the Pension Protection Act of 2006, which
primarily reflects a bipartisan House-Senate pension conference agreement. The
bill reforms the funding rules for employer-provided pension plans, effective
for plan years beginning after 2007, and was sent to the President in August
2006 for his signature. We are in the process of determining the impact of this
potential legislation on our financial statements.
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS
SFAS NO. 123(R) AND SAB NO. 107, SHARE-BASED PAYMENT: SFAS No. 123(R) requires
companies to use the fair value of employee stock options and similar awards at
the grant date to value the awards. SFAS No. 123(R) was effective for us on
January 1, 2006. We elected to adopt the modified prospective method recognition
provisions of this Statement instead of retrospective restatement. We adopted
the fair value method of accounting for share-based awards effective December
2002. Therefore, SFAS No. 123(R) did not have a significant impact on our
results of operations when it became effective. We applied the additional
guidance provided by SAB No. 107 upon implementation of SFAS No. 123(R). For
additional details, see Note 8, Executive Incentive Compensation.
NEW ACCOUNTING STANDARDS NOT YET EFFECTIVE
FIN 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES: In June 2006, the FASB
issued FIN 48. This interpretation provides a two-step approach for the
recognition and measurement of uncertain tax positions taken, or expected to be
taken, by a company on its income tax returns. The first step is to evaluate the
tax position to determine if, based on management's best judgment, it is greater
than 50 percent likely that the taxing authority will sustain the tax position.
The second step is to measure the appropriate amount of the benefit to
recognize. This is done by estimating the potential outcomes and recognizing the
greatest amount that has a cumulative probability of at least 50 percent. We are
presently evaluating the impacts, if any, of FIN 48. Any impacts of implementing
FIN 48 will result in a cumulative adjustment to retained earnings. This
interpretation is effective for us beginning January 1, 2007.
PROPOSED ACCOUNTING STANDARD
On March 31, 2006, the FASB released an exposure draft of a proposed SFAS
entitled "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans." The proposed SFAS would amend SFAS Nos. 87, 88, 106, and
132(R) and is expected to be effective for us on December 31, 2006. The most
significant requirement stated in the proposed SFAS is the balance sheet
recognition of the underfunded portion of our defined benefit postretirement
plans at the date of adoption. We expect that Consumers will be allowed to apply
SFAS No. 71 and recognize the underfunded portion as a regulatory asset. If we
determine that SFAS No. 71 does not apply, our other comprehensive income could
be reduced significantly. We are in the process of determining the impact of
this proposed SFAS on our financial statements.
CMS-30
CMS Energy Corporation
(This page intentionally left blank)
CMS-31
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------- --------------------
June 30 2006 2005 2006 2005
- ------- ------- ------- ------- -------
In Millions
OPERATING REVENUE $ 1,396 $ 1,230 $ 3,428 $ 3,075
EARNINGS FROM EQUITY METHOD INVESTEES 8 21 44 52
OPERATING EXPENSES
Fuel for electric generation 257 178 482 355
Fuel costs mark-to-market at the MCV Partnership 42 39 198 (170)
Purchased and interchange power 182 102 332 197
Cost of gas sold 297 334 1,243 1,173
Other operating expenses 247 257 526 491
Maintenance 87 58 167 116
Depreciation, depletion and amortization 127 122 289 278
General taxes 68 66 146 141
------- ------- ------- -------
1,307 1,156 3,383 2,581
------- ------- ------- -------
OPERATING INCOME 97 95 89 546
OTHER INCOME (DEDUCTIONS)
Accretion expense (2) (5) (4) (10)
Gain on asset sales, net - 2 - 5
Interest and dividends 22 15 39 25
Regulatory return on capital expenditures 7 15 10 31
Foreign currency gains (losses), net 1 (3) 1 (4)
Other income 15 10 22 18
Other expense (1) (5) (10) (12)
------- ------- ------- -------
42 29 58 53
------- ------- ------- -------
FIXED CHARGES
Interest on long-term debt 120 121 239 243
Interest on long-term debt - related parties 4 6 8 16
Other interest 9 6 16 10
Capitalized interest (3) (1) (5) (2)
Preferred dividends of subsidiaries 2 1 3 2
------- ------- ------- -------
132 133 261 269
------- ------- ------- -------
INCOME (LOSS) BEFORE MINORITY INTERESTS 7 (9) (114) 330
MINORITY INTERESTS (OBLIGATIONS), NET - (14) (68) 99
------- ------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES 7 5 (46) 231
INCOME TAX EXPENSE (BENEFIT) (66) (25) (94) 49
------- ------- ------- -------
INCOME FROM CONTINUING OPERATIONS 73 30 48 182
INCOME FROM DISCONTINUED OPERATIONS, NET OF
$- AND $1 TAX EXPENSE IN 2006 2 - 3 -
------- ------- ------- -------
NET INCOME 75 30 51 182
PREFERRED DIVIDENDS 3 3 6 5
------- ------- ------- -------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 72 $ 27 $ 45 $ 177
======= ======= ======= =======
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-32
THREE MONTHS ENDED SIX MONTHS ENDED
June 30 2006 2005 2006 2005
- ------- ------- ------ ------ -------
In Millions
CMS ENERGY
NET INCOME
Net Income Available to Common Stockholders $ 72 $ 27 $ 45 $ 177
======= ====== ====== =======
BASIC EARNINGS PER AVERAGE COMMON SHARE
Income from Continuing Operations $ 0.32 $ 0.12 $ 0.19 $ 0.86
Gain from Discontinued Operations 0.01 - 0.02 -
------- ------ ------ -------
Net Income Attributable to Common Stock $ 0.33 $ 0.12 $ 0.21 $ 0.86
======= ====== ====== =======
DILUTED EARNINGS PER AVERAGE COMMON SHARE
Income from Continuing Operations $ 0.30 $ 0.12 $ 0.19 $ 0.82
Gain from Discontinued Operations 0.01 - 0.01 -
------- ------ ------ -------
Net Income Attributable to Common Stock $ 0.31 $ 0.12 $ 0.20 $ 0.82
======= ====== ====== =======
DIVIDENDS DECLARED PER COMMON SHARE $ - $ - $ - $ -
------- ------ ------ -------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-33
CMS Energy Corporation
(This page intentionally left blank)
CMS-34
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
June 30 2006 2005
- ------- ------- -------
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 51 $ 182
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear
decommissioning of $3 per period) 289 278
Deferred income taxes and investment tax credit (184) 42
Minority interests (obligations), net (68) 99
Fuel costs mark-to-market at the MCV Partnership 198 (170)
Regulatory return on capital expenditures (10) (31)
Capital lease and other amortization 23 21
Earnings from equity method investees (44) (52)
Accretion expense 4 10
Gain on the sale of assets - (5)
Changes in other assets and liabilities:
Decrease (increase) in accounts receivable and accrued revenues 19 (78)
Decrease in inventories 103 112
Increase (decrease) in accounts payable (105) 23
Increase (decrease) in accrued taxes 23 (56)
Increase in accrued expenses 63 6
Increase (decrease) in the MCV Partnership gas supplier funds on deposit (100) 4
Cash distributions received from equity method investees 48 36
Decrease in other current and non-current assets 175 11
Increase in other current and non-current liabilities 4 48
------- -------
Net cash provided by operating activities $ 489 $ 480
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) $ (320) $ (280)
Cost to retire property (31) (18)
Restricted cash and restricted short-term investments 127 (20)
Investments in nuclear decommissioning trust funds (18) (3)
Proceeds from nuclear decommissioning trust funds 13 24
Proceeds from short-term investments - 295
Purchase of short-term investments - (186)
Maturity of the MCV Partnership restricted investment securities held-to-maturity 118 222
Purchase of the MCV Partnership restricted investment securities held-to-maturity (118) (223)
Proceeds from sale of assets - 59
Other investing (21) 20
------- -------
Net cash used in investing activities $ (250) $ (110)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes, bonds, and other long-term debt $ 43 $ 900
Issuance of common stock 12 283
Retirement of bonds and other long-term debt (271) (1,169)
Payment of preferred stock dividends (6) (6)
Payment of capital lease and financial lease obligations (5) (5)
Debt issuance costs and financing fees (9) (30)
------- -------
Net cash used in financing activities $ (236) $ (27)
------- -------
EFFECT OF EXCHANGE RATES ON CASH 1 1
------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS $ 4 $ 344
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 847 669
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 851 $ 1,013
======= =======
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-35
CMS ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30
2006 December 31
(Unaudited) 2005
------------ ------------
In Millions
PLANT AND PROPERTY (AT COST)
Electric utility $ 8,396 $ 8,204
Gas utility 3,179 3,151
Enterprises 1,060 1,068
Other 31 25
------------ ------------
12,666 12,448
Less accumulated depreciation, depletion and amortization 5,210 5,123
------------ ------------
7,456 7,325
Construction work-in-progress 572 520
------------ ------------
8,028 7,845
------------ ------------
INVESTMENTS
Enterprises 738 712
Other 10 13
------------ ------------
748 725
------------ ------------
CURRENT ASSETS
Cash and cash equivalents at cost, which approximates market 851 847
Restricted cash and restricted short-term investments 67 198
Accounts receivable, notes receivable and accrued revenue, less
allowances of $32 and $31, respectively 790 824
Accounts receivable, dividends receivable, and notes receivable - related parties 67 54
Inventories at average cost
Gas in underground storage 949 1,069
Materials and supplies 93 96
Generating plant fuel stock 129 110
Price risk management assets 59 113
Regulatory assets - postretirement benefits 19 19
Derivative instruments 95 242
Deferred property taxes 147 160
Prepayments and other 127 167
------------ ------------
3,393 3,899
------------ ------------
NON-CURRENT ASSETS
Regulatory Assets
Securitized costs 538 560
Additional minimum pension 399 399
Postretirement benefits 105 116
Customer Choice Act 206 222
Other 475 484
Price risk management assets 114 165
Nuclear decommissioning trust funds 563 555
Goodwill 30 27
Notes receivable - related parties 185 187
Notes receivable 210 187
Other 672 649
------------ ------------
3,497 3,551
------------ ------------
TOTAL ASSETS $ 15,666 $ 16,020
============ ============
CMS-36
STOCKHOLDERS' INVESTMENT AND LIABILITIES
June 30
2006 December 31
(Unaudited) 2005
------------ ------------
In Millions
CAPITALIZATION
Common stockholders' equity
Common stock, authorized 350.0 shares; outstanding 221.5 shares and
220.5 shares, respectively $ 2 $ 2
Other paid-in capital 4,452 4,436
Accumulated other comprehensive loss (282) (288)
Retained deficit (1,783) (1,828)
------------ ------------
2,389 2,322
Preferred stock of subsidiary 44 44
Preferred stock 261 261
Long-term debt 6,851 6,800
Long-term debt - related parties 178 178
Non-current portion of capital and finance lease obligations 310 308
------------ ------------
10,033 9,913
------------ ------------
MINORITY INTERESTS 362 333
------------ ------------
CURRENT LIABILITIES
Current portion of long-term debt, capital and finance leases 174 316
Current portion of long-term debt - related parties - 129
Accounts payable 496 597
Accounts payable - related parties 13 16
Accrued interest 157 145
Accrued taxes 354 331
Price risk management liabilities 66 80
Current portion of gas supply contract obligations 11 10
Deferred income taxes 72 55
MCV Partnership gas supplier funds on deposit 93 193
Other 242 241
------------ ------------
1,678 2,113
------------ ------------
NON-CURRENT LIABILITIES
Regulatory Liabilities
Regulatory liabilities for cost of removal 1,166 1,120
Income taxes, net 468 455
Other regulatory liabilities 222 178
Postretirement benefits 424 382
Deferred income taxes 79 297
Deferred investment tax credit 64 67
Asset retirement obligations 496 496
Price risk management liabilities 127 161
Gas supply contract obligations 53 61
Other 494 444
------------ ------------
3,593 3,661
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 2, 3 and 5)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $ 15,666 $ 16,020
============ ============
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-37
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
June 30 2006 2005 2006 2005
- ------- ------- ------- ------- -------
In Millions
COMMON STOCK
At beginning and end of period $ 2 $ 2 $ 2 $ 2
------- ------- ------- -------
OTHER PAID-IN CAPITAL
At beginning of period 4,445 4,147 4,436 4,140
Common stock issued 7 275 15 281
Common stock reissued - - 1 1
------- ------- ------- -------
At end of period 4,452 4,422 4,452 4,422
------- ------- ------- -------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Minimum Pension Liability
At beginning of period (19) (17) (19) (17)
Minimum pension liability adjustments (a) - (9) - (9)
------- ------- ------- -------
At end of period (19) (26) (19) (26)
------- ------- ------- -------
Investments
At beginning of period 11 8 9 9
Unrealized gain (loss) on investments (a) (1) - 1 (1)
------- ------- ------- -------
At end of period 10 8 10 8
------- ------- ------- -------
Derivative Instruments
At beginning of period 30 1 35 (9)
Unrealized gain (loss) on derivative instruments (a) 4 (6) - 12
Reclassification adjustments included in net income (loss) (a) 1 2 - (6)
------- ------- ------- -------
At end of period 35 (3) 35 (3)
------- ------- ------- -------
Foreign Currency Translation
At beginning of period (308) (315) (313) (319)
Other foreign currency translations (a) - 3 5 7
------- ------- ------- -------
At end of period (308) (312) (308) (312)
------- ------- ------- -------
At end of period (282) (333) (282) (333)
------- ------- ------- -------
RETAINED DEFICIT
At beginning of period (1,855) (1,584) (1,828) (1,734)
Net income (a) 75 30 51 182
Preferred stock dividends declared (3) (3) (6) (5)
------- ------- ------- -------
At end of period (1,783) (1,557) (1,783) (1,557)
------- ------- ------- -------
TOTAL COMMON STOCKHOLDERS' EQUITY $ 2,389 $ 2,534 $ 2,389 $ 2,534
======= ======= ======= =======
(A) DISCLOSURE OF OTHER COMPREHENSIVE INCOME:
Minimum Pension Liability
Minimum pension liability adjustments, net of tax benefit of
$-, $(5), $- and $(5), respectively $ - $ (9) $ - $ (9)
Investments
Unrealized gain (loss) on investments, net of tax of
$1, $-, $- and $-, respectively (1) - 1 (1)
Derivative Instruments
Unrealized gain (loss) on derivative instruments, net of tax (tax benefit) of
$(2), $4, $(7) and $13, respectively 4 (6) - 12
Reclassification adjustments included in net income, net of tax benefit of
$(1), $-, $(2) and $(6), respectively 1 2 - (6)
Foreign currency translation, net - 3 5 7
Net income 75 30 51 182
------- ------- ------- -------
Total Other Comprehensive Income $ 79 $ 20 $ 57 $ 185
======= ======= ======= =======
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-38
CMS Energy Corporation
CMS ENERGY CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
These interim Consolidated Financial Statements have been prepared by CMS Energy
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. As such, certain information and footnote
disclosures normally included in consolidated financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted. Certain prior year amounts have been
reclassified to conform to the presentation in the current year. In management's
opinion, the unaudited information contained in this report reflects all
adjustments of a normal recurring nature necessary to assure the fair
presentation of financial position, results of operations and cash flows for the
periods presented. The Condensed Notes to Consolidated Financial Statements and
the related Consolidated Financial Statements should be read in conjunction with
the Consolidated Financial Statements and related Notes contained in CMS
Energy's Form 10-K/A Amendment No. 1 for the year ended December 31, 2005. Due
to the seasonal nature of CMS Energy's operations, the results as presented for
this interim period are not necessarily indicative of results to be achieved for
the fiscal year.
1: CORPORATE STRUCTURE AND ACCOUNTING POLICIES
CORPORATE STRUCTURE: CMS Energy is an energy company operating primarily in
Michigan. We are the parent holding company of Consumers and Enterprises.
Consumers is a combination electric and gas utility company serving Michigan's
Lower Peninsula. Enterprises, through various subsidiaries and equity
investments, is engaged in domestic and international diversified energy
businesses including independent power production, electric distribution, and
natural gas transmission, storage and processing. We manage our businesses by
the nature of services each provides and operate principally in three business
segments: electric utility, gas utility, and enterprises.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include CMS
Energy, Consumers, Enterprises, and all other entities in which we have a
controlling financial interest or of which we are the primary beneficiary, in
accordance with FASB Interpretation No. 46(R). We use the equity method of
accounting for investments in companies and partnerships that are not
consolidated, where we have significant influence over operations and financial
policies, but are not the primary beneficiary. We eliminate intercompany
transactions and balances.
USE OF ESTIMATES: We prepare our consolidated financial statements in conformity
with U.S. generally accepted accounting principles. We are required to make
estimates using assumptions that may affect the reported amounts and
disclosures. Actual results could differ from those estimates.
We are required to record estimated liabilities in the consolidated financial
statements when it is probable that a loss will be incurred in the future as a
result of a current event, and when an amount can be reasonably estimated. We
have used this accounting principle to record estimated liabilities as discussed
in Note 2, Contingencies.
REVENUE RECOGNITION POLICY: We recognize revenues from deliveries of electricity
and natural gas, and the transportation, processing, and storage of natural gas
when services are provided. Sales taxes are recorded as liabilities and are not
included in revenues. Revenues on sales of marketed electricity,
CMS-39
CMS Energy Corporation
natural gas, and other energy products are recognized at delivery.
Mark-to-market changes in the fair values of energy trading contracts that
qualify as derivatives are recognized as revenues in the periods in which the
changes occur.
ACCOUNTING FOR MISO TRANSACTIONS: CMS ERM accounts for MISO transactions on a
net basis for all of the generating units for which CMS ERM markets power. CMS
ERM allocates other fixed costs associated with MISO settlements back to the
generating units and records billing adjustments when invoices are received.
Consumers accounts for MISO transactions on a net basis for all of its
generating units combined. Consumers records billing adjustments when invoices
are received and also records an expense accrual for future adjustments based on
historical experience.
INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY: Our subsidiaries and affiliates
whose functional currency is not the U.S. dollar translate their assets and
liabilities into U.S. dollars at the exchange rates in effect at the end of the
fiscal period. We translate revenue and expense accounts of such subsidiaries
and affiliates into U.S. dollars at the average exchange rates that prevailed
during the period. These foreign currency translation adjustments are shown in
the stockholders' equity section on our Consolidated Balance Sheets. Exchange
rate fluctuations on transactions denominated in a currency other than the
functional currency, except those that are hedged, are included in determining
net income.
At June 30, 2006, the cumulative Foreign Currency Translation component of
stockholders' equity is $308 million, which primarily represents currency losses
in Argentina and Brazil. The cumulative foreign currency loss due to the
unfavorable exchange rate of the Argentine peso using an exchange rate of 3.092
pesos per U.S. dollar was $266 million, net of tax. The cumulative foreign
currency loss due to the unfavorable exchange rate of the Brazilian real using
an exchange rate of 2.217 reais per U.S. dollar was $45 million, net of tax.
LONG-LIVED ASSETS AND EQUITY METHOD INVESTMENTS: Our assessment of the
recoverability of long-lived assets and equity method investments involves
critical accounting estimates. We periodically perform tests of impairment if
certain conditions that are other than temporary exist that may indicate the
carrying value may not be recoverable. Of our total assets, recorded at $15.666
billion at June 30, 2006, 56 percent represent long-lived assets and equity
method investments that are subject to this type of analysis.
There were no asset sales for the six months ended June 30, 2006. Gross cash
proceeds received from the sale of assets totaled $59 million for the six months
ended June 30, 2005. The impacts of these sales are included in Gain on assets
sales, net on our Consolidated Statements of Income.
For the six months ended June 30, 2005, we sold the following assets:
In Millions
------------------------
Pretax After-tax
Date sold Business/Project Gain Gain
- --------- ----------------------------------- --------- ---------
February GVK $ 3 $ 2
April Scudder Latin American Power Fund 2 1
April Gas turbine and auxiliary equipment - -
--------- ---------
Total gain on asset sales $ 5 $ 3
========= =========
CMS-40
CMS Energy Corporation
DETERMINATION OF PENSION MRV OF PLAN ASSETS: We determine the MRV for pension
plan assets, as defined in SFAS No. 87, as the fair value of plan assets on the
measurement date, adjusted by the gains or losses that will not be admitted into
MRV until future years. We reflect each year's assets gain or loss in MRV in
equal amounts over a five-year period beginning on the date the original amount
was determined. The MRV is used in the calculation of net pension cost.
OTHER INCOME AND OTHER EXPENSE: The following tables show the components of
Other income and Other expense:
In Millions
---------------------------------------------------
Three Months Ended Six Months Ended
--------------------- ---------------------
June 30 2006 2005 2006 2005
- ------- ------ ------ ------ ------
Other income
Interest and dividends - related parties $ 4 $ 3 $ 6 $ 5
Electric restructuring return 1 3 2 4
Return on stranded and security costs 2 2 3 3
Nitrogen oxide allowance sales 6 1 6 1
Refund of surety bond premium - - 1 -
Reduction of contingent liability - - - 3
All other 2 1 4 2
------ ------ ------ ------
Total other income $ 15 $ 10 $ 22 $ 18
====== ====== ====== ======
In Millions
---------------------------------------------------
Three Months Ended Six Months Ended
--------------------- ---------------------
June 30 2006 2005 2006 2005
- ------- ------ ------ ------ ------
Other expense
Investment write-down $ - $ - $ - $ (1)
Loss on SERP investment - (1) - (1)
Loss on reacquired and extinguished debt - (1) (5) (6)
Civic and political expenditures - - (1) (1)
Donations - - (1) -
All other (1) (3) (3) (3)
------ ------ ------ ------
Total other expense $ (1) $ (5) $ (10) $ (12)
====== ====== ====== ======
RECLASSIFICATIONS: Certain prior year amounts have been reclassified for
comparative purposes. These reclassifications did not affect consolidated net
income for the periods presented.
NEW ACCOUNTING STANDARDS NOT YET EFFECTIVE: FIN 48, Accounting for Uncertainty
in Income Taxes: In June 2006, the FASB issued FIN 48. This interpretation
provides a two-step approach for the recognition and measurement of uncertain
tax positions taken, or expected to be taken, by a company on its income tax
returns. The first step is to evaluate the tax position to determine if, based
on management's best judgment, it is greater than 50 percent likely that the
taxing authority will sustain the tax position. The second step is to measure
the appropriate amount of the benefit to recognize. This is done by estimating
the potential outcomes and recognizing the greatest amount that has a cumulative
probability of at least 50 percent. We are presently evaluating the impacts, if
any, of FIN 48. Any impacts of implementing FIN 48 will result in a cumulative
adjustment to retained earnings. This interpretation is effective for us
beginning January 1, 2007.
2: CONTINGENCIES
SEC AND OTHER INVESTIGATIONS: During the period of May 2000 through January
2002, CMS MST engaged in simultaneous, prearranged commodity trading
transactions in which energy commodities were sold and repurchased at the same
price. These so called round-trip trades had no impact on previously reported
consolidated net income, earnings per share, or cash flows but had the effect of
increasing operating revenues and operating expenses by equal amounts.
CMS-41
CMS Energy Corporation
CMS Energy is cooperating with an investigation by the DOJ concerning round-trip
trading, which the DOJ commenced in May 2002. CMS Energy is unable to predict
the outcome of this matter and what effect, if any, this investigation will have
on its business. In March 2004, the SEC approved a cease-and-desist order
settling an administrative action against CMS Energy related to round-trip
trading. The order did not assess a fine and CMS Energy neither admitted nor
denied the order's findings. The settlement resolved the SEC investigation
involving CMS Energy and CMS MST. Also in March 2004, the SEC filed an action
against three former employees related to round-trip trading by CMS MST. One of
the individuals has settled with the SEC. CMS Energy is currently advancing
legal defense costs for the remaining two individuals, in accordance with
existing indemnification policies. Those individuals filed a motion to dismiss
the SEC action, which was denied.
SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of
complaints were filed against CMS Energy, Consumers, and certain officers and
directors of CMS Energy and its affiliates. The cases were consolidated into a
single lawsuit, which generally seeks unspecified damages based on allegations
that the defendants violated United States securities laws and regulations by
making allegedly false and misleading statements about CMS Energy's business and
financial condition, particularly with respect to revenues and expenses recorded
in connection with round-trip trading by CMS MST. In January 2005, the court
granted a motion to dismiss Consumers and three of the individual defendants,
but denied the motions to dismiss CMS Energy and the 13 remaining individual
defendants. The court issued an opinion and order dated March 24, 2006, granting
in part and denying in part plaintiffs' amended motion for class certification.
The court conditionally certified a class consisting of "all persons who
purchased CMS Common Stock during the period of October 25, 2000 through and
including May 17, 2002 and who were damaged thereby." The court excluded
purchasers of CMS Energy's 8.75 percent Adjustable Convertible Trust Securities
("ACTS") from the class. Trial has been scheduled for March 2007. In response to
the court's opinion and order excluding purchasers of ACTS from the shareholder
class, a new class action lawsuit was filed on behalf of ACTS purchasers. The
new lawsuit names the same defendants as the shareholder action and contains
essentially the same allegations and class period. CMS Energy and the individual
defendants will defend themselves vigorously in this litigation but cannot
predict its outcome.
ERISA LAWSUITS: CMS Energy was a named defendant, along with Consumers, CMS MST,
and certain named and unnamed officers and directors, in two lawsuits, filed in
July 2002 in United States District Court for the Eastern District of Michigan,
brought as purported class actions on behalf of participants and beneficiaries
of the CMS Employees' Savings Plan (the Plan). Plaintiffs alleged breaches of
fiduciary duties under ERISA and sought restitution on behalf of the Plan with
respect to a decline in value of the shares of CMS Energy Common Stock held in
the Plan, as well as other equitable relief and legal fees. On March 1, 2006,
CMS Energy and Consumers reached an agreement, subject to court and independent
fiduciary approval, to settle the lawsuits. The settlement agreement required a
$28 million cash payment by CMS Energy's primary insurer to be used to pay Plan
participants and beneficiaries for alleged losses, as well as any legal fees and
expenses. In addition, CMS Energy agreed to certain other steps regarding
administration of the Plan. The hearing on final approval of the settlement was
held on June 15, 2006. On June 27, 2006, the judge entered the Order and Final
Judgment, approving the proposed settlement with minor modifications.
GAS INDEX PRICE REPORTING INVESTIGATION: CMS Energy has notified appropriate
regulatory and governmental agencies that some employees at CMS MST and CMS
Field Services appeared to have provided inaccurate information regarding
natural gas trades to various energy industry publications which compile and
report index prices. CMS Energy is cooperating with an ongoing investigation by
the DOJ regarding this matter. CMS Energy is unable to predict the outcome of
the DOJ investigation
CMS-42
CMS Energy Corporation
and what effect, if any, the investigation will have on its business. The CFTC
filed a civil injunctive action against two former CMS Field Services employees
in Oklahoma federal district court on February 1, 2005. The action alleges the
two engaged in reporting false natural gas trade information, and seeks to
enjoin such acts, compel compliance with the Commodities Exchange Act, and
impose monetary penalties. CMS Energy is currently advancing legal defense costs
to the two individuals in accordance with existing indemnification policies.
BAY HARBOR: As part of the development of Bay Harbor by certain subsidiaries of
CMS Energy, which went forward under an agreement with the MDEQ, third parties
constructed a golf course and a park over several abandoned cement kiln dust
(CKD) piles, left over from the former cement plant operation on the Bay Harbor
site. Pursuant to the agreement with the MDEQ, a water collection system was
constructed to recover seep water from one of the CKD piles and CMS Energy built
a treatment plant to treat the seep water. In 2002, CMS Energy sold its interest
in Bay Harbor, but retained its obligations under previous environmental
indemnifications entered into at the inception of the project.
In September 2004, following an eight month shutdown of the treatment plant, the
MDEQ issued a notice of noncompliance after finding high-pH seep water in Lake
Michigan adjacent to the property. The MDEQ also found higher than acceptable
levels of heavy metals, including mercury, in the seep water.
In February 2005, the EPA executed an Administrative Order on Consent (AOC) to
address problems at Bay Harbor, upon the consent of CMS Land Company, a
subsidiary of Enterprises (CMS Land) and CMS Capital, LLC, a subsidiary of CMS
Energy. Pursuant to the AOC, the EPA approved a final removal action work plan
in July 2005. Among other things, the plan calls for the installation of
collection trenches to intercept high-pH CKD leachate flow to the lake. Final
installation of the trenches in the western-most section has been delayed
because of the discovery of CKD on the beach. Regarding these areas, CMS Land
submitted an Interim Response Plan, which was approved by the EPA on March 30,
2006. On May 30, 2006, the EPA approved a pilot carbon dioxide augmentation plan
to augment the leachate recovery system by improving pH results in certain
areas. The augmentation system was installed in June 2006. In February 2006, CMS
Land submitted to the EPA a proposed Remedial Investigation and Feasibility
Study for the East Park CKD pile. The EPA approved a schedule for near-term
activities, which includes consolidating CKD materials and installing collection
trenches in the East Park leachate release area. On June 19, 2006, the EPA
approved an East CKD Removal Action Work Plan and Final Engineering Design for
Consolidation. The work plan calls for completion of the collection trenches in
East Park by November 15, 2006.
Several property owners at Bay Harbor made claims for loss or damage to their
property. The owner of one parcel has filed a lawsuit in Emmet County Circuit
Court against CMS Energy and several of its subsidiaries, as well as Bay Harbor
Golf Club Inc., Bay Harbor Company LLC, David C. Johnson, and David V. Johnson,
one of the developers at Bay Harbor. Several of these defendants have demanded
indemnification from CMS Energy and affiliates for the claims made against them
in the lawsuit. After a March 28, 2006 hearing on motions filed by CMS Energy
and other defendants, the judge dismissed various counts of the complaint. CMS
Land has entered into various access, purchase and settlement agreements with
several of the affected landowners at Bay Harbor and continues negotiations with
other landowners for access as necessary to implement remediation measures. CMS
Land completed the purchase of two unimproved lots and a lot with a house. CMS
Energy will defend vigorously the existing case, and any other property damage
and personal injury claims or lawsuits.
CMS-43
CMS Energy Corporation
CMS Energy has recorded a charge of $85 million for its obligations. An adverse
outcome of this matter could, depending on the size of any indemnification
obligation or liability under environmental laws, have a potentially significant
adverse effect on CMS Energy's financial condition and liquidity and could
negatively impact CMS Energy's financial results. CMS Energy cannot predict the
ultimate cost or outcome of this matter.
CONSUMERS' ELECTRIC UTILITY CONTINGENCIES
ELECTRIC ENVIRONMENTAL MATTERS: Our operations are subject to environmental laws
and regulations. Costs to operate our facilities in compliance with these laws
and regulations generally have been recovered in customer rates.
Clean Air Act: Compliance with the federal Clean Air Act and resulting
regulations has been, and will continue to be, a significant focus for us. The
Nitrogen Oxide State Implementation Plan requires significant reductions in
nitrogen oxide emissions. To comply with the regulations, we expect to incur
capital expenditures totaling $819 million through 2011. The key assumptions in
the capital expenditure estimate include:
- construction commodity prices, especially construction material and
labor,
- project completion schedules,
- cost escalation factor used to estimate future years' costs, and
- an AFUDC capitalization rate.
Our current capital cost estimates include an escalation rate of 2.6 percent and
an AFUDC capitalization rate of 8.4 percent. As of June 2006, we have incurred
$634 million in capital expenditures to comply with the federal Clean Air Act
and resulting regulations and anticipate that the remaining $185 million of
capital expenditures will be made in 2006 through 2011. These expenditures
include installing selective catalytic reduction control technology at four of
our coal-fired electric generating plants.
In addition to modifying coal-fired electric generating plants, our compliance
plan includes the use of nitrogen oxide emission allowances until all of the
control equipment is operational in 2011. The nitrogen oxide emission allowance
annual expense is projected to be $6 million per year, which we expect to
recover from our customers through the PSCR process. The projected annual
expense is based on market price forecasts and forecasts of regulatory
provisions, known as progressive flow control, that restrict the usage in any
given year of allowances banked from previous years. The allowances and their
cost are accounted for as inventory. The allowance inventory is expensed at the
rolling average cost as the coal-fired electric generating plants emit nitrogen
oxide.
Clean Air Interstate Rule: In March 2005, the EPA adopted the Clean Air
Interstate Rule that requires additional coal-fired electric generating plant
emission controls for nitrogen oxides and sulfur dioxide. The rule involves a
two-phase program to reduce emissions of nitrogen oxides by more than 60 percent
and sulfur dioxide by more than 70 percent from 2003 levels by 2015. The final
rule will require that we run our selective catalytic reduction control
technology units year round beginning in 2009 and may require that we purchase
additional nitrogen oxide allowances beginning in 2009. The additional nitrogen
oxide allowances are estimated to cost $4 million per year for years 2009
through 2011, which we expect to recover from our customers through the PSCR
process.
In addition to the selective catalytic reduction control technology installed to
meet the nitrogen oxide standards, our current plan includes installation of
flue gas desulfurization scrubbers. The scrubbers
CMS-44
CMS Energy Corporation
are to be installed by 2014 to meet the Phase I reduction requirements of the
Clean Air Interstate Rule, at an estimated total cost of $960 million. Our
capital cost estimates include an escalation rate of 2.6 percent and an AFUDC
capitalization rate of 8.4 percent. We currently have a surplus of sulfur
dioxide allowances, which were granted by the EPA and are accounted for as
inventory. In January 2006, we sold some of our excess sulfur dioxide allowances
for $61 million and recognized the proceeds as a regulatory liability.
Clean Air Mercury Rule: Also in March 2005, the EPA issued the Clean Air Mercury
Rule, which requires initial reductions of mercury emissions from coal-fired
electric generating plants by 2010 and further reductions by 2018. The Clean Air
Mercury Rule establishes a cap-and-trade system for mercury emissions that is
similar to the system used in the Clean Air Interstate Rule. The industry has
not reached a consensus on the technical methods for curtailing mercury
emissions. However, we anticipate our capital costs for mercury emissions
reductions required by Phase I of the Clean Air Mercury Rule to be less than $50
million and implemented by 2010. Phase II requirements of the Clean Air Mercury
Rule are not yet known and a cost estimate has not been determined.
In August 2005, the MDEQ filed a Motion to Intervene in a court challenge to
certain aspects of EPA's Clean Air Mercury Rule, asserting that the rule is
inadequate. We cannot predict the outcome of this proceeding.
In April 2006, Michigan's governor announced a plan that would result in mercury
emissions reductions of 90 percent by 2015. This plan would adopt the Clean Air
Mercury Rule through its first phase. Beginning in year 2015, the mercury
emissions reduction standards outlined in the governor's plan would become more
stringent than those included in the Clean Air Mercury Rule. We are working with
the MDEQ on the details of these rules. We will develop a cost estimate when the
details of these rules are determined.
The EPA has alleged that some utilities have incorrectly classified plant
modifications as "routine maintenance" rather than seeking permits to modify the
plant from the EPA. We have received and responded to information requests from
the EPA on this subject. We believe that we have properly interpreted the
requirements of "routine maintenance." If our interpretation is found to be
incorrect, we may be required to install additional pollution controls at some
or all of our coal-fired electric generating plants and potentially pay fines.
Additionally, the viability of certain plants remaining in operation could be
called into question.
Cleanup and Solid Waste: Under the Michigan Natural Resources and Environmental
Protection Act, we expect that we will ultimately incur investigation and
remedial action costs at a number of sites. We believe that these costs will be
recoverable in rates under current ratemaking policies.
We are a potentially responsible party at several contaminated sites
administered under Superfund. Superfund liability is joint and several, meaning
that many other creditworthy parties with substantial assets are potentially
responsible with respect to the individual sites. Based on our experience, we
estimate that our share of the total liability for the known Superfund sites
will be between $1 million and $10 million. At June 30, 2006, we have recorded a
liability for the minimum amount of our estimated Superfund liability.
In October 1998, during routine maintenance activities, we identified PCB as a
component in certain paint, grout, and sealant materials at Ludington. We
removed and replaced part of the PCB material.
CMS-45
CMS Energy Corporation
We have proposed a plan to deal with the remaining materials and are awaiting a
response from the EPA.
MCV Environmental Issue: On July 12, 2004, the MDEQ, Air Control Division,
issued the MCV Partnership a Letter of Violation asserting that the MCV Facility
violated its Air Use Permit to Install (PTI) by exceeding the carbon monoxide
emission limit on the Unit 14 duct burner and failing to maintain certain
records in the required format. The MCV Partnership there after declared five of
the six duct burners in the MCV Facility as unavailable for operational use
(which reduced the generation capability of the MCV Facility by approximately
100 MW) and took other corrective action to address the MDEQ's assertions.
Testing of the one available duct burner occurred in April 2005, and its
emissions met permitted levels due to the configuration of that particular unit.
In July 2004, the MCV Partnership filed a response to the Letter of Violation,
opposing its findings. On December 13, 2004, the MDEQ informed the MCV
Partnership that it was pursuing an escalated enforcement action against the MCV
Partnership. The MDEQ also stated that the alleged violations are deemed
federally significant and, as such, placed the MCV Partnership on the EPA's High
Priority Violators List (HPVL). Following voluntary settlement discussions, the
MDEQ issued the MCV Partnership a new PTI, which established higher carbon
monoxide emissions limits on the five duct burners that had been declared
unavailable. The MCV Partnership has returned those duct burners to service. The
MDEQ and the MCV Partnership are pursuing a settlement of the emission
violation, which will also satisfy state and federal requirements and remove the
MCV Partnership from the HPVL. At this time, we cannot predict the financial
impact or outcome of this issue.
