-----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, E03IplQKs2j+P1zBypDhzkHoOQNut/xNAZxcDqRs00ndEWyhoBx8pOaPJcLDzZTb o2LIMhjjYTXE5Wd8x3CcQg== 0000201533-98-000064.txt : 19980518 0000201533-98-000064.hdr.sgml : 19980518 ACCESSION NUMBER: 0000201533-98-000064 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980515 SROS: NYSE 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: 98624193 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: 98624194 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 1ST QTR FORM 10-Q 2 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 March 31, 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 April 30, 1998: CMS Energy Corporation: CMS Energy Common Stock, $.01 par value 101,337,341 CMS Energy Class G Common Stock, no par value 8,315,547 Consumers Energy Company, $10 par value, privately held by CMS Energy84,108,789 CMS Energy Corporation and Consumers Energy Company Quarterly reports on Form 10-Q to the Securities and Exchange Commission for the Quarter Ended March 31, 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 .............................................................. 3 PART I: CMS Energy Corporation Management's Discussion and Analysis ..........................6 Consolidated Statements of Income ............................23 Consolidated Balance Sheets ..................................25 Consolidated Statements of Cash Flows ........................27 Consolidated Statements of Common Stockholders' Equity .......28 Condensed Notes to Consolidated Financial Statements .........29 Report of Independent Public Accountants .....................44 Consumers Energy Company Management's Discussion and Analysis .........................45 Consolidated Statements of Income ............................57 Consolidated Statements of Cash Flows ........................58 Consolidated Balance Sheets ..................................59 Consolidated Statements of Common Stockholder's Equity .......61 Condensed Notes to Consolidated Financial Statements .........62 Report of Independent Public Accountants .....................72 Quantitative and Qualitative Disclosures about Market Risk....73 PART II: Item 1. Legal Proceedings .................................73 Item 6. Exhibits and Reports on Form 8-K ..................74 Signatures .............................................................75 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 NOMECO. . . . . . . . . . . . . . . . . CMS NOMECO Oil & Gas Co., 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 and $200 million Series D 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 Loy Yang. . . . . . . . . . . . . . . . . . A 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 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 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 utilities to their customers is set aside and pledged as security for the repayment of rate reduction bonds issued by a special purpose vehicle affiliated with such utilities SERP. . . . . . . . . . . . . . . . . . . . Supplemental Executive Retirement Plan Senior Credit Facilities. . . . . . . . . . $1.125 billion senior credit facilities consisting of a $400 million 364-day revolving credit facility, 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 6 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. 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 March 31 1998 1997 Change - -------------------------------------------------------------- (a) Three months ended Consolidated Net Income $ 83 $ 84 $ (1) Net Income Attributable to Common Stocks: CMS Energy 74 75 (1) Class G 9 9 - Earnings Per Average Common Share: CMS Energy Basic .73 .79 (.06) Diluted .72 .78 (.06) Class G Basic and Diluted 1.09 1.18 (.09) (a) Includes the cumulative effect of an accounting change 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. Twelve months ended Consolidated Net Income $ 267 $ 236 $ 31 Net Income Attributable to Common Stocks: CMS Energy 252 225 27 Class G 15 11 4 Earnings Per Average Common Share: CMS Energy Basic 2.57 2.41 .16 Diluted 2.55 2.39 .16 Class G Basic and Diluted 1.76 1.53 .23 =============================================================== CMS Energy's earnings for the first quarter of 1998 decreased from the comparable period in 1997 as a result of (1) Consumers' decreased gas deliveries due to record warm 1998 temperatures, (2) lower gas production, lower oil prices and a write down of the value of Colombia oil reserves in the oil and gas exploration and production business, (3) an increased provision for underrecoveries under the PPA of $37 million ($24 million after-tax) due to higher than expected plant availability and (4) increased interest on long-term debt due to higher amounts of debt outstanding. For further information on past and future underrecoveries, see Power Purchases from the MCV Partnership in Note 2. Partially offsetting these decreases, were (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 along with reduced purchased power costs, (3) a gain on the sale of Petal Gas Storage Company by the gas transmission, storage and processing business, and (4) increased income from the international independent power production business and improved earnings from the MCV Partnership,. The increase in consolidated net income for the twelve months ended 1998 compared to the 1997 period reflects (1) Consumers' change in accounting for property taxes as discussed above, (2) increased revenues from Consumers' transmission of electricity for others, (3) increased income from the international power production business, (4) increased income from the international gas transmission, storage and processing business, and (5) improved earnings from the MCV Partnership. In addition, the improved net income for the twelve months ended 1998 reflects the (6) recognition of a gain on the sale of CMS NOMECO's entire interest in oil and gas properties in Yemen, (7) an industry expertise service fee in connection with the Loy Yang A acquisition, and (8) an adjustment of Consumers' prior years' income taxes associated with non-taxable earnings on nuclear decommissioning trust funds of $9 million. 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 electric revenues because of special contract discounts negotiated with large industrial customers, (3) Consumers' decreased gas deliveries due to warmer weather during the first quarter of 1998 and (4) lower gas production and lower oil and gas prices and a write down of the value of Colombia oil reserves in the oil and gas exploration and production business. 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 Twelve Months Ended March 31 Ended March 31 Change Compared to Prior Year 1998 vs 1997 1998 vs 1997 - -------------------------------------------------------------------------- Sales (including special contract discounts) $ 6 $ 14 Rate increases and other regulatory issues (2) (1) Operations and maintenance 9 36 General taxes and depreciation (-) (17) ----- ----- Total change $ 13 $ 32 ========================================================================== Electric Deliveries: Total electric deliveries increased 6.5 percent for three months ended March 31, 1998 over the same period in 1997. Deliveries to ultimate customers increased 1.2 percent. Reduced sales to residential and commercial customers were more than offset by increased sales and deliveries to industrial customers. For twelve months ended, total electric deliveries increased 3.8 percent over the comparable 1997 period. The increase is primarily attributable to an increase in intersystem sales and a 1.3 percent increase in sales and deliveries to ultimate customers, primarily within the industrial class. Power Costs: In Millions March 31 1998 1997 Change - ----------------------------------------------------------------------- Three months ended $ 270 $ 282 $(12) Twelve months ended 1,128 1,110 18 ======================================================================== Although sales increased for the three months ended March 31, 1998 compared to the same period in 1997, power costs for the period decreased. This decrease results from increased internal generation and reduced power purchases from outside sources. Power costs increased for the twelve months ended 1998 compared to 1997. Both internal generation and power purchases from outside sources increased during this period to meet the increased sales demand. Consumers' Electric Business Unit Operating Issues: Power Purchases from the MCV Partnership: In 1992, Consumers recognized a loss for the present value of the estimated future underrecoveries of power purchases from the MCV Partnership. 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 three months of 1998, the MCV Facility was available 99 percent of the time, resulting in after-tax cash underrecoveries of $11 million. Consumers believes it will continue to experience after-tax cash underrecoveries associated with the PPA in amounts as those shown below. For further information, see Power Purchases from the MCV Partnership in Note 2. In Millions 1998 1999 2000 2001 2002 - -------------------------------------------------------------------------- Estimated cash under- recoveries, net of tax $28 $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. Electric Rate Proceedings: In 1996, the MPSC issued a final order authorizing Consumers to recover costs associated with the purchase of an additional 325 MW of MCV Facility capacity and to accelerate recovery of its nuclear plant investment. To implement the accelerated recovery, the order requires an increase in annual nuclear plant depreciation expense by $18 million with a corresponding decrease in fossil-fueled generating plant depreciation expense. The order also established an experimental direct-access program. For further information on these issues, see the Electric Business Outlook section of this MD&A and Note 2. Nuclear Matters: 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 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. In 1996, Consumers received an interim Safety Evaluation Report from the NRC indicating that the reactor vessel can be safely operated through 2003. Consumers believes that with a change in fuel management designed to minimize embrittlement, Palisades can be operated to the end of its license life in the year 2007. 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. On April 24, 1998 a planned refueling and maintenance outage of forty to fifty days began at Palisades. Consumers will replace a total of sixty nuclear fuel assemblies in the plant's reactor during the outage. 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. See the Electric Environmental Matters section of this MD&A for further information on decommissioning Big Rock and Note 8 on nuclear matters. Electric Environmental Matters: The Clean Air Act contains significant environmental provisions specific to utilities. During the past few years, Consumers incurred $46 million in capital expenditures to meet the Clean Air Act's requirements. Consumers believes it may incur an additional $26 million in capital expenditures by the year 2000 to comply with sulfur dioxide and nitrogen oxide emission limits established by the EPA under the Clean Air Act's Acid Rain Program. Consumers currently operates within all Clean Air Act requirements and meets current emission limits. The EPA, however, recently revised the national air quality standards, which may further limit small particulate and ozone related emissions, and proposed that the State of Michigan impose additional nitrogen oxide limits on fossil-fueled emitters, such as Consumers' generating units. It is unlikely that the State of Michigan will establish Consumers' 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 $210 million, plus an additional amount totaling $10 million per year for operation and maintenance costs. Consumers may need an equivalent amount to comply with the new small particulate standards. The State of Michigan has objected to the extent of the proposed EPA emission reductions. If the State of Michigan's position were to be adopted by the EPA, costs could be less than the current estimated amounts. Consumers supports the bipartisan effort in the U.S. Congress to delay implementation of the revised standards until the relationship between the new standards and health improvements is established scientifically. Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects to 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. Many other creditworthy, potentially responsible parties, with substantial assets also cooperate with respect to the individual sites. Based on current information, management believes it is unlikely that CMS Energy's liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on its financial position, liquidity or results of operations. 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. For further information regarding these and other environmental matters, see Electric Environmental Matters in Note 7. Stray Voltage: Various parties have sued Consumers relating to the effect of so-called stray voltage on certain 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 Michigan Supreme Court allowed each case that was not previously refiled to go forward separately. Consumers filed a motion for reconsideration with the Michigan Supreme Court, which was denied. As a result, 21 individual plaintiffs have re-filed their claims with the trial court. Consumers intends to vigorously defend these cases, but is unable to predict the outcome. As of March 31, 1998, Consumers had 6 individual stray voltage lawsuits, unrelated to the cases above, awaiting trial court action, down from 12 lawsuits as reported at year end 1997. For further information regarding Stray Voltage, see the Other section in Note 7. Other: In October 1997, two independent power producers sued Consumers and CMS Energy in a federal court alleging antitrust violations and economic losses due to special electric contracts signed by Consumers with large customers. The plaintiffs claim damages of $100 million (which a court can treble in antitrust cases as provided by law). The parties are awaiting the court's decision on Consumers' and CMS Energy's motion for summary judgment and/or dismissal of the complaint. CMS Energy believes the lawsuit is without merit and will vigorously defend against it, but cannot predict the outcome of this matter. For further information regarding this antitrust litigation, see Item 3, Legal Proceedings. Consumers Gas Group Results of Operations Gas Pretax Operating Income: In Millions Three Months Twelve Months Ended March 31 Ended March 31 Change Compared to Prior Year 1998 vs 1997 1998 vs 1997 - ----------------------------------------------------------------- Sales $ (13) $ (13) Gas wholesale and retail service activities (3) (11) Operations and maintenance (8) 11 ----- ----- Total change $(24) $ (13) ===== ===== Gas Deliveries: System deliveries for the three month period ended March 31, 1998, including miscellaneous transportation, totaled 146 bcf, a decrease of 22 bcf or 13 percent compared to the three month period ended March 31, 1997. Deliveries for the twelve month period ended March 31, 1998, including miscellaneous transportation, totaled 399 bcf, a decrease of 32 bcf or 7 percent compared to the twelve month period ended March 31, 1997. The decreased deliveries for three month and twelve month periods ended reflect warmer temperatures primarily for the first quarter