-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BVIpsrnSkUjjmIajoOFj6cfCwoFyU1r14MsC4EzuA5sKZP6rnZoRzE5EssTQwq+n mK9GMy9VXOUQ4RkGi9VGWw== 0000201533-98-000107.txt : 19981116 0000201533-98-000107.hdr.sgml : 19981116 ACCESSION NUMBER: 0000201533-98-000107 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONSUMERS ENERGY CO CENTRAL INDEX KEY: 0000201533 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC & OTHER SERVICES COMBINED [4931] IRS NUMBER: 380442310 STATE OF INCORPORATION: MI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-05611 FILM NUMBER: 98749201 BUSINESS ADDRESS: STREET 1: 212 W MICHIGAN AVE CITY: JACKSON STATE: MI ZIP: 49201 BUSINESS PHONE: 5177880550 MAIL ADDRESS: STREET 1: 212 W MICHIGAN AVE STREET 2: M 946 CITY: JACKSON STATE: MI ZIP: 49201 FORMER COMPANY: FORMER CONFORMED NAME: CONSUMERS POWER CO DATE OF NAME CHANGE: 19920703 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CMS ENERGY CORP CENTRAL INDEX KEY: 0000811156 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC & OTHER SERVICES COMBINED [4931] IRS NUMBER: 382726431 STATE OF INCORPORATION: MI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-09513 FILM NUMBER: 98749202 BUSINESS ADDRESS: STREET 1: FAIRLANE PLZ SOUTH STE 1100 STREET 2: 330 TOWN CENTER DR CITY: DEARBORN STATE: MI ZIP: 48126 BUSINESS PHONE: 3134369200 MAIL ADDRESS: STREET 1: FAIRLANE PLAZA SOUTH, SUITE 1100 STREET 2: 330 TOWN CENTER DRIVE CITY: DEARBORN STATE: MI ZIP: 48126 10-Q 1 BODY OF 3RD QTR FORM 10-Q 1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 [ X ]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 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) Fairlane Plaza South, Suite 1100 330 Town Center Drive, Dearborn, Michigan 48126 (313)436-9200 1-5611 CONSUMERS ENERGY COMPANY 38-0442310 (A Michigan Corporation) 212 West Michigan Avenue,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 Number of shares outstanding of each of the issuer's classes of common stock at October 31, 1998: CMS Energy Corporation: CMS Energy Common Stock, $.01 par value 103,437,840 CMS Energy Class G Common Stock, no par value 8,411,559 Consumers Energy Company, $10 par value, privately held by CMS Energy 84,108,789 CMS Energy Corporation and Consumers Energy Company Quarterly reports on Form 10-Q to the Securities and Exchange Commission for the Quarter Ended September 30, 1998 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 PART I: CMS Energy Corporation Management's Discussion and Analysis 8 Consolidated Statements of Income 25 Consolidated Balance Sheets 27 Consolidated Statements of Cash Flows 29 Consolidated Statements of Common Stockholders' Equity 30 Condensed Notes to Consolidated Financial Statements 31 Report of Independent Public Accountants 48 Consumers Energy Company Management's Discussion and Analysis 50 Consolidated Statements of Income 60 Consolidated Statements of Cash Flows 61 Consolidated Balance Sheets 63 Consolidated Statements of Common Stockholder's Equity 65 Condensed Notes to Consolidated Financial Statements 66 Report of Independent Public Accountants 77 Quantitative and Qualitative Disclosures about Market Risk 78 PART II: Item 1. Legal Proceedings 78 Item 6. Exhibits and Reports on Form 8-K 79 Signatures 80 3 GLOSSARY Certain terms used in the text and financial statements are defined below. ABATE . . . . . . . . . . . . . . . . . . . Association of Businesses Advocating Tariff Equity ALJ . . . . . . . . . . . . . . . . . . . . Administrative Law Judge Ames. . . . . . . . . . . . . . . . . . . . Crescent and Ames gas gathering systems and processing plant in Oklahoma Articles. . . . . . . . . . . . . . . . . . Articles of Incorporation Attorney General. . . . . . . . . . . . . . Michigan Attorney General bcf . . . . . . . . . . . . . . . . . . . . Billion cubic feet Big Rock. . . . . . . . . . . . . . . . . . Big Rock Point nuclear power plant, owned by Consumers Board of Directors. . . . . . . . . . . . . Board of Directors of CMS Energy Btu . . . . . . . . . . . . . . . . . . . . British thermal unit CFLCL . . . . . . . . . . . . . . . . . . . Companhia Forcia e Luz Cataguazes-Leopoldina, a Brazilian utility Class G Common Stock. . . . . . . . . . . . One of two classes of common stock of CMS Energy, no par value, which reflects the separate performance of the Consumers Gas Group Clean Air Act . . . . . . . . . . . . . . . Federal Clean Air Act, as amended CMS Electric and Gas. . . . . . . . . . . . CMS Electric and Gas Company, a subsidiary of Enterprises CMS Energy. . . . . . . . . . . . . . . . . CMS Energy Corporation CMS Energy Common Stock . . . . . . . . . . One of two classes of common stock of CMS Energy, par value $.01 per share CMS Gas Marketing . . . . . . . . . . . . . CMS Gas Marketing Company, a subsidiary of Enterprises CMS Gas Transmission. . . . . . . . . . . . CMS Gas Transmission and Storage Company, a subsidiary of Enterprises CMS Generation. . . . . . . . . . . . . . . CMS Generation Co., a subsidiary of Enterprises CMS Holdings. . . . . . . . . . . . . . . . CMS Midland Holdings Company, a subsidiary of Consumers CMS Midland . . . . . . . . . . . . . . . . CMS Midland Inc., a subsidiary of Consumers CMS MST . . . . . . . . . . . . . . . . . . CMS Marketing, Services and Trading Company, a subsidiary of Enterprises CMS Oil and Gas . . . . . . . . . . . . . . CMS Oil and Gas Company, a subsidiary of Enterprises Common Stock. . . . . . . . . . . . . . . . CMS Energy Common Stock and Class G Common Stock Consumers . . . . . . . . . . . . . . . . . Consumers Energy Company, a subsidiary of CMS Energy Consumers Gas Group . . . . . . . . . . . . The gas distribution, storage and transportation businesses currently conducted by Consumers and Michigan Gas Storage Court of Appeals. . . . . . . . . . . . . . Michigan Court of Appeals Detroit Edison. . . . . . . . . . . . . . . The Detroit Edison Company DOE . . . . . . . . . . . . . . . . . . . . U.S. Department of Energy Dow . . . . . . . . . . . . . . . . . . . . The Dow Chemical Company DSM . . . . . . . . . . . . . . . . . . . . Demand-side management Enterprises . . . . . . . . . . . . . . . . CMS Enterprises Company, a subsidiary of CMS Energy EPA . . . . . . . . . . . . . . . . . . . . Environmental Protection Agency EPS . . . . . . . . . . . . . . . . . . . . Earning per share FASB. . . . . . . . . . . . . . . . . . . . Financial Accounting Standards Board FERC. . . . . . . . . . . . . . . . . . . . Federal Energy Regulatory Commission FMLP. . . . . . . . . . . . . . . . . . . . First Midland Limited Partnership GCR . . . . . . . . . . . . . . . . . . . . Gas cost recovery Grand Lacs partnership. . . . . . . . . . . Grand Lacs Limited Partnership, a marketing center for natural gas GTNs. . . . . . . . . . . . . . . . . . . . CMS Energy General Term Notes, $250 million Series A, $125 million Series B, $150 million Series C, $200 million Series D and $400 million Series E Huron . . . . . . . . . . . . . . . . . . . Huron Hydrocarbons, Inc., a subsidiary of Consumers Jorf Lasfar . . . . . . . . . . . . . . . . A 1,320 MW coal-fueled power plant in Morocco, Africa, jointly owned by CMS Generation and ABB Energy Venture, Inc. kWh . . . . . . . . . . . . . . . . . . . . Kilowatt-hour LIHEAP. . . . . . . . . . . . . . . . . . . Low Income Home Energy Assistance Program Loy Yang. . . . . . . . . . . . . . . . . . The 2,000 MW brown coal fueled Loy Yang A power plant and an associated coal mine in Victoria, Australia, in which CMS Generation holds a 50 percent ownership interest Ludington . . . . . . . . . . . . . . . . . Ludington pumped storage plant, jointly owned by Consumers and Detroit Edison mcf . . . . . . . . . . . . . . . . . . . . Thousand cubic feet 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 MD&A. . . . . . . . . . . . . . . . . . . . Management's Discussion and Analysis MichCon . . . . . . . . . . . . . . . . . . Michigan Consolidated Gas Company Michigan Gas Storage. . . . . . . . . . . . Michigan Gas Storage Company, a subsidiary of Consumers Mbbls . . . . . . . . . . . . . . . . . . . Thousand barrels MMbbls. . . . . . . . . . . . . . . . . . . Million barrels MMBtu . . . . . . . . . . . . . . . . . . . Million British thermal unit MMcf. . . . . . . . . . . . . . . . . . . . Million cubic feet Moss Bluff. . . . . . . . . . . . . . . . . Moss Bluff Gas Storage Systems, a partnership that owns a gas storage facility MPSC. . . . . . . . . . . . . . . . . . . . Michigan Public Service Commission MW. . . . . . . . . . . . . . . . . . . . . Megawatts Natural Gas Act . . . . . . . . . . . . . . Federal Natural Gas Act NGL . . . . . . . . . . . . . . . . . . . . Natural gas liquids Nitrotec. . . . . . . . . . . . . . . . . . Nitrotec Corporation, a propriety gas technology company in which CMS Gas Transmission owns an equity interest NRC . . . . . . . . . . . . . . . . . . . . Nuclear Regulatory Commission Order 888 and Order 889 . . . . . . . . . . FERC final rules issued on April 24, 1996 Outstanding Shares. . . . . . . . . . . . . Outstanding shares of Class G Common Stock Palisades . . . . . . . . . . . . . . . . . Palisades nuclear power plant, owned by Consumers Panhandle Companies . . . . . . . . . . . . Panhandle Eastern Pipe Line Company and its principal subsidiaries, Trunkline Gas Company and Pan Gas Storage Company, as well as Panhandle Storage Company and Trunkline LNG Company PCBs. . . . . . . . . . . . . . . . . . . . Poly chlorinated biphenyls Pension Plan. . . . . . . . . . . . . . . . The trusteed, non- contributory, defined benefit pension plan of Consumers and CMS Energy PPA . . . . . . . . . . . . . . . . . . . . The Power Purchase Agreement between Consumers and the MCV Partnership with a 35- year term commencing in March 1990 ppm . . . . . . . . . . . . . . . . . . . . Parts per million PSCR. . . . . . . . . . . . . . . . . . . . Power supply cost recovery PUHCA . . . . . . . . . . . . . . . . . . . Public Utility Holding Company Act of 1935 Qualifying Facility . . . . . . . . . . . . A facility that produces electricity or steam and electricity and meets the ownership and technical requirements of PURPA Retained Interest Shares. . . . . . . . . . Authorized but unissued shares of Class G Common Stock not held by holders of the Outstanding Shares and attributable to the Retained Interest SEC . . . . . . . . . . . . . . . . . . . . Securities and Exchange Commission Securitization. . . . . . . . . . . . . . . A financing authorized by statute in which the statutorily assured flow of revenues from a portion of the rates charged by a utility to its customers is set aside and pledged as security for the repayment of rate reduction bonds issued by a special purpose entity affiliated with such utility SERP. . . . . . . . . . . . . . . . . . . . Supplemental Executive Retirement Plan Senior Credit Facilities. . . . . . . . . . $725 million senior credit facilities consisting of a $600 million three-year revolving credit facility and a five-year $125 million term loan facility SFAS. . . . . . . . . . . . . . . . . . . . Statement of Financial Accounting Standards Superfund . . . . . . . . . . . . . . . . . Comprehensive Environmental Response, Compensation and Liability Act TGN . . . . . . . . . . . . . . . . . . . . Transportadora de Gas del Norte S. A., a natural gas pipeline located in Argentina Transition Costs. . . . . . . . . . . . . . Costs incurred by utilities in order to serve their customers in a regulated monopoly environment, but 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, regulatory assets, and costs incurred in the transition to competition. Trust Preferred Securities. . . . . . . . . Undivided beneficial interest in the assets of statutory business trusts, these interests have a preference with respect to certain trust distributions over the interests of either CMS Energy or Consumers, as applicable, as owner of the common beneficial interests of the trusts Union . . . . . . . . . . . . . . . . . . . Utility Workers of America, AFL-CIO UST . . . . . . . . . . . . . . . . . . . . Underground storage tanks Voluntary Employee Beneficiary Association . . . . . . . . . . . . . . . A legal entity, established under guidelines of the Internal Revenue Code, through which the company can provide certain benefits for its employees or retirees (This page intentionally left blank) 8 CMS Energy Corporation Management's Discussion and Analysis The MD&A of this Form 10-Q should be read along with the MD&A and other parts of CMS Energy's 1997 Form 10-K and the restated financial information in a Form 8-K dated July 30, 1998. This MD&A also refers to, and in some sections specifically incorporates by reference from, CMS Energy's Condensed Notes to Consolidated Financial Statements and should be read in conjunction with such Statements and Notes. This report contains forward-looking statements, as defined by the Private Securities Litigation Reform Act of 1995, that include without limitation, discussions as to expectations, beliefs, plans, objectives and future financial performance, or assumptions underlying or concerning matters discussed in this report. Refer to the Forward-Looking Information section of this MD&A for some important factors that could cause actual results or outcomes to differ materially from those addressed in the forward-looking discussions. CMS Energy is the parent holding company of Consumers and Enterprises. Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan and is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Enterprises is engaged in several domestic and international energy-related businesses including: acquisition, development and operation of independent power production facilities; oil and gas exploration and production; storage, transmission and processing of natural gas; energy marketing, services and trading; and international energy distribution. RESULTS OF OPERATIONS CMS Energy Consolidated Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . In Millions, Except Per Share Amounts - ------------------------------------------------------------------------ September 30. . . . . . . . . . . . . . . . . 1998 1997(b) Change - ------------------------------------------------------------------------ Three months ended Consolidated Net Income . . . . . . . . . . $ 81 $ 60 $ 21 Net Income Attributable to Common Stocks: CMS Energy . . . . . . . . . . . . . . . 83 62 21 Class G. . . . . . . . . . . . . . . . . (2) (2) - . . . . . . . . . . . . . . . . . . . . . . Earnings Per Average Common Share: CMS Energy Basic . . . . . . . . . . . . . . . .81 .64 .17 Diluted . . . . . . . . . . . . . . .80 .63 .17 Class G. . . . . . . . . . . . . . . . . Basic and Diluted . . . . . . . . . (.16) (.21) .05 Nine months ended . . . . . . . . . . . . . . (a) Consolidated Net Income . . . . . . . . . . $234 $185 $ 49 Net Income Attributable to Common Stocks: CMS Energy . . . . . . . . . . . . . . . 226 176 50 Class G. . . . . . . . . . . . . . . . . 8 9 (1) Earnings Per Average Common Share: CMS Energy Basic . . . . . . . . . . . . . . . 2.23 1.85 .38 Diluted . . . . . . . . . . . . . . 2.19 1.83 .36 Class G Basic and Diluted . . . . . . . . . 1.04 1.13 (.09) Twelve months ended . . . . . . . . . . . . (a) Consolidated Net Income . . . . . . . . . . $293 $ 223 $ 70 Net Income Attributable to Common Stocks: CMS Energy . . . . . . . . . . . . . . . 279 210 69 Class G. . . . . . . . . . . . . . . . . 14 13 1 Earnings Per Average Common Share: CMS Energy . . . . . . . . . . . . . . . Basic . . . . . . . . . . . . . . . 2.77 2.22 .55 Diluted . . . . . . . . . . . . . . 2.73 2.20 .53 Class G Basic and Diluted . . . . . . . . . 1.73 1.57 .16 ==================== (a) Includes the cumulative effect of an accounting change for property taxes which increased net income attributable to CMS Energy Common Stock $43 million ($.40 per share - basic and diluted) and Class G Common Stock $12 million ($.36 per share - basic and diluted). Refer to the discussion below for further information. (b) Restated as a result of change in method of accounting for investments in oil and gas properties. Refer to the discussion below and Note 1 for further information. The combined effects of the changes in accounting for oil and gas investments resulted in decreases to net income of $6 million ($.06 per share), $19 million ($.19 per share) and $25 million ($.26 per share) for the three months, nine months and twelve months ended September 30, 1997, respectively. The following discussion of earnings variations compares the results of this year's periods to the restated results of last year's periods. CMS Energy's earnings for the third quarter of 1998 increased from the comparable period in 1997 as a result of (1) an increase in earnings from international independent power production plant operations and gains on the sales of a biomass power purchase agreement and plant assets and (2) Consumers' increased electric sales and gas deliveries. Partially offsetting these increases were (1) lower oil prices and the gain in the prior period from the sale of oil and gas properties in the oil and gas exploration and production business and (2) increased interest on long- term debt due to higher amounts of debt outstanding. CMS Energy's earnings for the nine months ended September 30, 1998 increased from the comparable period in 1997 as a result of (1) Consumers' one-time change in accounting for the recognition of property tax expense from a calendar-year basis to a fiscal-year basis which resulted in a benefit of $66 million ($43 million after-tax), (2) Consumers' increased electric sales partially offset by an increase in general taxes and depreciation, (3) a gain on the sale of Petal Gas Storage Company by the gas transmission, storage and processing business, (4) increased income from the international independent power production business, gains on the sale of two biomass project power purchase agreements, and gains on the sale of two biomass plants and (5) an increase in oil production and a decrease in exploration expenses and depreciation, depletion and amortization expenses. Partially offsetting these increases were (1) Consumers' decreased gas deliveries due to warmer temperatures during the winter heating season, (2) an increased provision for underrecoveries under the PPA of $37 million ($24 million after-tax) due to higher than expected plant availability of the MCV Facility, (3) lower earnings from international energy distribution businesses, (4) lower oil prices and the gain in the prior period from the sale of oil and gas properties in the oil and gas exploration and production business and (5) increased interest on long-term debt due to higher amounts of debt outstanding. For further information on past and future underrecoveries under the PPA, see Power Purchases from the MCV Partnership in Note 2. The increase in consolidated net income for the twelve months ended September 30, 1998 compared to the same period in 1997 reflects (1) Consumers' change in accounting for property taxes as discussed above and a $9 million adjustment of Consumers' prior years' income taxes associated with non-taxable earnings on nuclear decommissioning trust funds, (2) Consumers' increased electric sales and lower operation and maintenance expenses partially offset by increased general taxes and depreciation, (3) an increase in international plants earnings and operating fees from the independent power production business, gains on the sale of two biomass project power purchase agreements, and gains on the sale of two biomass plants, (4) a gain on the sale of Petal Gas Storage Company and a gain on the sale of Australian gas reserves in the gas transmission, storage and processing business and (5) an increase in oil production and a decrease in exploration expenses and depreciation, depletion and amortization expenses. Partially offsetting these increases were the (1) recognition of Consumers' after-tax loss associated with the underrecovery of power costs under the PPA as discussed above, (2) Consumers' decreased gas deliveries due to warmer weather during the first nine months of 1998, (3) lower oil prices in the oil and gas exploration and production business, (4) a scheduled decrease in the industry expertise service fee income earned in connection with Loy Yang, (5) lower earnings from international energy distribution businesses and (6) increased interest on long-term debt due to higher amounts of debt outstanding. For further information, see the individual results of operations for each CMS Energy business segment in this MD&A. Consumers' Electric Business Unit Results of Operations Electric Pretax Operating Income: . . . . . . . . . . . . . . . . . . . . . . . In Millions - ---------------------------------------------------------------------------- . . . . . . . . . . . . Three Months Nine Months Twelve Months . . . . . . . . . . . . Ended Sept. 30 Ended Sept. 30 Ended Sept. 30 Change Compared to Prior Year. 1998 vs 1997 1998 vs 1997 1998 vs 1997 - ----------------------------------------------------------------------------- Deliveries (including special contract discounts) . . . . . $ 38 $ 50 $ 51 Other non-commodity revenue . . . . . . (1) (2) (3) Operations and maintenance . . . . . (11) (1) 15 General taxes, depreciation and other . . . . . . . . . .. . . . (5) (11) (18) . . . . . . . . . . . . . . . . . ---------------------------------------- Total change. . . . . . . . . . . . . . $ 21 $ 36 $ 45 . . . . . ======================================== Electric Deliveries: Total electric deliveries increased 10.1 percent for the three months ended September 30, 1998 over the same period in 1997. The increase includes a 5.8 percent increase in deliveries to ultimate customers, primarily within the residential and commercial classes, and an increase in sales intersystem and wholesale customer deliveries. For the nine months ended September 30, 1998, total electric deliveries increased 8.2 percent over the comparable 1997 period. Deliveries to ultimate customers were up 3.4 percent, with the remaining change attributable to an increase in sales between utility systems and wholesale deliveries. For the twelve months ended September 30, 1998, total electric deliveries increased 8.0 percent over the comparable 1997 period. The increase is primarily attributable to an increase in sales between utility systems and a 2.7 percent increase in deliveries to ultimate customers. Power Costs: . . . . . . . . . . . . . . . . . . . . . . . In Millions - ------------------------------------------------------------------------ September 30. . . . . . . . . . . . . . . . . 1998 1997 Change - ------------------------------------------------------------------------ Three months ended. . . . . . . . . . . . . . $ 315 $ 296 $ 19 Nine months ended . . . . . . . . . . . . . . 899 847 52 Twelve months ended . . . . . . . . . . . . . 1,190 1,132 58 ========================================================================= Power costs increased for all the reported periods ended September 30, 1998 compared to 1997. Both internal generation and power purchases from outside sources increased during these periods to meet increased deliveries. Uncertainties: CMS Energy's financial position may be affected by a number of trends or uncertainties that have had, or CMS Energy reasonably expects will have, a materially favorable or unfavorable impact on net sales, revenues, or income from continuing electric operations. Such uncertainties are: 1) environmental liabilities arising from compliance with various federal, state and local environmental laws and regulations, including potential liability or expenses relating to the Michigan Natural Resources and Environmental Protection Act and Superfund; 2) capital expenditures for compliance with the Clean Air Act; 3) suits by various parties relating to the effect of so-called stray voltage on certain livestock; 4) suits by two independent power producers alleging antitrust violations and economic losses due to special electric contracts signed by Consumers; 5) cost recovery relating to the MCV Facility and nuclear plant investments and an experimental direct-access program; 6) electric industry restructuring; 7) after-tax cash underrecoveries associated with power purchases from the MCV Partnership; and 8) Big Rock decommissioning issues and ongoing issues relating to the storage of spent fuel and the operating life of Palisades. For detailed information about these trends or uncertainties see Note 2, "Consumers' Electric Business Unit Contingencies-Electric Environmental Matters," "Consumers' Electric Business Unit Contingencies-Stray Voltage," "Consumers' Electric Business Unit Contingencies-Anti-Trust," "Consumers' Electric Business Unit Rate Matters-Electric Restructuring," and "Other Consumers' Electric Business Unit Uncertainties-Nuclear Matters," incorporated by reference herein. For information about Consumers' electricity option contracts see Note 5, "Risk Management and Derivatives Transactions-Commodity Price Hedges", incorporated by reference herein. Consumers Gas Group Results Of Operations . . . . . . . . . . . . . . . . . . . . . . . In Millions - --------------------------------------------------------------------------- . . . . . . .. . . . . . . Three Months Nine Months Twelve Months . . . . . . . . . . . . . Ended Sept. 30 Ended Sept. 30 Ended Sept. 30 Change Compared to Prior Year. 1998 vs 1997 1998 vs 1997 1998 vs 1997 - ---------------------------------------------------------------------------- Gas deliveries. . . . . . . . . . . $ 5 $(14) $(15) Gas wholesale and retail service activities . . . . . . . . 3 - (2) Operations and maintenance. . . . .. 1 (8) 6 General taxes, depreciation and other . . . . . . . . . . . (2) 3 3 - --------------------------------------------------------------------------- Total change. . . . . . . . . . . . $ 7 $(19) $(8) =========================================================================== Gas Deliveries: System deliveries for the three month period ended September 30, 1998, excluding miscellaneous transportation, totaled 31 bcf, an increase of 1 bcf or 3 percent compared to the three month period ended September 30, 1997. Deliveries for the nine month period ended September 30, 1998, excluding miscellaneous transportation, totaled 203 bcf, a decrease of 29 bcf or 13 percent compared to the nine month period ended September 30, 1997. For the twelve month period ended September 30, 1998, deliveries excluding miscellaneous transportation, totaled 311 bcf, a decrease of 31 bcf or 9 percent compared to the twelve month period ended September 30, 1997. The decreased deliveries for the nine month and twelve month periods reflect warmer temperatures primarily for the first quarter of 1998. Miscellaneous transportation deliveries for the three month period ended September 30, 1998 totaled 11 bcf, a decrease of 8 bcf, or 40 percent compared to the three month period ended September 30, 1997. Miscellaneous transportation deliveries for the nine month period ended September 30, 1998 totaled 47 bcf, a decrease of 14 bcf, or 23 percent compared to the nine month period ended September 30, 1997. Miscellaneous transportation deliveries for the twelve month period ended September 30, 1998 totaled 65 bcf, a decrease of 18 bcf, or 22 percent compared to the twelve month period ended September 30, 1997. Cost of Gas Sold: . . . . . . . . . . . . . . . . . . . . . . . In Millions - ------------------------------------------------------------------------ September 30. . . . . . . . . .. . . . . 1998 1997 Change - ------------------------------------------------------------------------ Three months ended. . . . . . . . . . . $ 39 $ 39 $ - Nine Months ended . . . . . . . . . . . 377 472 (95) Twelve months ended . . . . . . . . . . 600 718 (118) ========================================================================== The cost decreases for the nine month and twelve month periods ended September 30, 1998 were the result of decreased sales and lower gas costs reflecting warmer temperatures during the winter heating season. Uncertainties: CMS Energy's financial position may be affected by a number of trends or uncertainties that have had, or CMS Energy reasonably expects will have, a materially favorable or unfavorable impact on net sales or revenues or income from continuing gas operations. Such uncertainties are: 1) potential environmental costs at a number of sites including sites formerly housing manufactured gas plant facilities, and 2) a statewide experimental gas transportation pilot program. For detailed information about these uncertainties see Note 2, "Consumers' Gas Group Contingencies-Gas Environmental Matters," and "Consumers' Gas Group Matters-Gas Restructuring," incorporated by reference herein. For information about Consumers' gas forward contracts, see Note 5, "Risk Management Activities and Derivatives Transactions-Commodity Price Hedges", incorporated by reference herein. Independent Power Production Results of Operations Pretax Operating Income: Pretax operating income for the three months ended September 30, 1998 increased $25 million (78 percent) over the comparable period in 1997. This increase primarily reflects increased operating income from international plants earnings and fees, a $14 million gain on the sale of a biomass project power purchase agreement, and a $9 million gain on the sale of two biomass plants, partially offset by higher net operating expenses and decreased earnings from the MCV Partnership due to a 1997 property tax adjustment. Pretax operating income for the nine months ended September 30, 1998 increased $56 million (84 percent) over the comparable period in 1997, primarily reflecting an increase in international plants earnings and operating fees, a $26 million gain on the sale of two biomass project power purchase agreements, and a $9 million gain on the sale of two biomass plants, partially offset by higher net operating expenses and lower industry expertise service fee income earned in connection with Loy Yang. Pretax operating income for the twelve months ended September 30, 1998 increased $79 million (108 percent) from the comparable period in 1997, primarily reflecting increased operating income resulting from increased international and domestic earnings, construction management fees earned in connection with Jorf Lasfar, a $26 million gain on the sale of two biomass project power purchase agreements, and a $9 million gain on the sale of two biomass plants, partially offset by lower industry expertise service fee income earned in connection with Loy Yang and higher operating expenses. Oil and Gas Exploration and Production Results of Operations In October 1998, CMS Energy Corporation changed the name of its oil and gas exploration and production business to CMS Oil and Gas Company, formerly known as CMS NOMECO Oil & Gas Co. Pretax Operating Income: Pretax operating income for the three months ended September 30, 1998 decreased $11 million (85 percent) from the comparable period in 1997. This decrease is the result of lower oil prices and the gain in the prior period from the sale of the entire interest in oil and gas properties in Yemen, partially offset by an increase in oil production and a decrease in depreciation, depletion and amortization charges. Pretax operating income for the nine months ended September 30, 1998 decreased $4 million (25 percent) over the comparable period in 1997 due to lower oil prices and the gain in the prior period from the sale of the entire interest in oil and gas properties in Yemen, partially offset by increased oil production, decreased exploration expenses, and decreased depreciation, depletion and amortization expenses. Pretax operating income for the twelve months ended September 30, 1998 was unchanged from the comparable period in 1997, primarily due to lower oil prices, offset by decreased exploration expenses and depreciation, depletion and amortization expenses, and increased oil volumes. CMS Oil and Gas changed its method of accounting effective January 1, 1998 for oil and gas operations from the full cost method to the successful efforts method. CMS Oil and Gas believes that the successful efforts method will minimize asset write-offs caused by periodic price swings, which may not be representative of overall or long-term markets, and will allow its results of operations to be more easily compared to other oil and gas companies. Nitrotec, in which CMS Gas Transmission has an equity investment, also elected to convert effective January 1, 1998 from the full cost method of accounting to the successful efforts method of accounting. All prior period financial statements have been restated to conform with successful efforts accounting. The effect, after tax, of the change in accounting method as of December 31, 1997, was a reduction to retained earnings of $175 million for CMS Oil and Gas and $15 million for CMS Gas Transmission, primarily attributable to a decrease in net plant and property and deferred tax liability of $270 million and $95 million, respectively, for CMS Oil and Gas and a $15 million decrease in CMS Gas Transmission's equity investment in Nitrotec. Natural Gas Transmission, Storage and Processing Results of Operations Pretax Operating Income: Pretax operating income for the three months ended September 30, 1998 was unchanged from the comparable period in 1997, primarily as a result of a decrease in earnings from international operations and higher operating expenses, offset by an increase in earnings from domestic operations. Pretax operating income for the nine months ended September 30, 1998 increased $6 million (27 percent) over the comparable 1997 period primarily reflecting a gain in the first quarter of 1998 on the sale of Petal Gas Storage Company, a gain on the sale of Australian gas reserves, and lower operating expenses, partially offset by a gain in the first quarter of 1997 on the sale of a portion of the Ames gas gathering system and a decrease in earnings from international operations. Pretax operating income for the twelve months ended September 30, 1998 increased $6 million (22 percent) over the comparable period in 1997, reflecting a gain on the sale of Petal Gas Storage Company and a gain on the sale of Australian gas reserves, partially offset by the gain in the first quarter of 1997 on the sale of a portion of the Ames gas gathering system. Marketing, Services and Trading Results of Operations Pretax Operating Income: Pretax operating income for the three months ended September 30, 1998 increased $2 million from the comparable period in 1997. This increase is the result of improved margins on electricity sales combined with increased electric sales volumes, partially offset by higher operating costs. Pretax operating income for the twelve months ended September 30, 1998 decreased $5 million from the comparable period in 1997, primarily reflecting lower gas margins and higher costs reflecting management's continuing commitment to future electric and energy management growth, partially offset by higher electric sales volumes. Electric marketing volumes reached 6.4 million MW for the nine months ended September 30, 1998 compared to .3 million for the comparable period in 1997. Gas marketed for end users totaled 223 bcf and 144 bcf for the nine months ended September 30, 1998 and 1997, respectively. Energy management service revenues for the nine months ended September 30, 1998 increased 67 percent over the comparable 1997 period. Market Risk Information CMS Energy is exposed to market risk including, but not limited to, changes in interest rates, currency exchange rates, and certain commodity and equity prices. Derivative instruments including, but not limited to, futures contracts, swaps, options and forward contracts may be used to manage these exposures. Derivatives are principally used as hedges and not for trading purposes. During the third quarter of 1998, trading activities were immaterial. Regarding hedges, management believes that any losses incurred on derivative instruments used as a hedge would be offset by the opposite movement of the underlying hedged item. Management uses commodity futures contracts, options and swaps (which require a net cash payment for the difference between a fixed and variable price) and oil swaps to manage commodity price risk. They also use forward exchange contracts to hedge certain receivables, payables and long-term debt relating to foreign investments. Management also uses equity investments in which CMS Energy or its subsidiaries hold less than a 20 percent interest. These commodity, financial and equity instruments do not expose CMS Energy to material market risk. Interest Rate Risk: Management uses a combination of fixed-rate and variable-rate debt to reduce interest rate exposure. Interest rate swaps and rate locks may be used to adjust exposure when deemed appropriate, based upon market conditions. These strategies attempt to provide and maintain the lowest cost of capital. The carrying amount of long-term debt (including current maturities) was $4.4 billion at September 30, 1998 with a fair value (including current maturities) of $4.5 billion. The fair value of CMS Energy's financial derivative instruments at September 30, 1998, with a notional amount of $923 million, was $26 million, representing the amount that CMS Energy would have paid to terminate these agreements on September 30, 1998. In October 1998, Consumers unwound an interest rate guarantee of $145 million associated with the issuance of $150 million senior notes. The effective rate of the debt is 7 percent taking into consideration the issuance costs, interest rate guarantee and insurance costs. In accordance with SEC disclosure requirements, CMS Energy performed a sensitivity analysis. The analysis assesses the potential loss in fair value, cash flows and earnings based upon hypothetical increases and decreases in market interest rates. A hypothetical 10 percent adverse shift in market rates in the near term would not have a material impact on CMS Energy's consolidated financial position, results of operations or cash flows as of September 30, 1998. Limitations of the Sensitivity Model: Management does not believe that a sensitivity analysis alone provides an accurate or reliable method for monitoring and controlling risk. Therefore, CMS Energy and its subsidiaries rely on the experience and judgement of senior management and traders to revise strategies and adjust positions as they deem necessary. Losses in excess of the amounts determined could occur if market rates or prices exceed the 10 percent shift used for the analysis. The model assumes that the maximum exposure associated with purchased options is limited to premiums paid. The model assumes that the Trust Preferred Securities are not converted into CMS Energy Common Stock. If the conversion occurred, the $173 million of Trust Preferred Securities would be discharged through the issuance of 4.2 million shares of CMS Energy Common Stock. The model also does not quantify short-term exposure to hypothetically adverse price fluctuations in inventories. For a discussion of accounting policies related to derivative transactions, see Note 5. CAPITAL RESOURCES AND LIQUIDITY Cash Position, Investing and Financing CMS Energy's primary ongoing source of operating cash is dividends from subsidiaries. During the nine months ended September 30, 1998, Consumers paid $94 million in common dividends to CMS Energy. In October 1998, Consumers declared a $68 million common dividend to be paid in November 1998. During 1998, Enterprises paid common dividends and other distributions of $76 million to CMS Energy. CMS Energy's consolidated operating cash requirements are met by its operating and financing activities. Operating Activities: CMS Energy's consolidated net cash provided by operating activities is derived mainly from the sale and transportation of natural gas by Consumers; the generation, transmission, and sale of electricity by Consumers; the sale of oil and natural gas by CMS Oil and Gas; the transportation, storage and processing of natural gas by CMS Gas Transmission; and the production and sale of electricity by other affiliates. Consolidated cash from operations totaled $386 million and $334 million for the first nine months of 1998 and 1997, respectively. The $52 million increase resulted from increases in consolidated net income and deferred income taxes. These increases were partially offset by a $29 million net decrease reflecting the cumulative effect of the accounting change for property taxes and an increased provision for underrecoveries under the PPA, both of which are noncash items. CMS Energy uses its operating cash primarily to expand its international businesses, to maintain and expand electric and gas systems of Consumers, to retire portions of its long-term debt and to pay dividends. Investing Activities: CMS Energy's consolidated net cash used in investing activities totaled $690 million and $1,141 million for the first nine months of 1998 and 1997, respectively. The decrease of $451 million primarily reflects decreased investments in international projects (1997 included an approximately $500 million investment in Loy Yang). CMS Energy's 1998 expenditures for its utility and international businesses were $290 million and $424 million, respectively, compared to $269 million and $837 million, respectively, during 1997. Financing Activities: CMS Energy's consolidated net cash provided by financing activities totaled $336 million and $885 million for the first nine months of 1998 and 1997, respectively. The decrease of $549 million in net cash provided by financing activities resulted from an increase of $524 million in the issuance of new securities (see table below), offset by increases in the retirement of bonds and other long-term debt ($548 million) and the repayment of bank loans ($488 million). . . . . . . . . . . . . . . . . . . . . . . . In Millions - ------------------------------------------------------------------------------ . . . . . . . .. . . . . . . . . . Distribution/ Principal Month Issued Maturity Interest Rate Amount Use of Proceeds - ------------------------------------------------------------------------------ CMS Energy GTNs Series D . . . . (1) (1) 6.8% (1) $119 General corporate purposes Extendible Tenor Rate Adjusted Securities . . January 2005 7.0% 180 Pay down . . . . . . . . . . . . . borrowings . . . . . . . . . . . . . . . . . . . . . . . ------ . . . . . . . . . . . . . . . . . . . . . . . $299 Consumers Senior Notes (2) February.. . . . 