LITIGATION: In October 2003, a group of eight PURPA qualifying facilities (the
plaintiffs), which sell power to us, filed a lawsuit in Ingham County Circuit
Court. The lawsuit alleged that we incorrectly calculated the energy charge
payments made pursuant to power purchase agreements with qualifying facilities.
In February 2004, the Ingham County Circuit Court judge deferred to the primary
jurisdiction of the MPSC, dismissing the circuit court case without prejudice.
The Michigan Court of Appeals upheld this order on the primary jurisdiction
question, but remanded the case back on another issue. In February 2005, the
MPSC issued an order in the 2004 PSCR plan case concluding that we
CMS-46
CMS Energy Corporation
have been correctly administering the energy charge calculation methodology. The
plaintiffs have appealed the MPSC order to the Michigan Court of Appeals. The
plaintiffs also filed suit in the United States Court for the Western District
of Michigan, which the judge subsequently dismissed. The plaintiffs have
appealed the dismissal to the United States Court of Appeals. We cannot predict
the outcome of these appeals.
CONSUMERS' ELECTRIC UTILITY RESTRUCTURING MATTERS
ELECTRIC ROA: The Customer Choice Act allows all of our electric customers to
buy electric generation service from us or from an alternative electric
supplier. At June 30, 2006, alternative electric suppliers were providing 311 MW
of generation service to ROA customers, which represents 4 percent of our total
distribution load. This represents a decrease of 11 percent of ROA load compared
to March 31, 2006 and a decrease of 62 percent of ROA load compared to June 30,
2005. It is difficult to predict future ROA customer trends.
STRANDED COSTS: Prior MPSC orders adopted a mechanism pursuant to the Customer
Choice Act to provide recovery of Stranded Costs that occur when customers leave
our system to purchase electricity from alternative suppliers. In November 2005,
we filed an application with the MPSC related to the determination of 2004
Stranded Costs. Applying the Stranded Cost methodology used in prior MPSC
orders, we concluded that we experienced Stranded Costs in 2004; however, we
also concluded that these costs were offset completely by our net sales of
excess power into the bulk electricity market.
In March 2006, the ALJ in our 2004 PSCR reconciliation case issued a Proposal
for Decision recommending that we use a greater portion of our net sales of
excess power into the bulk electricity market to offset our 2004 PSCR costs,
rather than 2004 Stranded Costs. We believe, if accepted, that this
recommendation would lead to a greater amount of 2004 Stranded Costs to recover
from ROA customers. However, in June 2006, the ALJ issued a Proposal for
Decision in our 2004 Stranded Cost case recommending that the MPSC find that we
had no Stranded Costs in 2004 because the ALJ did not believe we demonstrated
that the Stranded Costs were caused by ROA. If the MPSC adopts the ALJ
recommendations earnings would be impacted adversely by $10 million. In June
2006, we filed exceptions to this Proposal for Decision in the Stranded Cost
case. We cannot predict the outcome of these proceedings.
CONSUMERS' ELECTRIC UTILITY RATE MATTERS
POWER SUPPLY COSTS: To reduce the risk of high electric prices during peak
demand periods and to achieve our reserve margin target, we employ a strategy of
purchasing electric capacity and energy contracts for the physical delivery of
electricity primarily in the summer months and to a lesser degree in the winter
months. We have purchased capacity and energy contracts covering the reserve
margin requirements for 2006 and covering partially the estimated reserve margin
requirements for 2007 through 2010. As a result, we have recognized an asset of
$75 million for unexpired capacity and energy contracts at June 30, 2006. At
July 2006, we expect the total capacity cost of electric capacity and energy
contracts for 2006 to be $19 million.
CMS-47
CMS Energy Corporation
PSCR: The PSCR process allows recovery of reasonable and prudent power supply
costs. Revenues from the PSCR charges are subject to reconciliation after review
of actual costs for reasonableness and prudence. In September 2005, we submitted
our 2006 PSCR plan filing to the MPSC. In November 2005, we submitted an amended
2006 PSCR plan to the MPSC to include higher estimates for METC and coal supply
costs. In December 2005, the MPSC issued an order that temporarily excluded
these increased costs from our PSCR charge and further reduced the charge by one
mill per kWh. We implemented the temporary order in January 2006.
In April 2006, the MPSC Staff filed briefs in the 2006 PSCR plan case
recommending inclusion of all filed costs in the 2006 PSCR charge, including
those temporarily excluded in the December 2005 temporary order. In May 2006,
the ALJ issued a Proposal for Decision with a recommendation similar to the MPSC
Staff. However, the ALJ recommended that we continue to exclude those costs
temporarily excluded until addressed in our 2006 PSCR reconciliation case, which
we plan to file in March 2007. Depending on the action taken by the MPSC, our
cash underrecoveries of power supply costs for 2006 could range from $39 million
to $146 million.
These underrecoveries are due to increased bundled sales, and other cost
increases beyond those included in the September 2005 and November 2005 filings.
We expect to recover fully all of our PSCR costs. When we incur and are unable
to collect these costs in a timely manner, there is a negative impact on our
cash flows from electric utility operations.
In March 2006, we submitted our 2005 PSCR reconciliation filing to the MPSC. In
July 2006, we submitted supplemental testimony in which we calculated an
underrecovery of $37 million for commercial and industrial customers, which we
expect to recover fully. We cannot predict the outcome of these PSCR
proceedings.
OTHER CONSUMERS' ELECTRIC UTILITY CONTINGENCIES
THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and operates
the MCV Facility, contracted to sell electricity to Consumers for a 35-year
period beginning in 1990. We hold a 49 percent partnership interest in the MCV
Partnership, and a 35 percent lessor interest in the MCV Facility. In 2004, we
consolidated the MCV Partnership and the FMLP into our consolidated financial
statements in accordance with FASB Interpretation No. 46(R).
Sale of our Interest in the MCV Partnership and the FMLP: In July 2006, we
reached an agreement to sell 100 percent of the stock of CMS Midland, Inc. and
CMS Midland Holdings Company to an affiliate of GSO Capital Partners and
Rockland Capital Energy Investments for $60.5 million. These Consumers'
subsidiaries hold our interest in the MCV Partnership and the FMLP. The MCV PPA
and the associated customer rates are not affected by the sale. We are targeting
to close on the sale by the end of 2006. The sale is subject to various
regulatory approvals, including the MPSC's approval and the expiration of the
waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.
On July 27, 2006, the MPSC issued an order establishing a contested case
proceeding and provided a schedule, which will allow for a decision from the
MPSC by the end of 2006. We cannot predict the timing or the outcome of the
MPSC's decision. We further cannot predict with certainty whether or when this
transaction will be completed.
Further, because of the PPA in place between Consumers and the MCV Partnership,
the transaction is effectively a sale and leaseback for accounting purposes.
SFAS No. 98 specifies the accounting required for a seller's sale and
simultaneous leaseback transaction involving real estate,
CMS-48
CMS Energy Corporation
including real estate with equipment. In accordance with SFAS No. 98, the
transaction will be required to be accounted for as a financing and not a sale.
This is due to forms of continuing involvement we will have with the MCV
Partnership. At closing, we will remove from our Consolidated Balance Sheets all
of the assets, liabilities, and minority interest associated with both the MCV
Partnership and the FMLP except for the real estate assets and equipment of the
MCV Partnership. Those assets will remain at their carrying value. If the fair
value is determined to be less than the present carrying value, an impairment
charge would result.
Further, as disclosed in Note 5, Financial and Derivative Instruments,
"Derivative Contracts Associated with the MCV Partnership," we will reflect in
earnings certain cumulative amounts of MCV Partnership-related derivative fair
value changes that are accounted for in other comprehensive income. We will also
reflect in earnings a liability for the fair value of a guarantee, and income
related to certain MCV Partnership gas contracts which are being sold. The
transaction will not result in the MCV Partnership or the FMLP assets being
classified as held for sale on our Consolidated Balance Sheets.
Financial Condition of the MCV Partnership: Under the MCV PPA, variable energy
payments to the MCV Partnership are based on the cost of coal burned at our coal
plants and our operation and maintenance expenses. However, the MCV
Partnership's costs of producing electricity are tied to the cost of natural
gas. Historically high natural gas prices have caused the MCV Partnership to
reevaluate the economics of operating the MCV Facility and to record an
impairment charge in 2005. If natural gas prices remain at present levels or
increase, the operations of the MCV Facility would be adversely affected and
could result in the MCV Partnership failing to meet its obligations under the
sale and leaseback transactions and other contracts. Due to the impairment of
the MCV Facility and subsequent losses, the value of the equity held by all of
the owners of the MCV Partnership has decreased significantly and is now
negative. Since we are one of the general partners of the MCV Partnership, we
have recognized a portion of the limited partners' negative equity. At June 30,
2006, the negative minority interest for the other general partners' share,
including their portion of the limited partners' negative equity, is $112
million and is included in Other Non-current Assets on our Consolidated Balance
Sheets.
Underrecoveries related to the MCV PPA: Further, the cost that we incur under
the MCV PPA exceeds the recovery amount allowed by the MPSC. We expense all cash
underrecoveries directly to income. We estimate underrecoveries of $55 million
in 2006 and $39 million in 2007. Of the 2006 estimate, we expensed $28 million
during the six months ended June 30, 2006. However, Consumers' direct savings
from the RCP, after allocating a portion to customers, are used to offset our
capacity and fixed energy underrecoveries expense. After September 15, 2007, we
expect to claim relief under the regulatory out provision in the MCV PPA,
thereby limiting our capacity and fixed energy payments to the MCV Partnership
to the amounts that we collect from our customers. The MCV Partnership has
indicated that it may take issue with our exercise of the regulatory out clause
after September 15, 2007. We believe that the clause is valid and fully
effective, but cannot assure that it will prevail in the event of a dispute. If
we are successful in exercising the regulatory out clause, the MCV Partnership
has the right to terminate the MCV PPA. The MPSC's future actions on the
capacity and fixed energy payments recoverable from customers subsequent to
September 15, 2007 may affect negatively the financial performance of the MCV
Partnership.
In January 2005, the MPSC issued an order approving the RCP, with modifications.
The RCP allows us to recover the same amount of capacity and fixed energy
charges from customers as approved in prior MPSC orders. However, we are able to
dispatch the MCV Facility on the basis of natural gas
CMS-49
CMS Energy Corporation
market prices, which reduces the MCV Facility's annual production of electricity
and, as a result, reduces the MCV Facility's consumption of natural gas by an
estimated 30 to 40 bcf annually. This decrease in the quantity of high-priced
natural gas consumed by the MCV Facility benefits our interest in the MCV
Partnership.
In January 2005, we implemented the RCP. The underlying agreement for the RCP
between Consumers and the MCV Partnership extends through the term of the MCV
PPA. However, either party may terminate that agreement under certain
conditions. In February 2005, a group of intervenors in the RCP case filed for
rehearing of the MPSC order approving the RCP. The Attorney General also filed
an appeal with the Michigan Court of Appeals. We cannot predict the outcome of
these matters.
MCV PARTNERSHIP PROPERTY TAXES: In January 2004, the Michigan Tax Tribunal
issued its decision in the MCV Partnership's tax appeal against the City of
Midland for tax years 1997 through 2000. The City of Midland appealed the
decision to the Michigan Court of Appeals, and the MCV Partnership filed a
cross-appeal at the Michigan Court of Appeals. The MCV Partnership also has a
pending case with the Michigan Tax Tribunal for tax years 2001 through 2006. The
MCV Partnership estimates that the 1997 through 2005 tax year cases will result
in a refund to the MCV Partnership of $87 million, inclusive of interest, if the
decision of the Michigan Tax Tribunal is upheld. In February 2006, the Michigan
Court of Appeals largely affirmed the Michigan Tax Tribunal decision, but
remanded the case back to the Michigan Tax Tribunal to clarify certain aspects
of the Tax Tribunal decision. In April 2006, the City of Midland filed an
application for Leave to Appeal with the Michigan Supreme Court. The MCV
Partnership filed a response in opposition to that application. The remanded
proceedings may result in the determination of a greater refund to the MCV
Partnership. In July 2006, the Michigan Supreme Court denied the City of
Midland's application. The MCV Partnership cannot predict the outcome of these
proceedings; therefore, this anticipated refund has not been recognized in
earnings.
NUCLEAR PLANT DECOMMISSIONING: The MPSC and the FERC regulate the recovery of
costs to decommission, or remove from service, our Big Rock and Palisades
nuclear plants. Decommissioning funding practices approved by the MPSC require
us to file a report on the adequacy of funds for decommissioning at three-year
intervals. We prepared and filed updated cost estimates for Big Rock and
Palisades in March 2004. Excluding additional costs for spent nuclear fuel
storage due to the DOE's failure to accept this spent nuclear fuel on schedule,
these reports show a decommissioning cost of $361 million for Big Rock and $868
million for Palisades. Since Big Rock is currently in the process of
decommissioning, this estimated cost includes historical expenditures in nominal
dollars and future costs in 2003 dollars, with all Palisades costs given in 2003
dollars. Updated cost projections for Big Rock indicate an anticipated
decommissioning cost of $393 million as of June 2006.
Big Rock: In December 2000, funding of the Big Rock trust fund stopped because
the MPSC-authorized decommissioning surcharge collection period expired. In our
March 2004 report to the MPSC, we indicated that we would manage the
decommissioning trust fund to meet annual NRC financial assurance requirements
by withdrawing NRC radiological decommissioning costs from the fund and
initially funding non-NRC, greenfield costs out of corporate funds. In March
2006, we contributed $16 million to the trust fund from our corporate funds to
support NRC radiological decommissioning costs. Excluding the additional nuclear
fuel storage costs due to the DOE's failure to accept spent fuel on schedule, we
are projecting that the level of funds provided by the trust will fall short of
the amount needed to complete the decommissioning by $39 million, which is the
amount projected for non-NRC, greenfield costs. We plan initially to fund the
$39 million out of corporate funds. Therefore, at this time, we plan to provide
a total of $55 million from corporate funds for costs associated with NRC
CMS-50
CMS Energy Corporation
radiological and non-NRC greenfield decommissioning work. We plan to seek
recovery of such expenditures. We cannot predict the outcome of these efforts.
Palisades: Excluding additional nuclear fuel storage costs due to the DOE's
failure to accept spent fuel on schedule, we concluded, based on the cost
estimates filed in March 2004, that the existing Palisades' surcharge of $6
million needed to be increased to $25 million annually, beginning January 2006.
A settlement agreement was approved by the MPSC, providing for the continuation
of the existing $6 million annual decommissioning surcharge through 2011, our
current license expiration date, and for the next periodic review to be filed in
March 2007. Amounts collected from electric retail customers and deposited in
trusts, including trust earnings, are credited to a regulatory liability.
In March 2005, the NMC, which operates the Palisades plant, applied for a
20-year license renewal for the plant on behalf of Consumers. We expect a
decision from the NRC on the license renewal application in 2007. At this time,
we cannot determine what impact this will have on decommissioning costs or the
adequacy of funding.
In July 2006, we reached an agreement to sell Palisades and the Big Rock ISFSI
to Entergy. As part of the transaction, Entergy will sell us 100 percent of the
plant's output up to its current capacity of 798 MW under a 15-year power
purchase agreement. Because of the PPA that will be in place between Consumers
and Entergy, the transaction is effectively a sale and leaseback for accounting
purposes. SFAS No. 98 specifies the accounting required for a seller's sale and
simultaneous leaseback transaction involving real estate, including real estate
with equipment. In accordance with SFAS No. 98, the transaction will be
accounted for as a financing and not a sale. This is due to forms of continuing
involvement. As such, we will not classify the assets as held for sale on our
Consolidated Balance Sheets.
NUCLEAR MATTERS: Nuclear Fuel Cost: We amortize nuclear fuel cost to fuel
expense based on the quantity of heat produced for electric generation. For
nuclear fuel used after April 6, 1983, we charge certain disposal costs to
nuclear fuel expense, recover these costs through electric rates, and remit them
to the DOE quarterly. We elected to defer payment for disposal of spent nuclear
fuel burned before April 7, 1983. At June 30, 2006, our DOE liability is $148
million. This amount includes interest, which is payable upon the first delivery
of spent nuclear fuel to the DOE. The amount of this liability, excluding a
portion of interest, was recovered through electric rates. In conjunction with
the sale of Palisades and the Big Rock ISFSI, we will retain this obligation and
provide security to Entergy for this obligation in the form of either cash, a
letter of credit, or other acceptable means.
DOE Litigation: In 1997, a U.S. Court of Appeals decision confirmed that the DOE
was to begin accepting deliveries of spent nuclear fuel for disposal by January
1998. Subsequent U.S. Court of Appeals litigation, in which we and other
utilities participated, has not been successful in producing more specific
relief for the DOE's failure to accept the spent nuclear fuel.
There are two court decisions that support the right of utilities to pursue
damage claims in the United States Court of Claims against the DOE for failure
to take delivery of spent nuclear fuel. Over 60 utilities have initiated
litigation in the United States Court of Claims. We filed our complaint in
December 2002. If our litigation against the DOE is successful, we plan to use
any recoveries to pay the cost of spent nuclear fuel storage until the DOE takes
possession as required by law. We can make no assurance that the litigation
against the DOE will be successful.
CMS-51
CMS Energy Corporation
In 2002, the site at Yucca Mountain, Nevada was designated for the development
of a repository for the disposal of high-level radioactive waste and spent
nuclear fuel. We expect that the DOE, in due course, will submit a final license
application to the NRC for the repository. The application and review process is
estimated to take several years.
Insurance: We maintain nuclear insurance coverage on our nuclear plants. At
Palisades, we maintain nuclear property insurance from NEIL totaling $2.750
billion and insurance that would partially cover the cost of replacement power
during certain prolonged accidental outages. Because NEIL is a mutual insurance
company, we could be subject to assessments of up to $28 million in any policy
year if insured losses in excess of NEIL's maximum policyholders surplus occur
at our, or any other member's, nuclear facility. NEIL's policies include
coverage for acts of terrorism.
At Palisades, we maintain nuclear liability insurance for third-party bodily
injury and off-site property damage resulting from a nuclear energy hazard for
up to approximately $10.761 billion, the maximum insurance liability limits
established by the Price-Anderson Act. Part of the Price-Anderson Act's
financial protection is a mandatory industry-wide program under which owners of
nuclear generating facilities could be assessed if a nuclear incident occurs at
any nuclear generating facility. The maximum assessment against us could be $101
million per occurrence, limited to maximum annual installment payments of $15
million.
We also maintain insurance under a program that covers tort claims for bodily
injury to nuclear workers caused by nuclear hazards. The policy contains a $300
million nuclear industry aggregate limit. Under a previous insurance program
providing coverage for claims brought by nuclear workers, we remain responsible
for a maximum assessment of up to $6 million. This requirement will end December
31, 2007.
Big Rock remains insured for nuclear liability up to $544 million through
nuclear insurance and NRC indemnity, and maintains a nuclear property insurance
policy from NEIL.
Insurance policy terms, limits, and conditions are subject to change during the
year as we renew our policies.
CONSUMERS' GAS UTILITY CONTINGENCIES
GAS ENVIRONMENTAL MATTERS: We expect to incur investigation and remediation
costs at a number of sites under the Michigan Natural Resources and
Environmental Protection Act, a Michigan statute that covers environmental
activities including remediation. These sites include 23 former manufactured gas
plant facilities. We operated the facilities on these sites for some part of
their operating lives. For some of these sites, we have no current ownership or
may own only a portion of the original site. In 2005, we estimated our remaining
costs to be between $29 million and $71 million, based on 2005 discounted costs,
using a discount rate of three percent. The discount rate represents a 10-year
average of U.S. Treasury bond rates reduced for increases in the consumer price
index. We expect to fund most of these costs through proceeds derived from a
settlement with insurers and MPSC-approved rates. At June 30, 2006, we have a
liability of $28 million, net of $54 million of expenditures incurred to date,
and a regulatory asset of $59 million. Any significant change in assumptions,
such as an increase in the number of sites, different remediation techniques,
nature and extent of contamination, and legal and regulatory requirements, could
affect our estimate of remedial action costs.
CMS-52
CMS Energy Corporation
CONSUMERS' GAS UTILITY RATE MATTERS
GAS COST RECOVERY: The GCR process is designed to allow us to recover all of our
purchased natural gas costs if incurred under reasonable and prudent policies
and practices. The MPSC reviews these costs, policies, and practices for
prudency in annual plan and reconciliation proceedings.
The following table summarizes our GCR reconciliation filings with the MPSC:
Gas Cost Recovery Reconciliation
Net Over-
GCR Year Date Filed Order Date recovery Status
- -------- ---------- ---------- --------- ------
2004-2005 June 2005 April 2006 $2 million The net overrecovery includes interest expense through March 2005 and
refunds that we received from our suppliers that are required to be
refunded to our customers.
2005-2006 June 2006 Pending $3 million The net overrecovery includes $1 million interest income through
March 2006, which resulted from a net underrecovery position
during the majority of the GCR period.
GCR plan for year 2005-2006: In November 2005, the MPSC issued an order for our
2005-2006 GCR Plan year, which resulted in approval of a settlement agreement
and established a fixed price cap of $10.10 per mcf for the December 2005
through March 2006 billing period. We were able to maintain our billing GCR
factor below the authorized level for that period. The order was appealed to the
Michigan Court of Appeals by one intervenor. No action has been taken by the
Court of Appeals on the merits of the appeal and we are unable to predict the
outcome.
GCR plan for year 2006-2007: In December 2005, we filed an application with the
MPSC seeking approval of a GCR plan for the 12-month period of April 2006
through March 2007. Our request proposed using a GCR factor consisting of:
- a base GCR ceiling factor of $11.10 per mcf, plus
- a quarterly GCR ceiling price adjustment contingent upon future
events.
In July 2006, all parties signed a partial settlement agreement, which calls for
a base GCR ceiling factor of $9.48 per mcf. The settlement agreement is also
subject to a quarterly GCR ceiling price adjustment of up to $3.50 per MMbtu,
contingent upon future events. The settlement agreement is subject to MPSC
approval.
Our GCR factor for the billing month of August 2006 is $8.37 per mcf.
2001 GAS DEPRECIATION CASE: In October and December 2004, the MPSC issued
Opinions and Orders in our gas depreciation case, which:
- reaffirmed the previously-ordered $34 million reduction in our
depreciation expense,
CMS-53
CMS Energy Corporation
- required us to undertake a study to determine why our plant removal
costs are in excess of other regulated Michigan natural gas utilities,
and
- required us to file a study report with the MPSC Staff on or before
December 31, 2005.
We filed the study report with the MPSC Staff on December 29, 2005.
We are also required to file our next gas depreciation case within 90 days after
the MPSC issuance of a final order in the pending case related to ARO
accounting. We cannot predict when the MPSC will issue a final order in the ARO
accounting case.
If the depreciation case order is issued after the gas general rate case order,
we proposed to incorporate its results into the gas general rates using a
surcharge mechanism, a process used to incorporate specialty items into customer
rates.
2005 GAS RATE CASE: In July 2005, we filed an application with the MPSC seeking
a 12 percent authorized return on equity along with a $132 million annual
increase in our gas delivery and transportation rates. As part of this filing,
we also requested interim rate relief of $75 million.
The MPSC Staff and intervenors filed interim rate relief testimony on October
31, 2005. In its testimony, the MPSC Staff recommended granting interim rate
relief of $38 million.
In February 2006, the MPSC Staff recommended granting final rate relief of $62
million. The MPSC Staff proposed that $17 million of this amount be contributed
to a low income and energy efficiency fund. The MPSC Staff also recommended
reducing our allowed return on common equity to 11.15 percent, from our current
11.4 percent.
In March 2006, the MPSC Staff revised its recommended final rate relief to $71
million, which includes $17 million to be contributed to a low income and energy
efficiency fund. In April 2006, we revised our request for final rate relief
downward to $118 million.
In May 2006, the MPSC issued an order granting us interim gas rate relief of $18
million annually, which is under bond and subject to refund if final rate relief
is granted in a lesser amount. The order also extended the temporary two-year
surcharge of $58 million granted in October 2004 until the issuance of a final
order in this proceeding. The MPSC has not set a date for issuance of an order
granting final rate relief.
In July 2006, the ALJ issued a Proposal for Decision recommending final rate
relief of $74 million above current rate levels, which include interim and
temporary rate relief. The $74 million includes $17 million to be contributed to
a low income and energy efficiency fund. The Proposal for Decision also
recommended reducing our return on common equity to 11 percent, from our current
11.4 percent.
CMS-54
CMS Energy Corporation
OTHER CONTINGENCIES
EQUATORIAL GUINEA TAX CLAIM: CMS Energy received a request for indemnification
from Perenco, the purchaser of CMS Oil and Gas. The indemnification claim
relates to the sale by CMS Energy of its oil, gas and methanol projects in
Equatorial Guinea and the claim of the government of Equatorial Guinea that $142
million in taxes is owed it in connection with that sale. Based on information
currently available, CMS Energy and its tax advisors have concluded that the
government's tax claim is without merit, and Perenco has submitted a response to
the government rejecting the claim. CMS Energy cannot predict the outcome of
this matter.
GAS INDEX PRICE REPORTING LITIGATION: CMS Energy, CMS MST, CMS Field Services,
Cantera Natural Gas, Inc. (the company that purchased CMS Field Services) and
Cantera Gas Company are named as defendants in various lawsuits arising as a
result of false natural gas price reporting. Allegations include manipulation of
NYMEX natural gas futures and options prices, price-fixing conspiracies, and
artificial inflation of natural gas retail prices in California, Colorado,
Tennessee and Kansas. In February 2006, CMS MST and CMS Field Services reached
an agreement to settle a similar action that had been filed in New York. The
court approved the settlement in May 2006. The $6.975 million settlement was
paid by CMS MST. CMS Energy had established a reserve for this amount in the
fourth quarter of 2005. CMS Energy and the other CMS Energy defendants will
defend themselves vigorously against these matters but cannot predict their
outcome.
DEARBORN INDUSTRIAL GENERATION: In October 2001, Duke/Fluor Daniel (DFD), the
primary construction contractor for the DIG facility, presented DIG with a
change order to their construction contract and filed an action in Michigan
state court against DIG, claiming contractual damages in the amount of $110
million, plus interest and costs. DFD also filed a construction lien for the
$110 million. DIG is contesting both of the claims made by DFD. In addition to
drawing down on three letters of credit totaling $30 million that it obtained
from DFD, DIG filed an arbitration claim against DFD asserting in excess of an
additional $75 million in claims against DFD. The judge in the Michigan state
court case entered an order staying DFD's prosecution of its claims in the court
case and permitting the arbitration to proceed. The arbitration hearing began
October 10, 2005 and is scheduled to continue through late-2006. DIG will
continue to defend itself vigorously and pursue its claims. CMS Energy cannot
predict the outcome of this matter.
FORMER CMS OIL AND GAS OPERATIONS: A Michigan trial judge granted Star Energy,
Inc. and White Pine Enterprises, LLC a declaratory judgment in an action filed
in 1999 that claimed Terra Energy Ltd., a former CMS Oil and Gas subsidiary,
violated an oil and gas lease and other arrangements by failing to drill wells
it had committed to drill. A jury then awarded the plaintiffs a $7.6 million
award. Appeals were filed of the original verdict and a subsequent decision of
the court on remand. The court of appeals issued an opinion on May 26, 2005
remanding the case to the trial court for a new trial on damages. At a status
conference on April 10, 2006, the judge set a six-month discovery period. On May
19, 2006, the court issued a scheduling order and the case has been set for
trial in February 2007. The parties attended a court-ordered mediation on July
14, 2006 and the matter was not resolved. Enterprises has an indemnity
obligation with regard to losses to Terra that might result from this
litigation.
CMS ENSENADA CUSTOMER DISPUTE: Pursuant to a long-term power purchase agreement,
CMS Ensenada sells power and steam to YPF Repsol at the YPF refinery in La
Plata, Argentina. As a result of the so-called "Emergency Laws," payments by YPF
Repsol under the power purchase agreement have been converted to pesos at the
exchange rate of one U.S. dollar to one Argentine peso. Such
CMS-55
CMS Energy Corporation
payments are currently insufficient to cover CMS Ensenada's operating costs,
including quarterly debt service payments to the Overseas Private Investment
Corporation (OPIC). Enterprises is party to a Sponsor Support Agreement pursuant
to which Enterprises has guaranteed CMS Ensenada's debt service payments to OPIC
up to an amount which is in dispute, but which Enterprises estimates to be
approximately $7 million.
The Argentine commercial court granted injunctive relief to CMS Ensenada
pursuant to an ex parte action, and such relief will remain in effect until
completion of arbitration on the matter, to be administered by the International
Chamber of Commerce. The arbitration hearing was held in July 2005 and a
decision from the arbitration panel is expected in 2006.
ARGENTINA: As part of its energy privatization incentives, Argentina directed
CMS Gas Transmission to calculate tariffs in U.S. dollars, then convert them to
pesos at the prevailing exchange rate, and to adjust tariffs every six months to
reflect changes in inflation. Starting in early 2000, Argentina suspended the
inflation adjustments.
In January 2002, the Republic of Argentina enacted the Public Emergency and
Foreign Exchange System Reform Act. This law repealed the fixed exchange rate of
one U.S. dollar to one Argentine peso, converted all dollar-denominated utility
tariffs and energy contract obligations into pesos at the same one-to-one
exchange rate, and directed the Government of Argentina to renegotiate such
tariffs.
CMS Gas Transmission began arbitration proceedings against the Republic of
Argentina (Argentina) under the auspices of the International Centre for the
Settlement of Investment Disputes (ICSID) in mid-2001, citing breaches by
Argentina of the Argentine-U.S. Bilateral Investment Treaty (BIT). In May 2005,
an ICSID tribunal concluded, among other things, that Argentina's economic
emergency did not excuse Argentina from liability for violations of the BIT. The
ICSID tribunal found in favor of CMS Gas Transmission, and awarded damages of
U.S. $133 million, plus interest.
The ICSID Convention provides that either party may seek annulment of the award
based upon five possible grounds specified in the Convention. Argentina's
Application for Annulment was formally registered by ICSID on September 27, 2005
and will be considered by a newly constituted panel.
On December 28, 2005, certain insurance underwriters paid the sum of $75 million
to CMS Gas Transmission in respect of their insurance obligations resulting from
non-payment of the ICSID award. The payment, plus interest, is subject to
repayment by CMS Gas Transmission in the event that the ICSID award is annulled.
Pending the outcome of the annulment proceedings, CMS Energy recorded the $75
million payment as deferred revenue at December 31, 2005.
IRS AUDIT RESOLUTION: In August 2005, the IRS issued Revenue Ruling 2005-53 and
regulations to provide guidance with respect to the use of the "simplified
service cost" method of tax accounting. We have been using this tax accounting
method, generally allowed by the IRS under section 263A of the Internal Revenue
Code, with respect to the allocation of certain indirect overhead costs to the
tax basis of self-constructed utility assets.
In June 2006, the IRS concluded its most recent audit of CMS Energy and its
subsidiaries and proposed changes to taxable income for the years ended December
31, 1987 through December 31, 2001. The proposed overall cumulative increase to
taxable income related primarily to the disallowance of the simplified service
cost method with respect to certain self-constructed utility assets. We have
accepted these proposed adjustments to taxable income, which resulted in the
payment of $76 million of tax in
CMS-56
CMS Energy Corporation
July 2006, and a reduction of our June 2006 income tax provision of $62 million,
net of interest expense, primarily for the utilization or restoration of
previously written off income tax credits.
OTHER: In addition to the matters disclosed within this Note, Consumers and
certain other subsidiaries of CMS Energy are parties to certain lawsuits and
administrative proceedings before various courts and governmental agencies
arising from the ordinary course of business. These lawsuits and proceedings may
involve personal injury, property damage, contractual matters, environmental
issues, federal and state taxes, rates, licensing, and other matters.
We have accrued estimated losses for certain contingencies discussed within this
Note. Resolution of these contingencies is not expected to have a material
adverse impact on our financial position, liquidity, or future results of
operations.
FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS
FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS: The
Interpretation requires the guarantor, upon issuance of a guarantee, to
recognize a liability for the fair value of the obligation it undertakes in
issuing the guarantee.
The following table describes our guarantees at June 30, 2006:
In Millions
---------------------------------------------------------------------------
Issue Expiration Maximum Carrying
Guarantee Description Date Date Obligation Amount
- --------------------- ------------ ---------- ---------- --------
Indemnifications from asset sales and
other agreements (a) October 1995 Indefinite $1,133 $ 1
Standby letters of credit and loans (b) Various Various through 131 -
May 2010
Surety bonds and other indemnifications Various Indefinite 10 -
Other guarantees (c) Various Various through 218 1
September 2027
Nuclear insurance retrospective premiums Various Indefinite 135 -
(a) The majority of this amount arises from routine provisions in stock and
asset sales agreements under which we indemnify the purchaser for losses
resulting from events such as claims resulting from tax disputes and the failure
of title to the assets or stock sold by us to the purchaser. We believe the
likelihood of a loss for any remaining indemnifications to be remote.
(b) Standby letters of credit include letters of credit issued under an amended
credit agreement with Citicorp USA, Inc. The amended credit agreement is
supported by a guaranty issued by certain subsidiaries of CMS Energy. At June
30, 2006, letters of credit issued on behalf of unconsolidated affiliates
totaling $65 million were outstanding.
(c) Maximum obligation includes $85 million related to the MCV Partnership's
non-performance under a steam and electric power agreement with Dow. We have
reached an agreement to sell our interests in the MCV Partnership and the FMLP,
subject to certain regulatory and other closing conditions. The sales agreement
calls for the purchaser, an affilate of GSO Capital Partners and Rockland
Capital Energy Investments to pay $85 million, subject to certain reimbursement
rights, if Dow terminates an agreement under which it is provided power and
steam by the MCV Partenership.
CMS-57
CMS Energy Corporation
The purchaser will secure their reimbursement obligation with an irrevocable
letter of credit of up to $85 million.
The following table provides additional information regarding our guarantees:
Guarantee Description How Guarantee Arose Events That Would Require Performance
- --------------------- ------------------- -------------------------------------
Indemnifications from asset sales and Stock and asset sales agreements Findings of misrepresentation,
other agreements breach of warranties, and other
specific events or circumstances
Standby letters of credit Normal operations of coal power Noncompliance with environmental
plants regulations and inadequate response
to demands for corrective action
Natural gas transportation Nonperformance
Self-insurance requirement Nonperformance
Standby letters of credit and loans Credit agreement Non-payment by CMS Energy and
Enterprises of obligations under the
credit agreement
Surety bonds and other indemnifications Normal operating activity, permits Nonperformance
and licenses
Other guarantees Normal operating activity Nonperformance or non-payment by a
subsidiary under a related contract
Agreement to provide power and steam MCV Partnership's nonperformance or
to Dow non-payment under a related contract
Bay Harbor remediation efforts Owners exercising put options requiring
us to purchase property
Nuclear insurance retrospective premiums Normal operations of nuclear plants Call by NEIL and Price-Anderson Act
for nuclear incident
Project Financing: We enter into various project-financing security arrangements
such as equity pledge agreements and share mortgage agreements to provide
financial or performance assurance to third parties on behalf of certain
unconsolidated affiliates. Expiration dates for these agreements vary from March
2015 to June 2020 or terminate upon payment or cancellation of the obligation.
Non-payment or other act of default by an unconsolidated affiliate would trigger
enforcement of the security. If we were required to perform under these
agreements, the maximum amount of our obligation under these agreements would be
equal to the value of the shares relinquished to the guaranteed party at the
time of default.
At June 30, 2006, certain contracts contained provisions allowing us to recover,
from third-parties, amounts paid under the guarantees. For example, if we are
required to purchase a property under a put option agreement, we may sell the
property to recover the amount paid under the option.
We enter into agreements containing tax and other indemnification provisions in
connection with a variety of transactions. While we are unable to estimate the
maximum potential obligation related to
CMS-58
CMS Energy Corporation
these indemnities, we consider the likelihood that we would be required to
perform or incur significant losses related to these indemnities and the
guarantees listed in the preceding tables to be remote.
3: FINANCINGS AND CAPITALIZATION
Long-term debt is summarized as follows:
In Millions
------------------------------------
June 30, 2006 December 31, 2005
-------------- ------------------
CMS ENERGY CORPORATION
Senior notes $ 2,271 $ 2,347
Other long-term debt 2 2
---------- ----------
Total - CMS Energy Corporation 2,273 2,349
---------- ----------
CONSUMERS ENERGY COMPANY
First mortgage bonds 3,174 3,175
Senior notes and other 855 852
Securitization bonds 355 369
---------- ----------
Total - Consumers Energy Company 4,384 4,396
---------- ----------
OTHER SUBSIDIARIES 358 363
---------- ----------
TOTAL PRINCIPAL AMOUNTS OUTSTANDING 7,015 7,108
Current amounts (147) (289)
Net unamortized discount (17) (19)
---------- ----------
Total Long-term debt $ 6,851 $ 6,800
========== ==========
FINANCINGS: The following is a summary of significant long-term debt retirements
during the six months ended June 30, 2006:
Principal Interest
(in millions) Rate (%) Retirement Date Maturity Date
------------- -------- --------------- -------------
CMS ENERGY
Senior notes $ 76 9.875 January through October 2007
April 2006
CONSUMERS
Long-term debt - related parties 129 9.000 February 2006 June 2031
-----
TOTAL $ 205
=====
REGULATORY AUTHORIZATION FOR FINANCINGS: In May 2006, the FERC issued an order
authorizing Consumers to issue up to $2.0 billion of secured and unsecured
short-term securities for the following purposes:
- up to $1.0 billion for general corporate purposes, and
- up to $1.0 billion of FMB or other securities to be issued solely as
collateral for other short-term securities.