of 1998. Cost of Gas Sold: In Millions March 31 1998 1997 Change - ----------------------------------------------------------------------- Three months ended $264 $314 $(50) Twelve months ended 645 718 (73) ======================================================================== The cost decreases for the three month and twelve month periods ended March 31, 1998 were the result of decreased sales reflecting warmer temperatures during the winter heating seasons. Consumers Gas Group Operating Issues: Gas Rate Proceedings: Consumers entered into a special natural gas transportation contract in response to a customer's proposal to bypass Consumers' system in favor of a competitive alternative. In 1995, the MPSC approved the contract. The MPSC stated, however, that Consumers' shareholders must bear the revenue shortfall created by the difference between the contract's discounted rate and the floor price of an MPSC- authorized gas transportation rate. In 1995, Consumers filed an appeal with the Court of Appeals claiming that the MPSC decision denies Consumers the opportunity to earn its authorized rate of return and is therefore unconstitutional. In October 1997, the Court of Appeals issued an opinion affirming the MPSC's order. The Court of Appeals denied Consumers' subsequent request for a rehearing of that opinion. In March 1998, Consumers filed an application for leave to appeal with the Michigan Supreme Court. For further information on Gas Proceedings, see the Gas Business Outlook section of this MD&A and Note 3. Restructuring: In December 1997, the MPSC approved Consumers' application to implement a statewide three-year experimental gas transportation pilot program, eventually allowing 300,000 residential, commercial and industrial retail gas sales customers to choose their gas supplier. As of May 8, 1998, more than 7,500 customers chose alternative gas suppliers, representing approximately 10 bcf of gas load. Of these alternative gas suppliers, one was a CMS Energy affiliate. The program is voluntary for natural gas customers. Customers choosing to remain as sales customers of Consumers will not see a rate change in their natural gas rates. To minimize the risk of exposure to higher gas costs, Consumers currently has contracts in place at known prices covering a significant portion of its requirements through the year 2000. ABATE, the Attorney General and other parties filed claims of appeal of the MPSC's order with the Court of Appeals. For further information, see Note 3. GCR Matters: In 1995, the MPSC issued an order favorable to Consumers' position in a $44 million contract pricing dispute (excluding interest) between Consumers and certain gas producers. The Court of Appeals upheld the MPSC order. The gas producers have now appealed to the Michigan Supreme Court. Consumers believes the MPSC order correctly concludes that the producers' theories are without merit. Consumers will vigorously oppose any claims the producers may raise, but cannot predict the outcome of this issue. Gas Environmental Matters: Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some that formerly housed manufactured gas plant facilities. Consumers estimates its costs related to investigation and remedial action at $48 million to $98 million. This estimate is based on undiscounted 1998 costs. Any significant change in assumptions, such as remediation technique, nature and extent of contamination and regulatory requirements, could affect the estimate of investigation and remedial action costs for the sites. For further information regarding environmental matters, see Note 7. Independent Power Production Results of Operations Pretax Operating Income: The improved earnings in the independent power production business demonstrates the successful strategy to search for global opportunities. Pretax operating income for the three months ended March 31, 1998 increased $6 million (55 percent) over the comparable period in 1997. This increase primarily reflects increased operating income from international earnings and operating fees and lower net operating expenses. Pretax operating income for the twelve months ended March 31, 1998 increased $30 million (43 percent) from the comparable period in 1997, primarily reflecting increased operating income resulting from increased international earnings, higher electricity sales by the MCV Facility, and the industry expertise service fee income earned in connection with the Loy Yang transaction in 1997. Independent Power Production Operating Issues Contracts to sell 11 percent of Loy Yang's capacity will expire during 1998. Although Loy Yang will make attempts to replace these contracts at comparable prices, there is no assurance that the new contracts will be at the same price. CMS Generation does not currently expect to incur significant capital costs, if any, at its power facilities to comply with current environmental regulatory standards. Oil and Gas Exploration and Production Results of Operations Pretax Operating Income: Pretax operating income for the three months ended March 31, 1998 decreased $17 million from the comparable period in 1997. This decrease is the result of sharply lower oil prices and a write down of the value of Columbia oil reserves partially offset by higher oil production. Pretax operating income for the twelve months ended March 31, 1998 decreased $6 million from the comparable period in 1997, primarily due to lower oil and gas prices and gas production, a write down of the value of Colombia oil reserves and higher operating expenses partially offset by a gain on the sale of CMS NOMECO's entire interest in oil and gas properties in Yemen. Natural Gas Transmission, Storage and Processing Results of Operations Pretax Operating Income: Similar to the independent power production business, CMS Energy's natural gas transmission, storage and processing business earnings reflect the ability to acquire and develop major projects worldwide. Pretax operating income for the three months ended March 31, 1998 increased $4 million (45 percent) over the comparable period in 1997. The increase primarily reflects a gain on the sale of Petal Gas Storage Company, partially offset by a gain in the first quarter of 1997 on the sale of a portion of the Ames gas gathering system. Pretax operating income for the twelve months ended March 31, 1998 increased $8 million (26 percent) over the comparable period in 1997, reflecting a gain on the sale of Petal Gas Storage Company, income attributable to the Australian pipeline acquired in 1997, and income attributable to domestic and other international operations. Marketing, Services and Trading Results of Operations Pretax Operating Income: CMS MST sells natural gas, electricity and energy management services to commercial and industrial customers in the United States and Canada and plans to expand operations worldwide. CMS MST also markets oil and natural gas liquids through a partnership. Pretax operating income for the three months ended March 31, 1998 decreased $2 million from the comparable period in 1997. The decrease is a result of natural gas prices that impacted CMS MST's ability to achieve positive margins on fixed price sales and the expected costs of positioning CMS MST for future growth, partially offset by higher gas and electric volumes. Pretax operating income for the twelve months ended March 31, 1998 decreased $7 million from the comparable period in 1997, reflecting lower gas margins. Despite the decreased earnings, CMS MST continues to position itself for future growth in the new energy world. Gas marketed for end users totaled 91 bcf and 33 bcf for the three months ended March 31, 1998 and 1997, respectively. Wholesale electric marketing, a new marketing activity for CMS MST in the first quarter of 1998, totaled 1,349,000 MW. CMS MST completed over 169 energy management services projects resulting in $1.3 million in revenues in the first quarter of 1998. 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 first quarter of 1998, trading activities were immaterial. In the case of 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 was $ 3.8 billion at March 31, 1998 with a fair value of $3.8 billion. The fair value of CMS Energy's financial derivative instruments at March 31, 1998, with a notional amount of $795 million, was $4 million, representing the amount that CMS Energy would have paid to terminate these agreements on March 31, 1998. 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 March 31, 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 does not take into consideration that the Trust Preferred Securities are convertible into CMS Energy Common Stock. The model assumes that conversion does not take place. 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 6. CAPITAL RESOURCES AND LIQUIDITY Cash Position, Investing and Financing CMS Energy's primary ongoing source of operating cash is dividends from subsidiaries. In April 1998, Consumers declared a $50 million common dividend to be paid to CMS Energy in May 1998. In the first quarter of 1998, Enterprises paid common dividends and other distributions of $34 million to CMS Energy. CMS Energy's consolidated operating cash requirements are further 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 NOMECO; 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 $249 million and $379 million for the first three months of 1998 and 1997, respectively. The $130 million decrease resulted primarily from a decrease of $75 million in Consumers' sale of accounts receivable and a $29 million net decrease reflecting the cumulative effect of an accounting change and the loss on power purchases 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 $246 million and $157 million for the first three months of 1998 and 1997, respectively. The increase of $89 million primarily reflects increased investments in international projects. CMS Energy's 1998 expenditures for its utility and international businesses were $81 million and $166 million, respectively, compared to $82 million and $67 million, respectively, during 1997. Financing Activities: CMS Energy's net cash provided by (used in ) financing activities totaled $2 million and ($221) million for the first three months of 1998 and 1997, respectively. The increase of $223 million in net cash provided by financing activities resulted from the issuance of $719 million of new securities (see table below) and a $108 million decrease in the reduction of notes payable, offset by the retirement of $369 million of bonds and other long-term debt and a $295 million increase in the repayment of bank loans. In Millions Distribution/ Principal Use of Month Issued Maturity Interest Rate Amount Proceeds - ----------------------------------------------------------------------- CMS Energy GTNs Series D (1) (1) 6.8% (1) $ 64 General corporate purposes Extendible Tenor Rate Adjusted Securities January 2005 7.0% 180 Pay down borrowings ----- $244 Consumers Senior Notes (2) February 2008 6.375% $250 Pay down First Mortgage Bonds Senior Notes (2) March 2018 6.875% 225 Pay down First Mortgage Bonds ------ Total through March 31, 1998 $719 Senior Notes (2) May 2008 6.2% $250 Pay down First Mortgage Bonds and Long-Term Bank Debt Long-Term Bank Debt May2001-2003 6.05%(3) 225 Pay down Long-Term Bank Debt ----- Total through May 31, 1998 $1,194 ========================================================================== (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 asimilar amount. (3) The interest rate is variable; weighted average interest rate upon original issuance was 6.05 percent. As of March 31, 1998, CMS Energy had an aggregate $163 million in securities registered for future issuance and sale. For further information on the filing of registration statements for security offerings see Note 4. In the first quarter of 1998, CMS Energy declared and paid $30 million in cash dividends to holders of CMS Energy Common Stock and $3 million in cash dividends to holders of Class G Common Stock. In April 1998, the Board of Directors declared a quarterly dividend of $.30 per share on CMS Energy Common Stock and $.31 per share on Class G Common Stock, payable in May 1998. Other Investing and Financing Matters: At March 31, 1998, the book value per share of CMS Energy Common Stock and Class G Common Stock was $19.34 and $11.24, respectively. CMS Energy's $1.125 billion Senior Credit Facilities consist of a $400 million 364-day revolving credit facility, 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 $161 million. These credit facilities are available to finance working capital requirements and to pay for capital expenditures between long-term financings. At March 31, 1998, the total amount utilized under the Senior Credit Facilities was $222 million, including $52 million of contingent obligations, and under the unsecured lines of credit and letters of credit was $107 million. CMS Energy has a bank commitment through June 1998 to enter into a $580 million credit agreement to fund investments in power projects. During the first quarter of 1998, CMS Energy initiated and completed an offer to exchange up to $300 million of its privately placed 7.375 percent Senior Unsecured Notes due 2000, Series A for 7.375 percent Senior Unsecured Notes due 2000, Series B that have been registered with the SEC. For further information on the exchange offer see Note 4. At April 15, 1998, Consumers had remaining FERC authorization to: 1) issue or guarantee up to $900 million of short-term securities, outstanding at any one time, through 1998; 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 long-term securities with maturities up to 30 years, through November 1998, up to $401 million and $300 million for refinancing purposes and for general corporate purposes, respectively. In May 1998, Consumers used $475 million of FERC authorization by issuing the following long-term debt: 1) $250 million in senior notes; and 2) $225 million for a long-term bank loan. Additionally, in May 1998, Consumers requested authorization to issue from July 1998 through June 2000, up to $950 million of long-term securities for refinancing or refunding purposes and $200 million for general corporate purposes. This authorization would replace and supersede any remaining authorization previously granted to issue long-term securities, except for the $25 million in loan guarantees discussed above. Consumers has an unsecured $425 million credit facility and unsecured lines of credit aggregating $120 million. These facilities are available to finance seasonal working capital requirements and to pay for capital expenditures between long-term financings. At March 31, 1998, the total available amount remaining under these facilities was $300 million. Consumers also has in place a $500 million trade receivables sale program. At March 31, 1998, $160 million in receivables remained available for sale under the program. 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 $3.7 billion over the next three years. Cash generated by operations is expected to satisfy a substantial portion of these capital expenditures. 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) $ 320 $ 265 $ 255 Consumers gas operations (a) 115 115 115 Independent power production 368 469 400 Oil and gas exploration and production 110 160 175 Natural gas transmission and storage 210 61 100 International energy distribution 142 125 100 Marketing, services and trading 70 25 30 ------ ------ ------ $1,335 $1,220 $1,175 ====== ====== ====== (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 Electric Utility Operating Issues - Electric Environmental Matters above and Note 7. 