2008. 6.375% $250 Pay down First . . . . . . . . . . . . . . . . . . . . . . . Mortgage Bonds and general . . . . . . . . . . . . . . . . . . . corporate purposes Senior Notes (2) March. . . . 2018. 6.875% 225 Pay down First . . . . . . . . . . . . . . . . . . . . Mortgage Bonds and pay down . . . . . . . . . . . . . . . . . . . . borrowings under credit . . . . . . . . . . . . . . . . . . . facilities Senior Notes (2). . .May . 2008 6.2%(3) 250 Pay down First . . . . . . . . . . . . . . . . . . . .Mortgage Bonds, long-term bank debt and general corporate purposes Senior Notes (2). . June. 2018 6.5%(4) 200 Pay down First . . . . . . . . . . . . . . . . . . . . Mortgage Bonds and general corporate purposes Long-Term Bank Debt May 2001-2003. 6.05%(5) 225 Pay down long- term bank debt Senior Notes (2). October 2028. 6.5% 150 Pay down long- term bank debt and general . . . . . . . . . . . . . . . . . corporate purposes . . . . . . . . . . . . . . . . . . . . . . . -------- Total . . . . . . . . . . . . . . . . . . . . $1,599 =============================================================================== (1) GTNs are issued from time to time with various maturities. The rate shown herein is a weighted average interest rate. (2) The Senior Notes are secured by Consumers' First Mortgage Bonds issued contemporaneously in a similar amount. (3) The interest rate may be reset in May 2003. (4) The interest rate will be reset in June 2005. (5) The interest rate is variable; weighted average interest rate upon original issuance was 6.05 percent. As of September 30, 1998, CMS Energy had an aggregate $684 million in securities registered for future issuance and sale. CMS Energy also has Senior Credit Facilities, unsecured lines of credit and letters of credit as sources of funds needed to fulfill, in whole or in part, material commitments for capital expenditures. For detailed information, see "Short-Term and Long-Term Financing, and Capitalization-CMS Energy" in Note 3, incorporated by reference herein. Consumers has FERC authorization to issue securities and guarantees. Consumers has a credit facility, lines of credit and a trade receivable sale program in place as anticipated sources of funds needed to fulfill, in whole or in part, material commitments for capital expenditures as of September 30, 1998. For detailed information, see "Short-Term and Long- Term Financings, and Capitalization-Consumers" in Note 3, incorporated by reference herein. During the nine months ended September 30, 1998, CMS Energy declared and paid $94 million in cash dividends to holders of CMS Energy Common Stock and $8 million in cash dividends to holders of Class G Common Stock. In October 1998, the Board of Directors declared quarterly dividends of $.33 per share on CMS Energy Common Stock and $.325 per share on Class G Common Stock, payable in November 1998. In August 1998, CMS Energy filed a shelf registration statement with the SEC pursuant to Rule 415 of the Securities Act, for the issuance and the sale of $400 million of GTNs Series E. On November 10, 1998, CMS Energy sold 4.5 million new shares of CMS Energy Common Stock in a block trade. The net proceeds of approximately $208 million will be used for general corporate purposes. Other Investing and Financing Matters: At September 30, 1998, the book value per share of CMS Energy Common Stock and Class G Common Stock was $17.98 and $10.57, respectively. CMS Energy's $400 million, 364-day revolving credit facility expired June 30, 1998, and was not renewed, thus reducing the aggregate amount of the Senior Credit Facilities from $1.125 billion to $725 million. In October 1998, CMS Energy exchanged 1.4 million shares of CMS Energy Common Stock for 100% of the outstanding common stock of Continental Natural Gas, Inc. ("CNG"), an energy company engaged in gathering, processing, purchasing and marketing natural gas and natural gas liquids in Oklahoma and Texas. The acquisition of CNG will be accounted for as a pooling of interests, and all consolidated financial data for the periods subsequent to December 31, 1997 will be restated to include the financial data of CNG. The financial data of the pooled companies prior to January 1, 1998 will not be materially different from that previously reported by CMS Energy, and thus will not be restated. On November 2, 1998, CMS Energy announced the execution of a definitive Stock Purchase Agreement (the "Agreement") with PanEnergy Corp ("PanEnergy") and certain other wholly-owned subsidiaries of Duke Energy Company to acquire all of the stock of the Panhandle Companies for a cash payment of $1.9 billion and existing Panhandle Companies debt of $300 million. Closing of the transaction is subject to Hart-Scott-Rodino pre-merger notification clearance. The Agreement is subject to termination upon failure of CMS Energy to satisfy its financing contingency. The Agreement also provides that if, as a result of CMS's Energy's continuing due diligence investigation, CMS Energy learns of material facts not previously disclosed or inconsistent with representations and warranties made in the Agreement, CMS Energy may, on or prior to November 23, 1998, notify PanEnergy of its intent to terminate the Agreement and the Agreement will terminate unless PanEnergy corrects the asserted misrepresentations within 30 days. CMS Energy expects to have $1.9 billion of bridge financing commitments available to fund the purchase price and it anticipates permanent financing of the acquisition at or near closing with approximately $900 million from the sale of common stock and/or securities convertible into common stock by CMS Energy and approximately $1 billion from the issuance of debt securities by the Panhandle Companies. The following discussions contain forward-looking statements. See the Forward-Looking Information section of this MD&A for some important factors that could cause actual results or outcomes to differ materially from those discussed herein. Capital Expenditures Looking forward, CMS Energy estimates that capital expenditures, including new lease commitments and investments in partnerships and unconsolidated subsidiaries, will total $6.3 billion over the next three years. This total includes approximately $2.2 billion for the pending acquisition of the Panhandle Companies as discussed more fully in Note 6, Subsequent Event. Payment for the purchase of the Panhandle Companies is expected to be financed as described above. A substantial portion of the remaining capital expenditures is expected to be satisfied by cash from operations. Nevertheless, CMS Energy will continue to evaluate capital markets in 1998 as a potential source of financing its subsidiaries' investing activities. CMS Energy estimates capital expenditures by business segment over the next three years as follows: In Millions - ------------------------------------------------------------------------ Years Ended December 31 1998 1999 2000 - ------------------------------------------------------------------------ Consumers electric operations (a) (b) $ 341 $ 380 $ 385 Consumers gas operations (a) 117 125 125 Independent power production 308 410 435 Oil and gas exploration and production 140 165 165 Natural gas transmission and storage 270 2,350(c) 165 International energy distribution 163 150 100 Marketing, services and trading 1 5 15 - ------------------------------------------------------------------------ $1,340 $3,585 $1,390 ======================================================================== (a) These amounts include an attributed portion of Consumers' anticipated capital expenditures for plant and equipment common to both the electric and gas utility businesses. (b) These amounts do not include preliminary estimates for capital expenditures possibly required to comply with recently revised national air quality standards under the Clean Air Act. For further information see Note 2. (c) Includes approximately $2.2 billion for pending acquisition of the Panhandle Companies. CMS Energy currently plans investments from 1998 to 2000: (1) for oil and gas exploration and production operations, primarily in North and South America, offshore West Africa and North Africa; (2) for independent power production operations to pursue acquisitions and development of electric generating plants in the United States, Latin America, Asia, Australia, the Pacific Rim region, North Africa and the Middle East; (3) to continue development of non-utility natural gas storage, gathering and pipeline operations of CMS Gas Transmission, both domestic and international; (4) to acquire, develop and expand international energy distribution businesses; and (5) to provide gas, electric, oil and coal marketing, risk management and energy management services throughout the United States and eventually worldwide. These estimates are prepared for planning purposes and are subject to revision. OUTLOOK As the deregulation and privatization of the energy industry takes place in the United States and internationally, CMS Energy has positioned itself to be a leading international energy infrastructure company developing and operating energy facilities and providing energy services in major world growth markets. CMS Energy provides a complete range of international energy expertise from energy production to consumption. Beyond 1998 it intends to continue to grow its businesses by finding opportunities to invest in additional energy infrastructures and to capitalize on being a major, full-service energy company. CMS Energy will seek to increase its involvement in energy projects by pursuing opportunities in oil and gas exploration and production projects, natural gas pipelines, storage and processing facilities, power generation, and electric and gas distribution systems around the world. In addition, CMS Energy will focus more on marketing energy services and trading to take advantage of continued growth opportunities in both the domestic and international markets. International Operations Outlook CMS Energy will continue to grow internationally by investing in multiple projects in several countries as well as by developing synergistic projects across its lines of business. CMS Energy believes these integrated projects will create more opportunities and greater value than individual investments. Also, CMS Energy will achieve this growth through strategic partnering where appropriate. To improve the focus of its international energy businesses, CMS Energy has separated its development efforts from the operations of its assets. CMS Energy conducts its development efforts from offices in four regions of the world: Dearborn, Michigan for The Americas - Northern Hemisphere; Buenos Aires for The Americas - Southern Hemisphere; London for Africa and the Middle East; and Singapore for Asia. CMS Energy's development efforts will focus on countries where there are multiple investment opportunities across its businesses, high energy growth expectations, defined legal and regulatory structures, and economic policies that support private investment. CMS Energy will continue to create value by using the extensive knowledge and experience it has gained in the United States over the past century, to gain competitive positions in these countries. CMS Energy structures its investments to minimize operational and financial risks. These risks are mitigated when operating internationally by working with local partners, utilizing multi-lateral financing institutions, procuring political risk insurance and hedging foreign currency exposure where appropriate. Consumers' Electric Business Unit Outlook Growth: Consumers expects average annual growth of two and one-half percent per year in electric system deliveries over the next five years, absent the impact of restructuring on the industry and its regulation in Michigan. Abnormal weather, changing economic conditions, or the developing competitive market for electricity may affect actual electric sales in future periods. Electric Restructuring: Consumers' retail electric business is affected by competition. To meet its challenges, Consumers entered into multi-year contracts with some of its largest industrial customers to serve certain facilities. The MPSC has approved these contracts as part of its phased introduction to competition. Certain customers have the option of terminating their contracts early. FERC Orders 888 and 889, as amended, require utilities to provide direct access to the interstate transmission grid for wholesale transactions. Consumers and Detroit Edison disagree on the effect of the orders on the Michigan Electric Power Coordination Center pool. Consumers proposes to maintain the benefits of the pool through at least December 2000, while Detroit Edison contends that the pool agreement should be terminated immediately. Among Consumers' alternatives in the event of the pool being terminated would be joining an independent system operator. FERC has indicated this preference for structuring the operations of the electric transmission grid. As discussed in the Form 10-K, since June 1997 several orders have been issued and numerous appeals are pending at the Court of Appeals relating to the restructuring of the electric utility industry. Consumers cannot predict the outcome or timing of these matters. For material changes relating to the restructuring of the electric utility industry see "Electric Business Unit Rate Matters - Electric Restructuring" in Note 2, incorporated by reference herein. Electric Application of SFAS 71: Consumers applies the utility accounting standard, SFAS 71, that recognizes the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities related to the generation, transmission and distribution operations of its business in its financial statements. Consumers believes that the generation segment of its business is still subject to rate regulation based upon its present obligation to continue providing generation service to its customers, and the lack of definitive deregulation orders. If rate recovery of generation-related costs becomes unlikely or uncertain, whether due to competition or regulatory action, this accounting standard may no longer apply to the generation segment of Consumers' business. According to Emerging Issues Task Force Issue 97-4, Deregulation of the Pricing of Electricity - Issues Related to the Application of FASB Statements No. 71 and 101, Consumers can continue to carry its generation- related regulatory assets or liabilities for the part of the business being deregulated if deregulatory legislation or an MPSC rate order allows the collection of cash flows from its regulated transmission and distribution customers to recover these specific costs or settle obligations. Because the February 1998 MPSC order allows Consumers to fully recover its transition costs, Consumers believes that even if it was to discontinue application of SFAS 71 for the generation segment of its business, its regulatory assets, including those related to generation, are probable of future recovery from the regulated portion of the business. At September 30, 1998, Consumers had $251 million of generation-related net regulatory assets recorded on its balance sheet, and a net investment in generation facilities of $1.3 billion included in electric plant and property. For further information regarding electric restructuring, see "Electric Restructuring" above. Consumers' Gas Group Outlook Growth: Consumers currently anticipates gas deliveries, including gas customer choice deliveries (excluding transportation to the MCV Facility and off-system deliveries), to grow at an average annual rate of between one and two percent over the next five years based primarily on a steadily growing customer base. Abnormal weather, alternative energy prices, changes in competitive conditions, and the level of natural gas consumption may affect actual gas deliveries in future periods. Consumers is also offering a variety of energy-related services to its customers focused upon appliance maintenance, home safety, commodity choice and assistance to customers purchasing heating, ventilation and air conditioning equipment. In 1997, LIHEAP provided approximately $64 million in heating assistance to about 312,000 Michigan households, with approximately 13 percent of the funds going to Consumers' customers. Congress provided approximately $54 million in funding for Michigan for 1998. In October 1998, Congress approved funding for fiscal year 1999 of approximately $59 million for the state of Michigan. Consumers' expects presidential approval of the funding. Gas Application of SFAS 71: Based on a regulated utility accounting standard, SFAS 71, Consumers may defer certain costs to the future and record regulatory assets, based on the recoverability of those costs through the MPSC's approval. Consumers has evaluated its regulatory assets related to its gas business, and believes that sufficient regulatory assurance exists to provide for the recovery of these deferred costs. Other Matters New Accounting Standards In 1998, the FASB issued SFAS 132, Employers' Disclosures about Pensions and Other Postretirement Benefits. This standard requires expanded disclosure effective for 1998. Also in 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which will be effective for 1999. CMS Energy does not expect the application of these standards to materially affect its financial position, liquidity or results of operations. In addition, in 1998, the FASB issued SFAS 133, Accounting for Derivative Instruments and Hedging Activities, which requires that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. SFAS 133 is effective for fiscal years beginning after June 15, 1999. CMS Energy has not yet quantified the impacts of adopting SFAS 133 on its financial statements and has not determined the timing of or method of adoption of SFAS 133. However, SFAS 133 could increase volatility in earnings and other comprehensive income. Year 2000 Computer Modifications CMS Energy uses software and related technologies throughout its domestic and international businesses that the year 2000 date change will affect and, if uncorrected, could cause CMS Energy to, among other things, issue inaccurate bills, report inaccurate data, incur generating plant outages, or create energy delivery uncertainties. In 1995, CMS Energy established a Year 2000 Program to ensure the continued operation of the company at the turn of the century. CMS Energy's efforts included dividing the programs requiring modification between critical and noncritical programs. A formal methodology was established to identify critical business functions and risk scenarios, develop test plans and expected results, and execute tests. CMS Energy's Year 2000 Program involves an aggressive, comprehensive four-phase approach, including impact analysis, remediation, compliance review, and monitoring/contingency planning. The impact analysis phase includes the analysis, inventory, prioritization and remediation plan development for all technology essential to core business processes. The remediation phase involves testing and implementation of remediation technology. A mainframe test environment was established in 1997 and a test environment for network servers and stand-alone personal computers was established in mid-1998. All essential corporate business systems have been, or will be, tested in these test environments. The compliance review phase includes the assembling of compliance documentation for each technology component as remediation efforts are completed, and additional verification testing of essential technology where necessary. The monitoring/contingency planning phase includes compliance monitoring to ensure that year 2000 problems are not reintroduced into remediated technology, as well as the development of contingency plans to address reasonably likely risk scenarios. State of Readiness: CMS Energy is managing traditional information technology (IT), which consists of essential business systems such as payroll, billing, and purchasing, and infrastructure, including mainframe, wide area network, local area networks, personal computers, radios and telephone systems. CMS Energy is also managing process control computers and embedded systems contained in buildings, equipment and energy supply and delivery systems. Essential goods and services for CMS Energy are electric fuel supply, gas fuel supply, independent electric power supplies, facilities, electronic commerce, telecommunications network carriers, financial institutions, purchasing vendors, and software and hardware technology vendors. CMS Energy is addressing the preparedness of these businesses and their risk through readiness assessment questionnaires. The status of CMS Energy's Year 2000 Program by phase, with target dates for completion and current percentage complete based upon software and hardware inventory counts as of September 30, 1998, is as follows: Monitoring/ Impact Compliance Contingency Analysis Remediation Review Planning - ------------------------------------------------------------------------ (a) (b) (a) (b) (a) (b) (a) (b) Electric utility 3/98 100% 6/99 53% 6/99 22% 6/99 10% Gas utility 3/98 100% 6/99 66% 6/99 3% 6/99 10% Independent power production 12/98 55% 9/99 17% 9/99 0% 9/99 10% Oil and gas 12/98 79% 9/99 60% 9/99 0% 9/99 50% Natural gas transmission 12/98 45% 9/99 50% 9/99 0% 9/99 5% Marketing, services and trading 12/98 77% 9/99 50% 9/99 50% 9/99 10% Essential goods and services 6/99 35% N/A 9/99 0% 6/99 10% ========================================================================== (a) Target date for completion. (b) Current percentage complete. Cost of Remediation: CMS Energy will expense anticipated spending for modifications as incurred, while capitalizing and amortizing the cost for new software over its useful life. The total estimated cost of the Year 2000 Program is approximately $30 million. Costs incurred through September 30, 1998 are approximately $15 million. CMS Energy's annual Year 2000 Program costs have represented approximately 2% to 10% of CMS Energy's annual IT budget through 1998 and are expected to represent approximately 25% of CMS Energy's annual IT budget in 1999. Year 2000 compliance work is being funded primarily from operations. The devotion of CMS Energy resources to the year 2000 problem has not deferred any material IT projects which could have a material adverse affect on CMS Energy's financial position, liquidity or results of operations. Risk Assessment: CMS Energy considers the most reasonably likely worst- case scenarios to be: (1) a lack of communications to dispatch crews to electric or gas emergencies, (2) a lack of communications to contact generating units to balance electrical load, (3) power shortages due to the lack of stability of the electric grid and (4) a failure of fuel suppliers to deliver fuel to generating facilities. These scenarios could result in CMS Energy not being able to generate or distribute enough energy to meet customer demand for a period of time, which could result in lost sales and profits. Year 2000 remediation and testing efforts are concentrating on these risk areas and will continue through the end of 1999. Contingency plans will be revised and executed to further mitigate the risks associated with these scenarios. Contingency Plans: Contingency planning efforts are currently underway for all business systems and providers of essential goods and services. Extensive contingency plans are already in place in many locations and are currently being revised for reasonably likely worst-case scenarios related to year 2000 issues. In many cases, Consumers already has arrangements with multiple vendors of similar goods and services so that in the event that one cannot meet its commitments, others can. Current contingency plans provide for manual dispatching of crews and manual coordination of electrical load balancing and are being revised to provide for radio or satellite communications. Coordinated contingency planning efforts are in progress with third parties to minimize risk to electric generation, transmission and distribution systems. Expectations: CMS Energy does not expect that the cost of these modifications will materially affect its financial position, liquidity, or results of operations. There can be no guarantee, however, that these costs, plans or time estimates will be achieved, and actual results could differ materially. Because of the integrated nature of CMS Energy's business with other energy companies, utilities, jointly owned facilities operated by other entities, and business conducted with suppliers and large customers, CMS Energy may be indirectly affected by year 2000 compliance complications. At this time, CMS Energy is unable to anticipate the magnitude of the operational or financial impact on CMS Energy of year 2000 issues. Foreign Currency Translation CMS Energy adjusts common stockholders' equity to reflect foreign currency translation adjustments for the operation of long-term investments in foreign countries. As of September 30, 1998 the cumulative foreign currency translation adjustment was $132 million. The adjustment is primarily due to the exchange rate fluctuations between the U.S. dollar and each of the Australian dollar and Brazilian real. From January 1, 1998 through September 30, 1998, the change in the foreign currency translation adjustment totaled $36 million. Although management currently believes that the currency exchange rate fluctuations over the long term will not materially adversely affect CMS Energy's financial position, liquidity or results of operations, CMS Energy has hedged its exposure to the Australian dollar and the Brazilian real. CMS Energy uses forward exchange contracts and collared options to hedge certain receivables, payables, long-term debt and equity value relating to foreign investments. The notional amount of the outstanding foreign exchange contracts was $845 million at September 30, 1998, which includes $550 million and $250 million for Australian and Brazilian foreign exchange contracts, respectively. Forward-Looking Information Forward-looking information is included throughout this report. This report also describes material contingencies in the Notes to the Consolidated Financial Statements and should be read accordingly. Some important factors that could cause actual results or outcomes to differ are set forth in CMS Energy's 1997 Form 10-K, "Management's Discussion and Analysis-Forward-Looking Information." 25 CMS Energy Corporation Consolidated Statements of Income (Unaudited)
Three Months Ended Nine Months Ended Twelve Months Ended September 30 1998 1997* 1998 1997* 1998 1997* In Millions, Except Per Share Amounts Operating Revenue Electric utility $ 729 $ 670 $1,990 $1,888 $2,617 $2,507 Gas utility 117 110 716 828 1,092 1,230 Independent power production 95 45 214 116 266 148 Natural gas transmission, storage and processing 20 19 69 71 94 90 Oil and gas exploration and production 15 30 46 67 72 103 Marketing, services and trading 305 153 748 366 1,074 433 Other 5 3 9 11 11 16 ------ ------ ------ ------ ------ ------ 1,286 1,030 3,792 3,347 5,226 4,527 ------ ------ ------ ------ ------ ------ Operating Expenses Operation Fuel for electric generation 109 85 273 234 359 316 Purchased power - related parties 143 151 433 447 585 600 Purchased and interchange power 77 65 220 180 282 235 Cost of gas sold 154 164 799 785 1,325 1,100 Other 371 191 830 540 1,031 753 ------ ------ ------ ------ ------ ------ 854 656 2,555 2,186 3,582 3,004 Maintenance 49 40 128 122 180 180 Depreciation, depletion and amortization 112 108 347 342 472 458 General taxes 49 48 155 157 209 209 ------ ------ ------ ------ ------ ------ 1,064 852 3,185 2,807 4,443 3,851 ------ ------ ------ ------ ------ ------ Pretax Operating Income (Loss) Electric utility 153 132 378 342 468 423 Gas utility 6 (1) 81 100 134 142 Independent power production 57 32 123 67 152 73 Natural gas transmission, storage and processing 6 6 28 22 33 27 Oil and gas exploration and production 2 13 12 16 22 22 Marketing, services and trading 2 - 2 1 (4) 1 Other (4) (4) (17) (8) (22) (12) ------ ------ ------ ------ ------ ------ 222 178 607 540 783 676 ------ ------ ------ ------ ------ ------ Other Income (Deductions) Loss on MCV power purchases - - (37) - (37) - Accretion income 1 2 5 6 7 8 Accretion expense (4) (4) (12) (13) (16) (14) Other, net (3) 3 2 5 (6) 2 ------ ------ ------ ------ ------ ------ (6) 1 (42) (2) (52) (4) ------ ------ ------ ------ ------ ------ Fixed Charges Interest on long-term debt 79 71 234 198 309 254 Other interest 8 12 33 34 48 47 Capitalized interest (6) (3) (17) (9) (21) (11) Preferred dividends 5 6 14 20 19 27 Preferred securities distributions 8 6 24 11 31 13 ------ ------ ------ ------ ------ ------ 94 92 288 254 386 330 ------ ------ ------ ------ ------ ------ Income Before Income Taxes 122 87 277 284 345 342 Income Taxes 41 27 86 99 95 119 ------ ------ ------ ------ ------ ------ Consolidated Net Income before cumulative effect of change in accounting principle 81 60 191 185 250 223 Cumulative effect of change in accounting for property taxes, net of $23 tax (Note 1) - - 43 - 43 - ------ ------ ------ ------ ------ ------ Consolidated Net Income $ 81 $ 60 $ 234 $ 185 $ 293 $ 223 ====== ====== ====== ====== ====== ======
26
Three Months Ended Nine Months Ended Twelve Months Ended September 30 1998 1997* 1998 1997* 1998 1997* In Millions, Except Per Share Amounts Net Income (Loss) Attributable to Common Stocks CMS Energy $ 83 $ 62 $ 226 $ 176 $ 279 $ 210 Class G $ (2) $ (2) $ 8 $ 9 $ 14 $ 13 ------ ------ ------ ------ ------ ------ Average Common Shares Outstanding CMS Energy 102 96 101 95 101 95 Class G 8 8 8 8 8 8 ------ ------ ------ ------ ------ ------ Basic Earnings (Loss) Per Average Common Share Before Change in Accounting Principle CMS Energy $ .81 $ .64 $ 1.83 $ 1.85 $ 2.37 $ 2.22 Class G $ (.16) $ (.21) $ .68 $ 1.13 $ 1.37 $ 1.57 ------ ------ ------ ------ ------ ------ Cumulative Effect of Change in Accounting Principle, Net of Tax, Per Average Common Share CMS Energy $ - $ - $ .40 $ - $ .40 $ - Class G $ - $ - $ .36 $ - $ .36 $ - ------ ------ ------ ------ ------ ------ Basic Earnings (Loss) Per Average Common Share CMS Energy $ .81 $ .64 $ 2.23 $ 1.85 $ 2.77 $ 2.22 Class G $ (.16) $ (.21) $ 1.04 $ 1.13 $ 1.73 $ 1.57 ------ ------ ------ ------ ------ ------ Diluted Earnings (Loss) Per Average Common Share CMS Energy $ .80 $ .63 $ 2.19 $ 1.83 $ 2.73 $ 2.20 Class G $ (.16) $ (.21) $ 1.04 $ 1.13 $ 1.73 $ 1.57 ------ ------ ------ ------ ------ ------ Dividends Declared Per Common Share CMS Energy $ .33 $ .30 $ .93 $ .84 $ 1.23 $ 1.11 Class G $ .325 $ .31 $ .945 $ .90 $ 1.255 $1.195 ------ ------ ------ ------ ------ ------ * Restated, see Note 1. The accompanying condensed notes are an integral part of these statements.
27 CMS Energy Corporation Consolidated Balance Sheets
ASSETS September 30 September 30 1998 December 31 1997* (Unaudited) 1997* (Unaudited) In Millions Plant and Property (At Cost) Electric $ 6,641 $ 6,491 $ 6,447 Gas 2,498 2,528 2,502 Oil and gas properties (successful efforts method) 637 566 533 Other 320 168 100 ------- ------- ------- 10,096 9,753 9,582 Less accumulated depreciation, depletion and amortization 5,052 4,870 4,784 ------- ------- ------- 5,044 4,883 4,798 Construction work-in-progress 226 261 332 ------- ------- ------- 5,270 5,144 5,130 ------- ------- ------- Investments Independent power production 868 792 819 Natural gas transmission, storage and processing 341 241 236 International energy distribution 272 255 65 First Midland Limited Partnership (Note 2) 237 242 239 Midland Cogeneration Venture Limited Partnership (Note 2) 199 171 163 Other 35 45 46 ------- ------- ------- 1,952 1,746 1,568 ------- ------- ------- Current Assets Cash and temporary cash investments at cost, which approximates market 101 69 136 Accounts receivable and accrued revenue, less allowances of $8, $7 and $7, respectively (Note 3) 457 495 401 Inventories at average cost Gas in underground storage 276 197 253 Materials and supplies 91 87 95 Generating plant fuel stock 29 35 26 Deferred income taxes 14 38 18 Prepayments and other 170 235 108 ------- ------- ------- 1,138 1,156 1,037 ------- ------- ------- Non-current Assets Nuclear decommissioning trust funds 510 486 478 Postretirement benefits 381 404 411 Abandoned Midland Project 77 93 98 Other 602 479 499 ------- ------- ------- 1,570 1,462 1,486 ------- ------- ------- Total Assets $ 9,930 $ 9,508 $ 9,221 ======= ======= =======
28
STOCKHOLDERS' INVESTMENT AND LIABILITIES September 30 September 30 1998 December 31 1997* (Unaudited) 1997* (Unaudited) In Millions Capitalization Common stockholders' equity $ 1,922 $ 1,787 $ 1,649 Preferred stock of subsidiary 238 238 238 Company-obligated mandatorily redeemable Trust Preferred Securities of: Consumers Power Company Financing I (a) 100 100 100 Consumers Energy Company Financing II (a) 120 120 120 Company-obligated convertible Trust Preferred Securities of CMS Energy Trust I (b) 173 173 173 Long-term debt 4,248 3,272 3,060 Non-current portion of capital leases 77 75 82 ------- ------- ------- 6,878 5,765 5,422 ------- ------- ------- Current Liabilities Current portion of long-term debt and capital leases 171 643 911 Notes payable 302 382 394 Accounts payable 309 398 326 Accrued taxes 144 272 146 Accounts payable - related parties 90 80 70 Accrued interest 64 51 61 Power purchases (Note 2) 47 47 47 Accrued refunds 12 12 7 Other 189 190 191 ------- ------- ------- 1,328 2,075 2,153 ------- ------- ------- Non-current Liabilities Deferred income taxes 654 648 581 Postretirement benefits 499 514 520 Deferred investment tax credit 144 151 154 Power purchases (Note 2) 134 133 144 Regulatory liabilities for income taxes, net 83 54 86 Other 210 168 161 ------- ------- ------- 1,724 1,668 1,646 ------- ------- ------- Commitments and Contingencies (Note 2) Total Stockholders' Investment and Liabilities $ 9,930 $ 9,508 $ 9,221 ======= ======= ======= (a) The primary asset of Consumers Power Company Financing I is $103 million principal amount of 8.36 percent subordinated deferrable interest notes due 2015 from Consumers. The primary asset of Consumers Energy Company Financing II is $124 million principal amount of 8.20 percent subordinated deferrable interest notes due 2027 from Consumers. (b) The primary asset of CMS Energy Trust I is $178 million principal amount of 7.75 percent convertible subordinated debentures due 2027 from CMS Energy. * Restated, see Note 1. The accompanying condensed notes are an integral part of these statements.
29 CMS Energy Corporation Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended Twelve Months Ended September 30 1998 1997* 1998 1997* In Millions Cash Flows from Operating Activities Consolidated net income $ 234 $ 185 $ 293 $ 223 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear decommissioning of $38, $37, $51 and $49, respectively) 347 342 472 458 Deferred income taxes and investment tax credit 61 11 74 30 Loss on MCV power purchases 37 - 37 - Capital lease and debt discount amortization 29 36 37 44 Accretion expense 12 13 16 14 Accretion income - abandoned Midland project (5) (6) (7) (8) Undistributed earnings of related parties (36) (40) (54) (47) MCV power purchases (48) (47) (63) (67) Cumulative effect of accounting change for property taxes (66) - (66) - Other (8) (10) (7) 7 Changes in other assets and liabilities (171) (150) (56) (179) ------- ------- ------- ------- Net cash provided by operating activities 386 334 676 475 ------- ------- ------- ------- Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (448) (509) (617) (740) Investments in partnerships and unconsolidated subsidiaries (234) (588) (476) (604) Cost to retire property, net (65) (26) (68) (37) Investments in nuclear decommissioning trust funds (38) (37) (51) (49) Investment in Electric Restructuring Implementation Plan (9) - (10) - Other (7) (27) 8 (23) Proceeds from sale of property 56 46 59 91 Proceeds from nuclear decommissioning trust funds 43 - 43 - Proceeds from FMLP 12 - 12 - ------- ------- ------- ------- Net cash used in investing activities (690) (1,141) (1,100) (1,362) ------- ------- ------- ------- Cash Flows from Financing Activities Proceeds from bank loans, notes and bonds 1,636 827 2,023 875 Issuance of common stock 49 60 213 126 Retirement of bonds and other long-term debt (621) (73) (1,069) (73) Repayment of bank loans (520) (32) (517) (24) Payment of common stock dividends (102) (87) (134) (115) Increase (decrease) in notes payable, net (80) 61 (92) 53 Payment of capital lease obligations (26) (35) (35) (42) Proceeds from preferred securities - 286 - 286 Retirement of preferred stock - (120) - (120) Retirement of common stock - (2) - (2) ------- ------- ------- ------- Net cash provided by financing activities 336 885 389 964 ------- ------- ------- ------- Net Increase (Decrease) in Cash and Temporary Cash Investments 32 78 (35) 77 Cash and Temporary Cash Investments, Beginning of Period 69 58 136 59 ------- ------- ------- ------- Cash and Temporary Cash Investments, End of Period $ 101 $ 136 $ 101 $ 136 ======= ======= ======= ======= Other cash flow activities and non-cash investing and financing activities were: Cash transactions Interest paid (net of amounts capitalized) $ 229 $ 201 $ 321 $ 267 Income taxes paid (net of refunds) 51 57 61 78 Non-cash transactions Nuclear fuel placed under capital lease $ 21 $ 4 $ 21 $ 24 Other assets placed under capital leases 11 5 12 6 ======= ======= ======= ======= All highly liquid investments with an original maturity of three months or less are considered cash equivalents. *Restated, see Note 1. The accompanying condensed notes are an integral part of these statements.
30 CMS Energy Corporation Consolidated Statements of Common Stockholders' Equity (Unaudited)
Three Months Ended Nine Months Ended Twelve Months Ended September 30 1998 1997* 1998 1997* 1998 1997* In Millions Common Stock At beginning and end of period $ 1 $ 1 $ 1 $ 1 $ 1 $ 1 ------ ------ ------ ------ ----- ------ Other Paid-in Capital At beginning of period 2,297 2,075 2,267 2,045 2,103 1,979 Common stock reacquired - (2) - (2) - (2) Common stock issued: CMS Energy 18 28 45 56 206 120 Class G 1 2 4 4 7 6 ------ ------ ------ ------ ------ ------ At end of period 2,316 2,103 2,316 2,103 2,316 2,103 ------ ------ ------ ------ ------ ------ Revaluation Capital At beginning of period (6) (6) (6) (6) (4) (7) Change in unrealized investment-gain (loss) (a) (10) 2 (10) 2 (12) 3 ------ ------ ------ ------ ------ ------ At end of period (16) (4) (16) (4) (16) (4) ------ ------ ------ ------ ------ ------ Foreign Currency Translation At beginning of period (123) - (96) - (45) - Change in foreign currency translation (a) (9) (45) (36) (45) (87) (45) ------ ------ ------ ------ ------ ------ At end of period (132) (45) (132) (45) (132) (45) ------ ------ ------ ------ ------ ------ Retained Earnings (Deficit) At beginning of period (292) (435) (379) (504) (406) (514) Consolidated net income (a) 81 60 234 185 293 223 Common stock dividends declared: CMS Energy (33) (28) (94) (80) (123) (105) Class G (3) (3) (8) (7) (11) (10) ------ ------ ------ ------ ------ ------ At end of period (247) (406) (247) (406) (247) (406) ------ ------ ------ ------ ------ ------ Total Common Stockholders' Equity $1,922 $1,649 $1,922 $1,649 $1,922 $1,649 ====== ====== ====== ====== ====== ====== (a) Disclosure of Comprehensive Income: Revaluation capital Unrealized investment-gain (loss), net of tax of $5, $-, $5, $-, $6 and $(1), respectively $ (10) $ 2 $ (10) $ 2 $ (12) $ 3 Foreign currency translation (9) (45) (36) (45) (87) (45) Consolidated net income 81 60 234 185 293 223 ------ ------ ------ ------ ------ ------ Total Consolidated Comprehensive Income $ 62 $ 17 $ 188 $ 142 $ 194 $ 181 ====== ====== ====== ====== ====== ====== * Restated, see Note 1. The accompanying condensed notes are an integral part of these statements.