Also in May 2006, the FERC issued an order authorizing Consumers to issue up to
$5.0 billion of secured and unsecured long-term securities for the following
purposes:
- up to $1.5 billion for general corporate purposes,
- up to $1.0 billion for purposes of refinancing or refunding existing
long-term debt, and
CMS-59
CMS Energy Corporation
- up to $2.5 billion of FMB or other securities to be issued solely as
collateral for other long-term securities.
Any long-term issuances during the two-year authorization period are exempt from
the FERC's competitive bidding and negotiated placement requirements.
The authorizations are for a two-year period beginning July 1, 2006 and ending
June 30, 2008.
REVOLVING CREDIT FACILITIES: The following secured revolving credit facilities
with banks are available at June 30, 2006:
In Millions
Outstanding -----------
Amount of Amount Letters-of- Amount
Company Expiration Date Facility Borrowed Credit Available
------- --------------- --------- -------- ----------- -----------
CMS Energy May 18, 2010 $ 300 $ - $ 103 $ 197
Consumers March 30, 2007 300 - - 300
Consumers May 18, 2010 500 - 42 458
MCV Partnership August 26, 2006 50 - 2 48
In March 2006, Consumers entered into a short-term secured revolving credit
agreement with banks. This facility provides $300 million of funds for working
capital and other general corporate purposes.
DIVIDEND RESTRICTIONS: Our amended and restated $300 million secured revolving
credit facility restricts payments of dividends on our common stock during a
12-month period to $150 million, dependent on the aggregate amounts of
unrestricted cash and unused commitments under the facility.
Under the provisions of its articles of incorporation, at June 30, 2006,
Consumers had $184 million of unrestricted retained earnings available to pay
common stock dividends. Covenants in Consumers' debt facilities cap common stock
dividend payments at $300 million in a calendar year. For the six months ended
June 30, 2006, we received $40 million of common stock dividends from Consumers.
Also, the provisions of the Federal Power Act and the Natural Gas Act
effectively restrict dividends to the amount of Consumers' retained earnings.
CAPITAL AND FINANCE LEASE OBLIGATIONS: Our capital leases are comprised mainly
of leased service vehicles, power purchase agreements, and office furniture. At
June 30, 2006, capital lease obligations totaled $56 million. In order to obtain
permanent financing for the MCV Facility, the MCV Partnership entered into a
sale and lease back agreement with a lessor group, which includes the FMLP, for
substantially all of the MCV Partnership's fixed assets. In accordance with SFAS
No. 98, the MCV Partnership accounted for the transaction as a financing
arrangement. At June 30, 2006, finance lease obligations totaled $281 million,
which represents the third-party portion of the MCV Partnership's finance lease
obligation.
SALE OF ACCOUNTS RECEIVABLE: Under a revolving accounts receivable sales
program, Consumers sells certain accounts receivable to a wholly owned,
consolidated, bankruptcy remote special purpose entity. In turn, the special
purpose entity may sell an undivided interest in up to $325 million of the
receivables. The special purpose entity sold no receivables at June 30, 2006 and
$325 million of receivables at December 31, 2005. Consumers continues to service
the receivables sold to the special purpose entity. The purchaser of the
receivables has no recourse against Consumers' other assets for failure of a
debtor to pay when due and no right to any receivables not sold. Consumers has
neither
CMS-60
CMS Energy Corporation
recorded a gain or loss on the receivables sold nor retained interest in the
receivables sold.
Certain cash flows under Consumers' accounts receivable sales program are shown
in the following table:
In Millions
----------------------
Six months ended June 30 2006 2005
- ------------------------ ------- -------
Net cash flow as a result of accounts receivable financing $ (325) $ (304)
Collections from customers $3,232 $ 2,787
CONTINGENTLY CONVERTIBLE SECURITIES: In June 2006, the $11.87 per share
conversion trigger price contingency was met for our $250 million 4.50 percent
contingently convertible preferred stock. As a result, these securities are
convertible at the option of the security holders for the three months ending
September 30, 2006, with the par value payable in cash. As of July 2006, none of
the security holders have notified us of their intention to convert these
securities.
In June 2006, the $12.81 per share conversion trigger price contingency was not
met for our $150 million 3.375 percent contingently convertible senior notes.
Therefore, they retained the characteristics of a long-term liability and we
reclassified them as long-term debt.
4: EARNINGS PER SHARE
The following table presents the basic and diluted earnings per share
computations based on Income from Continuing Operations:
In Millions, Except Per Share Amounts
-------------------------------------
Three Months Ended June 30 2006 2005
- -------------------------- ------- -------
EARNINGS AVAILABLE TO COMMON STOCKHOLDERS
Income from Continuing Operations $ 73 $ 30
Less Preferred Dividends (3) (3)
------- -------
Income from Continuing Operations
Available to Common Stockholders
- Basic and Diluted $ 70 $ 27
======= =======
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
Weighted Average Shares - Basic 219.6 217.9
Add dilutive impact of Contingently
Convertible Securities 8.6 10.2
Add dilutive Stock Options and Warrants 1.4 0.8
------- -------
Weighted Average Shares - Diluted 229.6 228.9
======= =======
EARNINGS PER AVERAGE COMMON SHARE
AVAILABLE TO COMMON STOCKHOLDERS
Basic $ 0.32 $ 0.12
Diluted $ 0.30 $ 0.12
======= =======
CMS-61
CMS Energy Corporation
In Millions, Except Per Share Amounts
-------------------------------------
Six Months Ended June 30 2006 2005
- ------------------------ ------- -------
EARNINGS AVAILABLE TO COMMON STOCKHOLDERS
Income from Continuing Operations $ 48 $ 182
Less Preferred Dividends (6) (5)
------- -------
Income from Continuing Operations Available to
Common Stockholders - Basic and Diluted $ 42 $ 177
======= =======
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
Weighted Average Shares - Basic 219.3 206.7
Add dilutive impact of Contingently
Convertible Securities 9.6 8.2
Add dilutive Stock Options and Warrants 1.4 0.8
------- -------
Weighted Average Shares - Diluted 230.3 215.7
======= =======
EARNINGS PER AVERAGE COMMON SHARE
AVAILABLE TO COMMON STOCKHOLDERS
Basic $ 0.19 $ 0.86
Diluted $ 0.19 $ 0.82
======= =======
Contingently Convertible Securities: Our contingently convertible securities
dilute EPS to the extent that the conversion value, which is based on the
average market price of our common stock, exceeds the principal or par value.
Stock Options and Warrants: Since the exercise price was greater than the
average market price of our common stock, there was no impact to diluted EPS for
additional options and warrants to purchase 1.8 million shares of common stock
for the three months ended June 30, 2006, and 3.4 million shares of common stock
for the three months ended June 30, 2005. There was also no impact to diluted
EPS for additional options and warrants to purchase 1.8 million shares of common
stock for the six months ended June 30, 2006, and 3.5 million shares of common
stock for the six months ended June 30, 2005.
Convertible Debentures: Due to accounting EPS dilution principles, for the three
and six months ended June 30, 2006, there was no impact to diluted EPS from our
7.75 percent convertible subordinated debentures. Using the if-converted method,
the debentures would have:
- increased the numerator of diluted EPS by $2 million for the three
months ended June 30, 2006 and $4 million for the six months ended
June 30, 2006, from an assumed reduction of interest expense, net of
tax, and
- increased the denominator of diluted EPS by 4.2 million shares.
We can revoke the conversion rights if certain conditions are met.
CMS-62
CMS Energy Corporation
5: FINANCIAL AND DERIVATIVE INSTRUMENTS
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments, and
current liabilities approximate their fair values because of their short-term
nature. We estimate the fair values of long-term financial instruments based on
quoted market prices or, in the absence of specific market prices, on quoted
market prices of similar instruments, or other valuation techniques.
The cost and fair value of our long-term financial instruments are as follows:
In Millions
-------------------------------------------------------------------------------
June 30, 2006 December 31, 2005
------------------------------------ ------------------------------------
Fair Unrealized Fair Unrealized
Cost Value Gain (Loss) Cost Value Gain (Loss)
------ ------ ----------- ------ ------ -----------
Long-term debt, $6,998 $6,926 $ 72 $7,089 $7,315 $ (226)
including current amounts
Long-term debt - related parties,
including current amounts 178 145 33 307 280 27
Available-for-sale securities:
SERP:
Equity securities 35 51 16 34 49 15
Debt securities 16 15 (1) 17 17 -
Nuclear decommissioning investments:
Equity securities 135 253 118 134 252 118
Debt securities 306 303 (3) 287 291 4
In July 2006, Consumers reached an agreement to sell Palisades and the Big Rock
ISFSI to Entergy. Entergy will assume responsibility for the future
decommissioning of the plant and for storage and disposal of spent nuclear fuel.
Accordingly, upon completion of the sale, Consumers will transfer $366 million
of nuclear decommissioning trust fund assets to Entergy and retain $200 million.
Consumers will also be entitled to receive a return of $116 million of
decommissioning trust fund assets pending either a favorable federal tax ruling
regarding the release of the funds, or, if the funds are available, after
decommissioning of the Palisades site is complete. The disposition of the
retained and receivable nuclear decommissioning funds is subject to regulatory
proceedings.
DERIVATIVE INSTRUMENTS: In order to limit our exposure to certain market risks,
we may enter into various risk management contracts, such as swaps, options,
futures, and forward contracts. These contracts, used primarily to manage our
exposure to changes in interest rates, commodity prices, and currency exchange
rates, are classified as either non-trading or trading. We enter into these
contracts using established policies and procedures, under the direction of
both:
- an executive oversight committee consisting of senior management
representatives, and
- a risk committee consisting of business unit managers.
The contracts we use to manage market risks may qualify as derivative
instruments that are subject to derivative and hedge accounting under SFAS No.
133. If a contract is a derivative, it is recorded on the balance sheet at its
fair value. We then adjust the resulting asset or liability each quarter to
reflect any change in the market value of the contract, a practice known as
marking the contract to market. If a derivative qualifies for cash flow hedge
accounting treatment, the changes in fair value (gains or
CMS-63
CMS Energy Corporation
losses) are reported in accumulated other comprehensive income; otherwise, the
changes are reported in earnings.
For a derivative instrument to qualify for hedge accounting:
- the relationship between the derivative instrument and the item being
hedged must be formally documented at inception,
- the derivative instrument must be highly effective in offsetting the
hedged item's cash flows or changes in fair value, and
- if hedging a forecasted transaction, the forecasted transaction must
be probable.
If a derivative qualifies for cash flow hedge accounting treatment and gains or
losses are recorded in accumulated other comprehensive income, those gains or
losses will be reclassified into earnings in the same period or periods the
hedged forecasted transaction affects earnings. If a cash flow hedge is
terminated early because it is determined that the forecasted transaction will
not occur, any gain or loss recorded in accumulated other comprehensive income
at that date is recognized immediately in earnings. If a cash flow hedge is
terminated early for other economic reasons, any gain or loss as of the
termination date is deferred and then reclassified to earnings when the
forecasted transaction affects earnings. The ineffective portion, if any, of all
hedges is recognized in earnings.
To determine the fair value of our derivatives, we use information from external
sources (i.e., quoted market prices and third-party valuations), if available.
For certain contracts, this information is not available and we use mathematical
valuation models to value our derivatives. These models require various inputs
and assumptions, including commodity market prices and volatilities, as well as
interest rates and contract maturity dates. The cash returns we actually realize
on these contracts may vary, either positively or negatively, from the results
that we estimate using these models. As part of valuing our derivatives at
market, we maintain reserves, if necessary, for credit risks arising from the
financial condition of our counterparties.
The majority of our commodity purchase and sale contracts are not subject to
derivative accounting under SFAS No. 133 because:
- they do not have a notional amount (that is, a number of units
specified in a derivative instrument, such as MW of electricity or bcf
of natural gas),
- they qualify for the normal purchases and sales exception, or
- there is not an active market for the commodity.
Our coal purchase contracts are not derivatives because there is not an active
market for the coal we purchase. Similarly, certain of our electric capacity and
energy contracts are not derivatives due to the lack of an active energy market
in Michigan. If active markets for these commodities develop in the future, some
of these contracts may qualify as derivatives. For our coal purchase contracts,
the resulting mark-to-market impact on earnings could be material. For our
electric capacity and energy contracts, we believe that we would be able to
apply the normal purchases and sales exception to the majority of these
contracts (including the MCV PPA) and, therefore, would not be required to mark
these contracts to market.
In 2005, the MISO began operating the Midwest Energy Market. As a result, the
MISO now centrally dispatches electricity and transmission service throughout
much of the Midwest and provides day-ahead and real-time energy market
information. At this time, we believe that the establishment of this
CMS-64
CMS Energy Corporation
market does not represent the development of an active energy market in
Michigan, as defined by SFAS No. 133. However, as the Midwest Energy Market
matures, we will continue to monitor its activity level and evaluate whether or
not an active energy market may exist in Michigan.
Derivative accounting is required for certain contracts used to limit our
exposure to interest rate risk, commodity price risk, and foreign exchange risk.
The following table summarizes our derivative instruments:
In Millions
------------------------------------------------------------------------------
June 30, 2006 December 31, 2005
------------------------------------ ------------------------------------
Fair Unrealized Fair Unrealized
Derivative Instruments Cost Value Gain (Loss) Cost Value Gain (Loss)
- ---------------------- ----- ----- ----------- ----- ----- ----------
Non-trading:
Gas supply option contracts $ - $ - $ - $ 1 $ (1) $ (2)
FTRs - 1 1 - 1 1
Derivative contracts associated with the MCV
Partnership:
Long-term gas contracts (a) - 59 59 - 205 205
Gas futures, options, and swaps (a) - 121 121 - 223 223
CMS ERM contracts:
Non-trading electric / gas contracts - (64) (64) - (63) (63)
Trading electric / gas contracts (b) (3) 44 47 (3) 100 103
Derivative contracts associated with equity
investments in:
Shuweihat - (6) (6) - (20) (20)
Taweelah (35) (6) 29 (35) (17) 18
Jorf Lasfar - (6) (6) - (8) (8)
Other - 2 2 - 1 1
(a) The fair value of the MCV Partnership's long-term gas contracts and gas
futures, options, and swaps has decreased significantly from December 31, 2005
partly due to a decrease in natural gas prices since that time. The decrease is
also the result of the normal reversal of such derivative assets. As gas has
been purchased under the long-term gas contracts and the gas futures, options,
and swap contracts have been settled, the fair value of the contracts has
decreased.
(b) The fair value of CMS ERM's trading electric and gas contracts has decreased
significantly from December 31, 2005 due to decreases in prices for natural gas
and electricity since that time.
We record the fair value of our gas supply option contracts, FTRs, and the
derivative contracts associated with the MCV Partnership in Derivative
instruments, Other assets, or Other liabilities on our Consolidated Balance
Sheets. We include the fair value of the derivative contracts held by CMS ERM in
either Price risk management assets or Price risk management liabilities on our
Consolidated Balance Sheets. The fair value of derivative contracts associated
with our equity investments is included in Investments - Enterprises on our
Consolidated Balance Sheets.
GAS SUPPLY OPTION CONTRACTS: Our gas utility business uses fixed-priced
weather-based gas supply call options and fixed-priced gas supply call and put
options to meet our regulatory obligation to provide gas to our customers at a
reasonable and prudent cost. As part of the GCR process, the mark-to-market
gains and losses associated with these options are reported directly in earnings
as part of
CMS-65
CMS Energy Corporation
Other income, and then immediately reversed out of earnings and recorded on the
balance sheet as a regulatory asset or liability.
FTRS: With the establishment of the Midwest Energy Market, FTRs were
established. FTRs are financial instruments that manage price risk related to
electricity transmission congestion. An FTR entitles its holder to receive
compensation (or, conversely, to remit payment) for congestion-related
transmission charges. FTRs are marked-to-market each quarter, with changes in
fair value reported to earnings as part of Other income.
DERIVATIVE CONTRACTS ASSOCIATED WITH THE MCV PARTNERSHIP: Long-term gas
contracts: The MCV Partnership uses long-term gas contracts to purchase and
manage the cost of the natural gas it needs to generate electricity and steam.
The MCV Partnership believes that certain of these contracts qualify as normal
purchases under SFAS No. 133. Accordingly, we have not recognized these
contracts at fair value on our Consolidated Balance Sheets at June 30, 2006.
The MCV Partnership also holds certain long-term gas contracts that do not
qualify as normal purchases because these contracts contain volume optionality.
In addition, as a result of implementing the RCP in 2005, a significant portion
of long-term gas contracts no longer qualify as normal purchases, because the
gas will not be used to generate electricity or steam. Accordingly, all of these
contracts are accounted for as derivatives, with changes in fair value recorded
in earnings each quarter. For further details on the RCP, see Note 2,
Contingencies, "Other Consumers' Electric Utility Contingencies - The Midland
Cogeneration Venture."
For the six months ended June 30, 2006, we recorded a $145 million loss, before
considering tax effects and minority interest, associated with the decrease in
fair value of these long-term gas contracts. This loss is included in the total
Fuel costs mark-to-market at the MCV Partnership on our Consolidated Statements
of Income. Because of the volatility of the natural gas market, the MCV
Partnership expects future earnings volatility on these contracts, since gains
and losses will be recorded each quarter. We will continue to record these gains
and losses in our consolidated financial statements until we close the sale of
our ownership interest in the MCV Partnership.
We have recorded derivative assets totaling $59 million associated with the fair
value of long-term gas contracts on our Consolidated Balance Sheets at June 30,
2006. The MCV Partnership expects almost all of these assets, which represent
cumulative net mark-to-market gains, to reverse as losses through earnings
during 2006 and 2007 as the gas is purchased, with the remainder reversing
between 2008 and 2011. As the MCV Partnership recognizes future losses from the
reversal of these derivative assets, we will continue to assume a portion of the
limited partners' share of those losses, in addition to our proportionate share,
but only until we close the sale of our ownership interest in the MCV
Partnership.
At the closing of this sale, these assets, which represent cumulative net
mark-to-market gains, will be sold in conjunction with the sale of our ownership
interest. Also at the closing, we will record any additional mark-to-market
gains or losses associated with the long-term gas contracts and recognize the
changes in fair value in earnings. Any such changes in the fair value of these
contracts recognized before the closing will not affect the purchase price of
our ownership interest in the MCV Partnership. After the closing of the sale, we
will no longer record the fair value of these long-term gas contracts on our
Consolidated Balance Sheets and will not be required to recognize gains or
losses related to changes in the fair value of these contracts on our
Consolidated Statements of Income.
For further details on the sale of our interest in the MCV Partnership, see Note
2, Contingencies, "Other Consumers' Electric Utility Contingencies - The
Midland Cogeneration Venture."
CMS-66
CMS Energy Corporation
Gas Futures, Options, and Swaps: The MCV Partnership enters into natural gas
futures, options, and over-the-counter swap transactions in order to hedge
against unfavorable changes in the market price of natural gas. The MCV
Partnership uses these financial instruments to:
- ensure an adequate supply of natural gas for the projected generation
and sales of electricity and steam, and
- manage price risk by fixing the price to be paid for natural gas on
some of its long-term gas contracts.
At June 30, 2006, the MCV Partnership held natural gas futures, options, and
swaps. We have recorded a net derivative asset amount of $121 million on our
Consolidated Balance Sheets at June 30, 2006 associated with the fair value of
these contracts. Certain of the futures and swaps qualify for cash flow hedge
accounting and we record our proportionate share of their mark-to-market gains
and losses in Accumulated other comprehensive loss. The remaining contracts are
not cash flow hedges and their mark-to-market gains and losses are recorded to
earnings.
Those contracts that qualify as cash flow hedges represent assets of $122
million of the net $121 million derivative assets recorded on our Consolidated
Balance Sheets. We have recorded a cumulative net gain of $39 million, net of
tax and minority interest, in Accumulated other comprehensive loss at June 30,
2006, representing our proportionate share of the cash flow hedges held by the
MCV Partnership. If we have not closed the sale of our ownership interest in the
MCV Partnership within the next 12 months, we can expect to reclassify $17
million of this balance, net of tax and minority interest, as an increase to
earnings as the contracts settle, offsetting the costs of gas purchases. There
was no ineffectiveness associated with any of these cash flow hedges.
The remaining futures, options, and swap contracts, representing derivative
liabilities of $1 million, do not qualify as cash flow hedges. The futures and
swap contracts were previously accounted for as cash flow hedges. Since the RCP
was implemented in 2005, these instruments no longer qualify for cash flow hedge
accounting and we record any changes in their fair value in earnings each
quarter. The MCV Partnership expects almost all of these derivative liabilities
to be realized during 2006 as the contracts settle, with the remainder to be
realized during 2007. For further details on the RCP, see Note 2, Contingencies,
"Other Consumers' Electric Utility Contingencies - The Midland Cogeneration
Venture."
For the six months ended June 30, 2006, we recorded a $53 million loss, before
considering tax effects and minority interest, associated with the decrease in
fair value of these instruments. This loss is included in the total Fuel costs
mark-to-market at the MCV Partnership on our Consolidated Statements of Income.
Because of the volatility of the natural gas market, the MCV Partnership expects
future earnings volatility on these contracts, since gains and losses will be
recorded each quarter. We will continue to record these gains and losses in our
consolidated financial statements until we close the sale of our ownership
interest in the MCV Partnership.
In conjunction with the sale of our ownership interest in the MCV Partnership,
all of the futures, options, and swaps will be sold. At the closing of this
sale, we will record any additional mark-to-market gains or losses associated
with these contracts and recognize the changes in fair value in Accumulated
other comprehensive loss or earnings, accordingly. Any such changes in the fair
value of these contracts recognized before the closing will not affect the
purchase price of our ownership interest in the MCV Partnership. Then, for those
futures and swaps that qualify as cash flow hedges, the related balance of net
cumulative gains recorded in Accumulated other comprehensive loss will be
reclassified and recognized in earnings. After the sale of these assets,
CMS-67
CMS Energy Corporation
we will no longer record the fair value of these contracts on our Consolidated
Balance Sheets and will not be required to recognize gains or losses related to
changes in the fair value of these contracts on our Consolidated Statements of
Income. For additional details on the sale of our interest in the MCV
Partnership, see Note 2, Contingencies, "Other Consumers' Electric Utility
Contingencies - The Midland Cogeneration Venture."
CMS ERM CONTRACTS: CMS ERM enters into and owns energy contracts as a part of
activities considered to be an integral part of CMS Energy's ongoing operations.
CMS ERM holds certain contracts for the future purchase and sale of natural gas
that will result in physical delivery of the commodity at contractual prices.
These forward contracts are generally long-term in nature and are classified as
non-trading. CMS ERM also uses various financial instruments, including swaps,
options, and futures, to manage commodity price risks associated with its
forward purchase and sale contracts and with generation assets owned by CMS
Energy or its subsidiaries. These financial contracts are classified as trading
activities.
In accordance with SFAS No. 133, non-trading and trading contracts that qualify
as derivatives are recorded at fair value on our Consolidated Balance Sheets.
The resulting assets and liabilities are marked to market each quarter, and
changes in fair value are recorded in earnings as a component of Operating
Revenue. For trading contracts, these gains and losses are recorded net in
accordance with EITF Issue No. 02-03. Contracts that do not meet the definition
of a derivative are accounted for as executory contracts (that is, on an accrual
basis).
DERIVATIVE CONTRACTS ASSOCIATED WITH EQUITY INVESTMENTS: At June 30, 2006, some
of our equity method investees held:
- interest rate contracts that hedged the risk associated with
variable-rate debt, and
- foreign exchange contracts that hedged the foreign currency risk
associated with payments to be made under operating and maintenance
service agreements.
We record our proportionate share of the change in fair value of these contracts
in Accumulated other comprehensive loss if the contracts qualify for cash flow
hedge accounting; otherwise, we record our share in Earnings from Equity Method
Investees.
FOREIGN EXCHANGE DERIVATIVES: At times, we use forward exchange and option
contracts to hedge the value of investments in foreign operations. These
contracts limit the risk from currency exchange rate movements because gains and
losses on such contracts offset losses and gains, respectively, on the hedged
investments. At June 30, 2006, we had no outstanding foreign exchange contracts.
However, the impact of previous hedges on our investments in foreign operations
is reflected in Accumulated other comprehensive loss as a component of the
foreign currency translation adjustment on our Consolidated Balance Sheets.
Gains or losses from the settlement of these hedges are maintained in the
foreign currency translation adjustment until we sell or liquidate the hedged
investments. At June 30, 2006, our total foreign currency translation adjustment
was a net loss of $308 million, which included a net hedging loss of $26
million, net of tax, related to settled contracts.
CREDIT RISK: Our swaps, options, and forward contracts contain credit risk,
which is the risk that counterparties will fail to perform their contractual
obligations. We reduce this risk through established credit policies. For each
counterparty, we assess credit quality by using credit ratings, financial
condition, and other available information. We then establish a credit limit for
each counterparty based upon our evaluation of credit quality. We monitor the
degree to which we are
CMS-68
CMS Energy Corporation
exposed to potential loss under each contract and take remedial action, if
necessary.
CMS ERM and the MCV Partnership enter into contracts primarily with companies in
the electric and gas industry. This industry concentration may have an impact on
our exposure to credit risk, either positively or negatively, based on how these
counterparties are affected by similar changes in economic conditions, the
weather, or other conditions. CMS ERM and the MCV Partnership typically use
industry-standard agreements that allow for netting positive and negative
exposures associated with the same counterparty, thereby reducing exposure.
These contracts also typically provide for the parties to demand adequate
assurance of future performance when there are reasonable grounds for doing so.
The following table illustrates our exposure to potential losses at June 30,
2006, if each counterparty within this industry concentration failed to perform
its contractual obligations. This table includes contracts accounted for as
financial instruments. It does not include trade accounts receivable, derivative
contracts that qualify for the normal purchases and sales exception under SFAS
No. 133, or other contracts that are not accounted for as derivatives.
In Millions
----------------------------------------------------------------------------------
Net Exposure Net Exposure
Exposure from Investment from Investment
Before Collateral Net Grade Grade
Collateral (a) Held (b) Exposure Companies Companies (%)
-------------- ---------- -------- --------------- ---------------
CMS ERM $ 71 $ - $ 71 $ 9 (c) 13
MCV Partnership 181 96 85 82 (d) 96
(a) Exposure is reflected net of payables or derivative liabilities if netting
arrangements exist.
(b) Collateral held includes cash and letters of credit received from
counterparties.
(c) The majority of the remaining balance of CMS ERM's net exposure was from a
counterparty whose credit rating fell below investment grade after December 31,
2005.
(d) The remaining balance of the MCV Partnership's net exposure was from
independent natural gas producers/suppliers that do not have published credit
ratings.
Based on our credit policies, our current exposures, and our credit reserves, we
do not expect a material adverse effect on our financial position or future
earnings as a result of counterparty nonperformance.
CMS-69
CMS Energy Corporation
6: RETIREMENT BENEFITS
We provide retirement benefits to our employees under a number of different
plans, including:
- a non-contributory, defined benefit Pension Plan,
- a cash balance pension plan for certain employees hired between July
1, 2003 and August 31, 2005,
- a DCCP for employees hired on or after September 1, 2005,
- benefits to certain management employees under SERP,
- a defined contribution 401(k) Savings Plan,
- benefits to a select group of management under the EISP, and
- health care and life insurance benefits under OPEB.
Pension Plan: The Pension Plan includes funds for most of our current employees,
the employees of our subsidiaries, and Panhandle, a former subsidiary. The
Pension Plan's assets are not distinguishable by company.
Effective January 11, 2006, the MPSC electric rate order authorized Consumers to
include $33 million of electric pension expense in its electric rates. Due to
the volatility of these particular costs, the order also established a pension
equalization mechanism to track actual costs. If actual pension expenses are
greater than the $33 million included in electric rates, the difference will be
recognized as a regulatory asset for future recovery from customers. If actual
pension expenses are less than the $33 million included in electric rates, the
difference will be recognized as a regulatory liability, and refunded to our
customers. The difference between pension expense allowed in our electric rates
and pension expense under SFAS No. 87 resulted in a net reduction in pension
expense of $2 million for the three months ended June 30, 2006 and $5 million
for the six months ended June 30, 2006. We have established a corresponding
regulatory asset of $5 million.
OPEB: Effective January 11, 2006, the MPSC electric rate order authorized
Consumers to include $28 million of electric OPEB expense in its electric rates.
Due to the volatility of these particular costs, the order also established an
OPEB equalization mechanism to track actual costs. If actual OPEB expenses are
greater than the $28 million included in electric rates, the difference will be
recognized as a regulatory asset for future recovery from our customers. If
actual OPEB expenses are less than the $28 million included in electric rates,
the difference will be recognized as a regulatory liability, and refunded to our
customers. The difference between OPEB expense allowed in our electric rates and
OPEB expense under SFAS No. 106 resulted in a $1 million net reduction in OPEB
expense for the three months and the six months ended June 30, 2006. We have
established a corresponding regulatory asset of $1 million.
CMS-70
Costs: The following table recaps the costs incurred in our retirement benefits
plans:
In Millions
---------------------------------------------------
Pension
---------------------------------------------------
Three Months Ended Six Months Ended
------------------ ---------------------
June 30 2006 2005 2006 2005
- ------- ------ ------ ------ ------
Service cost $ 12 $ 15 $ 24 $ 25
Interest expense 21 30 42 49
Expected return on plan assets (21) (38) (43) (63)
Amortization of:
Net loss 11 7 22 14
Prior service cost 2 3 4 4
------ ------ ------ ------
Net periodic cost 25 17 49 29
Regulatory adjustment (2) - (5) -
------ ------ ------ ------
Net periodic cost after regulatory adjustment $ 23 $ 17 $ 44 $ 29
====== ====== ====== ======
In Millions
---------------------------------------------------
OPEB
---------------------------------------------------
Three Months Ended Six Months Ended
------------------ ---------------------
June 30 2006 2005 2006 2005
- ------- ------ ------ ------ ------
Service cost $ 6 $ 5 $ 12 $ 11
Interest expense 16 16 32 32
Expected return on plan assets (15) (14) (29) (28)
Amortization of:
Net loss 5 5 10 9
Prior service cost (2) (2) (5) (4)
------ ------ ------ ------
Net periodic cost 10 10 20 20
Regulatory adjustment (1) - (1) -
------ ------ ------ ------
Net periodic cost after regulatory adjustment $ 9 $ 10 $ 19 $ 20
====== ====== ====== ======
SERP: On April 1, 2006, we implemented a Defined Contribution Supplemental
Executive Retirement Plan (DC SERP) and froze further new participation in the
defined benefit SERP. The DC SERP provides promoted and newly hired participants
benefits ranging from 5 to 15 percent of total compensation. The DC SERP
requires a minimum of five years of participation before vesting. Our
contributions to the plan, if any, will be placed in a grantor trust. For the
six months ended June 30, 2006, no contributions were made to the plan.
MCV: The MCV Partnership sponsors defined cost postretirement health care plans
that cover all full-time employees, except key management. Participants in the
postretirement health care plans become eligible for the benefits if they retire
on or after the attainment of age 65 or upon a qualified disability retirement,
or if they have 10 or more years of service and retire at age 55 or older. The
MCV Partnership's net periodic postretirement health care cost for the three
months and six months ended June 30, 2006 and 2005 was less than $1 million.
CMS-71
CMS Energy Corporation
7: ASSET RETIREMENT OBLIGATIONS
SFAS NO. 143: This standard requires companies to record the fair value of the
cost to remove assets at the end of their useful life, if there is a legal
obligation to remove them. We have legal obligations to remove some of our
assets, including our nuclear plants, at the end of their useful lives.
The fair value of ARO liabilities has been calculated using an expected present
value technique. This technique reflects assumptions such as costs, inflation,
and profit margin that third parties would consider to assume the settlement of
the obligation. Fair value, to the extent possible, should include a market risk
premium for unforeseeable circumstances. No market risk premium was included in
our ARO fair value estimate since a reasonable estimate could not be made. If a
five percent market risk premium were assumed, our ARO liability would increase
by $25 million.
If a reasonable estimate of fair value cannot be made in the period in which the
ARO is incurred, such as for assets with indeterminate lives, the liability is
to be recognized when a reasonable estimate of fair value can be made.
Generally, electric and gas transmission and distribution assets have
indeterminate lives. Retirement cash flows cannot be determined and there is a
low probability of a retirement date. Therefore, no liability has been recorded
for these assets or associated obligations related to potential future
abandonment. Also, no liability has been recorded for assets that have
insignificant cumulative disposal costs, such as substation batteries. The
measurement of the ARO liabilities for Palisades and Big Rock are based on
decommissioning studies that largely utilize third-party cost estimates.
FASB INTERPRETATION NO. 47, ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT
OBLIGATIONS: This Interpretation clarified the term "conditional asset
retirement obligation" as used in SFAS No. 143. The term refers to a legal
obligation to perform an asset retirement activity in which the timing and (or)
method of settlement are conditional on a future event. We determined that
abatement of asbestos included in our plant investments qualifies as a
conditional ARO, as defined by FASB Interpretation No. 47.
The following tables describe our assets that have legal obligations to be
removed at the end of their useful life:
June 30, 2006 In Millions
- ----------------------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
- --------------- ---------- ----------------- -----
Palisades-decommission plant site 1972 Palisades nuclear plant $551
Big Rock-decommission plant site 1962 Big Rock nuclear plant 12
JHCampbell intake/discharge water line 1980 Plant intake/discharge water line -
Closure of coal ash disposal areas Various Generating plants coal ash areas -
Closure of wells at gas storage fields Various Gas storage fields -
Indoor gas services equipment relocations Various Gas meters located inside structures -
Asbestos abatement 1973 Electric and gas utility plant -
Natural gas-fired power plant 1997 Gas fueled power plant -
Close gas treating plant and gas wells Various Gas transmission and storage -
CMS-72
CMS Corporation
In Millions
--------------------------------------------------------------------------------
ARO ARO
Liability Cash flow Liability
ARO Description 12/31/05 Incurred Settled(a) Accretion Revisions 6/30/06
- --------------- --------- -------- ---------- --------- --------- ---------
Palisades-decommission $ 375 $ - $ - $ 12 $ - $ 387
Big Rock-decommission 27 - (15) 2 - 14
JHCampbell intake line - - - - - -
Coal ash disposal areas 54 - (1) 2 - 55
Wells at gas storage fields 1 - - - - 1
Indoor gas services relocations 1 - - - - 1
Natural gas-fired power plant 1 - - - - 1
Close gas treating plant and gas wells 1 - - 1 - 2
Asbestos abatement 36 - (2) 1 - 35
------- ------- ------ -------- ------- -------
Total $ 496 $ - $ (18) $ 18 $ - $ 496
======= ======= ====== ======== ======= =======
(a) These cash payments are included in the Other current and non-current
liabilities line in Net cash provided by operating activities on our
Consolidated Statements of Cash Flows. Cash payments for the six months ended
June 30, 2005 were $26 million.
In October 2004, the MPSC initiated a generic proceeding to review SFAS No. 143,
FERC Order No. 631, Accounting, Financial Reporting, and Rate Filing
Requirements for Asset Retirement Obligations, and related accounting and
ratemaking issues for MPSC-jurisdictional electric and gas utilities. In
December 2005, the ALJ issued a Proposal for Decision recommending that the MPSC
dismiss the proceeding. In March 2006, the MPSC remanded the case to the ALJ for
findings and recommendations. We consider the proceeding a clarification of
accounting and reporting issues that relate to all Michigan utilities. We cannot
predict the outcome of the proceeding.
8: EXECUTIVE INCENTIVE COMPENSATION
We provide a Performance Incentive Stock Plan (the Plan) to key employees and
non-employee directors based on their contributions to the successful management
of the company. The Plan has a five-year term, expiring in May 2009.
All grants awarded under the Plan for the six months ended June 30, 2006 and in
2005 were in the form of restricted stock. Restricted stock awards are
outstanding shares to which the recipient has full voting and dividend rights
and vest 100 percent after three years of continued employment. Restricted stock
awards granted to officers in 2005 and 2004 are also subject to the achievement
of specified levels of total shareholder return, including a comparison to a
peer group of companies. All restricted stock awards are subject to forfeiture
if employment terminates before vesting. However, if certain minimum service
requirements are met, restricted shares may continue to vest upon retirement or
disability and vest fully if control of CMS Energy changes, as defined by the
Plan.
The Plan also allows for the following types of awards:
- stock options,
- stock appreciation rights,
- phantom shares, and
- performance units.
CMS-73
CMS Energy Corporation
For the six months ended June 30, 2006 and in 2005, we did not grant any of
these types of awards.
Select participants may elect to receive all or a portion of their incentive
payments under the Officer's Incentive Compensation Plan in the form of cash,
shares of restricted common stock, shares of restricted stock units, or any
combination of these. These participants may also receive awards of additional
restricted common stock or restricted stock units, provided the total value of
these additional grants does not exceed $2.5 million for any fiscal year.
Shares awarded or subject to stock options, phantom shares, and performance
units may not exceed 6 million shares from June 2004 through May 2009, nor may
such awards to any participant exceed 250,000 shares in any fiscal year. We may
issue awards of up to 4,906,300 shares of common stock under the Plan at June
30, 2006. Shares for which payment or exercise is in cash, as well as shares or
stock options that are forfeited, may be awarded or granted again under the
Plan.
SFAS NO. 123(R) AND SAB NO. 107, SHARE-BASED PAYMENT: SFAS No. 123(R) was
effective for us on January 1, 2006. SFAS No. 123(R) requires companies to use
the fair value of employee stock options and similar awards at the grant date to
value the awards. Companies must expense this value over the required service
period of the awards. As a result, future compensation costs for share-based
awards with accelerated service provisions upon retirement will need to be fully
expensed by the period in which the employee becomes eligible to retire. At
January 1, 2006, unrecognized compensation cost for such share-based awards held
by retirement-eligible employees was not material.