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 all major world growth markets. CMS Energy provides a complete range of international energy expertise from wellhead to burner tip. Beyond 1998 it will 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 increase its involvement in energy projects by pursuing opportunities in oil and gas exploration and development 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 efficiency and 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 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' electric retail service is affected by competition. To meet the challenge of competition, 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 to terminate 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, while Detroit Edison has given notice of early termination. Consumers expects FERC to rule on this issue in 1998. 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. 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 orders in October 1997 and in January and February 1998. Ultimately, the MPSC allowed Consumers: 1) to recover 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) to commence the phase-in of direct access in March 1998; 3) to suspend the power supply cost recovery clause; and 4) the MPSC order allows all customers to be free to choose power suppliers on January 1, 2002. See Note 2 for further information regarding the effect of the PSCR suspension on the recovery of MCV Facility capacity charges. The orders also confirm the MPSC's belief that Securitization may be a beneficial mechanism for recovery of Transition Costs while recognizing that Securitization requires state legislation to occur. 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 in the annual true-up proceeding and stranded cost adjusted appropriately. 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. Consumers has filed an application for leave to appeal with the Michigan Supreme Court, which, if granted, would bypass the Court of Appeals, and thereby achieve an earlier resolution of the matter. As directed in the MPSC's February 1998 order, Consumers submitted to the MPSC its draft plan in April 1998 for implementing retail open access. The primary issues addressed in the proposed plan are: 1) the implementation schedule; 2) the retail open access service options available to customers and suppliers; 3) the process and requirements for customers and others to obtain retail open access service; and 4) the roles and responsibilities for Consumers, customers and suppliers. Under the proposed schedule in the draft plan, Consumers will allocate 750 MW of electric capacity for retail open access to customers. In 1998, 300 MW of retail open access for bidding will be open, and an additional 150 MW will open for each year from 1999 to 2001. This plan supports the previous order regarding the phase-in process. Due to the time required to provide an opportunity for interested parties and the MPSC to review the plan, Consumers does not believe retail open access will commence prior to the fourth quarter of 1998. For further information regarding restructuring, see Note 3. 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 March 31, 1998, Consumers had $268 million of generation- related net regulatory assets recorded on its balance sheet, and a net investment in generation facilities of $1.4 billion included in electric plant and property. For further information regarding this issue, see the Electric Business Outlook - 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 and home security. 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, and 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. Computer Modifications for Year 2000 CMS Energy and its subsidiaries use software and related technologies throughout its 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, or incur plant outages. In 1995, CMS Energy began modification of its computer software systems by dividing programs requiring modification between critical and noncritical programs. All necessary program modifications are expected to be completed by the year 2000. CMS Energy devoted significant internal and external resources to these modifications. It will expense anticipated spending for these modifications as incurred, while capitalizing and amortizing the costs for new software over the software's useful life. CMS Energy does not expect that the cost of these modifications will materially affect its financial position, liquidity or results of operations. 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 March 31, 1998 the foreign currency translation adjustment was $94 million relating primarily to the U.S. and Australian dollar exchange rate fluctuations related to Loy Yang. CMS Energy currently believes that the Australian economy is stable and does not expect currency exchange rate fluctuations over the long term to materially adversely affect CMS Energy's financial position, liquidity or results of operations. 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 materially from those discussed in the forward-looking statements include prevailing governmental policies and regulatory actions (including those of FERC and the MPSC) with respect to rates, proposed electric and natural gas industries restructuring, change in industry and rate structure, operation of a nuclear power facility, acquisition and disposal of assets and facilities, operation and construction of plant facilities, operation and construction of natural gas pipeline and storage facilities, recovery of the cost of purchased power or natural gas, decommissioning costs, and present or prospective wholesale and retail competition, among other important factors. The business and profitability of CMS Energy are also influenced by economic and geographic factors, including political and economic risks, changes in environmental laws and policies, weather conditions, competition for retail and wholesale customers, pricing and transportation of commodities, market demand for energy, inflation or deflation, capital market conditions, and the ability to secure agreement in pending negotiations, among other important factors. All such factors are difficult to predict, contain uncertainties that may materially affect actual results, and may be beyond the control of CMS Energy. 23 CMS Energy Corporation Consolidated Statements of Income (Unaudited)
Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 In Millions, Except Per Share Amounts Operating Revenue Electric utility $ 612 $ 620 $2,507 $2,474 Gas utility 429 498 1,135 1,231 Independent power production 44 29 183 143 Oil and gas exploration and production 12 17 88 116 Natural gas transmission, storage and processing 27 26 103 76 Marketing, services and trading 247 99 840 286 Other 3 6 10 19 ------ ------ ------ ------ 1,374 1,295 4,866 4,345 ------ ------ ------ ------ Operating Expenses Operation Fuel for electric generation 71 69 300 292 Purchased power - related parties 145 151 594 600 Purchased and interchange power 54 62 234 218 Cost of gas sold 463 398 1,375 984 Other 215 169 775 735 ------ ------ ------ ------ 948 849 3,278 2,829 Maintenance 37 41 170 179 Depreciation, depletion and amortization 143 131 489 448 General taxes 59 61 209 204 ------ ------ ------ ------ 1,187 1,082 4,146 3,660 ------ ------ ------ ------ Pretax Operating Income (Loss) Electric utility 119 106 444 412 Gas utility 54 78 130 143 Independent power production 16 10 102 72 Oil and gas exploration and production (8) 9 33 39 Natural gas transmission, storage and processing 13 9 37 29 Marketing, services and trading (1) 1 (7) - Other (6) - (19) (10) ------ ------ ------ ------ 187 213 720 685 ------ ------ ------ ------ Other Income (Deductions) Loss on MCV power purchases (37) - (37) - Accretion income 2 2 7 9 Accretion expense (4) (5) (17) (19) Other, net 3 1 1 (1) ------ ------ ------ ------ (36) (2) (46) (11) ------ ------ ------ ------ Fixed Charges Interest on long-term debt 76 60 289 233 Other interest 12 11 51 43 Capitalized interest (5) (3) (19) (9) Preferred dividends 5 7 23 28 Preferred securities distributions 8 2 24 8 ------ ------ ------ ------ 96 77 368 303 ------ ------ ------ ------ Income Before Income Taxes 55 134 306 371 Income Taxes 15 50 82 135 ------ ------ ------ ------ Consolidated Net Income before cumulative effect of change in accounting principle 40 84 224 236 Cumulative effect of change in accounting for property taxes, net of $23 tax (Note 1) 43 - 43 - ------ ------ ------ ------ Consolidated Net Income $ 83 $ 84 $ 267 $ 236 ====== ====== ====== ======
24
Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 In Millions, Except Per Share Amounts Net Income Attributable to Common Stocks CMS Energy $ 74 $ 75 $ 252 $ 225 Class G $ 9 $ 9 $ 15 $ 11 ------ ------ ------ ------ Average Common Shares Outstanding CMS Energy 101 95 98 93 Class G 8 8 8 8 ------ ------ ------ ------ Basic Earnings Per Average Common Share CMS Energy $ .33 $ .79 $ 2.17 $ 2.41 Before Change in Accounting Principle Class G $ .73 $ 1.18 $ 1.40 $ 1.53 ------ ------ ------ ------ Cumulative Effect of Change in Accounting Principle, Net of Tax, Per Average CMS Energy $ .40 $ - $ .40 $ - Common Share Class G $ .36 $ - $ .36 $ - ------ ------ ------ ------ Basic Earnings Per Average Common Share CMS Energy $ .73 $ .79 $ 2.57 $ 2.41 Class G $ 1.09 $ 1.18 $ 1.76 $ 1.53 ------ ------ ------ ------ Diluted Earnings Per Average Common Share CMS Energy $ .72 $ .78 $ 2.55 $ 2.39 Class G $ 1.09 $ 1.18 $ 1.76 $ 1.53 ------ ------ ------ ------ Dividends Declared Per Common Share CMS Energy $ .30 $ .27 $ 1.14 $ 1.05 Class G $ .31 $ .295 $1.225 $ 1.165 ------ ------ ------ ------ The accompanying condensed notes are an integral part of these statements.
25 CMS Energy Corporation Consolidated Balance Sheets
ASSETS March 31 March 31 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Plant and Property (At Cost) Electric $ 6,547 $ 6,491 $ 6,412 Gas 2,531 2,528 2,374 Oil and gas properties (full-cost method) 1,274 1,257 1,154 Other 171 168 95 ------- ------- ------- 10,523 10,444 10,035 Less accumulated depreciation, depletion and amortization 5,416 5,270 4,991 ------- ------- ------- 5,107 5,174 5,044 Construction work-in-progress 272 261 235 ------- ------- ------- 5,379 5,435 5,279 ------- ------- ------- Investments Independent power production 884 791 325 Natural gas transmission, storage and processing 279 256 235 International energy distribution 266 255 65 First Midland Limited Partnership (Note 2) 244 242 235 Midland Cogeneration Venture Limited Partnership (Note 2) 179 171 140 Other 42 48 23 ------- ------- ------- 1,894 1,763 1,023 ------- ------- ------- Current Assets Cash and temporary cash investments at cost, which approximates market 72 67 57 Accounts receivable and accrued revenue, less allowances of $7, $7 and $9, respectively (Note 4) 472 476 300 Inventories at average cost Gas in underground storage 79 197 51 Materials and supplies 90 85 89 Generating plant fuel stock 39 35 44 Deferred income taxes 28 38 42 Prepayments and other 248 240 185 ------- ------- ------- 1,028 1,138 768 ------- ------- ------- Non-current Assets Nuclear decommissioning trust funds 518 486 401 Postretirement benefits 396 404 427 Abandoned Midland Project 88 93 108 Other 478 474 396 ------- ------- ------- 1,480 1,457 1,332 ------- ------- ------- Total Assets $ 9,781 $ 9,793 $ 8,402 ======= ======= =======
26
STOCKHOLDERS' INVESTMENT AND LIABILITIES March 31 March 31 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Capitalization Common stockholders' equity $ 2,052 $ 1,977 $ 1,775 Preferred stock of subsidiary 238 238 356 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 - Company-obligated convertible Trust Preferred Securities of CMS Energy Trust I (b) 173 173 - Long-term debt 3,755 3,272 2,629 Non-current portion of capital leases 74 75 99 ------- ------- ------- 6,512 5,955 4,959 ------- ------- ------- Current Liabilities Current portion of long-term debt and capital leases 318 643 668 Notes payable 245 382 88 Accounts payable 330 398 322 Accrued taxes 235 272 228 Accounts payable - related parties 82 80 65 Accrued interest 56 51 49 Power purchases (Note 2) 47 47 47 Accrued refunds 11 12 6 Other 182 190 189 ------- ------- ------- 1,506 2,075 1,662 ------- ------- ------- Non-current Liabilities Deferred income taxes 717 743 689 Postretirement benefits 510 514 529 Power purchases (Note 2) 157 133 167 Deferred investment tax credit 148 151 158 Regulatory liabilities for income taxes, net 61 54 75 Other 170 168 163 ------- ------- ------- 1,763 1,763 1,781 ------- ------- ------- Commitments and Contingencies (Notes 2, 3, 7 and 8) Total Stockholders' Investment and Liabilities $ 9,781 $ 9,793 $ 8,402 ======= ======= ======= (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. For further discussion, see Note 4 to the Consolidated Financial Statements. (b) As described in Note 4, 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. The accompanying condensed notes are an integral part of these statements.
27 CMS Energy Corporation Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 In Millions Cash Flows from Operating Activities Consolidated net income $ 83 $ 84 $ 267 $ 236 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear decommissioning of $13, $13, $50 and $48, respectively) 143 131 489 448 Loss on MCV power purchases 37 - 37 - Capital lease and debt discount amortization 11 8 47 40 Accretion expense 4 5 17 19 Accretion income - abandoned Midland project (2) (2) (7) (9) Cumulative effect of accounting change (66) - (66) - MCV power purchases (17) (15) (65) (66) Undistributed earnings of related parties (17) (13) (68) (56) Deferred income taxes and investment tax credit (12) 3 18 43 Other (8) (6) (16) 8 Changes in other assets and liabilities 93 184 (126) 28 ------ ------ ------ ------ Net cash provided by operating activities 249 379 527 691 ------ ------ ------ ------ Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (128) (132) (707) (681) Investments in partnerships and unconsolidated subsidiaries (112) (12) (930) (104) Cost to retire property, net (17) (4) (41) (28) Investments in nuclear decommissioning trust funds (13) (13) (50) (48) Other (4) (9) (9) - Deferred demand-side management costs - - - (4) Proceeds from sale of property 28 13 64 92 ------ ------ ------ ------ Net cash used in investing activities (246) (157) (1,673) (773) ------ ------ ------ ------ Cash Flows from Financing Activities Proceeds from bank loans, notes and bonds 850 70 1,994 164 Issuance of common stock 20 17 227 104 Retirement of bonds and other long-term debt (369) - (890) (37) Repayment of bank loans (322) (27) (324) (38) Increase (decrease) in notes payable, net (137) (245) 157 50 Payment of common stock dividends (33) (28) (124) (107) Payment of capital lease obligations (7) (8) (43) (38) Retirement of preferred stock - - (120) - Retirement of common stock - - (2) (1) Proceeds from preferred securities - - 286 - ------ ------ ------ ------ Net cash provided by (used in) financing activities 2 (221) 1,161 97 ------ ------ ------ ------ Net Increase in Cash and Temporary Cash Investments 5 1 15 15 Cash and Temporary Cash Investments, Beginning of Period 67 56 57 42 ------ ------ ------ ------ Cash and Temporary Cash Investments, End of Period $ 72 $ 57 $ 72 $ 57 ====== ====== ====== ====== The accompanying condensed notes are an integral part of these statements.