31 CMS Energy Corporation Condensed Notes to Consolidated Financial Statements These Consolidated Financial Statements and their related Condensed Notes should be read along with the Consolidated Financial Statements and Notes contained in the 1997 Form 10-K and the restated financial information in a Form 8-K dated July 30, 1998 of CMS Energy, which include the Reports of Independent Public Accountants. Certain prior year amounts have been reclassified to conform with the presentation in the current year. In the opinion of management, the unaudited information herein reflects all adjustments necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. 1: Corporate Structure, Basis of Presentation And Changes of Significant Accounting Policies Corporate Structure and Basis of Presentation CMS Energy is the parent holding company of Consumers and Enterprises. Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan and is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Enterprises is engaged in several domestic and international energy-related businesses including: acquisition, development and operation of independent power production facilities; oil and gas exploration and production; transmission, storage, and processing of natural gas; energy marketing, services and trading; and international energy distribution. CMS Energy uses the equity method of accounting for investments in companies and partnerships where it has more than a 20 percent but less than a majority ownership interest and includes these results in operating income. For the three, nine and twelve month periods ended September 30, 1998, undistributed equity earnings were $2 million, $36 million and $54 million, respectively, compared to $19 million, $40 million and $47 million for the three, nine and twelve month periods ended September 30, 1997. Foreign currency translation adjustments relating to the operation of CMS Energy's long-term investments in foreign countries are included in common stockholders' equity. As of September 30, 1998 the cumulative foreign currency translation adjustment was $132 million relating primarily to the U.S. and Australian dollar exchange rate fluctuations related to Loy Yang. From January 1, 1998 through September 30, 1998, the change in the foreign currency translation adjustment totaled $36 million. In October 1998, CMS Energy changed the name of its oil and gas exploration and production business to CMS Oil and Gas Company, formerly known as CMS NOMECO Oil & Gas Co. In 1997, the FASB issued SFAS 130, Reporting Comprehensive Income. This statement, which is effective for 1998 financial statement reporting, establishes standards for reporting and display of comprehensive income and its components. Equity adjustments related to unrealized investment gains and losses (net of tax) and foreign currency translation, along with consolidated net income, comprise comprehensive income. Change in Method of Accounting for Property Taxes During the first quarter of 1998, Consumers implemented a change in the method of accounting for property taxes so that such taxes are recognized during the fiscal period of the taxing authority for which the taxes are levied. This change provides a better matching of property tax expense with the services provided by the taxing authorities, and is considered the most acceptable basis of recording property taxes. Prior to 1998, Consumers recorded property taxes monthly during the year following the assessment date (December 31). The cumulative effect of this one-time change in accounting increased other income by $66 million, and earnings, net of tax, by $43 million or $.40 per share. The pro forma effect on prior years' consolidated net income of retroactively recording property taxes as if the new method of accounting had been in effect for all periods presented is not material. Change in Method of Accounting For Investments in Oil and Gas Properties CMS Oil and Gas elected to convert effective January 1, 1998 from the full cost method to the successful efforts method of accounting for its investments in oil and gas properties. CMS Oil and Gas believes this accounting change will more accurately present the results of its exploration and development activities and minimize asset write-offs caused by periodic price swings, which may not be representative of overall or long-term markets. In addition, the FASB has stated a preference for the use of successful efforts accounting. Nitrotec, in which CMS Gas Transmission has an equity investment, also elected to convert effective January 1, 1998 from the full cost method of accounting to the successful efforts method of accounting. Accordingly, all prior period financial statements have been restated to conform with successful efforts accounting. The effect, after tax, of the change in accounting method as of December 31, 1997, was a reduction to retained earnings of $175 million for CMS Oil and Gas and $15 million for CMS Gas Transmission, primarily attributable to a decrease in net plant and property and deferred tax liability of $270 million and $95 million, respectively, for CMS Oil and Gas and a $15 million decrease in CMS Gas Transmission's equity investment in Nitrotec. For the three, nine and twelve months ended September 30, 1997, the combined effects of the changes in accounting method resulted in decreases to net income of $6 million ($.06 per share), $19 million ($.19 per share), and $25 million ($.26 per share), respectively. Oil and Gas Properties CMS Oil and Gas utilizes the successful efforts method of accounting for its investments in oil and gas properties. CMS Oil and Gas capitalizes the costs of property acquisitions, successful exploratory wells, all development costs, and support equipment and facilities when incurred. It expenses unsuccessful exploratory wells when they are determined to be non-productive. CMS Oil and Gas also charges to expense production costs, overhead, and all exploration costs other than exploratory drilling as incurred. Depreciation, depletion and amortization of proved oil and gas properties is determined on a field-by-field basis using the unit-of- production method over the life of the remaining proved reserves. Business Combination In October 1998, CMS Energy exchanged 1.4 million shares of CMS Energy Common Stock for 100% of the outstanding common stock of Continental Natural Gas, Inc. ("CNG"), an energy company engaged in gathering, processing, purchasing and marketing natural gas and natural gas liquids in Oklahoma and Texas. The acquisition of CNG will be accounted for as a pooling of interests, and all consolidated financial data for the periods subsequent to December 31, 1997 will be restated to include the financial data of CNG. The financial data of the pooled companies prior to January 1, 1998 will not be materially different from that previously reported by CMS Energy, and thus will not be restated. 2: Uncertainties Consumers' Electric Business Unit Contingencies Electric Environmental Matters: The Clean Air Act limits emissions of sulfur dioxide and nitrogen oxides and requires emissions monitoring. Consumers' coal-fueled electric generating units burn low-sulfur coal and are currently operating at or near the sulfur dioxide emission limits that will be effective in the year 2000. During the past few years, in order to comply with the Act, Consumers incurred capital expenditures totaling $46 million to install equipment at certain generating units. Consumers estimates capital expenditures for ongoing and proposed modifications at other coal-fueled units to be an additional $26 million by the year 2000. Management believes that these expenditures will not materially affect Consumers' annual operating costs. Consumers currently operates within all Clean Air Act requirements and meets current emission limits. The Act requires the EPA to review, periodically, the effectiveness of the national air quality standards in preventing adverse health affects. In 1997 the EPA revised these standards. Monitoring for the new standards is reasonably likely to result in further limitations on small particulate and ozone related emissions. Following completion of the Ozone Transport Assessment Group process and requests by several Northeastern states, in September 1998, the EPA Administrator signed final regulations requiring the State of Michigan to further limit nitrogen oxide emissions. Fossil-fueled emitters, such as Consumers' generating units, can anticipate reduction in nitrogen oxide emissions by 2003 to only 32 percent of levels allowed for the year 2000. The State of Michigan has one year to submit an implementation plan. It is unlikely that the State of Michigan will establish Consumers' nitrogen oxide emissions reduction target until mid-to-late 1999. Until this target is established, the estimated cost of compliance is subject to significant revision. The preliminary estimate of capital costs to reduce nitrogen oxide-related emissions for Consumers' fossil-fueled generating units is approximately $290 million, plus an additional amount totaling $10 million per year for operation and maintenance costs. Consumers may need an equivalent amount of capital expenditures and operation and maintenance costs to comply with the new small particulate standards. The State of Michigan has objected to the extent of the required EPA emission reductions. If a court were to order the EPA to adopt the State of Michigan's position, costs could be less than the current estimated amounts. Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites. Nevertheless, it believes that these costs are properly recoverable in rates under current ratemaking policies. Consumers is a so-called potentially responsible party at several contaminated sites administered under Superfund. Superfund liability is joint and several; along with Consumers, many other creditworthy, potentially responsible parties with substantial assets cooperate with respect to the individual sites. Based upon past negotiations, Consumers estimates that its share of the total liability for the known Superfund sites will be between $3 million and $9 million. At September 30, 1998, Consumers has accrued $3 million for its estimated Superfund liability. While decommissioning Big Rock, Consumers found that some areas of the plant have coatings that contain both metals and PCBs. Consumers does not believe that any facility in the United States currently accepts the radioactive portion of that waste. The cost of removal and disposal is currently unknown. These costs would constitute part of the cost to decommission the plant, and will be paid from the decommissioning fund. Consumers is studying the extent of the contamination and reviewing options. Stray Voltage: Various parties have sued Consumers relating to the effect of so-called stray voltage on certain livestock. Claimants contend that stray voltage results when low-level electrical currents present in grounded electrical systems are diverted from their intended path. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns. It also has an ongoing mitigation program to modify the service of all customers with livestock. In December 1997, the Michigan Supreme Court remanded for further proceedings a 1994 Michigan trial court decision that refused to allow the claims of over 200 named plaintiffs to be joined in a single action. The trial court dismissed all of the plaintiffs except the first-named plaintiff, allowing the others to re-file separate actions. Of the original plaintiffs, only 49 re-filed separate cases. All of those 49 cases have been resolved. The Michigan Supreme Court remanded the matter, finding that the proper remedy for misjoinder was not dismissal, but to automatically allow each case to go forward separately. Consumers filed a motion for reconsideration with the Michigan Supreme Court, which was denied. As a result, 21 individual plaintiffs elected to exercise their right to proceed with separate actions. Consumers has now resolved all 21 of those cases. As of November 3, 1998, Consumers had 3 individual stray voltage lawsuits awaiting trial court action, down from 12 cases as reported at year end 1997. Anti-Trust: In October 1997, two independent power producers sued Consumers and CMS Energy in a federal court. The suit alleges antitrust violations relating to contracts which Consumers entered into with some of its customers and claims relating to power facilities. The plaintiffs claim damages of $100 million (which a court can treble in antitrust cases as provided by law). In September 1998, the court issued an opinion and order granting CMS Energy's motion to dismiss. The court has not yet ruled on Consumers' motion to dismiss. Consumers believes the lawsuit is without merit and will vigorously defend against it, but cannot predict the outcome of this matter. Consumers' Electric Business Unit Rate Matters Electric Proceedings: In 1996, the MPSC issued a final order that authorized Consumers to recover costs associated with the purchase of the additional 325 MW of MCV Facility capacity (see "Power Purchases from the MCV Partnership" in this Note) and recover its nuclear plant investment by increasing prospective annual nuclear plant depreciation expense by $18 million, with a corresponding decrease in fossil-fueled generating plant depreciation expense. It also established an experimental direct-access program. Customers having a maximum demand of at least 2 MW are eligible to purchase generation services directly from any eligible third-party power supplier and Consumers would transmit the power for a fee. The direct-access program is limited to 134 MW of load. In accordance with the MPSC order, Consumers held a lottery in April 1997 to select the customers to participate in the direct-access program. Subsequently, direct access for a portion of this 134 MW began in late 1997. Consumers expects the remaining amount of direct access to begin later in 1998. In January 1998, the Court of Appeals affirmed an MPSC conclusion that the MPSC has statutory authority to authorize an experimental electric retail wheeling program. By its terms, no retail wheeling has yet occurred pursuant to that program. In October 1998, the Michigan Supreme Court issued an order granting Consumers' application for leave to appeal. A decision by the Michigan Supreme Court in this matter is expected in mid- 1999. For information on other orders, see the Electric Restructuring section below. Electric Restructuring: As part of ongoing proceedings relating to the restructuring of the electric utility industry in Michigan, in June 1997 the MPSC issued an order proposing that beginning January 1, 1998 Consumers transmit and distribute energy on behalf of competing power suppliers to serve retail customers. Subsequent to the June 1997 order, the MPSC issued further restructuring orders in October 1997 and in January and February 1998. These orders provide for: 1) the recovery of estimated Transition Costs of $1.755 billion through a charge to all direct-access customers until the end of the transition period in 2007, subject to an adjustment through a true-up mechanism; 2) the commencement of the phase-in of direct-access in 1998; 3) the suspension of the power supply cost recovery clause; and 4) all customers to be free to choose power suppliers on January 1, 2002. See "Other Electric Uncertainties" below for further information regarding the effect of the PSCR suspension on the recovery of MCV Facility capacity charges. Consumers believes that the Transition Cost surcharge will apply to all customers beginning in 2002. The recovery of prudent costs of implementing a direct-access program, estimated at an additional $200 million, would be reviewed for prudence and recovered via a charge approved by the MPSC. Nuclear decommissioning costs will also continue to be collected through a separate surcharge to all customers. Consumers expects Michigan legislative consideration of the entire subject of electric industry restructuring in 1998. To be acceptable to Consumers, the legislation would have to provide for full recovery of Transition Costs. Consumers expects the legislature to review all of the policy choices made by the MPSC during the restructuring proceedings to assure that they are in accord with those that the legislature believes should be paramount. There are numerous appeals pending at the Court of Appeals relating to the MPSC's restructuring orders, including appeals by Consumers and Detroit Edison. Consumers believes that the MPSC lacks statutory authority to mandate industry restructuring, and its appeal is limited to this jurisdictional issue. As a result of an informal process involving consultations with MPSC staff and other interested parties, as directed in the MPSC's February 1998 order, Consumers submitted to the MPSC in June 1998 its plan for implementing direct access. The primary issues addressed in the plan are: 1) the implementation schedule; 2) the direct-access service options available to customers and suppliers; 3) the process and requirements for customers and others to obtain direct-access service; and 4) the roles and responsibilities for Consumers, customers and suppliers. Under the schedule in the plan, Consumers will, over the 1998-2001 period, phase-in 750 MW of retail customer load to direct-access customers. At one time, 300 MW of direct-access load was to be opened for bidding in 1998, and an additional 150 MW each year from 1999 to 2001. This plan is consistent with the previous orders regarding the phase-in process. Due to the time required for the MPSC to review the plan, Consumers does not believe direct access will commence prior to the first quarter of 1999. For further information regarding the effects of the restructuring on accounting methods, see Consumers' Electric Business Unit Outlook - Electric Application of SFAS 71 in the MD&A. CMS Energy cannot predict the outcome or timing of electric restructuring on CMS Energy's financial position, liquidity, or results of operations. On October 2, 1998, Consumers initiated a process for the solicitation of bids to acquire Consumers' rights to 1,240 MW of contract capacity and associated energy under its PPA with the MCV Partnership. Consumers' rights to the 1,240 MW of contract capacity and associated energy are being offered in one 1,240 MW block or in two 620 MW pieces, for the period from the effective date in 1999 through either September 2007 or March 2025. Consumers has reserved the right at any time, in its sole discretion, to terminate the bidding process or to reject any or all bids. Consumers will not consummate a transaction unless important customer benefits flow from that transaction. Any such transaction would be subject to the approval of Consumers' Board of Directors and obtaining satisfactory rate making and accounting treatment from the MPSC and the FERC with respect to the definitive agreements, including any necessary approval by FERC of the transfer of the 1,240 MW of contract capacity and associated energy. In an order issued October 12, 1998, the MPSC delayed its consideration of the auction process until the definitive agreements with the winning bidder(s) are presented for review, but stated that Consumers' approach offers a legitimate way to utilize independent market forces to determine the above-market or stranded portion of Consumers' obligations under the PPA with the MCV Partnership. Consumers anticipates that such definitive agreements, if any, will be negotiated by early February 1999 and appropriate filings will be made with MPSC for consideration during the first quarter of 1999. Other Consumers' Electric Business Unit Uncertainties 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 and to supply electricity and steam to Dow. Consumers, through two wholly owned subsidiaries, holds the following assets related to the MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through FMLP, a 35 percent lessor interest in the MCV Facility. Summarized Statements of Income for CMS Midland and CMS Holdings- In Millions - -------------------------------------------------------------------------- Three Months Ended Nine Months Ended Twelve Months Ended September 30 1998 1997 1998 1997 1998 1997 - -------------------------------------------------------------------------- Pretax operating income $13 $18 $36 $36 $46 $45 Income taxes and other 4 6 11 11 14 13 - ------------------------------------------------------------------------- Net income $ 9 $12 $25 $25 $32 $32 ========================================================================= Power Purchases from the MCV Partnership- After September 2007, pursuant to the terms of the PPA and related undertakings, Consumers will only be required to pay the MCV Partnership the capacity charge and energy charge amounts authorized for recovery from electric customers by the MPSC. Currently, Consumers' annual obligation to purchase capacity from the MCV Partnership is 1,240 MW through the termination of the PPA in 2025. The PPA provides that Consumers is to pay the MCV Partnership a levelized average capacity charge of 3.77 cents per kWh, a fixed energy charge, and a variable energy charge based primarily on Consumers' average cost of coal consumed. The MPSC has, since January 1, 1993, permitted Consumers to recover capacity charges averaging 3.62 cents per kWh for 915 MW, plus a substantial portion of the fixed and variable energy charges. Beginning January 1, 1996, the MPSC has also permitted Consumers to recover capacity charges for the remaining 325 MW of MCV Facility contract capacity. The order approving such recovery indicated that the recoverable capacity charge for the 325 MW would gradually increase from an initial average charge of 2.86 cents per kWh to an average charge of 3.62 cents per kWh by 2004, which latter would be collected thereafter. Because the MPSC suspended the PSCR process as part of the electric industry restructuring order (see "Electric Restructuring" in this Note), Consumers expects to recover the future increases approved for the 325 MW capacity through an adjustment to the frozen PSCR level; this adjustment is currently under consideration by the MPSC. Consumers recognized a loss in 1992 for the present value of the estimated future underrecoveries of power costs under the PPA. At September 30, 1998 and December 31,1997, the after-tax present value of the PPA liability totaled $118 million and $117 million, respectively. The increase in the liability since December 31, 1997 reflects an additional $37 million accrual ($24 million after-tax) for higher than anticipated MCV Facility availability levels experienced in prior periods and an after-tax accretion expense of $8 million, partially offset by after-tax cash underrecoveries of $31 million. The undiscounted after-tax amount associated with the liability totaled $170 million at September 30, 1998. The after-tax cash underrecoveries are currently based on the assumption that the MCV Facility will be available to generate electricity 91.5 percent of the time over its expected life. For the first nine months of 1998 the MCV Facility was available 99.3 percent of the time, resulting in $14 million over anticipated after-tax cash underrecoveries. Consumers believes it will continue to experience after-tax cash underrecoveries associated with the PPA in amounts comparable to those shown below. In Millions - ---------------------------------------------------------------------- 1998 1999 2000 2001 2002 - ---------------------------------------------------------------------- Estimated cash underrecoveries, net of tax $37 $22 $21 $20 $19 ====================================================================== Consumers bases the above estimated underrecoveries, in part, on an estimate of the future availability of the MCV Facility. If the MCV Facility operates at levels above management's estimate over the remainder of the PPA, Consumers will need to recognize losses for future underrecoveries larger than amounts previously recorded. Therefore, Consumers would experience larger amounts of cash underrecoveries than originally anticipated. Management will continue to evaluate the adequacy of the accrued liability considering actual MCV Facility operations. In February 1998, the MCV Partnership filed a claim of appeal from the January 1998 and February 1998 MPSC orders in the electric utility industry restructuring. At the same time, the MCV Partnership filed suit in the U.S. District Court seeking a declaration that the MPSC's failure to provide Consumers and the MCV Partnership a certain source of recovery of capacity payments after 2007 deprived the MCV Partnership of its rights under the Public Utilities Regulatory Policies Act of 1978. The MCV Partnership is seeking to prohibit the MPSC from implementing portions of the order. PSCR Matters Related to Power Purchases from the MCV Partnership- As part of a 1995 decision in the 1993 PSCR reconciliation case, the MPSC disallowed a portion of the costs related to purchases from the MCV Partnership and instead assumed recovery of those costs from wholesale customers. Consumers believed this was contrary to the terms of an earlier 1993 settlement order and appealed. The MCV Partnership and ABATE also filed separate appeals of this order. In November 1996, the Court of Appeals affirmed the MPSC's 1995 decision. The MCV Partnership filed an application for leave to appeal with the Michigan Supreme Court which was denied in January 1998. This matter is now closed. Nuclear Matters: Consumers filed updated decommissioning information with the MPSC in 1995 that estimated decommissioning costs for Big Rock and Palisades. In April 1996, the MPSC issued an order in Consumers' nuclear decommissioning case, which fully supported Consumers' request and did not change the overall surcharge revenues collected from retail customers. The MPSC ordered Consumers to file a report on the adequacy of the surcharge revenues with the MPSC at three-year intervals beginning in 1998. On March 31, 1998, Consumers filed with the MPSC a new decommissioning cost estimate for Big Rock and Palisades of $294 million and $518 million (in 1997 dollars) respectively. The estimated decommissioning costs decreased from previous estimates primarily due to a decrease in offsite burial costs. Consumers recommended a reallocation of its existing surcharge between the two plants on January 1, 1999 to provide additional funds to decommission Big Rock. Consumers filed a revision to its Post Shutdown Activities Report (formerly decommissioning report) with the NRC to reflect the shutdown of Big Rock. Big Rock is being decommissioned. It was closed permanently on August 29, 1997 because management determined that it would be uneconomical to operate in an increasingly competitive environment. Consumers had originally scheduled the plant to close May 31, 2000, at the end of the plant's operating license. Plant decommissioning began in September 1997 and may take five to ten years to return the site to its original condition. In January 1997, the NRC issued its Systematic Assessment of Licensee Performance report for Palisades. The report rated all areas as good, unchanged from the previous assessment. The NRC suspended the Systematic Assessment of Licensee Performance process for all licensees. Palisades was to have been reevaluated in September 1998. Palisades' temporary on-site storage pool for spent nuclear fuel is at capacity. Consequently, Consumers is using NRC-approved steel and concrete vaults, commonly known as "dry casks", for temporary on-site storage. As of September 30, 1998 Consumers had loaded 13 dry storage casks with spent nuclear fuel at Palisades. Consumers plans to load five additional casks at Palisades in 1999 pending approval by the NRC. In June 1997, the NRC approved Consumers' process for unloading spent fuel from a cask at Palisades previously discovered to have minor weld flaws. Consumers intends to transfer the spent fuel to a new transportable cask when one is available. A planned outage for refueling and maintenance at Palisades was completed June 7, 1998. Consumers replaced 60 nuclear fuel assemblies in the plant's reactor during the outage. The NRC requires Consumers to make certain calculations and report to it on the continuing ability of the Palisades reactor vessel to withstand postulated pressurized thermal shock events during its remaining license life, considering the embrittlement of reactor vessel materials over time due to operation in a radioactive environment. Based on continuing analysis of data in December 1996, Consumers received an interim Safety Evaluation Report from the NRC indicating that the reactor vessel can be safely operated through 2003 before reaching the NRC's screening criteria for reactor embrittlement. Consumers believes that with fuel management designed to minimize embrittlement, it can operate Palisades to the end of its license life in the year 2007 without annealing the reactor vessel. Nevertheless, Consumers will continue to monitor the matter. Consumers Gas Group Contingencies Gas Environmental Matters: Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. In 1998 Consumers plans to study indoor air issues at residences on some sites and ground water impacts or surface soil impacts at other sites. On sites where Consumers has received site-wide study plan approvals, it will continue to implement these plans. It will also work toward closure of environmental issues at sites as studies are completed. Data available to Consumers and its continued internal review have resulted in an estimate for all costs related to investigation and remedial action for all 23 sites of between $48 million and $98 million of which Consumers accrued a liability for $48 million. These estimates are based on undiscounted 1998 costs. As of September 30,1998, Consumers has a remaining accrued liability of $46 million and a regulatory asset for approximately the same amount. Any significant change in assumptions, such as remediation techniques, nature and extent of contamination, and legal and regulatory requirements, could affect the estimate of remedial action costs for the sites. According to an MPSC rate order issued in 1996, Consumers will defer and amortize, over a period of ten years, environmental clean-up costs above the amount currently being recovered in rates. Rate recognition of amortization expense will not begin until after a prudence review in a general rate case. The order authorizes current recovery of $1 million annually. Consumers has initiated a lawsuit against certain insurance companies regarding coverage for some or all of the costs that it may incur for these sites. Consumers Gas Group Matters Gas Restructuring: In December 1997, the MPSC approved Consumers' application to implement a statewide experimental gas transportation pilot program. Consumers' expanded experimental program will extend over a three-year period, eventually allowing 300,000 residential, commercial and industrial retail gas sales customers to choose their gas supplier. The program is voluntary for natural gas customers. Participating customers are being selected on a first-come, first-served basis, up to a limit of 100,000 customers beginning April 1, 1998. As of October 23, 1998, more than 80,000 customers chose alternative gas suppliers, representing approximately 24 bcf of gas load. Of these alternative gas suppliers, one was a CMS Energy affiliate. Up to 100,000 more customers may be added beginning April 1 of each of the next two years. Customers choosing to remain as sales customers of Consumers will not see a rate change in their natural gas rates. The order allowing the implementation of this program: 1) suspends Consumers' gas cost recovery clause, effective April 1, 1998 for a three-year period, establishing a gas commodity cost at a fixed rate of $2.84 per mcf; 2) establishes an earnings sharing mechanism that will provide for refunds to customers if Consumers' earnings during the three- year term of the program exceed certain pre-determined levels; and 3) establishes a gas transportation code of conduct that addresses concerns about the relationship between Consumers and marketers, including its affiliated marketers. This experimental program will allow competing gas suppliers, including marketers and brokers, to market natural gas to a large number of retail customers in direct competition with Consumers. In January 1998, the Attorney General, ABATE and other parties filed claims of appeal regarding the program with the Court of Appeals. For further information regarding the effects of the restructuring on accounting methods, see Consumers' Gas Group Outlook - Application of SFAS 71 in the MD&A. Other Uncertainities CMS Generation Environmental Matters: CMS Generation does not currently expect to incur significant capital costs, if any, at its power facilities to comply with current environmental regulatory standards. Capital Expenditures: CMS Energy estimates capital expenditures, including investments in unconsolidated subsidiaries and new lease commitments, of $1.340 billion for 1998, $3.585 billion for 1999 (which includes approximately $2.2 billion for pending acquisition of the Panhandle Companies), and $1.390 billion for 2000. For further information, see the Capital Resources and Liquidity-Capital Expenditures in the MD&A. Other: As of September 30, 1998, CMS Energy and Enterprises have guaranteed up to $415 million in contingent obligations of unconsolidated affiliates and related parties. In addition to the matters disclosed in 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. CMS Energy has accrued estimated losses for certain contingencies discussed in this Note. Resolution of these contingencies is not expected to have a material adverse impact on CMS Energy's financial position, liquidity, or results of operations. 3: Short-Term and Long-Term Financings, and Capitalization CMS Energy: CMS Energy's Senior Credit Facilities consist of a $600 million three-year revolving credit facility and a five-year $125 million term loan facility. Additionally, CMS Energy has unsecured lines of credit and letters of credit in an aggregate amount of $167 million. At September 30, 1998, the total amount utilized under the Senior Credit Facilities was $407 million, including $47 million of contingent obligations, and under the unsecured lines of credit and letters of credit was $51 million. At September 30, 1998 CMS Energy has $123 million of Series A GTNs, $125 million of Series B GTNs, $150 million of Series C GTNs, and $198 million of Series D GTNs issued and outstanding with weighted average interest rates of 7.8 percent, 7.9 percent, 7.7 percent, and 7.0 percent, respectively. In January 1998, a Delaware statutory business trust established by CMS Energy sold $180 million of certificates due January 15, 2005 in a public offering. In exchange for those proceeds, CMS Energy sold to the trust $180 million aggregate principal amount of 7 percent Extendible Tenor Rate Adjusted Securities due January 15, 2005. Net proceeds to CMS Energy from the sale totaled $176 million. In March 1998, CMS Energy and an affiliated business trust filed a shelf registration statement with the SEC pursuant to Rule 415 of the Securities Act, for the issuance and the sale of an additional $200 million of CMS Energy Common Stock, Class G Common Stock, subordinated debentures, stock purchase contracts, stock purchase units, and Trust Preferred Securities. In August 1998, CMS Energy filed a shelf registration statement with the SEC pursuant to Rule 415 of the Securities Act, for the issuance and the sale of $400 million of General Term Notes Series E. On November 10, 1998, CMS Energy sold 4.5 million new shares of CMS Energy Common Stock in a block trade. The net proceeds of aproximately $208 million will be used for general corporate purposes. The primary asset of CMS Energy Trust I is $178 million principal amount of 7.75 percent convertible subordinated debentures due 2027 from CMS Energy. Consumers: At November 1, 1998, Consumers had remaining FERC authorization to: 1) issue or guarantee through June 2000, up to $900 million of short-term securities outstanding at any one time; 2) guarantee, through 1999, up to $25 million in loans made by others to residents of Michigan for making energy-related home improvements; and 3) issue through June 2000, up to $900 million long-term securities with maturities up to 30 years for refinancing purposes. Consumers has an unsecured $425 million credit facility and unsecured lines of credit aggregating $130 million. These facilities are available to finance seasonal working capital requirements and to pay for capital expenditures between long-term financings. At September 30, 1998, a total of $302 million was outstanding at a weighted average interest rate of 6.3 percent, compared with $389 million outstanding at September 30, 1997, at a weighted average interest rate of 6.2 percent. In January 1998, Consumers entered into interest rate swaps totaling $300 million. These swap arrangements have had an immaterial effect on interest expense. Consumers also has in place a $500 million trade receivables sale program. At September 30, 1998 and 1997, receivables sold under the program totaled $307 million and $250 million, respectively. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold. The primary asset of Consumers Power Company Financing I is $103 million principal amount of 8.36 percent subordinated deferrable interest notes due 2015 from Consumers. The primary asset of Consumers Energy Company Financing II is $124 million principal amount of 8.20 percent subordinated deferrable interest notes due 2027 from Consumers. The following table describes the new issuances of long-term financings which have occurred during 1998 through early November 1998. In Millions - ------------------------------------------------------------------------- Month Interest Principal Issued Maturity Rate (%) Amount Use of Proceeds - ------------------------------------------------------------------------- Senior Notes (a) February 2008 6.375 $ 250 Pay down First Mortgage Bonds and general corporate purposes Senior Notes (a) March 2018 6.875 225 Pay down First Mortgage Bonds and other long-term debt Senior Notes (a) May 2008 6.2 (b) 250 Pay down First Mortgage Bonds, long-term bank debt and general corporate purposes Long-Term Bank Debt May 2001-2003 6.05 (d) 225 Pay down long-term bank debt and general corporate purposes Senior Notes (a) June 2018 6.5 (c) 200 Pay down First Mortgage Bonds and general corporate purposes Senior Notes (e) October 2028 6.5 150 Pay down long-term bank debt and general corporate purposes - ------------------------------------------------------------------------ Total $1,300 ======================================================================== (a) The Senior Notes are secured by Consumers First Mortgage Bonds issued contemporaneously in a similar amount. (b) The interest rate may be reset in 2003. (c) The interest rate will be reset in June 2005. (d) The interest rate is variable; weighted average interest rate upon original issuance was 6.05 percent. (e) The Senior Notes are secured by Consumers First Mortgage Bonds issued contemporaneously in a similar amount and are insured for full debt service. The following table describes the retirements of long-term financings which have occurred during 1998 through early November 1998. In Millions - ---------------------------------------------------------------------- Month Interest Principal Retired Maturity Rate (%) Amount - ---------------------------------------------------------------------- First Mortgage Bonds February 1998 8.75 $248 Long-Term Bank Debt February 1998 6.4 (a) 50 First Mortgage Bonds March 2001-2002 7.5 119 First Mortgage Bonds April 2023 7.375 36 First Mortgage Bonds May 1998 6.875 43 Long-Term Bank Debt May 1998-1999 6.3 (b) 350 First Mortgage Bonds July 1999 8.875 136 First Mortgage Bonds October 1998 6.625 45 Long-Term Bank Debt November 2001-2003 6.05 50 - ---------------------------------------------------------------------- Total $1,077 ====================================================================== (a) The interest rate was variable; weighted average interest rate at December 31, 1997 was 6.4 percent. (b) The interest rate was variable; weighted average interest rate at March 31, 1998 was 6.3 percent. Consumers had unsecured, variable rate long-term bank debt with an outstanding balance at September 30, 1998 and 1997 of $225 million and $400 million, respectively. At September 30, 1998 and 1997 the debt carried weighted average interest rates of 6.1 percent and 6.3 percent, respectively. In February 1998, Consumers retired $50 million of its $400 million unsecured long-term bank debt. In May 1998, Consumers refinanced the remaining $350 million unsecured long-term bank debt, in part with $225 million unsecured long-term bank debt. To cover the remaining $125 million of bank debt refinancing, in May 1998 Consumers issued $250 million of senior notes due 2008, at an interest rate of 6.2 percent. The $125 million balance of senior notes due 2008 was used for repurchasing $36 million of 7.375 percent First Mortgage Bonds and for general corporate purposes. Under the provisions of its Articles of Incorporation at September 30, 1998, Consumers had $295 million of unrestricted retained earnings available to pay common dividends. In October 1998, Consumers declared a $68 million common dividend to be paid in November 1998. 4: Earnings Per Share and Dividends Earnings per share attributable to Common Stock for the three, nine and twelve month periods ended September 30, 1998 reflect the performance of the Consumers Gas Group. The Class G Common Stock has participated in earnings and dividends from its original issue date in July 1995. The allocation of earnings attributable to each class of common stock and the related amounts per share are computed by considering the weighted average number of shares outstanding. Earnings attributable to the Outstanding Shares are equal to Consumers Gas Group net income multiplied by a fraction; the numerator is the weighted average number of Outstanding Shares during the period and the denominator is the weighted average number of Outstanding Shares and Retained Interest Shares during the period. The earnings attributable to Class G Common Stock on a per share basis for the nine months ended September 30, 1998 and 1997 are based on 25.38 percent and 24.65 percent, respectively, of the income of Consumers Gas Group. Computation of Earnings Per Share: In Millions, Except Per Share Amounts - ------------------------------------------------------------------------------ Three Months Nine Months Twelve Months Ended Ended Ended September 30 September 30 September 30 1998 1997 1998 1997 1998 1997 - ------------------------------------------------------------------------------ (b) (a) (b) (a) (b) Net Income Applicable to Basic and Diluted EPS Consolidated Net Income $ 81 $ 60 $234 $185 $293 $223 ================================================== Net Income Attributable to Common Stocks: CMS Energy - Basic EPS $ 83 $ 62 $226 $176 $279 $210 Add conversion of 7.75% Trust Preferred Securities (net of tax) 2 2 6 2 9 2 ---------------------------------------------------- CMS Energy - Diluted EPS $ 85 $ 64 $232 $178 $288 $212 ==================================================== Class G: Basic and Diluted EPS $ (2) $ (2) $ 8 $ 9 $ 14 $ 13 ==================================================== Average Common Shares Outstanding Applicable to Basic and Diluted EPS CMS Energy: Average Shares - Basic 102 96 101 95 101 95 Add conversion of 7.75% Trust Preferred Securities 4 4 4 1 4 1 Options-Treasury Shares 1 1 1 1 1 1 ---------------------------------------------------- Average Shares - Diluted 107 101 106 97 106 97 ==================================================== Class G: Average Shares Basic and Diluted 8 8 8 8 8 8 ==================================================== Earnings Per Average Common Share CMS Energy: Basic $ .81 $ .64 $ 2.23 $1.85 $2.77 $2.22 Diluted $ .80 $ .63 $ 2.19 $1.83 $2.73 $2.20 Class G: Basic and Diluted $(.16) $(.21) $1.04 $1.13 $1.73 $1.57 ================================================================================ (a) Includes the cumulative effect of an accounting change in the first quarter of 1998 which increased net income attributible to CMS Energy Common Stock $43 million ($.40 per share - basic and diluted) and Class G Common Stock $12 million ($.36 per share - basic and diluted). (b) Restated; see Note 1. In February and May 1998, CMS Energy paid dividends of $.30 per share on CMS Energy Common Stock and $.31 per share on Class G Common Stock. In August 1998, CMS Energy paid dividends of $.33 per share on CMS Energy Common Stock and $.325 per share on Class G Common Stock. In October 1998, the Board of Directors declared a quarterly dividend of $.33 per share on CMS Energy Common Stock and $ .325 per share on Class G Common Stock to be paid in November 1998. 5: Risk Management Activities and Derivatives Transactions CMS Energy and its subsidiaries use a variety of derivative instruments (derivatives), including futures contracts, swaps, options and forward contracts, to manage exposure to fluctuations in commodity prices, interest rates and foreign exchange rates. To qualify for hedge accounting, derivatives must meet the following criteria: (1) the item to be hedged exposes the enterprise to price, interest or exchange rate risk; and (2) the derivative reduces that exposure and is designated as a hedge. Derivative instruments contain credit risk if the counter parties, including financial institutions and energy marketers, fail to perform under the agreements. CMS Energy minimizes such risk by performing financial credit reviews using, among other things, publicly available credit ratings of such counter parties. Nonperformance by counter parties is not expected to have a material adverse impact on CMS Energy's financial position, liquidity, or results of operations. Commodity Price Hedges: CMS Energy accounts for its commodity price derivatives as hedges, as defined above, and as such, defers any changes in market value and gains and losses resulting from settlements until the hedged transaction is complete. If there was a loss of correlation between the changes in (1) the market value of the commodity price contracts and (2) the market price ultimately received for the hedged item, and the impact was material, the open commodity price contracts would be marked to market and gains and losses would be recognized in the income statement currently. Consumers uses gas forward contracts and electricity option contracts to limit its risk associated with gas and electricity price increases. In both the gas forward contracts and the electricity option contracts, it is management's intent to take physical delivery of the commodities. For gas forward contracts, Consumers is obligated to take physical delivery of the gas and would incur a significant penalty for nonperformance. At September 30, 1998, Consumers had an exposure to gas price increases if the cost was to exceed $2.84 per mcf for the following volumes: 5 percent of its 1998 requirements; 40 percent of its 1999 requirements; and 65 percent of its 2000 requirements. Additional forward contract coverage is currently under review. The gas forward contracts currently in place were consummated at prices less than $2.84 per mcf. The contracts are being used to protect against gas price increases in a three-year experimental gas program where Consumers is recovering from its customers $2.84 per mcf for gas delivered. Consumers enters into electricity option contracts to insure a reliable source of capacity to meet its customers' electricity requirements and to limit its risk associated with electricity price increases. It is management's intent to take physical delivery of the commodity. Consumers continuously evaluates its daily capacity needs and sells the option contracts, if marketable, when it has excess daily capacity. Consumers' maximum exposure associated with these options is limited to premiums paid. Consumers purchased $5 million of options to insure a reliable source of capacity during the summer months of 1998. As a result of weather conditions and fluctuations in the price of electricity, some options were sold to third parties for $11 million during June, July, and August 1998. As of September 30, 1998, all of the remaining options had expired. The costs relating to the expired options and income received from the sale of options were reflected as purchased power costs. CMS Oil and Gas has one arrangement which is used to fix the prices that CMS Oil and Gas will pay to supply gas to the MCV for the years 2001 through 2006 by purchasing the economic equivalent of 10,000 MMBtu per day at a fixed price, escalating at 8 percent per year thereafter, starting at $2.82 per MMBtu in 2001. The settlement periods are each a one-year period ending December 31, 2001 through 2006 on 3.65 million MMBtu. If the floating price, essentially the then-current Gulf Coast spot price, for a period is higher than the fixed price, the seller pays CMS Oil and Gas the difference, and vice versa. If a party's exposure at any time exceeds $5 million, that party is required to obtain a letter of credit in favor of the other party for the excess over $5 million and up to $10 million. At September 30, 1998, no letter of credit was posted by either party to the agreement. As of September 30, 1998, the fair value of this contract reflected payment due from CMS Oil and Gas of $13 million. CMS MST uses natural gas and oil futures contracts, options and swaps (which require a net cash payment for the difference between a fixed and variable price). Interest Rate Hedges: CMS Energy and some of its subsidiaries enter into interest rate swap agreements to exchange variable rate interest payment obligations to fixed rate obligations without exchanging the underlying notional amounts. These agreements convert variable rate debt to fixed rate debt to reduce the impact of interest rate fluctuations. The notional amounts parallel the underlying debt levels and are used to measure interest to be paid or received and do not represent the exposure to credit loss. The notional amount of CMS Energy's and its subsidiaries' interest rate swaps was $923 million at September 30, 1998. In October 1998, Consumers unwound an interest rate guarantee of $145 million associated with the issuance of $150 million senior notes. The effective rate of the debt is 7 percent taking into consideration the issuance costs, interest rate guarantee and insurance costs. The difference between the amounts paid and received under the swaps is accrued and recorded as an adjustment to interest expense over the life of the hedged agreement. Foreign Exchange Hedges: CMS Energy uses forward exchange contracts and collared options to hedge certain receivables, payables, long-term debt and equity value relating to foreign investments. The purpose of CMS Energy's foreign currency hedging activities is to protect the company from the risk that U.S. dollar net cash flows resulting from sales to foreign customers and purchases from foreign suppliers and the repayment of non-U.S. dollar borrowings as well as equity reported on the company's balance sheet, may be adversely affected by changes in exchange rates. These contracts do not subject CMS Energy to risk from exchange rate movements because gains and losses on such contracts offset losses and gains, respectively, on assets and liabilities being hedged. The notional amount of the outstanding foreign exchange contracts was $845 million at September 30, 1998, which includes $550 million and $250 million for Australian and Brazilian foreign exchange contracts, respectively. 