We elected to adopt the modified prospective method recognition provisions of
this Statement instead of retrospective restatement. The modified prospective
method applies the recognition provisions to all awards granted or modified
after the adoption date of this Statement. We adopted the fair value method of
accounting for share-based awards effective December 2002. Therefore, SFAS No.
123(R) did not have a significant impact on our results of operations when it
became effective.
The SEC issued SAB No. 107 to express the views of the staff regarding the
interaction between SFAS No. 123(R) and certain SEC rules and regulations. Also,
the SEC issued SAB No. 107 to provide the staff's views regarding the valuation
of share-based payments, including assumptions such as expected volatility and
expected term. We applied the additional guidance provided by SAB No. 107 upon
implementation of SFAS No. 123(R) with no impact on our consolidated results of
operations.
The following table summarizes restricted stock activity under the Plan:
Weighted-
Average Grant
Date Fair
Restricted Stock Number of Shares Value
- ---------------- ---------------- -------------
Nonvested at December 31, 2005 1,682,056 $ 10.64
Granted 47,830 $ 13.00
Vested (19,886) $ 9.12
Forfeited (35,000) $ 10.92
--------- ----------
Nonvested at June 30, 2006 1,675,000 $ 10.72
========= ==========
The total fair value of shares vested was less than $1 million for the six
months ended June 30, 2006 and 2005.
CMS-74
CMS Energy Corporation
We calculate the fair value of restricted shares granted based on the price of
our common stock on the grant date and expense the fair value over the required
service period. Total compensation cost recognized in income related to
restricted stock was $3 million for the six months ended June 30, 2006 and $2
million for the six months ended June 30, 2005. The total related income tax
benefit recognized in income was $1 million for the six months ended June 30,
2006 and 2005. At June 30, 2006, there was $10 million of total unrecognized
compensation cost related to restricted stock. We expect to recognize this cost
over a weighted-average period of 2.0 years.
The following table summarizes stock option activity under the Plan:
Weighted-
Options Weighted- Average Aggregate
Outstanding, Average Remaining Intrinsic
Fully Vested, Exercise Contractual Value
Stock Options and Exercisable Price Term (In Millions)
- ------------- --------------- --------- ----------- -------------
Outstanding at December 31, 2005 3,541,338 $ 21.21 5.4 years $ (24)
Granted - -
Exercised (53,000) $ 7.08
Cancelled or Expired (392,640) $ 30.76
--------- -------- --------- -----
Outstanding at June 30, 2006 3,095,698 $ 20.24 5.1 years $ (23)
========= ======== ========= =====
Stock options give the holder the right to purchase common stock at a price
equal to the fair value of our common stock on the grant date. Stock options are
exercisable upon grant, and expire up to 10 years and one month from the grant
date. We issue new shares when participants exercise stock options. The total
intrinsic value of stock options exercised was less than $1 million for the six
months ended June 30, 2006 and $1 million for the six months ended June 30,
2005. Cash received from exercise of these stock options was less than $1
million for the six months ended June 30, 2006 and $1 million for the six months
ended June 30, 2005. Since we have utilized tax loss carryforwards, we were not
able to realize the excess tax benefits upon exercise of stock options.
Therefore, we did not recognize the related excess tax benefits in equity.
9: EQUITY METHOD INVESTMENTS
Where ownership is more than 20 percent but less than a majority, we account for
certain investments in other companies, partnerships, and joint ventures by the
equity method of accounting, in accordance with APB Opinion No. 18. Earnings
from equity method investments was $8 million for the three months ended June
30, 2006 and $21 million for the three months ended June 30, 2005. Earnings from
equity method investments was $44 million for the six months ended June 30, 2006
and $52 million for the six months ended June 30, 2005. The most significant of
these investments is our 50 percent interest in Jorf Lasfar.
CMS-75
CMS Energy Corporation
Summarized financial information for Jorf Lasfar is as follows:
Income Statement Data
In Millions
---------------------------------------------------
JORF LASFAR Three Months Ended Six Months Ended
- ----------- ------------------ -------------------
June 30 2006 2005 2006 2005
- ------- ---- ---- ---- ----
Operating revenue $113 $129 $234 $259
Operating expenses 79 90 158 173
---- ---- ---- ----
Operating income 34 39 76 86
Other expense, net 13 14 26 28
---- ---- ---- ----
Net income $ 21 $ 25 $ 50 $ 58
==== ==== ==== ====
10: REPORTABLE SEGMENTS
Our reportable segments consist of business units organized and managed by their
products and services. We evaluate performance based upon the net income of each
segment. We operate principally in three reportable segments: electric utility,
gas utility, and enterprises.
The "Other" segment includes corporate interest and other and discontinued
operations. The following tables show our financial information by reportable
segment:
In Millions
---------------------------------------------------------
Three Months Ended Six Months Ended
------------------------ -----------------------
June 30 2006 2005 2006 2005
- ------- ------- ------- ------- -------
Operating Revenue
Electric utility $ 791 $ 644 $ 1,520 $ 1,272
Gas utility 334 355 1,375 1,347
Enterprises 271 231 533 456
------- ------- ------- -------
Total Operating Revenue $ 1,396 $ 1,230 $ 3,428 $ 3,075
======= ======= ======= =======
Net Income Available to Common Stockholders
Electric utility $ 37 $ 46 $ 66 $ 79
Gas utility (3) (3) 34 55
Enterprises 4 29 (45) 134
Other 34 (45) (10) (91)
------- ------- ------- -------
Total Net Income Available to Common Stockholders $ 72 $ 27 $ 45 $ 177
======= ======= ======= =======
In Millions
-------------------------------
June 30, 2006 December 31, 2005
------------- -----------------
Assets
Electric utility (a) $ 7,925 $ 7,743
Gas utility (a) 3,503 3,600
Enterprises 3,695 4,130
Other 543 547
------- -------
Total Assets $15,666 $16,020
======= =======
CMS-76
CMS Energy Corporation
(a) Amounts include a portion of Consumers' other common assets attributable to
both the electric and gas utility businesses.
CMS-77
CMS Energy Corporation
(This page intentionally left blank)
CMS-78
Consumers Energy Company
CONSUMERS ENERGY COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS
In this MD&A, Consumers Energy, which includes Consumers Energy Company and all
of its subsidiaries, is at times referred to in the first person as "we," "our"
or "us." This MD&A has been prepared in accordance with the instructions to Form
10-Q and Item 303 of Regulation S-K. This MD&A should be read in conjunction
with the MD&A contained in Consumers Energy's Form 10-K for the year ended
December 31, 2005.
EXECUTIVE OVERVIEW
Consumers, a subsidiary of CMS Energy, a holding company, is a combination
electric and gas utility company serving Michigan's Lower Peninsula. Our
customer base includes a mix of residential, commercial, and diversified
industrial customers.
We manage our business by the nature of services each provides and operate
principally in two business segments: electric utility and gas utility. Our
electric utility operations include the generation, purchase, distribution, and
sale of electricity. Our gas utility operations include the purchase,
transportation, storage, distribution, and sale of natural gas.
We earn our revenue and generate cash from operations by providing electric and
natural gas utility services, electric power generation, gas distribution,
transmission, and storage, and other energy related services. Our businesses are
affected primarily by:
- weather, especially during the traditional heating and cooling
seasons,
- economic conditions,
- regulation and regulatory issues,
- energy commodity prices,
- interest rates, and
- our debt credit rating.
During the past several years, our business strategy has involved improving our
balance sheet and maintaining focus on our core strength: utility operations and
service.
We are focused on growing the equity base of our company and have been
refinancing our debt to reduce interest rate costs. In 2006, we received $200
million of cash contributions from CMS Energy and we extinguished, through a
legal defeasance, $129 million of 9 percent related party notes.
In July 2006, we reached an agreement to sell the Palisades nuclear plant to
Entergy for $380 million. We also signed a 15-year power purchase agreement for
100 percent of the plant's current electric output. We are targeting to close
the sale in the first quarter of 2007. The sale will result in an immediate
improvement in our cash flow, a reduction in our nuclear operating and
decommissioning risk, and an improvement in our financial flexibility to support
other utility investments. We expect that a portion of the proceeds will benefit
our customers. We plan to use the cash that we retain from the sale to reduce
debt.
CE-1
Consumers Energy Company
Working capital and cash flow continue to be a challenge for us. Natural gas
prices continue to be volatile and remain at high levels. Although our natural
gas purchases are recoverable from our utility customers, higher priced natural
gas stored as inventory requires additional liquidity due to the lag in cost
recovery.
In addition to causing working capital issues for us, historically high natural
gas prices caused the MCV Partnership to reevaluate the economics of operating
the MCV Facility and to record an impairment charge in 2005. High gas prices
could result in a further impairment of our interest in the MCV Partnership.
Due to the impairment of the MCV Facility, and operating losses from
mark-to-market adjustments on derivative instruments, the equity held by a
Consumers' subsidiary and the other minority interest owners in the MCV
Partnership has decreased significantly and is now negative. As the MCV
Partnership recognizes future losses, we will assume an additional 7 percent of
the MCV Partnership's negative equity, which is a portion of the limited
partners' negative equity, in addition to our proportionate share. In July 2006,
we reached an agreement to sell our interests in the MCV Partnership and the
FMLP. The sale is subject to various regulatory approvals including the MPSC. If
the sale closes by the end of 2006, as expected, it will have a $56 million
positive impact on our 2006 cash flow. The sale will reduce our exposure to
sustained high natural gas prices. We will use the proceeds to reduce utility
debt. If the sale is not completed, the viability of the MCV Facility is still
in question.
Going forward, our strategy will continue to focus on:
- managing cash flow issues,
- maintaining and growing earnings, and
- investing in our utility system to enable us to meet our customer
commitments, comply with increasing environmental performance
standards, and maintain adequate supply and capacity.
As we execute our strategy, we will need to overcome a sluggish Michigan economy
that has been further hampered by recent negative developments in Michigan's
automotive industry and limited growth in the non-automotive sectors of our
economy.
These negative effects will be offset somewhat by the reduction we are
experiencing in ROA load in our service territory. At June 30, 2006, alternative
electric suppliers were providing 311 MW of generation service to ROA customers.
This is 4 percent of our total distribution load and represents a decrease of 62
percent of ROA load compared to June 30, 2005. It is, however, difficult to
predict future ROA customer trends.
FORWARD-LOOKING STATEMENTS AND INFORMATION
This Form 10-Q and other written and oral statements that we make contain
forward-looking statements as defined by the Private Securities Litigation
Reform Act of 1995. Our 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. We designed this discussion of potential risks and uncertainties to
highlight important factors that may impact our business and financial outlook.
We have 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 our actual results to differ
materially from the results anticipated in these statements. Such factors
include our inability to predict and (or) control:
CE-2
Consumers Energy Company
- capital and financial market conditions, including the price of CMS
Energy Common Stock, and the effect of such market conditions on the
Pension Plan, interest rates, and access to the capital markets,
including availability of financing to Consumers, CMS Energy, or any
of their affiliates and the energy industry,
- market perception of the energy industry, Consumers, CMS Energy, or
any of their affiliates,
- credit ratings of Consumers, CMS Energy, or any of their affiliates,
- factors affecting utility and diversified energy operations, such as
unusual weather conditions, catastrophic weather-related damage,
unscheduled generation outages, maintenance or repairs, environmental
incidents, or electric transmission or gas pipeline system
constraints,
- international, national, regional, and local economic, competitive,
and regulatory policies, conditions and developments,
- adverse regulatory or legal decisions, including those related to
environmental laws and regulations, and potential environmental
remediation costs associated with such decisions,
- potentially adverse regulatory treatment and (or) regulatory lag
concerning a number of significant questions presently before the MPSC
including:
- recovery of Clean Air Act costs and other environmental and
safety-related expenditures,
- power supply and natural gas supply costs when oil prices
and other fuel prices are increasing rapidly,
- timely recognition in rates of additional equity investments
in Consumers,
- adequate and timely recovery of additional electric and gas
rate-based investments,
- adequate and timely recovery of higher MISO energy costs,
and
- recovery of Stranded Costs incurred due to customers
choosing alternative energy suppliers,
- the impact of adverse natural gas prices on the MCV Partnership and
the FMLP investments, regulatory decisions that limit recovery of
capacity and fixed energy payments, and our ability to complete the
sale of our interests in the MCV Partnership and the FMLP,
- if successful in exercising the regulatory out clause of the MCV PPA,
and if the sale of our interests in the MCV Partnership and the FMLP
is not completed, the negative impact on the MCV Partnership's
financial performance,
- if we exercise our regulatory out rights causing the MCV Partnership
to terminate the MCV PPA, the effects on our ability to purchase
capacity to serve our customers and recover the cost of these
purchases,
- federal regulation of electric sales and transmission of electricity,
including periodic re-examination by federal regulators of our
market-based sales authorizations in wholesale power markets without
price restrictions,
CE-3
Consumers Energy Company
- energy markets, including availability of capacity and the timing and
extent of changes in commodity prices for oil, coal, natural gas,
natural gas liquids, electricity and certain related products due to
lower or higher demand, shortages, transportation problems, or other
developments,
- our ability to collect accounts receivable from our customers,
- the GAAP requirement that we utilize mark-to-market accounting on
certain energy commodity contracts and interest rate swaps, which may
have, in any given period, a significant positive or negative effect
on earnings, which could change dramatically or be eliminated in
subsequent periods and could add to earnings volatility,
- the effect on our electric utility of the direct and indirect impacts
of the continued economic downturn experienced by our automotive and
automotive parts manufacturing customers,
- potential disruption or interruption of facilities or operations due
to accidents or terrorism, and the ability to obtain or maintain
insurance coverage for such events,
- nuclear power plant performance, decommissioning, policies,
procedures, incidents, and regulation, including the availability of
spent nuclear fuel storage,
- technological developments in energy production, delivery, and usage,
- achievement of capital expenditure and operating expense goals,
- changes in financial or regulatory accounting principles or policies,
- changes in tax laws or new IRS interpretations of existing tax laws,
- outcome, cost, and other effects of legal and administrative
proceedings, settlements, investigations and claims,
- disruptions in the normal commercial insurance and surety bond markets
that may increase costs or reduce traditional insurance coverage,
particularly terrorism and sabotage insurance and performance bonds,
- other business or investment considerations that may be disclosed from
time to time in Consumers' or CMS Energy's SEC filings, or in other
publicly issued written documents, and
- other uncertainties that are difficult to predict, many of which are
beyond our control.
For additional information regarding these and other uncertainties, see the
"Outlook" section included in this MD&A, Note 2, Contingencies, and Part II,
Item 1A. Risk Factors.
CE-4
Consumers Energy Company
RESULTS OF OPERATIONS
NET INCOME AVAILABLE TO COMMON STOCKHOLDER
In Millions
-------------------------------
Three months ended June 30 2006 2005 Change
- -------------------------- ---- ---- ------
Electric $ 37 $ 46 $ (9)
Gas (3) (3) -
Other (Includes the MCV Partnership interest) 1 (11) 12
---- ---- ----
Net income available to common stockholder $ 35 $ 32 $ 3
==== ==== ====
For the three months ended June 30, 2006, net income available to our common
stockholder was $35 million, compared to $32 million for the three months ended
June 30, 2005. The increase reflects higher electric utility revenues due to an
electric rate increase authorized in December 2005 and a $14 million impact from
the resolution of an IRS income tax audit. The audit resolution resulted in an
increase to net income of $4 million at the electric utility, $3 million at the
gas utility, and $7 million in our other segment. Partially offsetting these
increases are higher operating and maintenance costs at our electric utility.
Specific changes to net income available to our common stockholder for 2006
versus 2005 are:
In Millions
-----------
- - increase in electric delivery revenue primarily due to the MPSC's December 2005
electric rate order, $ 39
- - decrease in income taxes, offset by interest expense, primarily due to an IRS income tax audit, 14
- - increase in operating expenses primarily due to higher depreciation and amortization expense,
expense, higher electric maintenance expense, and higher customer service expense, and (44)
- - other net decreases (6)
----
Total Change $ 3
====
In Millions
-----------------------------------
Six months ended June 30 2006 2005 Change
- ------------------------ ------ ------ ------
Electric $ 66 $ 79 $ (13)
Gas 34 55 (21)
Other (Includes the MCV Partnership interest) (55) 55 (110)
------ ------ ------
Net income available to common stockholder $ 45 $ 189 $ (144)
====== ====== ======
For the six months ended June 30, 2006, net income available to our common
stockholder was $45 million, compared to $189 million for the six months ended
June 30, 2005. The decrease reflects the impact of gas prices on the market
value of certain long-term gas contracts and financial hedges. In order to
reflect the market value, mark-to-market losses were recorded in 2006 to reduce
partially gains
CE-5
Consumers Energy Company
recorded on these assets in 2005. The decrease also reflects a reduction in net
income from our gas utility due to lower, weather-driven sales, and higher
operating and maintenance costs at our electric utility. Partially offsetting
these losses are higher electric utility revenues primarily due to an electric
rate increase authorized in December 2005 and the $14 million impact from the
resolution of an IRS income tax audit.
Specific changes to net income available to our common stockholder for 2006
versus 2005 are:
In Millions
-----------
- - decrease in earnings from our ownership interest in the MCV Partnership primarily due to
a decrease in the fair value of certain long-term gas contracts and financial hedges, $ (122)
- - increase in operating expenses primarily due to higher depreciation and amortization expense,
expense, higher electric maintenance expense, and higher customer service expense, (88)
- - decrease in gas delivery revenue primarily due to warmer weather and increased
conservation efforts, (23)
- - decrease in return on electric utility capital expenditures in excess of depreciation base
as allowed by the Customer Choice Act, (14)
- - increase in electric delivery revenue primarily due to the MPSC's December 2005
electric rate order, 77
- - decrease in income taxes, offset by interest expense, primarily due to an IRS income tax audit, 14
- - increase in earnings due to the expiration of rate caps that, in 2005, would not allow us
to recover fully our power supply costs from our residential customers, and 8
- - other net increases 4
------
Total Change $ (144)
======
CE-6
Consumers Energy Company
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
----------------------------------
June 30 2006 2005 Change
- ------- ------ ------ ------
Three months ended $ 37 $ 46 $ (9)
Six months ended $ 66 $ 79 $ (13)
====== ====== ======
Three Months Ended Six Months Ended
Reasons for the change: June 30, 2006 vs. 2005 June 30, 2006 vs. 2005
- ----------------------- ---------------------- ----------------------
Electric deliveries $ 60 $ 119
Power supply costs and related revenue 3 12
Other operating expenses, other income, and
non-commodity revenue (71) (130)
Regulatory return on capital expenditures (8) (21)
General taxes (1) (1)
Interest charges (3) (2)
Income taxes 11 10
------ ------
Total change $ (9) $ (13)
====== ======
ELECTRIC DELIVERIES: For the three months ended June 30, 2006, electric
deliveries, excluding intersystem sales, decreased 0.2 billion kWh or 2.1
percent versus 2005. For the six months ended June 30, 2006, electric
deliveries, excluding intersystem sales, decreased 0.3 billion kWh or 1.8
percent versus 2005. The decrease in electric deliveries for both periods is
primarily due to weather. Despite lower electric deliveries, electric delivery
revenue increased primarily due to an electric rate order, increased surcharge
revenue, and the return to full-service rates of customers previously using
alternative energy suppliers.
In December 2005, the MPSC issued an order authorizing an annual rate increase
of $86 million for service rendered on and after January 11, 2006. As a result
of this order, electric delivery revenues increased $23 million for the three
months ended June 30, 2006 and $43 million for the six months ended June 30,
2006 versus the same periods in 2005.
Effective January 1, 2006, we started collecting a surcharge that the MPSC
authorized under Section 10d(4) of the Customer Choice Act. This surcharge
increased electric delivery revenue by $12 million for the three months ended
June 30, 2006 and $23 million for the six months ended June 30, 2006 versus the
same periods in 2005. In addition, on January 1, 2006, we began recovering
customer choice transition costs from our residential customers, thereby
increasing electric delivery revenue by another $2 million for the three months
ended June 30, 2006 and $5 million for the six months ended June 30, 2006 versus
the same periods in 2005.
The Customer Choice Act allows all of our electric customers to buy electric
generation service from us or from an alternative electric supplier. At June 30,
2006, alternative electric suppliers were providing 311 MW of generation service
to ROA customers. This amount represents a decrease of 62 percent of ROA load
compared to June 30, 2005. The return of former ROA customers to full-service
rates increased electric revenues $15 million for the three months ended June
30, 2006 and $28 million for the six months ended June 30, 2006 versus the same
periods in 2005.
CE-7
Consumers Energy Company
POWER SUPPLY COSTS AND RELATED REVENUE: In 2005, power supply costs exceeded
power supply revenue due to rate caps for our residential customers. Rate caps
for our residential customers expired on December 31, 2005. In 2006, the absence
of rate caps allows us to record power supply revenue to offset fully our power
supply costs. Our ability to recover fully these power supply costs resulted in
a $3 million increase to electric revenue for the three months ended June 30,
2006 and $12 million for the six months ended June 30, 2006 versus the same
periods in 2005.
OTHER OPERATING EXPENSES, OTHER INCOME AND NON-COMMODITY REVENUE: For the three
months ended June 30, 2006, other operating expenses increased $73 million,
other income increased $3 million, and non-commodity revenue decreased $1
million versus 2005. For the six months ended June 30, 2006, other operating
expenses increased $135 million, other income increased $8 million, and
non-commodity revenue decreased $3 million versus 2005.
The increase in other operating expenses reflects higher operating and
maintenance expense, customer service expense, depreciation and amortization
expense, and pension and benefit expense. Operating and maintenance expense
increased primarily due to costs related to a planned refueling outage at our
Palisades nuclear plant, and higher tree trimming and storm restoration costs.
Higher customer service expense reflects contributions, which started in January
2006 pursuant to a December 2005 MPSC order, to a fund that provides energy
assistance to low-income customers. Depreciation and amortization expense
increased due to higher plant in service and greater amortization of certain
regulatory assets. Pension and benefit expense reflects changes in actuarial
assumptions in 2005, and the latest collective bargaining agreement between the
Utility Workers Union of America and Consumers.
The increase in other income is primarily due to higher interest income and the
absence, in 2006, of expenses recorded in 2005 associated with the early
retirement of debt. The decrease in non-commodity revenue is primarily due to a
decrease in capital-related services provided to METC in 2006 versus 2005.
REGULATORY RETURN ON CAPITAL EXPENDITURES: The $8 million decrease for the three
months ended June 30, 2006 and $21 million decrease for the six months ended
June 30, 2006 versus the same periods in 2005, is due to lower income associated
with recording a return on capital expenditures in excess of our depreciation
base as allowed by the Customer Choice Act. In December 2005, the MPSC issued an
order that authorized us to recover $333 million of Section 10d(4) costs. The
order authorized recovery of a lower level of costs versus the level used to
record 2005 income.
GENERAL TAXES: For the three and six months ended June 30, 2006, the increase in
general taxes reflect higher MSBT expense, offset partially by lower property
tax expense.
INTEREST CHARGES: For the three and six months ended June 30, 2006, interest
charges increased primarily due to adjustments made in connection with an IRS
income tax audit. The settlement recognized that Consumers' taxable income for
prior years was higher than originally filed, resulting in the accrual of
interest on the additional tax liability for these prior years.
INCOME TAXES: For the three and six months ended June 30, 2006, income taxes
decreased versus 2005 primarily due to lower earnings by the electric utility
and the resolution of an IRS income tax audit, which resulted in a $4 million
income tax benefit primarily for the utilization or restoration of income tax
credits.
CE-8
Consumers Energy Company
GAS UTILITY RESULTS OF OPERATIONS
In Millions
------------------------------------
June 30 2006 2005 Change
- ------- ------ ------ ------
Three months ended $ (3) $ (3) $ -
Six months ended $ 34 $ 55 $ (21)
====== ====== ======
Three Months Ended Six Months Ended
Reasons for the change: June 30, 2006 vs. 2005 June 30, 2006 vs. 2005
- ----------------------- ---------------------- ----------------------
Gas deliveries $ (5) $ (36)
Gas wholesale and retail services, other gas
revenues and other income 6 11
Operation and maintenance 1 (2)
General taxes and depreciation (2) (5)
Interest charges (3) (3)
Income taxes 3 14
------ ------
Total change $ - $ (21)
====== ======
GAS DELIVERIES: For the three months ended June 30, 2006, gas deliveries,
including miscellaneous transportation to end-use customers, decreased 6 bcf or
12 percent. The decrease in gas deliveries is due to increased customer
conservation efforts in response to higher gas prices and warmer than normal
weather.
For the six months ended June 30, 2006, gas deliveries, including miscellaneous
transportation to end-use customers, decreased 28 bcf or 14.4 percent. The
decrease in gas deliveries is primarily due to warmer weather in 2006 versus
2005 and increased customer conservation efforts in response to higher gas
prices. Average temperatures during the six-month period in 2006 were 4.3
percent warmer than 2005.
GAS WHOLESALE AND RETAIL SERVICES, OTHER GAS REVENUES AND OTHER INCOME: For the
three and six months ended June 30, 2006, the increase is related primarily to
increased gas wholesale and retail services revenue.
OPERATION AND MAINTENANCE: For the three months ended June 30, 2006, operation
and maintenance expenses decreased versus 2005 primarily due to a reduction in
our injuries and damages expense, offset partially by higher pension and benefit
expense and customer service expense. Pension and benefit expense reflects
changes in actuarial assumptions and the latest collective bargaining agreement
between the Utility Workers Union of America and Consumers. Customer service
expense increased primarily due to higher uncollectible accounts expense.
For the six months ended June 30, 2006, operation and maintenance expenses
increased versus 2005 primarily due to higher pension and benefit expense and
customer service expense. Pension and benefit expense reflects changes in
actuarial assumptions and the latest collective bargaining agreement between the
Utility Workers Union of America and Consumers. Customer service expense
increased primarily due to higher uncollectible accounts expense.
CE-9
Consumers Energy Company
GENERAL TAXES AND DEPRECIATION: For the three and six months ended June 30,
2006, depreciation expense increased versus 2005 primarily due to higher plant
in service. The increase in general taxes reflects higher MSBT expense,
partially offset by lower property tax expense.
INTEREST CHARGES: For the three and six months ended June 30, 2006, interest
charges increased primarily due to adjustments made in connection with an IRS
income tax audit.
INCOME TAXES: For the three and six months ended June 30, 2006, income taxes
decreased versus 2005 primarily due to lower earnings by the gas utility and the
resolution of an IRS income tax audit, which resulted in a $3 million income tax
benefit primarily for the utilization or restoration of income tax credits.
OTHER RESULTS OF OPERATIONS
In Millions
------------------------------------
June 30 2006 2005 Change
- ------- ------ ------ ------
Three months ended $ 1 $ (11) $ 12
Six months ended $ (55) $ 55 $ (110)
====== ====== ======
For the three months ended June 30, 2006, other operations net income was $1
million, an increase of $12 million versus 2005. The change is primarily due to
a $5 million increase in earnings from our ownership interest in the MCV
Partnership, primarily due to lower depreciation expense and higher dispatch
revenue. Also contributing to the increase were lower interest charges and lower
income tax expense at Consumers. The decrease in income tax expense is primarily
due to the resolution of an IRS income tax audit, which resulted in a $7 million
income tax benefit primarily for the utilization or restoration of income tax
credits.
For the six months ended June 30, 2006, other operations net loss was $55
million, a decrease of $110 million versus 2005. The change is primarily due to
a $122 million decrease in earnings from our ownership interest in the MCV
Partnership. The decrease in MCV Partnership earnings is due to the impact of
gas prices on the market value of certain long-term gas contracts and financial
hedges. In order to reflect the market value of these contracts and hedges,
mark-to-market losses were recorded in 2006 to reduce partially gains recorded
on these assets in 2005. The 2005 gains were primarily due to the
marking-to-market of certain long-term gas contracts and financial hedges that,
as a result of the implementation of the RCP, no longer qualified as normal
purchases or cash flow hedges.
CRITICAL ACCOUNTING POLICIES
The following accounting policies are important to an understanding of our
results of operations and financial condition and should be considered an
integral part of our MD&A.
USE OF ESTIMATES AND ASSUMPTIONS
In preparing our financial statements, we use estimates and assumptions that may
affect reported amounts and disclosures. We use accounting estimates for asset
valuations, depreciation, amortization, financial and derivative instruments,
employee benefits, and contingencies. For example, we estimate the rate of
return on plan assets and the cost of future health-care benefits to determine
our annual pension and other postretirement benefit costs. There are risks and
uncertainties that may cause actual results to differ from estimated results,
such as changes in the regulatory environment, competition, regulatory
decisions, and lawsuits.
CE-10
Consumers Energy Company
CONTINGENCIES: We are involved in various regulatory and legal proceedings that
arise in the ordinary course of our business. We record a liability for
contingencies based upon our assessment that a loss is probable and the amount
of loss can be reasonably estimated. The recording of estimated liabilities for
contingencies is guided by the principles in SFAS No. 5. We consider many
factors in making these assessments, including the history and specifics of each
matter. Significant contingencies are discussed in the "Outlook" section
included in this MD&A.
ACCOUNTING FOR FINANCIAL AND DERIVATIVE INSTRUMENTS AND MARKET RISK INFORMATION
FINANCIAL INSTRUMENTS: We account for investments in debt and equity securities
using SFAS No. 115. For additional details on accounting for financial
instruments, see Note 4, Financial and Derivative Instruments.
DERIVATIVE INSTRUMENTS: We account for derivative instruments in accordance with
SFAS No. 133. Except as noted within this section, there have been no material
changes to the accounting for derivative instruments since the year ended
December 31, 2005. For additional details on accounting for derivatives, see
Note 4, Financial and Derivative Instruments.
To determine the fair value of our derivatives, we use information from external
sources (i.e., quoted market prices and third-party valuations), if available.
For certain contracts, this information is not available and we use mathematical
valuation models to value our derivatives. These models require various inputs
and assumptions, including commodity market prices and volatilities, as well as
interest rates and contract maturity dates. Changes in forward prices or
volatilities could significantly change the calculated fair value of our
derivative contracts. The cash returns we actually realize on these contracts
may vary, either positively or negatively, from the results that we estimate
using these models. As part of valuing our derivatives at market, we maintain
reserves, if necessary, for credit risks arising from the financial condition of
our counterparties.
The following table summarizes the interest rate and volatility rate assumptions
we used to value these contracts at June 30, 2006:
Interest Rates (%) Volatility Rates (%)
------------------ --------------------
Long-term gas contracts associated with the MCV
Partnership 5.33 - 5.68 31 - 69
Establishment of the Midwest Energy Market: In 2005, the MISO began operating
the Midwest Energy Market. As a result, the MISO now centrally dispatches
electricity and transmission service throughout much of the Midwest and provides
day-ahead and real-time energy market information. At this time, we believe that
the establishment of this market does not represent the development of an active
energy market in Michigan, as defined by SFAS No. 133. However, as the Midwest
Energy Market matures, we will continue to monitor its activity level and
evaluate whether or not an active energy market may exist in Michigan. If an
active market develops in the future, some of our electric purchase and sale
contracts may qualify as derivatives. However, we believe that we would be able
to apply the normal purchases and sales exception of SFAS No. 133 to these
contracts and, therefore, would not be required to mark these contracts to
market.
CE-11
Consumers Energy Company
Implementation of the RCP: As a result of implementing the RCP in 2005, a
significant portion of the MCV Partnership's long-term gas contracts no longer
qualify as normal purchases because the gas will not be used to generate
electricity or steam. Accordingly, these contracts are accounted for as
derivatives, with changes in fair value recorded in earnings each quarter.
Additionally, certain of the MCV Partnership's natural gas futures and swap
contracts, which are used to hedge variable-priced long-term gas contracts, no
longer qualify for cash flow hedge accounting and we record any changes in their
fair value in earnings each quarter. As a result of recording the changes in
fair value of these long-term gas contracts and the related futures, options,
and swaps to earnings, the MCV Partnership has recognized the following losses
in 2006:
In Millions
-------------------------------------
2006
-------------------------------------
First Second Year to
Quarter Quarter Date
------- ------- -------
Long-term gas contracts $ (111) $ (34) $ (145)
Related futures, options, and swaps (45) (8) (53)
------ ------ ------
Total $ (156) $ (42) $ (198)
====== ====== ======
These losses, shown before consideration of tax effects and minority interest,
are included in the total Fuel costs mark-to-market at the MCV Partnership on
our Consolidated Statements of Income. Because of the volatility of the natural
gas market, the MCV Partnership expects future earnings volatility on both its
long-term gas contracts and its futures, options, and swap contracts, since
gains and losses will be recorded each quarter. We will continue to record
these gains and losses in our consolidated financial statements until we close
the sale of our interest in the MCV Partnership.
We have recorded derivative assets totaling $58 million associated with the fair
value of these contracts on our Consolidated Balance Sheets at June 30, 2006.
The MCV Partnership expects almost all of these assets, which represent
cumulative net mark-to-market gains, to reverse as losses through earnings
during 2006 and 2007 as the gas is purchased and the futures, options, and swaps
settle, with the remainder reversing between 2008 and 2011. Due to the
impairment of the MCV Facility and subsequent losses, the value of the equity
held by all of the owners of the MCV Partnership has decreased significantly and
is now negative. Since we are one of the general partners of the MCV
Partnership, we have recognized a portion of the limited partners' negative
equity. As the MCV Partnership recognizes future losses from the reversal of
these derivative assets, we will continue to assume a portion of the limited
partners' share of those losses, in addition to our proportionate share, but
only until we close the sale of our interest in the MCV Partnership.
At the closing of this sale, these assets, which represent cumulative net
mark-to-market gains, will be sold in conjunction with the sale of our ownership
interest. As a result, we will no longer record the fair value of these
long-term gas contracts or the related futures, options, and swaps on our
Consolidated Balance Sheets and will not be required to recognize gains or
losses related to changes in the fair value of these contracts on our
Consolidated Statements of Income. Additionally, at June 30, 2006, we have
recorded a cumulative net gain of $39 million, net of tax and minority interest,
in Accumulated other comprehensive income representing our proportionate share
of the cash flow hedges held by the MCV Partnership. At the closing of the sale
of our interest, this amount, adjusted for any additional changes in fair value,
will be reclassified and recognized in earnings.
CE-12
Consumers Energy Company
Any changes in the fair value of these contracts recognized before the closing
will not affect the purchase price of our ownership interest in the MCV
Partnership. For additional details on the sale of our interest in the MCV
Partnership, see the "Other Electric Business Uncertainties - MCV
Underrecoveries" section in this MD&A and Note 2, Contingencies, "Other Electric
Contingencies - The Midland Cogeneration Venture."
MARKET RISK INFORMATION: The following is an update of our risk sensitivities
since December 31, 2005. These sensitivities indicate the potential loss in fair
value, cash flows, or future earnings from our financial instruments, including
our derivative contracts, assuming a hypothetical adverse change in market rates
or prices of 10 percent. Changes in excess of the amounts shown in the
sensitivity analyses could occur if changes in market rates or prices exceed the
10 percent shift used for the analyses.
Interest Rate Risk Sensitivity Analysis (assuming an adverse change in market
interest rates of 10 percent):
In Millions
--------------------------------------
June 30, 2006 December 31, 2005
------------- -----------------
Variable-rate financing - before tax annual earnings exposure $ 2 $ 3
Fixed-rate financing - potential REDUCTION in fair value (a) 148 149
(a) Fair value exposure could only be realized if we repurchased all of our
fixed-rate financing.
Commodity Price Risk Sensitivity Analysis (assuming an adverse change in market
prices of 10 percent):
In Millions
-----------------------------------------
June 30, 2006 December 31, 2005
------------- -----------------
Potential REDUCTION in fair value:
Gas supply option contracts $ - $ 1
Derivative contracts associated with the MCV Partnership:
Long-term gas contracts 19 39
Gas futures, options, and swaps 34 48
Investment Securities Price Risk Sensitivity Analysis (assuming an adverse
change in market prices of 10 percent):
In Millions
-----------------------------------------
June 30, 2006 December 31, 2005
------------- -----------------
Potential REDUCTION in fair value of available-for-sale equity
securities (SERP investments and investments in CMS Energy common
stock) $ 5 $ 6
We maintain trust funds, as required by the NRC, for the purpose of funding
certain costs of nuclear plant decommissioning. At June 30, 2006 and December
31, 2005, these funds were invested primarily in equity securities, fixed-rate,
fixed-income debt securities, and cash and cash equivalents, and are recorded at
fair value on our Consolidated Balance Sheets. These investments are exposed to
price fluctuations in equity markets and changes in interest rates. Because the
accounting for nuclear plant decommissioning recognizes that costs are recovered
through our electric rates, fluctuations in equity prices or interest rates do
not affect our consolidated earnings or cash flows.
For additional details on market risk and derivative activities, see Note 4,
Financial and Derivative Instruments. For additional details on nuclear plant
decommissioning at Big Rock and Palisades, see the "Other Electric Business
Uncertainties - Nuclear Matters" section included in this MD&A.
CE-13
Consumers Energy Company
OTHER
Other accounting policies important to an understanding of our results of
operations and financial condition include:
- accounting for long-lived assets and equity method investments,
- accounting for the effects of industry regulation,
- accounting for pension and OPEB,
- accounting for asset retirement obligations,
- accounting for nuclear decommissioning costs, and
- accounting for related party transactions.
These accounting policies were disclosed in our 2005 Form 10-K and there have
been no subsequent material changes.
CAPITAL RESOURCES AND LIQUIDITY
Factors affecting our liquidity and capital requirements are:
- results of operations,
- capital expenditures,
- energy commodity costs,
- contractual obligations,
- regulatory decisions,
- debt maturities,
- credit ratings,
- working capital needs, and
- collateral requirements.