28 CMS Energy Corporation Consolidated Statements of Common Stockholders' Equity (Unaudited)
Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 In Millions Common Stock At beginning and end of period $ 1 $ 1 $ 1 $ 1 ------ ------ ------ ------ Other Paid-in Capital At beginning of period 2,267 2,045 2,062 1,959 Common stock reacquired - - (2) (1) Common stock issued: CMS Energy 18 16 219 99 Class G 2 1 8 5 ------ ------ ------ ------ At end of period 2,287 2,062 2,287 2,062 ------ ------ ------ ------ Revaluation Capital At beginning of period (6) (6) (6) (8) Change in unrealized investment-gain (a) 3 - 3 2 ------ ------ ------ ------ At end of period (3) (6) (3) (6) ------ ------ ------ ------ Foreign Currency Translation At beginning of period (96) - - - Change in foreign currency translation (a) 2 - (94) - ------ ------ ------ ------ At end of period (94) - (94) - ------ ------ ------ ------ Retained Earnings (Deficit) At beginning of period (189) (338) (282) (411) Consolidated net income (a) 83 84 267 236 Common stock dividends declared: CMS Energy (30) (26) (113) (98) Class G (3) (2) (11) (9) ------ ------ ------ ------ At end of period (139) (282) (139) (282) ------ ------ ------ ------ Total Common Stockholders' Equity $2,052 $1,775 $2,052 $1,775 ====== ====== ====== ====== (a) Disclosure of Comprehensive Income: Revaluation capital Unrealized investment-gain, net of tax of $(1), $-, $(2) and $-, respectively $ 3 $ - $ 3 $ 2 Foreign currency translation 2 - (94) - Consolidated net income 83 84 267 236 ----- ----- ----- ----- Total Consolidated Comprehensive Income $ 88 $ 84 $ 176 $ 238 ===== ===== ===== ===== The accompanying condensed notes are an integral part of these statements.
29 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 of CMS Energy Corporation which includes the Report 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 Change 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 and twelve month periods ended March 31, 1998, undistributed equity earnings were $17 million and $68 million, respectively and $13 million and $56 million for the three and twelve month periods ended March 31, 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 March 31, 1998 the foreign currency translation adjustment was $94 million relating primarily to the U.S. and Australian dollar exchange rate fluctuations related to Loy Yang. 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. 2: 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 Twelve Months Ended March 31 1998 1997 1998 1997 - ---------------------------------------------------------------------- Pretax operating income $10 $ 8 $47 $46 Income taxes and other 3 2 14 14 ---- ---- ---- ---- Net income $ 7 $ 6 $33 $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 minimum 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 over the 1996-2004 time period. Because the MPSC allowed Consumers to suspend the PSCR process as part of the electric industry restructuring order (see Note 3), Consumers expects to recover a portion of the future increases in approved capacity charges through an adjustment to the frozen PSCR charge. Consumers recognized a loss in 1992 for the present value of the estimated future underrecoveries of power costs under the PPA. At March 31, 1998 and December 31,1997, the after-tax present value of the PPA liability totaled $133 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 $3 million, partially offset by after-tax cash underrecoveries of $11 million. The undiscounted after-tax amount associated with the liability totaled $182 million at March 31, 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 three months of 1998 the MCV Facility was available 99 percent of the time, resulting in $5 million over anticipated after-tax cash underrecoveries. Consumers believes it will continue to experience after-tax cash underrecoveries associated with the PPA in amounts as those shown below. In Millions 1998 1999 2000 2001 2002 - ------------------------------------------------------------------ Estimated cash under recoveries, net of tax $28 $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. On the same day, 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. 3: 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 Note 2) and to accelerate recovery of 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 program is limited to 650 MW of load, of which 100 MW is available solely to direct-access customers for at least 18 months. The Commissions' order allowed existing special contracts to fill 410 MW of the load. The remaining 140 MW of the 650 MW load could be filled by either special contracts or direct access loads. The load was filled by new special contracts signed subsequent to the order. According to the MPSC order, Consumers held a lottery in April 1997 to select the customers to purchase 100 MW by direct access. Direct access for a portion of this 100 MW began in late 1997. Consumers expects the remaining amount of direct access to begin 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. Consumers filed with the Michigan Supreme Court seeking leave to appeal that ruling. 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 orders in October 1997 and in January and February 1998. Ultimately, the MPSC allowed Consumers: 1) to recover 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) to commence the phase-in of direct access in March 1998; 3) to suspend the power supply cost recovery clause; and 4) the MPSC order allows all customers to be free to choose power suppliers on January 1, 2002. See Note 2 for further information regarding the effect of the PSCR suspension on the recovery of MCV Facility capacity charges. The orders also confirm the MPSC's belief that Securitization may be a beneficial mechanism for recovery of Transition Costs while recognizing that Securitization requires state legislation to occur. 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 in the annual true-up proceeding and stranded cost adjusted appropriately. 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. Consumers has filed an application for leave to appeal with the Michigan Supreme Court, which, if granted, would bypass the Court of Appeals, and thereby achieve an earlier resolution of the matter. As directed in the MPSC's February 1998 order, Consumers submitted to the MPSC its draft plan in April 1998 for implementing retail open access. The primary issues addressed in the proposed plan are: 1) the implementation schedule; 2) the retail open access service options available to customers and suppliers; 3) the process and requirements for customers and others to obtain retail open access service; and 4) the roles and responsibilities for Consumers, customers and suppliers. Under the proposed schedule in the draft plan, Consumers will allocate 750 MW of electric capacity for retail open access to customers. In 1998, 300 MW of retail open access for bidding will be open, and an additional 150 MW will open for each year from 1999 to 2001. This plan supports the previous order regarding the phase-in process. Due to the time required to provide an opportunity for interested parties and the MPSC to review the plan, Consumers does not believe retail open access will commence prior to the fourth quarter of 1998. For further information see Electric Business Outlook - Application of SFAS 71 in the MD&A. 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 will be selected on a first-come, first-served basis, up to a limit of 100,000 customers on April 1, 1998. As of May 8, 1998 approximately 7,500 customers chose alternative gas suppliers, representing approximately 10 bcf of gas load. Of these alternative gas suppliers, one was a CMS Energy affiliate. Up to 100,000 more customers will be added on 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. To minimize the risk of exposure to higher gas costs, Consumers currently has contracts in place at known prices covering 75 percent of its 1998 requirements, 35 percent of its 1999 requirements and 25 percent of its 2000 requirements. Additional forward coverage is currently under review. Gas Proceedings: In 1995, the MPSC issued an order regarding a $44 million (excluding interest) gas supply contract pricing dispute between Consumers and certain gas producers. The order stated that Consumers was not obligated to seek prior approval of market-based pricing changes that Consumers implemented under the contracts in question. The Court of Appeals upheld the MPSC order. The producers sought leave to appeal with the Michigan Supreme Court. Their request is still pending. Consumers believes the MPSC order correctly concludes that the producers' theories are without merit and will vigorously oppose any claims they may raise, but cannot predict the outcome of this issue. Resolution of the issues discussed in this Note is not expected to materially affect CMS Energy's financial position, liquidity or results of operations. 4: Short-Term and Long-Term Financings, and Capitalization CMS Energy: CMS Energy's $1.125 billion Senior Credit Facilities consist of a $400 million 364-day revolving credit facility, 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 $161 million. At March 31, 1998, the total amount utilized under the Senior Credit Facilities was $222 million, including $52 million of contingent obligations, and under the unsecured lines of credit and letters of credit was $107 million. At March 31, 1998 CMS Energy has $138 million of Series A GTNs, $125 million of Series B GTNs, $150 million of Series C GTNs, and $142 million of Series D GTNs issued and outstanding with weighted average interest rates of 7.7 percent, 7.9 percent, 7.7 percent, and 7.1 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 January 1998, CMS Energy announced the commencement of an offer to exchange up to $300 million of its 7.375 percent Senior Unsecured Notes due 2000, Series A for 7.375 percent Senior Unsecured Notes due 2000, Series B that have been registered with the SEC. Other than their registration, the terms of the Series B Notes are substantially similar to the Series A (except that the Series B do not have transfer restrictions). CMS Energy completed the exchange in February 1998. 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. Consumers: At April 15, 1998, Consumers had remaining FERC authorization to: 1) issue or guarantee up to $900 million of short-term securities, outstanding at any one time, through 1998; 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 long- term securities with maturities up to 30 years, through November 1998, up to $401 million and $300 million for refinancing purposes and for general corporate purposes, respectively. In May 1998, Consumers used $475 million of FERC authorization by issuing the following long-term debt: 1) $250 million in senior notes; and 2) $225 million for a long-term bank loan. Additionally, in May 1998, Consumers requested authorization to issue from July 1998 through June 2000, up to $950 million of long-term securities for refinancing or refunding purposes and $200 million for general corporate purposes. This authorization would replace and supersede any remaining authorization previously granted to issue long-term securities, except for the $25 million in loan guarantees discussed above. Consumers has an unsecured $425 million credit facility and unsecured lines of credit aggregating $120 million. These facilities are available to finance seasonal working capital requirements and to pay for capital expenditures between long-term financings. At March 31, 1998, a total of $245 million was outstanding at a weighted average interest rate of 6.2 percent, compared with $88 million outstanding at March 31, 1997, at a weighted average interest rate of 6.8 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 March 31, 1998 and 1997, receivables sold under the program totaled $340 million and $398 million, respectively. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold. In 1996, 4 million shares of 8.36 percent Trust Preferred Securities were issued and sold through Consumers Power Company Financing I, a wholly owned business trust consolidated with Consumers. Net proceeds from the sale totaled $97 million. In 1997, 4.8 million shares of 8.2 percent Trust Preferred Securities were issued and sold through Consumers Energy Company Financing II, a wholly owned business trust consolidated with Consumers. Net proceeds from the sale totaled $116 million. Consumers formed both trusts for the sole purpose of issuing the tax deductible Trust Preferred Securities. Consumers' obligations with respect to the Trust Preferred Securities under the notes, under the indenture through which Consumers issued the notes, under Consumers' guarantee of the Trust Preferred Securities, and under the declaration by the trusts, taken together, constitute a full and unconditional guarantee by Consumers of the trusts' obligations under the Trust Preferred Securities. For additional information, see footnote (a) on the Consolidated Balance Sheets. The following table describes the new issuances of long-term financings which have occurred during 1998 through early May 1998. In Millions Month Interest Principal Use of Issued Maturity Rate (%) Amount Proceeds - ---------------------------------------------------------------------- Senior Notes (a) February 2008 6.375 $250 Pay down First Mortgage Bonds Senior Notes (a) March 2018 6.875 225 Pay down First Mortgage Bonds Senior Notes (a) May 2008 6.2 250 Pay down First Mortgage Bonds and Long-Term Bank Debt Long-Term Bank Debt May2001-2003 6.05 (b) 225 Pay down Long-Term Bank Debt and general corporate purposes ----- Total $950 ===== (a) The Senior Notes are secured by Consumers First Mortgage Bonds issued contemporaneously in a similar amount. (b) The interest rate is variable; weighted average interest rate upon original issuance was 6.05 percent. The following table describes the retirements of long-term financings which have occurred during 1998 through early May 1998. In Millions Month Interest Principal Retired Maturity Rate (%) Amount - ---------------------------------------------------------------------- First Mortgage Bonds February 1998 8.75 $248 Long-Term Bank Debt February 1998-1999 6.4 (a) 50 First Mortgage Bonds March 2001-2002 7.5 119 First Mortgage Bonds April 2023 7.375 36 ----- Total $453 ===== (a) The interest rate was variable; weighted average interest rate at December 31, 1997 was 6.4 percent. Consumers had an unsecured, variable rate long-term bank loan with an outstanding balance at March 31, 1998 and 1997 of $350 million and $400 million, respectively. At March 31, 1998 and 1997 the loan carried a weighted average interest rate of 6.3 percent and 6.0 percent, respectively. In May 1998, Consumers refinanced this term loan with a new $225 million unsecured long-term loan, and issued $250 million of senior notes due 2008, at an interest rate of 6.2 percent to cover the remaining $125 million refinancing. The balance of the new senior notes, $125 million, is to be used to retire first mortgage bonds and for general corporate purposes. Under the provisions of its Articles of Incorporation at March 31, 1998, Consumers had $302 million of unrestricted retained earnings available to pay common dividends. In January 1998, Consumers declared an $80 million common dividend paid in February 1998. 5: Earnings Per Share and Dividends Earnings per share attributable to Common Stock for the three and twelve month periods ended March 31, 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 three months ended March 31, 1998 and 1997 are based on 25.16 percent and 24.29 percent, respectively, of the income of Consumers Gas Group. Computation of Earnings Per Share: In Millions, Except Per Share Amounts Three Months Ended Twelve Months Ended 1998 1997 1998 1997 - --------------------------------------------------------------------- (a) (a) Net Income Applicable to Basic and Diluted EPS Consolidated Net Income $ 83 $ 84 $267 $236 Net Income Attributable to Common Stocks: CMS Energy - Basic EPS $ 74 $ 75 $252 $225 Add conversion of 7.75% Trust Preferred Securities (net of tax) 2 - 7 - ---- ---- ---- ---- CMS Energy - Diluted EPS $ 76 $ 75 $259 $225 ===== ===== ===== ===== Class G: Basic and Diluted EPS $ 9 $ 9 $ 15 $ 11 ===== ===== ===== ===== Average Common Shares Outstanding Applicable to Basic and Diluted EPS CMS Energy: Average Shares - Basic 100.9 94.9 97.6 93.3 Add conversion of 7.75% Trust Preferred Securities 4.2 - 3.3 - Options-Treasury Shares .6 .3 .4 .3 ----- ----- ----- ----- Average Shares - Diluted 105.7 95.2 101.3 93.6 ===== ===== ===== ===== Class G: Average Shares Basic and Diluted 8.2 7.9 8.1 7.8 ===== ===== ===== ===== Earnings Per Average Common Share CMS Energy: Basic $ .73 $ .79 $ 2.58 $ 2.41 Diluted $ .72 $ .78 $ 2.56 $ 2.40 Class G: Basic and Diluted $ 1.09 $ 1.18 $ 1.76 $ 1.53 ======================================================================= (a) Includes the cumulative effect of an accounting change 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). In February 1998, CMS Energy declared and paid dividends of $.30 per share on CMS Energy Common Stock and $.31 per share on Class G Common Stock. In April 1998, the Board of Directors declared a quarterly dividend of $.30 per share on CMS Energy Common Stock and $.31 per share on Class G Common Stock to be paid in May 1998. 