6: Subsequent Event On November 2, 1998, CMS Energy announced the execution of a definitive Stock Purchase Agreement (the "Agreement") with PanEnergy Corp ("PanEnergy") and certain other wholly-owned subsidiaries of Duke Energy Company to acquire all of the stock of the Panhandle Companies for a cash payment of $1.9 billion and existing Panhandle Companies debt of $300 million. This transaction will be accounted for under the purchase method of accounting. The Panhandle Companies are primarily engaged in the interstate transportation and storage of natural gas. The assets to be acquired include 1,400 miles of mainline gas pipeline extending from the Texas Gulf Coast to Michigan and 1,300 miles of mainline gas pipeline extending from the Kansas/Oklahoma mid-continent to Michigan, 340 miles of pipeline in the offshore Gulf of Mexico, 70 billion cubic feet of underground gas storage facilities, a liquified natural gas port, and unloading and regasification facilities. Closing of the transaction is subject to Hart-Scott-Rodino pre-merger notification clearance. The Agreement is subject to termination upon failure of CMS Energy to satisfy its financing contingency. The Agreement also provides that if, as a result of CMS Energy's continuing due diligence investigation, CMS Energy learns of material facts not previously disclosed or inconsistent with representations and warranties made in the Agreement, CMS Energy may, on or prior to November 23, 1998, notify PanEnergy of its intent to terminate the Agreement and the Agreement will terminate unless PanEnergy corrects the asserted misrepresentations within 30 days. CMS Energy expects to have $1.9 billion of bridge financing commitments available to fund the purchase price and it anticipates permanent financing of the acquisition at or near closing with approximately $900 million from the sale of common stock and/or securities convertible into common stock by CMS Energy and approximately $1 billion from the issuance of debt securities by the Panhandle Companies. If CMS Energy is unable to provide the appropriate financing commitments by November 23, 1998 or is unable to close the purchase when it otherwise would be obligated to close, it must pay PanEnergy a $75 million termination fee. The closing is scheduled for January 4, 1999, but may be delayed by mutual agreement. 48 ARTHUR ANDERSEN LLP Report of Independent Public Accountants To CMS Energy Corporation: We have reviewed the accompanying consolidated balance sheets of CMS ENERGY CORPORATION (a Michigan corporation) and subsidiaries as of September 30, 1998 and 1997, the related consolidated statements of income and common stockholders' equity for the three-month, nine-month, and twelve-month periods then ended, and the related consolidated statements of cash flows for the nine-month and twelve-month periods then ended. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet and consolidated statement of preferred stock of CMS Energy Corporation and subsidiaries as of December 31, 1997, and the related consolidated statements of income, common stockholders' equity and cash flows for the year then ended (not presented herein), and, in our report dated July 27, 1998, we expressed an unqualified opinion on those statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 1997, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. Arthur Andersen LLP Detroit, Michigan, November 10, 1998. 50 Consumers Energy Company Management's Discussion and Analysis The MD&A of this Form 10-Q should be read along with the MD&A and other parts of Consumers' 1997 Form 10-K. This MD&A also refers to, and in some sections specifically incorporates by reference, Consumers' Condensed Notes to Consolidated Financial Statements and should be read in conjunction with such Statements and Notes. This report contains forward- looking statements, as defined by the Private Securities Litigation Reform Act of 1995, that include without limitation, discussions as to expectations, beliefs, plans, objectives and future financial performance, or assumptions underlying or concerning matters discussed in this report. Refer to the Forward-Looking Information section of this MD&A for some important factors that could cause actual results or outcomes to differ materially from those addressed in the forward-looking discussions. Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan and is the principal subsidiary of CMS Energy, a holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Results of Operations In Millions September 30 1998 1997 Change ----- ----- ------ Three months ended $ 77 $ 71 $ 6 Nine months ended 239 212 27 Twelve months ended 311 269 42 Net income available to common stockholders was $77 million for the third quarter of 1998 compared with $71 million for the same 1997 period. The improved net income reflects increased electric and gas deliveries, the operation of the gas customer choice program (see note 2, Gas Rate Matters), along with increased revenues from gas retail and wholesale services activities. Net income available to common stockholders after the cumulative effect of a change in accounting for property taxes was $239 million for the first nine months of 1998 compared with $212 million for the same 1997 period. The increase in earnings for the first nine months of 1998 reflects revised accounting to recognize property tax expense on the fiscal year basis of the taxing units instead of on a calendar year basis. This one-time change in accounting for property taxes resulted in a benefit of $66 million ($43 million after-tax). Earnings for the first nine months of 1998 also reflect the recognition of a $37 million dollar loss ($24 million after tax) for the underrecovery of power costs under the PPA. Net income available to common stockholders was $311 million for the twelve months ended September 30,1998 compared with $269 million for the same 1997 period. The increase in earnings for this twelve months reflects the change in accounting for property taxes implemented during the first half of 1998 as discussed above. In addition, the improved net income for the twelve months ended September 30, 1998 reflects an adjustment of prior years' income taxes associated with non-taxable earnings on nuclear decommissioning trust funds of $9 million. Partially offsetting these increases were the recognition, in the first half of 1998, of the loss associated with the underrecovery of power costs under the PPA as discussed above, and decreased gas deliveries due to warmer weather during the first half of 1998. The first nine months of 1998 were the fourth warmest since 1864. For further information concerning results of operations, see the Electric and Gas Utility Results of Operations sections of this MD&A and Power Purchases from the MCV Partnership in Note 2. ELECTRIC UTILITY RESULTS OF OPERATIONS Electric Pretax Operating Income: In Millions September 30 1998 1997 Change ----- ----- ------ Three months ended $ 153 $ 132 $ 21 Nine months ended 378 342 36 Twelve months ended 468 423 45 Electric pretax operating income for all the above periods ended September 30, 1998 benefitted from increased deliveries compared to the same periods in 1997. These increases were partly offset by increased general taxes and depreciation associated with additional plant investment. Electric pretax operating income for the three months ended had increased operation and maintenance costs while the twelve months ended September 30, 1998 benefited from controlling operation expenses. The following table quantifies these impacts on pretax operating income. In Millions Three Months Nine Months Twelve Months Ended Sept. 30 Ended Sept. 30 Ended Sept. 30 Change Compared to Prior Year 1998 vs 1997 1998 vs 1997 1998 vs 1997 ------- ------- ------- Deliveries (including special contract discounts) $ 38 $ 50 $ 51 Other non-commodity revenue (1) (2) (3) Operations and maintenance (11) (1) 15 General taxes, depreciation and other (5) (11) (18) ------ ------ ------ Total change $ 21 $ 36 $ 45 ====== ====== ====== Electric Deliveries: Total electric deliveries increased 10.1 percent for the three months ended September 30, 1998 over the same period in 1997. The increase includes a 5.8 percent increase in deliveries to ultimate customers, primarily within the residential and commercial classes and an increase in sales between utility systems and wholesale customer deliveries. For the nine months ended September 30, 1998, total electric deliveries increased 8.2 percent over the comparable 1997 period. Deliveries to ultimate customers were up 3.4 percent, with the remaining change attributable to an increase in sales between utility systems and wholesale deliveries. For the twelve months ended September 30, 1998, total electric deliveries increased 8.0 percent over the comparable 1997 period. The increase is primarily attributable to an increase in sales between utility systems and a 2.7 percent increase in deliveries to ultimate customers. Power Costs: In Millions September 30 1998 1997 Change ----- ----- ------ Three months ended $ 315 $ 296 $ 19 Nine months ended 899 847 52 Twelve months ended 1,190 1,132 58 Power costs increased for all the reported periods ended September 30, 1998 compared to 1997. Both internal generation and power purchases from outside sources increased during these periods to meet increased deliveries. Uncertainties: Consumers' financial position may be affected by a number of trends or uncertainties that have had, or Consumers reasonably expects will have, a materially favorable or unfavorable impact on net sales, revenues, or income from continuing electric operations. Such uncertainties are: 1) environmental liabilities arising from compliance with various federal, state and local environmental laws and regulations, including potential liability or expenses relating to the Michigan Natural Resources and Environmental Protection Act and Superfund; 2) capital expenditures for compliance with the Clean Air Act; 3) suits by various parties relating to the effect of so-called stray voltage on certain livestock; 4) suits by two independent power producers alleging antitrust violations and economic losses due to special electric contracts signed by Consumers; 5) cost recovery relating to the MCV Facility and nuclear plant investments and an experimental direct-access program; 6) electric industry restructuring; 7) after-tax cash underrecoveries associated with power purchases from the MCV Partnership; and 8) Big Rock decommissioning issues and ongoing issues relating to the storage of spent fuel and the operating life of Palisades. For detailed information about these trends or uncertainties see Note 2, Uncertainties, "Electric Contingencies- Electric Environmental Matters," "Electric Contingencies-Stray Voltage," "Electric Contingencies-Anti-Trust," "Electric Rate Matters-Electric Proceedings," "Electric Rate Matters-Electric Restructuring," "Other Electric Uncertainties-The Midland Cogeneration Venture-Power Purchases from the MCV Partnership," and "Other Electric Uncertainties-Nuclear Matters," incorporated by reference herein. Consumers enters into electricity option contracts to insure a reliable source of capacity to meet its customers' electricity requirements and to limit its risk associated with electricity price increases. It is management's intent to take physical delivery of the commodity. Consumers continuously evaluates its daily capacity needs and sells the option contracts, if marketable, when it has excess daily capacity. Consumers' maximum exposure associated with these options is limited to premiums paid. Consumers purchased $5 million of options to insure a reliable source of capacity during the summer months of 1998. As a result of weather conditions and fluctuations in the price of electricity, some options were sold to third parties for $11 million during June, July, and August 1998. As of September 30, 1998, all of the remaining options had expired. The costs relating to the expired options and income received from the sale of options were reflected as purchased power costs. GAS UTILITY RESULTS OF OPERATIONS Gas Pretax Operating Income: In Millions September 30 1998 1997 Change ----- ----- ------ Three months ended $ 6 $ (1) $ 7 Nine months ended 81 100 (19) Twelve months ended 134 142 (8) Gas pretax operating income increased in the three month period ended September 30, 1998 as a result of increased gas deliveries, operation of the gas customer choice program (see note 2, Gas Rate Matters) and increased revenues from gas retail and wholesale services. The change in general taxes and depreciation for the three month period ended September 30, 1998 is primarily a timing issue. Warmer temperatures during the winter heating seasons resulted in reduced gas deliveries which decreased gas pretax operating income in the nine month and twelve month periods ended September 30,1998. The decreased gas pretax operating income for the nine month period ended September 30, 1998 also reflects higher operations expense. In part, the higher operations expense reflects the absence of 1997 non-recurring expense reductions for uncollectible accounts and injuries and damages reserves. Gas pretax operating income for the three month and twelve month periods ended September 30, 1998 benefited from controlling operations and maintenance expenses. Gas wholesale and retail service revenues were down for the twelve month period ended September 30, 1998 due to the elimination of surcharges related to past conservation programs. The benefit to gas pretax operating income from reduced costs in general taxes and depreciation for the nine month and twelve month periods ended September 30, 1998 is primarily a timing issue. The following table quantifies these impacts on pretax operating income. In Millions Three Months Nine Months Twelve Months Ended Sept. 30 Ended Sept. 30 Ended Sept. 30 Change Compared to Prior Year 1998 vs 1997 1998 vs 1997 1998 vs 1997 ----------- ----------- ------------ Gas deliveries $ 5 $(14) $(15) Gas wholesale and retail service activities 3 - (2) Operations and maintenance 1 (8) 6 General taxes, depreciation and other (2) 3 3 ---- ---- ---- Total change $ 7 $(19) $(8) ==== ==== ==== Gas Deliveries: System deliveries for the three month period ended September 30, 1998, excluding miscellaneous transportation, totaled 31 bcf, an increase of 1 bcf or 3 percent compared to the three month period ended September 30, 1997. Deliveries for the nine month period ended September 30, 1998, excluding miscellaneous transportation, totaled 203 bcf, a decrease of 29 bcf or 13 percent compared to the nine month period ended September 30, 1997. For the twelve month period ended September 30, 1998, deliveries excluding miscellaneous transportation, totaled 311 bcf, a decrease of 31 bcf or 9 percent compared to the twelve month period ended September 30, 1997. The decreased deliveries for the nine month and twelve month periods reflect warmer temperatures primarily for the first quarter of 1998. Miscellaneous transportation deliveries for the three month period ended September 30, 1998 totaled 11 bcf, a decrease of 8 bcf or 40 percent compared to the three month period ended September 30, 1997. Miscellaneous transportation deliveries for the nine month period ended September 30, 1998, totaled 47 bcf, a decrease of 14 bcf or 23 percent compared to the nine month period ended September 30, 1997. Miscellaneous transportation deliveries for the twelve month period ended September 30, 1998, totaled 65 bcf, a decrease of 18 bcf or 22 percent compared to the twelve month period ended September 30, 1997. Cost of Gas Sold: In Millions September 30 1998 1997 Change ---- ---- ---- Three months ended $ 39 $ 39 $ - Nine Months ended 377 472 (95) Twelve months ended 600 718 (118) The cost decreases for the nine month and twelve month periods ended September 30, 1998 were the result of decreased sales and lower gas costs reflecting warmer temperatures during the winter heating season. Uncertainties: Consumers' financial position may be affected by a number of trends or uncertainties that have had, or Consumers reasonably expects will have, a materially favorable or unfavorable impact on net sales or revenues or income from continuing gas operations. Such uncertainties are: 1) potential environmental costs at a number of sites including sites formerly housing manufactured gas plant facilities, and 2) a statewide experimental gas transportation pilot program. For detailed information about these uncertainties see Note 2, Uncertainties, "Gas Contingencies-Gas Environmental Matters," and "Gas Rate Matters-Gas Restructuring," incorporated by reference herein. Consumers uses gas forward contracts to limit its risk associated with gas price increases. It is management's intent to take physical delivery of the commodity. For gas forward contracts, Consumers is obligated to take physical delivery of the gas and would incur a significant penalty for nonperformance. At September 30, 1998, Consumers had an exposure to gas price increases if the cost was to exceed $2.84 per mcf for the following volumes: 5 percent of its 1998 requirements; 40 percent of its 1999 requirements; and 65 percent of its 2000 requirements. Additional forward contract coverage is currently under review. The gas forward contracts currently in place were consummated at prices less than $2.84 per mcf. The contracts are being used to protect against gas price increases in a three-year experimental gas program where Consumers is recovering from its customers $2.84 per mcf for gas delivered. Capital Resources and Liquidity CASH POSITION, INVESTING AND FINANCING Operating Activities: Consumers derives cash from the sale and transportation of natural gas and the generation, transmission and sale of electricity. Cash from operations totaled $452 million and $458 million for the first nine months of 1998 and 1997, respectively. The $6 million decrease resulted primarily from the timing of cash payments related to normal operations. Other items included in income but which had no effect on cash flow were a one-time change in accounting for property taxes resulting in a $66 million ($43 million after-tax) gain and the recognition of a $37 million loss ($24 million after-tax) for the underrecovery of power costs under the PPA. Consumers uses operating cash primarily to maintain and expand electric and gas systems, to retire portions of long-term debt, and to pay dividends. Investing Activities: Cash used in investing activities totaled $(235) million and $(277) million for the first nine months of 1998 and 1997, respectively. The change of $(42) million was primarily the result of receiving $27 million from the sale of two partnerships, $12 million distribution from FMLP and $43 million from the nuclear decommissioning trust funds previously collected from electric customers for decommissioning Big Rock, offset by the payment of $39 million in cost of plant retired. Financing Activities: Cash used in financing activities totaled $(196) and $(176) million for the first nine months of 1998 and 1997, respectively. The change of $20 million is primarily the result of a net increase in cash of $79 million due to refinancing and issuance of Consumers' debt and $8 million decrease in capital lease payments. Offsetting this increase was a $60 million increase in the payment of common stock dividends and a $50 million return of paid in capital to Consumers' common stockholder. Consumers has FERC authorization to issue securities and guarantees. Consumers has a credit facility, lines of credit and a trade receivable sale program in place as anticipated sources of funds needed to fulfill, in whole or in part, material commitments for capital expenditures. For detailed information about these source of funds, see "Authorization" and "Short-Term Financings" in Note 3. Outlook The following discussions contain forward-looking statements. See the Forward-Looking Information section of this MD&A for some important factors that could cause actual results or outcomes to differ materially from those discussed herein. CAPITAL EXPENDITURES OUTLOOK Consumers estimates the following capital expenditures, including new lease commitments, by company and by business segment over the next three years. These estimates are prepared for planning purposes and are subject to revision. In Millions Years Ended December 31 1998(b) 1999 2000 ---- ---- ---- Consumers Construction $388 $465 $490 Nuclear fuel lease 54 20 - Capital leases other than nuclear fuel 13 17 17 Michigan Gas Storage 3 3 3 ---- ---- ---- $458 $505 $510 ==== ==== ==== Electric utility operations (a) $341 $380 $385 Gas utility operations (a) 117 125 125 ---- ---- ---- $458 $505 $510 ==== ==== ==== (a) These amounts include an attributed portion of Consumers' anticipated capital expenditures for plant and equipment common to both the electric and gas utility businesses. (b) Includes actual amounts incurred during the first three quarters and estimate for fourth quarter. ELECTRIC BUSINESS OUTLOOK Growth: Consumers expects average annual growth of two and one-half percent per year in electric system deliveries over the next five years, absent the impact of restructuring on the industry and its regulation in Michigan. Abnormal weather, changing economic conditions, or the developing competitive market for electricity may affect actual electric sales in future periods. Restructuring: Consumers' retail electric business is affected by competition. To meet its challenges, Consumers entered into multi-year contracts with some of its largest industrial customers to serve certain facilities. The MPSC has approved these contracts as part of its phased introduction to competition. Certain customers have the option of terminating their contracts early. FERC Orders 888 and 889, as amended, require utilities to provide direct access to the interstate transmission grid for wholesale transactions. Consumers and Detroit Edison disagree on the effect of the orders on the Michigan Electric Power Coordination Center pool. Consumers proposes to maintain the benefits of the pool through at least December 2000, while Detroit Edison contends that the pool agreement should be terminated immediately. Among Consumers' alternatives in the event of the pool being terminated would be joining an independent system operator. FERC has indicated this preference for structuring the operations of the electric transmission grid. As discussed in the Form 10-K, since June 1997 several orders have been issued and numerous appeals are pending at the Court of Appeals relating to the restructuring of the electric utility industry. Consumers cannot predict the outcome or timing of these matters. For material changes relating to the restructuring of the electric utility industry see "Electric Rate Matters - Electric Restructuring" in Note 2, incorporated by reference herein. Electric Application of SFAS 71: Consumers applies the utility accounting standard, SFAS 71, that recognizes the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities related to the generation, transmission and distribution operations of its business in its financial statements. Consumers believes that the generation segment of its business is still subject to rate regulation based upon its present obligation to continue providing generation service to its customers, and the lack of definitive deregulation orders. If rate recovery of generation-related costs becomes unlikely or uncertain, whether due to competition or regulatory action, this accounting standard may no longer apply to the generation segment of Consumers' business. According to Emerging Issues Task Force Issue 97-4, Deregulation of the Pricing of Electricity - Issues Related to the Application of FASB Statements No. 71 and 101, Consumers can continue to carry its generation- related regulatory assets or liabilities for the part of the business being deregulated if deregulatory legislation or an MPSC rate order allows the collection of cash flows from its regulated transmission and distribution customers to recover these specific costs or settle obligations. Because the February 1998 MPSC order allows Consumers to fully recover its transition costs, Consumers believes that even if it was to discontinue application of SFAS 71 for the generation segment of its business, its regulatory assets, including those related to generation, are probable of future recovery from the regulated portion of the business. At September 30, 1998, Consumers had $251 million of generation-related net regulatory assets recorded on its balance sheet, and a net investment in generation facilities of $1.3 billion included in electric plant and property. For further information regarding electric restructuring, see "Restructuring" above. GAS BUSINESS OUTLOOK Growth: Consumers currently anticipates gas deliveries, including gas customer choice deliveries (excluding transportation to the MCV Facility and off-system deliveries), to grow at an average annual rate of between one and two percent over the next five years based primarily on a steadily growing customer base. Abnormal weather, alternative energy prices, changes in competitive conditions, and the level of natural gas consumption may affect actual gas deliveries in future periods. Consumers is also offering a variety of energy-related services to its customers focused upon appliance maintenance, home safety, commodity choice and assistance to customers purchasing heating, ventilation and air conditioning equipment. In 1997, LIHEAP provided approximately $64 million in heating assistance to about 312,000 Michigan households, with approximately 13 percent of the funds going to Consumers' customers. Congress provided approximately $54 million in funding for Michigan for 1998. In October 1998, Congress approved funding for fiscal year 1999 of approximately $59 million for the state of Michigan. Consumers' expects presidential approval of the funding. Gas Application of SFAS 71: Based on a regulated utility accounting standard, SFAS 71, Consumers may defer certain costs to the future and record regulatory assets, based on the recoverability of those costs through the MPSC's approval. Consumers has evaluated its regulatory assets related to its gas business, and believes that sufficient regulatory assurance exists to provide for the recovery of these deferred costs. Other Matters NEW ACCOUNTING STANDARDS In 1998, the FASB issued SFAS 132, Employers' Disclosures about Pensions and Other Postretirement Benefits. This standard requires expanded disclosure effective for 1998. Also in 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which will be effective for 1999. Consumers does not expect the application of these standards to materially affect its financial position, liquidity or results of operations. In addition, in 1998, the FASB issued SFAS 133, Accounting for Derivative Instruments and Hedging Activities, which requires that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. SFAS 133 is effective for fiscal years beginning after June 15, 1999. Consumers has not yet quantified the impacts of adopting SFAS 133 on its financial statements and has not determined the timing of or method of adoption. YEAR 2000 COMPUTER MODIFICATIONS Consumers uses software and related technologies throughout its businesses that the year 2000 date change will affect and, if uncorrected, could cause Consumers to, among other things, issue inaccurate bills, report inaccurate data, incur generating plant outages, or create energy delivery uncertainties. In 1995, Consumers established a Year 2000 Program to ensure the continued operation of the company at the turn of the century. Consumers efforts included dividing the programs requiring modification between critical and noncritical programs. A formal methodology was established to identify critical business functions and risk scenarios, develop test plans and expected results, and execute tests. Consumers Year 2000 Program involves an aggressive, comprehensive, four-phase approach, including impact analysis, remediation, compliance review, and monitoring/contingency planning. The impact analysis phase includes the analysis, inventory, prioritization and remediation plan development for all technology essential to core business processes. The remediation phase involves testing and implementation of remediation technology. A mainframe test environment was established in 1997 and a test environment for network servers and stand-alone personal computers was established in mid-1998. All essential corporate business systems have been, or will be, tested in this test environment. The compliance review phase includes the assembling of compliance documentation for each technology component as remediation efforts are completed, and additional verification testing of essential technology where necessary. The monitoring/contingency planning phase includes compliance monitoring to ensure that year 2000 problems are not reintroduced into remediated technology, as well as the development of contingency plans to address reasonably likely risk scenarios. State of Readiness: Year 2000 issues are being managed by the major departments of Consumers. Traditional information technology consists of essential business systems such as payroll, billing and purchasing, and infrastructure, including mainframe, wide area network, local area networks, personal computers, radios and telephone systems. Process control computers and embedded systems contained in buildings, equipment and energy supply and delivery systems are also being managed. Essential goods and services for Consumers are electric fuel supply, gas fuel supply, independent electric power supplies, facilities, electronic commerce, telecommunications network carriers, financial institutions, purchasing vendors, and software and hardware technology vendors. Consumers is addressing the preparedness of these businesses and their risk through readiness assessment questionnaires. The status of Consumers Year 2000 Program by phase, with target dates for completion and current percentage complete based upon software and hardware inventory counts as of September 30, 1998, is as follows: Monitoring/ Impact Compliance Contingency Analysis Remediation Review Planning ---------- ----------- ---------- ---------- Business System (a) (b) (a) (b) (a) (b) (a) (b) Electric 3/98 100% 6/99 53% 6/99 22% 6/99 10% Gas 3/98 100% 6/99 66% 6/99 3% 6/99 10% Corporate 3/98 100% 6/99 62% 6/99 3% 6/99 10% Operating Services 3/98 100% 6/99 63% 6/99 40% 6/99 10% Essential Goods & Services 6/99 35% NA 9/99 0% 6/99 10% (a) Target date for completion. (b) Current percentage complete. Cost of Remediation: Consumers will expense anticipated spending for modifications as incurred, while capitalizing and amortizing the cost for new software over its useful life. The total estimated cost of the Year 2000 Program is approximately $22 million. Costs incurred through September 30, 1998 are $14 million. Consumers annual Year 2000 Program costs represent approximately 1% to 10% of a typical Consumers annual information technology budget. Year 2000 compliance work is being funded primarily from operations. The devotion of Consumers resources to the year 2000 problem has not deferred any material information technology projects which could have a material adverse affect on Consumers financial position, liquidity or results of operations. Risk Assessment: Consumers considers the most reasonably likely worst- case scenarios to be: (1) a lack of communications to dispatch crews to electric or gas emergencies, (2) a lack of communications to contact generating units to balance electrical load, and (3) power shortages due to the lack of stability of the regional or national electric grid. These scenarios could result in Consumers not being able to generate or distribute enough energy to meet customer demand for a period of time, which could result in lost sales and profits. Year 2000 remediation and testing efforts are concentrating on these risk areas and will continue through the end of 1999. Contingency plans will be revised and executed to further mitigate the risks associated with these scenarios. Contingency Plans: Contingency planning efforts are currently underway for all business systems and providers of essential goods and services. Extensive contingency plans are already in place in many locations and are currently being revised for reasonably likely worst-case scenarios related to year 2000 issues. In many cases, Consumers already has arrangements with multiple vendors of similar goods and services so that in the event that one cannot meet its commitments, others can. Current contingency plans provide for manual dispatching of crews and manual coordination of electrical load balancing, and are being revised to provide for radio or satellite communications. Coordinated contingency planning efforts are in progress with the North American Electric Reliability Council and its Regional Reliability Councils to minimize risk to electric generation, transmission and distribution systems. Expectations: Consumers does not expect that the cost of these modifications will materially affect its financial position, liquidity, or results of operations. There can be no guarantee, however, that these costs, plans or time estimates will be achieved, and actual results could differ materially. Because of the integrated nature of Consumers business with other energy companies, utilities, jointly owned facilities operated by other entities, and business conducted with suppliers and large customers, Consumers may be indirectly affected by year 2000 compliance complications. At this time, Consumers is unable to anticipate the magnitude of the operational or financial impact on Consumers of year 2000 issues. Forward-Looking Information Forward-looking information is included throughout this report. This report also describes material contingencies in the Notes to the Consolidated Financial Statements and should be read accordingly. Important factors that could cause actual results or outcomes to differ are set forth in Consumers' 1997 Form 10-K, "Management's Discussion and Analysis-Forward-Looking Information." 60 Consumers Energy Company Consolidated Statements of Income (Unaudited)
Three Months Ended Nine Months Ended Twelve Months Ended September 30 1998 1997 1998 1997 1998 1997 In Millions Operating Revenue Electric $ 729 $ 670 $1,990 $1,888 $2,617 $2,507 Gas 117 110 716 828 1,092 1,230 Other 14 19 37 39 48 49 ------ ------ ------ ------ ------ ------ 860 799 2,743 2,755 3,757 3,786 ------ ------ ------ ------ ------ ------ Operating Expenses Operation Fuel for electric generation 95 80 246 220 323 297 Purchased power - related parties 143 151 433 447 585 600 Purchased and interchange power 77 65 220 180 282 235 Cost of gas sold 39 39 377 472 600 718 Other 147 144 409 404 548 566 ------ ------ ------ ------ ------ ------ 501 479 1,685 1,723 2,338 2,416 Maintenance 48 38 126 119 177 176 Depreciation, depletion and amortization 93 88 291 286 395 384 General taxes 47 45 146 148 199 198 ------ ------ ------ ------ ------ ------ 689 650 2,248 2,276 3,109 3,174 ------ ------ ------ ------ ------ ------ Pretax Operating Income Electric 153 132 378 342 468 423 Gas 6 (1) 81 100 134 142 Other 12 18 36 37 46 47 ------ ------ ------ ------ ------ ------ 171 149 495 479 648 612 ------ ------ ------ ------ ------ ------ Other Income (Deductions) Loss on MCV power purchases - - (37) - (37) - Dividends and interest from affiliates 4 11 11 20 15 24 Accretion income 1 2 5 6 7 8 Accretion expense (4) (4) (12) (13) (16) (14) Other, net 1 1 3 1 - (3) ------ ------ ------ ------ ------ ------ 2 10 (30) 14 (31) 15 ------ ------ ------ ------ ------ ------ Interest Charges Interest on long-term debt 35 34 103 103 137 138 Other interest 9 9 28 25 39 33 Capitalized interest - - - - (1) - ------ ------ ------ ------ ------ ------ 44 43 131 128 175 171 ------ ------ ------ ------ ------ ------ Net Income Before Income Taxes 129 116 334 365 442 456 Income Taxes 43 36 111 126 137 151 ------ ------ ------ ------ ------ ------ Net Income before cumulative effect of change in accounting principle 86 80 223 239 305 305 Cumulative effect of change in accounting for property taxes, net of $23 tax (Note 1) - - 43 - 43 - ------ ------ ------ ------ ------ ------ Net Income 86 80 266 239 348 305 Preferred Stock Dividends 5 6 14 20 19 27 Preferred Securities Distributions 4 3 13 7 18 9 ------ ------ ------ ------ ------ ------ Net Income Available to Common Stockholder $ 77 $ 71 $ 239 $ 212 $ 311 $ 269 ====== ====== ====== ====== ====== ====== The accompanying condensed notes are an integral part of these statements.
61 Consumers Energy Company Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended Twelve Months Ended September 30 1998 1997 1998 1997 ---- ---- ---- ---- In Millions Cash Flows from Operating Activities Net income $ 266 $239 $ 348 $ 305 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear decommissioning of $38, $37, $51 and $49, respectively) 291 286 395 384 Loss on MCV power purchases 37 - 37 - Capital lease and other amortization 27 35 36 42 Deferred income taxes and investment tax credit 21 11 24 32 Accretion expense 12 13 16 14 Accretion income - abandoned Midland project (5) (6) (7) (8) Undistributed earnings of related parties (37) (35) (48) (45) MCV power purchases (48) (47) (63) (67) Cumulative effect of accounting change (66) - (66) - Changes in other assets and liabilities (46) (38) 81 13 ---- ---- ---- ---- Net cash provided by operating activities 452 458 753 670 ---- ---- ---- ---- Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (258) (260) (358) (371) Associated company preferred stock redemption 50 50 50 50 Proceeds from nuclear decommissioning trust funds 43 - 43 - Proceeds from the sale of two partnerships 27 - 27 - Proceeds from FMLP 12 - 12 - Investment in Electric Restructuring Implementatioin Plan (9) - (10) - Investments in nuclear decommissioning trust funds (38) (37) (51) (49) Cost to retire property, net (65) (26) (68) (37) Other 3 (4) 4 (4) ---- ---- ---- ---- Net cash used in investing activities (235) (277) (351) (411) ---- ---- ---- ---- Cash Flows from Financing Activities Proceeds from senior notes 914 - 914 - Retirement of bonds and other long-term debt (759) (51) (759) (51) Payment of common stock dividends (173) (113) (278) (199) Increase (decrease) in notes payable, net (75) 56 (87) 49 Contribution from stockholder (50) - (100) - Payment of capital lease obligations (26) (34) (36) (42) Payment of preferred stock dividends (14) (23) (19) (29) Preferred securities distributions (13) (7) (18) (9) Retirement of preferred stock - (120) - (120) Proceeds from Trust Preferred Securities - 116 - 116 Proceeds from bank loans - - - 23 ---- ---- ---- ---- Net cash provided by (used in) financing activities (196) (176) (383) (262) ---- ---- ---- ---- Net Increase (Decrease) in Cash and Temporary Cash Investments 21 5 19 (4) Cash and Temporary Cash Investments, Beginning of Period 7 4 9 13 ---- ---- ---- ---- Cash and Temporary Cash Investments, End of Period $ 28 $ 9 $ 28 $ 9 ==== ==== ==== ==== Nine Months Ended Twelve Months Ended September 30 1998 1997 1998 1997 ---- ---- ---- ---- In Millions Other cash flow activities and non-cash investing and financing activities were: Cash transactions Interest paid (net of amounts capitalized) $ 128 $ 129 $ 165 $ 164 Income taxes paid (net of refunds) 113 122 108 135 Non-cash transactions Nuclear fuel placed under capital lease $ 21 $ 4 $ 21 $ 24 Other assets placed under capital leases 11 5 12 6 ==== ==== ==== ==== All highly liquid investments with an original maturity of three months or less are considered cash equivalents. The accompanying condensed notes are an integral part of these statements.
63 Consumers Energy Company Consolidated Balance Sheets
ASSETS September 30 September 30 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Plant (At original cost) Electric $6,641 $6,491 $6,447 Gas 2,328 2,322 2,292 Other 26 24 25 ------ ------ ------ 8,995 8,837 8,764 Less accumulated depreciation, depletion and amortization 4,748 4,603 4,540 ------ ------ ------ 4,247 4,234 4,224 Construction work-in-progress 165 145 146 ------ ------ ------ 4,412 4,379 4,370 ------ ------ ------ Investments Stock of affiliates 227 278 258 First Midland Limited Partnership (Note 2) 237 242 239 Midland Cogeneration Venture Limited Partnership (Note 2) 199 171 163 Other - 7 7 ------ ------ ------ 663 698 667 ------ ------ ------ Current Assets Cash and temporary cash investments at cost, which approximates market 28 7 9 Accounts receivable and accrued revenue, less allowances of $5, $6 and $6, respectively (Note 3) - 82 47 Accounts receivable - related parties 77 62 87 Inventories at average cost Gas in underground storage 276 197 253 Materials and supplies 65 63 69 Generating plant fuel stock 29 35 26 Postretirement benefits 25 25 25 Deferred income taxes - 22 9 Prepayments and other 124 161 51 ------ ------ ------ 624 654 576 ------ ------ ------ Non-current Assets Nuclear decommissioning trust funds 510 486 478 Postretirement benefits 380 404 411 Abandoned Midland Project 77 93 98 Other 250 235 238 ------ ------ ------ 1,217 1,218 1,225 ------ ------ ------ Total Assets $6,916 $6,949 $6,838 ====== ====== ======
STOCKHOLDERS' INVESTMENT AND LIABILITIES September 30 September 30 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Capitalization Common stockholder's equity Common stock $ 841 $ 841 $ 841 Paid-in capital 402 452 502 Revaluation capital 57 58 45 Retained earnings since December 31, 1992 429 363 396 ------ ------ ------ 1,729 1,714 1,784 Preferred stock 238 238 238 Company-obligated mandatorily redeemable preferred securities of: Consumers Power Company Financing I (a) 100 100 100 Consumers Energy Company Financing II (a) 120 120 120 Long-term debt 1,977 1,369 1,462 Non-current portion of capital leases 77 74 82 ------ ------ ------ 4,241 3,615 3,786 ------ ------ ------ Current Liabilities Current portion of long-term debt and capital leases 146 579 483 Notes payable 302 377 389 Accounts payable 160 171 140 Accrued taxes 109 244 97 Accounts payable - related parties 72 79 75 Power purchases (Note 2) 47 47 47 Accrued interest 26 32 25 Accrued refunds 12 12 7 Deferred income taxes 4 - - Other 143 136 139 ------ ------ ------ 1,021 1,677 1,402 ------ ------ ------ Non-current Liabilities Deferred income taxes 661 688 630 Postretirement benefits 467 489 495 Power purchases (Note 2) 134 133 144 Deferred investment tax credit 142 149 152 Regulatory liabilities for income taxes, net 83 54 86 Other 167 144 143 ------ ------ ------ 1,654 1,657 1,650 ------ ------ ------ Commitments and Contingencies (Note 2) Total Stockholders' Investment and Liabilities $6,916 $6,949 $6,838 ====== ====== ====== (a) The primary asset of Consumers Power Company Financing I is $103 million principal amount of 8.36% subordinated deferrable interest notes due 2015 from Consumers. The primary asset of Consumers Energy Company Financing II is $124 million principal amount of 8.20% subordinated deferrable interest notes due 2027 from Consumers. The accompanying condensed notes are an integral part of these statements.
65 Consumers Energy Company Consolidated Statements of Common Stockholder's Equity (Unaudited)
Three Months Ended Nine Months Ended Twelve Months Ended September 30 1998 1997 1998 1997 1998 1997 In Millions Common Stock At beginning and end of period $ 841 $ 841 $ 841 $ 841 $ 841 $ 841 ------- ------- ------- ------- ------- ------- Other Paid-in Capital At beginning of period 452 504 452 504 502 504 Return of stockholder's contribution (50) - (50) - (100) - Preferred stock reacquired - (2) - (2) - (2) ------- ------- ------- ------- ------- ------- At end of period 402 502 402 502 402 502 ------- ------- ------- ------- ------- ------- Revaluation Capital At beginning of period 59 41 58 37 45 30 Change in unrealized investment - gain (loss) (a) (2) 4 (1) 8 12 15 ------- ------- ------- ------- ------- ------- At end of period 57 45 57 45 57 45 ------- ------- ------- ------- ------- ------- Retained Earnings At beginning of period 396 368 363 297 396 326 Net income (a) 86 80 266 239 348 305 Common stock dividends declared (44) (43) (173) (113) (278) (199) Preferred stock dividends declared (5) (6) (14) (20) (19) (27) Preferred securities distributions (4) (3) (13) (7) (18) (9) ------- ------- ------- ------- ------- ------- At end of period 429 396 429 396 429 396 ------- ------- ------- ------- ------- ------- Total Common Stockholder's Equity $1,729 $1,784 $1,729 $1,784 $1,729 $1,784 ======= ======= ======= ======= ======= ======= (a) Disclosure of Comprehensive Income: Revaluation capital Unrealized investment - gain (loss), net of tax of $(1), $2, $-, $4, $7 and $8, respectively $ (2) $ 4 $ (1) $ 8 $ 12 $ 15 Net income 86 80 266 239 348 305 ------- ------- ------- ------- ------- ------- Total Comprehensive Income $ 84 $ 84 $ 265 $ 247 $ 360 $ 320 ======= ======= ======= ======= ======= ======= The accompanying condensed notes are an integral part of these statements.