During the summer months, we purchase natural gas and store it for resale
primarily during the winter heating season. Although our prudent natural gas
purchases are recoverable from our customers, the amount paid for natural gas
stored as inventory requires additional liquidity due to the timing of the cost
recoveries. We have credit agreements with our commodity suppliers and those
agreements contain terms that have resulted in margin calls. Additional margin
calls or other credit support may be required if agency ratings are lowered or
if market conditions remain unfavorable relative to our obligations to those
parties.
Our current financial plan includes controlling operating expenses and capital
expenditures and evaluating market conditions for financing opportunities. Due
to the adverse impact of the MCV Partnership asset impairment charge recorded in
2005 and the MCV Partnership fuel cost mark-to-market charges during 2006, our
ability to issue FMB as primary obligations or as collateral for financing is
expected to be limited to $298 million through December 31, 2006. After December
31, 2006, our ability to issue FMB in excess of $298 million is based on
achieving a two-times FMB interest coverage ratio.
CE-14
Consumers Energy Company
We believe the following items will be sufficient to meet our liquidity needs:
- our current level of cash and revolving credit facilities,
- our ability to access junior secured and unsecured borrowing capacity
in the capital markets, and
- our anticipated cash flows from operating and investing activities.
CASH POSITION, INVESTING, AND FINANCING
Our operating, investing, and financing activities meet consolidated cash needs.
At June 30, 2006, $511 million consolidated cash was on hand, which includes $55
million of restricted cash and $265 million from entities consolidated pursuant
to FASB Interpretation No. 46(R).
SUMMARY OF CONSOLIDATED STATEMENTS OF CASH FLOWS:
In Millions
---------------------
Six Months Ended June 30 2006 2005
- ------------------------ ------ ------
Net cash provided by (used in):
Operating activities $ 274 $ 564
Investing activities (214) (284)
------ ------
Net cash provided by operating and investing activities 60 280
Financing activities (20) 162
------ ------
Net Increase in Cash and Cash Equivalents $ 40 $ 442
====== ======
OPERATING ACTIVITIES: For the six months ended June 30, 2006, net cash provided
by operating activities was $274 million, a decrease of $290 million versus
2005. This was a result of income tax payments to the parent and decreases in
the MCV Partnership gas supplier funds on deposit, offset by a decrease in
accounts receivable and an increase in accounts payable. The decrease in the MCV
Partnership gas supplier funds on deposit was the result of refunds to suppliers
from decreased exposure due to declining gas prices in 2006. The decrease in
accounts receivable was primarily due to the expiration of emergency rules
initiated by the MPSC, which delayed customer payments during the heating
season. The increase in accounts payable was due to the timing of additional tax
payments to the parent related to the IRS income tax audit offset by payments
for higher priced gas that were accrued as of December 31, 2005.
INVESTING ACTIVITIES: For the six months ended June 30, 2006, net cash used in
investing activities was $214 million, a decrease of $70 million versus 2005.
This decrease was due to the release of restricted cash in February 2006, which
we used to extinguish long-term debt - related parties.
FINANCING ACTIVITIES: For the six months ended June 30, 2006, net cash used in
financing activities was $20 million, an increase of $182 million versus 2005.
This increase was primarily due to lower stockholder's contributions from the
parent, partially offset by a decrease in payments of common stock dividends of
$127 million.
For additional details on long-term debt activity, see Note 3, Financings and
Capitalization.
OBLIGATIONS AND COMMITMENTS
DIVIDEND RESTRICTIONS: For details on dividend restrictions, see Note 3,
Financings and Capitalization.
CE-15
Consumers Energy Company
OFF-BALANCE SHEET ARRANGEMENTS: We enter into various arrangements in the normal
course of business to facilitate commercial transactions with third-parties.
These arrangements include indemnifications, letters of credit and surety bonds.
For details on guarantee arrangements, see Note 2, Contingencies, "Other
Contingencies -FASB Interpretation No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others."
REVOLVING CREDIT FACILITIES: For details on revolving credit facilities, see
Note 3, Financings and Capitalization.
SALE OF ACCOUNTS RECEIVABLE: For details on the sale of accounts receivable, see
Note 3, Financings and Capitalization.
OUTLOOK
ELECTRIC BUSINESS OUTLOOK
GROWTH: Summer 2005 temperatures were higher than historical averages, leading
to increased demand from electric customers. In 2006, we project electric
deliveries will decline less than one percent from 2005 levels. This short-term
outlook assumes a stabilizing economy and normal weather conditions throughout
the remainder of the year.
Over the next five years, we expect electric deliveries to grow at an average
rate of about one and one-half percent per year. However, such growth is
dependent on a modestly growing customer base and a stabilizing Michigan
economy. This growth rate includes both full-service sales and delivery service
to customers who choose to buy generation service from an alternative electric
supplier, but excludes transactions with other wholesale market participants and
other electric utilities. This growth rate reflects a long-range expected trend
of growth. Growth from year to year may vary from this trend due to customer
response to fluctuations in weather conditions and changes in economic
conditions, including utilization and expansion or contraction of manufacturing
facilities.
ELECTRIC RESERVE MARGIN: We have a reserve margin of approximately 11 percent
for summer 2006, or supply resources equal to 111 percent of projected firm
summer peak load. The 2006 supply resources of 111 percent come from our
electric generating plants, long-term power purchase contracts, and other
contractual arrangements. We have purchased capacity and energy contracts
covering the reserve margin requirements for 2006 and covering partially the
estimated reserve margin requirements for 2007 through 2010. As a result, we
recognized an asset of $75 million for unexpired capacity and energy contracts
at June 30, 2006. Upon the completion of the sale of the Palisades plant, the
power purchase agreement will offset for the term of the agreement, the
reduction in the owned capacity represented by the Palisades plant.
The MCV PPA is not affected by our agreement to sell our interest in the MCV
Partnership. After September 15, 2007, we expect to exercise our claim for
relief under the regulatory out provision in the MCV PPA. If we are successful
in exercising our claim, the MCV Partnership has the right to terminate the MCV
PPA, which could impact our reserve margin status.
ELECTRIC TRANSMISSION EXPENSES: METC, which provides electric transmission
service to us, increased substantially the transmission rates it charges us in
2006. The increased rates are subject to refund and to reduction based on the
outcome of hearings at the FERC scheduled for December 2006. We are attempting
to recover these costs through our 2006 PSCR plan case. The PSCR process allows
recovery of all reasonable and prudent power supply costs. However, we cannot
predict when recovery of these transmission costs will commence. To the extent
that we incur and are unable to collect these increased costs in a timely
manner, our cash flows from electric utility operations will be affected
negatively. For additional details, see Note 2, Contingencies, "Electric Rate
Matters - Power Supply Costs."
CE-16
Consumers Energy Company
In May 2006, ITC, a company that operates electric transmission facilities
through a wholly owned subsidiary, including the transmission system within
Detroit Edison's territory, filed an application with the FERC to acquire METC.
The FERC subsequently delayed hearings concerning the METC transmission rates.
We will continue to participate in the FERC proceeding concerning the METC
transmission rates and the FERC proceeding concerning ITC's proposed acquisition
of METC. We are unable to predict the nature and timing of any action by the
FERC on transmission rates or if and when the ITC's purchase of METC will be
completed.
INDUSTRIAL REVENUE OUTLOOK: Our electric utility customer base includes a mix of
residential, commercial, and diversified industrial customers. In November 2005,
General Motors Corporation, a large industrial customer of Consumers, announced
plans to reduce certain manufacturing operations in Michigan. However, since the
targeted operations are outside of our service territory, we do not anticipate a
significant impact on electric utility revenue. In March 2006, Delphi
Corporation, also a large industrial customer of Consumers with six facilities
in our service territory, announced plans to sell or close all but one of their
manufacturing operations in Michigan as part of their bankruptcy restructuring.
Our electric utility operations are not dependent upon a single customer, or
even a few customers, and customers in the automotive sector constitute 4
percent of our total electric revenue. In addition, returning former ROA
industrial customers will benefit our electric utility revenue. However, we
cannot predict the impact of these restructuring plans or possible future
actions by other industrial customers.
THE ELECTRIC CAPACITY NEED FORUM: In January 2006, the MPSC Staff issued a
report on future electric capacity in the state of Michigan. The report
indicated that existing generation resources are adequate in the short term, but
could be insufficient to maintain reliability standards by 2009. The report also
indicated that new coal-fired baseload generation may be needed by 2011. The
MPSC Staff recommended an approval and bid process for new power plants. To
address revenue stability risks, the Staff also proposed a special reliability
charge that a utility would assess on all electric distribution customers. In
April 2006, the governor of Michigan issued an executive directive calling for
the development of a comprehensive energy plan for the state of Michigan. The
directive calls for the Chairman of the MPSC, working in cooperation with
representatives from the public and private sectors, to make recommendations on
Michigan's energy policy by the end of 2006. We will continue to participate as
the MPSC addresses future electric capacity needs.
BURIAL OF OVERHEAD POWER LINES: The City of Taylor, a municipality located in
Wayne county, Michigan, passed an ordinance that required Detroit Edison to bury
a section of overhead power lines at Detroit Edison's expense. In September
2004, the Michigan Court of Appeals upheld a lower court decision affirming the
legality of the ordinance over Detroit Edison's objections. Other municipalities
in our service territory adopted, or proposed the adoption of, similar
ordinances. Detroit Edison appealed the Michigan Court of Appeals ruling to the
Michigan Supreme Court. In May 2006, the Michigan Supreme Court ruled in favor
of Detroit Edison. The Court found that the MPSC has primary jurisdiction over
this issue and accordingly, the Taylor ordinance is subject to any applicable
rules and regulations of the MPSC, including issues concerning who should bear
the expense of underground facilities. If incurred, we would seek recovery of
these costs from the municipality, or from our customers located in the
municipality, subject to MPSC approval.
CE-17
Consumers Energy Company
ELECTRIC BUSINESS UNCERTAINTIES
Several electric business trends or uncertainties may affect our financial
results and condition. These trends or uncertainties have, or we reasonably
expect could have, a material impact on revenues or income from continuing
electric operations.
ELECTRIC ENVIRONMENTAL ESTIMATES: Our operations are subject to environmental
laws and regulations. Costs to operate our facilities in compliance with these
laws and regulations generally have been recovered in customer rates.
Clean Air Act: Compliance with the federal Clean Air Act and resulting
regulations has been, and will continue to be, a significant focus for us. The
Nitrogen Oxide State Implementation Plan requires significant reductions in
nitrogen oxide emissions. To comply with the regulations, we expect to incur
capital expenditures totaling $819 million. As of June 2006, we have incurred
$634 million in capital expenditures to comply with the federal Clean Air Act
and resulting regulations and anticipate that the remaining $185 million of
capital expenditures will be made in 2006 through 2011. In addition to modifying
coal-fired electric generating plants, our compliance plan includes the use of
nitrogen oxide emission allowances until all of the control equipment is
operational in 2011. The nitrogen oxide emission allowance annual expense is
projected to be $6 million per year, which we expect to recover from our
customers through the PSCR process.
Clean Air Interstate Rule: In March 2005, the EPA adopted the Clean Air
Interstate Rule that requires additional coal-fired electric generating plant
emission controls for nitrogen oxides and sulfur dioxide. We plan to meet this
rule by year round operation of our selective catalytic reduction control
technology units and installation of flue gas desulfurization scrubbers at an
estimated total cost of $960 million, to be incurred by 2014.
Clean Air Mercury Rule: Also in March 2005, the EPA issued the Clean Air Mercury
Rule, which requires initial reductions of mercury emissions from coal-fired
electric generating plants by 2010 and further reductions by 2018. We anticipate
our capital costs for mercury emissions reductions required by Phase I of the
Clean Air Mercury Rule to be less than $50 million and implemented by 2010.
Phase II requirements of the Clean Air Mercury Rule are not yet known and a cost
estimate has not been determined.
In April 2006, Michigan's governor announced a plan that would result in mercury
emissions reductions of 90 percent by 2015. We are working with the MDEQ on the
details of these rules. We will develop a cost estimate when the details of
these rules are determined.
Greenhouse gases: Several legislative proposals have been introduced in the
United States Congress that would require reductions in emissions of greenhouse
gases, including potentially carbon dioxide. We cannot predict whether any
federal mandatory greenhouse gas emission reduction rules ultimately will be
enacted, or the specific requirements of any of these rules and their effect on
our operations and financial results.
To the extent that greenhouse gas emission reduction rules come into effect, the
mandatory emissions reduction requirements could have far-reaching and
significant implications for the energy sector. We cannot estimate the potential
effect of federal or state level greenhouse gas policy on our future
consolidated results of operations, cash flows, or financial position due to the
uncertain nature of the
CE-18
Consumers Energy Company
policies at this time. However, we stay abreast of greenhouse gas policy
developments and will continue to assess and respond to their potential
implications on our business operations.
Water: In March 2004, the EPA issued rules that govern electric generating plant
cooling water intake systems. The rules require significant reduction in fish
killed by operating equipment. Fish kill reduction studies are required to be
submitted to the EPA in 2007 and 2008. EPA compliance options in the rule are
currently being challenged in court and we will finalize our cost estimates in
2008, when a decision on the final rule is anticipated. We expect to implement
the EPA approved process from 2009 to 2011.
For additional details on electric environmental matters, see Note 2,
Contingencies, "Electric Contingencies - Electric Environmental Matters."
COMPETITION AND REGULATORY RESTRUCTURING: The Customer Choice Act allows all of
our electric customers to buy electric generation service from us or from an
alternative electric supplier. At June 30, 2006, alternative electric suppliers
were providing 311 MW of generation service to ROA customers, which represents 4
percent of our total distribution load. It is difficult to predict future ROA
customer trends.
Section 10d(4) Regulatory Assets: In December 2005, the MPSC issued an order
that authorized us to recover $333 million in Section 10d(4) costs. Instead of
collecting these costs evenly over five years, the order instructed us to
collect 10 percent of the regulatory asset total in the first year, 15 percent
in the second year, and 25 percent in each of the third, fourth, and fifth
years. In January 2006, we filed a petition for rehearing with the MPSC that
disputed the aspect of the order dealing with the timing of our collection of
these costs. In April 2006, the MPSC issued an order that denied our petition
for rehearing.
Stranded Costs: Prior MPSC orders adopted a mechanism pursuant to the Customer
Choice Act to provide recovery of Stranded Costs that occur when customers leave
our system to purchase electricity from alternative suppliers. In November 2005,
we filed an application with the MPSC related to the determination of 2004
Stranded Costs.
In March 2006, the ALJ in our 2004 PSCR reconciliation case issued a Proposal
for Decision recommending that we use a greater portion of our net sales of
excess power into the bulk electricity market to offset our 2004 PSCR costs,
rather than 2004 Stranded Costs. In June 2006, the ALJ issued a Proposal for
Decision in our 2004 Stranded Cost case recommending that the MPSC find that we
had no Stranded Costs in 2004. If the MPSC adopts the ALJ recommendations,
earnings would be impacted adversely by $10 million. We cannot predict the
outcome of these proceedings.
Through and Out Rates: From December 2004 to March 2006, we paid a transitional
charge pursuant to a FERC order eliminating regional "through and out" rates. In
May 2006, the FERC approved an agreement between the PJM RTO transmission owners
and Consumers concerning these transitional charges. The agreement resolves all
issues regarding transitional charges for Consumers and eliminates the potential
for refunds or additional charges to Consumers. In May 2006, Baltimore Gas &
Electric filed a notice of withdrawal from the settlement. Consumers, PJM, and
others filed responses with the FERC on this matter. The FERC has not ruled on
whether the notice of withdrawal is effective, but we do not believe this action
will have any material impact on us.
CE-19
Consumers Energy Company
For additional details and material changes relating to the restructuring of the
electric utility industry and electric rate matters, see Note 2, Contingencies,
"Electric Restructuring Matters," and "Electric Rate Matters."
OTHER ELECTRIC BUSINESS UNCERTAINTIES
MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the MCV
Facility, contracted to sell electricity to Consumers for a 35-year period
beginning in 1990. We hold a 49 percent partnership interest in the MCV
Partnership, and a 35 percent lessor interest in the MCV Facility.
Sale of our Interest in the MCV Partnership and the FMLP: In July 2006, we
reached an agreement to sell 100 percent of the stock of CMS Midland, Inc. and
CMS Midland Holdings Company to an affiliate of GSO Capital Partners and
Rockland Capital Energy Investments for $60.5 million. These Consumers'
subsidiaries hold our interests in the MCV Partnership and the FMLP. The sales
agreement calls for the purchaser, an affiliate of GSO Capital Partners and
Rockland Capital Energy Investments to pay $85 million, subject to certain
conditions and reimbursement rights, if Dow terminates an agreement under which
it is provided power and steam by the MCV Partnership. The purchaser will secure
their reimbursement obligation with an irrevocable letter of credit of up to $85
million. The MCV PPA and the associated customer rates are not affected by the
sale. We are targeting to close on the sale before the end of 2006. The sale is
subject to various regulatory approvals, including the MPSC's approval and the
expiration of the waiting period under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976. The MPSC has established a contested case proceeding
schedule, which will allow for a decision from the MPSC by the end of 2006. We
cannot predict the timing or the outcome of the MPSC's decision. We further
cannot predict with certainty whether or when this transaction will be
completed.
For additional details on the sale of our interests in the MCV Partnership and
the FMLP, see Note 2, Contingencies, "Other Electric Contingencies -- The
Midland Cogeneration Venture", and the Stock Purchase Agreement, which is
attached as Exhibit 10c to this filing.
Financial Condition of the MCV Partnership: Under the MCV PPA, variable energy
payments to the MCV Partnership are based on the cost of coal burned at our coal
plants and our operation and maintenance expenses. However, the MCV
Partnership's costs of producing electricity are tied to the cost of natural
gas. Historically high natural gas prices have caused the MCV Partnership to
reevaluate the economics of operating the MCV Facility and to record an
impairment charge in 2005. If natural gas prices remain at present levels or
increase, the operations of the MCV Facility would be adversely affected and
could result in the MCV Partnership failing to meet its obligations under the
sale and leaseback transactions and other contracts.
Underrecoveries related to the MCV PPA: Further, the cost that we incur under
the MCV PPA exceeds the recovery amount allowed by the MPSC. As a result, we
estimate cash underrecoveries of capacity and fixed energy payments of $55
million in 2006 and $39 million in 2007. However, Consumers' direct savings from
the RCP, after allocating a portion to customers, are used to offset a portion
of our capacity and fixed energy underrecoveries expense. After September 15,
2007, we expect to claim relief under the regulatory out provision in the MCV
PPA, thereby limiting our capacity and fixed energy payments to the MCV
Partnership to the amounts that we collect from our customers. The effect of any
such action would be to:
- reduce cash flow to the MCV Partnership, which could have an adverse
effect on the MCV Partnership's financial performance, and
CE-20
Consumers Energy Company
- eliminate our underrecoveries of capacity and fixed energy payments.
The MCV Partnership has indicated that it may take issue with our exercise of
the regulatory out clause after September 15, 2007. We believe that the clause
is valid and fully effective, but cannot assure that it will prevail in the
event of a dispute. If we are successful in exercising the regulatory out
clause, the MCV Partnership has the right to terminate the MCV PPA. The MPSC's
future actions on the capacity and fixed energy payments recoverable from
customers subsequent to September 15, 2007 may affect negatively the financial
performance of the MCV Partnership. If the MCV Partnership terminates the MCV
PPA, we would be required to replace the lost capacity to maintain an adequate
electric reserve margin. This could involve entering into a new PPA and (or)
entering into electric capacity contracts on the open market. We cannot predict
our ability to enter into such contracts at a reasonable price. We are also
unable to predict regulatory approval of the terms and conditions of such
contracts, or that the MPSC would allow full recovery of our incurred costs.
For additional details on the MCV Partnership, see Note 2, Contingencies, "Other
Electric Contingencies - The Midland Cogeneration Venture."
NUCLEAR MATTERS: Sale of Nuclear Assets: In July 2006, we reached an agreement
to sell Palisades and the Big Rock Independent Spent Fuel Storage Installation
(ISFSI) for $380 million to Entergy. The sales price reflects a $35 million
premium above the estimated Palisades asset values at the closing date after
accounting for estimated sales-related costs. This premium is expected to
benefit our customers. Entergy will assume responsibility for the future
decommissioning of the plant and for storage and disposal of spent nuclear fuel.
At the date of close, decommissioning trust assets are estimated to be $566
million. Consumers will retain $200 million of these funds at the time of close
and will be entitled to receive a return of $116 million of decommissioning
trust fund assets, pending either a favorable federal tax ruling regarding the
release of the funds or, if the funds are available, after decommissioning of
the Palisades site is complete. The disposition of the retained and receivable
nuclear decommissioning funds is subject to regulatory approval. We expect that
a portion of the proceeds will benefit our customers. We plan to use the cash
that we retain from the sale to reduce debt.
As part of the transaction, Entergy will sell us 100 percent of the plant's
output up to its current capacity of 798 MW under a 15-year power purchase
agreement. During the term of the PPA, Entergy is obligated to supply, and we
are obligated to take, all capacity and energy from the Palisades plant,
exclusive of uprates above the plant's presently specified capacity. When the
plant is not operating or is derated, under certain circumstances, Entergy can
elect to provide replacement power from another source at the rates set in the
PPA. Otherwise, we would have to obtain replacement power from the market.
However, we are only obligated to pay Entergy for capacity and energy actually
delivered by Entergy either from the plant or from an allowable replacement
source chosen by Entergy. If Entergy schedules a plant outage in June, July or
August, Entergy is required to provide replacement power at PPA rates. There are
significant penalties incurred by Entergy if the delivered energy fails to
achieve a minimum capacity factor level during July and August. Over the term of
the PPA, the pricing is structured such that Consumers' ratepayers will retain
the benefits of the Palisades plant's low-cost nuclear generation.
The sale is subject to various regulatory approvals, including the MPSC's
approval of the power purchase agreement, the FERC's approval for Entergy to
sell power to us under the PPA and other related matters, the NRC's approval of
the transfer of the operating license to Entergy and other related matters, and
the expiration of the waiting period under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976. The final purchase price will be subject to various
closing adjustments such as working capital and capital
CE-21
Consumers Energy Company
expenditure adjustments, adjustments for nuclear fuel usage and inventory, and
the date of closing. We are targeting to complete the sale in the first quarter
of 2007. However, the sale agreement can be terminated if the closing does not
occur within 18 months of the execution of the agreement. The closing can be
extended for up to six months to accommodate delays in receiving regulatory
approval. We cannot predict with certainty whether or when the closing
conditions will be satisfied or whether or when this transaction will be
completed.
For additional details on the sale of Palisades and the Big Rock ISFSI, see the
Asset Sale Agreement and the Power Purchase Agreement, which are attached as
Exhibits 10a and 10b to this filing.
Big Rock: Decommissioning of the site is nearing completion. Demolition of the
last remaining plant structure, the containment building, and removal of
remaining underground utilities and temporary office structures is expected to
be complete by the end of the third quarter of 2006. Final radiological surveys
will then be completed to ensure that the site meets all requirements for free,
unrestricted release in accordance with the NRC approved License Termination
Plan (LTP) for the project. We anticipate NRC approval to return approximately
475 acres of the site, including the area formerly occupied by the nuclear
plant, to a natural setting for unrestricted use by early 2007. An area of
approximately 105 acres encompassing the Big Rock ISFSI, where eight casks
loaded with spent fuel and other high-level radioactive material are stored, has
been sold to Entergy. We will be required to pay Entergy $30 million for
accepting responsibility for the storage and disposal of these materials.
Palisades: The amount of spent nuclear fuel at Palisades exceeds the plant's
temporary onsite wet storage pool capacity. We are using dry casks for temporary
onsite dry storage to supplement the wet storage pool capacity. As of June 2006,
we have loaded 29 dry casks with spent nuclear fuel.
Palisades' current license from the NRC expires in 2011. In March 2005, the NMC,
which operates the Palisades plant, applied for a 20-year license renewal for
the plant on behalf of Consumers. We expect a decision from the NRC on the
license renewal application in 2007.
For additional details on nuclear plant decommissioning at Big Rock and
Palisades, see Note 2, Contingencies, "Other Electric Contingencies - Nuclear
Plant Decommissioning."
GAS BUSINESS OUTLOOK
GROWTH: In 2006, we project gas deliveries will decline by four percent, on a
weather-adjusted basis, from 2005 levels due to increased conservation and
overall economic conditions in the state of Michigan. Over the next five years,
we expect gas deliveries to be relatively flat. Actual gas deliveries in future
periods may be affected by:
- fluctuations in weather patterns,
- use by independent power producers,
- competition in sales and delivery,
- changes in gas commodity prices,
- Michigan economic conditions,
- the price of competing energy sources or fuels, and
- gas consumption per customer.
CE-22
Consumers Energy Company
GAS BUSINESS UNCERTAINTIES
Several gas business trends or uncertainties may affect our future financial
results and financial condition. These trends or uncertainties could have a
material impact on revenues or income from gas operations.
GAS ENVIRONMENTAL ESTIMATES: We expect to incur investigation and remedial
action costs at a number of sites, including 23 former manufactured gas plant
sites. For additional details, see Note 2, Contingencies, "Gas Contingencies -
Gas Environmental Matters."
GAS COST RECOVERY: The GCR process is designed to allow us to recover all of our
purchased natural gas costs if incurred under reasonable and prudent policies
and practices. The MPSC reviews these costs, policies, and practices for
prudency in annual plan and reconciliation proceedings. For additional details
on gas cost recovery, see Note 2, Contingencies, "Gas Rate Matters - Gas Cost
Recovery."
2001 GAS DEPRECIATION CASE: In October and December 2004, the MPSC issued
Opinions and Orders in our gas depreciation case, which:
- reaffirmed the previously-ordered $34 million reduction in our
depreciation expense,
- required us to undertake a study to determine why our plant removal
costs are in excess of other regulated Michigan natural gas utilities,
and
- required us to file a study report with the MPSC Staff on or before
December 31, 2005.
We filed the study report with the MPSC Staff on December 29, 2005.
We are also required to file our next gas depreciation case within 90 days after
the MPSC issuance of a final order in the pending case related to ARO
accounting. We cannot predict when the MPSC will issue a final order in the ARO
accounting case.
If the depreciation case order is issued after the gas general rate case order,
we proposed to incorporate its results into the gas general rates using a
surcharge mechanism, a process used to incorporate specialty items into customer
rates.
2005 GAS RATE CASE: In July 2005, we filed an application with the MPSC seeking
a 12 percent authorized return on equity along with a $132 million annual
increase in our gas delivery and transportation rates. As part of this filing,
we also requested interim rate relief of $75 million.
The MPSC Staff and intervenors filed interim rate relief testimony on October
31, 2005. In its testimony, the MPSC Staff recommended granting interim rate
relief of $38 million.
In February 2006, the MPSC Staff recommended granting final rate relief of $62
million. The MPSC Staff proposed that $17 million of this amount be contributed
to a low income and energy efficiency fund. The MPSC Staff also recommended
reducing our allowed return on common equity to 11.15 percent, from our current
11.4 percent.
In March 2006, the MPSC Staff revised its recommended final rate relief to $71
million, which includes $17 million to be contributed to a low income and energy
efficiency fund. In April 2006, we revised our request for final rate relief
downward to $118 million.
CE-23
Consumers Energy Company
In May 2006, the MPSC issued an order granting us interim gas rate relief of $18
million annually, which is under bond and subject to refund if final rate relief
is granted in a lesser amount. The order also extended the temporary two-year
surcharge of $58 million granted in October 2004 until the issuance of a final
order in this proceeding. The MPSC has not set a date for issuance of an order
granting final rate relief.
In July 2006, the ALJ issued a Proposal for Decision recommending final rate
relief of $74 million above current rate levels, which include interim and
temporary rate relief. The $74 million includes $17 million to be contributed to
a low income and energy efficiency fund. The Proposal for Decision also
recommended reducing our return on common equity to 11 percent, from our current
11.4 percent.
OTHER OUTLOOK
MCV PARTNERSHIP NEGATIVE EQUITY: Due to the impairment of the MCV Facility and
operating losses from mark-to-market adjustments on derivative instruments, the
equity held by Consumers and by all of the owners of the MCV Partnership has
decreased significantly and is now negative. Since Consumers is one of the
general partners of the MCV Partnership, we have recognized a portion of the
limited partners' negative equity. As the MCV Partnership recognizes future
losses, we will continue to assume a portion of the limited partners' share of
those losses, in addition to our proportionate share.
LITIGATION AND REGULATORY INVESTIGATION: CMS Energy is the subject of various
investigations as a result of round-trip trading transactions by CMS MST,
including an investigation by the DOJ. For additional details regarding this
investigation and litigation, see Note 2, Contingencies.
PENSION REFORM: Both branches of Congress passed legislation aimed at reforming
pension plans in 2005. The U.S. Senate passed The Pension Security and
Transparency Act in November 2005 and The House of Representatives passed the
Pension Protection Act of 2005 in December 2005. Although the Senate and House
bills were similar, they did contain a number of differences. The House and
Senate have passed the Pension Protection Act of 2006, which primarily reflects
a bipartisan House-Senate pension conference agreement. The bill reforms the
funding rules for employer-provided pension plans, effective for plan years
beginning after 2007, and was sent to the President in August 2006 for his
signature. We are in the process of determining the impact of this potential
legislation on our financial statements.
IMPLEMENTATION OF NEW ACCOUNTING STANDARDS
SFAS NO. 123(R) AND SAB NO. 107, SHARE-BASED PAYMENT: SFAS No. 123(R) requires
companies to use the fair value of employee stock options and similar awards at
the grant date to value the awards. SFAS No. 123(R) was effective for us on
January 1, 2006. We elected to adopt the modified prospective method recognition
provisions of this Statement instead of retrospective restatement. We adopted
the fair value method of accounting for share-based awards effective December
2002. Therefore, SFAS No. 123(R) did not have a significant impact on our
results of operations when it became effective. We applied the additional
guidance provided by SAB No. 107 upon implementation of SFAS No. 123(R). For
additional details, see Note 7, Executive Incentive Compensation.
CE-24
Consumers Energy Company
NEW ACCOUNTING STANDARDS NOT YET EFFECTIVE
FIN 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES: In June 2006, the FASB
issued FIN 48. This interpretation provides a two-step approach for the
recognition and measurement of uncertain tax positions taken, or expected to be
taken, by a company on its income tax returns. The first step is to evaluate the
tax position to determine if, based on management's best judgment, it is greater
than 50 percent likely that the taxing authority will sustain the tax position.
The second step is to measure the appropriate amount of the benefit to
recognize. This is done by estimating the potential outcomes and recognizing the
greatest amount that has a cumulative probability of at least 50 percent. We are
presently evaluating the impacts, if any, of FIN 48. Any impacts of implementing
FIN 48 will result in a cumulative adjustment to retained earnings. This
interpretation is effective for us beginning January 1, 2007.
PROPOSED ACCOUNTING STANDARD
On March 31, 2006, the FASB released an exposure draft of a proposed SFAS
entitled "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans." The proposed SFAS would amend SFAS Nos. 87, 88, 106, and
132(R) and is expected to be effective for us on December 31, 2006. The most
significant requirement stated in the proposed SFAS is the balance sheet
recognition of the underfunded portion of our defined benefit postretirement
plans at the date of adoption. We expect that we will be allowed to apply SFAS
No. 71 and recognize the underfunded portion as a regulatory asset. If we
determine that SFAS No. 71 does not apply, our other comprehensive income could
be reduced significantly. We are in the process of determining the impact of
this proposed SFAS on our financial statements.
CE-25
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<Table>
<Caption>
In Millions
---------------------------------------------------------------
Three Months Ended Six Months Ended
----------------------------- -----------------------------
June 30 2006 2005 2006 2005
- ------- ------------ ------------ ------------ ------------
OPERATING REVENUE $ 1,138 $ 1,016 $ 2,920 $ 2,648
EARNINGS FROM EQUITY METHOD INVESTEES 1 - 1 -
OPERATING EXPENSES
Fuel for electric generation 172 157 344 311
Fuel costs mark-to-market at the MCV Partnership 42 39 198 (170)
Purchased and interchange power 134 63 244 127
Purchased power - related parties 19 14 37 31
Cost of gas sold 223 242 1,039 982
Other operating expenses 220 201 435 389
Maintenance 79 50 150 102
Depreciation, depletion, and amortization 116 111 268 256
General taxes 56 53 121 118
------------ ------------ ------------ ------------
1,061 930 2,836 2,146
------------ ------------ ------------ ------------
OPERATING INCOME 78 86 85 502
OTHER INCOME (DEDUCTIONS)
Accretion expense - (1) - (1)
Interest and dividends 16 10 26 15
Regulatory return on capital expenditures 7 15 10 31
Other income 10 6 14 10
Other expense (1) (2) (4) (8)
------------ ------------ ------------ ------------
32 28 46 47
------------ ------------ ------------ ------------
INTEREST CHARGES
Interest on long-term debt 74 75 146 147
Interest on long-term debt - related parties - 2 1 9
Other interest 5 2 8 4
Capitalized interest (3) (1) (5) (2)
------------ ------------ ------------ ------------
76 78 150 158
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTERESTS 34 36 (19) 391
MINORITY INTERESTS (OBLIGATIONS), NET (3) (14) (75) 97
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 37 50 56 294
INCOME TAX EXPENSE 1 17 10 104
------------ ------------ ------------ ------------
NET INCOME 36 33 46 190
PREFERRED STOCK DIVIDENDS 1 1 1 1
------------ ------------ ------------ ------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 35 $ 32 $ 45 $ 189
============ ============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-26
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<Table>
<Caption>
In Millions
-----------------
Six Months Ended
-----------------
June 30 2006 2005
- ------- ------ ------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 46 $ 190
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion, and amortization (includes nuclear
decommissioning of $3 per year) 268 256
Deferred income taxes and investment tax credit (260) 78
Fuel costs mark-to-market at the MCV Partnership 198 (170)
Minority interests (obligations), net (75) 97
Regulatory return on capital expenditures (10) (31)
Capital lease and other amortization 18 17
Earnings from equity method investees (1) -
Changes in assets and liabilities:
Increase in accounts receivable and accrued revenue (6) (94)
Decrease in inventories 91 107
Increase in accounts payable 147 35
Increase in accrued expenses 62 4
Decrease in accrued taxes (202) (30)
Increase (decrease) in the MCV Partnership gas supplier funds on deposit (100) 4
Decrease in other current and non-current assets 53 125
Increase (decrease) in other current and non-current liabilities 45 (24)
------ ------
Net cash provided by operating activities 274 564
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) (310) (270)
Cost to retire property (31) (18)
Restricted cash and restriced short-term investments 128 (33)
Investments in nuclear decommissioning trust funds (18) (3)
Proceeds from nuclear decommissioning trust funds 13 24
Proceeds from short-term investments - 145
Purchase of short-term investments - (141)
Maturity of the MCV Partnership restricted investment securities held-to-maturity 118 222
Purchase of the MCV Partnership restricted investment securities held-to-maturity (118) (223)
Cash proceeds from sale of assets - 1
Other investing 4 12
------ ------
Net cash used in investing activities (214) (284)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of long term debt - 735
Retirement of long-term debt (144) (925)
Payment of common stock dividends (40) (167)
Payment of preferred stock dividends (1) (1)
Payment of capital and finance lease obligations (5) (5)
Stockholder's contribution, net 200 550
Decrease in notes payable (27) -
Debt issuance and financing costs (3) (25)
------ ------
Net cash provided by (used in) financing activities (20) 162
------ ------
Net Increase in Cash and Cash Equivalents 40 442
Cash and Cash Equivalents, Beginning of Period 416 171
------ ------
Cash and Cash Equivalents, End of Period $ 456 $ 613
====== ======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-27
CONSUMERS ENERGY COMPANY
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
In Millions
------------------------------
June 30
2006 December 31
(Unaudited) 2005
------------- -------------
ASSETS
PLANT AND PROPERTY (AT COST)
Electric $ 8,396 $ 8,204
Gas 3,179 3,151
Other 229 227
------------- -------------
11,804 11,582
Less accumulated depreciation, depletion, and amortization 4,891 4,804
------------- -------------
6,913 6,778
Construction work-in-progress 559 509
------------- -------------
7,472 7,287
------------- -------------
INVESTMENTS
Stock of affiliates 28 33
Other 4 7
------------- -------------
32 40
------------- -------------
CURRENT ASSETS
Cash and cash equivalents at cost, which approximates market 456 416
Restricted cash and restricted short-term investments 55 183
Accounts receivable, notes receivable, and accrued revenue,
less allowances of $14 in 2006 and $13 in 2005 649 653
Accounts receivable - related parties 9 9
Inventories at average cost
Gas in underground storage 949 1,068
Materials and supplies 74 75
Generating plant fuel stock 109 80
Deferred property taxes 147 159
Regulatory assets - postretirement benefits 19 19
Derivative instruments 95 242
Prepayments and other 89 70
------------- -------------
2,651 2,974
------------- -------------
NON-CURRENT ASSETS
Regulatory assets
Securitized costs 538 560
Additional minimum pension 399 399
Postretirement benefits 105 116
Customer Choice Act 206 222
Other 475 484
Nuclear decommissioning trust funds 563 555
Other 547 520
------------- -------------
2,833 2,856
------------- -------------
TOTAL ASSETS $ 12,988 $ 13,157
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-28
STOCKHOLDER'S INVESTMENT AND LIABILITIES
In Millions
--------------------------
June 30
2006 December 31
(Unaudited) 2005
----------- -----------
CAPITALIZATION
Common stockholder's equity
Common stock, authorized 125.0 shares; outstanding
84.1 shares for all periods $ 841 $ 841
Paid-in capital 1,832 1,632
Accumulated other comprehensive income 53 72
Retained earnings since December 31, 1992 238 233
----------- -----------
2,964 2,778
Preferred stock 44 44
Long-term debt 4,291 4,303
Non-current portion of capital leases and finance lease obligations 310 308
----------- -----------
7,609 7,433
----------- -----------
MINORITY INTERESTS 269 259
----------- -----------
CURRENT LIABILITIES
Current portion of long-term debt, capital leases and finance leases 113 112
Current portion of long-term debt - related parties - 129
Notes payable - related parties - 27
Accounts payable 385 458
Accounts payable - related parties 260 40
Accrued interest 93 82
Accrued taxes 198 400
Deferred income taxes 72 55
MCV Partnership gas supplier funds on deposit 93 193
Other 180 150
----------- -----------
1,394 1,646
----------- -----------
NON-CURRENT LIABILITIES
Deferred income taxes 727 1,027
Regulatory liabilities
Regulatory liabilities for cost of removal 1,166 1,120
Income taxes, net 468 455
Other regulatory liabilities 222 178
Postretirement benefits 347 308
Asset retirement obligations 493 494
Deferred investment tax credit 64 67
Other 229 170
----------- -----------
3,716 3,819
----------- -----------
Commitments and Contingencies (Notes 2, 3, and 4)
TOTAL STOCKHOLDER'S INVESTMENT AND LIABILITIES $ 12,988 $ 13,157
=========== ===========
</Table>
CE-29
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
<Table>
<Caption>
In Millions
---------------------------------------------------
Three Months Ended Six Months Ended
----------------------- -----------------------
June 30 2006 2005 2006 2005
- ------- --------- --------- --------- ---------
COMMON STOCK
At beginning and end of period (a) $ 841 $ 841 $ 841 $ 841
--------- --------- --------- ---------
OTHER PAID-IN CAPITAL
At beginning of period 1,832 1,132 1,632 932
Stockholder's contribution - 350 200 550
--------- --------- --------- ---------
At end of period 1,832 1,482 1,832 1,482
--------- --------- --------- ---------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Minimum pension liability
At beginning of period (2) (1) (2) (1)
Minimum pension liability adjustment (b) - (1) - (1)
--------- --------- --------- ---------
At end of period (2) (2) (2) (2)
--------- --------- --------- ---------
Investments
At beginning of period 16 15 18 12
Unrealized gain (loss) on investments (b) - 3 (2) 6
--------- --------- --------- ---------
At end of period 16 18 16 18
--------- --------- --------- ---------
Derivative instruments
At beginning of period 44 26 56 20
Unrealized gain (loss) on derivative instruments (b) (4) 7 (14) 23
Reclassification adjustments included in net income (b) (1) (1) (3) (11)
--------- --------- --------- ---------
At end of period 39 32 39 32
--------- --------- --------- ---------
Total Accumulated Other Comprehensive Income 53 48 53 48
--------- --------- --------- ---------
RETAINED EARNINGS
At beginning of period 203 647 233 608
Net income 36 33 46 190
Cash dividends declared - Common Stock - (49) (40) (167)
Cash dividends declared - Preferred Stock (1) (1) (1) (1)
--------- --------- --------- ---------
At end of period 238 630 238 630
--------- --------- --------- ---------
TOTAL COMMON STOCKHOLDER'S EQUITY $ 2,964 $ 3,001 $ 2,964 $ 3,001
========= ========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-30
(a) Number of shares of common stock outstanding was 84,108,789 for all
periods presented.