6: 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 counterparties, 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 counterparties. The risk of nonperformance by the counterparties is considered remote. 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. CMS NOMECO has one arrangement which is used to fix the prices that CMS NOMECO 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 NOMECO 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 March 31, 1998, a letter of credit was not posted by either party to the agreement. As of March 31, 1998, the fair value of this contract reflected payment due from CMS NOMECO of $11 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 Rates 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 $795 million at March 31, 1998. 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 to hedge certain receivables, payables, and long-term debt 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 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 $220 million at March 31, 1998. 7: Commitments and 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 in-process 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. The EPA recently revised these standards. The revisions may further limit small particulate and ozone related emissions. Consumers supports the bipartisan effort in the U.S. Congress to delay implementation of the revised standards until the relationship between the new standards and health improvements is established scientifically. In October 1997, pursuant to recommendations from the Ozone Transport Assessment Group and the requests of several Northeastern states, the EPA proposed that the State of Michigan impose additional nitrogen oxide limits on fossil-fueled emitters, such as Consumers' generating units. The limits are an effort to reduce statewide nitrogen oxide emissions by 32 percent, as early as 2002. The State of Michigan will have one year to review and challenge the proposed recommendations, and one year after that to implement final requirements. 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 $210 million, plus an additional amount totaling $10 million per year for operation and maintenance costs. Consumers may need an equivalent amount to comply with the new small particulate standards. The State of Michigan has objected to the extent of the proposed EPA emission reductions. If the State of Michigan's position were to be adopted by the EPA, 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 March 31, 1998, Consumers has accrued $3 million for its estimated Superfund liability. 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 the company 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. These estimates are based on undiscounted 1998 costs. As of March 31, 1998, Consumers has accrued a liability of $48 million and has established a regulatory asset for approximately the same amount. Any significant change in assumptions, such as remediation technique, 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 is continuing discussions with, or has initiated a lawsuit against, certain insurance companies regarding coverage for some or all of the costs that it may incur for these sites. Capital Expenditures: CMS Energy estimates capital expenditures, including investments in unconsolidated subsidiaries and new lease commitments, of $1.335 billion for 1998, $1.220 billion for 1999, and $1.175 million for 2000. For further information, see the Capital Resources and Liquidity - Capital Expenditures in the MD&A. Other: As of March 31, 1998, CMS Energy and Enterprises have guaranteed up to $469 million in contingent obligations of unconsolidated affiliates and unrelated parties. 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 have re-filed their claims with the trial court. Consumers intends to vigorously defend these cases, but is unable to predict the outcome. As of March 31, 1998, Consumers had 6 individual stray voltage lawsuits, unrelated to the cases above, awaiting trial court action, down from 12 lawsuits as reported at year end 1997. 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). The parties are awaiting the court's decision on Consumers' and CMS Energy's motion for summary judgment and/or dismissal of the complaint. Consumers believes the lawsuit is without merit and will vigorously defend against it, but cannot predict the outcome of this matter. Under agreements relating to CMS NOMECO's 1995 acquisition of Walter International, Inc. and its Congo operations, CMS Energy and CMS NOMECO could become jointly and severally liable for the recapture of "dual consolidated losses" under Section 1503(d) of the IRC if a "triggering event" were to occur. Potential triggering events include certain asset or stock dispositions to unrelated parties, certain tax deconsolidations, certain usage of the losses on a foreign tax return, and certain failures to comply with Internal Revenue Service regulations. CMS Energy and CMS NOMECO have no plans to effect any transaction that would be a triggering event. The amount of the potential tax liability as of March 31, 1998, was estimated to be up to $67 million plus interest. In connection with the same acquisition, a subsidiary of CMS NOMECO could also be jointly and severally liable with an unrelated party, as of March 31, 1998, for up to $50 million of tax plus interest. In that event, CMS NOMECO has certain indemnity rights against that unrelated party. Additionally, CMS NOMECO and its domestic subsidiaries have incurred losses in certain foreign countries that could be recaptured if a triggering event were to occur. The additional tax liability as of March 31, 1998, could be up to $10 million plus interest. In addition to the matters disclosed in these Notes, 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. 8: 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 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. As of March 31, 1998 Consumers 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 forty to fifty day planned outage at Palisades commenced on April 24, 1998 for refueling and maintenance. Consumers will replace a total of sixty 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. 9: Supplemental Cash Flow Information For purposes of the Consolidated Statements of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Other cash flow activities and non-cash investing and financing activities were: In Millions Three Months Ended Twelve Months Ended 1998 1997 1998 1997 - ---------------------------------------------------------------- Cash transactions Interest paid (net of amounts capitalized) $ 75 $ 63 $305 $257 Income taxes paid (net of refunds) 19 - 86 80 Non-cash transactions Nuclear fuel placed under capital leases $ 5 $ 3 $ 6 $ 31 Other assets placed under capital leases 2 2 7 4 ====================================================================== 44 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 March 31, 1998 and 1997, and the related consolidated statements of income, common stockholders' equity and cash flows for the three-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 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, May 11, 1998. 45 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 from, 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 March 31 1998 1997 Change ---- ---- ------ Three months ended $102 $ 88 $14 Twelve months ended 299 254 45 Net income available to common stockholders after the cumulative effect of a change in accounting for property taxes was $102 million for the first quarter of 1998 compared to $88 million for the same 1997 period. The increase in earnings for the first quarter 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 quarter 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. Earnings for the first quarter of 1998 also reflect decreased gas deliveries due to warmer 1998 temperatures and increased electric sales along with reduced purchased power costs. For further information on past and future MCV underrecoveries, see Power Purchases from the MCV Partnership in Note 2. The increase in earnings for the twelve months ended 1998 compared to the 1997 period reflects the change in accounting for property taxes implemented during March 1998 as discussed above and the one-time recognition of interest income of $7 million ($5 million after-tax) from a related party property sale. In addition, the improved net income for the twelve months ended 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 March 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 quarter of 1998. For further information, see the Electric and Gas Utility Results of Operations sections and Note 3. Electric Utility Results of Operations Electric Pretax Operating Income: In Millions March 31 1998 1997 Change ---- ---- ----- Three months ended $ 119 $ 106 $13 Twelve months ended 444 412 32 Electric pretax operating income for the three months ended March 31, 1998 benefitted from increased sales and control of operation and maintenance costs compared to the same period in 1997. The twelve months ended 1998 also benefitted from increased sales and control of operation and maintenance costs when compared to the 1997 period. These increases were partly offset by increased general taxes and depreciation. The following table quantifies these impacts on Pretax Operating Income: In Millions Three Months Twelve Months Ended March 31 Ended March 31 Change Compared to Prior Year 1998 vs 1997 1998 vs 1997 ------------- ------------- Sales (including special contract discounts) $ 6 $ 14 Rate increases and other regulatory issues (2) (1) Operations and maintenance 9 36 General taxes and depreciation - (17) ---- ---- Total change $ 13 $ 32 ==== ==== Electric Deliveries: Total electric deliveries increased 6.5 percent for three months ended March 31, 1998 over the same period in 1997. Deliveries to ultimate customers increased 1.2 percent. Reduced sales to residential and commercial customers were more than offset by increased sales and deliveries to industrial customers. For twelve months ended, total electric deliveries increased 3.8 percent over the comparable 1997 period. The increase is primarily attributable to an increase in intersystem sales and a 1.3 percent increase in sales and deliveries to ultimate customers, primarily within the industrial class. Power Costs: In Millions March 31 1998 1997 Change ------ ------ ------ Three months ended $ 270 $ 282 $(12) Twelve months ended 1,128 1,110 18 Although sales increased for the three months ended March 31, 1998 compared to the same period in 1997, power costs for the period decreased. This decrease results from increased internal generation and reduced power purchases from outside sources. Power costs increased for the twelve months ended 1998 compared to 1997. Both internal generation and power purchases from outside sources increased during this period to meet the increased sales demand. Electric Utility Operating Issues: Power Purchases from the MCV Partnership: In 1992, Consumers recognized a loss for the present value of the estimated future underrecoveries of power purchases from the MCV Partnership. 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 three months of 1998, the MCV Facility was available 99 percent of the time, resulting in after-tax cash underrecoveries of $11 million. Consumers believes it will continue to experience after-tax cash underrecoveries associated with the PPA in amounts as those shown below. For further information, see Power Purchases from the MCV Partnership in Note 2. In Millions 1998 1999 2000 2001 2002 ---- ---- ---- ---- ---- Estimated cash underrecoveries, net of tax $28 $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. Electric Rate Proceedings: In 1996, the MPSC issued a final order authorizing Consumers to recover costs associated with the purchase of an additional 325 MW of MCV Facility capacity and to accelerate recovery of its nuclear plant investment. To implement the accelerated recovery, the order requires an increase in annual nuclear plant depreciation expense by $18 million with a corresponding decrease in fossil-fueled generating plant depreciation expense. The order also established an experimental direct-access program. For further information on these issues, see the Electric Business Outlook section of this MD&A and Note 2. Nuclear Matters: 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 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. In 1996, Consumers received an interim Safety Evaluation Report from the NRC indicating that the reactor vessel can be safely operated through 2003. Consumers believes that with a change in fuel management designed to minimize embrittlement, Palisades can be operated to the end of its license life in the year 2007. 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. On April 24, 1998 a planned refueling and maintenance outage of forty to fifty days began at Palisades. Consumers will replace a total of sixty nuclear fuel assemblies in the plant's reactor during the outage. 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. See the Electric Environmental Matters section of this MD&A for further information on decommissioning Big Rock and Note 6 on nuclear matters. Electric Environmental Matters: The Clean Air Act contains significant environmental provisions specific to utilities. During the past few years, Consumers incurred $46 million in capital expenditures to meet the Clean Air Act's requirements. Consumers believes it may incur an additional $26 million in capital expenditures by the year 2000 to comply with sulfur dioxide and nitrogen oxide emission limits established by the EPA under the Clean Air Act's Acid Rain Program. Consumers currently operates within all Clean Air Act requirements and meets current emission limits. The EPA, however, recently revised the national air quality standards, which may further limit small particulate and ozone related emissions, and proposed that the State of Michigan impose additional nitrogen oxide limits on fossil-fueled emitters, such as Consumers' generating units. It is unlikely that the State of Michigan will establish Consumers' 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 $210 million, plus an additional amount totaling $10 million per year for operation and maintenance costs. Consumers may need an equivalent amount to comply with the new small particulate standards. The State of Michigan has objected to the extent of the proposed EPA emission reductions. If the State of Michigan's position were to be adopted by the EPA, costs could be less than the current estimated amounts. Consumers supports the bipartisan effort in the U.S. Congress to delay implementation of the revised standards until the relationship between the new standards and health improvements is established scientifically. Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects to 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. Many other creditworthy, potentially responsible parties, with substantial assets also cooperate with respect to the individual sites. Based on current information, management believes it is unlikely that Consumers' liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on its financial position, liquidity or results of operations. 