66 Consumers Energy Company Condensed Notes to Consolidated Financial Statements These Consolidated Financial Statements and their related Condensed Notes should be read along with the Consolidated Financial Statements and Notes contained in Consumers' 1997 Form 10-K that includes the Report of Independent Public Accountants. In the opinion of management, the unaudited information herein reflects all adjustments necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. 1: Corporate Structure and Change of Significant Accounting Policies CORPORATE STRUCTURE Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan and is the principal subsidiary of CMS Energy, a holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. IMPLEMENTATION OF NEW ACCOUNTING STANDARD In 1997, the FASB issued SFAS 130, Reporting Comprehensive Income. This statement, which is effective for 1998 financial statement reporting, establishes standards for reporting and display of comprehensive income and its components. Equity adjustments related to unrealized investment gains and losses (net of tax), along with consolidated net income, comprise comprehensive income. CHANGE IN METHOD OF ACCOUNTING FOR PROPERTY TAXES During the first quarter of 1998, Consumers implemented a change in the method of accounting for property taxes so that such taxes are recognized during the fiscal period of the taxing authority for which the taxes are levied. This change provides a better matching of property tax expense with the services provided by the taxing authorities, and is considered the most acceptable basis of recording property taxes. Prior to 1998, Consumers recorded property taxes monthly during the year following the assessment date (December 31). The cumulative effect of this one-time change in accounting increased other income by $66 million, and earnings, net of tax, by $43 million. The pro forma effect on prior years' consolidated net income of retroactively recording property taxes as if the new method of accounting had been in effect for all periods presented is not material. 2: Uncertainties ELECTRIC CONTINGENCIES Electric Environmental Matters: The Clean Air Act limits emissions of sulfur dioxide and nitrogen oxides and requires emissions monitoring. Consumers' coal-fueled electric generating units burn low-sulfur coal and are currently operating at or near the sulfur dioxide emission limits that will be effective in the year 2000. During the past few years, in order to comply with the Act, Consumers incurred capital expenditures totaling $46 million to install equipment at certain generating units. Consumers estimates capital expenditures for ongoing and proposed modifications at other coal-fueled units to be an additional $26 million by the year 2000. Management believes that these expenditures will not materially affect Consumers' annual operating costs. Consumers currently operates within all Clean Air Act requirements and meets current emission limits. The Act requires the EPA to review, periodically, the effectiveness of the national air quality standards in preventing adverse health affects. In 1997 the EPA revised these standards. Monitoring for the new standards is reasonably likely to result in further limitations on small particulate and ozone related emissions. Following completion of the Ozone Transport Assessment Group process and requests by several Northeastern states, in September 1998, the EPA Administrator signed final regulations requiring the State of Michigan to further limit nitrogen oxide emissions. Fossil-fueled emitters, such as Consumers' generating units, can anticipate reduction in nitrogen oxide emissions by 2003 to only 32 percent of levels allowed for the year 2000. The State of Michigan has one year to submit an implementation plan. It is unlikely that the State of Michigan will establish Consumers' nitrogen oxide emissions reduction target until mid-to-late 1999. Until this target is established, the estimated cost of compliance is subject to significant revision. The preliminary estimate of capital costs to reduce nitrogen oxide-related emissions for Consumers' fossil-fueled generating units is approximately $290 million, plus an additional amount totaling $10 million per year for operation and maintenance costs. Consumers may need an equivalent amount of capital expenditures and operation and maintenance costs to comply with the new small particulate standards. The State of Michigan has objected to the extent of the required EPA emission reductions. If a court were to order the EPA to adopt the State of Michigan's position, costs could be less than the current estimated amounts. Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites. Nevertheless, it believes that these costs are properly recoverable in rates under current ratemaking policies. Consumers is a so-called potentially responsible party at several contaminated sites administered under Superfund. Superfund liability is joint and several; along with Consumers, many other creditworthy, potentially responsible parties with substantial assets cooperate with respect to the individual sites. Based upon past negotiations, Consumers estimates that its share of the total liability for the known Superfund sites will be between $3 million and $9 million. At September 30, 1998, Consumers has accrued $3 million for its estimated Superfund liability. While decommissioning Big Rock, Consumers found that some areas of the plant have coatings that contain both metals and PCBs. Consumers does not believe that any facility in the United States currently accepts the radioactive portion of that waste. The cost of removal and disposal is currently unknown. These costs would constitute part of the cost to decommission the plant, and will be paid from the decommissioning fund. Consumers is studying the extent of the contamination and reviewing options. Stray Voltage: Various parties have sued Consumers relating to the effect of so-called stray voltage on certain livestock. Claimants contend that stray voltage results when low-level electrical currents present in grounded electrical systems are diverted from their intended path. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns. It also has an ongoing mitigation program to modify the service of all customers with livestock. In December 1997, the Michigan Supreme Court remanded for further proceedings a 1994 Michigan trial court decision that refused to allow the claims of over 200 named plaintiffs to be joined in a single action. The trial court dismissed all of the plaintiffs except the first-named plaintiff, allowing the others to re-file separate actions. Of the original plaintiffs, only 49 re-filed separate cases. All of those 49 cases have been resolved. The Michigan Supreme Court remanded the matter, finding that the proper remedy for misjoinder was not dismissal, but to automatically allow each case to go forward separately. Consumers filed a motion for reconsideration with the Michigan Supreme Court, which was denied. As a result, 21 individual plaintiffs elected to exercise their right to proceed with separate actions. Consumers has now resolved all 21 of those cases. As of November 3, 1998, Consumers had 3 individual stray voltage lawsuits awaiting trial court action, down from 12 cases as reported at year end 1997. Anti-Trust: In October 1997, two independent power producers sued Consumers and CMS Energy in a federal court. The suit alleges antitrust violations relating to contracts which Consumers entered into with some of its customers and claims relating to power facilities. The plaintiffs claim damages of $100 million (which a court can treble in antitrust cases as provided by law). In September 1998, the court issued an opinion and order granting CMS Energy's motion to dismiss. The court has not yet ruled on Consumers' motion to dismiss. Consumers believes the lawsuit is without merit and will vigorously defend against it, but cannot predict the outcome of this matter. ELECTRIC RATE MATTERS Electric Proceedings: In 1996, the MPSC issued a final order that authorized Consumers to recover costs associated with the purchase of the additional 325 MW of MCV Facility capacity (see "Power Purchases from the MCV Partnership" in this Note) and recover its nuclear plant investment by increasing prospective annual nuclear plant depreciation expense by $18 million, with a corresponding decrease in fossil-fueled generating plant depreciation expense. It also established an experimental direct-access program. Customers having a maximum demand of at least 2 MW are eligible to purchase generation services directly from any eligible third-party power supplier and Consumers would transmit the power for a fee. The direct-access program is limited to 134 MW of load. In accordance with the MPSC order, Consumers held a lottery in April 1997 to select the customers to participate in the direct-access program. Subsequently, direct access for a portion of this 134 MW began in late 1997. Consumers expects the remaining amount of direct access to begin later in 1998. In January 1998, the Court of Appeals affirmed an MPSC conclusion that the MPSC has statutory authority to authorize an experimental electric retail wheeling program. By its terms, no retail wheeling has yet occurred pursuant to that program. In October 1998, the Michigan Supreme Court issued an order granting Consumers' application for leave to appeal. A decision by the Michigan Supreme Court in this matter is expected in mid- 1999. For information on other orders, see the Electric Restructuring section below. Electric Restructuring: As part of ongoing proceedings relating to the restructuring of the electric utility industry in Michigan, in June 1997 the MPSC issued an order proposing that beginning January 1, 1998 Consumers transmit and distribute energy on behalf of competing power suppliers to serve retail customers. Subsequent to the June 1997 order, the MPSC issued further restructuring orders in October 1997 and in January and February 1998. These orders provide for: 1) the recovery of estimated Transition Costs of $1.755 billion through a charge to all direct-access customers until the end of the transition period in 2007, subject to an adjustment through a true-up mechanism; 2) the commencement of the phase-in of direct-access in 1998; 3) the suspension of the power supply cost recovery clause; and 4) all customers to be free to choose power suppliers on January 1, 2002. See "Other Electric Uncertainties" below for further information regarding the effect of the PSCR suspension on the recovery of MCV Facility capacity charges. Consumers believes that the Transition Cost surcharge will apply to all customers beginning in 2002. The recovery of prudent costs of implementing a direct-access program, estimated at an additional $200 million, would be reviewed for prudence and recovered via a charge approved by the MPSC. Nuclear decommissioning costs will also continue to be collected through a separate surcharge to all customers. Consumers expects Michigan legislative consideration of the entire subject of electric industry restructuring in 1998. To be acceptable to Consumers, the legislation would have to provide for full recovery of Transition Costs. Consumers expects the legislature to review all of the policy choices made by the MPSC during the restructuring proceedings to assure that they are in accord with those that the legislature believes should be paramount. There are numerous appeals pending at the Court of Appeals relating to the MPSC's restructuring orders, including appeals by Consumers and Detroit Edison. Consumers believes that the MPSC lacks statutory authority to mandate industry restructuring, and its appeal is limited to this jurisdictional issue. As a result of an informal process involving consultations with MPSC staff and other interested parties, as directed in the MPSC's February 1998 order, Consumers submitted to the MPSC in June 1998 its plan for implementing direct access. The primary issues addressed in the plan are: 1) the implementation schedule; 2) the direct-access service options available to customers and suppliers; 3) the process and requirements for customers and others to obtain direct-access service; and 4) the roles and responsibilities for Consumers, customers and suppliers. Under the schedule in the plan, Consumers will, over the 1998-2001 period, phase in 750 MW of retail customer load to direct-access customers. At one time, 300 MW of direct-access load was to be opened for bidding in 1998, and an additional 150 MW each year from 1999 to 2001. This plan is consistent with the previous orders regarding the phase-in process. Due to the time required for the MPSC to review the plan, Consumers does not believe direct access will commence prior to the first quarter of 1999. For further information regarding the effects of the restructuring on accounting methods, see Electric Business Outlook - Electric Application of SFAS 71 in the MD&A. Consumers cannot predict the outcome or timing of electric restructuring on Consumers' financial position, liquidity, or results of operations. On October 2, 1998, Consumers initiated a process for the solicitation of bids to acquire Consumers' rights to 1,240 MW of contract capacity and associated energy under its PPA with the MCV Partnership. Consumers' rights to the 1,240 MW of contract capacity and associated energy are being offered in one 1,240 MW block or in two 620 MW pieces, for the period from the effective date in 1999 through either September 2007 or March 2025. Consumers has reserved the right at any time, in its sole discretion, to terminate the bidding process or to reject any or all bids. Consumers will not consummate a transaction unless important customer benefits flow from that transaction. Any such transaction would be subject to the approval of Consumers' Board of Directors and obtaining satisfactory rate making and accounting treatment from the MPSC and the FERC with respect to the definitive agreements, including any necessary approval by FERC of the transfer of the 1,240 MW of contract capacity and associated energy. In an order issued October 12, 1998, the MPSC delayed its consideration of the auction process until the definitive agreements with the winning bidder(s) are presented for review, but stated that Consumers' approach offers a legitimate way to utilize independent market forces to determine the above-market or stranded portion of Consumers' obligations under the PPA with the MCV Partnership. Consumers anticipates that such definitive agreements, if any, will be negotiated by early February 1999 and appropriate filings will be made with MPSC for consideration during the first quarter of 1999. OTHER ELECTRIC UNCERTAINTIES 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 and to supply electricity and steam to Dow. Consumers, through two wholly owned subsidiaries, holds the following assets related to the MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through FMLP, a 35 percent lessor interest in the MCV Facility. Summarized Statements of Income for CMS Midland and CMS Holdings- In Millions Three Months Ended Nine Months Ended Twelve Months Ended September 30 1998 1997 1998 1997 1998 1997 ---- ---- ---- ---- ---- ---- Pretax operating income $13 $18 $36 $36 $46 $45 Income taxes and other 4 6 11 11 14 13 ---- ---- ---- ---- ---- ---- Net income $ 9 $12 $25 $25 $32 $32 ==== ==== ==== ==== ==== ==== Power Purchases from the MCV Partnership- After September 2007, pursuant to the terms of the PPA and related undertakings, Consumers will only be required to pay the MCV Partnership the capacity charge and energy charge amounts authorized for recovery from electric customers by the MPSC. Currently, Consumers' annual obligation to purchase capacity from the MCV Partnership is 1,240 MW through the termination of the PPA in 2025. The PPA provides that Consumers is to pay the MCV Partnership a levelized average capacity charge of 3.77 cents per kWh, a fixed energy charge, and a variable energy charge based primarily on Consumers' average cost of coal consumed. The MPSC has, since January 1, 1993, permitted Consumers to recover capacity charges averaging 3.62 cents per kWh for 915 MW, plus a substantial portion of the fixed and variable energy charges. Beginning January 1, 1996, the MPSC has also permitted Consumers to recover capacity charges for the remaining 325 MW of MCV Facility contract capacity. The order approving such recovery indicated that the recoverable capacity charge for the 325 MW would gradually increase from an initial average charge of 2.86 cents per kWh to an average charge of 3.62 cents per kWh by 2004, which latter amount would be collected thereafter. Because the MPSC suspended the PSCR process as part of the electric industry restructuring order (see "Electric Restructuring" in this Note), Consumers expects to recover the future increases approved for the 325 MW capacity through an adjustment to the frozen PSCR level; this adjustment is currently under consideration by the MPSC. Consumers recognized a loss in 1992 for the present value of the estimated future underrecoveries of power costs under the PPA. At September 30, 1998 and December 31,1997, the after-tax present value of the PPA liability totaled $118 million and $117 million, respectively. The increase in the liability since December 31, 1997 reflects an additional $37 million accrual ($24 million after-tax) for higher than anticipated MCV Facility availability levels experienced in prior periods and an after-tax accretion expense of $8 million, partially offset by after-tax cash underrecoveries of $31 million. The undiscounted after-tax amount associated with the liability totaled $170 million at September 30, 1998. The after-tax cash underrecoveries are currently based on the assumption that the MCV Facility will be available to generate electricity 91.5 percent of the time over its expected life. For the first nine months of 1998 the MCV Facility was available 99.3 percent of the time, resulting in $14 million over anticipated after-tax cash underrecoveries. Consumers believes it will continue to experience after-tax cash underrecoveries associated with the PPA in amounts comparable to those shown below. In Millions 1998 1999 2000 2001 2002 Estimated cash underrecoveries, net of tax $37 $22 $21 $20 $19 Consumers bases the above estimated underrecoveries, in part, on an estimate of the future availability of the MCV Facility. If the MCV Facility operates at levels above management's estimate over the remainder of the PPA, Consumers will need to recognize losses for future underrecoveries larger than amounts previously recorded. Therefore, Consumers would experience larger amounts of cash underrecoveries than originally anticipated. Management will continue to evaluate the adequacy of the accrued liability considering actual MCV Facility operations. In February 1998, the MCV Partnership filed a claim of appeal from the January 1998 and February 1998 MPSC orders in the electric utility industry restructuring. At the same time, the MCV Partnership filed suit in the U.S. District Court seeking a declaration that the MPSC's failure to provide Consumers and the MCV Partnership a certain source of recovery of capacity payments after 2007 deprived the MCV Partnership of its rights under the Public Utilities Regulatory Policies Act of 1978. The MCV Partnership is seeking to prohibit the MPSC from implementing portions of the order. PSCR Matters Related to Power Purchases from the MCV Partnership- As part of a 1995 decision in the 1993 PSCR reconciliation case, the MPSC disallowed a portion of the costs related to purchases from the MCV Partnership and instead assumed recovery of those costs from wholesale customers. Consumers believed this was contrary to the terms of an earlier 1993 settlement order and appealed. The MCV Partnership and ABATE also filed separate appeals of this order. In November 1996, the Court of Appeals affirmed the MPSC's 1995 decision. The MCV Partnership filed an application for leave to appeal with the Michigan Supreme Court which was denied in January 1998. This matter is now closed. Nuclear Matters: Consumers filed updated decommissioning information with the MPSC in 1995 that estimated decommissioning costs for Big Rock and Palisades. In April 1996, the MPSC issued an order in Consumers' nuclear decommissioning case, which fully supported Consumers' request and did not change the overall surcharge revenues collected from retail customers. The MPSC ordered Consumers to file a report on the adequacy of the surcharge revenues with the MPSC at three-year intervals beginning in 1998. On March 31, 1998, Consumers filed with the MPSC a new decommissioning cost estimate for Big Rock and Palisades of $294 million and $518 million (in 1997 dollars) respectively. The estimated decommissioning costs decreased from previous estimates primarily due to a decrease in offsite burial costs. Consumers recommended a reallocation of its existing surcharge between the two plants on January 1, 1999 to provide additional funds to decommission Big Rock. Consumers filed a revision to its Post Shutdown Activities Report (formerly decommissioning report) with the NRC to reflect the shutdown of Big Rock. Big Rock is being decommissioned. It was closed permanently on August 29, 1997 because management determined that it would be uneconomical to operate in an increasingly competitive environment. Consumers had originally scheduled the plant to close May 31, 2000, at the end of the plant's operating license. Plant decommissioning began in September 1997 and may take five to ten years to return the site to its original condition. In January 1997, the NRC issued its Systematic Assessment of Licensee Performance report for Palisades. The report rated all areas as good, unchanged from the previous assessment. The NRC suspended the Systematic Assessment of Licensee Performance process for all licensees. Palisades was to have been reevaluated in September 1998. Palisades' temporary on-site storage pool for spent nuclear fuel is at capacity. Consequently, Consumers is using NRC-approved steel and concrete vaults, commonly known as "dry casks", for temporary on-site storage. As of September 30, 1998 Consumers had loaded 13 dry storage casks with spent nuclear fuel at Palisades. Consumers plans to load five additional casks at Palisades in 1999 pending approval by the NRC. In June 1997, the NRC approved Consumers' process for unloading spent fuel from a cask at Palisades previously discovered to have minor weld flaws. Consumers intends to transfer the spent fuel to a new transportable cask when one is available. A planned outage for refueling and maintenance at Palisades was completed June 7, 1998. Consumers replaced 60 nuclear fuel assemblies in the plant's reactor during the outage. The NRC requires Consumers to make certain calculations and report to it on the continuing ability of the Palisades reactor vessel to withstand postulated pressurized thermal shock events during its remaining license life, considering the embrittlement of reactor vessel materials over time due to operation in a radioactive environment. Based on continuing analysis of data in December 1996, Consumers received an interim Safety Evaluation Report from the NRC indicating that the reactor vessel can be safely operated through 2003 before reaching the NRC's screening criteria for reactor embrittlement. Consumers believes that with fuel management designed to minimize embrittlement, it can operate Palisades to the end of its license life in the year 2007 without annealing the reactor vessel. Nevertheless, Consumers will continue to monitor the matter. Capital Expenditures: Consumers estimates electric capital expenditures, including new lease commitments, of $341 million for 1998, $380 million for 1999, and $385 million for 2000. For further information, see the Capital Expenditures Outlook section in the MD&A. GAS CONTINGENCIES Gas Environmental Matters: Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. In 1998 Consumers plans to study indoor air issues at residences on some sites and ground water impacts or surface soil impacts at other sites. On sites where Consumers has received site-wide study plan approvals, it will continue to implement these plans. It will also work toward closure of environmental issues at sites as studies are completed. Data available to Consumers and its continued internal review have resulted in an estimate for all costs related to investigation and remedial action for all 23 sites of between $48 million and $98 million, of which Consumers accrued a liability for $48 million. These estimates are based on undiscounted 1998 costs. As of September 30,1998, Consumers has a remaining accrued liability of $46 million and a regulatory asset for approximately the same amount. Any significant change in assumptions, such as remediation techniques, nature and extent of contamination, and legal and regulatory requirements, could affect the estimate of remedial action costs for the sites. According to an MPSC rate order issued in 1996, Consumers will defer and amortize, over a period of ten years, environmental clean-up costs above the amount currently being recovered in rates. Rate recognition of amortization expense will not begin until after a prudence review in a general rate case. The order authorizes current recovery of $1 million annually. Consumers has initiated a lawsuit against certain insurance companies regarding coverage for some or all of the costs that it may incur for these sites. GAS RATE MATTERS Gas Restructuring: In December 1997, the MPSC approved Consumers' application to implement a statewide experimental gas transportation pilot program. Consumers' expanded experimental program will extend over a three-year period, eventually allowing 300,000 residential, commercial and industrial retail gas sales customers to choose their gas supplier. The program is voluntary for natural gas customers. Participating customers are being selected on a first-come, first-served basis, up to a limit of 100,000 customers beginning April 1, 1998. As of October 23, 1998, more than 80,000 customers chose alternative gas suppliers, representing approximately 24 bcf of gas load. Of these alternative gas suppliers, one was a CMS Energy affiliate. Up to 100,000 more customers may be added beginning April 1 of each of the next two years. Customers choosing to remain as sales customers of Consumers will not see a rate change in their natural gas rates. The order allowing the implementation of this program: 1) suspends Consumers' gas cost recovery clause, effective April 1, 1998 for a three-year period, establishing a gas commodity cost at a fixed rate of $2.84 per mcf; 2) establishes an earnings sharing mechanism that will provide for refunds to customers if Consumers' earnings during the three- year term of the program exceed certain pre-determined levels; and 3) establishes a gas transportation code of conduct that addresses concerns about the relationship between Consumers and marketers, including its affiliated marketers. This experimental program will allow competing gas suppliers, including marketers and brokers, to market natural gas to a large number of retail customers in direct competition with Consumers. In January 1998, the Attorney General, ABATE and other parties filed claims of appeal regarding the program with the Court of Appeals. At September 30, 1998, Consumers had an exposure to gas price increases if the cost was to exceed $2.84 per mcf for the following volumes: 5 percent of its 1998 requirements; 40 percent of its 1999 requirements; and 65 percent of its 2000 requirements. Additional forward coverage is currently under review. The forward contracts currently in place were consummated at prices less than $2.84 per mcf. The contracts are being used to manage Consumers' exposure to gas commodity cost increases in a three-year experimental gas program. For further information regarding the effects of the restructuring on accounting methods, see Gas Business Outlook - Application of SFAS 71 in the MD&A. OTHER GAS UNCERTAINTIES Capital Expenditures: Consumers estimates gas capital expenditures, including new lease commitments, of $117 million for 1998, $125 million for 1999, and $125 million for 2000. For further information, see the Capital Expenditures Outlook section in the MD&A. In addition to the matters disclosed in this note, Consumers and certain of its subsidiaries 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. Consumers has accrued estimated losses for certain contingencies discussed in this Note. Resolution of these contingencies is not expected to have a material adverse impact on Consumers' financial position, liquidity, or results of operations. 3: Short-Term Financings and Capitalization Authorization: At November 1, 1998, Consumers had remaining FERC authorization to: 1) issue or guarantee through June 2000, up to $900 million of short-term securities outstanding at any one time; 2) guarantee, through 1999, up to $25 million in loans made by others to residents of Michigan for making energy-related home improvements; and 3) issue through June 2000, up to $900 million long-term securities with maturities up to 30 years for refinancing purposes. Short-Term Financings: Consumers has an unsecured $425 million credit facility and unsecured lines of credit aggregating $130 million. These facilities are available to finance seasonal working capital requirements and to pay for capital expenditures between long-term financings. At September 30, 1998, a total of $302 million was outstanding at a weighted average interest rate of 6.3 percent, compared with $389 million outstanding at September 30, 1997, at a weighted average interest rate of 6.2 percent. In January 1998, Consumers entered into interest rate swaps totaling $300 million. These swap arrangements have had an immaterial effect on interest expense. Consumers also has in place a $500 million trade receivables sale program. At September 30, 1998 and 1997, receivables sold under the program totaled $307 million and $250 million, respectively. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold. Capital Stock: The primary asset of Consumers Power Company Financing I is $103 million principal amount of 8.36 percent subordinated deferrable interest notes due 2015 from Consumers. The primary asset of Consumers Energy Company Financing II is $124 million principal amount of 8.20 percent subordinated deferrable interest notes due 2027 from Consumers. Long-Term Financings: The following table describes the new issuances of long-term financings which have occurred during 1998 through early November 1998.
In Millions Month Interest Principal Issued Maturity Rate (%) Amount Use of Proceeds - ---------------- ------ -------- ------- --------- --------------------------- Senior Notes (a) February 2008 6.375 $ 250 Pay down First Mortgage Bonds and general corporate purposes Senior Notes (a) March 2018 6.875 225 Pay down First Mortgage Bonds and other long-term debt Senior Notes (a) May 2008 6.2 (b) 250 Pay down First Mortgage Bonds, long-term bank debt and general corporate purposes Long-Term Bank Debt May 2001-2003 6.05 (d) 225 Pay down long-term bank debt and general corporate purposes Senior Notes (a) June 2018 6.5 (c) 200 Pay down First Mortgage Bonds and general corporate purposes Senior Notes (e) October 2028 6.5 150 Pay down long-term bank debt and general corporate purposes ------- Total $1,300 (a) The Senior Notes are secured by Consumers First Mortgage Bonds issued contemporaneously in a similar amount. (b) The interest rate may be reset in 2003. (c) The interest rate will be reset in June 2005. (d) The interest rate is variable; weighted average interest rate upon original issuance was 6.05 percent. (e) The Senior Notes are secured by Consumers First Mortgage Bonds issued contemporaneously in a similar amount and are insured for full debt service.
In October 1998, Consumers unwound an interest rate guarantee of $145 million associated with the issuance of $150 million senior notes. The effective rate of the debt is 7 percent taking into consideration the issuance costs, interest rate guarantee and insurance costs. The following table describes the retirements of long-term financings which have occurred during 1998 through early November 1998. In Millions Month Interest Principal Retired Maturity Rate (%) Amount ------- ------- ------- ---------- First Mortgage Bonds February 1998 8.75 $248 Long-Term Bank Debt February 1998 6.4 (a) 50 First Mortgage Bonds March 2001-2002 7.5 119 First Mortgage Bonds April 2023 7.375 36 First Mortgage Bonds May 1998 6.875 43 Long-Term Bank Debt May 1998-1999 6.3 (b) 350 First Mortgage Bonds July 1999 8.875 136 First Mortgage Bonds October 1998 6.625 45 Long-Term Bank Debt November 2001-2003 6.05 50 ----- Total $1,077 ===== (a) The interest rate was variable; weighted average interest rate at December 31, 1997 was 6.4 percent. (b) The interest rate was variable; weighted average interest rate at March 31, 1998 was 6.3 percent. Consumers had unsecured, variable rate long-term bank debt with an outstanding balance at September 30, 1998 and 1997 of $225 million and $400 million, respectively. At September 30, 1998 and 1997 the debt carried weighted average interest rates of 6.1 percent and 6.3 percent, respectively. In February 1998, Consumers retired $50 million of its $400 million unsecured long-term bank debt. In May 1998, Consumers refinanced the remaining $350 million unsecured long-term bank debt, in part with $225 million unsecured long-term bank debt. To cover the remaining $125 million of bank debt refinancing, in May 1998 Consumers issued $250 million of senior notes due 2008, at an interest rate of 6.2 percent. The $125 million balance of senior notes due 2008 was used for repurchasing $36 million of 7.375 percent First Mortgage Bonds and for general corporate purposes. Under the provisions of its Articles of Incorporation at September 30, 1998, Consumers had $295 million of unrestricted retained earnings available to pay common dividends. In October 1998, Consumers declared a $68 million common dividend to be paid in November 1998. 77 ARTHUR ANDERSEN LLP Report of Independent Public Accountants To Consumers Energy Company: We have reviewed the accompanying consolidated balance sheets of CONSUMERS ENERGY COMPANY (a Michigan corporation and wholly owned subsidiary of CMS Energy Corporation) and subsidiaries as of September 30, 1998 and 1997, the related consolidated statements of income and common stockholder's equity for the three-month, nine-month, and twelve-month periods then ended, and the related consolidated statements of cash flows for the nine-month and twelve-month periods then ended. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet and consolidated statements of long-term debt and preferred stock of Consumers Energy Company and subsidiaries as of December 31, 1997, and the related consolidated statements of income, common stockholder's equity and cash flows for the year then ended (not presented herein), and, in our report dated January 26, 1998, we expressed an unqualified opinion on those statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 1997, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. Arthur Andersen LLP Detroit, Michigan, November 10, 1998. 78 Quantitative and Qualitative Disclosures about Market Risk CMS Energy Quantitative and Qualitative Disclosures About Market Risk is contained in PART I: CMS Energy Corporation Management's Discussion and Analysis which is incorporated by reference herein. 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 and Consumers' Form 10-K for the year ended December 31, 1997, and in their Form 10-Q for the quarters ended March 31, and June 30, 1998. Reference is made to the Notes to the Consolidated Financial Statements included herein for additional information regarding various pending administrative and judicial proceedings involving rate, operating and environmental matters. Consumers Stray Voltage Litigation For a discussion of Consumers' stray voltage litigation see Note 2, subsection "Stray Voltage" of the Condensed Notes to the Consolidated Financial Statements in Part I of this Report, incorporated by reference herein. CMS Energy and Consumers Antitrust Litigation For a discussion of CMS Energy's and Consumers' antitrust litigation see Note 2, subsection "Anti-Trust" of the Condensed Notes to the Consolidated Financial Statements in Part I of this Report, incorporated by reference herein. CMS Energy Independent Power Production Project Litigation In August 1995, William R. Williams and two of his corporations, Altresco Philippines, Inc. and WRW Corporation (formerly Altresco International, Inc.), filed a lawsuit against CMS Generation in connection with a project to be developed in the Philippines by Luzon Power Associates, Inc. in which CMS Generation owned a 50 percent interest. The plaintiffs' claims primarily relate to a confidentiality agreement between the parties and CMS Generation's alleged violation of a restrictive covenant in the confidentiality agreement. The plaintiffs claimed direct damages of approximately $85 million and indirect damages in a like amount from loss of future business, plus punitive damages, interest, and attorney's fees. Arbitration was completed in June 1998 and a decision by the International Chamber of Commerce ("ICC"), International Court of Arbitration was rendered in September 1998. The ICC ruled that the plaintiffs are entitled to a sum of $3 million in direct damages together with interest thereon at 7 percent per annum, plus a total of $3.7 million in attorneys fees and costs. Related litigation in Denver Federal District Court remains pending, with a trial scheduled for April 1999. ITEM 6. Exhibits and Reports on Form 8-K (a) List of Exhibits (4)(a) - Consumers: Third Supplemental Indenture dated as of October 29, 1998, between Consumers and The Chase Manhattan Bank, as Trustee (4)(b) - Consumers: Seventy-fourth Supplemental Indenture dated as of October 29, 1998, between Consumers and The Chase Manhattan Bank, as Trustee (12) - CMS Energy: Statements regarding computation of Ratio of Earnings to Fixed Charges (15)(a) - Consumers: Letter of Independent Public Accountant (15)(b) - CMS Energy: Letter of Independent Public Accountant (27)(a) - CMS Energy: Financial Data Schedule (27)(b) - Consumers: Financial Data Schedule (99) - CMS Energy: Consumers Gas Group Financials (b) Reports on Form 8-K A Current Report on Form 8-K dated October 2, 1998 was filed by each of CMS Energy and Consumers, and Current Reports on Form 8-K dated June 23, July 30, October 2, and November 3, 1998 were filed by CMS Energy, all covering matters pursuant to "Item 5. Other Events." 80 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: November 12, 1998 By_____________________ Alan M. Wright Senior Vice President and Chief Financial Officer CONSUMERS ENERGY COMPANY (Registrant) Dated: November 12, 1998 By_____________________ Alan M. Wright Senior Vice President and Chief Financial Officer UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 CMS ENERGY CORPORATION AND CONSUMERS ENERGY COMPANY FORM 10-Q EXHIBITS FOR QUARTER ENDED SEPTEMBER 30, 1998 EXHIBIT INDEX Exhibit Numbers Description (4)(a) Consumers: Third Supplemental Indenture dated as of October 29, 1998, between Consumers and The Chase Manhattan Bank, as Trustee (4)(b) Consumers: Seventy-fourth Supplemental Indenture dated as of October 29, 1998, between Consumers and The Chase Manhattan Bank, as Trustee (12) CMS Energy: Statements regarding computation of Ratio of Earnings to Fixed Charges (15)(a) Consumers: Letter of Independent Public Accountant (15)(b) CMS Energy: Letter of Independent Public Accountant (27)(a) CMS Energy: Financial Data Schedule (27)(b) Consumers: Financial Data Schedule (99) CMS Energy: Consumers Gas Group Financials EX-4 2 CONSUMERS THIRD SUPPLEMENTAL INDENTURE Exhibit (4)(a) THIRD SUPPLEMENTAL INDENTURE dated as of October 29, 1998 ____________________ This Third Supplemental Indenture, dated as of the 29th day of October, 1998 between Consumers Energy Company, a corporation duly organized and existing under the laws of the State of Michigan (hereinafter called the "Company") and having its principal office at 212 West Michigan Avenue, Jackson, Michigan 49201, and The Chase Manhattan Bank, a New York corporation (hereinafter called the "Trustee") and having an office at 450 W. 33rd Street, 15th Floor, New York, New York, 10001. WITNESSETH: WHEREAS, the Company and the Trustee entered into an Indenture, dated as of February 1, 1998 (the "Original Indenture"), pursuant to which one or more series of debt of the Company (the "Notes") may be issued from time to time; and WHEREAS, Section 2.01 of the Original Indenture permits the terms of any series of Notes to be established in an indenture supplemental to the Original Indenture; and WHEREAS, Section 13.01 of the Original Indenture provides that a supplemental indenture may be entered into by the Company and the Trustee without the consent of any Holders of the Notes to establish the form and terms of the Notes of any series; and WHEREAS, the Company has requested the Trustee to join with it in the execution and delivery of this Third Supplemental Indenture in order to supplement and amend the Original Indenture by, among other things, establishing the form and terms of a series of Notes to be known as the Company's "6.50% Senior Secured Insured Quarterly Notes due October 1, 2028" (the "Senior Secured Insured Quarterly Notes"); and WHEREAS, the Company and the Trustee desire to enter into this Third Supplemental Indenture for the purposes set forth in Sections 2.01 and 13.01 of the Original Indenture as referred to above; and WHEREAS, the Company has furnished the Trustee with a Board Resolution authorizing the execution of this Third Supplemental Indenture; and WHEREAS, all things necessary to make this Third Supplemental Indenture a valid agreement of the Company and the Trustee and a valid supplement to the Original Indenture have been done, NOW, THEREFORE, THIS THIRD SUPPLEMENTAL INDENTURE WITNESSETH: For and in consideration of the premises and the purchase of the Senior Secured Insured Quarterly Notes to be issued hereunder by holders thereof, the Company and the Trustee mutually covenant and agree, for the equal and proportionate benefit of the respective holders from time to time of the Senior Secured Insured Quarterly Notes as follows: ARTICLE I STANDARD PROVISIONS; DEFINITIONS SECTION 1.01. Standard Provisions. The Original Indenture together with this Third Supplemental Indenture are hereinafter sometimes collectively referred to as the "Indenture." All capitalized terms which are used herein and not otherwise defined herein or in Exhibit A hereto are defined in the Original Indenture and are used herein with the same meanings as in the Original Indenture. ARTICLE II DESIGNATION AND TERMS OF THE NOTES; FORMS SECTION 2.01. Establishment of Series. There is hereby created a series of Notes to be known and designated as the "6.5% Senior Secured Insured Quarterly Notes due October 1, 2028," such series limited in aggregate principal amount (except as contemplated in Section 2.05(c) of the Original Indenture) to $150,000,000. The form and terms of the Senior Secured Insured Quarterly Notes are established in the form of Senior Secured Insured Quarterly Notes attached hereto as Exhibit A. ARTICLE III DEFINITIONS SECTION 3.01 Definitions. The following defined terms used herein shall, unless the context otherwise requires, have the meanings specified below. "Holder" means any person in whose name a Senior Secured Insured Quarterly Note is registered on the records of the Depository. "Insurance Trustee" means United States Trust Company of New York, or any successor thereto, as the Insurance Trustee under the Policy. "Insurer" means Ambac Assurance Corporation, a Wisconsin- domiciled stock insurance company. "Interest Payment Dates" means January 1, April 1, July 1 and October 1 of each year. "Original Issue Date" means October 29, 1998. "Paying Agent" means any Person (including the Company acting as Paying Agent) authorized by the Company to pay the principal of or interest on the Senior Secured Insured Quarterly Notes on behalf of the Company. "Policy" shall mean the financial guaranty insurance policy issued by the Insurer insuring the payment when due of the principal of and interest on the Senior Secured Insured Quarterly Notes as provided therein. "Redemption Date" means with respect to any Senior Secured Insured Quarterly Note to be redeemed, in whole or in part, the date fixed for such redemption by or pursuant to this Indenture. "Redemption Price" means with respect to any Senior Secured Insured Quarterly Note to be redeemed, the price at which it is to be redeemed pursuant to this Indenture. "Regular Record Date" means the 15th calendar day of the month preceding the month in which the respective Interest Payment Date occurs (whether or not a Business Day). "Stated Maturity" means October 1, 2028. ARTICLE IV PAYMENT OF PRINCIPAL AND INTEREST SECTION 4.01. Payment of Principal and Interest. The principal of the Senior Secured Insured Quarterly Notes shall be due at Stated Maturity (unless earlier redeemed). The unpaid principal amount of the Senior Secured Insured Quarterly Notes shall bear interest at the rate of 6.50% per annum until paid or duly provided for. Interest shall be paid quarterly in arrears on each Interest Payment Date to the Person in whose name the Senior Secured Insured Quarterly Notes are registered on the Regular Record Date for such Interest Payment Date. Any such interest that is not so punctually paid or duly provided for will forthwith cease to be payable to the Holders on such Regular Record Date and may either be paid to the Person or Persons in whose name the Senior Secured Insured Quarterly Notes are registered at the close of business on a Special Record Date for the payment of such defaulted interest to be fixed by the Trustee, notice whereof shall be given to Holders of the Senior Secured Insured Quarterly Notes not less than ten days prior to such Special Record Date. Payments of interest on the Senior Secured Insured Quarterly Notes will include interest accrued to but excluding the respective Interest Payment Dates. Interest payments for the Senior Secured Insured Quarterly Notes shall be computed and paid on the basis of a 360-day year of twelve 30 day months. ARTICLE V REDEMPTION SECTION 5.01. Redemption at the Company's Option. The Senior Secured Insured Quarterly Notes shall be subject to redemption at the option of the Company, in whole or in part, without premium or penalty, at any time or from time to time on or after October 1, 2003, upon not less than 30 nor more than 60 days' notice, at a Redemption Price equal to 100% of the principal amount to be redeemed plus accrued but unpaid interest to the Redemption Date. If notice of redemption is given as aforesaid, the Senior Secured Insured Quarterly Notes so to be redeemed shall, on the Redemption Date, become due and payable at the Redemption Price together with any accrued interest thereon, and from and after such date (unless the Company shall default in the payment of the Redemption Price and accrued interest) the Senior Secured Insured Quarterly Notes shall cease to bear interest. If any Senior Secured Insured Quarterly Note called for redemption shall not be paid upon surrender thereof for redemption, the principal shall, until paid, bear interest from the Redemption Date at 6.5%. Subject to the foregoing and applicable law (including without limitation, United States federal securities laws), the Company or its affiliates may, at any time and from time to time, purchase outstanding Senior Secured Insured Quarterly Notes by tender, in the open market or by private agreement. SECTION 5.02. Redemption at the Holder's Option. For purposes of this Section 5.02 a "Beneficial Owner" means the Person who has the right to sell, transfer or otherwise dispose of an interest in Senior Secured Insured Quarterly Notes and the right to receive the proceeds therefrom, as well as the interest and principal payable to the Holder thereof. In general, a determination of beneficial ownership in the Senior Secured Insured Quarterly Notes will be determined by the Company, in its sole discretion, which determinations shall be final and binding on all parties. Unless the Senior Secured Insured Quarterly Notes have been declared due and payable prior to their maturity by reason of an Event of Default, the personal representative or other Person authorized to represent the estate of the deceased Beneficial Owner or from a surviving joint tenant(s) or tenant(s) by the entirety (each, a "Representative") of a deceased Beneficial Owner has the right to request redemption prior to Stated Maturity of all or part of such interest, expressed