(b) Disclosure of Other Comprehensive Income:
In Millions
-------------------------------------------
Three Months Ended Six Months Ended
------------------- -------------------
June 30 2006 2005 2006 2005
- ------- ------- ------- ------- -------
Minimum Pension Liability
Minimum pension liability adjustment, net of tax of
$-, $-, $-, and $-, respectively $ - $ (1) $ - $ (1)
Investments
Unrealized gain (loss) on investments, net of tax (tax benefit) of
$-, $1, $(1), and $3, respectively $ - $ 3 $ (2) $ 6
Derivative instruments
Unrealized gain (loss) on derivative instruments, net of tax (tax benefit)
of $(2), $3, $(7), and $12, respectively (4) 7 (14) 23
Reclassification adjustments included in net income, net of tax
benefit of $-, $(1), $(1), and $(6), respectively (1) (1) (3) (11)
Net income 36 33 46 190
------- ------- ------- -------
Total Comprehensive Income $ 31 $ 41 $ 27 $ 207
======= ======= ======= =======
</Table>
CE-31
Consumers Energy Company
(This page intentionally left blank)
CE-32
Consumers Energy Company
CONSUMERS ENERGY COMPANY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
These interim Consolidated Financial Statements have been prepared by Consumers
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. As such, certain information and footnote
disclosures normally included in consolidated financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted. Certain prior year amounts have been
reclassified to conform to the presentation in the current year. In management's
opinion, the unaudited information contained in this report reflects all
adjustments of a normal recurring nature necessary to assure the fair
presentation of financial position, results of operations and cash flows for the
periods presented. The Condensed Notes to Consolidated Financial Statements and
the related Consolidated Financial Statements should be read in conjunction with
the Consolidated Financial Statements and related Notes contained in the
Consumers' Form 10-K for the year ended December 31, 2005. Due to the seasonal
nature of Consumers' operations, the results as presented for this interim
period are not necessarily indicative of results to be achieved for the fiscal
year.
1: CORPORATE STRUCTURE AND ACCOUNTING POLICIES
CORPORATE STRUCTURE: Consumers, a subsidiary of CMS Energy, a holding company,
is a combination electric and gas utility company serving Michigan's Lower
Peninsula. Our customer base includes a mix of residential, commercial, and
diversified industrial customers. We manage our business by the nature of
services each provides and operate principally in two business segments:
electric utility and gas utility.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
Consumers, and all other entities in which we have a controlling financial
interest or are the primary beneficiary, in accordance with FASB Interpretation
No. 46(R). We use the equity method of accounting for investments in companies
and partnerships that are not consolidated, where we have significant influence
over operations and financial policies, but are not the primary beneficiary. We
eliminate intercompany transactions and balances.
USE OF ESTIMATES: We prepare our consolidated financial statements in conformity
with U.S. generally accepted accounting principles. We are required to make
estimates using assumptions that may affect the reported amounts and
disclosures. Actual results could differ from those estimates.
We are required to record estimated liabilities in the consolidated financial
statements when it is probable that a loss will be incurred in the future as a
result of a current event, and when the amount can be reasonably estimated. We
have used this accounting principle to record estimated liabilities as discussed
in Note 2, Contingencies.
REVENUE RECOGNITION POLICY: We recognize revenues from deliveries of electricity
and natural gas, and the storage of natural gas when services are provided.
Sales taxes are recorded as liabilities and are not included in revenues.
CE-33
Consumers Energy Company
ACCOUNTING FOR MISO TRANSACTIONS: We account for MISO transactions on a net
basis for all of our generating units combined. We record billing adjustments
when invoices are received and also record an expense accrual for future
adjustments based on historical experience.
LONG-LIVED ASSETS AND EQUITY METHOD INVESTMENTS: Our assessment of the
recoverability of long-lived assets and equity method investments involves
critical accounting estimates. We periodically perform tests of impairment if
certain conditions that are other than temporary exist that may indicate the
carrying value may not be recoverable. Of our total assets, recorded at $12.988
billion at June 30, 2006, 58 percent represent long-lived assets and equity
method investments that are subject to this type of analysis.
DETERMINATION OF PENSION MRV OF PLAN ASSETS: We determine the MRV for pension
plan assets, as defined in SFAS No. 87, as the fair value of plan assets on the
measurement date, adjusted by the gains or losses that will not be admitted into
MRV until future years. We reflect each year's assets gain or loss in MRV in
equal amounts over a five-year period beginning on the date the original amount
was determined. The MRV is used in the calculation of net pension cost.
OTHER INCOME AND OTHER EXPENSE: The following tables show the components of
Other income and Other expense:
<Table>
<Caption>
In Millions
------------------------------------------------
Three Months Ended Six Months Ended
-------------------- --------------------
June 30 2006 2005 2006 2005
- ------- ------ ------ ------ ------
Other income
Electric restructuring return $ 1 $ 3 $ 2 $ 4
Return on stranded and security costs 2 2 3 3
Nitrogen oxide allowance sales 6 1 6 1
Gain on stock - - 1 1
All other 1 - 2 1
------ ------ ------ ------
Total other income $ 10 $ 6 $ 14 $ 10
====== ====== ====== ======
</Table>
<Table>
<Caption>
In Millions
---------------------------------------------------
Three Months Ended Six Months Ended
--------------------- ---------------------
June 30 2006 2005 2006 2005
- ------- ------ ------ ------ ------
Other expense
Loss on reacquired debt $ - $ (1) $ - $ (6)
Civic and political expenditures - - (1) (1)
Donations - - (1) -
All other (1) (1) (2) (1)
------ ------ ------ ------
Total other expense $ (1) $ (2) $ (4) $ (8)
====== ====== ====== ======
RECLASSIFICATIONS: Certain prior year amounts have been reclassified for
comparative purposes. These reclassifications did not affect consolidated net
income for the periods presented.
NEW ACCOUNTING STANDARDS NOT YET EFFECTIVE: FIN 48, Accounting for Uncertainty
in Income Taxes: In June 2006, the FASB issued FIN 48. This interpretation
provides a two-step approach for the recognition and measurement of uncertain
tax positions taken, or expected to be taken, by a company on its income tax
returns. The first step is to evaluate the tax position to determine if, based
on management's best judgment, it is greater than 50 percent likely that the
taxing authority will sustain the tax position. The second step is to measure
the appropriate amount of the benefit to recognize. This is done by estimating
the potential outcomes and recognizing the greatest amount that has a cumulative
probability of at least 50 percent. We are presently evaluating the impacts, if
any, of FIN 48. Any impacts of implementing FIN 48 will result in a cumulative
adjustment to retained earnings. This interpretation is effective for us
beginning January 1, 2007.
CE-34
Consumers Energy Company
2: CONTINGENCIES
SEC AND OTHER INVESTIGATIONS: During the period of May 2000 through January
2002, CMS MST engaged in simultaneous, prearranged commodity trading
transactions in which energy commodities were sold and repurchased at the same
price. These so called round-trip trades had no impact on previously reported
consolidated net income, earnings per share, or cash flows but had the effect of
increasing operating revenues and operating expenses by equal amounts.
CMS Energy is cooperating with an investigation by the DOJ concerning round-trip
trading, which the DOJ commenced in May 2002. CMS Energy is unable to predict
the outcome of this matter and what effect, if any, this investigation will have
on its business. In March 2004, the SEC approved a cease-and-desist order
settling an administrative action against CMS Energy related to round-trip
trading. The order did not assess a fine and CMS Energy neither admitted nor
denied the order's findings. The settlement resolved the SEC investigation
involving CMS Energy and CMS MST. Also in March 2004, the SEC filed an action
against three former employees related to round-trip trading by CMS MST. One of
the individuals has settled with the SEC. CMS Energy is currently advancing
legal defense costs for the remaining two individuals, in accordance with
existing indemnification policies. Those individuals filed a motion to dismiss
the SEC action, which was denied.
SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of
complaints were filed against CMS Energy, Consumers, and certain officers and
directors of CMS Energy and its affiliates. The cases were consolidated into a
single lawsuit, which generally seeks unspecified damages based on allegations
that the defendants violated United States securities laws and regulations by
making allegedly false and misleading statements about CMS Energy's business and
financial condition, particularly with respect to revenues and expenses recorded
in connection with round-trip trading by CMS MST. In January 2005, the court
granted a motion to dismiss Consumers and three of the individual defendants,
but denied the motions to dismiss CMS Energy and the 13 remaining individual
defendants. The court issued an opinion and order dated March 24, 2006, granting
in part and denying in part plaintiffs' amended motion for class certification.
The court conditionally certified a class consisting of "all persons who
purchased CMS Common Stock during the period of October 25, 2000 through and
including May 17, 2002 and who were damaged thereby." The court excluded
purchasers of CMS Energy's 8.75 percent Adjustable Convertible Trust Securities
("ACTS") from the class. Trial has been scheduled for March 2007. In response to
the court's opinion and order excluding purchasers of ACTS from the shareholder
class, a new class action lawsuit was filed on behalf of ACTS purchasers. The
new lawsuit names the same defendants as the shareholder action and contains
essentially the same allegations and class period. CMS Energy and the individual
defendants will defend themselves vigorously in this litigation but cannot
predict its outcome.
ERISA LAWSUITS: CMS Energy was a named defendant, along with Consumers, CMS MST,
and certain named and unnamed officers and directors, in two lawsuits, filed in
July 2002 in United States District Court for the Eastern District of Michigan,
brought as purported class actions on behalf of participants and beneficiaries
of the CMS Employees' Savings Plan (the Plan). Plaintiffs alleged breaches of
fiduciary duties under ERISA and sought restitution on behalf of the Plan with
respect to a decline in value of the shares of CMS Energy Common Stock held in
the Plan, as well as other equitable relief and legal fees. On March 1, 2006,
CMS Energy and Consumers reached an agreement, subject to court and independent
fiduciary approval, to settle the lawsuits. The settlement agreement required a
$28 million cash payment by CMS Energy's primary insurer to be used to pay Plan
participants and beneficiaries for alleged losses, as well as any legal fees and
expenses. In addition, CMS Energy agreed to certain other steps regarding
administration of the Plan. The hearing on final approval of the
CE-35
Consumers Energy Company
settlement was held on June 15, 2006. On June 27, 2006, the judge entered the
Order and Final Judgment, approving the proposed settlement with minor
modifications.
ELECTRIC CONTINGENCIES
ELECTRIC ENVIRONMENTAL MATTERS: Our operations are subject to environmental laws
and regulations. Costs to operate our facilities in compliance with these laws
and regulations generally have been recovered in customer rates.
Clean Air Act: Compliance with the federal Clean Air Act and resulting
regulations has been, and will continue to be, a significant focus for us. The
Nitrogen Oxide State Implementation Plan requires significant reductions in
nitrogen oxide emissions. To comply with the regulations, we expect to incur
capital expenditures totaling $819 million through 2011. The key assumptions in
the capital expenditure estimate include:
- construction commodity prices, especially construction material and
labor,
- project completion schedules,
- cost escalation factor used to estimate future years' costs, and
- an AFUDC capitalization rate.
Our current capital cost estimates include an escalation rate of 2.6 percent and
an AFUDC capitalization rate of 8.4 percent. As of June 2006, we have incurred
$634 million in capital expenditures to comply with the federal Clean Air Act
and resulting regulations and anticipate that the remaining $185 million of
capital expenditures will be made in 2006 through 2011. These expenditures
include installing selective catalytic reduction control technology at four of
our coal-fired electric generating plants.
In addition to modifying coal-fired electric generating plants, our compliance
plan includes the use of nitrogen oxide emission allowances until all of the
control equipment is operational in 2011. The nitrogen oxide emission allowance
annual expense is projected to be $6 million per year, which we expect to
recover from our customers through the PSCR process. The projected annual
expense is based on market price forecasts and forecasts of regulatory
provisions, known as progressive flow control, that restrict the usage in any
given year of allowances banked from previous years. The allowances and their
cost are accounted for as inventory. The allowance inventory is expensed at the
rolling average cost as the coal-fired electric generating plants emit nitrogen
oxide.
Clean Air Interstate Rule: In March 2005, the EPA adopted the Clean Air
Interstate Rule that requires additional coal-fired electric generating plant
emission controls for nitrogen oxides and sulfur dioxide. The rule involves a
two-phase program to reduce emissions of nitrogen oxides by more than 60 percent
and sulfur dioxide by more than 70 percent from 2003 levels by 2015. The final
rule will require that we run our selective catalytic reduction control
technology units year round beginning in 2009 and may require that we purchase
additional nitrogen oxide allowances beginning in 2009. The additional nitrogen
oxide allowances are estimated to cost $4 million per year for years 2009
through 2011, which we expect to recover from our customers through the PSCR
process.
In addition to the selective catalytic reduction control technology installed to
meet the nitrogen oxide standards, our current plan includes installation of
flue gas desulfurization scrubbers. The scrubbers are to be installed by 2014 to
meet the Phase I reduction requirements of the Clean Air Interstate Rule, at an
estimated total cost of $960 million. Our capital cost estimates include an
escalation rate of 2.6 percent and an AFUDC capitalization rate of 8.4 percent.
We currently have a surplus of sulfur dioxide allowances, which were granted by
the EPA and are accounted for as inventory. In January 2006, we
CE-36
Consumers Energy Company
sold some of our excess sulfur dioxide allowances for $61 million and recognized
the proceeds as a regulatory liability.
Clean Air Mercury Rule: Also in March 2005, the EPA issued the Clean Air Mercury
Rule, which requires initial reductions of mercury emissions from coal-fired
electric generating plants by 2010 and further reductions by 2018. The Clean Air
Mercury Rule establishes a cap-and-trade system for mercury emissions that is
similar to the system used in the Clean Air Interstate Rule. The industry has
not reached a consensus on the technical methods for curtailing mercury
emissions. However, we anticipate our capital costs for mercury emissions
reductions required by Phase I of the Clean Air Mercury Rule to be less than $50
million and implemented by 2010. Phase II requirements of the Clean Air Mercury
Rule are not yet known and a cost estimate has not been determined.
In August 2005, the MDEQ filed a Motion to Intervene in a court challenge to
certain aspects of EPA's Clean Air Mercury Rule, asserting that the rule is
inadequate. We cannot predict the outcome of this proceeding.
In April 2006, Michigan's governor announced a plan that would result in mercury
emissions reductions of 90 percent by 2015. This plan would adopt the Clean Air
Mercury Rule through its first phase. Beginning in year 2015, the mercury
emissions reduction standards outlined in the governor's plan would become more
stringent than those included in the Clean Air Mercury Rule. We are working with
the MDEQ on the details of these rules. We will develop a cost estimate when the
details of these rules are determined.
The EPA has alleged that some utilities have incorrectly classified plant
modifications as "routine maintenance" rather than seeking permits to modify the
plant from the EPA. We have received and responded to information requests from
the EPA on this subject. We believe that we have properly interpreted the
requirements of "routine maintenance." If our interpretation is found to be
incorrect, we may be required to install additional pollution controls at some
or all of our coal-fired electric generating plants and potentially pay fines.
Additionally, the viability of certain plants remaining in operation could be
called into question.
Cleanup and Solid Waste: Under the Michigan Natural Resources and Environmental
Protection Act, we expect that we will ultimately incur investigation and
remedial action costs at a number of sites. We believe that these costs will be
recoverable in rates under current ratemaking policies.
We are a potentially responsible party at several contaminated sites
administered under Superfund. Superfund liability is joint and several, meaning
that many other creditworthy parties with substantial assets are potentially
responsible with respect to the individual sites. Based on our experience, we
estimate that our share of the total liability for the known Superfund sites
will be between $1 million and $10 million. At June 30, 2006, we have recorded a
liability for the minimum amount of our estimated Superfund liability.
In October 1998, during routine maintenance activities, we identified PCB as a
component in certain paint, grout, and sealant materials at Ludington. We
removed and replaced part of the PCB material. We have proposed a plan to deal
with the remaining materials and are awaiting a response from the EPA.
CE-37
Consumers Energy Company
MCV Environmental Issue: On July 12, 2004, the MDEQ, Air Control Division,
issued the MCV Partnership a Letter of Violation asserting that the MCV Facility
violated its Air Use Permit to Install (PTI) by exceeding the carbon monoxide
emission limit on the Unit 14 duct burner and failing to maintain certain
records in the required format. The MCV Partnership there after declared five of
the six duct burners in the MCV Facility as unavailable for operational use
(which reduced the generation capability of the MCV Facility by approximately
100 MW) and took other corrective action to address the MDEQ's assertions.
Testing of the one available duct burner occurred in April 2005, and its
emissions met permitted levels due to the configuration of that particular unit.
In July 2004, the MCV Partnership filed a response to the Letter of Violation,
opposing its findings. On December 13, 2004, the MDEQ informed the MCV
Partnership that it was pursuing an escalated enforcement action against the MCV
Partnership. The MDEQ also stated that the alleged violations are deemed
federally significant and, as such, placed the MCV Partnership on the EPA's High
Priority Violators List (HPVL). Following voluntary settlement discussions, the
MDEQ issued the MCV Partnership a new PTI, which established higher carbon
monoxide emissions limits on the five duct burners that had been declared
unavailable. The MCV Partnership has returned those duct burners to service. The
MDEQ and the MCV Partnership are pursuing a settlement of the emission
violation, which will also satisfy state and federal requirements and remove the
MCV Partnership from the HPVL. At this time, we cannot predict the financial
impact or outcome of this issue.
LITIGATION: In October 2003, a group of eight PURPA qualifying facilities (the
plaintiffs), which sell power to us, filed a lawsuit in Ingham County Circuit
Court. The lawsuit alleged that we incorrectly calculated the energy charge
payments made pursuant to power purchase agreements with qualifying facilities.
In February 2004, the Ingham County Circuit Court judge deferred to the primary
jurisdiction of the MPSC, dismissing the circuit court case without prejudice.
The Michigan Court of Appeals upheld this order on the primary jurisdiction
question, but remanded the case back on another issue. In February 2005, the
MPSC issued an order in the 2004 PSCR plan case concluding that we have been
correctly administering the energy charge calculation methodology. The
plaintiffs have appealed the MPSC order to the Michigan Court of Appeals. The
plaintiffs also filed suit in the United States Court for the Western District
of Michigan, which the judge subsequently dismissed. The plaintiffs have
appealed the dismissal to the United States Court of Appeals. We cannot predict
the outcome of these appeals.
CE-38
Consumers Energy Company
ELECTRIC RESTRUCTURING MATTERS
ELECTRIC ROA: The Customer Choice Act allows all of our electric customers to
buy electric generation service from us or from an alternative electric
supplier. At June 30, 2006, alternative electric suppliers were providing 311 MW
of generation service to ROA customers, which represents 4 percent of our total
distribution load. This represents a decrease of 11 percent of ROA load compared
to March 31, 2006 and a decrease of 62 percent of ROA load compared to June 30,
2005. It is difficult to predict future ROA customer trends.
STRANDED COSTS: Prior MPSC orders adopted a mechanism pursuant to the Customer
Choice Act to provide recovery of Stranded Costs that occur when customers leave
our system to purchase electricity from alternative suppliers. In November 2005,
we filed an application with the MPSC related to the determination of 2004
Stranded Costs. Applying the Stranded Cost methodology used in prior MPSC
orders, we concluded that we experienced Stranded Costs in 2004; however, we
also concluded that these costs were offset completely by our net sales of
excess power into the bulk electricity market.
In March 2006, the ALJ in our 2004 PSCR reconciliation case issued a Proposal
for Decision recommending that we use a greater portion of our net sales of
excess power into the bulk electricity market to offset our 2004 PSCR costs,
rather than 2004 Stranded Costs. We believe, if accepted, that this
recommendation would lead to a greater amount of 2004 Stranded Costs to recover
from ROA customers. However, in June 2006, the ALJ issued a Proposal for
Decision in our 2004 Stranded Cost case recommending that the MPSC find that we
had no Stranded Costs in 2004 because the ALJ did not believe we demonstrated
that the Stranded Costs were caused by ROA. If the MPSC adopts the ALJ
recommendations earnings would be impacted adversely by $10 million. In June
2006, we filed exceptions to this Proposal for Decision in the Stranded Cost
case. We cannot predict the outcome of these proceedings.
ELECTRIC RATE MATTERS
POWER SUPPLY COSTS: To reduce the risk of high electric prices during peak
demand periods and to achieve our reserve margin target, we employ a strategy of
purchasing electric capacity and energy contracts for the physical delivery of
electricity primarily in the summer months and to a lesser degree in the winter
months. We have purchased capacity and energy contracts covering the reserve
margin requirements for 2006 and covering partially the estimated reserve margin
requirements for 2007 through 2010. As a result, we have recognized an asset of
$75 million for unexpired capacity and energy contracts at June 30, 2006. At
July 2006, we expect the total capacity cost of electric capacity and energy
contracts for 2006 to be $19 million.
PSCR: The PSCR process allows recovery of reasonable and prudent power supply
costs. Revenues from the PSCR charges are subject to reconciliation after review
of actual costs for reasonableness and prudence. In September 2005, we submitted
our 2006 PSCR plan filing to the MPSC. In November 2005, we submitted an amended
2006 PSCR plan to the MPSC to include higher estimates for METC and coal supply
costs. In December 2005, the MPSC issued an order that temporarily excluded
these increased costs from our PSCR charge and further reduced the charge by one
mill per kWh. We implemented the temporary order in January 2006.
CE-39
Consumers Energy Company
In April 2006, the MPSC Staff filed briefs in the 2006 PSCR plan case
recommending inclusion of all filed costs in the 2006 PSCR charge, including
those temporarily excluded in the December 2005 temporary order. In May 2006,
the ALJ issued a Proposal for Decision with a recommendation similar to the MPSC
Staff. However, the ALJ recommended that we continue to exclude those costs
temporarily excluded until addressed in our 2006 PSCR reconciliation case, which
we plan to file in March 2007. Depending on the action taken by the MPSC, our
cash underrecoveries of power supply costs for 2006 could range from $39 million
to $146 million.
These underrecoveries are due to increased bundled sales, and other cost
increases beyond those included in the September 2005 and November 2005 filings.
We expect to recover fully all of our PSCR costs. When we incur and are unable
to collect these costs in a timely manner, there is a negative impact on our
cash flows from electric utility operations.
In March 2006, we submitted our 2005 PSCR reconciliation filing to the MPSC. In
July 2006, we submitted supplemental testimony in which we calculated an
underrecovery of $37 million for commercial and industrial customers, which we
expect to recover fully. We cannot predict the outcome of these PSCR
proceedings.
OTHER ELECTRIC CONTINGENCIES
THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and operates
the MCV Facility, contracted to sell electricity to Consumers for a 35-year
period beginning in 1990. We hold a 49 percent partnership interest in the MCV
Partnership, and a 35 percent lessor interest in the MCV Facility. In 2004, we
consolidated the MCV Partnership and the FMLP into our consolidated financial
statements in accordance with FASB Interpretation No. 46(R).
Sale of our Interest in the MCV Partnership and the FMLP: In July 2006, we
reached an agreement to sell 100 percent of the stock of CMS Midland, Inc. and
CMS Midland Holdings Company to an affiliate of GSO Capital Partners and
Rockland Capital Energy Investments for $60.5 million. These Consumers'
subsidiaries hold our interest in the MCV Partnership and the FMLP. The MCV PPA
and the associated customer rates are not affected by the sale. We are targeting
to close on the sale by the end of 2006. The sale is subject to various
regulatory approvals, including the MPSC's approval and the expiration of the
waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.
On July 27, 2006, the MPSC issued an order establishing a contested case
proceeding and provided a schedule, which will allow for a decision from the
MPSC by the end of 2006. We cannot predict the timing or the outcome of the
MPSC's decision. We further cannot predict with certainty whether or when this
transaction will be completed.
Further, because of the PPA in place between Consumers and the MCV Partnership,
the transaction is effectively a sale and leaseback for accounting purposes.
SFAS No. 98 specifies the accounting required for a seller's sale and
simultaneous leaseback transaction involving real estate, including real estate
with equipment. In accordance with SFAS No. 98, the transaction will be required
to be accounted for as a financing and not a sale. This is due to forms of
continuing involvement we will have with the MCV Partnership. At closing, we
will remove from our Consolidated Balance Sheets all of the assets, liabilities,
and minority interest associated with both the MCV Partnership and the FMLP
except for the real estate assets and equipment of the MCV Partnership. Those
assets will remain at their carrying value. If the fair value is determined to
be less than the present carrying value, an impairment charge would result.
CE-40
Consumers Energy Company
Further, as disclosed in Note 4, Financial and Derivative Instruments,
"Derivative Contracts Associated with the MCV Partnership," we will reflect in
earnings certain cumulative amounts of MCV Partnership-related derivative fair
value changes that are accounted for in other comprehensive income. We will also
reflect in earnings a liability for the fair value of a guarantee, and income
related to certain MCV Partnership gas contracts which are being sold. The
transaction will not result in the MCV Partnership or the FMLP assets being
classified as held for sale on our Consolidated Balance Sheets.
Financial Condition of the MCV Partnership: Under the MCV PPA, variable energy
payments to the MCV Partnership are based on the cost of coal burned at our coal
plants and our operation and maintenance expenses. However, the MCV
Partnership's costs of producing electricity are tied to the cost of natural
gas. Historically high natural gas prices have caused the MCV Partnership to
reevaluate the economics of operating the MCV Facility and to record an
impairment charge in 2005. If natural gas prices remain at present levels or
increase, the operations of the MCV Facility would be adversely affected and
could result in the MCV Partnership failing to meet its obligations under the
sale and leaseback transactions and other contracts. Due to the impairment of
the MCV Facility and subsequent losses, the value of the equity held by all of
the owners of the MCV Partnership has decreased significantly and is now
negative. Since we are one of the general partners of the MCV Partnership, we
have recognized a portion of the limited partners' negative equity. At June 30,
2006, the negative minority interest for the other general partners' share,
including their portion of the limited partners' negative equity, is $112
million and is included in Other Non-current Assets on our Consolidated Balance
Sheets.
Underrecoveries related to the MCV PPA: Further, the cost that we incur under
the MCV PPA exceeds the recovery amount allowed by the MPSC. We expense all cash
underrecoveries directly to income. We estimate underrecoveries of $55 million
in 2006 and $39 million in 2007. Of the 2006 estimate, we expensed $28 million
during the six months ended June 30, 2006. However, Consumers' direct savings
from the RCP, after allocating a portion to customers, are used to offset our
capacity and fixed energy underrecoveries expense. After September 15, 2007, we
expect to claim relief under the regulatory out provision in the MCV PPA,
thereby limiting our capacity and fixed energy payments to the MCV Partnership
to the amounts that we collect from our customers. The MCV Partnership has
indicated that it may take issue with our exercise of the regulatory out clause
after September 15, 2007. We believe that the clause is valid and fully
effective, but cannot assure that it will prevail in the event of a dispute. If
we are successful in exercising the regulatory out clause, the MCV Partnership
has the right to terminate the MCV PPA. The MPSC's future actions on the
capacity and fixed energy payments recoverable from customers subsequent to
September 15, 2007 may affect negatively the financial performance of the MCV
Partnership.
In January 2005, the MPSC issued an order approving the RCP, with modifications.
The RCP allows us to recover the same amount of capacity and fixed energy
charges from customers as approved in prior MPSC orders. However, we are able to
dispatch the MCV Facility on the basis of natural gas market prices, which
reduces the MCV Facility's annual production of electricity and, as a result,
reduces the MCV Facility's consumption of natural gas by an estimated 30 to 40
bcf annually. This decrease in the quantity of high-priced natural gas consumed
by the MCV Facility benefits our interest in the MCV Partnership.
In January 2005, we implemented the RCP. The underlying agreement for the RCP
between Consumers and the MCV Partnership extends through the term of the MCV
PPA. However, either party may terminate that agreement under certain
conditions. In February 2005, a group of intervenors in the RCP case filed for
rehearing of the MPSC order approving the RCP. The Attorney General also filed
an appeal with the Michigan Court of Appeals. We cannot predict the outcome of
these matters.
CE-41
Consumers Energy Company
MCV PARTNERSHIP PROPERTY TAXES: In January 2004, the Michigan Tax Tribunal
issued its decision in the MCV Partnership's tax appeal against the City of
Midland for tax years 1997 through 2000. The City of Midland appealed the
decision to the Michigan Court of Appeals, and the MCV Partnership filed a
cross-appeal at the Michigan Court of Appeals. The MCV Partnership also has a
pending case with the Michigan Tax Tribunal for tax years 2001 through 2006. The
MCV Partnership estimates that the 1997 through 2005 tax year cases will result
in a refund to the MCV Partnership of $87 million, inclusive of interest, if the
decision of the Michigan Tax Tribunal is upheld. In February 2006, the Michigan
Court of Appeals largely affirmed the Michigan Tax Tribunal decision, but
remanded the case back to the Michigan Tax Tribunal to clarify certain aspects
of the Tax Tribunal decision. In April 2006, the City of Midland filed an
application for Leave to Appeal with the Michigan Supreme Court. The MCV
Partnership filed a response in opposition to that application. The remanded
proceedings may result in the determination of a greater refund to the MCV
Partnership. In July 2006, the Michigan Supreme Court denied the City of
Midland's application. The MCV Partnership cannot predict the outcome of these
proceedings; therefore, this anticipated refund has not been recognized in
earnings.
NUCLEAR PLANT DECOMMISSIONING: The MPSC and the FERC regulate the recovery of
costs to decommission, or remove from service, our Big Rock and Palisades
nuclear plants. Decommissioning funding practices approved by the MPSC require
us to file a report on the adequacy of funds for decommissioning at three-year
intervals. We prepared and filed updated cost estimates for Big Rock and
Palisades in March 2004. Excluding additional costs for spent nuclear fuel
storage due to the DOE's failure to accept this spent nuclear fuel on schedule,
these reports show a decommissioning cost of $361 million for Big Rock and $868
million for Palisades. Since Big Rock is currently in the process of
decommissioning, this estimated cost includes historical expenditures in nominal
dollars and future costs in 2003 dollars, with all Palisades costs given in 2003
dollars. Updated cost projections for Big Rock indicate an anticipated
decommissioning cost of $393 million as of June 2006.
Big Rock: In December 2000, funding of the Big Rock trust fund stopped because
the MPSC-authorized decommissioning surcharge collection period expired. In our
March 2004 report to the MPSC, we indicated that we would manage the
decommissioning trust fund to meet annual NRC financial assurance requirements
by withdrawing NRC radiological decommissioning costs from the fund and
initially funding non-NRC, greenfield costs out of corporate funds. In March
2006, we contributed $16 million to the trust fund from our corporate funds to
support NRC radiological decommissioning costs. Excluding the additional nuclear
fuel storage costs due to the DOE's failure to accept spent fuel on schedule, we
are projecting that the level of funds provided by the trust will fall short of
the amount needed to complete the decommissioning by $39 million, which is the
amount projected for non-NRC, greenfield costs. We plan initially to fund the
$39 million out of corporate funds. Therefore, at this time, we plan to provide
a total of $55 million from corporate funds for costs associated with NRC
radiological and non-NRC greenfield decommissioning work. We plan to seek
recovery of such expenditures. We cannot predict the outcome of these efforts.
Palisades: Excluding additional nuclear fuel storage costs due to the DOE's
failure to accept spent fuel on schedule, we concluded, based on the cost
estimates filed in March 2004, that the existing Palisades' surcharge of $6
million needed to be increased to $25 million annually, beginning January 2006.
A settlement agreement was approved by the MPSC, providing for the continuation
of the existing $6 million annual decommissioning surcharge through 2011, our
current license expiration date, and for the next periodic review to be filed in
March 2007. Amounts collected from electric retail customers and deposited in
trusts, including trust earnings, are credited to a regulatory liability.
CE-42
Consumers Energy Company
In March 2005, the NMC, which operates the Palisades plant, applied for a
20-year license renewal for the plant on behalf of Consumers. We expect a
decision from the NRC on the license renewal application in 2007. At this time,
we cannot determine what impact this will have on decommissioning costs or the
adequacy of funding.
In July 2006, we reached an agreement to sell Palisades and the Big Rock ISFSI
to Entergy. As part of the transaction, Entergy will sell us 100 percent of the
plant's output up to its current capacity of 798 MW under a 15-year power
purchase agreement. Because of the PPA that will be in place between Consumers
and Entergy, the transaction is effectively a sale and leaseback for accounting
purposes. SFAS No. 98 specifies the accounting required for a seller's sale and
simultaneous leaseback transaction involving real estate, including real estate
with equipment. In accordance with SFAS No. 98, the transaction will be
accounted for as a financing and not a sale. This is due to forms of continuing
involvement. As such, we will not classify the assets as held for sale on our
Consolidated Balance Sheets.
NUCLEAR MATTERS: Nuclear Fuel Cost: We amortize nuclear fuel cost to fuel
expense based on the quantity of heat produced for electric generation. For
nuclear fuel used after April 6, 1983, we charge certain disposal costs to
nuclear fuel expense, recover these costs through electric rates, and remit them
to the DOE quarterly. We elected to defer payment for disposal of spent nuclear
fuel burned before April 7, 1983. At June 30, 2006, our DOE liability is $148
million. This amount includes interest, which is payable upon the first delivery
of spent nuclear fuel to the DOE. The amount of this liability, excluding a
portion of interest, was recovered through electric rates. In conjunction with
the sale of Palisades and the Big Rock ISFSI, we will retain this obligation and
provide security to Entergy for this obligation in the form of either cash, a
letter of credit, or other acceptable means.
DOE Litigation: In 1997, a U.S. Court of Appeals decision confirmed that the DOE
was to begin accepting deliveries of spent nuclear fuel for disposal by January
1998. Subsequent U.S. Court of Appeals litigation, in which we and other
utilities participated, has not been successful in producing more specific
relief for the DOE's failure to accept the spent nuclear fuel.
There are two court decisions that support the right of utilities to pursue
damage claims in the United States Court of Claims against the DOE for failure
to take delivery of spent nuclear fuel. Over 60 utilities have initiated
litigation in the United States Court of Claims. We filed our complaint in
December 2002. If our litigation against the DOE is successful, we plan to use
any recoveries to pay the cost of spent nuclear fuel storage until the DOE takes
possession as required by law. We can make no assurance that the litigation
against the DOE will be successful.
In 2002, the site at Yucca Mountain, Nevada was designated for the development
of a repository for the disposal of high-level radioactive waste and spent
nuclear fuel. We expect that the DOE, in due course, will submit a final license
application to the NRC for the repository. The application and review process is
estimated to take several years.