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. For further information regarding these and other environmental matters, see Electric Environmental Matters in Note 5. Stray Voltage: Various parties have sued Consumers relating to the effect of so-called stray voltage on certain 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 Michigan Supreme Court allowed each case that was not previously refiled to go forward separately. Consumers filed a motion for reconsideration with the Michigan Supreme Court, which was denied. As a result, 21 individual plaintiffs have re-filed their claims with the trial court. Consumers intends to vigorously defend these cases, but is unable to predict the outcome. As of March 31, 1998, Consumers had 6 individual stray voltage lawsuits, unrelated to the cases above, awaiting trial court action, down from 12 lawsuits as reported at year end 1997. For further information regarding Stray Voltage, see the Other section in Note 5. Other: In October 1997, two independent power producers sued Consumers and CMS Energy in a federal court alleging antitrust violations and economic losses due to special electric contracts signed by Consumers with large customers. The plaintiffs claim damages of $100 million (which a court can treble in antitrust cases as provided by law). The parties are awaiting the court's decision on Consumers' and CMS Energy's motion for summary judgment and/or dismissal of the complaint. Consumers believes the lawsuit is without merit and will vigorously defend against it, but cannot predict the outcome of this matter. For further information regarding this antitrust litigation, see Item 3, Legal Proceedings. Gas Utility Results of Operations Gas Pretax Operating Income: In Millions March 31 1998 1997 Change ---- ---- ------ Three months ended $ 54 $ 78 $(24) Twelve months ended 130 143 (13) Gas pretax operating income decreased in both the three month and twelve month periods ended March 31, 1998, as a result of decreased gas deliveries and wholesale services due to warmer temperatures during the winter heating seasons. Revenues and wholesale services were also down for the three month and twelve month periods ended March 31, 1998 due to the elimination of surcharges related to past conservation programs. The decreased gas pretax operating income for the three months ended March 31, 1998 reflects higher operations expense related to growth in retail services programs and the absence of 1997 non-recurring expense reductions for uncollectible accounts and injuries and damages reserves. Gas pretax operating income for the twelve month period ended March 31, 1998 benefited from lower operations and maintenance expenses that resulted from cost controls. The following table quantifies these impacts on Pretax Operating Income: In Millions Three Months Twelve Months Ended March 31 Ended March 31 Change Compared to Prior Year 1998 vs 1997 1998 vs 1997 ------------ ------------ Sales $ (13) $ (13) Gas wholesale and retail service activities (3) (11) Operations and maintenance (8) 11 ------------ ------------ Total change $(24) $ (13) ============ ============ Gas Deliveries: System deliveries for the three month period ended March 31, 1998, including miscellaneous transportation, totaled 146 bcf, a decrease of 22 bcf or 13 percent compared to the three month period ended March 31, 1997. Deliveries for the twelve month period ended March 31, 1998, including miscellaneous transportation, totaled 399 bcf, a decrease of 32 bcf or 7 percent compared to the twelve month period ended March 31, 1997. The decreased deliveries for three month and twelve month periods ended reflect warmer temperatures primarily for the first quarter of 1998. Cost of Gas Sold: In Millions March 31 1998 1997 Change ---- ---- ----- Three months ended $264 $314 $(50) Twelve months ended 645 718 (73) The cost decreases for the three month and twelve month periods ended March 31, 1998 were the result of decreased sales reflecting warmer temperatures during the winter heating seasons. Gas Utility Operating Issues: Gas Rate Proceedings: Consumers entered into a special natural gas transportation contract in response to a customer's proposal to bypass Consumers' system in favor of a competitive alternative. In 1995, the MPSC approved the contract. The MPSC stated, however, that Consumers' shareholders must bear the revenue shortfall created by the difference between the contract's discounted rate and the floor price of an MPSC- authorized gas transportation rate. In 1995, Consumers filed an appeal with the Court of Appeals claiming that the MPSC decision denies Consumers the opportunity to earn its authorized rate of return and is therefore unconstitutional. In October 1997, the Court of Appeals issued an opinion affirming the MPSC's order. The Court of Appeals denied Consumers' subsequent request for a rehearing of that opinion. In March 1998, Consumers filed an application for leave to appeal with the Michigan Supreme Court. For further information on Gas Proceedings, see the Gas Business Outlook section of this MD&A and Note 3. Restructuring: In December 1997, the MPSC approved Consumers' application to implement a statewide three-year experimental gas transportation pilot program, eventually allowing 300,000 residential, commercial and industrial retail gas sales customers to choose their gas supplier. As of May 8, 1998, more than 7,500 customers chose alternative gas suppliers, representing approximately 10 bcf of gas load. Of these alternative gas suppliers, one was a CMS Energy affiliate. The program is voluntary for natural gas customers. Customers choosing to remain as sales customers of Consumers will not see a rate change in their natural gas rates. To minimize the risk of exposure to higher gas costs, Consumers currently has contracts in place at known prices covering a significant portion of its requirements through the year 2000. ABATE, the Attorney General and other parties filed claims of appeal of the MPSC's order with the Court of Appeals. For further information, see Note 3. GCR Matters: In 1995, the MPSC issued an order favorable to Consumers' position in a $44 million contract pricing dispute (excluding interest) between Consumers and certain gas producers. The Court of Appeals upheld the MPSC order. The gas producers have now appealed to the Michigan Supreme Court. Consumers believes the MPSC order correctly concludes that the producers' theories are without merit. Consumers will vigorously oppose any claims the producers may raise, but cannot predict the outcome of this issue. Gas Environmental Matters: Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some that formerly housed manufactured gas plant facilities. Consumers estimates its costs related to investigation and remedial action at $48 million to $98 million. This estimate is based on undiscounted 1998 costs. Any significant change in assumptions, such as remediation technique, nature and extent of contamination and regulatory requirements, could affect the estimate of investigation and remedial action costs for the sites. For further information regarding environmental matters, see Note 5. CAPITAL RESOURCES AND LIQUIDITY Cash Position, Investing and Financing Operating Activities: Consumers derives cash from operations from the sale and transportation of natural gas and the generation, transmission and sale of electricity. Cash from operations totaled $287 million and $368 million for the first three months of 1998 and 1997, respectively. The $81 million decrease resulted primarily from a decrease of $75 million in the sale of accounts receivable. Other items included in the income statement 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 $100 million and $98 million for the first three months of 1998 and 1997, respectively. Consumers used the cash primarily for capital expenditures. Financing Activities: Cash used in financing activities totaled $178 million and $262 million for the first three months of 1998 and 1997, respectively. The decrease of $84 million is primarily the result of the retirement of $418 million in bonds and other long term debt and the payment of $80 million in common stock dividend offset by a $113 million decrease in the reduction of notes payable and the issuance of $475 million in senior notes. Other Investing and Financing Matters: At April 15, 1998, Consumers had remaining FERC authorization to: 1) issue or guarantee up to $900 million of short-term securities, outstanding at any one time, through 1998; 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 long-term securities with maturities up to 30 years, through November 1998, up to $401 million and $300 million for refinancing purposes and for general corporate purposes, respectively. In May 1998, Consumers used $475 million of FERC authorization by issuing the following long-term debt: 1) $250 million in senior notes; and 2) $225 million for a long-term bank loan. Additionally, in May 1998, Consumers requested authorization to issue from July 1998 through June 2000, up to $950 million of long-term securities for refinancing or refunding purposes and $200 million for general corporate purposes. This authorization would replace and supersede any remaining authorization previously granted to issue long-term securities, except for the $25 million in loan guarantees discussed above. Consumers has an unsecured $425 million credit facility and unsecured lines of credit aggregating $120 million. These facilities are available to finance seasonal working capital requirements and to pay for capital expenditures between long-term financings. At March 31, 1998, the total available amount remaining under these facilities was $300 million. Consumers also has in place a $500 million trade receivables sale program. At March 31, 1998, $160 million in receivables remained available for sale under the program. The following table describes the new issuances of long-term financings which have occurred during 1998 through early May 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 Senior Notes (a) March 2018 6.875 225 Pay down First Mortgage Bonds Senior Notes (a) May 2008 6.2 250 Pay down First Mortgage Bonds and Long-Term Bank Debt Long-Term Bank Debt May 2001-2003 6.05 (b) 225 Pay down Long- Term Bank Debt and general corporate purposes ----- Total $950 ===== (a) The Senior Notes are secured by Consumers First Mortgage Bonds issued contemporaneously in a similar amount. (b) The interest rate is variable; weighted average interest rate upon original issuance was 6.05 percent. The following table describes the retirements of long-term financings which have occurred during 1998 through early May 1998. In Millions Month Interest Principal Retired Maturity Rate (%) Amount -------- -------- ----- ----------- First Mortgage Bonds February 1998 8.75 $248 Long-Term Bank Debt February 1998-1999 6.4 (a) 50 First Mortgage Bonds March 2001-2002 7.5 119 First Mortgage Bonds April 2023 7.375 36 ----- Total $453 ===== (a) The interest rate was variable; weighted average interest rate at December 31, 1997 was 6.4 percent. 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 1999 2000 ---- ---- ---- Consumers Construction $367 $358 $350 Nuclear fuel lease 54 - 1 Capital leases other than nuclear fuel 11 19 16 Michigan Gas Storage 3 3 3 ---- ---- ---- $435 $380 $370 ---- ---- ---- Electric utility operations (a) (b) $320 $265 $255 Gas utility operations (a) 115 115 115 ---- ---- ---- $435 $380 $370 ==== ==== ==== (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 Electric Utility Operating Issues-Electric Environmental Matters above and Note 5. 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' electric retail service is affected by competition. To meet the challenge of competition, 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 to terminate 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, while Detroit Edison has given notice of early termination. Consumers expects FERC to rule on this issue in 1998. 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. 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 orders in October 1997 and in January and February 1998. Ultimately, the MPSC allowed Consumers: 1) to recover 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) to commence the phase-in of direct access in March 1998; 3) to suspend the power supply cost recovery clause; and 4) the MPSC order allows all customers to be free to choose power suppliers on January 1, 2002. See Note 2 for further information regarding the effect of the PSCR suspension on the recovery of MCV Facility capacity charges. The orders also confirm the MPSC's belief that Securitization may be a beneficial mechanism for recovery of Transition Costs while recognizing that Securitization requires state legislation to occur. 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 in the annual true-up proceeding and stranded cost adjusted appropriately. 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. Consumers has filed an application for leave to appeal with the Michigan Supreme Court, which, if granted, would bypass the Court of Appeals, and thereby achieve an earlier resolution of the matter. As directed in the MPSC's February 1998 order, Consumers submitted to the MPSC its draft plan in April 1998 for implementing retail open access. The primary issues addressed in the proposed plan are: 1) the implementation schedule; 2) the retail open access service options available to customers and suppliers; 3) the process and requirements for customers and others to obtain retail open access service; and 4) the roles and responsibilities for Consumers, customers and suppliers. Under the proposed schedule in the draft plan, Consumers will allocate 750 MW of electric capacity for retail open access to customers. In 1998, 300 MW of retail open access for bidding will be open, and an additional 150 MW will open for each year from 1999 to 2001. This plan supports the previous order regarding the phase-in process. Due to the time required to provide an opportunity for interested parties and the MPSC to review the plan, Consumers does not believe retail open access will commence prior to the fourth quarter of 1998. For further information regarding restructuring, see Note 3. 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 March 31, 1998, Consumers had $268 million of generation- related net regulatory assets recorded on its balance sheet, and a net investment in generation facilities of $1.4 billion included in electric plant and property. For further information regarding this issue, see the Electric Business Outlook - 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 and home security. 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, and 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. Computer Modifications for Year 2000 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, or incur plant outages. In 1995, Consumers began modification of its computer software systems by dividing programs requiring modification between critical and noncritical programs. All necessary program modifications are expected to be completed by the year 2000. Consumers devoted significant internal and external resources to these modifications. It will expense anticipated spending for these modifications as incurred, while capitalizing and amortizing the costs for new software over the software's useful life. Consumers does not expect that the cost of these modifications will materially affect its financial position, liquidity or results of operations. Derivatives and Hedges Consumers is exposed to market risk associated with changes in interest rates. Management uses a combination of fixed-rate and variable-rate debt to reduce interest rate exposure. Interest rate swaps may be used to adjust exposure when deemed appropriate, based upon market conditions. Derivatives are principally used as hedges and not for trading purposes. During the first quarter of 1998, trading activities were immaterial. In the case of 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. These strategies attempt to provide and maintain the lowest cost of capital. The fair value of Consumers' financial derivative instruments at March 31, 1998 was immaterial. Additionally, exposure to market risk in the near term would not have a material impact on Consumers consolidated financial position, results of operations or cash flows as of March 31, 1998. For a discussion of accounting policies related to derivative transactions, see Note 4. 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 materially from those discussed in the forward-looking statements include prevailing governmental policies and regulatory actions (including those of FERC and the MPSC) with respect to rates, proposed electric and natural gas industries restructuring, change in industry and rate structure, operation of a nuclear power facility, acquisition and disposal of assets and facilities, operation and construction of plant facilities, operation and construction of natural gas pipeline and storage facilities, recovery of the cost of purchased power or natural gas, decommissioning costs, and present or prospective wholesale and retail competition, among other important factors. The business and profitability of Consumers are also influenced by economic and geographic factors, including political and economic risks, changes in environmental laws and policies, weather conditions, competition for retail and wholesale customers, pricing and transportation of commodities, market demand for energy, inflation or deflation, capital market conditions, and the ability to secure agreement in pending negotiations, among other important factors. All such factors are difficult to predict, contain uncertainties that may materially affect actual results, and may be beyond the control of Consumers. 57 Consumers Energy Company Consolidated Statements of Income (Unaudited)
Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 In Millions Operating Revenue Electric $ 612 $ 620 $2,507 $2,474 Gas 429 498 1,135 1,231 Other 11 9 51 49 ------ ------ ------ ------ 1,052 1,127 3,693 3,754 ------ ------ ------ ------ Operating Expenses Operation Fuel for electric generation 71 69 300 292 Purchased power - related parties 145 151 594 600 Purchased and interchange power 54 62 234 218 Cost of gas sold 264 314 645 718 Other 133 130 544 583 ------ ------ ------ ------ 667 726 2,317 2,411 Maintenance 37 40 166 174 Depreciation, depletion and amortization 110 111 389 374 General taxes 55 57 198 192 ------ ------ ------ ------ 869 934 3,070 3,151 ------ ------ ------ ------ Pretax Operating Income Electric 119 106 444 412 Gas 54 78 130 143 Other 10 9 49 48 ------ ------ ------ ------ 183 193 623 603 ------ ------ ------ ------ Other Income (Deductions) Loss on MCV power purchases (37) - (37) - Dividends and interest from affiliates 4 4 23 17 Accretion income 2 2 7 9 Accretion expense (4) (5) (17) (19) Other, net 1 1 1 (4) ------ ------ ------ ------ (34) 2 (23) 3 ------ ------ ------ ------ Interest Charges Interest on long-term debt 34 35 137 138 Other interest 10 8 38 31 Capitalized interest - - (1) (1) ------ ------ ------ ------ 44 43 174 168 ------ ------ ------ ------ Net Income Before Income Taxes 105 152 426 438 Income Taxes 36 55 133 148 ------ ------ ------ ------ Net Income before cumulative effect of change in accounting principle 69 97 293 290 Cumulative effect of change in accounting for property taxes, net of $23 tax (Note 1) 43 - 43 - ------ ------ ------ ------ Net Income 112 97 336 290 Preferred Stock Dividends 5 7 23 28 Preferred Securities Distributions 5 2 14 8 ------ ------ ------ ------ Net Income Available to Common Stockholder $ 102 $ 88 $ 299 $ 254 ====== ====== ====== ====== The accompanying condensed notes are an integral part of these statements.