in integral multiples of $1,000 principal amount, in the Senior Secured Insured Quarterly Notes, and the Company will redeem the same subject to the limitations that the Company will not be obligated to redeem, during the period from the Original Issue Date through and including October 1, 1999 (the "Initial Period"), and during any twelve- month period which ends on and includes each October 1 thereafter (each such twelve-month period being hereinafter referred to as a "Subsequent Period"), (i) on behalf of a deceased Beneficial Owner any interest in the Senior Secured Insured Quarterly Notes which exceeds an aggregate principal amount of $25,000 or (ii) interests in the Senior Secured Insured Quarterly Notes in an aggregate principal amount exceeding $3,000,000. A request for redemption may be initiated by the Representative of a deceased Beneficial Owner at any time and in any principal amount in integral multiples of $1,000. Representatives of deceased Beneficial Owners must make arrangements with the Participant through whom such interest is owned in order that timely presentation of redemption requests can be made by the Participant to the Trustee. If the Company, although not obligated to do so, chooses to redeem interests of any deceased Beneficial Owner in the Senior Secured Insured Quarterly Notes in the Initial Period or any Subsequent Period in excess of the $25,000 limitation, such redemption, to the extent that it exceeds the $25,000 limitation for any deceased Beneficial Owner, shall not be included in the computation of the $3,000,000 limitation for such Initial Period or such Subsequent Period, as the case may be, or for any succeeding Subsequent Period. Any Senior Secured Insured Note (or portion thereof) tendered pursuant to a redemption request may be withdrawn by a written request by the Representative received by the Trustee at least 10 days prior to its repayment. Subject to the $25,000 and $3,000,000 limitations, the Company will, after the death of any Beneficial Owner, redeem the interest of such Beneficial Owner in the Senior Secured Insured Quarterly Notes on the next Interest Payment Date following receipt by the Trustee of a redemption request received at least 20 days in advance of the next Interest Payment Date. The Trustee will notify the Company promptly after receipt of any redemption request and the Company will provide all funds necessary for such redemption prior to the date of redemption to the Paying Agent. If redemption requests exceed the aggregate principal amount of interests in Senior Secured Insured Quarterly Notes required to be redeemed during the Initial Period or during any Subsequent Period, then such excess redemption requests will be applied in the order received by the Trustee to successive Subsequent Periods, regardless of the number of Subsequent Periods required to redeem such interests. All redemption requests will be redeemed in the order in which the trustee receives the redemption request. To obtain repayment pursuant to a redemption request, the Representative must provide to the Participant (i) a written request for repayment signed by the Representative, and such signature must be guaranteed by a member firm of a registered national securities exchange or of the NASD or a commercial bank or trust company having an office or correspondent in the United States, (ii) appropriate evidence satisfactory to the Company and the Trustee that (A) the Representative has authority to act on behalf of the deceased Beneficial Owner, (B) the death of such Beneficial Owner has occurred and (C) the deceased was the owner of a beneficial interest in such Senior Secured Insured Quarterly Note at the time of death, (iii) if applicable, a properly executed assignment or endorsement, and (iv) if the beneficial interest in such Senior Secured Insured Quarterly Note is held by a nominee of the deceased Beneficial Owner, a certificate satisfactory to the Trustee from such nominee attesting to the deceased's ownership of a beneficial interest in such Senior Secured Insured Quarterly Note. The Participant will provide these documents to the Trustee. All questions as to the eligibility or validity of any exercise of redemption on behalf of a deceased Beneficial Owner will be determined by the Company, in its sole discretion, which determinations will be final and binding on all parties. For purposes of this Section 5.02 an interest in Senior Secured Insured Quarterly Notes held in tenancy by the entirety, joint tenancy or by tenants in common will be deemed to be held by a single Beneficial Owner and the death of a tenant by the entirety, joint tenant or tenant in common will be deemed the death of a Beneficial Owner. The death of a Person who, during his lifetime, was entitled to substantially all of the rights of a Beneficial Owner of an interest in the Senior Secured Insured Quarterly Notes will be deemed the death of the Beneficial Owner, regardless of the recordation of such interest on the records of the Participant, if such rights can be established to the satisfaction of the Participant and the Company. In the case of any redemption request which is presented pursuant to this Section 5.02 and which has not been fulfilled at the time the Company gives notice of its election to partially redeem Senior Secured Insured Quarterly Notes pursuant to Section 5.01 hereof, such interest or portion thereof shall not be subject to redemption pursuant to such Section 5.01, but shall remain subject to redemption pursuant to this Section 5.02 ARTICLE VI SPECIAL INSURANCE PROVISIONS SECTION 6.01. Insurer as Third Party Beneficiary. To the extent that the Indenture confers upon or gives or grants to the Insurer any right, remedy or claim, the Insurer is hereby explicitly recognized as being a third-party beneficiary hereunder and may enforce any such right remedy or claim conferred, given or granted hereunder. SECTION 6.02. Notices and Information. (a) The Company shall furnish to the Insurer: (1) Any notice that is required to be given to a Holder of the Senior Secured Insured Quarterly Notes or to the Trustee pursuant to the Indenture. (2) As soon as practicable after the filing thereof, a copy of any financial statement of the Company and a copy of any audit and annual report of the Company; a copy of any notice to be given to the registered owners of the Senior Secured Insured Quarterly Notes including, without limitation, notice of any redemption of or defeasance of the Senior Secured Insured Quarterly Notes; and such additional information it may reasonably request. b. The Company will permit the Insurer to have access to and to make copies of all books and records relating to the Senior Secured Insured Quarterly Notes at any reasonable time. c. Notwithstanding any other provision of the Indenture, the Trustee and the Company shall notify the Insurer in accordance with Section 6.06 if at any time after such amounts are due to be paid to the Trustee or Paying Agent there are insufficient moneys to make any payments of principal and/or interest as required and promptly upon the occurrence of any Event of Default hereunder. All notices and information required to be given to the Insurer shall be in writing and shall be sent by overnight delivery to Ambac Assurance Corporation, One State Street Plaza, New York, NY 10004, Attention: Dennis Pidherny. SECTION 6.03. Concerning the Special Insurance Provisions. The provisions of this Article VI shall apply notwithstanding anything in the Indenture to the contrary, but only so long as the Policy shall be in full force and effect and the Insurer is not in default thereunder. SECTION 6.04. Amendments. Any provision of the Indenture expressly recognizing or granting rights in or to the Insurer may not be amended in any manner which affects the rights of the Insurer hereunder without the prior written consent of the Insurer. SECTION 6.05. Defeasance. Notwithstanding anything herein to the contrary, in the event that the principal and/or interest due on the Senior Secured Insured Quarterly Notes shall be paid by the Insurer pursuant to the Policy, the Senior Secured Insured Quarterly Notes shall remain Outstanding for all purposes, not be defeased or otherwise satisfied and not be considered paid by the Company, and the assignment and pledge of moneys held in trust by the Trustee and all covenants, agreements and other obligations of the Company to the registered owners shall continue to exist and shall run to the benefit of the Insurer, and the Insurer shall be subrogated to the rights of such registered owners. SECTION 6.06. Insurer's Rights to Notice; Subrogation.As long as the Policy shall be in full force and effect, the Company, the Trustee and any Paying Agent agree to comply with the following provisions: (a) If the Trustee or Paying Agent determines that there will be insufficient funds to pay the principal of or interest on the Senior Secured Insured Quarterly Notes on an Interest Payment Date, the Trustee or Paying Agent shall so notify the Insurer within one business day after such determination. Such notice shall specify the amount of the anticipated deficiency, the Senior Secured Insured Quarterly Notes to which such deficiency is applicable and whether such Senior Secured Insured Quarterly Notes will be deficient as to principal or interest, or both. The Insurer will make payments of principal or interest due on the Senior Secured Insured Quarterly Notes on or before the first day next following the date on which the Insurer shall have received notice of nonpayment from the Trustee or Paying Agent. (b) The Trustee or Paying Agent shall, after giving notice to the Insurer as provided in (a) above, make available to the Insurer and, at the Insurer's direction, to the Insurance Trustee, the registration books of the Company maintained by the Trustee or Paying Agent and all records relating to the Senior Secured Insured Quarterly Notes maintained by the Trustee or the Paying Agent under the Indenture. (c) The Trustee or Paying Agent shall provide the Insurer and the Insurance Trustee with a list of registered owners of Senior Secured Insured Quarterly Notes entitled to receive principal or interest payments from the Insurer under the terms of the Policy, and shall make arrangements with the Insurance Trustee (i) to mail checks or pay by wire transfer to the registered owners of Senior Secured Insured Quarterly Notes entitled to receive all or partial interest payments from the Insurer and (ii) to pay principal upon Senior Secured Insured Quarterly Notes surrendered to the Insurance Trustee by the registered owners of Senior Secured Insured Quarterly Notes entitled to receive full or partial principal payments from the Insurer. (d) The Trustee or Paying Agent shall, at the time it provides notice to the Insurer pursuant to (a) above, notify registered owners of Senior Secured Insured Quarterly Notes entitled to receive the payment of principal or interest thereon from the Insurer (i) as to the fact of such entitlement, (ii) that the Insurer will remit to them all or a part of the interest payments next coming due upon proof of any Holder's entitlement to interest payments and delivery to the Insurance Trustee, in form satisfactory to the Insurance Trustee, of an appropriate assignment of the registered owner's right to payment, (iii) that should they be entitled to receive full payment of principal from the Insurer, they must surrender their Senior Secured Insured Quarterly Notes (along with an appropriate instrument of assignment in form satisfactory to the Insurance Trustee to permit ownership of such Senior Secured Insured Quarterly Notes to be registered in the name of the Insurer) for payment to the Insurance Trustee, and not the Trustee or Paying Agent and (iv) that should they be entitled to receive partial payment of principal from the Insurer, they must surrender their Senior Secured Insured Quarterly Notes for payment thereon first to the Trustee or Paying Agent who shall note on such Senior Secured Insured Quarterly Notes the portion of the principal paid by the Company through the Trustee or Paying Agent and then, along with an appropriate instrument of assignment in form satisfactory to the Insurance Trustee, to the Insurance Trustee, which will then pay the unpaid portion of principal. e. In the event that the Trustee or Paying Agent has notice that any payment of principal of or interest on Senior Secured Insured Quarterly Notes which has become Due for Payment (as defined in the Policy) and which is made to a Holder of Senior Secured Insured Quarterly Notes by or on behalf of the Company has been deemed a preferential transfer and theretofore recovered from its registered owner pursuant to the United States Bankruptcy Code by a trustee in bankruptcy in accordance with the final, nonappealable order of a court having competent jurisdiction, the Trustee or Paying Agent shall, at the time the Insurer is notified pursuant to (a) above, notify all registered owners that in the event that any registered owner's payment is so recovered, such registered owner will be entitled to payment from the Insurer to the extent of such recovery if sufficient funds are not otherwise available, and the Trustee or Paying Agent shall furnish to the Insurer its records evidencing the payments of principal of and interest on the Senior Secured Insured Quarterly Notes which have been made by the Trustee or Paying Agent and subsequently recovered from registered owners and the dates on which such payments were made. f. In addition to those rights granted the Insurer under the Indenture, the Insurer shall, to the extent it makes payment of principal of or interest on the Senior Secured Insured Quarterly Notes, become subrogated to the rights of the recipients of such payments in accordance with the terms of the Policy, and to evidence such subrogation (i) in the case of subrogation as to claims for past due interest, the Trustee or Paying Agent shall note the Insurer's rights as subrogee on the registration books of the Company maintained by the Trustee or Paying Agent upon receipt from the Insurer of proof of the payment of interest thereon to the registered owners of the Senior Secured Insured Quarterly Notes, and (ii) in the case of subrogation as to claims for past due principal, the Trustee or Paying Agent shall note the Insurer's rights as subrogee on the registration books of the Company maintained by the Trustee or Paying Agent upon surrender of the Senior Secured Insured Quarterly Notes by the registered owners thereof together with proof from the Insurer of the payment of principal thereof. SECTION 6.07. Insurer's Rights Concerning the Trustee. (a) The Insurer shall receive prompt written notice from the Company of any Trustee or Paying Agent resignation. (b) Notwithstanding any other provision of the Indenture, in determining whether the rights of the Holders of Senior Secured Insured Quarterly Notes will be adversely affected in any material respect by any action taken pursuant to the terms and provisions of the Indenture, the Trustee or Paying Agent shall consider the effect on the Holders of Senior Secured Insured Quarterly Notes as if there were no Policy. SECTION 6.08. Insurer's Rights. Anything in the Indenture to the contrary notwithstanding, upon the occurrence and continuance of an Event of Default, so long as the Policy shall be in full force and effect and the Insurer is not in default under the terms of the Policy, the Insurer shall be entitled to control and direct the enforcement of all rights and remedies granted to the Holders of Senior Insured Quarterly Notes. In the event that any Holder of the Senior Secured Insured Quarterly Notes is entitled to a vote under the terms of the Indenture, such Holder shall appoint the Insurer by a written proxy instrument as their proxy for such vote in accordance with Section 11.04. ARTICLE VII SUPPLEMENTAL INDENTURES SECTION 7.01. Effect On Original Indenture This Third Supplemental Indenture is a supplement to the Original Indenture. As supplemented by this Third Supplemental Indenture, the Original Indenture is in all respects ratified, approved and confirmed, and the Original Indenture and this Third Supplemental Indenture shall together constitute one and the same instrument. ARTICLE VIII MISCELLANEOUS SECTION 8.01. Counterparts. This Third Supplemental Indenture may be executed in any number of counterparts, each of which so executed shall be deemed to be an original, but all such counterparts shall together constitute but one and the same instrument. SECTION 8.02. Recitals. The recitals contained herein shall be taken as the statements of the Company and the Trustee assumes no responsibility for their correctness. The Trustee makes no representations as to the validity or sufficiency of this Third Supplemental Indenture. SECTION 8.03. Governing Law. This Third Supplemental Indenture shall be governed by and construed in accordance with the laws of the jurisdiction which govern the Original Indenture and its construction. IN WITNESS WHEREOF, the parties hereto have caused this Third Supplemental Indenture to be duly executed and their respective corporate seals to be hereunto affixed and attested, all as of the day and year first written above. CONSUMERS ENERGY COMPANY By: /s/ A.M. Wright ________________________________ Name: Alan M. Wright Title: Senior Vice President and Chief Financial Officer Attest: /s/ Thomas A. McNish _______________________ Name: Thomas A. McNish Title:Vice President and Secretary (Corporate Seal) THE CHASE MANHATTAN BANK, AS TRUSTEE By: /s/ Glenn G. McKeever ___________________________ Name: Title: Attest: (Corporate Seal) EXHIBIT A THIS SECURITY IS A GLOBAL SECURITY WITHIN THE MEANING OF THE INDENTURE HEREINAFTER REFERRED TO AND IS REGISTERED IN THE NAME OF A DEPOSITARY OR A NOMINEE THEREOF. THIS SECURITY MAY NOT BE EXCHANGED IN WHOLE OR IN PART FOR A SECURITY REGISTERED, AND NO TRANSFER OF THIS SECURITY IN WHOLE OR IN PART MAY BE REGISTERED, IN THE NAME OF ANY PERSON OTHER THAN SUCH DEPOSITARY OR ITS NOMINEE EXCEPT IN THE LIMITED CIRCUMSTANCES DESCRIBED IN THE INDENTURE. UNLESS THIS CERTIFICATE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITORY TRUST COMPANY, A NEW YORK CORPORATION ("DTC"), TO THE COMPANY OR ITS AGENT FOR REGISTRATION OF TRANSFER, EXCHANGE, OR PAYMENT, AND ANY CERTIFICATE ISSUED IS REGISTERED IN THE NAME OF CEDE & CO. OR IN SUCH OTHER NAME AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC (AND ANY PAYMENT IS MADE TO CEDE & CO. OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC), ANY TRANSFER, PLEDGE OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL INASMUCH AS THE REGISTERED OWNER HEREOF, CEDE & CO., HAS AN INTEREST HEREIN. __________________________________________________________________________ No.: $150,000,000 CONSUMERS ENERGY COMPANY 6.50% SENIOR SECURED INSURED QUARTERLY NOTES (IQ NOTES) DUE OCTOBER 1, 2028 CUSIP: 210518BE5 CONSUMERS ENERGY COMPANY, a Michigan corporation (herein called the "Company," which term includes any successor corporation under the Indenture referred to herein), for value received, hereby promises to pay to: CEDE & CO. or registered assigns, the principal sum of *ONE HUNDRED AND FIFTY MILLION DOLLARS* on October 1, 2028 and to pay interest on such principal sum at the rate of six and one-half percent (6.50%) per annum. The Company will pay interest quarterly in arrears January 1 (beginning January 1, 1999), April 1, July 1 and October 1 (each such date an "Interest Payment Date"), until the principal hereof is otherwise paid or duly provided for. The interest so payable, and punctually paid or duly provided for, on any Interest Payment Date will, as provided in the Indenture (as defined below), be paid to the holder (the "Holder") of this Note (or one or more predecessor Notes) of record at the close of business on the regular record date (the "Regular Record Date") for such Interest Payment Date, which, except in the case of interest payable at the Stated Maturity (as defined in the Indenture), shall be the fifteenth calendar day of the month preceding the month in which the respective Interest Payment Date occurs (whether or not a Business Day), and, in the case of interest payable at the Stated Maturity, shall be the date such that interest payable at the Stated Maturity is payable to the same Person to whom principal on this Note is payable. Interest will be computed on the basis of a 360-day year of twelve 30-day months. Any such interest not so punctually paid or duly provided for shall forthwith cease to be payable to the Holder on such Regular Record Date by virtue of his having been such Holder, and may be paid to the Holder of this Note (or one or more predecessor Notes) of record at the close of business on a special record date (the "Special Record Date") fixed by the Company for the payment of such defaulted interest, notice whereof shall be given to Holders not less than 10 days prior to such Special Record Date, all as more fully provided in the Indenture. Payment of the principal of this Note and the interest thereon will be made at the office or agency of the Company in the Borough of Manhattan, City and State of New York in such currency of the United States of America as at the time of payment is legal tender for payment of public and private debts. Financial Guaranty Insurance Policy No. FG0372BE (the "Policy") with respect to payments due for principal of and interest on this Note has been issued by Ambac Assurance Corporation (the "Insurer"). The Policy has been delivered to United States Trust Company of New York, as the insurance trustee (the "Insurance Trustee") under said Policy and will be held by such Insurance Trustee or any successor insurance trustee. The Policy is on file and available for inspection at the principal office of the Insurance Trustee and a copy thereof may be secured from the Insurer or the Insurance Trustee. All payments required to be made under the Policy shall be made in accordance with the provisions thereof. The owner of this Note acknowledges and consents to the subrogation rights of the Insurer as more fully set forth in the Policy. CONSUMERS ENERGY COMPANY 6.50% Senior Secured Insured Quarterly Notes (IQ Notes) Due October 1, 2028 This Note is one of a duly authorized issue of debt securities of the Company (herein called the "Securities"), issuable in one or more series, issued and to be issued under and pursuant to an Indenture dated as of February 1, 1998, as previously supplemented and as further supplemented by that certain Third Supplemental Indenture, dated as of October 29, 1998 (such Indenture, as so supplemented, the "Indenture"), duly executed and delivered by the Company to The Chase Manhattan Bank, as trustee (the "Trustee," which term includes any successor trustee under the Indenture), and is one of a series limited in aggregate principal amount to One Hundred and Fifty Million Dollars ($150,000,000) and designated as 6.50% Senior Secured Insured Quarterly Notes (IQ Notes) Due October 1, 2028 (the "Notes"). Reference is hereby made to the Indenture for a description of the rights, limitations of rights, obligations, duties and immunities thereunder of the Trustee, the Company and the Holders of Securities (including Holders of the Notes). The Notes are subject to defeasance at the option of the Company as provided in the Indenture. As long as this Note is represented in global form (the "Global Security") registered in the name of DTC or its nominee, except as provided in the Indenture and subject to certain limitations therein set forth, no Global Security shall be exchangeable or transferrable. If an Event of Default (as defined in the Indenture) with respect to the Notes shall occur and be continuing, the principal plus any accrued interest may be declared due and payable in the manner and with the effect and subject to the conditions provided in the Indenture. Prior to the Release Date (as hereinafter defined), the Notes will be secured by first mortgage bonds (the "Senior IQ Mortgage Bonds") delivered by the Company to the Trustee for the benefit of the Holders of the Notes, issued under the Indenture, dated as of September 1, 1945, from the Company to The Chase Manhattan Bank, as trustee (the "Mortgage Trustee"), as amended and supplemented by various supplemental indentures and as supplemented by the Seventy-Fourth Supplemental Indenture, dated October 29, 1998, providing for a series of first mortgage bonds relating to the Notes (collectively, the "Mortgage"). Reference is made to the Mortgage and the Indenture for a description of the rights of the Trustee as holder of the Senior IQ Mortgage Bonds, the property mortgaged and pledged, the nature and extent of the security, the rights of the holders of first mortgage bonds under the Mortgage and the rights of the Company and of the Mortgage Trustee in respect thereof, the duties and immunities of the Mortgage Trustee and the terms and conditions upon which the Senior IQ Mortgage Bonds are secured and the circumstances under which additional first mortgage bonds may be issued. From and after such time as all first mortgage bonds (other than Senior IQ Mortgage Bonds) issued under the Mortgage have been retired through payment, redemption or otherwise at, before or after the maturity thereof (the "Release Date"), the Senior IQ Mortgage Bonds shall cease to secure the Notes in any manner. In certain circumstances prior to the Release Date as provided in the Indenture, the Company is permitted to reduce the aggregate principal amount of a series of Senior IQ Mortgage Bonds held by the Trustee, but in no event prior to the Release Date to an amount less than the aggregate outstanding principal amount of the series of Notes initially issued contemporaneously with such Senior IQ Mortgage Bonds. The Indenture permits the amendment thereof and the modification of the rights and obligations of the Company and the rights of the Holders under the Indenture at any time by the Company and the Trustee with the consent of the Holders of a majority in aggregate principal amount of the Securities then Outstanding (as defined in the Indenture) of all series which are affected by such amendment or modification, except that certain amendments which do not adversely affect the rights of any Holder of the Securities may be made without the approval of Holders of the Securities. No amendment or modification may, among other things, change the Stated Maturity of any Security, reduce the principal amount thereof, reduce the rate or change the time of payment of any interest thereon, or reduce the aforesaid majority in aggregate principal amount of Securities of any series, the consent of the Holders of which is required for any such amendment or modification, without the consent of each Security holder affected. Any provision of the Indenture expressly recognizing or granting rights in or to the Insurer may not be amended in any manner which affects the rights of the Insurer hereunder without the prior written consent of the Insurer. Notwithstanding any provision in the Indenture or any provision of this Note, the Holder of this Note shall have the right, which is absolute and unconditional, to receive payment of the principal of (and premium, if any) and interest on this Note at the times, place and rate, and in the currency herein prescribed. The Company shall have the right, subject to the terms and conditions of the Indenture, to redeem this Note, in whole or in part, without premium or penalty, at any time or from time to time on or after October 1, 2003, at a Redemption Price equal to 100% of the principal amount to be redeemed plus accrued but unpaid interest to the Redemption Date. If any Note called for redemption shall not be paid upon surrender thereof for redemption, the principal shall, until paid, bear interest from the Redemption Date at 6.50%. In addition, at the option of any deceased Beneficial Owner's Representative (as such terms are defined in the Indenture), interests in Notes are redeemable at 100% of their principal amount, plus accrued interest, subject to certain limitations provided in the Indenture. In the event of redemption of this Note in part only, a new Note or Notes of this series for the unredeemed portion hereof will be issued in the name of the Holder hereof upon surrender of the Note or the Note will be reduced in accordance with the provisions of the Indenture. The Notes will not have a sinking fund. THIS NOTE AND THE INDENTURE SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF MICHIGAN. All terms used in this Note which are defined in the Indenture have the meanings assigned to them in the Indenture. Unless the certificate of authentication hereon has been executed by or on behalf of the Trustee by manual signature, this Note shall not be entitled to any benefit under the Indenture or be valid or obligatory for any purpose. IN WITNESS WHEREOF, the Company has caused this Note to be duly executed. CONSUMERS ENERGY COMPANY By: ________________________________ Name: Title: Attested: _______________________________ Name: Title: TRUSTEE'S CERTIFICATE OF AUTHENTICATION Dated:___________________________________ This is one of the Securities of the series designated herein referred to in the within-mentioned Indenture. THE CHASE MANHATTAN BANK as Trustee By: _________________________________ Authorized Officer SCHEDULE OF EXCHANGES OF INTERESTS IN THE NOTE The following exchanges of interests in this Note have been made: Principal Amount of this NoteSignature of Amount ofAmount of followingauthorized Date of Decrease increase such decreasesignatory Exchange in this Notein this Note(or increase)of Trustee ________ _________________________________________________ ASSIGNMENT FORM To assign this Note, fill in the form below: I or we assign and transfer this Note to __________________ __________________ Insert assignee's social security or tax I.D. no. __________________________________________________________________________ (Print or type assignee's name, address and zip code) __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ and all rights thereunder and irrevocably appoint ________________________ __________________________________________________________________________ agent to transfer this Note on the books of the Company. The agent may substitute another to act for him. __________________________________________________________________________ Dated: _________________________________________________ ____________________________ THE SIGNATURE TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME AS IT APPEARS ON THE FIRST PAGE OF THE WITHIN NOTE. Signature Guarantee: ____________________________________ THE SIGNATURE MUST BE GUARANTEED BY AN "ELIGIBLE GUARANTOR INSTITUTION" THAT IS A MEMBER OR PARTICIPANT IN A "SIGNATURE GUARANTEE PROGRAM" (E.G., THE SECURITIES TRANSFER AGENTS MEDALLION PROGRAM, THE STOCK EXCHANGE MEDALLION PROGRAM OR THE NEW YORK STOCK EXCHANGE, INC. MEDALLION PROGRAM). EXHIBIT B CERTIFICATE OF AUTHENTICATION This is one of the Senior Secured Insured Quarterly Notes referred to in the within-mentioned Indenture. THE CHASE MANHATTAN BANK, as Trustee By: _______________________ Authorized Signatory Dated: EXHIBIT C FORM OF REQUEST FOR REDEMPTION CONSUMERS ENERGY COMPANY 6.50% Senior Secured Insured Quarterly Notes due October 1, 2028 CUSIP No. 210518BE5 The undersigned Participant does hereby certify, pursuant to Section 5.01 of the Supplemental Indenture dated as of October 29, 1998 to the Indenture dated as of February 1, 1998 between CONSUMERS ENERGY COMPANY (the "Company") and THE CHASE MANHATTAN BANK, as trustee (the "Trustee"), to the Company and the Trustee that: 1. [Name of deceased Beneficial Owner] is deceased. 2. [Name of deceased Beneficial Owner] had a $__________ interest in the Company's ____% Senior Secured Insured Quarterly Notes due October 1, 2028 (the "Notes"). 3. [Name of Representative] is [Beneficial Owner's personal representative/other person authorized to represent the estate of the Beneficial Owner/surviving joint tenant/surviving tenant by the entirety] of [Name of deceased Beneficial Owner] and has delivered to the undersigned a request for redemption in form satisfactory to the undersigned, requesting that $__________ [$ 1,000 or an integral multiple thereof] be redeemed pursuant to said Section 108. Such request and the documents accompanying such request, all of which are satisfactory to the undersigned, are delivered herewith. 4. [Name of Participant] holds the interest in the Notes with respect to which this Request for Redemption is being made on behalf of [Name of deceased Beneficial Owner]. IN WITNESS WHEREOF, the undersigned has executed this Request for Redemption as of __________, ____. [Name of Participant] By:________________________________ Name: __________________________ Title:__________________________ Signature Guarantee For Use by Eligible Institutions Only Name of Guarantor _______________ Authorized Signature________________ EX-4 3 CONSUMERS 74TH SUPPLEMENTAL INDENTURE Exhibit (4)(b) SEVENTY-FOURTH SUPPLEMENTAL INDENTURE Providing among other things for FIRST MORTGAGE BONDS, 6.50% Senior Secured Insured Quarterly Notes due October 1, 2028 ______________ Dated as of October 29, 1998 ______________ CONSUMERS ENERGY COMPANY TO THE CHASE MANHATTAN BANK, Trustee Counterpart ______ of 100 1 SEVENTY-FOURTH SUPPLEMENTAL INDENTURE, dated as of October 29, 1998 (herein sometimes referred to as "this Supplemental Indenture"), made and entered into by and between CONSUMERS ENERGY COMPANY, a corporation organized and existing under the laws of the State of Michigan, with its principal executive office and place of business at 212 West Michigan Avenue, in Jackson, Jackson County, Michigan 49201, formerly known as Consumers Power Company, (hereinafter sometimes referred to as the "Company"), and THE CHASE MANHATTAN BANK, a corporation organized and existing under the laws of the State of New York, with its corporate trust offices at 450 W. 33rd Street, in the Borough of Manhattan, The City of New York, New York 10001 (hereinafter sometimes referred to as the "Trustee"), as Trustee under the Indenture dated as of September 1, 1945 between Consumers Power Company, a Maine corporation (hereinafter sometimes referred to as the "Maine corporation"), and City Bank Farmers Trust Company (Citibank, N.A., successor, hereinafter sometimes referred to as the "Predecessor Trustee"), securing bonds issued and to be issued as provided therein (hereinafter sometimes referred to as the "Indenture"), WHEREAS at the close of business on January 30, 1959, City Bank Farmers Trust Company was converted into a national banking association under the title "First National City Trust Company"; and WHEREAS at the close of business on January 15, 1963, First National City Trust Company was merged into First National City Bank; and WHEREAS at the close of business on October 31, 1968, First National City Bank was merged into The City Bank of New York, National Association, the name of which was thereupon changed to First National City Bank; and WHEREAS effective March 1, 1976, the name of First National City Bank was changed to Citibank, N.A.; and WHEREAS effective July 16, 1984, Manufacturers Hanover Trust Company succeeded Citibank, N.A. as Trustee under the Indenture; and WHEREAS effective June 19, 1992, Chemical Bank succeeded by merger to Manufacturers Hanover Trust Company as Trustee under the Indenture; and WHEREAS effective July 15, 1996, The Chase Manhattan Bank (National Association), merged with and into Chemical Bank which thereafter was renamed The Chase Manhattan Bank as Trustee under the Indenture; and WHEREAS the Indenture was executed and delivered for the purpose of securing such bonds as may from time to time be issued under and in accordance with the terms of the Indenture, the aggregate principal amount of bonds to be secured thereby being limited to $5,000,000,000 at any one time outstanding (except as provided in Section 2.01 of the Indenture), and the Indenture describes and sets forth the property conveyed thereby and is filed in the Office of the Secretary of State of the State of Michigan and is of record in the Office of the Register of Deeds of each county in the State of Michigan in which this Supplemental Indenture is to be recorded; and WHEREAS the Indenture has been supplemented and amended by various indentures supplemental thereto, each of which is filed in the Office of the Secretary of State of the State of Michigan and is of record in the Office of the Register of Deeds of each county in the State of Michigan in which this Supplemental Indenture is to be recorded; and WHEREAS the Company and the Maine corporation entered into an Agreement of Merger and Consolidation, dated as of February 14, 1968, which provided for the Maine corporation to merge into the Company; and WHEREAS the effective date of such Agreement of Merger and Consolidation was June 6, 1968, upon which date the Maine corporation was merged into the Company and the name of the Company was changed from "Consumers Power Company of Michigan" to "Consumers Power Company"; and WHEREAS the Company and the Predecessor Trustee entered into a Sixteenth Supplemental Indenture, dated as of June 4, 1968, which provided, among other things, for the assumption of the Indenture by the Company; and WHEREAS said Sixteenth Supplemental Indenture became effective on the effective date of such Agreement of Merger and Consolidation; and WHEREAS the Company has succeeded to and has been substituted for the Maine corporation under the Indenture with the same effect as if it had been named therein as the mortgagor corporation; and WHEREAS effective March 11, 1997, the name of Consumers Power Company was changed to Consumers Energy Company; and WHEREAS, the Company has entered into an Indenture dated as of February 1, 1998, as amended and supplemented, ("Senior Note Indenture") with The Chase Manhattan Bank, as trustee ("Senior Note Trustee") providing for the issuance of notes thereunder, and pursuant to such Senior Note Indenture the Company has agreed to issue to the Senior Note Trustee, as security for the notes ("Senior Notes") to be issued thereunder, a new series of bonds under the Indenture at the time of authentication of each series of Senior Notes issued under such Senior Note Indenture; and WHEREAS, for such purposes the Company desires to issue a new series of bonds, to be designated First Mortgage Bonds, 6.50% Senior Secured Insured Quarterly Notes due October 1, 2028 each of which bonds shall also bear the descriptive title "First Mortgage Bond" (hereinafter provided for and hereinafter sometimes referred to as the "Senior IQ Note Bonds"), the bonds of which series are to be issued as registered bonds without coupons and are to bear interest at the rate per annum specified herein and are to mature October 1, 2028; and WHEREAS, the Senior IQ Note Bonds shall be issued to the Senior Note Trustee in connection with the issuance by the Company of its 6.50% Senior Secured Insured Quarterly Notes due October 1, 2028, (the "Notes"); and WHEREAS each of the registered bonds without coupons of the Senior IQ Note Bonds and the Trustee's Authentication Certificate thereon are to be substantially in the following forms, to wit: 3 [FORM OF REGISTERED BOND OF THE SENIOR IQ NOTE BONDS] [FACE] NOTWITHSTANDING ANY PROVISIONS HEREOF OR IN THE INDENTURE, THIS BOND IS NOT ASSIGNABLE OR TRANSFERABLE EXCEPT AS PERMITTED OR REQUIRED BY SECTION 4.04 OF THE INDENTURE, DATED AS OF FEBRUARY 1, 1998 BETWEEN CONSUMERS ENERGY COMPANY AND THE CHASE MANHATTAN BANK, AS TRUSTEE. CONSUMERS ENERGY COMPANY FIRST MORTGAGE BOND, 6.50% SENIOR SECURED INSURED QUARTERLY NOTES DUE OCTOBER 1, 2028 No. $ CONSUMERS ENERGY COMPANY, a Michigan corporation (hereinafter called the "Company"), for value received, hereby promises to pay to The Chase Manhattan Bank, as trustee under the Senior Note Indenture hereinafter referred to, or registered assigns, the principal sum of One Hundred Fifty Million Dollars on October 1, 2028, and to pay to the registered holder hereof interest on said sum from the latest quarterly interest payment date to which interest has been paid on the bonds of this series preceding the date hereof, unless the date hereof be an interest payment date to which interest is being paid, in which case from the date hereof, or unless the date hereof is prior to January 1, 1999, in which case from October 29, 1998, (or if this bond is dated between the record date for any interest payment date and such interest payment date, then from such interest payment date, provided, however, that if the Company shall default in payment of the interest due on such interest payment date, then from the next preceding quarterly interest payment date to which interest has been paid on the bonds of this series, or if such interest payment date is January 1, 1999, from October 29, 1998), at the rate per annum of 6.50% until the principal hereof shall have become due and payable, payable on each January 1, April 1, July 1 and October 1 in each year, commencing January 1, 1999. Under an Indenture dated as of February 1, 1998 (hereinafter sometimes referred to as the "Senior Note Indenture"), between Consumers Energy Company and The Chase Manhattan Bank, as trustee (hereinafter sometimes called the "Senior Note Trustee"), the Company will issue, concurrently with the issuance of this bond, an issue of notes under the Senior Note Indenture entitled 6.50% Senior Secured Insured Quarterly Notes due October 1, 2028 (the "Notes"). Pursuant to Article IV of the Senior Note Indenture, this bond is issued to the Senior Note Trustee to secure any and all obligations of the Company under the Notes and any other series of senior notes from time to time outstanding under the Senior Note Indenture. Payment of principal of, or premium, if any, or interest on, the Notes shall constitute payments on this bond as further provided herein and in the supplemental indenture pursuant to which this bond has been issued (the "Supplemental Indenture"). The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not be valid or become obligatory for any purpose unless and until it shall have been authenticated by the execution by the Trustee or its successor in trust under the Indenture of the certificate hereon. IN WITNESS WHEREOF, Consumers Energy Company has caused this bond to be executed in its name by its Chairman of the Board, its President or one of its Vice Presidents by his or her signature or a facsimile thereof, and its corporate seal or a facsimile thereof to be affixed hereto or imprinted hereon and attested by its Secretary or one of its Assistant Secretaries by his or her signature or a facsimile thereof. CONSUMERS ENERGY COMPANY, Dated: By ___________________ Its ___________________ Attest: ____________________ Secretary [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This is one of the bonds, of the series designated therein, described in the within-mentioned Indenture. THE CHASE MANHATTAN BANK, Trustee By _________________________ Authorized Officer [REVERSE] CONSUMERS ENERGY COMPANY FIRST MORTGAGE BOND, 6.50% SENIOR SECURED INSURED QUARTERLY NOTES DUE OCTOBER 1, 2028 The interest payable on any January 1, April 1, July 1 and October 1 (each "Interest Payment Date") will, subject to certain exceptions provided in the Indenture hereinafter mentioned, be paid to the person in whose name this bond is registered at the close of business on the record date, which shall be on the fifteenth calendar day of the month preceding the month in which the respective Interest Payment Date occurs ("Record Date"), or, if such Record Date shall be a legal holiday or a day on which banking institutions in the City of New York, New York or the City of Detroit, Michigan are authorized by law to close, the next succeeding day which shall not be a legal holiday or a day on which such institutions are so authorized to close. The principal of and the premium, if any, and the interest on this bond shall be payable at the office or agency of the Company in the City of Jackson, Michigan designated for that purpose, in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts. Upon any payment of the principal of, premium, if any, and interest on, all or any portion of the Notes, whether at maturity or prior to maturity by redemption or otherwise or upon provision for the payment thereof having been made in accordance with Section 5.01(a) of the Senior Note Indenture, Senior IQ Note Bonds in a principal amount equal to the principal amount of such Notes and having both a corresponding maturity date and interest rate shall, to the extent of such payment of principal, premium, if any, and interest, be deemed paid and the obligation of the Company thereunder to make such payment shall be discharged to such extent and, in the case of the payment of principal (and premium, if any) such bonds of said series shall be surrendered to the Company for cancellation as provided in Section 4.08 of the Senior Note Indenture. The Trustee may at anytime and all times conclusively assume that the obligation of the Company to make payments with respect to the principal of and premium, if any, and interest on the Senior IQ Note Bonds, so far as such payments at the time have become due, has been fully satisfied and discharged pursuant to the foregoing sentence unless and until the Trustee shall have received a written notice from the Senior Note Trustee signed by one of its officers stating (i) that timely payment of, or premium or interest on, the Notes has not been made, (ii) that the Company is in arrears as to the payments required to be made by it to the Senior Note Trustee pursuant to the Senior Note Indenture, and (iii) the amount of the arrearage. For purposes of Section 4.09 of the Senior Note Indenture, this bond shall be deemed to be the "related series of Senior Note First Mortgage Bonds" in respect of the Notes. This bond is one of the bonds issued and to be issued from time to time under and in accordance with and all secured by an Indenture dated as of September 1, 1945, given by the Company (or its predecessor, Consumers Power Company, a Maine corporation) to City Bank Farmers Trust Company (The Chase Manhattan Bank, successor) (hereinafter sometimes referred to as the "Trustee"), and indentures supplemental thereto, heretofore or hereafter executed, to which indenture and indentures supplemental thereto (hereinafter referred to collectively as the "Indenture") reference is hereby made for a description of the property mortgaged and pledged, the nature and extent of the security and the rights, duties and immunities thereunder of the Trustee and the rights of the holders of said bonds and of the Trustee and of the Company in respect of such security, and the limitations on such rights. By the terms of the Indenture, the bonds to be secured thereby are issuable in series which may vary as to date, amount, date of maturity, rate of interest and in other respects as provided in the Indenture. The Indenture contains provisions permitting the Company and the Trustee, with the consent of the holders of not less than seventy-five per centum in principal amount of the bonds (exclusive of bonds disqualified by reason of the Company's interest therein) at the time outstanding, including, if more than one series of bonds shall be at the time outstanding, not less than sixty per centum in principal amount of each series affected, to effect, by an indenture supplemental to the Indenture, modifications or alterations of the Indenture and of the rights and obligations of the Company and the rights of the holders of the bonds and coupons; provided, however, that no such modification or alteration shall be made without the written approval or consent of the holder hereof which will (a) extend the maturity of this bond or reduce the rate or extend the time of payment of interest hereon or reduce the amount of the principal hereof, or (b) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of the Indenture, or (c) reduce the percentage of the principal amount of the bonds the holders of which are required to approve any such supplemental indenture. The Company reserves the right, without any consent, vote or other action by holders of bonds of this series or any other series created after the Sixty-eighth Supplemental Indenture to amend the Indenture to reduce the percentage of the principal amount of bonds the holders of which are required to approve any supplemental indenture (other than any supplemental indenture which is subject to the proviso contained in the immediately preceding sentence) (a) from not less than seventy-five per centum (including sixty per centum of each series affected) to not less than a majority in principal amount of the bonds at the time outstanding or (b) in case fewer than all series are affected, not less than a majority in principal amount of the