Insurance: We maintain nuclear insurance coverage on our nuclear plants. At
Palisades, we maintain nuclear property insurance from NEIL totaling $2.750
billion and insurance that would partially cover the cost of replacement power
during certain prolonged accidental outages. Because NEIL is a mutual insurance
company, we could be subject to assessments of up to $28 million in any policy
year if insured losses in excess of NEIL's maximum policyholders surplus occur
at our, or any other member's, nuclear facility. NEIL's policies include
coverage for acts of terrorism.
CE-43
Consumers Energy Company
At Palisades, we maintain nuclear liability insurance for third-party bodily
injury and off-site property damage resulting from a nuclear energy hazard for
up to approximately $10.761 billion, the maximum insurance liability limits
established by the Price-Anderson Act. Part of the Price-Anderson Act's
financial protection is a mandatory industry-wide program under which owners of
nuclear generating facilities could be assessed if a nuclear incident occurs at
any nuclear generating facility. The maximum assessment against us could be $101
million per occurrence, limited to maximum annual installment payments of $15
million.
We also maintain insurance under a program that covers tort claims for bodily
injury to nuclear workers caused by nuclear hazards. The policy contains a $300
million nuclear industry aggregate limit. Under a previous insurance program
providing coverage for claims brought by nuclear workers, we remain responsible
for a maximum assessment of up to $6 million. This requirement will end December
31, 2007.
Big Rock remains insured for nuclear liability up to $544 million through
nuclear insurance and NRC indemnity, and maintains a nuclear property insurance
policy from NEIL.
Insurance policy terms, limits, and conditions are subject to change during the
year as we renew our policies.
GAS CONTINGENCIES
GAS ENVIRONMENTAL MATTERS: We expect to incur investigation and remediation
costs at a number of sites under the Michigan Natural Resources and
Environmental Protection Act, a Michigan statute that covers environmental
activities including remediation. These sites include 23 former manufactured gas
plant facilities. We operated the facilities on these sites for some part of
their operating lives. For some of these sites, we have no current ownership or
may own only a portion of the original site. In 2005, we estimated our remaining
costs to be between $29 million and $71 million, based on 2005 discounted costs,
using a discount rate of three percent. The discount rate represents a 10-year
average of U.S. Treasury bond rates reduced for increases in the consumer price
index. We expect to fund most of these costs through proceeds derived from a
settlement with insurers and MPSC-approved rates. At June 30, 2006, we have a
liability of $28 million, net of $54 million of expenditures incurred to date,
and a regulatory asset of $59 million. Any significant change in assumptions,
such as an increase in the number of sites, different remediation techniques,
nature and extent of contamination, and legal and regulatory requirements, could
affect our estimate of remedial action costs.
GAS RATE MATTERS
GAS COST RECOVERY: The GCR process is designed to allow us to recover all of our
purchased natural gas costs if incurred under reasonable and prudent policies
and practices. The MPSC reviews these costs, policies, and practices for
prudency in annual plan and reconciliation proceedings.
CE-44
Consumers Energy Company
The following table summarizes our GCR reconciliation filings with the MPSC:
Gas Cost Recovery Reconciliation
- -------------------------------------------------------------------------------------------------------------------
Net Over-
GCR Year Date Filed Order Date recovery Status
- --------- ---------- ---------- ------------ -------------------------------------------
2004-2005 June 2005 April 2006 $2 million The net overrecovery includes interest
expense through March 2005 and refunds that
we received from our suppliers that are
required to be refunded to our customers.
The net overrecovery includes $1 million
2005-2006 June 2006 Pending $3 million interest income through March 2006, which
resulted from a net underrecovery position
during the majority of the GCR period.
</Table>
GCR plan for year 2005-2006: In November 2005, the MPSC issued an order for our
2005-2006 GCR Plan year, which resulted in approval of a settlement agreement
and established a fixed price cap of $10.10 per mcf for the December 2005
through March 2006 billing period. We were able to maintain our billing GCR
factor below the authorized level for that period. The order was appealed to the
Michigan Court of Appeals by one intervenor. No action has been taken by the
Court of Appeals on the merits of the appeal and we are unable to predict the
outcome.
GCR plan for year 2006-2007: In December 2005, we filed an application with the
MPSC seeking approval of a GCR plan for the 12-month period of April 2006
through March 2007. Our request proposed using a GCR factor consisting of:
- a base GCR ceiling factor of $11.10 per mcf, plus
- a quarterly GCR ceiling price adjustment contingent upon future
events.
In July 2006, all parties signed a partial settlement agreement, which calls for
a base GCR ceiling factor of $9.48 per mcf. The settlement agreement is also
subject to a quarterly GCR ceiling price adjustment of up to $3.50 per MMbtu,
contingent upon future events. The settlement agreement is subject to MPSC
approval.
Our GCR factor for the billing month of August 2006 is $8.37 per mcf.
2001 GAS DEPRECIATION CASE: In October and December 2004, the MPSC issued
Opinions and Orders in our gas depreciation case, which:
- reaffirmed the previously-ordered $34 million reduction in our
depreciation expense,
- required us to undertake a study to determine why our plant removal
costs are in excess of other regulated Michigan natural gas
utilities, and
- required us to file a study report with the MPSC Staff on or before
December 31, 2005.
We filed the study report with the MPSC Staff on December 29, 2005.
CE-45
Consumers Energy Company
We are also required to file our next gas depreciation case within 90 days after
the MPSC issuance of a final order in the pending case related to ARO
accounting. We cannot predict when the MPSC will issue a final order in the ARO
accounting case.
If the depreciation case order is issued after the gas general rate case order,
we proposed to incorporate its results into the gas general rates using a
surcharge mechanism, a process used to incorporate specialty items into customer
rates.
2005 GAS RATE CASE: In July 2005, we filed an application with the MPSC seeking
a 12 percent authorized return on equity along with a $132 million annual
increase in our gas delivery and transportation rates. As part of this filing,
we also requested interim rate relief of $75 million.
The MPSC Staff and intervenors filed interim rate relief testimony on October
31, 2005. In its testimony, the MPSC Staff recommended granting interim rate
relief of $38 million.
In February 2006, the MPSC Staff recommended granting final rate relief of $62
million. The MPSC Staff proposed that $17 million of this amount be contributed
to a low income and energy efficiency fund. The MPSC Staff also recommended
reducing our allowed return on common equity to 11.15 percent, from our current
11.4 percent.
In March 2006, the MPSC Staff revised its recommended final rate relief to $71
million, which includes $17 million to be contributed to a low income and energy
efficiency fund. In April 2006, we revised our request for final rate relief
downward to $118 million.
In May 2006, the MPSC issued an order granting us interim gas rate relief of $18
million annually, which is under bond and subject to refund if final rate relief
is granted in a lesser amount. The order also extended the temporary two-year
surcharge of $58 million granted in October 2004 until the issuance of a final
order in this proceeding. The MPSC has not set a date for issuance of an order
granting final rate relief.
In July 2006, the ALJ issued a Proposal for Decision recommending final rate
relief of $74 million above current rate levels, which include interim and
temporary rate relief. The $74 million includes $17 million to be contributed to
a low income and energy efficiency fund. The Proposal for Decision also
recommended reducing our return on common equity to 11 percent, from our current
11.4 percent.
OTHER CONTINGENCIES
IRS AUDIT RESOLUTION: In August 2005, the IRS issued Revenue Ruling 2005-53 and
regulations to provide guidance with respect to the use of the "simplified
service cost" method of tax accounting. We have been using this tax accounting
method, generally allowed by the IRS under section 263A of the Internal Revenue
Code, with respect to the allocation of certain indirect overhead costs to the
tax basis of self-constructed utility assets.
In June 2006, the IRS concluded its most recent audit of CMS Energy and its
subsidiaries, and proposed changes to taxable income for the years ended
December 31, 1987 through December 31, 2001. The proposed overall cumulative
increase to taxable income related primarily to the disallowance of the
simplified service cost method with respect to certain self-constructed utility
assets. CMS Energy has accepted these proposed adjustments to taxable income,
which has been allocated based upon Consumers' separate taxable income in
accordance with CMS Energy's tax sharing agreement. We had
CE-46
Consumers Energy Company
tax related payables to CMS Energy with respect to its share of audit
adjustments of $232 million, and a reduction of our June 2006 income tax
provision of $14 million, net of interest expense, primarily for the
utilization or restoration of previously written off income tax credits.
OTHER: In addition to the matters disclosed within this Note, we are party to
certain lawsuits and administrative proceedings before various courts and
governmental agencies arising from the ordinary course of business. These
lawsuits and proceedings may involve personal injury, property damage,
contractual matters, environmental issues, federal and state taxes, rates,
licensing, and other matters.
We have accrued estimated losses for certain contingencies discussed within this
Note. Resolution of these contingencies is not expected to have a material
adverse impact on our financial position, liquidity, or results of operations.
FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS
FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS: The
Interpretation requires the guarantor, upon issuance of a guarantee, to
recognize a liability for the fair value of the obligation it undertakes in
issuing the guarantee.
The following table describes our guarantees at June 30, 2006:
<Table>
<Caption>
In Millions
----------------------------------------------------------
Issue Expiration Maximum Carrying
Guarantee Description Date Date Obligation Amount
- --------------------- ------------ ---------- ---------- --------
Standby letters of credit Various Various $ 41 $ -
Surety bonds Various Indefinite 1 -
Guarantee (a) January 1987 March 2015 85 -
Nuclear insurance retrospective premiums Various Indefinite 135 -
</Table>
(a) We have reached an agreement to sell our interests in the MCV Partnership
and the FMLP, subject to certain regulatory and other closing conditions. The
sales agreement calls for the purchaser, an affiliate of GSO Capital Partners
and Rockland Capital Energy Investments to pay $85 million, subject to certain
reimbursement rights, if Dow terminates an agreement under which it is provided
power and steam by the MCV Partnership. The purchaser will secure their
reimbursement obligation with an irrevocable letter of credit of up to $85
million.
CE-47
Consumers Energy Company
The following table provides additional information regarding our guarantees:
<Table>
<Caption>
Guarantee Description How Guarantee Arose Events That Would Require Performance
- --------------------- ------------------- -------------------------------------
Standby letters of credit Normal operations of coal power plants Noncompliance with environmental
regulations and inadequate response
to demands for corrective action
Natural gas transportation Nonperformance
Self-insurance requirement Nonperformance
Surety bonds Normal operating activity, permits and Nonperformance
licenses
Guarantee Agreement to provide power and steam to MCV Partnership's nonperformance or
Dow non-payment under a related contract
Nuclear insurance retrospective premiums Normal operations of nuclear plants Call by NEIL and Price-Anderson Act
for nuclear incident
At June 30, 2006, none of our guarantees contained provisions allowing us to
recover, from third-parties, any amount paid under the guarantees. We enter into
various agreements containing indemnification provisions in connection with a
variety of transactions. While we are unable to estimate the maximum potential
obligation related to these indemnities, we consider the likelihood that we
would be required to perform or incur significant losses related to these
indemnities and the guarantees listed in the preceding tables to be remote.
3: FINANCINGS AND CAPITALIZATION
Long-term debt is summarized as follows:
In Millions
-------------------------------------------
June 30, 2006 December 31, 2005
------------- -----------------
First mortgage bonds $ 3,174 $ 3,175
Senior notes and other 855 852
Securitization bonds 355 369
--------- ---------
Principal amounts outstanding 4,384 4,396
Current amounts (86) (85)
Net unamortized discount (7) (8)
--------- ---------
Total Long-term debt $ 4,291 $ 4,303
========= =========
DEBT RETIREMENTS: The following is a summary of significant long-term debt
retirements during the six months ended June 30, 2006:
<Table>
<Caption>
Principal Interest Retirement
(in millions) Rate (%) Date Maturity Date
------------- -------- ---------------- -------------
Long-term debt - related parties $ 129 9.00 February 2006 June 2031
</Table>
CE-48
Consumers Energy Company
REGULATORY AUTHORIZATION FOR FINANCINGS: In May 2006, the FERC issued an order
authorizing us to issue up to $2.0 billion of secured and unsecured short-term
securities for the following purposes:
- up to $1.0 billion for general corporate purposes, and
- up to $1.0 billion of FMB or other securities to be issued solely as
collateral for other short-term securities.
Also in May 2006, the FERC issued an order authorizing us to issue up to $5.0
billion of secured and unsecured long-term securities for the following
purposes:
- up to $1.5 billion for general corporate purposes,
- up to $1.0 billion for purposes of refinancing or refunding existing
long-term debt, and
- up to $2.5 billion of FMB or other securities to be issued solely as
collateral for other long-term securities.
Any long-term issuances during the two-year authorization period are exempt from
FERC's competitive bidding and negotiated placement requirements.
The authorizations are for a two-year period beginning July 1, 2006 and ending
June 30, 2008.
REVOLVING CREDIT FACILITIES: The following secured revolving credit facilities
with banks are available at June 30, 2006:
<Table>
<Caption>
In Millions
-----------
Outstanding
Amount of Amount Letters-of- Amount
Company Expiration Date Facility Borrowed Credit Available
------- --------------- --------- -------- ----------- ----------
Consumers March 30, 2007 $ 300 $ - $ - $ 300
Consumers May 18, 2010 500 - 42 458
MCV Partnership August 26, 2006 50 - 2 48
</Table>
In March 2006, we entered into a short-term secured revolving credit agreement
with banks. This facility provides $300 million of funds for working capital and
other general corporate purposes.
DIVIDEND RESTRICTIONS: Under the provisions of our articles of incorporation, at
June 30, 2006, we had $184 million of unrestricted retained earnings available
to pay common stock dividends. Covenants in our debt facilities cap common stock
dividend payments at $300 million in a calendar year. For the six months ended
June 30, 2006, we paid $40 million in common stock dividends to CMS Energy.
Also, the provisions of the Federal Power Act and the Natural Gas Act
effectively restrict dividends to the amount of our retained earnings.
CAPITAL AND FINANCE LEASE OBLIGATIONS: Our capital leases are comprised mainly
of leased service vehicles, power purchase agreements, and office furniture. At
June 30, 2006, capital lease obligations totaled $56 million. In order to obtain
permanent financing for the MCV Facility, the MCV Partnership entered into a
sale and lease back agreement with a lessor group, which includes the FMLP, for
substantially all of the MCV Partnership's fixed assets. In accordance with SFAS
No. 98, the MCV Partnership accounted for the transaction as a financing
arrangement. At June 30, 2006, finance lease obligations totaled $281 million,
which represents the third-party portion of the MCV Partnership's finance lease
obligation.
CE-49
Consumers Energy Company
SALE OF ACCOUNTS RECEIVABLE: Under a revolving accounts receivable sales
program, we sell certain accounts receivable to a wholly owned, consolidated,
bankruptcy remote special purpose entity. In turn, the special purpose entity
may sell an undivided interest in up to $325 million of the receivables. The
special purpose entity sold no receivables at June 30, 2006 and $325 million of
receivables at December 31, 2005. We continue to service the receivables sold to
the special purpose entity. The purchaser of the receivables has no recourse
against our other assets for failure of a debtor to pay when due and no right to
any receivables not sold. We have neither recorded a gain or loss on the
receivables sold nor retained interest in the receivables sold.
Certain cash flows under our accounts receivable sales program are shown in the
following table:
<Table>
<Caption>
In Millions
-------------------
Six months ended June 30 2006 2005
- ------------------------ ------ ------
Net cash flow as a result of accounts receivable financing $ (325) $ (304)
Collections from customers $3,232 $2,787
</Table>
4: FINANCIAL AND DERIVATIVE INSTRUMENTS
FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments, and
current liabilities approximate their fair values because of their short-term
nature. We estimate the fair values of long-term financial instruments based on
quoted market prices or, in the absence of specific market prices, on quoted
market prices of similar instruments or other valuation techniques.
The cost and fair value of our long-term financial instruments are as follows:
<Table>
<Caption>
In Millions
-----------------------------------------------------------------------------
June 30, 2006 December 31, 2005
----------------------------------- -----------------------------------
Fair Unrealized Fair Unrealized
Cost Value Gain (Loss) Cost Value Gain (Loss)
------ ------ ----------- ------ ------ -----------
Long-term debt, $4,377 $4,214 $ 163 $4,388 $4,393 $ (5)
including current amounts
Long-term debt - related parties,
including current amounts - - - 129 131 (2)
Available-for-sale securities:
Common stock of CMS Energy 10 29 19 10 33 23
SERP:
Equity securities 17 23 6 16 22 6
Debt securities 8 7 (1) 8 8 -
Nuclear decommissioning investments:
Equity securities 135 253 118 134 252 118
Debt securities 306 303 (3) 287 291 4
</Table>
In July 2006, we reached an agreement to sell Palisades and the Big Rock ISFSI
to Entergy. Entergy will assume responsibility for the future decommissioning of
the plant and for storage and disposal of spent nuclear fuel. Accordingly, upon
completion of the sale, we will transfer $366 million of nuclear decommissioning
trust fund assets to Entergy and retain $200 million. We will also be entitled
to receive a return of $116 million of decommissioning trust fund assets pending
either a favorable federal
CE-50
Consumers Energy Company
tax ruling regarding the release of the funds, or, if the funds are available,
after decommissioning of the Palisades site is complete. The disposition of
the retained and receivable nuclear decommissioning funds is subject to
regulatory proceedings.
DERIVATIVE INSTRUMENTS: In order to limit our exposure to certain market risks,
we may enter into various risk management contracts, such as swaps, options,
futures, and forward contracts. These contracts, used primarily to manage our
exposure to changes in interest rates and commodity prices, are entered into for
purposes other than trading. We enter into these contracts using established
policies and procedures, under the direction of both:
- an executive oversight committee consisting of senior management
representatives, and
- a risk committee consisting of business unit managers.
The contracts we use to manage market risks may qualify as derivative
instruments that are subject to derivative and hedge accounting under SFAS No.
133. If a contract is a derivative, it is recorded on the balance sheet at its
fair value. We then adjust the resulting asset or liability each quarter to
reflect any change in the market value of the contract, a practice known as
marking the contract to market. If a derivative qualifies for cash flow hedge
accounting treatment, the changes in fair value (gains or losses) are reported
in accumulated other comprehensive income; otherwise, the changes are reported
in earnings.
For a derivative instrument to qualify for hedge accounting:
- the relationship between the derivative instrument and the item
being hedged must be formally documented at inception,
- the derivative instrument must be highly effective in offsetting the
hedged item's cash flows or changes in fair value, and
- if hedging a forecasted transaction, the forecasted transaction must
be probable.
If a derivative qualifies for cash flow hedge accounting treatment and gains or
losses are recorded in accumulated other comprehensive income, those gains or
losses will be reclassified into earnings in the same period or periods the
hedged forecasted transaction affects earnings. If a cash flow hedge is
terminated early because it is determined that the forecasted transaction will
not occur, any gain or loss recorded in accumulated other comprehensive income
at that date is recognized immediately in earnings. If a cash flow hedge is
terminated early for other economic reasons, any gain or loss as of the
termination date is deferred and then reclassified to earnings when the
forecasted transaction affects earnings. The ineffective portion, if any, of all
hedges is recognized in earnings.
To determine the fair value of our derivatives, we use information from external
sources (i.e., quoted market prices and third-party valuations), if available.
For certain contracts, this information is not available and we use mathematical
valuation models to value our derivatives. These models require various inputs
and assumptions, including commodity market prices and volatilities, as well as
interest rates and contract maturity dates. The cash returns we actually realize
on these contracts may vary, either positively or negatively, from the results
that we estimate using these models. As part of valuing our derivatives at
market, we maintain reserves, if necessary, for credit risks arising from the
financial condition of our counterparties.
CE-51
Consumers Energy Company
The majority of our commodity purchase and sale contracts are not subject to
derivative accounting under SFAS No. 133 because:
- they do not have a notional amount (that is, a number of units
specified in a derivative instrument, such as MW of electricity or
bcf of natural gas),
- they qualify for the normal purchases and sales exception, or
- there is not an active market for the commodity.
Our coal purchase contracts are not derivatives because there is not an active
market for the coal we purchase. Similarly, our electric capacity and energy
contracts are not derivatives due to the lack of an active energy market in
Michigan. If active markets for these commodities develop in the future, some of
these contracts may qualify as derivatives. For our coal purchase contracts, the
resulting mark-to-market impact on earnings could be material. For our electric
capacity and energy contracts, we believe that we would be able to apply the
normal purchases and sales exception, and, therefore, would not be required to
mark these contracts to market.
In 2005, the MISO began operating the Midwest Energy Market. As a result, the
MISO now centrally dispatches electricity and transmission service throughout
much of the Midwest and provides day-ahead and real-time energy market
information. At this time, we believe that the establishment of this market does
not represent the development of an active energy market in Michigan, as defined
by SFAS No. 133. However, as the Midwest Energy Market matures, we will continue
to monitor its activity level and evaluate whether or not an active energy
market may exist in Michigan.
Derivative accounting is required for certain contracts used to limit our
exposure to commodity price risk. The following table summarizes our derivative
instruments:
<Table>
<Caption>
In Millions
-----------------------------------------------------------------------
June 30, 2006 December 31, 2005
------------------------------- ----------------------------------
Fair Unrealized Fair Unrealized
Derivative Instruments Cost Value Gain Cost Value Gain (Loss)
- ---------------------- ---- ----- ---------- ----- ----- -----------
Gas supply option contracts $- $ - $ - $ 1 $ (1) $ (2)
FTRs - 1 1 - 1 1
Derivative contracts associated with the MCV
Partnership:
Long-term gas contracts (a) - 59 59 - 205 205
Gas futures, options, and swaps (a) - 121 121 - 223 223
(a) The fair value of the MCV Partnership's long-term gas contracts and gas
futures, options, and swaps has decreased significantly from December 31, 2005
due to a decrease in natural gas prices since that time. The decrease is partly
also the result of the normal reversal of such derivative assets. As gas has
been purchased under the long-term gas contracts and the gas futures, options,
and swap contracts have been settled, the fair value of the contracts has
decreased.
We record the fair value of our derivative contracts in Derivative instruments,
Other assets, or Other liabilities on our Consolidated Balance Sheets.
GAS SUPPLY OPTION CONTRACTS: Our gas utility business uses fixed-priced
weather-based gas supply call options and fixed-priced gas supply call and put
options to meet our regulatory obligation to provide
CE-52
Consumers Energy Company
gas to our customers at a reasonable and prudent cost. As part of the GCR
process, the mark-to-market gains and losses associated with these options are
reported directly in earnings as part of Other income, and then immediately
reversed out of earnings and recorded on the balance sheet as a regulatory asset
or liability.
FTRs: With the establishment of the Midwest Energy Market, FTRs were
established. FTRs are financial instruments that manage price risk related to
electricity transmission congestion. An FTR entitles its holder to receive
compensation (or, conversely, to remit payment) for congestion-related
transmission charges. FTRs are marked-to-market each quarter, with changes in
fair value reported to earnings as part of Other income.
DERIVATIVE CONTRACTS ASSOCIATED WITH THE MCV PARTNERSHIP: Long-term gas
contracts: The MCV Partnership uses long-term gas contracts to purchase and
manage the cost of the natural gas it needs to generate electricity and steam.
The MCV Partnership believes that certain of these contracts qualify as normal
purchases under SFAS No. 133. Accordingly, we have not recognized these
contracts at fair value on our Consolidated Balance Sheets at June 30, 2006.
The MCV Partnership also holds certain long-term gas contracts that do not
qualify as normal purchases because these contracts contain volume optionality.
In addition, as a result of implementing the RCP in 2005, a significant portion
of long-term gas contracts no longer qualify as normal purchases, because the
gas will not be used to generate electricity or steam. Accordingly, all of these
contracts are accounted for as derivatives, with changes in fair value recorded
in earnings each quarter. For further details on the RCP, see Note 2,
Contingencies, "Other Electric Contingencies - The Midland Cogeneration
Venture."
For the six months ended June 30, 2006, we recorded a $145 million loss, before
considering tax effects and minority interest, associated with the decrease in
fair value of these long-term gas contracts. This loss is included in the total
Fuel costs mark-to-market at the MCV Partnership on our Consolidated Statements
of Income. Because of the volatility of the natural gas market, the MCV
Partnership expects future earnings volatility on these contracts, since gains
and losses will be recorded each quarter. We will continue to record these gains
and losses in our consolidated financial statements until we close the sale of
our interest in the MCV Partnership.
We have recorded derivative assets totaling $59 million associated with the fair
value of long-term gas contracts on our Consolidated Balance Sheets at June 30,
2006. The MCV Partnership expects almost all of these assets, which represent
cumulative net mark-to-market gains, to reverse as losses through earnings
during 2006 and 2007 as the gas is purchased, with the remainder reversing
between 2008 and 2011. As the MCV Partnership recognizes future losses from the
reversal of these derivative assets, we will continue to assume a portion of the
limited partners' share of those losses, in addition to our proportionate share,
but only until we close the sale of our interest in the MCV Partnership.
At the closing of this sale, these assets, which represent cumulative net
mark-to-market gains, will be sold in conjunction with the sale of our interest.
Also at the closing, we will record any additional mark-to-market gains or
losses associated with the long-term gas contracts and recognize the changes in
fair value in earnings. Any such changes in the fair value of these contracts
recognized before the closing will not affect the purchase price of our
ownership interest in the MCV Partnership. After the closing of the sale, we
will no longer record the fair value of these long-term gas contracts on our
Consolidated Balance Sheets and will not be required to recognize gains or
losses related to changes in the fair value of these contracts on our
Consolidated Statements of Income.
For further details on the sale of our interest in the MCV Partnership, see Note
2, Contingencies, "Other Electric Contingencies - The Midland Cogeneration
Venture."
CE-53
Consumers Energy Company
Gas Futures, Options, and Swaps: The MCV Partnership enters into natural gas
futures, options, and over-the-counter swap transactions in order to hedge
against unfavorable changes in the market price of natural gas. The MCV
Partnership uses these financial instruments to:
- ensure an adequate supply of natural gas for the projected
generation and sales of electricity and steam, and
- manage price risk by fixing the price to be paid for natural gas on
some of its long-term gas contracts.
At June 30, 2006, the MCV Partnership held natural gas futures, options, and
swaps. We have recorded a net derivative asset amount of $121 million on our
Consolidated Balance Sheets at June 30, 2006 associated with the fair value of
these contracts. Certain of the futures and swaps qualify for cash flow hedge
accounting and we record our proportionate share of their mark-to-market gains
and losses in Accumulated other comprehensive income. The remaining contracts
are not cash flow hedges and their mark-to-market gains and losses are recorded
to earnings.
Those contracts that qualify as cash flow hedges represent assets of $122
million of the net $121 million derivative assets recorded on our Consolidated
Balance Sheets. We have recorded a cumulative net gain of $39 million, net of
tax and minority interest, in Accumulated other comprehensive income at June 30,
2006, representing our proportionate share of the cash flow hedges held by the
MCV Partnership. If we have not closed the sale of our interest in the MCV
Partnership within the next 12 months, we can expect to reclassify $17 million
of this balance, net of tax and minority interest, as an increase to earnings as
the contracts settle, offsetting the costs of gas purchases. There was no
ineffectiveness associated with any of these cash flow hedges.
The remaining futures, options, and swap contracts, representing derivative
liabilities of $1 million, do not qualify as cash flow hedges. The futures and
swap contracts were previously accounted for as cash flow hedges. Since the RCP
was implemented in 2005, these instruments no longer qualify for cash flow hedge
accounting and we record any changes in their fair value in earnings each
quarter. The MCV Partnership expects almost all of these derivative liabilities
to be realized during 2006 as the contracts settle, with the remainder to be
realized during 2007. For further details on the RCP, see Note 2, Contingencies,
"Other Electric Contingencies - The Midland Cogeneration Venture."
For the six months ended June 30, 2006, we recorded a $53 million loss, before
considering tax effects and minority interest, associated with the decrease in
fair value of these instruments. This loss is included in the total Fuel costs
mark-to-market at the MCV Partnership on our Consolidated Statements of Income.
Because of the volatility of the natural gas market, the MCV Partnership expects
future earnings volatility on these contracts, since gains and losses will be
recorded each quarter. We will continue to record these gains and losses in our
consolidated financial statements until we close the sale of our interest in the
MCV Partnership.
In conjunction with the sale of our interest in the MCV Partnership, all of the
futures, options, and swaps will be sold. At the closing of this sale, we will
record any additional mark-to-market gains or losses associated with these
contracts and recognize the changes in fair value in Accumulated other
comprehensive income or earnings, accordingly. Any such changes in the fair
value of these contracts recognized before the closing will not affect the
purchase price of our ownership interest in the MCV Partnership. Then, for those
futures and swaps that qualify as cash flow hedges, the related balance of net
cumulative gains recorded in Accumulated other comprehensive income will be
reclassified and recognized in earnings. After the sale of these assets, we will
no longer record the fair value of these contracts on our Consolidated Balance
Sheets and will not be required to
CE-54
Consumers Energy Company
recognize gains or losses related to changes in the fair value of these
contracts on our Consolidated Statements of Income. For additional details on
the sale of our interest in the MCV Partnership, see Note 2, Contingencies,
"Other Electric Contingencies -- The Midland Cogeneration Venture."
CREDIT RISK: Our swaps and forward contracts contain credit risk, which is the
risk that counterparties will fail to perform their contractual obligations. We
reduce this risk through established credit policies. For each counterparty, we
assess credit quality by using credit ratings, financial condition, and other
available information. We then establish a credit limit for each counterparty
based upon our evaluation of credit quality. We monitor the degree to which we
are exposed to potential loss under each contract and take remedial action, if
necessary.
The MCV Partnership enters into contracts primarily with companies in the
electric and gas industry. This industry concentration may have an impact on our
exposure to credit risk, either positively or negatively, based on how these
counterparties are affected by similar changes in economic conditions, the
weather, or other conditions. The MCV Partnership typically uses
industry-standard agreements that allow for netting positive and negative
exposures associated with the same counterparty, thereby reducing exposure.
These contracts also typically provide for the parties to demand adequate
assurance of future performance when there are reasonable grounds for doing so.
The following table illustrates our exposure to potential losses at June 30,
2006, if each counterparty within this industry concentration failed to perform
its contractual obligations. This table includes contracts accounted for as
financial instruments. It does not include trade accounts receivable, derivative
contracts that qualify for the normal purchases and sales exception under SFAS
No. 133, or other contracts that are not accounted for as derivatives.
<Table>
<Caption>
In Millions
---------------------------------------------------------------------------------------
Net Exposure Net Exposure
Exposure from Investment from Investment
Before Collateral Net Grade Grade
Collateral (a) Held (b) Exposure Companies (c) Companies (%)
-------------- ---------- -------- --------------- ---------------
MCV Partnership $181 $96 $85 $82 96
</Table>
(a) Exposure is reflected net of payables or derivative liabilities if netting
arrangements exist.
(b) Collateral held includes cash and letters of credit received from
counterparties.
(c) The remaining balance of our net exposure was from independent natural gas
producers/suppliers that do not have published credit ratings.
Based on our credit policies and our current exposures, we do not expect a
material adverse effect on our financial position or future earnings as a result
of counterparty nonperformance.
CE-55
Consumers Energy Company
5: RETIREMENT BENEFITS
We provide retirement benefits to our employees under a number of different
plans, including:
- a non-contributory, defined benefit Pension Plan,
- a cash balance pension plan for certain employees hired between July
1, 2003 and August 31, 2005,
- a DCCP for employees hired on or after September 1, 2005,
- benefits to certain management employees under SERP,
- a defined contribution 401(k) Savings Plan,
- benefits to a select group of management under the EISP, and
- health care and life insurance benefits under OPEB.
Pension Plan: The Pension Plan includes funds for most of our current employees,
our non-utility affiliates, and Panhandle, a former affiliate. The Pension
Plan's assets are not distinguishable by company.
Effective January 11, 2006, the MPSC electric rate order authorized us to
include $33 million of electric pension expense in our electric rates. Due to
the volatility of these particular costs, the order also established a pension
equalization mechanism to track actual costs. If actual pension expenses are
greater than the $33 million included in electric rates, the difference will be
recognized as a regulatory asset for future recovery from customers. If actual
pension expenses are less than the $33 million included in electric rates, the
difference will be recognized as a regulatory liability, and refunded to our
customers. The difference between pension expense allowed in our electric rates
and pension expense under SFAS No. 87 resulted in a net reduction in pension
expense of $2 million for the three months ended June 30, 2006 and $5 million
for the six months ended June 30, 2006. We have established a corresponding
regulatory asset of $5 million.
OPEB: Effective January 11, 2006, the MPSC electric rate order authorized us to
include $28 million of electric OPEB expense in our electric rates. Due to the
volatility of these particular costs, the order also established an OPEB
equalization mechanism to track actual costs. If actual OPEB expenses are
greater than the $28 million included in electric rates, the difference will be
recognized as a regulatory asset for future recovery from our customers. If
actual OPEB expenses are less than the $28 million included in electric rates,
the difference will be recognized as a regulatory liability, and refunded to our
customers. The difference between OPEB expense allowed in our electric rates and
OPEB expense under SFAS No. 106 resulted in a $1 million net reduction in OPEB
expense for the three months and the six months ended June 30, 2006. We have
established a corresponding regulatory asset of $1 million.
CE-56
Consumers Energy Company
Costs: The following table recaps the costs incurred in our retirement benefits
plans:
<Table>
<Caption>
In Millions
---------------------------------------------
Pension
---------------------------------------------
Three Months Ended Six Months Ended
------------------- -------------------
June 30 2006 2005 2006 2005
- --------------------------------------------- ------ ------ ------ ------
Service cost $ 11 $ 14 $ 23 $ 23
Interest expense 20 27 39 45
Expected return on plan assets (20) (35) (40) (58)
Amortization of:
Net loss 10 7 20 14
Prior service cost 2 2 4 3
------ ------ ------ ------
Net periodic cost 23 15 46 27
Regulatory adjustment (2) - (5) -
------ ------ ------ ------
Net periodic cost after regulatory adjustment $ 21 $ 15 $ 41 $ 27
====== ====== ====== ======
<Table>
<Caption>
In Millions
---------------------------------------------
OPEB
---------------------------------------------
Three Months Ended Six Months Ended
------------------- -------------------
June 30 2006 2005 2006 2005
- ------- ------ ------ ------ ------
Service cost $ 6 $ 5 $ 12 $ 10
Interest expense 16 15 32 30
Expected return on plan assets (15) (13) (29) (26)
Amortization of:
Net loss 5 5 10 10
Prior service cost (2) (2) (5) (4)
------ ------ ------ ------
Net periodic cost 10 10 20 20
Regulatory adjustment (1) - (1) -
------ ------ ------ ------
Net periodic cost after regulatory adjustment $ 9 $ 10 $ 19 $ 20
====== ====== ====== ======
SERP: On April 1, 2006, we implemented a Defined Contribution Supplemental
Executive Retirement Plan (DC SERP) and froze further new participation in the
defined benefit SERP. The DC SERP provides promoted and newly hired participants
benefits ranging from 5 to 15 percent of total compensation. The DC SERP
requires a minimum of five years of participation before vesting. Our
contributions to the plan, if any, will be placed in a grantor trust. For the
six months ended June 30, 2006, no contributions were made to the plan.
MCV: The MCV Partnership sponsors defined cost postretirement health care plans
that cover all full-time employees, except key management. Participants in the
postretirement health care plans become eligible for the benefits if they retire
on or after the attainment of age 65 or upon a qualified disability retirement,
or if they have 10 or more years of service and retire at age 55 or older. The
MCV Partnership's net periodic postretirement health care cost for the three
months and six months ended June 30, 2006 and 2005 was less than $1 million.
CE-57
Consumers Energy Company
6: ASSET RETIREMENT OBLIGATIONS
SFAS NO. 143: This standard requires companies to record the fair value of the
cost to remove assets at the end of their useful life, if there is a legal
obligation to remove them. We have legal obligations to remove some of our
assets, including our nuclear plants, at the end of their useful lives.
The fair value of ARO liabilities has been calculated using an expected present
value technique. This technique reflects assumptions such as costs, inflation,
and profit margin that third parties would consider to assume the settlement of
the obligation. Fair value, to the extent possible, should include a market risk
premium for unforeseeable circumstances. No market risk premium was included in
our ARO fair value estimate since a reasonable estimate could not be made. If a
five percent market risk premium were assumed, our ARO liability would increase
by $25 million.
If a reasonable estimate of fair value cannot be made in the period in which the
ARO is incurred, such as for assets with indeterminate lives, the liability is
to be recognized when a reasonable estimate of fair value can be made.
Generally, gas transmission and electric and gas distribution assets have
indeterminate lives. Retirement cash flows cannot be determined and there is a
low probability of a retirement date. Therefore, no liability has been recorded
for these assets or associated obligations related to potential future
abandonment. Also, no liability has been recorded for assets that have
insignificant cumulative disposal costs, such as substation batteries. The
measurement of the ARO liabilities for Palisades and Big Rock include use of
decommissioning studies that largely utilize third-party cost estimates.
FASB INTERPRETATION NO. 47, ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT
OBLIGATIONS: This Interpretation clarified the term "conditional asset
retirement obligation" as used in SFAS No. 143. The term refers to a legal
obligation to perform an asset retirement activity in which the timing and (or)
method of settlement are conditional on a future event. We determined that
abatement of asbestos included in our plant investments qualifies as a
conditional ARO, as defined by FASB Interpretation No. 47.