58 Consumers Energy Company Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 In Millions Cash Flows from Operating Activities Net income $ 112 $ 97 $ 336 $ 290 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear decommissioning of $13, $13, $50 and $48, respectively) 110 111 389 374 Loss on MCV power purchases 37 - 37 - Capital lease and other amortization 8 8 43 39 Accretion expense 4 5 17 19 Accretion income - abandoned Midland project (2) (2) (7) (9) Deferred income taxes and investment tax credit (10) - 3 46 Undistributed earnings of related parties (11) (9) (48)) (46) Cumulative effect of accounting change (66) - (66) - MCV power purchases (17) (15) (65) (66) Other 2 1 5 3 Changes in other assets and liabilities 120 172 34 80 Net cash provided by operating activities 287 368 678 730 Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (74) (77) (357) (404) Cost to retire property, net (17) (4) (41) (28) Investments in nuclear decommissioning trust funds (13) (13) (50) (48) Other 4 (4) 54 (4) Deferred demand-side management costs - - - (4) Net cash used in investing activities (100) (98) (394) (488) Cash Flows from Financing Activities Proceeds from senior notes 469 - 469 - Retirement of bonds and other long-term debt (418) - (470) (37) Increase (decrease) in notes payable, net (132) (245) 157 50 Payment of common stock dividends (80) - (298) (200) Payment of capital lease obligations (7) (8) (43) (38) Payment of preferred stock dividends (5) (7) (27) (28) Preferred securities distributions (5) (2) (14) (8) Retirement of preferred stock - - (120) - Proceeds from preferred securities - - 116 - Contribution from (return of equity to) stockholder - - (50) - Proceeds from bank loans - - - 23 Net cash used in financing activities (178) (262) (280) (238) Net Increase (Decrease) in Cash and Temporary Cash Investments 9 8 4 4 Cash and Temporary Cash Investments, Beginning of Period 7 4 12 8 Cash and Temporary Cash Investments, End of Period $ 16 $ 12 $ 16 $ 12 The accompanying condensed notes are an integral part of these statements.
59 Consumers Energy Company Consolidated Balance Sheets
ASSETS March 31 March 31 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Plant (At original cost) Electric $6,547 $6,491 $6,412 Gas 2,346 2,322 2,242 Other 24 24 26 ------ ------ ------ 8,917 8,837 8,680 Less accumulated depreciation, depletion and amortization 4,722 4,603 4,378 ------ ------ ------ 4,195 4,234 4,302 Construction work-in-progress 144 145 114 ------ ------ ------ 4,339 4,379 4,416 ------ ------ ------ Investments Stock of affiliates 287 278 295 First Midland Limited Partnership (Note 2) 244 242 235 Midland Cogeneration Venture Limited Partnership (Note 2) 179 171 140 Other 7 7 9 ------ ------ ------ 717 698 679 ------ ------ ------ Current Assets Cash and temporary cash investments at cost, which approximates market 16 7 12 Accounts receivable and accrued revenue, less allowances of $6, $6 and $8, respectively (Note 4) 52 82 61 Accounts receivable - related parties 71 62 62 Inventories at average cost Gas in underground storage 79 197 51 Materials and supplies 64 63 72 Generating plant fuel stock 39 35 44 Postretirement benefits 25 25 25 Deferred income taxes 13 22 21 Prepayments and other 182 161 132 ------ ------ ------ 541 654 480 ------ ------ ------ Non-current Assets Nuclear decommissioning trust funds 518 486 401 Postretirement benefits 395 404 427 Abandoned Midland Project 88 93 108 Other 235 235 239 ------ ------ ------ 1,236 1,218 1,175 ------ ------ ------ Total Assets $6,833 $6,949 $6,750 ====== ====== ====== /TABLE 60
STOCKHOLDERS' INVESTMENT AND LIABILITIES March 31 March 31 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Capitalization Common stockholder's equity Common stock $ 841 $ 841 $ 841 Paid-in capital 452 452 504 Revaluation capital 65 58 36 Retained earnings since December 31, 1992 385 363 385 ------ ------ ------ 1,743 1,714 1,766 Preferred stock 238 238 356 Company-obligated mandatorily redeemable preferred securities of: Consumers Power Company Financing I (a) 100 100 100 Consumers Energy Company Financing II (a) 120 120 - Long-term debt 1,722 1,369 1,652 Non-current portion of capital leases 73 74 97 ------ ------ ------ 3,996 3,615 3,971 ------ ------ ------ Current Liabilities Current portion of long-term debt and capital leases 284 579 348 Notes payable 245 377 88 Accrued taxes 232 244 190 Accounts payable 128 171 164 Accounts payable - related parties 82 79 70 Power purchases (Note 2) 47 47 47 Accrued interest 20 32 25 Accrued refunds 11 12 6 Other 132 136 147 ------ ------ ------ 1,181 1,677 1,085 ------ ------ ------ Non-current Liabilities Deferred income taxes 668 688 633 Postretirement benefits 480 489 508 Power purchases (Note 2) 157 133 167 Deferred investment tax credit 147 149 157 Regulatory liabilities for income taxes, net 61 54 75 Other 143 144 154 ------ ------ ------ 1,656 1,657 1,694 ------ ------ ------ Commitments and Contingencies (Notes 2, 3, 5 and 6) Total Stockholders' Investment and Liabilities $6,833 $6,949 $6,750 ====== ====== ====== (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. For further discussion, see Note 4. The accompanying condensed notes are an integral part of these statements.
61 Consumers Energy Company Consolidated Statements of Common Stockholder's Equity (Unaudited)
Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 In Millions Common Stock At beginning and end of period $ 841 $ 841 $ 841 $ 841 ------ ------ ------ ------ Other Paid-in Capital At beginning of period 452 504 504 504 Preferred stock required - - (2) - Return of stockholder's contribution - - (50) - ------ ------ ------ ------ At end of period 452 504 452 504 ------ ------ ------ ------ Revaluation Capital At beginning of period 58 37 36 29 Change in unrealized investment-gain (loss) (a) 7 (1) 29 7 ------ ------ ------ ------ At end of period 65 36 65 36 ------ ------ ------ ------ Retained Earnings At beginning of period 363 297 385 331 Net income (a) 112 97 336 290 Common stock dividends declared (80) - (299) (200) Preferred stock dividends declared (5) (7) (23) (28) Preferred securities distributions (5) (2) (14) (8) ------ ------ ------ ------ At end of period 385 385 385 385 ------ ------ ------ ------ Total Common Stockholder's Equity $1,743 $1,766 $1,743 $1,766 ====== ====== ====== ====== (a) Disclosure of Comprehensive Income: Revaluation capital Unrealized investment-gain (loss), net of tax of $4, $(1), $16 and $4, respectively $ 7 $ (1) $ 29 $ 7 Net income 112 97 336 290 ---- ---- ---- ---- Total Comprehensive Income $119 $ 96 $365 $297 ==== ==== ==== ==== The accompanying condensed notes are an integral part of these statements.