bonds of all affected series, voting together. This bond is not redeemable except on the respective dates, in the respective principal amounts and for the respective redemption prices which correspond to the redemption dates for, the principal amounts to be redeemed of, and the redemption prices for, the Notes, and except upon written demand of the Senior Note Trustee following the occurrence of an Event of Default under the Senior Note Indenture and the acceleration of the senior notes, as provided in Section 8.01 of the Senior Note Indenture. This bond is not redeemable by the operation of the improvement fund or the maintenance and replacement provisions of the Indenture or with the proceeds of released property. This bond shall not be assignable or transferable except as permitted or required by Section 4.04 of the Senior Note Indenture. Any such transfer shall be effected at the Investor Services Department of the Company, as transfer agent (hereinafter referred to as "corporate trust office"). This bond shall be exchangeable for other registered bonds of the same series, in the manner and upon the conditions prescribed in the Indenture, upon the surrender of such bonds at said corporate trust office of the transfer agent. However, notwithstanding the provisions of Section 2.05 of the Indenture, no charge shall be made upon any registration of transfer or exchange of bonds of said series other than for any tax or taxes or other governmental charge required to be paid by the Company. As provided in Section 4.11 of the Senior Note Indenture, from and after the Release Date (as defined in the Senior Note Indenture), the obligations of the Company with respect to this bond shall be deemed to be satisfied and discharged, this bond shall cease to secure in any manner any senior notes outstanding under the Senior Note Indenture, and, pursuant to Section 4.08 of the Senior Note Indenture, the Senior Note Trustee shall forthwith deliver this bond to the Company for cancellation. In case of certain defaults as specified in the Indenture, the principal of this bond may be declared or may become due and payable on the conditions, at the time, in the manner and with the effect provided in the Indenture. No recourse shall be had for the payment of the principal of or premium, if any, or interest on this bond, or for any claim based hereon, or otherwise in respect hereof or of the Indenture, to or against any incorporator, stockholder, director or officer, past, present or future, as such, of the Company, or of any predecessor or successor company, either directly or through the Company, or such predecessor or successor company, or otherwise, under any constitution or statute or rule of law, or by the enforcement of any assessment or penalty, or otherwise, all such liability of incorporators, stockholders, directors and officers, as such, being waived and released by the holder and owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Indenture. ____________________ AND WHEREAS all acts and things necessary to make the bonds of the Senior IQ Note Bonds, when duly executed by the Company and authenticated by the Trustee or its agent and issued as prescribed in the Indenture, as heretofore supplemented and amended, and this Supplemental Indenture provided, the valid, binding and legal obligations of the Company, and to constitute the Indenture, as supplemented and amended as aforesaid, as well as by this Supplemental Indenture, a valid, binding and legal instrument for the security thereof, have been done and performed, and the creation, execution and delivery of this Supplemental Indenture and the creation, execution and issuance of bonds subject to the terms hereof and of the Indenture, as so supplemented and amended, have in all respects been duly authorized; NOW, THEREFORE, in consideration of the premises, of the acceptance and purchase by the holders thereof of the bonds issued and to be issued under the Indenture, as supplemented and amended as above set forth, and of the sum of One Dollar duly paid by the Trustee to the Company, and of other good and valuable considerations, the receipt whereof is hereby acknowledged, and for the purpose of securing the due and punctual payment of the principal of and premium, if any, and interest on all bonds now outstanding under the Indenture and the $150,000,000 principal amount of Senior IQ Note Bonds proposed to be issued initially and all other bonds which shall be issued under the Indenture, as supplemented and amended from time to time, and for the purpose of securing the faithful performance and observance of all covenants and conditions therein, and in any indenture supplemental thereto, set forth, the Company has given, granted, bargained, sold, released, transferred, assigned, hypothecated, pledged, mortgaged, confirmed, set over, warranted, alienated and conveyed and by these presents does give, grant, bargain, sell, release, transfer, assign, hypothecate, pledge, mortgage, confirm, set over, warrant, alien and convey unto The Chase Manhattan Bank, as Trustee, as provided in the Indenture, and its successor or successors in the trust thereby and hereby created and to its or their assigns forever, all the right, title and interest of the Company in and to all the property, described in Section 13 hereof, together (subject to the provisions of Article X of the Indenture) with the tolls, rents, revenues, issues, earnings, income, products and profits thereof, excepting, however, the property, interests and rights specifically excepted from the lien of the Indenture as set forth in the Indenture. TOGETHER WITH all and singular the tenements, hereditaments and appurtenances belonging or in any wise appertaining to the premises, property, franchises and rights, or any thereof, referred to in the foregoing granting clause, with the reversion and reversions, remainder and remainders and (subject to the provisions of Article X of the Indenture) the tolls, rents, revenues, issues, earnings, income, products and profits thereof, and all the estate, right, title and interest and claim whatsoever, at law as well as in equity, which the Company now has or may hereafter acquire in and to the aforesaid premises, property, franchises and rights and every part and parcel thereof. SUBJECT, HOWEVER, with respect to such premises, property, franchises and rights, to excepted encumbrances as said term is defined in Section 1.02 of the Indenture, and subject also to all defects and limitations of title and to all encumbrances existing at the time of acquisition. TO HAVE AND TO HOLD all said premises, property, franchises and rights hereby conveyed, assigned, pledged or mortgaged, or intended so to be, unto the Trustee, its successor or successors in trust and their assigns forever; BUT IN TRUST, NEVERTHELESS, with power of sale for the equal and proportionate benefit and security of the holders of all bonds now or hereafter authenticated and delivered under and secured by the Indenture and interest coupons appurtenant thereto, pursuant to the provisions of the Indenture and of any supplemental indenture, and for the enforcement of the payment of said bonds and coupons when payable and the performance of and compliance with the covenants and conditions of the Indenture and of any supplemental indenture, without any preference, distinction or priority as to lien or otherwise of any bond or bonds over others by reason of the difference in time of the actual authentication, delivery, issue, sale or negotiation thereof or for any other reason whatsoever, except as otherwise expressly provided in the Indenture; and so that each and every bond now or hereafter authenticated and delivered thereunder shall have the same lien, and so that the principal of and premium, if any, and interest on every such bond shall, subject to the terms thereof, be equally and proportionately secured, as if it had been made, executed, authenticated, delivered, sold and negotiated simultaneously with the execution and delivery thereof. AND IT IS EXPRESSLY DECLARED by the Company that all bonds authenticated and delivered under and secured by the Indenture, as supplemented and amended as above set forth, are to be issued, authenticated and delivered, and all said premises, property, franchises and rights hereby and by the Indenture and indentures supplemental thereto conveyed, assigned, pledged or mortgaged, or intended so to be, are to be dealt with and disposed of under, upon and subject to the terms, conditions, stipulations, covenants, agreements, trusts, uses and purposes expressed in the Indenture, as supplemented and amended as above set forth, and the parties hereto mutually agree as follows: SECTION 1. There is hereby created one series of bonds (the "Senior IQ Note Bonds") designated as hereinabove provided, which shall also bear the descriptive title "First Mortgage Bond", and the form thereof shall be substantially as hereinbefore set forth. Senior IQ Note Bonds shall be issued in the aggregate principal amount of $150,000,000, shall mature on October 1, 2028 and shall be issued only as registered bonds without coupons in denominations of $1,000 and any multiple thereof. The serial numbers of bonds of the Senior IQ Note Bonds shall be such as may be approved by any officer of the Company, the execution thereof by any such officer either manually or by facsimile signature to be conclusive evidence of such approval. Senior IQ Note Bonds shall bear interest at a rate of 6.50% per annum until the principal thereof shall have become due and payable, payable quarterly on January 1, April 1, July 1 and October 1 in each year commencing January 1, 1999. The principal of and the premium, if any, and the interest on said bonds shall be payable in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, at the office or agency of the Company in the City of Jackson, Michigan designated for that purpose. Upon any payment of the principal of, premium, if any, and interest on, all or any portion of the Notes whether at maturity or prior to maturity by redemption or otherwise or upon provision for the payment thereof having been made in accordance with Section 5.01(a) of the Senior Note Indenture, Senior IQ Note Bonds in a principal amount equal to the principal amount of such Notes and having both a corresponding maturity date and interest rate shall, to the extent of such payment of principal, premium, if any, and interest, be deemed paid and the obligation of the Company thereunder to make such payment shall be discharged to such extent and, in the case of the payment of principal (and premium, if any) such bonds of said series shall be surrendered to the Company for cancellation as provided in Section 4.08 of the Senior Note Indenture. The Trustee may at anytime and all times conclusively assume that the obligation of the Company to make payments with respect to the principal of and premium, if any, and interest on the Senior IQ Note Bonds, so far as such payments at the time have become due, has been fully satisfied and discharged pursuant to the foregoing sentence unless and until the Trustee shall have received a written notice from the Senior Note Trustee signed by one of its officers stating (i) that timely payment of, or premium or interest on, the Notes has not been so made, (ii) that the Company is in arrears as to the payments required to be made by it to the Senior Note Trustee pursuant to the Senior Note Indenture, and (iii) the amount of the arrearage. Each Senior IQ Note Bond is to be issued to and registered in the name of The Chase Manhattan Bank, as trustee, or a successor trustee (said trustee or any successor trustee being hereinafter referred to as the "Senior Note Trustee") under the Indenture, dated as of February 1, 1998 (hereinafter sometimes referred to as the "Senior Note Indenture") between Consumers Energy Company and the Senior Note Trustee, to secure any and all obligations of the Company under the Notes and any other series of senior notes from time to time outstanding under the Senior Note Indenture. The Senior IQ Note Bonds shall not be assignable or transferable except as permitted or required by Section 4.04 of the Senior Note Indenture. Any such transfer shall be effected at the Investor Services Department of the Company, as transfer agent (hereinafter referred to as "corporate trust office"). The Senior IQ Note Bonds shall be exchangeable for other registered bonds of the same series, in the manner and upon the conditions prescribed in the Indenture, upon the surrender of such bonds at said corporate trust office of the transfer agent. However, notwithstanding the provisions of Section 2.05 of the Indenture, no charge shall be made upon any registration of transfer or exchange of bonds of said series other than for any tax or taxes or other governmental charge required to be paid by the Company. SECTION 2. Senior IQ Note Bonds shall not be redeemable except on the respective dates, in the respective principal amounts and for the respective redemption prices which correspond to the redemption dates for, the principal amounts to be redeemed of, and the redemption prices for, the Notes, and except as set forth in Section 3 hereof. In the event the Company redeems any Notes prior to maturity in accordance with the provisions of the Senior Note Indenture or in accordance with the provisions of the Third Supplemental Indenture to the Senior Note Indenture dated as of October 29, 1998 (the "Third Supplemental Indenture to the Senior Note Indenture"), the Senior Note Trustee shall on the same date deliver to the Company the Senior IQ Note Bonds in principal amounts corresponding to the Notes so redeemed, as provided in Section 4.08 of the Senior Note Indenture. The Company agrees to give the Trustee and the Senior Note Trustee notice of any such redemption of the Notes on or before the date fixed for any such redemption. In the event a Beneficial Owner (as such term is defined in the Third Supplemental Indenture to the Senior Note Indenture) redeems any Notes prior to maturity in accordance with the provisions of the Third Supplemental Indenture to the Senior Note Indenture, the Senior Note Trustee shall on the same date deliver to the Company the Senior IQ Note Bonds in principal amounts corresponding to the Notes so redeemed, as provided in Section 4.08 of the Senior Note Indenture. The Company agrees to give the Trustee and the Senior Note Trustee notice of any such redemption of the Notes on or before the date fixed for any such redemption. Senior IQ Note Bonds are not redeemable by the operation of the improvement fund or the maintenance and replacement provisions of this Indenture or with the proceeds of released property. SECTION 3. Upon the occurrence of an Event of Default under the Senior Note Indenture and the acceleration of the Notes, the Senior IQ Note Bonds shall be redeemable in whole upon receipt by the Trustee of a written demand (hereinafter called a "Redemption Demand") from the Senior Note Trustee stating that there has occurred under the Senior Note Indenture both an Event of Default and a declaration of acceleration of payment of principal, accrued interest and premium, if any, on the Notes, specifying the last date to which interest on such notes has been paid (such date being hereinafter referred to as the "Initial Interest Accrual Date") and demanding redemption of Senior IQ Note Bonds. The Company waives any right it may have to prior notice of such redemption under the Indenture. Upon surrender of the Senior IQ Note Bonds by the Senior Note Trustee to the Trustee, the Senior IQ Note Bonds shall be redeemed at a redemption price equal to the principal amount thereof plus accrued interest thereon from the Initial Interest Accrual Date to the date of the Redemption Demand; provided, however, that in the event of a recision of acceleration of senior notes pursuant to the last paragraph of Section 8.01(a) of the Senior Note Indenture, then any Redemption Demand shall thereby be deemed to be rescinded by the Senior Note Trustee; but no such recision or annulment shall extend to or affect any subsequent default or impair any right consequent thereon. SECTION 4. For purposes of Section 4.09 of the Senior Note Indenture, this bond shall be deemed to be the "related series of Senior Note First Mortgage Bonds" in respect of the Notes. SECTION 5. As provided in Section 4.11 of the Senior Note Indenture, from and after the Release Date (as defined in the Senior Note Indenture), the obligations of the Company with respect to the Senior IQ Note Bonds (the "Bonds") shall be deemed to be satisfied and discharged, the Bonds shall cease to secure in any manner any senior notes outstanding under the Senior Note Indenture, and, pursuant to Section 4.08 of the Senior Note Indenture, the Senior Note Trustee shall forthwith deliver the Bonds to the Company for cancellation. SECTION 6. The Company reserves the right, without any consent, vote or other action by the holder of the Senior IQ Note Bonds or the holders of any Notes, or of any subsequent series of bonds issued under the Indenture, to make such amendments to the Indenture, as supplemented, as shall be necessary in order to amend Section 17.02 to read as follows: SECTION 17.02. With the consent of the holders of not less than a majority in principal amount of the bonds at the time outstanding or their attorneys-in-fact duly authorized, or, if fewer than all series are affected, not less than a majority in principal amount of the bonds at the time outstanding of each series the rights of the holders of which are affected, voting together, the Company, when authorized by a resolution, and the Trustee may from time to time and at any time enter into an indenture or indentures supplemental hereto for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Indenture or of any supplemental indenture or modifying the rights and obligations of the Company and the rights of the holders of any of the bonds and coupons; provided, however, that no such supplemental indenture shall (1) extend the maturity of any of the bonds or reduce the rate or extend the time of payment of interest thereon, or reduce the amount of the principal thereof, or reduce any premium payable on the redemption thereof, without the consent of the holder of each bond so affected, or (2) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of this Indenture, without the consent of the holders of all the bonds then outstanding, or (3) reduce the aforesaid percentage of the principal amount of bonds the holders of which are required to approve any such supplemental indenture, without the consent of the holders of all the bonds then outstanding. For the purposes of this Section, bonds shall be deemed to be affected by a supplemental indenture if such supplemental indenture adversely affects or diminishes the rights of holders thereof against the Company or against its property. The Trustee may in its discretion determine whether or not, in accordance with the foregoing, bonds of any particular series would be affected by any supplemental indenture and any such determination shall be conclusive upon the holders of bonds of such series and all other series. Subject to the provisions of Sections 16.02 and 16.03 hereof, the Trustee shall not be liable for any determination made in good faith in connection herewith. Upon the written request of the Company, accompanied by a resolution authorizing the execution of any such supplemental indenture, and upon the filing with the Trustee of evidence of the consent of bondholders as aforesaid (the instrument or instruments evidencing such consent to be dated within one year of such request), the Trustee shall join with the Company in the execution of such supplemental indenture unless such supplemental indenture affects the Trustee's own rights, duties or immunities under this Indenture or otherwise, in which case the Trustee may in its discretion but shall not be obligated to enter into such supplemental indenture. It shall not be necessary for the consent of the bondholders under this Section to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such consent shall approve the substance thereof. The Company and the Trustee, if they so elect, and either before or after such consent has been obtained, may require the holder of any bond consenting to the execution of any such supplemental indenture to submit his bond to the Trustee or to ask such bank, banker or trust company as may be designated by the Trustee for the purpose, for the notation thereon of the fact that the holder of such bond has consented to the execution of such supplemental indenture, and in such case such notation, in form satisfactory to the Trustee, shall be made upon all bonds so submitted, and such bonds bearing such notation shall forthwith be returned to the persons entitled thereto. Prior to the execution by the Company and the Trustee of any supplemental indenture pursuant to the provisions of this Section, the Company shall publish a notice, setting forth in general terms the substance of such supplemental indenture, at least once in one daily newspaper of general circulation in each city in which the principal of any of the bonds shall be payable, or, if all bonds outstanding shall be registered bonds without coupons or coupon bonds registered as to principal, such notice shall be sufficiently given if mailed, first class, postage prepaid, and registered if the Company so elects, to each registered holder of bonds at the last address of such holder appearing on the registry books, such publication or mailing, as the case may be, to be made not less than thirty days prior to such execution. Any failure of the Company to give such notice, or any defect therein, shall not, however, in any way impair or affect the validity of any such supplemental indenture. SECTION 7. As supplemented and amended as above set forth, the Indenture is in all respects ratified and confirmed, and the Indenture and all indentures supplemental thereto shall be read, taken and construed as one and the same instrument. SECTION 8. Nothing contained in this Supplemental Indenture shall, or shall be construed to, confer upon any person other than a holder of bonds issued under the Indenture, as supplemented and amended as above set forth, the Company, the Trustee and the Senior Note Trustee, for the benefit of the holder or holders of the Notes, any right or interest to avail himself of any benefit under any provision of the Indenture, as so supplemented and amended. SECTION 9. The Trustee assumes no responsibility for or in respect of the validity or sufficiency of this Supplemental Indenture or of the Indenture as hereby supplemented or the due execution hereof by the Company or for or in respect of the recitals and statements contained herein (other than those contained in the sixth and seventh recitals hereof), all of which recitals and statements are made solely by the Company. SECTION 10. This Supplemental Indenture may be simultaneously executed in several counterparts and all such counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. SECTION 11. In the event the date of any notice required or permitted hereunder or the date of maturity of interest on or principal of the Senior IQ Note Bonds or the date fixed for redemption or repayment of the Senior IQ Note Bonds shall not be a Business Day, then (notwithstanding any other provision of the Indenture or of any supplemental indenture thereto) such notice or such payment of such interest or principal need not be made on such date, but may be made on the next succeeding Business Day with the same force and effect as if made on the date fixed for such notice or as if made on the date of maturity or the date fixed for redemption or repayment, and no interest shall accrue for the period from and after such date. "Business Day" means, with respect to this Section 11, a day of the year on which banks are not required or authorized to close in New York City or Detroit, Michigan. SECTION 12. This Supplemental Indenture and the Senior IQ Note Bonds shall be governed by and deemed to be a contract under, and construed in accordance with, the laws of the State of Michigan, and for all purposes shall be construed in accordance with the laws of such state, except as may otherwise be required by mandatory provisions of law. SECTION 13. Detailed Description of Property Mortgaged: I. ELECTRIC GENERATING PLANTS AND DAMS All the electric generating plants and stations of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, including all powerhouses, buildings, reservoirs, dams, pipelines, flumes, structures and works and the land on which the same are situated and all water rights and all other lands and easements, rights of way, permits, privileges, towers, poles, wires, machinery, equipment, appliances, appurtenances and supplies and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such plants and stations or any of them, or adjacent thereto. II. ELECTRIC TRANSMISSION LINES All the electric transmission lines of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, including towers, poles, pole lines, wires, switches, switch racks, switchboards, insulators and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such transmission lines or any of them or adjacent thereto; together with all real property, rights of way, easements, permits, privileges, franchises and rights for or relating to the construction, maintenance or operation thereof, through, over, under or upon any private property or any public streets or highways, within as well as without the corporate limits of any municipal corporation. Also all the real property, rights of way, easements, permits, privileges and rights for or relating to the construction, maintenance or operation of certain transmission lines, the land and rights for which are owned by the Company, which are either not built or now being constructed. III. ELECTRIC DISTRIBUTION SYSTEMS All the electric distribution systems of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, including substations, transformers, switchboards, towers, poles, wires, insulators, subways, trenches, conduits, manholes, cables, meters and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such distribution systems or any of them or adjacent thereto; together with all real property, rights of way, easements, permits, privileges, franchises, grants and rights, for or relating to the construction, maintenance or operation thereof, through, over, under or upon any private property or any public streets or highways within as well as without the corporate limits of any municipal corporation. IV. ELECTRIC SUBSTATIONS, SWITCHING STATIONS AND SITES All the substations, switching stations and sites of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, for transforming, regulating, converting or distributing or otherwise controlling electric current at any of its plants and elsewhere, together with all buildings, transformers, wires, insulators and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with any of such substations and switching stations, or adjacent thereto, with sites to be used for such purposes. V. GAS COMPRESSOR STATIONS, GAS PROCESSING PLANTS, DESULPHURIZATION STATIONS, METERING STATIONS, ODORIZING STATIONS, REGULATORS AND SITES All the compressor stations, processing plants, desulphurization stations, metering stations, odorizing stations, regulators and sites of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, for compressing, processing, desulphurizing, metering, odorizing and regulating manufactured or natural gas at any of its plants and elsewhere, together with all buildings, meters and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with any of such purposes, with sites to be used for such purposes. VI. GAS STORAGE FIELDS The natural gas rights and interests of the Company, including wells and well lines (but not including natural gas, oil and minerals), the gas gathering system, the underground gas storage rights, the underground gas storage wells and injection and withdrawal system used in connection therewith, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture: In the Overisel Gas Storage Field, located in the Township of Overisel, Allegan County, and in the Township of Zeeland, Ottawa County, Michigan; in the Northville Gas Storage Field located in the Township of Salem, Washtenaw County, Township of Lyon, Oakland County, and the Townships of Northville and Plymouth and City of Plymouth, Wayne County, Michigan; in the Salem Gas Storage Field, located in the Township of Salem, Allegan County, and in the Township of Jamestown, Ottawa County, Michigan; in the Ray Gas Storage Field, located in the Townships of Ray and Armada, Macomb County, Michigan; in the Lenox Gas Storage Field, located in the Townships of Lenox and Chesterfield, Macomb County, Michigan; in the Ira Gas Storage Field, located in the Township of Ira, St. Clair County, Michigan; in the Puttygut Gas Storage Field, located in the Township of Casco, St. Clair County, Michigan; in the Four Corners Gas Storage Field, located in the Townships of Casco, China, Cottrellville and Ira, St. Clair County, Michigan; in the Swan Creek Gas Storage Field, located in the Township of Casco and Ira, St. Clair County, Michigan; and in the Hessen Gas Storage Field, located in the Townships of Casco and Columbus, St. Clair, Michigan. VII. GAS TRANSMISSION LINES All the gas transmission lines of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, including gas mains, pipes, pipelines, gates, valves, meters and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such transmission lines or any of them or adjacent thereto; together with all real property, right of way, easements, permits, privileges, franchises and rights for or relating to the construction, maintenance or operation thereof, through, over, under or upon any private property or any public streets or highways, within as well as without the corporate limits of any municipal corporation. VIII. GAS DISTRIBUTION SYSTEMS All the gas distribution systems of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, including tunnels, conduits, gas mains and pipes, service pipes, fittings, gates, valves, connections, meters and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such distribution systems or any of them or adjacent thereto; together with all real property, rights of way, easements, permits, privileges, franchises, grants and rights, for or relating to the construction, maintenance or operation thereof, through, over, under or upon any private property or any public streets or highways within as well as without the corporate limits of any municipal corporation. IX. OFFICE BUILDINGS, SERVICE BUILDINGS, GARAGES, ETC. All office, garage, service and other buildings of the Company, wherever located, in the State of Michigan, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, together with the land on which the same are situated and all easements, rights of way and appurtenances to said lands, together with all furniture and fixtures located in said buildings. X. TELEPHONE PROPERTIES AND RADIO COMMUNICATION EQUIPMENT All telephone lines, switchboards, systems and equipment of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the line of the Indenture, used or available for use in the operation of its properties, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such telephone properties or any of them or adjacent thereto; together with all real estate, rights of way, easements, permits, privileges, franchises, property, devices or rights related to the dispatch, transmission, reception or reproduction of messages, communications, intelligence, signals, light, vision or sound by electricity, wire or otherwise, including all telephone equipment installed in buildings used as general and regional offices, substations and generating stations and all telephone lines erected on towers and poles; and all radio communication equipment of the Company, together with all property, real or personal (except any in the Indenture expressly excepted), fixed stations, towers, auxiliary radio buildings and equipment, and all appurtenances used in connection therewith, wherever located, in the State of Michigan. XI. OTHER REAL PROPERTY All other real property of the Company and all interests therein, of every nature and description (except any in the Indenture expressly excepted) wherever located, in the State of Michigan, acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the line of the Indenture. Such real property includes but is not limited to the following described property, such property is subject to any interests that were excepted or reserved in the conveyance to the Company: Alcona County Certain land in Caledonia Township, Alcona County, Michigan described as: The East 330 feet of the South 660 feet of the SW 1/4 of the SW 1/4 of Section 8, T28N, R8E, except the West 264 feet of the South 330 feet thereof; said land being more particularly described as follows: To find the place of beginning of this description, commence at the Southwest corner of said section, run thence East along the South line of said section 1243 feet to the place of beginning of this description, thence continuing East along said South line of said section 66 feet to the West 1/8 line of said section, thence N 02 09' 30" E along the said West 1/8 line of said section 660 feet, thence West 330 feet, thence S 02 09' 30" W, 330 feet, thence East 264 feet, thence S 02 09' 30" W, 330 feet to the place of beginning. Allegan County Certain land in Lee Township, Allegan County, Michigan described as: The NE 1/4 of the NW 1/4 of Section 16, T1N, R15W. Alpena County Certain land in Wilson and Green Townships, Alpena County, Michigan described as: All that part of the S'ly 1/2 of the former Boyne City- Gaylord and Alpena Railroad right of way, being the Southerly 50 feet of a 100 foot strip of land formerly occupied by said Railroad, running from the East line of Section 31, T31N, R7E, Southwesterly across said Section 31 and Sections 5 and 6 of T30N, R7E and Sections 10, 11 and the E1/2 of Section 9, except the West 1646 feet thereof, all in T30N, R6E. Antrim County Certain land in Mancelona Township, Antrim County, Michigan described as: The S 1/2 of the NE 1/4 of Section 33, T29N, R6W, excepting therefrom all mineral, coal, oil and gas and such other rights as were reserved unto the State of Michigan in that certain deed running from the State of Michigan to August W. Schack and Emma H. Schack, his wife, dated April 15, 1946 and recorded May 20, 1946 in Liber 97 of Deeds on page 682 of Antrim County Records. Arenac County Certain land in Standish Township, Arenac County, Michigan described as: A parcel of land in the SW 1/4 of the NW 1/4 of Section 12, T18N, R4E, described as follows: To find the place of beginning of said parcel of land, commence at the Northwest corner of Section 12, T18N, R4E; run thence South along the West line of said section, said West line of said section being also the center line of East City Limits Road 2642.15 feet to the W 1/4 post of said section and the place of beginning of said parcel of land; running thence N 88 26' 00" E along the East and West 1/4 line of said section, 660.0 feet; thence North parallel with the West line of said section, 310.0 feet; thence S 88 26' 00" W, 330.0 feet; thence South parallel with the West line of said section, 260.0 feet; thence S 88 26' 00" W, 330.0 feet to the West line of said section and the center line of East City Limits Road; thence South along the said West line of said section, 50.0 feet to the place of beginning. Barry County Certain land in Johnstown Township, Barry County, Michigan described as: A strip of land 311 feet in width across the SW 1/4 of the NE 1/4 of Section 31, T1N, R8W, described as follows: To find the place of beginning of this description, commence at the E 1/4 post of said section; run thence N 00 55' 00" E along the East line of said section, 555.84 feet; thence N 59 36' 20" W, 1375.64 feet; thence N 88 30' 00" W, 130 feet to a point on the East 1/8 line of said section and the place of beginning of this description; thence continuing N 88 30' 00" W, 1327.46 feet to the North and South 1/4 line of said section; thence S 00 39' 35" W along said North and South 1/4 line of said section, 311.03 feet to a point, which said point is 952.72 feet distant N'ly from the East and West 1/4 line of said section as measured along said North and South 1/4 line of said section; thence S 88 30' 00" E, 1326.76 feet to the East 1/8 line of said section; thence N 00 47' 20" E along said East 1/8 line of said section, 311.02 feet to the place of beginning. Bay County Certain land in Frankenlust Township, Bay County, Michigan described as: The South 250 feet of the N 1/2 of the W 1/2 of the W 1/2 of the SE 1/4 of Section 9, T13N, R4E. Benzie County Certain land in Benzonia Township, Benzie County, Michigan described as: A parcel of land in the Northeast 1/4 of Section 7, Township 26 North, Range 14 West, described as beginning at a point on the East line of said Section 7, said point being 320 feet North measured along the East line of said section from the East 1/4 post; running thence West 165 feet; thence North parallel with the East line of said section 165 feet; thence East 165 feet to the East line of said section; thence South 165 feet to the place of beginning. Branch County Certain land in Girard Township, Branch County, Michigan described as: A parcel of land in the NE1/4 of Section 23 T5S, R6W, described as beginning at a point on the North and South quarter line of said section at a point 1278.27 feet distant South of the North quarter post of said section, said distance being measured along the North and South quarter line of said section, running thence S89 21'E 250 feet, thence North along a line parallel with the said North and South quarter line of said section 200 feet, thence N89 21'W 250 feet to the North and South quarter line of said section, thence South along said North and South quarter line of said section 200 feet to the place of beginning. Calhoun County Certain land in Convis Township, Calhoun County, Michigan described as: A parcel of land in the SE 1/4 of the SE 1/4 of Section 32, T1S, R6W, described as follows: To find the place of beginning of this description, commence at the Southeast corner of said section; run thence North along the East line of said section 1034.32 feet to the place of beginning of this description; running thence N 89 39' 52" W, 333.0 feet; thence North 290.0 feet to the South 1/8 line of said section; thence S 89 39' 52" E along said South 1/8 line of said section 333.0 feet to the East line of said section; thence South along said East line of said section 290.0 feet to the place of beginning. (Bearings are based on the East line of Section 32, T1S, R6W, from the Southeast corner of said section to the Northeast corner of said section assumed as North.) Cass County Certain easement rights located across land in Marcellus Township, Cass County, Michigan described as: The East 6 rods of the SW 1/4 of the SE 1/4 of Section 4, T5S, R13W. Charlevoix County Certain land in South Arm Township, Charlevoix County, Michigan described as: A parcel of land in the SW 1/4 of Section 29, T32N, R7W, described as follows: Beginning at the Southwest corner of said section and running thence North along the West line of said section 788.25 feet to a point which is 528 feet distant South of the South 1/8 line of said section as measured along the said West line of said section; thence N 89 30' 19" E, parallel with said South 1/8 line of said section 442.1 feet; thence South 788.15 feet to the South line of said section; thence S 89 29' 30" W, along said South line of said section 442.1 feet to the place of beginning. Cheboygan County Certain land in Inverness Township, Cheboygan County, Michigan described as: A parcel of land in the SW frl 1/4 of Section 31, T37N, R2W, described as beginning at the Northwest corner of the SW frl 1/4, running thence East on the East and West quarter line of said Section, 40 rods, thence South parallel to the West line of said Section 40 rods, thence West 40 rods to the West line of said Section, thence North 40 rods to the place of beginning. Clare County Certain land in Frost Township, Clare County, Michigan described as: The East 150 feet of the North 225 feet of the NW 1/4 of the NW 1/4 of Section 15, T20N, R4W. Clinton County Certain land in Watertown Township, Clinton County, Michigan described as: The NE 1/4 of the NE 1/4 of the SE 1/4 of Section 22, and the North 165 feet of the NW 1/4 of the NE 1/4 of the SE 1/4 of Section 22, T5N, R3W. Crawford County Certain land in Lovells Township, Crawford County, Michigan described as: A parcel of land in Section 1, T28N, R1W, described as: Commencing at NW corner said section; thence South 89 53'30" East along North section line 105.78 feet to point of beginning; thence South 89 53'30" East along North section line 649.64 feet; thence South 55 42'30" East 340.24 feet; thence South 55 44'37" East 5,061.81 feet to the East section line; thence South 00 00'08" West along East section line 441.59 feet; thence North 55 44'37" West 5,310.48 feet; thence North 55 42'30" West 877.76 feet to point of beginning. Eaton County Certain land in Eaton Township, Eaton County, Michigan described as: A parcel of land in the SW 1/4 of Section 6, T2N, R4W, described as follows: To find the place of beginning of this description commence at the Southwest corner of said section; run thence N 89 51' 30" E along the South line of said section 400 feet to the place of beginning of this description; thence continuing N 89 51' 30" E, 500 feet; thence N 00 50' 00" W, 600 feet; thence S 89 51' 30" W parallel with the South line of said section 500 feet; thence S 00 50' 00" E, 600 feet to the place of beginning. Emmet County Certain land in Wawatam Township, Emmet County, Michigan described as: The West 1/2 of the Northeast 1/4 of the Northeast 1/4 of Section 23, T39N, R4W. Genesee County Certain land in Argentine Township, Genesee County, Michigan described as: A parcel of land of part of the SW 1/4 of Section 8, T5N, R5E, being more particularly described as follows: Beginning at a point of the West line of Duffield Road, 100 feet wide, (as now established) distant 829.46 feet measured N01 42'56"W and 50 feet measured S88 14'04"W from the South quarter corner, Section 8, T5N, R5E; thence S88 14'04"W a distance of 550 feet; thence N01 42'56"W a distance of 500 feet to a point on the North line of the South half of the Southwest quarter of said Section 8; thence N88 14'04"E along the North line of South half of the Southwest quarter of said Section 8 a distance 550 feet to a point on the West line of Duffield Road, 100 feet wide (as now established); thence S01 42'56"E along the West line of said Duffield Road a distance of 500 feet to the point of beginning. Gladwin County Certain land in Secord Township, Gladwin County, Michigan described as: The East 400 feet of the South 450 feet of Section 2, T19N, R1E. Grand Traverse County Certain land in Mayfield Township, Grand Traverse County, Michigan described as: A parcel of land in the Northwest 1/4 of Section 3, T25N, R11W, described as follows: Commencing at the Northwest corner of said section, running thence S 89 19'15" E along the North line of said section and the center line of Clouss Road 225 feet, thence South 400 feet, thence N 89 19'15" W 225 feet to the West line of said section and the center line of Hannah Road, thence North along the West line of said section and the center line of Hannah Road 400 feet to the place of beginning for this description. Gratiot County Certain land in Washington Township, Gratiot County, Michigan described as: Commencing at the Northeast corner of Section 10, T9N, R2W, running thence West along the North line of said section a distance of 194.5 feet, thence S0 07'10"W 200 feet to a point, thence East 194.5 feet to the East line of said Section 10, thence N0 07'10"E along the East line of said section a distance of 200 feet to the point of beginning. Hillsdale County Certain land in Litchfield Village, Hillsdale County, Michigan described as: Lots numbered three (3) and four (4) of Block three (3) of Harvey Smiths Southern Addition to the Village of Litchfield according to the recorded plat thereof as recorded in Liber AK of deeds, page 490. Huron County Certain easement rights located across land in Sebewaing Township, Huron County, Michigan described as: The North 1/2 of the Northwest 1/4 of Section 15, T15N, R9E. Ingham County Certain land in Vevay Township, Ingham County, Michigan described as: A parcel of land 660 feet wide in the Southwest 1/4 of Section 7 lying South of the centerline of Sitts Road as extended to the North-South 1/4 line of said Section 7, T2N, R1W, more particularly described as follows: Commence at the Southwest corner of said Section 7, thence North along the West line of said Section 2502.71 feet to the centerline of Sitts Road; thence South 89 54'45" East along said centerline 2282.38 feet to the place of beginning of this description; thence continuing South 89 54'45" East along said centerline and said centerline extended 660.00 feet to the North-South 1/4 line of said section; thence South 00 07'20" West 1461.71 feet; thence North 89 34'58" West 660.00 feet; thence North 00 07'20" East 1457.91 feet to the centerline of Sitts Road and the place of beginning. Ionia County Certain land in Sebewa Township, Ionia County, Michigan described as: A strip of land 280 feet wide across that part of the SW 1/4 of the NE 1/4 of Section 15, T5N, R6W, described as follows: To find the place of beginning of this description commence at the E 1/4 corner of said section; run thence N 00 05' 38" W along the East line of said section, 1218.43 feet; thence S 67 18' 24" W, 1424.45 feet to the East 1/8 line of said section and the place of beginning of this description; thence continuing S 67 18' 24" W, 1426.28 feet to the North and South 1/4 line of said section at a point which said point is 105.82 feet distant N'ly of the center of said section as measured along said North and South 1/4 line of said section; thence N 00 04' 47" E along said North and South 1/4 line of said section, 303.67 feet; thence N 67 18' 24" E, 1425.78 feet to the East 1/8 line of said section; thence S 00 00' 26" E along said East 1/8 line of said section, 303.48 feet to the place of beginning. (Bearings are based on the East line of Section 15, T5N, R6W, from the E 1/4 corner of said section to the Northeast corner of said section assumed as N 00 05' 38" W.) Iosco County Certain land in Alabaster Township, Iosco County, Michigan described as: A parcel of land in the NW 1/4 of Section 34, T21N, R7E, described as follows: To find the place of beginning of this description commence at the N 1/4 post of said section; run thence South along the North and South 1/4 line of said section, 1354.40 feet to the place of beginning of this description; thence continuing South along the said North and South 1/4 line of said section, 165.00 feet to a point on the said North and South 1/4 line of said section which said point is 1089.00 feet distant North of the center of said section; thence West 440.00 feet; thence North 165.00 feet; thence East 440.00 feet to the said North and South 1/4 line of said section and the place of beginning. Isabella County Certain land in Chippewa Township, Isabella County, Michigan described as: The North 8 rods of the NE 1/4 of the SE 1/4 of Section 29, T14N, R3W. Jackson County Certain land in Waterloo Township, Jackson County, Michigan described as: A parcel of land in the North fractional part of the N fractional 1/2 of Section 2, T1S, R2E, described as follows: To find the place of beginning of this description commence at the E 1/4 post of said section; run thence N 01 03' 40" E along the East line of said section 13335.45 feet to the North 1/8 line of said section and the place of beginning of this description; thence N 89 32' 00" W, 2677.7 feet to the North and South 1/4 line of said section; thence S 00 59' 25" W along the North and South 1/4 line of said section 22.38 feet to the North 1/8 line of said section; thence S 89 59' 10" W along the North 1/8 line of said section 2339.4 feet to the center line of State Trunkline Highway M-52; thence N 53 46' 00" W along the center line of said State Trunkline Highway 414.22 feet to the West line of said section; thence N 00 55' 10" E along the West line of said section 74.35 feet; thence S 89 32' 00" E, 5356.02 feet to the East line of said section; thence S 01 03' 40" W along the East line of said section 250 feet to the place of beginning. Kalamazoo County Certain land in Alamo Township, Kalamazoo County, Michigan described as: The South 350 feet of the NW 1/4 of the NW 1/4 of Section 16, T1S, R12W, being more particularly described as follows: To find the place of beginning