The following tables describe our assets that have legal obligations to be
removed at the end of their useful life:
<Table>
<Caption>
June 30, 2006 In Millions
- ---------------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
- --------------- ---- ----------------- ----
Palisades - decommission plant site 1972 Palisades nuclear plant $551
Big Rock - decommission plant site 1962 Big Rock nuclear plant 12
JHCampbell intake/discharge water line 1980 Plant intake/discharge water line -
Closure of coal ash disposal areas Various Generating plants coal ash areas -
Closure of wells at gas storage fields Various Gas storage fields -
Indoor gas services equipment relocations Various Gas meters located inside structures -
Asbestos abatement 1973 Electric and gas utility plant -
</Table>
CE-58
Consumers Energy Company
<Table>
<Caption>
In Millions
------------------------------------------------------------------------------
ARO ARO
Liability Cash flow Liability
ARO Description 12/31/05 Incurred Settled (a) Accretion Revisions 6/30/06
- --------------- -------- -------- ----------- --------- --------- -------
Palisades - decommission $375 $ - $- $12 $ - $387
Big Rock - decommission 27 - (15) 2 - 14
JHCampbell intake line - - - - - -
Coal ash disposal areas 54 - (1) 2 - 55
Wells at gas storage fields 1 - - - - 1
Indoor gas services relocations 1 - - - - 1
Asbestos abatement 36 - (2) 1 - 35
---- --- ---- --- --- ----
Total $494 $ - $(18) $17 $ - $493
==== === ==== === === ====
(a) These cash payments are included in the Other current and non-current
liabilities line in Net cash provided by operating activities on our
Consolidated Statements of Cash Flows. Cash payments for the six months ended
June 30, 2005 were $26 million.
In October 2004, the MPSC initiated a generic proceeding to review SFAS No. 143,
FERC Order No. 631, Accounting, Financial Reporting, and Rate Filing
Requirements for Asset Retirement Obligations, and related accounting and
ratemaking issues for MPSC-jurisdictional electric and gas utilities. In
December 2005, the ALJ issued a Proposal for Decision recommending that the MPSC
dismiss the proceeding. In March 2006, the MPSC remanded the case to the ALJ for
findings and recommendations. We consider the proceeding a clarification of
accounting and reporting issues that relate to all Michigan utilities. We cannot
predict the outcome of the proceeding.
7: EXECUTIVE INCENTIVE COMPENSATION
We provide a Performance Incentive Stock Plan (the Plan) to key employees and
non-employee directors based on their contributions to the successful management
of the company. The Plan has a five-year term, expiring in May 2009.
All grants awarded under the Plan for the six months ended June 30, 2006 and in
2005 were in the form of restricted stock. Restricted stock awards are
outstanding shares to which the recipient has full voting and dividend rights
and vest 100 percent after three years of continued employment. Restricted stock
awards granted to officers in 2005 and 2004 are also subject to the achievement
of specified levels of total shareholder return, including a comparison to a
peer group of companies. All restricted stock awards are subject to forfeiture
if employment terminates before vesting. However, if certain minimum service
requirements are met, restricted shares may continue to vest upon retirement or
disability and vest fully if control of CMS Energy changes, as defined by the
Plan.
The Plan also allows for the following types of awards:
- stock options,
- stock appreciation rights,
- phantom shares, and
- performance units.
For the six months ended June 30, 2006 and for the year ended 2005, we did not
grant any of these types of awards.
CE-59
Consumers Energy Company
Select participants may elect to receive all or a portion of their incentive
payments under the Officer's Incentive Compensation Plan in the form of cash,
shares of restricted common stock, shares of restricted stock units, or any
combination of these. These participants may also receive awards of additional
restricted common stock or restricted stock units, provided the total value of
these additional grants does not exceed $2.5 million for any fiscal year.
Shares awarded or subject to stock options, phantom shares, and performance
units may not exceed 6 million shares from June 2004 through May 2009, nor may
such awards to any participant exceed 250,000 shares in any fiscal year. We may
issue awards of up to 4,906,300 shares of common stock under the Plan at June
30, 2006. Shares for which payment or exercise is in cash, as well as shares or
stock options that are forfeited, may be awarded or granted again under the
Plan.
SFAS NO. 123(R) AND SAB NO. 107, SHARE-BASED PAYMENT: SFAS No. 123(R) was
effective for us on January 1, 2006. SFAS No. 123(R) requires companies to use
the fair value of employee stock options and similar awards at the grant date to
value the awards. Companies must expense this value over the required service
period of the awards. As a result, future compensation costs for share-based
awards with accelerated service provisions upon retirement will need to be fully
expensed by the period in which the employee becomes eligible to retire. At
January 1, 2006, unrecognized compensation cost for such share-based awards held
by retirement-eligible employees was not material.
We elected to adopt the modified prospective method recognition provisions of
this Statement instead of retrospective restatement. The modified prospective
method applies the recognition provisions to all awards granted or modified
after the adoption date of this Statement. We adopted the fair value method of
accounting for share-based awards effective December 2002. Therefore, SFAS No.
123(R) did not have a significant impact on our results of operations when it
became effective.
The SEC issued SAB No. 107 to express the views of the staff regarding the
interaction between SFAS No. 123(R) and certain SEC rules and regulations. Also,
the SEC issued SAB No. 107 to provide the staff's views regarding the valuation
of share-based payments, including assumptions such as expected volatility and
expected term. We applied the additional guidance provided by SAB No. 107 upon
implementation of SFAS No. 123(R) with no impact on our consolidated results of
operations.
The following table summarizes restricted stock activity under the Plan:
<Table>
<Caption>
Weighted-
Average Grant
Restricted Stock Number of Shares Date Fair Value
- ---------------- ---------------- ---------------
Nonvested at December 31, 2005 1,141,316 $10.84
Granted 43,330 $12.98
Vested (10,000) $ 6.23
Forfeited - -
--------- ------
Nonvested at June 30, 2006 1,174,646 $10.96
========= ======
</Table>
The total fair value of shares vested was less than $1 million for the six
months ended June 30, 2006 and 2005.
CE-60
Consumers Energy Company
We calculate the fair value of restricted shares granted based on the price of
our common stock on the grant date and expense the fair value over the required
service period. Total compensation cost recognized in income related to
restricted stock was $2 million for the six months ended June 30, 2006 and $1
million for the six months ended June 30, 2005. The total related income tax
benefit recognized in income was $1 million for the six months ended June 30,
2006 and less than $1 million for the six months ended June 30, 2005. At June
30, 2006, there was $7 million of total unrecognized compensation cost related
to restricted stock. We expect to recognize this cost over a weighted-average
period of 2.0 years.
The following table summarizes stock option activity under the Plan:
<Table>
<Caption>
Weighted-
Options Weighted- Average Aggregate
Outstanding, Average Remaining Intrinsic
Fully Vested, Exercise Contractual Value
Stock Options and Exercisable Price Term (In Millions)
- ------------- --------------- --------- ----------- -------------
Outstanding at December 31, 2005 1,714,787 $18.13 5.9 years $ (6)
Granted - -
Exercised (14,000) 6.35
Cancelled or Expired - -
--------- ------ --------- ----
Outstanding at June 30, 2006 1,700,787 $18.22 5.4 years $ (9)
========= ====== ========= ====
</Table>
Stock options give the holder the right to purchase common stock at a price
equal to the fair value of our common stock on the grant date. Stock options are
exercisable upon grant, and expire up to 10 years and one month from the grant
date. We issue new shares when participants exercise stock options. The total
intrinsic value of stock options exercised was less than $1 million for the six
months ended June 30, 2006 and $1 million for the six months ended June 30,
2005. Cash received from exercise of these stock options was less than $1
million for the six months ended June 30, 2006 and $1 million for the six months
ended June 30, 2005. Since we have utilized tax loss carryforwards, we were not
able to realize the excess tax benefits upon exercise of stock options.
Therefore, we did not recognize the related excess tax benefits in equity.
CE-61
Consumers Energy Company
8: REPORTABLE SEGMENTS
Our reportable segments are strategic business units organized and managed by
the nature of the products and services each provides. We evaluate performance
based upon the net income of each segment. We operate principally in two
segments: electric utility and gas utility.
The following table shows our financial information by reportable segment:
<Table>
<Caption>
In Millions
------------------------------------------------
Three Months Ended Six Months Ended
-------------------- ---------------------
June 30 2006 2005 2006 2005
- ------- ---- ---- ---- ----
Operating revenue
Electric $ 791 $ 649 $ 1,520 $ 1,277
Gas 334 355 1,375 1,347
Other 13 12 25 24
------- ------- ------- -------
Total Operating Revenue $ 1,138 $ 1,016 $ 2,920 $ 2,648
======= ======= ======= =======
Net income available to common stockholder
Electric $ 37 $46 $ 66 $79
Gas (3) (3) 34 55
Other 1 (11) (55) 55
------- ------- ------- -------
Total Net Income Available to Common Stockholder $ 35 $ 32 $ 45 $ 189
======= ======= ======= =======
</Table>
<Table>
<Caption>
In Millions
-----------------------------------------
June 30, 2006 December 31, 2005
------------- -----------------
Assets
Electric (a) $ 7,925 $7,743
Gas (a) 3,503 3,600
Other 1,560 1,814
-------- --------
Total Assets $ 12,988 $ 13,157
======== ========
</Table>
(a) Amounts include a portion of our other common assets attributable to both
the electric and gas utility businesses.
CE-62
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CMS ENERGY
Quantitative and Qualitative Disclosures about Market Risk is contained in PART
I: CMS Energy Corporation's Management's Discussion and Analysis, which is
incorporated by reference herein.
CONSUMERS
Quantitative and Qualitative Disclosures about Market Risk is contained in PART
I: Consumers Energy Company's Management's Discussion and Analysis, which is
incorporated by reference herein.
ITEM 4. CONTROLS AND PROCEDURES
CMS ENERGY
Disclosure Controls and Procedures: CMS Energy's management, with the
participation of its CEO and CFO, has evaluated the effectiveness of its
disclosure controls and procedures (as such term is defined in Rules 13a-15(e)
and 15d-15(e) under the Exchange Act) as of the end of the period covered by
this report. Based on such evaluation, CMS Energy's CEO and CFO have concluded
that, due to the fact that the material weakness in CMS Energy's internal
control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) identified in its 2005 Form 10-K, has not had adequate
testing to confirm evidence of remediation, its disclosure controls and
procedures were not effective at June 30, 2006.
Management continues to validate the remedial actions it has taken to correct
the income tax-related material weakness identified in CMS Energy's 2005 Form
10-K. Management believes it has implemented the necessary processes and
procedures to overcome the material weakness relating to income taxes; however,
these processes and procedures, and correlating controls, have not been in place
for an adequate period of time to conclude that the material weakness has been
remediated at June 30, 2006. Management will continue to monitor and test the
continuous effectiveness of these controls and procedures and make appropriate
modifications, as necessary.
Management believes that the consolidated financial statements included in this
Form 10-Q fairly present, in all material respects, CMS Energy's financial
condition, results of operations and cash flows for the periods presented.
Internal Control Over Financial Reporting: There have not been any changes in
CMS Energy's internal control over financial reporting (as such term is defined
in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal
quarter that have materially affected, or are reasonably likely to materially
affect, its internal control over financial reporting.
CONSUMERS
Disclosure Controls and Procedures: Consumers' management, with the
participation of its CEO and CFO, has evaluated the effectiveness of its
disclosure controls and procedures (as such term is defined in Rules 13a-15(e)
and 15d-15(e) under the Exchange Act) as of the end of the period covered by
this report. Based on such evaluation, Consumers' CEO and CFO have concluded
that, as of the end of such period, its disclosure controls and procedures are
effective.
CO-1
Internal Control Over Financial Reporting: There have not been any changes in
Consumers' internal control over financial reporting (as such term is defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal
quarter that have materially affected, or are reasonably likely to materially
affect, its internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The discussion below is limited to an update of developments that have occurred
in various judicial and administrative proceedings, many of which are more fully
described in CMS Energy's Form 10-K/A Amendment No. 1 and Consumers' Form 10-K
for the year ended December 31, 2005 and Forms 10-Q for the quarter ended March
31, 2006. Reference is also made to the CONDENSED NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS, in particular, Note 2, Contingencies, for CMS Energy and
Note 2, Contingencies, for Consumers, included herein for additional information
regarding various pending administrative and judicial proceedings involving
rate, operating, regulatory and environmental matters.
CMS ENERGY
SEC REQUEST
On August 5, 2004, CMS Energy received a request from the SEC that CMS Energy
voluntarily produce documents and data relating to the SEC's inquiry into
payments made to the officials or relatives of officials of the government of
Equatorial Guinea. On August 17, 2004, CMS Energy submitted its response,
advising the SEC of the information and documentation it had available. On March
8, 2005, CMS Energy received a request from the SEC that CMS Energy voluntarily
produce certain of such documents. CMS Energy has provided responsive documents
to the SEC and will continue to provide such documents as it reviews its
electronic records in further response to the SEC's request. The SEC
subsequently issued a formal order of private investigation on this matter on
August 1, 2005. CMS Energy and several other companies who have conducted
business in Equatorial Guinea received subpoenas from the SEC to provide
documents regarding payments made to officials or relatives of officials of the
government of Equatorial Guinea. CMS Energy is cooperating and has been and will
continue to produce documents responsive to the subpoena.
GAS INDEX PRICE REPORTING LITIGATION
CMS MST and CMS Field Services (which was sold to Cantera Natural Gas, LLC and
for which CMS Energy has indemnification obligations) were defendants in a
consolidated class action lawsuit filed in the United States District Court for
the Southern District of New York. Cornerstone Propane Partners, L.P. filed the
original complaint in August 2003 as a putative class action and it was later
consolidated with two similar complaints filed by other plaintiffs. The amended
consolidated complaint, filed in January 2004, alleged that false natural gas
price reporting by the defendants manipulated the prices of NYMEX natural gas
futures and options. The complaint contained two counts under the Commodity
Exchange Act, one for manipulation and one for aiding and abetting violations.
On May 24, 2006, the judge entered a Final Judgment and Order of Dismissal
approving settlements between plaintiffs and various defendants, including CMS
MST and CMS Field Services. The settlement agreement required a $6.975 million
cash payment that CMS MST was responsible to pay. The payment was made into a
settlement fund that will be used to pay the class members as well as any legal
fees awarded to plaintiffs' attorneys. CMS Energy had established a reserve for
this amount in the fourth quarter of 2005.
CO-2
In a similar but unrelated matter, Texas-Ohio Energy, Inc. filed a putative
class action lawsuit in the United States District Court for the Eastern
District of California in November 2003 against a number of energy companies
engaged in the sale of natural gas in the United States (including CMS Energy).
The complaint alleged defendants entered into a price-fixing scheme by engaging
in activities to manipulate the price of natural gas in California. The
complaint alleged violations of the federal Sherman Act, the California
Cartwright Act, and the California Business and Professions Code relating to
unlawful, unfair and deceptive business practices. The complaint sought both
actual and exemplary damages for alleged overcharges, attorneys fees and
injunctive relief regulating defendants' future conduct relating to pricing and
price reporting. In April 2004, a Nevada Multidistrict Litigation (MDL) Panel
ordered the transfer of the Texas-Ohio case to a pending MDL matter in the
Nevada federal district court that at the time involved seven complaints
originally filed in various state courts in California. These complaints make
allegations similar to those in the Texas-Ohio case regarding price reporting,
although none contain a federal Sherman Act claim. In November 2004, those seven
complaints, as well as a number of others that were originally filed in various
state courts in California and subsequently transferred to the MDL proceeding,
were remanded back to California state court. The Texas-Ohio case remained in
Nevada federal district court, and defendants, with CMS Energy joining, filed a
motion to dismiss. The court issued an order granting the motion to dismiss on
April 8, 2005 and entered a judgment in favor of the defendants on April 11,
2005. Texas-Ohio has appealed the dismissal to the Ninth Circuit Court of
Appeals.
Three federal putative class actions, Fairhaven Power Company v. Encana Corp. et
al., Utility Savings & Refund Services LLP v. Reliant Energy Resources Inc. et
al., and Abelman Art Glass v. Encana Corp. et al., all of which make allegations
similar to those in the Texas-Ohio case regarding price manipulation and seek
similar relief, were originally filed in the United States District Court for
the Eastern District of California in September 2004, November 2004 and December
2004, respectively. The Fairhaven and Abelman Art Glass cases also include
claims for unjust enrichment and a constructive trust. The three complaints were
filed against CMS Energy and many of the other defendants named in the
Texas-Ohio case. In addition, the Utility Savings case names CMS MST and Cantera
Resources Inc. (Cantera Resources Inc. is the parent of Cantera Natural Gas,
LLC. and CMS Energy is required to indemnify Cantera Natural Gas, LLC and
Cantera Resources Inc. with respect to these actions.)
The Fairhaven, Utility Savings and Abelman Art Glass cases have been transferred
to the MDL proceeding, where the Texas-Ohio case was pending. Pursuant to
stipulation by the parties and court order, defendants were not required to
respond to the Fairhaven, Utility Savings and Abelman Art Glass complaints until
the court ruled on defendants' motion to dismiss in the Texas-Ohio case.
Plaintiffs subsequently filed a consolidated class action complaint alleging
violations of federal and California antitrust laws. Defendants filed a motion
to dismiss, arguing that the consolidated complaint should be dismissed for the
same reasons as the Texas-Ohio case. The court issued an order granting the
motion to dismiss on December 19, 2005 and entered judgment in favor of
defendants on December 23, 2005. Plaintiffs have appealed the dismissal to the
Ninth Circuit Court of Appeals.
Commencing in or about February 2004, 15 state law complaints containing
allegations similar to those made in the Texas-Ohio case, but generally limited
to the California Cartwright Act and unjust enrichment, were filed in various
California state courts against many of the same defendants named in the federal
price manipulation cases discussed above. In addition to CMS Energy, CMS MST is
named in all of the 15 state law complaints. Cantera Gas Company and Cantera
Natural Gas, LLC (erroneously sued as Cantera Natural Gas, Inc.) are named in
all but one complaint.
In February 2005, these 15 separate actions, as well as nine other similar
actions that were filed in California state court but do not name CMS Energy or
any of its former or current subsidiaries, were ordered coordinated with pending
coordinated proceedings in the San Diego Superior Court. The 24 state
CO-3
court complaints involving price reporting were coordinated as Natural Gas
Antitrust Cases V. Plaintiffs in Natural Gas Antitrust Cases V were ordered to
file a consolidated complaint, but a consolidated complaint was filed only for
the two putative class action lawsuits. On April 8, 2005, defendants filed a
demurrer to the master class action complaint and the individual complaints and
on May 13, 2005, plaintiffs filed a memorandum of points and authorities in
opposition to defendants' federal preemption demurrer and motion to strike.
Pursuant to a ruling dated June 29, 2005, the demurrer was overruled and the
motion to strike was denied.
Samuel D. Leggett, et al v. Duke Energy Corporation, et al, a class action
complaint brought on behalf of retail and business purchasers of natural gas in
Tennessee, was filed in the Chancery Court of Fayette County, Tennessee in
January 2005. The complaint contains claims for violations of the Tennessee
Trade Practices Act based upon allegations of false reporting of price
information by defendants to publications that compile and publish indices of
natural gas prices for various natural gas hubs. The complaint seeks statutory
full consideration damages and attorneys fees and injunctive relief regulating
defendants' future conduct. The defendants include CMS Energy, CMS MST and CMS
Field Services. On August 10, 2005, certain defendants, including CMS MST, filed
a motion to dismiss and CMS Energy and CMS Field Services filed a motion to
dismiss for lack of personal jurisdiction. Defendants attempted to remove the
case to federal court, but it was remanded to state court by a federal judge.
Plaintiffs have opposed the motions to dismiss and they remain pending.
On November 20, 2005, CMS MST was served with a summons and complaint which
named CMS Energy, CMS MST and CMS Field Services as defendants in a new putative
class action filed in Kansas state court, Learjet, Inc., et al. v. Oneok, Inc.,
et al. Similar to the other actions that have been filed, the complaint alleges
that during the putative class period, January 1, 2000 through October 31, 2002,
defendants engaged in a scheme to violate the Kansas Restraint of Trade Act by
knowingly reporting false or inaccurate information to the publications, thereby
affecting the market price of natural gas. Plaintiffs, who allege they purchased
natural gas from defendants and others for their facilities, are seeking
statutory full consideration damages consisting of the full consideration paid
by plaintiffs for natural gas. On December 7, 2005, the case was removed to the
United States District Court for the District of Kansas and later that month a
motion was filed to transfer the case to the MDL proceeding. On January 6, 2006,
plaintiffs filed a motion to remand the case to Kansas state court. On January
23, 2006, a conditional transfer order transferring the case to the MDL
proceeding was issued. On February 7, 2006, plaintiffs filed an opposition to
the conditional transfer order.
Breckenridge Brewery of Colorado, LLC and BBD Acquisition Co. v. Oneok, Inc., et
al., a class action complaint brought on behalf of retail direct purchasers of
natural gas in Colorado, was filed in Colorado state court in May 2006.
Defendants, including CMS Energy, CMS Field Services, and CMS MST are alleged to
have violated the Colorado Antitrust Act of 1992 in connection with their
natural gas price reporting activities. Plaintiffs are seeking full refund
damages.
CMS Energy and the other CMS defendants will defend themselves vigorously
against these matters but cannot predict their outcome.
CMS ENERGY AND CONSUMERS
SECURITIES CLASS ACTION LAWSUITS
Beginning on May 17, 2002, a number of complaints were filed against CMS Energy,
Consumers, and certain officers and directors of CMS Energy and its affiliates.
The cases were consolidated into a single lawsuit, which generally seeks
unspecified damages based on allegations that the defendants violated United
States securities laws and regulations by making allegedly false and misleading
statements about
CO-4
CMS Energy's business and financial condition, particularly with respect to
revenues and expenses recorded in connection with round-trip trading by CMS MST.
In January 2005, the court granted a motion to dismiss Consumers and three of
the individual defendants, but denied the motions to dismiss CMS Energy and the
13 remaining individual defendants. The court issued an opinion and order dated
March 24, 2006, granting in part and denying in part plaintiffs' amended motion
for class certification. The court conditionally certified a class consisting of
"all persons who purchased CMS Common Stock during the period of October 25,
2000 through and including May 17, 2002 and who were damaged thereby." The court
excluded purchasers of CMS Energy's 8.75 percent Adjustable Convertible Trust
Securities ("ACTS") from the class. Trial has been scheduled for March 2007. In
response to the court's opinion and order excluding purchasers of ACTS from the
shareholder class, a new class action lawsuit was filed on behalf of ACTS
purchasers. The new lawsuit names the same defendants as the shareholder action
and contains essentially the same allegations and class period. CMS Energy and
the individual defendants will defend themselves vigorously in this litigation
but cannot predict its outcome.
ERISA LAWSUITS
CMS Energy was a named defendant, along with Consumers, CMS MST, and certain
named and unnamed officers and directors, in two lawsuits, filed in July 2002 in
United States District Court for the Eastern District of Michigan, brought as
purported class actions on behalf of participants and beneficiaries of the CMS
Employees' Savings Plan (the Plan). Plaintiffs alleged breaches of fiduciary
duties under ERISA and sought restitution on behalf of the Plan with respect to
a decline in value of the shares of CMS Energy Common Stock held in the Plan, as
well as other equitable relief and legal fees. On March 1, 2006, CMS Energy and
Consumers reached an agreement, subject to court and independent fiduciary
approval, to settle the lawsuits. The settlement agreement required a $28
million cash payment by CMS Energy's primary insurer to be used to pay Plan
participants and beneficiaries for alleged losses, as well as any legal fees and
expenses. In addition, CMS Energy agreed to certain other steps regarding
administration of the Plan. The hearing on final approval of the settlement was
held on June 15, 2006. On June 27, 2006, the judge entered the Order and Final
Judgment, approving the proposed settlement with minor modifications.
ENVIRONMENTAL MATTERS
CMS Energy, Consumers and their subsidiaries and affiliates are subject to
various federal, state and local laws and regulations relating to the
environment. Several of these companies have been named parties to various
actions involving environmental issues. Based on their present knowledge and
subject to future legal and factual developments, CMS Energy and Consumers
believe that it is unlikely that these actions, individually or in total, will
have a material adverse effect on their financial condition. See CMS Energy's
and Consumers' MANAGEMENT'S DISCUSSION AND ANALYSIS and CMS Energy's and
Consumers' CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
ITEM 1A. RISK FACTORS
Other than discussed below, there have been no material changes to the Risk
Factors as previously disclosed in CMS Energy's Form 10-K/A Amendment No. 1 and
Consumers' Form 10-K for the year ended December 31, 2005 and CMS Energy's and
Consumers' Forms 10-Q for the quarter ended March 31, 2006.
CO-5
RISKS RELATED TO CMS ENERGY
CMS ENERGY'S NATURAL GAS PIPELINE AND ELECTRIC GENERATION PROJECT LOCATED IN
ARGENTINA AND CHILE MAY BE NEGATIVELY IMPACTED BY ARGENTINE GOVERNMENTAL
RESTRICTIONS PLACED ON NATURAL GAS EXPORTS TO CHILE.
On March 24, 2004, the Argentine government authorized the restriction of
exports of natural gas to Chile, giving priority to domestic demand in
Argentina. This restriction has had a detrimental effect on GasAtacama's
earnings since GasAtacama's gas-fired electric generating plant is located in
Chile and uses Argentine gas for fuel. From April through December 2004,
Bolivia agreed to export 4 million cubic meters of gas per day to Argentina,
which allowed Argentina to minimize its curtailments to Chile. Argentina and
Bolivia extended the term of that agreement through December 31, 2006. With the
Bolivian gas supply, Argentina relaxed its export restrictions to GasAtacama,
allowing GasAtacama to receive approximately 50 percent of its contracted gas
quantities at its electric generating plant.
On May 1, 2006, the Bolivian government announced its intention to nationalize
the natural gas industry and raise prices under its existing gas export
contracts. Since May, gas flow from Bolivia has been restricted as Argentina and
Bolivia have been renegotiating the price for gas. Simultaneously, gas supply to
GasAtacama has been further curtailed. In July 2006, Argentina agreed to
increase the price it pays for gas from Bolivia through the term of the existing
contract, December 31, 2006. Concurrently, Argentina announced that it would
recover all of this price increase by a special tax on its gas exports. The
decision of Argentina to pass all of these increased costs to exports in
addition to maintaining the current curtailment scheme, has increased the risk
and cost of GasAtacama's fuel supply. CMS Energy is analyzing this situation to
determine what effect these actions may have on the value of its investment in
GasAtacama, but at this time cannot determine the effect. If an appropriate
resolution of this issue is not reached, it could result in an impairment of our
investment in GasAtacama. At June 30, 2006, the carrying value of CMS Energy's
investment in GasAtacama was $361 million.
RISKS RELATED TO CMS ENERGY AND CONSUMERS
CMS ENERGY AND CONSUMERS MAY BE NEGATIVELY IMPACTED BY THE RESULTS OF AN
EMPLOYEE BENEFIT LAWSUIT.
CMS Energy was a named defendant, along with Consumers, CMS MST, and certain
named and unnamed officers and directors, in two lawsuits, filed in July 2002 in
United States District Court for the Eastern District of Michigan, brought as
purported class actions on behalf of participants and beneficiaries of the CMS
Employees' Savings Plan (the Plan). Plaintiffs alleged breaches of fiduciary
duties under ERISA and sought restitution on behalf of the Plan with respect to
a decline in value of the shares of CMS Energy Common Stock held in the Plan, as
well as other equitable relief and legal fees. On March 1, 2006, CMS Energy and
Consumers reached an agreement, subject to court and independent fiduciary
approval, to settle the lawsuits. The settlement agreement required a $28
million cash payment by CMS Energy's primary insurer to be used to pay Plan
participants and beneficiaries for alleged losses, as well as any legal fees and
expenses. In addition, CMS Energy agreed to certain other steps regarding
administration of the Plan. The hearing on final approval of the settlement was
held on June 15, 2006. On June 27, 2006, the judge entered the Order and Final
Judgment, approving the proposed settlement with minor modifications. With the
conclusion of this matter, there is no further risk to CMS Energy and Consumers.
CONSUMERS' OWNERSHIP OF A NUCLEAR GENERATING FACILITY CREATES RISK RELATING
TO NUCLEAR ENERGY.
Consumers owns the Palisades nuclear power plant and is, therefore, subject
to the risks of nuclear generation, including the risks associated with the
operation of plant facilities and the storage and disposal
CO-6
of spent fuel and other radioactive waste. The NRC has broad authority under
federal law to impose licensing and safety-related requirements for the
operation of nuclear generation facilities. In the event of non-compliance, the
NRC has the authority to impose fines or shut down a unit, or both, depending
upon its assessment of the severity of the situation, until compliance is
achieved. In addition, if a serious nuclear incident were to occur at Consumers'
plant, it could harm Consumers' results of operations and financial condition. A
major incident at a nuclear facility anywhere in the world could cause the NRC
to limit or prohibit the operation or licensing of any domestic nuclear unit.
In July 2006, Consumers reached an agreement to sell the Palisades nuclear
plant to Entergy for $380 million. Consumers also signed a 15-year power
purchase agreement for 100 percent of the plant's current electric output. We
are targeting to close the sale in the first quarter of 2007. The sale will
result in an immediate reduction in our nuclear operating and decommissioning
risk.
CONSUMERS CURRENTLY UNDERRECOVERS IN ITS RATES ITS PAYMENTS TO THE MCV
PARTNERSHIP FOR CAPACITY AND ENERGY, AND IS ALSO EXPOSED TO FUTURE CHANGES IN
THE MCV PARTNERSHIP'S FINANCIAL CONDITION THROUGH ITS EQUITY AND LESSOR
INVESTMENTS.
The MCV Partnership, which leases and operates the MCV Facility, contracted
to sell electricity to Consumers for a 35-year period beginning in 1990. We hold
a 49 percent partnership interest in the MCV Partnership, and a 35 percent
lessor interest in the MCV Facility.
Under the MCV PPA, variable energy payments to the MCV Partnership are based on
the cost of coal burned at our coal plants and our operation and maintenance
expenses. However, the MCV Partnership's costs of producing electricity are tied
to the cost of natural gas. Historically high natural gas prices have caused the
MCV Partnership to reevaluate the economics of operating the MCV Facility and to
record an impairment charge in 2005. If natural gas prices remain at present
levels or increase, the operations of the MCV Facility would be adversely
affected and could result in the MCV Partnership failing to meet its obligations
under the sale and leaseback transactions and other contracts. We are evaluating
various alternatives in order to develop a new long-term strategy with respect
to the MCV Facility.
Further, the cost that we incur under the MCV PPA exceeds the recovery
amount allowed by the MPSC. As a result, we estimate cash underrecoveries of
capacity and fixed energy payments of $55 million in 2006 and $39 million in
2007. However, Consumers' direct savings from the RCP, after allocating a
portion to customers, are used to offset a portion of our capacity and fixed
energy underrecoveries expense. After September 15, 2007, we expect to claim
relief under the regulatory out provision in the MCV PPA, thereby limiting our
capacity and fixed energy payments to the MCV Partnership to the amounts that we
collect from our customers. The effect of any such action would be to reduce
cash flow to the MCV Partnership, which could have an adverse effect on the MCV
Partnership's financial performance, and eliminate our underrecoveries of
capacity and fixed energy payments.
The MCV Partnership has indicated that it may take issue with our exercise
of the regulatory out clause after September 15, 2007. We believe that the
clause is valid and fully effective, but cannot assure that it will prevail in
the event of a dispute. If we are successful in exercising the regulatory out
clause, the MCV Partnership has the right to terminate the MCV PPA. The MPSC's
future actions on the capacity and fixed energy payments recoverable from
customers subsequent to September 15, 2007 may affect negatively the financial
performance of the MCV Partnership.
In January 2005, Consumers implemented the RCP. The underlying agreement for
the RCP between Consumers and the MCV Partnership extends through the term of
the MCV PPA. However, either party may terminate that agreement under certain
conditions. In February 2005, a group of intervenors in the
CO-7
RCP case filed for rehearing of the MPSC order approving the RCP. The Attorney
General also filed an appeal with the Michigan Court of Appeals. Consumers
cannot predict the outcome of these matters.
CMS Energy and Consumers cannot estimate, at this time, the impact of these
issues on Consumers' future earnings or cash flow from its interest in the MCV
Partnership. The ability to develop a new long-term strategy with respect to the
MCV Facility, the future price of natural gas and an MPSC decision related to
Consumers' recovery of capacity payments are the three most significant
variables in the analysis of the MCV Partnership's future financial performance.
It is not presently possible to predict the future price of natural gas, or the
actions of the MPSC in 2007 or later. For these reasons, at this time CMS Energy
and Consumers cannot predict the impact of these issues on Consumers' future
earnings or cash flows or on the value of its equity interest in the MCV
Partnership and CMS Energy's lessor interest in the FMLP.
In July 2006, we reached an agreement to sell 100 percent of the stock of
CMS Midland, Inc. and CMS Midland Holdings Company to an affiliate of GSO
Capital Partners and Rockland Capital Energy Investments for $60.5 million.
These Consumers' subsidiaries hold our interest in the MCV Partnership and the
FMLP. We are targeting to close on the sale by the end of 2006. The sale will
result in reduced exposure to sustained high natural gas prices.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the CMS Energy Annual Meeting of Shareholders held on May 19, 2006, the CMS
Energy shareholders voted upon two proposals, as follows:
o Ratification of the appointment of Ernst & Young LLP as the independent
registered public accounting firm to audit CMS Energy's financial
statements for the year ending December 31, 2006, with a vote of
185,968,036 shares in favor, 807,698 against and 1,369,527 abstentions;
and
o Election of eleven members to the Board of Directors. The votes for
individual nominees were as follows:
CMS ENERGY
Number of Votes: For Withheld Total
- -------------------------------------------------------------------------------------------------
Merribel S. Ayres 183,831,106 4,316,601 188,147,707
Jon E. Barfield 182,673,024 5,474,683 188,147,707
Richard M. Gabrys 183,863,009 4,284,698 188,147,707
David W. Joos 182,597,983 5,549,724 188,147,707
Philip R. Lochner, Jr. 182,245,636 5,902,071 188,147,707
Michael T. Monahan 180,418,128 7,729,579 188,147,707
Joseph F. Paquette, Jr. 181,141,145 7,006,562 188,147,707
Percy A. Pierre 181,914,512 6,233,195 188,147,707
Kenneth L. Way 181,075,586 7,072,121 188,147,707
Kenneth Whipple 182,847,974 5,299,733 188,147,707
John B. Yasinsky 181,992,749 6,154,958 188,147,707
CO-8
CONSUMERS
Consumers did not solicit proxies for the matters submitted to votes at the
contemporaneous May 19, 2006 Consumers' Annual Meeting of Shareholders. All
84,108,789 shares of Consumers Common Stock were voted in favor of electing the
above-named individuals as directors of Consumers and in favor of the remaining
proposals for Consumers. None of the 441,599 shares of Consumers Preferred Stock
were voted at the Annual Meeting.
ITEM 5. OTHER INFORMATION
A shareholder who wishes to submit a proposal for consideration at the CMS
Energy 2007 Annual Meeting pursuant to the applicable rules of the SEC must send
the proposal to reach CMS Energy's Corporate Secretary on or before December 15,
2006. In any event, if CMS Energy has not received written notice of any matter
to be proposed at that meeting by February 28, 2007, the holders of proxies may
use their discretionary voting authority on such matter. The proposals should be
addressed to: Corporate Secretary, CMS Energy Corporation, One Energy Plaza,
Jackson, MI 49201.
ITEM 6. EXHIBITS
(10)(a) Asset Sale Agreement dated as of July 11, 2006 by and among
Consumers Energy Company as Seller and Entergy Nuclear Palisades,
LLC as Buyer
(10)(b) Palisades Nuclear Power Plant Power Purchase Agreement dated as of
July 11, 2006 between Entergy Nuclear Palisades, LLC and Consumers
Energy Company
(10)(c) Stock Purchase Agreement dated as of July 24, 2006 by and among
Consumers Energy Company, CMS Midland, Inc., CMS Midland Holdings
Company, and MCV Power Partners, Inc.
(31)(a) CMS Energy Corporation's certification of the CEO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(b) CMS Energy Corporation's certification of the CFO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(c) Consumers Energy Company's certification of the CEO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(d) Consumers Energy Company's certification of the CFO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(32)(a) CMS Energy Corporation's certifications pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
CO-9
(32)(b) Consumers Energy Company's certifications pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
CO-10
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, each
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. The signature for each undersigned
company shall be deemed to relate only to matters having reference to such
company or its subsidiary.
CMS ENERGY CORPORATION
(Registrant)
Dated: August 4, 2006 By: /s/ Thomas J. Webb
-------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
CONSUMERS ENERGY COMPANY
(Registrant)
Dated: August 4, 2006 By: /s/ Thomas J. Webb
-------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
CO-11
CMS ENERGY AND CONSUMERS EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
(10)(a) Asset Sale Agreement dated as of July 11, 2006 by and among
Consumers Energy Company as Seller and Entergy Nuclear Palisades,
LLC as Buyer
(10)(b) Palisades Nuclear Power Plant Power Purchase Agreement dated as of
July 11, 2006 between Entergy Nuclear Palisades, LLC and Consumers
Energy Company
(10)(c) Stock Purchase Agreement dated as of July 24, 2006 by and among
Consumers Energy Company, CMS Midland, Inc., CMS Midland Holdings
Company, and MCV Power Partners, Inc.
(31)(a) CMS Energy Corporation's certification of the CEO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(b) CMS Energy Corporation's certification of the CFO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(c) Consumers Energy Company's certification of the CEO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(31)(d) Consumers Energy Company's certification of the CFO pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
(32)(a) CMS Energy Corporation's certifications pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
(32)(b) Consumers Energy Company's certifications pursuant to Section 906
of the Sarbanes-Oxley Act of 2002