of this description, commence at the Northwest corner of said section; run thence S 00 36' 55" W along the West line of said section 971.02 feet to the place of beginning of this description; thence continuing S 00 36' 55" W along said West line of said section 350.18 feet to the North 1/8 line of said section; thence S 87 33' 40" E along the said North 1/8 line of said section 1325.1 feet to the West 1/8 line of said section; thence N 00 38' 25" E along the said West 1/8 line of said section 350.17 feet; thence N 87 33' 40" W, 1325.25 feet to the place of beginning. Kalkaska County Certain land in Kalkaska Township, Kalkaska County, Michigan described as: The NW 1/4 of the SW 1/4 of Section 4, T27N, R7W, excepting therefrom all mineral, coal, oil and gas and such other rights as were reserved unto the State of Michigan in that certain deed running from the Department of Conservation for the State of Michigan to George Welker and Mary Welker, his wife, dated October 9, 1934 and recorded December 28, 1934 in Liber 39 on page 291 of Kalkaska County Records, and subject to easement for pipeline purposes as granted to Michigan Consolidated Gas Company by first party herein on April 4, 1963 and recorded June 21, 1963 in Liber 91 on page 631 of Kalkaska County Records. Kent County Certain land in Caledonia Township, Kent County, Michigan described as: A parcel of land in the Northwest fractional 1/4 of Section 15, T5N, R10W, described as follows: To find the place of beginning of this description commence at the North 1/4 corner of said section, run thence S 0 59' 26" E along the North and South 1/4 line of said section 2046.25 feet to the place of beginning of this description, thence continuing S 0 59' 26" E along said North and South 1/4 line of said section 332.88 feet, thence S 88 58' 30" W 2510.90 feet to a point herein designated "Point A" on the East bank of the Thornapple River, thence continuing S 88 53' 30" W to the center thread of the Thornapple River, thence NW'ly along the center thread of said Thornapple River to a point which said point is S 88 58' 30" W of a point on the East bank of the Thornapple River herein designated "Point B", said "Point B" being N 23 41' 35" W 360.75 feet from said above-described "Point A", thence N 88 58' 30" E to said "Point B", thence continuing N 88 58' 30" E 2650.13 feet to the place of beginning. (Bearings are based on the East line of Section 15, T5N, R10W between the East 1/4 corner of said section and the Northeast corner of said section assumed as N 0 59' 55" W.) Lake County Certain land in Pinora and Cherry Valley Townships, Lake County, Michigan described as: A strip of land 50 feet wide East and West along and adjoining the West line of highway on the East side of the North 1/2 of Section 13 T18N, R12W. Also a strip of land 100 feet wide East and West along and adjoining the East line of the highway on the West side of following described land: The South 1/2 of NW 1/4, and the South 1/2 of the NW 1/4 of the SW 1/4, all in Section 6, T18N, R11W. Lapeer County Certain land in Hadley Township, Lapeer County, Michigan described as: The South 825 feet of the W 1/2 of the SW 1/4 of Section 24, T6N, R9E, except the West 1064 feet thereof. Leelanau County Certain land in Cleveland Township, Leelanau County, Michigan described as: The North 200 feet of the West 180 feet of the SW 1/4 of the SE 1/4 of Section 35, T29N, R13W. Lenawee County Certain land in Madison Township, Lenawee County, Michigan described as: A strip of land 165 feet wide off the West side of the following described premises: The E1/2 of the SE1/4 of Section 12. The E1/2 of the NE1/4 and the NE1/4 of the SE1/4 of Section 13, being all in T7S, R3E, excepting therefrom a parcel of land in the E1/2 of the SE1/4 of Section 12, T7S, R3E, beginning at the Northwest corner of said E1/2 of the SE1/4 of Section 12, running thence East 4 rods, thence South 6 rods, thence West 4 rods, thence North 6 rods to the place of beginning. Livingston County Certain land in Cohoctah Township, Livingston County, Michigan described as: Parcel 1 The East 390 feet of the East 50 rods of the SW 1/4 of Section 30, T4N, R4E. Parcel 2 A parcel of land in the NW 1/4 of Section 31, T4N, R4E, described as follows: To find the place of beginning of this description commence at the N 1/4 post of said section; run thence N 89 13' 06" W along the North line of said section, 330 feet to the place of beginning of this description; running thence S 00 52' 49" W, 2167.87 feet; thence N 88 59' 49" W, 60 feet; thence N 00 52' 49" E, 2167.66 feet to the North line of said section; thence S 89 13' 06" E along said North line of said section, 60 feet to the place of beginning. Mackinac County Certain easement rights located across land in Moran Township, Mackinac County, Michigan described as: A 20 foot wide strip of land, 10 feet on each side of the hereinafter described center line, through Lots 16, 17 and 21, Block 12 of Partition Plat of Private Claim No. 1, Section 23, Township 40 North, Range 4 West: Said center line being described as beginning at Edison Sault Electric Company's existing 35 foot service pole located 200 feet, more or less, Northerly of the shoreline of the Straits of Mackinac, running thence Easterly to a point approximately 20 feet Westerly of the center line of Lakehead Pipeline Company's existing 20 inch pipeline, thence Northerly and Easterly along and approximately 20 feet Westerly and Northerly of the center line of said 20 inch existing pipeline to a certain Michigan Bell Telephone Company's existing pole located Easterly of the Westerly line of Lot 22, Block 12 of Partition Plat of Private Claim No. 1 in said Section 23. Macomb County Certain land in Macomb Township, Macomb County, Michigan described as: A parcel of land commencing on the West line of the E 1/2 of the NW 1/4 of fractional Section 6, 20 chains South of the NW corner of said E 1/2 of the NW 1/4 of Section 6; thence South on said West line and the East line of A. Henry Kotner's Hayes Road Subdivision #15, according to the recorded plat thereof, as recorded in Liber 24 of Plats, on page 7, 24.36 chains to the East and West 1/4 line of said Section 6; thence East on said East and West 1/4 line 8.93 chains; thence North parallel with the said West line of the E 1/2 of the NW 1/4 of Section 6, 24.36 chains; thence West 8.93 chains to the place of beginning, all in T3N, R13E. Manistee County Certain land in Manistee Township, Manistee County, Michigan described as: A parcel of land in the SW 1/4 of Section 20, T22N, R16W, described as follows: To find the place of beginning of this description, commence at the Southwest corner of said section; run thence East along the South line of said section 832.2 feet to the place of beginning of this description; thence continuing East along said South line of said section 132 feet; thence North 198 feet; thence West 132 feet; thence South 198 feet to the place of beginning, excepting therefrom the South 2 rods thereof which was conveyed to Manistee Township for highway purposes by a Quitclaim Deed dated June 13, 1919 and recorded July 11, 1919 in Liber 88 of Deeds on page 638 of Manistee County Records. Mason County Certain land in Riverton Township, Mason County, Michigan described as: Parcel 1 The South 10 acres of the West 20 acres of the S 1/2 of the NE 1/4 of Section 22, T17N, R17W. Parcel 2 A parcel of land containing 4 acres of the West side of highway, said parcel of land being described as commencing 16 rods South of the Northwest corner of the NW 1/4 of the SW 1/4 of Section 22, T17N, R17W, running thence South 64 rods, thence NE'ly and N'ly and NW'ly along the W'ly line of said highway to the place of beginning, together with any and all right, title, and interest of Howard C. Wicklund and Katherine E. Wicklund in and to that portion of the hereinbefore mentioned highway lying adjacent to the E'ly line of said above described land. Mecosta County Certain land in Wheatland Township, Mecosta County, Michigan described as: A parcel of land in the SW1/4 of the SW1/4 of Section 16, T14N, R7W, described as beginning at the Southwest corner of said section; thence East along the South line of Section 133 feet; thence North parallel to the West section line 133 feet; thence West 133 feet to the West line of said Section; thence South 133 feet to the place of beginning. Midland County Certain land in Ingersoll Township, Midland County, Michigan described as: The West 200 feet of the W 1/2 of the NE 1/4 of Section 4, T13N, R2E. Missaukee County Certain land in Norwich Township, Missaukee County, Michigan described as: A parcel of land in the NW 1/4 of the NW 1/4 of Section 16, T24N, R6W, described as follows: Commencing at the Northwest corner of said section, running thence N 89 01' 45" E along the North line of said section 233.00 feet; thence South 233.00 feet; thence S 89 01' 45" W, 233.00 feet to the West line of said section; thence North along said West line of said section 233.00 feet to the place of beginning. (Bearings are based on the West line of Section 16, T24N, R6W, between the Southwest and Northwest corners of said section assumed as North.) Monroe County Certain land in LaSalle Township, Monroe County, Michigan described as: A strip of land 150 feet in width across part of the S 1/2 of the SE 1/4 of Section 35, T7S, R8E, described as follows: To find the place of beginning of this description commence at the S 1/4 post of said section; run thence N 89 30' 20" E along the South line of said section 2118.39 feet to the place of beginning of this description; thence continuing N 89 30' 20" E along said South line of said section 198.56 feet to the NW'ly right- of-way line of Highway I-75, so called; thence N 40 26' 30" E along the NW'ly line of said highway 477.72 feet to the East line of said section; thence N 00 25' 15" W along the East line of said section 229.27 feet; thence S 40 26' 30" W, 781.21 feet to the place of beginning. Montcalm County Certain land in Crystal Township, Montcalm County, Michigan described as: The N 1/2 of the S 1/2 of the SE 1/4 of Section 35, T10N, R5W. Montmorency County Certain land in the Village of Hillman, Montmorency County, Michigan described as: Lot 14 of Hillman Industrial Park, being a subdivision in the South 1/2 of the Northwest 1/4 of Section 24, T31N, R4E, according to the plat thereof recorded in Liber 4 of Plats on Pages 32-34, Montmorency County Records. Muskegon County Certain land in Casnovia Township, Muskegon County, Michigan described as: The West 433 feet of the North 180 feet of the South 425 feet of the SW 1/4 of Section 3, T10N, R13W. Newaygo County Certain land in Ashland Township, Newaygo County, Michigan described as: The West 250 feet of the NE 1/4 of Section 23, T11N, R13W. Oakland County Certain land in Wixcom City, Oakland County, Michigan described as: The E 75 feet of the N 160 feet of the N 330 feet of the W 526.84 feet of the NW 1/4 of the NW 1/4 of Section 8, T1N, R8E, more particularly described as follows: Commence at the NW corner of said Section 8, thence N 87 14' 29" E along the North line of said Section 8 a distance of 451.84 feet to the place of beginning for this description; thence continuing N 87 14' 29" E along said North section line a distance of 75.0 feet to the East line of the West 526.84 feet of the NW 1/4 of the NW 1/4 of said Section 8; thence S 02 37' 09" E along said East line a distance of 160.0 feet; thence S 87 14' 29" W a distance of 75.0 feet; thence N 02 37' 09" W a distance of 160.0 feet to the place of beginning. Oceana County Certain land in Crystal Township, Oceana County, Michigan described as: The East 290 feet of the SE 1/4 of the NW 1/4 and the East 290 feet of the NE 1/4 of the SW 1/4, all in Section 20, T16N, R16W. Ogemaw County Certain land in West Branch Township, Ogemaw County, Michigan described as: The South 660 feet of the East 660 feet of the NE 1/4 of the NE 1/4 of Section 33, T22N, R2E. Osceola County Certain land in Hersey Township, Osceola County, Michigan described as: A parcel of land in the North 1/2 of the Northeast 1/4 of Section 13, T17N, R9W, described as commencing at the Northeast corner of said Section; thence West along the North Section line 999 feet to the point of beginning of this description; thence S 01 54' 20" E 1327.12 feet to the North 1/8 line; thence S 89 17' 05" W along the North 1/8 line 330.89 feet; thence N 01 54' 20" W 1331.26 feet to the North Section line; thence East along the North Section line 331 feet to the point of beginning. Oscoda County Certain land in Comins Township, Oscoda County, Michigan described as: The East 400 feet of the South 580 feet of the W 1/2 of the SW 1/4 of Section 15, T27N, R3E. Otsego County Certain land in Corwith Township, Otsego County, Michigan described as: Part of the NW 1/4 of the NE 1/4 of Section 28, T32N, R3W, described as: Beginning at the N 1/4 corner of said section; running thence S 89 04' 06" E along the North line of said section, 330.00 feet; thence S 00 28' 43" E, 400.00 feet; thence N 89 04' 06" W, 330.00 feet to the North and South 1/4 line of said section; thence N 00 28' 43" W along the said North and South 1/4 line of said section, 400.00 feet to the point of beginning; subject to the use of the N'ly 33.00 feet thereof for highway purposes. Ottawa County Certain land in Robinson Township, Ottawa County, Michigan described as: The North 660 feet of the West 660 feet of the NE 1/4 of the NW 1/4 of Section 26, T7N, R15W. Presque Isle County Certain land in Belknap and Pulawski Townships, Presque Isle County, Michigan described as: Part of the South half of the Northeast quarter, Section 24, T34N, R5E, and part of the Northwest quarter, Section 19, T34N, R6E, more fully described as: Commencing at the East 1/4 corner of said Section 24; thence N 00 15'47" E, 507.42 feet, along the East line of said Section 24 to the point of beginning; thence S 88 15'36" W, 400.00 feet, parallel with the North 1/8 line of said Section 24; thence N 00 15'47" E, 800.00 feet, parallel with said East line of Section 24; thence N 88 15'36"E, 800.00 feet, along said North 1/8 line of Section 24 and said line extended; thence S 00 15'47" W, 800.00 feet, parallel with said East line of Section 24; thence S 88 15'36" W, 400.00 feet, parallel with said North 1/8 line of Section 24 to the point of beginning. Together with a 33 foot easement along the West 33 feet of the Northwest quarter lying North of the North 1/8 line of Section 24, Belknap Township, extended, in Section 19, T34N, R6E. Roscommon County Certain land in Backus Township, Roscommon County, Michigan described as: A parcel of land the NW 1/4 of the NE 1/4 of the NE 1/4 of Section 18, T22N, R2W described as commencing at the North quarter corner thereof; thence North 89 00'56" East along the North Section line 208 feet to the point of beginning; thence continue East along the North line of said Section 245 feet; thence South 00 59'03" East 233 feet; thence South 89 00'57" West 245 feet; thence North 00 59'03" West 233 feet to the point of beginning. Saginaw County Certain land in Chapin Township, Saginaw County, Michigan described as: A parcel of land in the SW 1/4 of Section 13, T9N, R1E, described as follows: To find the place of beginning of this description commence at the Southwest corner of said section; run thence North along the West line of said section 1581.4 feet to the place of beginning of this description; thence continuing North along said West line of said section 230 feet to the center line of a creek; thence S 70 07' 00" E along said center line of said creek 196.78 feet; thence South 163.13 feet; thence West 185 feet to the West line of said section and the place of beginning. Sanilac County Certain easement rights located across land in Minden Township, Sanilac County, Michigan described as: The Southeast 1/4 of the Southeast 1/4 of Section 1, T14N, R14E, excepting therefrom the South 83 feet of the East 83 feet thereof. Shiawassee County Certain land in Burns Township, Shiawassee County, Michigan described as: The South 330 feet of the E 1/2 of the NE 1/4 of Section 36, T5N, R4E. St. Clair County Certain land in Ira Township, St. Clair County, Michigan described as: The N 1/2 of the NW 1/4 of the NE 1/4 of Section 6, T3N, R15E. St. Joseph County Certain land in Mendon Township, St. Joseph County, Michigan described as: The North 660 feet of the West 660 feet of the NW 1/4 of SW 1/4, Section 35, T5S, R10W. Tuscola County Certain land in Millington Township, Tuscola County, Michigan described as: A strip of land 280 feet wide across the East 96 rods of the South 20 rods of the N 1/2 of the SE 1/4 of Section 34, T10N, R8E, more particularly described as commencing at the Northeast corner of Section 3, T9N, R8E, thence S 89 55' 35" W along the South line of said Section 34 a distance of 329.65 feet, thence N 18 11' 50" W a distance of 1398.67 feet to the South 1/8 line of said Section 34 and the place of beginning for this description; thence continuing N 18 11' 50" W a distance of 349.91 feet; thence N 89 57' 01" W a distance of 294.80 feet; thence S 18 11' 50" E a distance of 350.04 feet to the South 1/8 line of said Section 34; thence S 89 58' 29" E along the South 1/8 line of said section a distance of 294.76 feet to the place of beginning. Van Buren County Certain land in Covert Township, Van Buren County, Michigan described as: All that part of the West 20 acres of the N 1/2 of the NE fractional 1/4 of Section 1, T2S, R17W, except the West 17 rods of the North 80 rods, being more particularly described as follows: To find the place of beginning of this description commence at the N 1/4 post of said section; run thence N 89 29' 20" E along the North line of said section 280.5 feet to the place of beginning of this description; thence continuing N 89 29' 20" E along said North line of said section 288.29 feet; thence S 00 44' 00" E, 1531.92 feet; thence S 89 33' 30" W, 568.79 feet to the North and South 1/4 line of said section; thence N 00 44' 00" W along said North and South 1/4 line of said section 211.4 feet; thence N 89 29' 20" E, 280.5 feet; thence N 00 44' 00" W, 1320 feet to the North line of said section and the place of beginning. Washtenaw County Certain land in Manchester Township, Washtenaw County, Michigan described as: A parcel of land in the NE 1/4 of the NW 1/4 of Section 1, T4S, R3E, described as follows: To find the place of beginning of this description commence at the Northwest corner of said section; run thence East along the North line of said section 1355.07 feet to the West 1/8 line of said section; thence S 00 22' 20" E along said West 1/8 line of said section 927.66 feet to the place of beginning of this description; thence continuing S 00 22' 20" E along said West 1/8 line of said section 660 feet to the North 1/8 line of said section; thence N 86 36' 57" E along said North 1/8 line of said section 660.91 feet; thence N 00 22' 20" W, 660 feet; thence S 86 36' 57" W, 660.91 feet to the place of beginning. Wayne County Certain land in Livonia City, Wayne County, Michigan described as: Commencing at the Southeast corner of Section 6, T1S, R9E; thence North along the East line of Section 6 a distance of 253 feet to the point of beginning; thence continuing North along the East line of Section 6 a distance of 50 feet; thence Westerly parallel to the South line of Section 6, a distance of 215 feet; thence Southerly parallel to the East line of Section 6 a distance of 50 feet; thence easterly parallel with the South line of Section 6 a distance of 215 feet to the point of beginning. Wexford County Certain land in Selma Township, Wexford County, Michigan described as: A parcel of land in the NW1/4 of Section 7, T22N, R10W, described as beginning on the North line of said section at a point 200 feet East of the West line of said section, running thence East along said North section line 450 feet, thence South parallel with said West section line 350 feet, thence West parallel with said North section line 450 feet, thence North parallel with said West section line 350 feet to the place of beginning.SECTION 14. The Company is a transmitting utility under Section 9401(5) of the Michigan Uniform Commercial Code (M.C.L. 440.9401(5)) as defined in M.C.L. 440.9105(n). IN WITNESS WHEREOF, said Consumers Energy Company has caused this Supplemental Indenture to be executed in its corporate name by its Chairman of the Board, President, a Vice President or its Treasurer and its corporate seal to be hereunto affixed and to be attested by its Secretary or an Assistant Secretary, and said The Chase Manhattan Bank, as Trustee as aforesaid, to evidence its acceptance hereof, has caused this Supplemental Indenture to be executed in its corporate name by a Vice President and its corporate seal to be hereunto affixed and to be attested by a Trust Officer, in several counterparts, all as of the day and year first above written. CONSUMERS ENERGY COMPANY (SEAL) By /s/ A.M. Wright _________________________ Alan M. Wright Attest: Senior Vice President and Chief Financial Officer /s/ Joyce H. Norkey ____________________________ Joyce H. Norkey Assistant Secretary Signed, sealed and delivered by CONSUMERS ENERGY COMPANY in the presence of /s/ Kimberly A. Connelly ____________________________ Kimberly A. Connelly /s/ Sammie B. Dalton ____________________________ Sammie B. Dalton STATE OF MICHIGAN) ss. COUNTY OF JACKSON) The foregoing instrument was acknowledged before me this 29th day of October, 1998, by Alan M. Wright, Senior Vice President and Chief Financial Officer of CONSUMERS ENERGY COMPANY, a Michigan corporation, on behalf of the corporation. /s/ Margaret Hillman ______________________________ Margaret Hillman, Notary Public [Seal] Jackson County, Michigan My Commission Expires: June 14, 2000 THE CHASE MANHATTAN BANK, AS TRUSTEE (SEAL) By /s/ Glenn G. McKeever ______________________________ Attest: Vice President /s/ T. O'Brien ____________________________ Senior Trust Officer T. O'Brien Signed, sealed and delivered by THE CHASE MANHATTAN BANK in the presence of /s/ Natalie B. Pesce ____________________________ Natalie B. Pesce Administrator /s/ Eric S. Butler ____________________________ Eric S. Butler Administrator STATE OF NEW YORK) ss. COUNTY OF NEW YORK) The foregoing instrument was acknowledged before me this 29th day of October, 1998, by Glenn G. McKeever, a Vice President of THE CHASE MANHATTAN BANK, a New York corporation, on behalf of the corporation. /s/ Emily Fayan ______________________________ Notary Public [Seal] New York County, New York My Commission Expires: 12/31/98 Prepared by: When recorded, return to: Kimberly A. ConnellyConsumers Energy Company 212 West Michigan AvenueGeneral Services Real Estate Department Jackson, MI 49201 Attn: Nancy P. Fisher, P-21-410B 1945 W. Parnall Road Jackson, MI 49201 EX-12 4 CMS ENERGY RATIO OF EARNINGS TO FIXED CHARGES
Exhibit (12) CMS ENERGY CORPORATION Ratio of Earnings to Fixed Charges and Preferred Securities Dividends and Distributions (Millions of Dollars) Nine Months Ended Years Ended December 31 September 30, 1998 1997 1996 1995 1994 1993 (b) Earnings as defined (a) Consolidated net income $ 191 $ 244 $ 224 $ 195 $ 177 $ 130 Income taxes 86 108 137 113 91 62 Exclude equity basis subsidiaries (75) (80) (85) (57) (18) (6) Fixed charges as defined, adjusted to exclude capitalized interest of $17, $13, $5, $4, $2, and $2 million for the nine months ended September 30, 1998 and for the years ended December 31, 1997, 1996, 1995, 1994 and 1993, respectively 293 360 313 299 253 247 Earnings as defined $ 495 $ 632 $ 589 $ 550 $ 503 $ 433 Fixed charges as defined (a) Interest on long-term debt $ 234 $ 273 $ 230 $ 224 $ 193 $ 204 Estimated interest portion of lease rental 5 8 10 9 9 12 Other interest charges 33 49 43 42 30 25 Preferred securities dividends and distributions 58 67 54 42 36 17 Fixed charges as defined $ 330 $ 397 $ 337 $ 317 $ 268 $ 258 Ratio of earnings to fixed charges and preferred securities dividends and distributions 1.50 1.59 1.75 1.74 1.88 1.68 NOTES: (a) Earnings and fixed charges as defined in instructions for Item 503 of Regulation S-K. (b) Excludes a cumulative effect of change in accounting after-tax gain of $43 million.
EX-15 5 CONSUMERS ENERGY AUDITOR LETTER ARTHUR ANDERSEN LLP Exhibit (15) To Consumers Energy Company: We are aware that Consumers Energy Company has incorporated by reference in its Registration Statements No. 333-63969 and No. 333-64323 its Form 10-Q for the quarter ended September 30, 1998, which includes our report dated November 10, 1998 covering the unaudited interim financial information contained therein. Pursuant to Regulation C of the Securities Act of 1933, that report is not considered a part of the registration statement prepared or certified by our firm or a report prepared or certified by our firm within the meaning of Sections 7 and 11 of the Act. Arthur Andersen LLP Detroit, Michigan, November 10, 1998. EX-15 6 CMS ENERGY AUDITOR LETTER ARTHUR ANDERSEN LLP Exhibit (15) To CMS Energy Corporation: We are aware that CMS Energy Corporation has incorporated by reference in its Registration Statements No. 33-29681, No. 33-47629, No. 33-60007, No. 33-61595, No. 33-62573, No. 333-32229, No. 333-48899, No. 333-60795 and No. 333-63229 its Form 10-Q for the quarter ended September 30, 1998, which includes our report dated November 10, 1998 covering the unaudited interim financial information contained therein. Pursuant to Regulation C of the Securities Act of 1933, that report is not considered a part of the registration statement prepared or certified by our firm or a report prepared or certified by our firm within the meaning of Sections 7 and 11 of the Act. Arthur Andersen LLP Detroit, Michigan, November 10, 1998. EX-27 7 CMS ENERGY FINANCIAL DATA SCHEDULE
UT THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE STATEMENT OF INCOME, STATEMENT OF CASH FLOWS, BALANCE SHEET, AND STATEMENT OF COMMON STOCKHOLDERS' EQUITY, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000811156 CMS ENERGY CORPORATION 1,000,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 PER-BOOK 4,391 2,831 1,138 1,570 0 9,930 1 2,316 (247) 1,922 393 238 1,522 302 2,726 0 131 0 77 40 2,431 9,930 3,792 109 3,185 3,294 498 24 522 250 272 38 234 102 0 386 2.23 2.19 EPS for CMS Energy Common Stock $2.23 EPS for Class G Common Stock $1.04
EX-27 8 CONSUMERS ENERGY FINANCIAL DATA SCHEDULE
UT THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE STATEMENT OF INCOME, STATEMENT OF CASH FLOWS, BALANCE SHEET, AND STATEMENT OF COMMON STOCKHOLDER'S EQUITY, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000201533 CONSUMERS ENERGY COMPANY 1,000,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 PER-BOOK 4,391 684 624 1,217 0 6,916 841 402 429 1,729 220 238 861 302 1,116 0 106 0 77 40 2,284 6,916 2,743 134 2,248 2,382 361 36 397 131 266 27 239 173 0 452 0 0
EX-99 9 GAS GROUP DISCLOSURE 1 Consumers Gas Group Management's Discussion and Analysis In 1995, CMS Energy issued a total of 7.62 million shares of Class G Common Stock. This class of common stock reflects the separate performance of the gas distribution, storage and transportation businesses conducted by Consumers and Michigan Gas Storage Company, a subsidiary of Consumers (collectively, Consumers Gas Group). Accordingly, this MD&A should be read along with the MD&A in the 1997 Annual Report of CMS Energy included and incorporated by reference herein. CMS Energy is the parent holding company of Consumers and CMS Enterprises Company. Consumers, a combination electric and gas utility company serving the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. For further information regarding the businesses of CMS Energy, including the nature and issuance of Class G Common Stock, see the MD&A of CMS Energy. Results of Operations In Millions - -------------------------------------------------------------------------- September 30 1998 1997 Change __________________________________________________________________________ Three months ended $(5) $(7) $2 Nine months ended 35 37 (2) Twelve months ended 58 52 6 ========================================================================== The increase in earnings for the three months ended September 30, 1998 compared to the same 1997 period reflects increased gas deliveries, the operation of the gas customer choice program and increased revenues from gas retail and wholesale services activities. The decrease in earnings for the first nine months of 1998 compared to the same 1997 period reflects decreased gas deliveries due to warmer 1998 temperatures. The first nine months of 1998 were the fourth warmest since 1864. Revenues were down for the nine month period ended September 30, 1998 due to the elimination of surcharges related to past conservation programs. Partially offsetting the decrease for the nine month period ended September 30, 1998 was the benefit resulting from an accounting change for property taxes. The recognition of property tax expense was changed from expensing on a calendar year basis to a fiscal year basis which resulted in a benefit of $18 million ($12 million after-tax). This one-time benefit helped to offset the warmest winter since 1880. The increase in earnings for the twelve months ended September 30, 1998 compared to the 1997 period reflects the change in accounting for property taxes implemented in March 1998 as discussed above. Partially offsetting these increases were decreased gas deliveries due to warmer winter temperatures during the 1997/1998 winter heating season and reduced revenues due to the elimination of surcharges related to past conservation programs. Gas Issues For a discussion of Consumers Gas Group operating issues, see Consumers Gas Group Results of Operations-Uncertainties in CMS Energy's MD&A. Cash Position, Investing and Financing Operating Activities: Consumers Gas Group's cash requirements are met by its operating and financing activities. Consumers Gas Group's cash from operations is derived mainly from Consumers' sale and transportation of natural gas. Cash from operations for the first nine months of 1998 and 1997 totaled $66 million and $122 million, respectively. The $56 million decrease is due primarily to higher gas inventory balances because of lower sales as a result of warmer weather, the noncash effect of the property tax accounting change and a decrease in accounts payable. Consumers Gas Group uses its operating cash mainly to maintain and expand its gas utility transmission and distribution systems and to retire portions of its long-term debt and pay dividends. Investing Activities: Cash used in investing activities for the first nine months of 1998 and 1997 totaled $84 million and $87 million, respectively. The $3 million decrease in cash used primarily reflects an increase in the proceeds received from the sale of assets. Financing Activities: Cash provided by financing activities during the first nine months of 1998 totaled $20 million compared to cash used in financing activities during the first nine months of 1997 of $31 million. The $51 million increase in cash provided primarily reflects an increase in the proceeds from senior notes, partially offset by an increase in the retirement of bonds and other long-term debt, and the return of CMS Energy stockholders' contributions. Other Investing and Financing Matters: Consumers has an agreement permitting the sale of certain accounts receivable for up to $500 million. At September 30, 1998, receivables sold under the program totaled $307 million. Consumers Gas Group's attributed portion of receivables sold under the program totaled $52 million. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold. For detailed information, see "Short-Term and Long-Term Financings, and Capitalization" in CMS Energy's Note 3. Forward-Looking Information For cautionary statements relating to Consumers Gas Group's forward- looking information, see the Forward-Looking Information section in CMS Energy's MD&A. Capital Expenditures: CMS Energy estimates the following capital expenditures for Consumers Gas Group, including new lease commitments, over the next three years. These estimates are prepared for planning purposes and are subject to revision. In Millions - ----------------------------------------------------------------- Years Ended December 31 1998 1999 2000 - ----------------------------------------------------------------- Gas utility (a) $114 $122 $122 Michigan Gas Storage 3 3 3 _______________________ $117 $125 $125 ================================================================= (a) Includes a portion of anticipated capital expenditures common to Consumers' gas and electric utility businesses. Consumers Gas Group expects that cash from operations and the ability to access debt markets will provide necessary working capital and liquidity to fund future capital expenditures, required debt payments, and other cash needs in the foreseeable future. For further information regarding the outlook of Consumers Gas Group, see the Consumers Gas Group Outlook discussion in CMS Energy's MD&A. 4 Consumers Gas Group Statements of Income (Unaudited)
Three Months Ended Nine Months Ended Twelve Months Ended September 30 1998 1997 1998 1997 1998 1997 In Millions, Except Per Share Amounts Operating Revenue $ 117 $ 110 $ 716 $ 828 $1,092 $1,230 ------ ------ ------ ------ ------ ------ Operating Expenses Operation Cost of gas sold 39 39 377 472 600 718 Other 46 47 136 128 183 186 ------ ------ ------ ------ ------ ------ 85 86 513 600 783 904 Maintenance 8 9 25 24 34 37 Depreciation, depletion and amortization 10 9 60 64 89 91 General taxes 8 7 37 40 52 56 ------ ------ ------ ------ ------ ------ 111 111 635 728 958 1,088 ------ ------ ------ ------ ------ ------ Pretax Operating Income (Loss) 6 (1) 81 100 134 142 ------ ------ ------ ------ ------ ------ Other Income (Deductions) - 1 - - (2) (4) ------ ------ ------ ------ ------ ------ Fixed Charges Interest on long-term debt 7 7 21 21 28 29 Other interest 3 3 11 9 15 13 Capitalized interest - - - - - (1) Preferred stock dividends 1 1 3 4 4 5 ------ ------ ------ ------ ------ ------ 11 11 35 34 47 46 ------ ------ ------ ------ ------ ------ Income (Loss) Before Income Taxes (5) (11) 46 66 85 92 Income Taxes - (4) 23 29 39 40 ------ ------ ------ ------ ------ ------ Net Income (Loss) before cumulative effect of change in accounting principle (5) (7) 23 37 46 52 Cumulative effect of change in accounting for property taxes, net of $6 tax - - 12 - 12 - ------ ------ ------ ------ ------ ------ Net Income (Loss) $ (5) $ (7) $ 35 $ 37 $ 58 $ 52 ====== ====== ====== ====== ====== ====== Net Income (Loss) Attributable to CMS Energy Shareholders through Retained Interest $ (3) $ (5) $ 27 $ 28 $ 44 $ 39 ------ ------ ------ ------ ------ ------ Net Income (Loss) Attributable to Class G Shareholders $ (2) $ (2) $ 8 $ 9 $ 14 $ 13 ------ ------ ------ ------ ------ ------ Average Class G Common Shares Outstanding 8 8 8 8 8 8 ------ ------ ------ ------ ------ ------ Basic and Diluted Earnings (Loss) Per Average Class G Common Share Before Change in Accounting Principle $ (.16) $ (.21) $ .68 $ 1.13 $ 1.37 $ 1.57 ------ ------ ------ ------ ------ ------ Cumulative Effect of Change in Accounting Principle, Net of Tax, Per Average Class G Common Share $ - $ - $ .36 $ - $ .36 $ - ------ ------ ------ ------ ------ ------ Basic and Diluted Earnings (Loss) Per Average Class G Common Share $ (.16) $ (.21) $ 1.04 $ 1.13 $ 1.73 $ 1.57 ------ ------ ------ ------ ------ ------ Dividend Declared Per Class G Common Share $ .325 $ .31 $ .945 $ .90 $1.255 $1.195 ====== ====== ====== ====== ====== ====== The accompanying condensed notes are an integral part of these statements. /TABLE 5 Consumers Gas Group Statements of Cash Flows (Unaudited)
Nine Months Ended Twelve Months Ended September 30 1998 1997 1998 1997 In Millions Cash Flows from Operating Activities Net income $ 35 $ 37 $ 58 $ 52 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization 60 64 89 91 Deferred income taxes and investment tax credit 11 7 9 10 Capital lease and other amortization 5 3 6 4 Other - (1) - - Cumulative effect of accounting change for property taxes (18) - (18) - Changes in other assets and liabilities (27) 12 23 27 ------ ------ ------ ------ Net cash provided by operating activities 66 122 167 184 ------ ------ ------ ------ Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (81) (79) (115) (122) Cost to retire property, net (7) (6) (10) (8) Proceeds from the sale of Marysville assets 3 - 3 - Other 1 (2) 3 (2) ------ ------ ------ ------ Net cash used in investing activities (84) (87) (119) (132) ------ ------ ------ ------ Cash Flows from Financing Activities Proceeds from senior notes 182 - 182 - Increase in notes payable, net 37 40 2 1 Contribution of CMS Energy stockholders 15 - 15 - Issuance of common stock 4 4 7 6 Retirement of bonds and other long-term debt (150) (40) (150) (40) Return of CMS Energy stockholders' contribution (32) - (71) - Payment of common stock dividends (31) (29) (42) (39) Payment of capital lease obligations (5) (3) (6) (4) Proceeds from long-term note - 25 - 25 Proceeds from bank loans - - - 23 Retirement of preferred stock - (26) - (26) Repayment of long-term note - (2) - (2) ------ ------ ------ ------ Net cash provided by (used in) financing activities 20 (31) (63) (56) ------ ------ ------ ------ Net Increase (Decrease) in Cash and Temporary Cash Investments 2 4 (15) (4) Cash and Temporary Cash Investments, Beginning of Period 2 15 19 23 ------ ------ ------ ------ Cash and Temporary Cash Investments, End of Period $ 4 $ 19 $ 4 $ 19 ====== ====== ====== ====== Other cash flow activities and non-cash investing and financing activities were: Cash transactions Interest paid (net of amounts capitalized) $ 29 $ 32 $ 39 $ 42 Income taxes paid (net of refunds) 35 37 38 41 Non-cash transactions Assets placed under capital lease $ 5 $ 2 $ 6 $ 2 ====== ====== ====== ====== All highly liquid investments with an original maturity of three months or less are considered cash equivalents. The accompanying condensed notes are an integral part of these statements.
6 Consumers Gas Group Balance Sheets
ASSETS September 30 September 30 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Plant and Property (At Cost) Plant and property $2,328 $2,322 $2,292 Less accumulated depreciation, depletion and amortization 1,213 1,231 1,209 ------ ------ ------ 1,115 1,091 1,083 Construction work-in-progress 31 28 28 ------ ------ ------ 1,146 1,119 1,111 ------ ------ ------ Current Assets Cash and temporary cash investments at cost, which approximates market 4 2 19 Accounts receivable and accrued revenue, less allowances of $3, $3 and $2, respectively (Note 3) 5 53 33 Inventories at average cost Gas in underground storage 276 197 253 Materials and supplies 6 7 8 Deferred income taxes - 6 4 Prepayments and other 40 51 20 ------ ------ ------ 331 316 337 ------ ------ ------ Non-current Assets Postretirement benefits 134 142 145 Deferred income taxes 14 6 12 Other 62 61 60 ------ ------ ------ 210 209 217 ------ ------ ------ Total Assets $1,687 $1,644 $1,665 ====== ====== ======
7
STOCKHOLDERS' INVESTMENT AND LIABILITIES September 30 September 30 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Capitalization Common stockholders' equity $ 349 $ 358 $ 382 Preferred stock 52 52 52 Long-term debt 449 333 351 Non-current portion of capital leases 16 16 16 ------ ------ ------ 866 759 801 ------ ------ ------ Current Liabilities Current portion of long-term debt and capital leases 39 118 100 Notes payable 156 119 154 Accounts payable 86 94 94 Accrued taxes 34 65 30 Accrued refunds 10 10 5 Accrued interest 6 4 3 Deferred income taxes 4 - - Other 43 44 41 ------ ------ ------ 378 454 427 ------ ------ ------ Non-current Liabilities Regulatory liabilities for income taxes, net 183 173 178 Postretirement benefits 162 168 170 Deferred investment tax credit 24 25 26 Other 74 65 63 ------ ------ ------ 443 431 437 ------ ------ ------ Commitments and Contingencies (Note 4) Total Stockholders' Investment and Liabilities $1,687 $1,644 $1,665 ====== ====== ====== The accompanying condensed notes are an integral part of these statements.
8 Consumers Gas Group Statements of Common Stockholders' Equity (Unaudited)
Three Months Ended Nine Months Ended Twelve Months Ended September 30 1998 1997 1998 1997 1998 1997 In Millions Common Stock At beginning and end of period $184 $184 $184 $184 $184 $184 ---- ---- ---- ---- ---- ---- Other Paid-in Capital At beginning of period 84 136 102 134 138 132 Common stock issued 1 2 4 4 7 6 CMS Energy stockholders' contribution 15 - 15 - 15 - Return of CMS Energy stockholders' contribution (11) - (32) - (71) - ---- ---- ---- ---- ---- ---- At end of period 89 138 89 138 89 138 ---- ---- ---- ---- ---- ---- Retained Earnings At beginning of period 92 77 72 52 60 47 Net income (loss) (5) (7) 35 37 58 52 Common stock dividends declared (11) (10) (31) (29) (42) (39) ---- ---- ---- ---- ---- ---- At end of period 76 60 76 60 76 60 ---- ---- ---- ---- ---- ---- Total Common Stockholders' Equity $349 $382 $349 $382 $349 $382 ==== ==== ==== ==== ==== ==== The accompanying condensed notes are an integral part of these statements.
9 Consumers Gas Group Condensed Notes to Financial Statements 1: Corporate Structure CMS Energy is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. For further information regarding the businesses of CMS Energy, see the Notes to Consolidated Financial Statements of CMS Energy included and incorporated by reference herein. CMS Energy has issued shares of Class G Common Stock. This class of common stock reflects the separate performance of the gas distribution, storage and transportation businesses conducted by Consumers and Michigan Gas Storage Company, a subsidiary of Consumers (collectively, Consumers Gas Group). For further information regarding the nature and issuance of the Class G Common Stock, see Note 4 to the Consolidated Financial Statements of CMS Energy included and incorporated by reference herein. These Financial Statements and their related Notes should be read along with the Financial Statements and Notes contained in the 1997 Annual Report of CMS Energy that includes the Report of Independent Public Accountants, included and incorporated by reference herein. Change In Method of Accounting For Property Taxes During the first quarter of 1998, Consumers Gas Group implemented a change in the method of accounting for property taxes so that taxes are recognized during the fiscal period of the taxing authority for which the taxes are levied. This change provides a better matching of property tax expenses with the services provided by the taxing authorities, and is considered the most acceptable basis of recording property taxes. Prior to 1998, Consumers Gas Group recorded property taxes monthly during the year following the assessment date (December 31). The cumulative effect of this one-time change in accounting increased other income by $18 million, and earnings net of tax, by $12 million. The pro forma effect on prior years' consolidated net income of retroactively recording property taxes as if the new method of accounting had been in effect for all periods presented is not material. 2: Earnings Per Share and Dividends Earnings per share for the three month period ended September 30, 1998 and September 30, 1997 reflect the performance of Consumers Gas Group. The Class G Common Stock has participated in earnings and dividends since its original issue date in July 1995. The earnings (loss) attributable to Class G Common Stock and the related amounts per share are computed by considering the weighted average number of shares of Class G Common Stock outstanding. Earnings attributable to outstanding Class G Common Stock are equal to Consumers Gas Group's net income multiplied by a fraction; the numerator is the weighted average number of Outstanding Shares during the period, and the denominator is the weighted average number of Outstanding Shares and Retained Interest Shares during the period. The earnings attributable to Class G Common Stock on a per share basis, for the nine months ended September 30, 1998 and 1997, are based on 25.38 percent and 24.65 percent of the income of Consumers Gas Group, respectively. In February and May 1998, CMS Energy declared and paid dividends of $.31 per share on Class G Common Stock. In July 1998, the Board of Directors declared a quarterly dividend of $.325 per share on Class G Common Stock which was paid in August 1998. This represents an increase in the annualized dividend on Class G Common Stock to $1.30 per share from the previous dividend of $1.24 per share (a 4.8 percent increase). In October 1998, the Board of Directors declared a quarterly dividend of .325 per share on Class G Common Stock to be paid in November 1998. 3: Short-Term And Long-Term Financings, and Capitalization Short-Term Financings: Consumers' short-term financings are discussed in Consolidated Financial Statements of CMS Energy Note 3 included and incorporated by reference herein. Consumers generally manages its short-term financings on a centralized consolidated basis. The portion of receivables sold attributable to Consumers Gas Group at September 30, 1998 and 1997, is estimated by management to be $52 million and $36 million, respectively. Accounts receivable and accrued revenue in the balance sheets have been reduced to reflect receivables sold. The portions of short-term debt and receivables sold attributable to Consumers Gas Group reflect the high utilization of short-term borrowing to finance the purchase of gas for storage in the summer and fall periods. The allocation of short-term financings and related interest charges to Consumers Gas Group generally follows the ratio of gas utility assets to total Consumers' assets. Additionally, the carrying costs for Consumers' sales of certain of its accounts receivable under its trade receivable purchase and sale agreement generally are allocated to Consumers Gas Group based on the ratio of customer revenues contributed by Consumers' gas customers to total Consumers' revenue. As a result of the centralized management of short-term financing, the amounts allocated to Consumers Gas Group are further adjusted in both the seasonal gas inventory build-up period (second and third quarters) and the high seasonal gas sales period (first and fourth quarters) to more closely reflect the higher short-term financing requirements of the inventory build-up period and conversely the lower financing requirements during the higher sales periods. Management believes these allocations to be reasonable. Capital Stock and Long-Term Debt: Consumers Gas Group's capital stock and long-term debt, including debt resulting from the sale of Trust Preferred Securities, have been allocated based on the ratio of gas utility assets (including common assets attributed to the gas utility segment) to total Consumers' assets. Management believes these measurements are reasonable. For information regarding the long-term debt and capital stock of CMS Energy and Consumers, see Note 3 to the Consolidated Financial Statements of CMS Energy included and incorporated by reference herein. 4: Commitments and Contingencies Capital Expenditures: Consumers Gas Group estimates capital expenditures, including new lease commitments, of $117 million for 1998, $125 million for 1999, and $125 million for 2000. These estimates include an attributed portion of Consumers' anticipated capital expenditures for common plant and equipment. For further information regarding commitments and contingencies directly affecting Consumers Gas Group (including those involving former manufactured gas plant sites), see the Consumers Gas Group Contingencies and Consumers Gas Group Matters in CMS Energy's Note 2 included and incorporated by reference herein. 11 ARTHUR ANDERSEN LLP Report of Independent Public Accountants To CMS Energy Corporation: We have reviewed the accompanying balance sheets of CONSUMERS GAS GROUP (representing a business unit of Consumers Energy Company and its wholly- owned subsidiary, Michigan Gas Storage Company) as of September 30, 1998 and 1997, the related statements of income and common stockholders' equity for the three-month, nine-month, and twelve-month periods then ended, and the related consolidated statements of cash flows for the nine-month and twelve-month periods then ended. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the balance sheet of Consumers Gas Group as of December 31, 1997, and the related statements of income, common stockholders' equity and cash flows for the year then ended (not presented herein), and, in our report dated January 26, 1998, we expressed an unqualified opinion on those statements. In our opinion, the information set forth in the accompanying balance sheet as of December 31, 1997, is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived. Arthur Andersen LLP Detroit, Michigan, November 10, 1998. -----END PRIVACY-ENHANCED MESSAGE-----