62 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 the Consumers 1997 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 Statement of Financial Accounting Standards No. 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: 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 Twelve Months Ended March 31 1998 1997 1998 1997 ----- ----- ----- ----- Pretax operating income $10 $ 8 $47 $46 Income taxes and other 3 2 14 14 Net income $ 7 $ 6 $33 $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 minimum 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 over the 1996-2004 time period. Because the MPSC allowed Consumers to suspend the PSCR process as part of the electric industry restructuring order (see Note 3), Consumers expects to recover a portion of the future increases in approved capacity charges through an adjustment to the frozen PSCR charge. Consumers recognized a loss in 1992 for the present value of the estimated future underrecoveries of power costs under the PPA. At March 31, 1998 and December 31,1997, the after-tax present value of the PPA liability totaled $133 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 $3 million, partially offset by after-tax cash underrecoveries of $11 million. The undiscounted after-tax amount associated with the liability totaled $182 million at March 31, 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 three months of 1998 the MCV Facility was available 99 percent of the time, resulting in $5 million over anticipated after-tax cash underrecoveries. Consumers believes it will continue to experience after-tax cash underrecoveries associated with the PPA in amounts as those shown below. In Millions 1998 1999 2000 2001 2002 ---- ---- ---- ---- ---- Estimated cash underrecoveries, net of tax $28 $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. On the same day, 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. 3: 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 Note 2) and to accelerate recovery of 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 program is limited to 650 MW of load, of which 100 MW is available solely to direct-access customers for at least 18 months. The Commissions' order allowed existing special contracts to fill 410 MW of the load. The remaining 140 MW of the 650 MW load could be filled by either special contracts or direct access loads. The load was filled by new special contracts signed subsequent to the order. According to the MPSC order, Consumers held a lottery in April 1997 to select the customers to purchase 100 MW by direct access. Direct access for a portion of this 100 MW began in late 1997. Consumers expects the remaining amount of direct access to begin 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. Consumers filed with the Michigan Supreme Court seeking leave to appeal that ruling. 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 orders in October 1997 and in January and February 1998. Ultimately, the MPSC allowed Consumers: 1) to recover 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) to commence the phase-in of direct access in March 1998; 3) to suspend the power supply cost recovery clause; and 4) the MPSC order allows all customers to be free to choose power suppliers on January 1, 2002. See Note 2 for further information regarding the effect of the PSCR suspension on the recovery of MCV Facility capacity charges. The orders also confirm the MPSC's belief that Securitization may be a beneficial mechanism for recovery of Transition Costs while recognizing that Securitization requires state legislation to occur. 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 in the annual true-up proceeding and stranded cost adjusted appropriately. 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. Consumers has filed an application for leave to appeal with the Michigan Supreme Court, which, if granted, would bypass the Court of Appeals, and thereby achieve an earlier resolution of the matter. As directed in the MPSC's February 1998 order, Consumers submitted to the MPSC its draft plan in April 1998 for implementing retail open access. The primary issues addressed in the proposed plan are: 1) the implementation schedule; 2) the retail open access service options available to customers and suppliers; 3) the process and requirements for customers and others to obtain retail open access service; and 4) the roles and responsibilities for Consumers, customers and suppliers. Under the proposed schedule in the draft plan, Consumers will allocate 750 MW of electric capacity for retail open access to customers. In 1998, 300 MW of retail open access for bidding will be open, and an additional 150 MW will open for each year from 1999 to 2001. This plan supports the previous order regarding the phase-in process. Due to the time required to provide an opportunity for interested parties and the MPSC to review the plan, Consumers does not believe retail open access will commence prior to the fourth quarter of 1998. For further information see Electric Business Outlook - Application of SFAS 71 in the MD&A. 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 will be selected on a first-come, first-served basis, up to a limit of 100,000 customers on April 1, 1998. As of May 8, 1998 approximately 7,500 customers chose alternative gas suppliers, representing approximately 10 bcf of gas load. Of these alternative gas suppliers, one was a CMS Energy affiliate. Up to 100,000 more customers will be added on 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. To minimize the risk of exposure to higher gas costs, Consumers currently has contracts in place at known prices covering 75 percent of its 1998 requirements, 35 percent of its 1999 requirements and 25 percent of its 2000 requirements. Additional forward coverage is currently under review. Gas Proceedings: In 1995, the MPSC issued an order regarding a $44 million (excluding interest) gas supply contract pricing dispute between Consumers and certain gas producers. The order stated that Consumers was not obligated to seek prior approval of market-based pricing changes that Consumers implemented under the contracts in question. The Court of Appeals upheld the MPSC order. The producers sought leave to appeal with the Michigan Supreme Court. Their request is still pending. Consumers believes the MPSC order correctly concludes that the producers' theories are without merit and will vigorously oppose any claims they may raise, but cannot predict the outcome of this issue. Resolution of the issues discussed in this Note is not expected to materially affect Consumers' financial position, liquidity or results of operations. 4: Short-Term Financings and Capitalization Authorization: At April 15, 1998, Consumers had remaining FERC authorization to: 1) issue or guarantee up to $900 million of short-term securities, outstanding at any one time, through 1998; 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 long- term securities with maturities up to 30 years, through November 1998, up to $401 million and $300 million for refinancing purposes and for general corporate purposes, respectively. In May 1998, Consumers used $475 million of FERC authorization by issuing the following long-term debt: 1) $250 million in senior notes; and 2) $225 million for a long-term bank loan. Additionally, in May 1998, Consumers requested authorization to issue from July 1998 through June 2000, up to $950 million of long-term securities for refinancing or refunding purposes and $200 million for general corporate purposes. This authorization would replace and supersede any remaining authorization previously granted to issue long-term securities, except for the $25 million in loan guarantees discussed above. Short-Term Financings: Consumers has an unsecured $425 million credit facility and unsecured lines of credit aggregating $120 million. These facilities are available to finance seasonal working capital requirements and to pay for capital expenditures between long-term financings. At March 31, 1998, a total of $245 million was outstanding at a weighted average interest rate of 6.2 percent, compared with $88 million outstanding at March 31, 1997, at a weighted average interest rate of 6.8 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 March 31, 1998 and 1997, receivables sold under the program totaled $340 million and $398 million, respectively. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold. Derivatives: Consumers entered into interest rate swap agreements (derivatives) to exchange variable rate interest payment obligations for fixed rate obligations. These swaps attempt to reduce the impact of interest rate fluctuations. To qualify for hedge accounting, derivatives must meet the following criteria initially: 1) the item to be hedged exposes the enterprise to interest rate risk; and 2) the derivative reduces that exposure and is designated as a hedge. The hedged amounts are used to measure interest to be paid or received and do not represent the exposure to principal loss. Consumers accrues the difference between the amounts paid and received under the swaps and records it as an adjustment to interest expense over the life of the hedged agreement. Derivative instruments contain credit risk if the counterparties, including financial institutions, fail to perform under the agreements. Consumers minimizes such risk by performing financial credit reviews using, among other things, publicly available credit ratings of such counterparties. The risk of nonperformance by the counterparties is considered remote. Capital Stock: In 1996, 4 million shares of 8.36 percent Trust Preferred Securities were issued and sold through Consumers Power Company Financing I, a wholly owned business trust consolidated with Consumers. Net proceeds from the sale totaled $97 million. In 1997, 4.8 million shares of 8.2 percent Trust Preferred Securities were issued and sold through Consumers Energy Company Financing II, a wholly owned business trust consolidated with Consumers. Net proceeds from the sale totaled $116 million. Consumers formed both trusts for the sole purpose of issuing the tax deductible Trust Preferred Securities. Consumers' obligations with respect to the Trust Preferred Securities under the notes, under the indenture through which Consumers issued the notes, under Consumers' guarantee of the Trust Preferred Securities, and under the declaration by the trusts, taken together, constitute a full and unconditional guarantee by Consumers of the trusts' obligations under the Trust Preferred Securities. For additional information, see footnote (a) on the Consolidated Balance Sheets. Long-Term Financings: The following table describes the new issuances of long-term financings which have occurred during 1998 through early May 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 Senior Notes (a) March 2018 6.875 225 Pay down First Mortgage Bonds Senior Notes (a) May 2008 6.2 250 Pay down First Mortgage Bonds and Long-Term Bank Debt Long-Term Bank Debt May 2001-2003 6.05 (b) 225 Pay down Long-Term Bank Debt and general corporate purposes ----- Total $950 ===== (a) The Senior Notes are secured by Consumers First Mortgage Bonds issued contemporaneously in a similar amount. (b) The interest rate is variable; weighted average interest rate upon original issuance was 6.05 percent. The following table describes the retirements of long-term financings which have occurred during 1998 through early May 1998. In Millions Month Interest Principal Retired Maturity Rate (%) Amount -------- --------- -------- ----------- First Mortgage Bonds February 1998 8.75 $248 Long-Term Bank Debt February 1998-1999 6.4 (a) 50 First Mortgage Bonds March 2001-2002 7.5 119 First Mortgage Bonds April 2023 7.375 36 ----- Total $453 ===== (a) The interest rate was variable; weighted average interest rate at December 31, 1997 was 6.4 percent. Consumers had an unsecured, variable rate long-term bank loan with an outstanding balance at March 31, 1998 and 1997 of $350 million and $400 million, respectively. At March 31, 1998 and 1997 the loan carried a weighted average interest rate of 6.3 percent and 6.0 percent, respectively. In May 1998, Consumers refinanced this term loan with a new $225 million unsecured long-term loan, and issued $250 million of senior notes due 2008, at an interest rate of 6.2 percent to cover the remaining $125 million refinancing. The balance of the new senior notes, $125 million, is to be used to retire first mortgage bonds and for general corporate purposes. Under the provisions of its Articles of Incorporation at March 31, 1998, Consumers had $302 million of unrestricted retained earnings available to pay common dividends. In January 1998, Consumers declared an $80 million common dividend paid in February 1998. 5: Commitments and 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 in-process 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. The EPA recently revised these standards. The revisions may further limit small particulate and ozone related emissions. Consumers supports the bipartisan effort in the U.S. Congress to delay implementation of the revised standards until the relationship between the new standards and health improvements is established scientifically. In October 1997, pursuant to recommendations from the Ozone Transport Assessment Group and the requests of several Northeastern states, the EPA proposed that the State of Michigan impose additional nitrogen oxide limits on fossil-fueled emitters, such as Consumers' generating units. The limits are an effort to reduce statewide nitrogen oxide emissions by 32 percent, as early as 2002. The State of Michigan will have one year to review and challenge the proposed recommendations, and one year after that to implement final requirements. 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 $210 million, plus an additional amount totaling $10 million per year for operation and maintenance costs. Consumers may need an equivalent amount to comply with the new small particulate standards. The State of Michigan has objected to the extent of the proposed EPA emission reductions. If the State of Michigan's position were to be adopted by the EPA, 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 March 31, 1998, Consumers has accrued $3 million for its estimated Superfund liability. 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 the company 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. These estimates are based on undiscounted 1998 costs. As of March 31, 1998, Consumers has accrued a liability of $48 million and has established a regulatory asset for approximately the same amount. Any significant change in assumptions, such as remediation technique, 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 is continuing discussions with, or has initiated a lawsuit against, certain insurance companies regarding coverage for some or all of the costs that it may incur for these sites. Capital Expenditures: Consumers estimates capital expenditures, including new lease commitments, of $435 million for 1998, $380 million for 1999, and $370 million for 2000. For further information, see the Capital Expenditures Outlook section in the MD&A. Other: 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 have re-filed their claims with the trial court. Consumers intends to vigorously defend these cases, but is unable to predict the outcome. As of March 31, 1998, Consumers had 6 individual stray voltage lawsuits, unrelated to the cases above, awaiting trial court action, down from 12 lawsuits as reported at year end 1997. 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). The parties are awaiting the court's decision on Consumers' and CMS Energy's motion for summary judgment and/or dismissal of the complaint. Consumers believes the lawsuit is without merit and will vigorously defend against it, but cannot predict the outcome of this matter. In addition to the matters disclosed in these Notes, 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. 6: 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 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. As of March 31, 1998 Consumers 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 forty to fifty day planned outage at Palisades commenced on April 24, 1998 for refueling and maintenance. Consumers will replace a total of sixty 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. 7: Supplemental Cash Flow Information For purposes of the Consolidated Statements of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Other cash flow activities and non-cash investing and financing activities were: In Millions Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 ----- ----- ----- ----- Cash transactions Interest paid (net of amounts capitalized) $ 53 $ 48 $170 $160 Income taxes paid (net of refunds) 3 1 119 115 Non-cash transactions Nuclear fuel placed under capital lease $ 5 $ 3 $ 6 $ 31 Other assets placed under capital leases 2 2 7 4 72 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 March 31, 1998 and 1997, and the related consolidated statements of income, common stockholder's equity and cash flows for the three-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, May 11, 1998. 73 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. 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 Consumers has a number of lawsuits relating to so-called stray voltage, which results when small electrical currents present in grounded electric systems are diverted from their intended path. Pursuant to a December 1997 Michigan Supreme Court order that remanded for further proceedings the March 1994 trial court decision, 165 plaintiffs were permitted to refile individual lawsuits. Of the 165 potential plaintiffs, only 21 refiled their claims prior to the court ordered deadline. Consumers presently intends vigorously to defend against these lawsuits, but is unable to predict the outcome. As of March 31, 1998, Consumers had 6 individual stray voltage lawsuits, unrelated to the cases above, awaiting trial court action, down from approximately 12 lawsuits at year end 1997. CMS Energy and Consumers Antitrust Litigation In October 1997, Indeck Energy Services, Inc., and an affiliate, Indeck Saginaw Limited Partnership, independent power producers, filed a lawsuit against CMS Energy and Consumers in the United States District Court for the Eastern District of Michigan. The suit alleges antitrust violations relating to contracts that Consumers entered into with some of its large customers as well as allegations that Consumers used its monopoly power to interfere with plaintiffs access to power facilities and business opportunities. The plaintiffs claim damages of $100 million (which can be trebled in antitrust cases as provided by law). The parties are presently awaiting the court's written opinion on CMS Energy's and Consumers' motions for summary judgment and or dismissal of the complaint. CMS Energy and Consumers believe the lawsuit is entirely without merit and will vigorously defend against it, but cannot predict the outcome of this matter. Consumers' Joint Lawsuit Against DOE: Under the Nuclear Waste Policy Act of 1982, by January 31, 1998 the DOE was required to begin accepting deliveries of spent nuclear fuel for disposal, even if a permanent storage repository was not then operational. Utilities, including Consumers, and their customers have been prepaying the costs of DOE transport and disposal through fees based on electric generation by their nuclear plants. In response to the DOE's declaration in December 1996 that it would not begin to accept spent nuclear fuel deliveries in 1998, Consumers, other utilities and states filed suit. The parties sought, among other relief, an order requiring the DOE to develop a program to begin acceptance of spent nuclear fuel by January 31, 1998. In November 1997, the United States Court of Appeals decided that DOE could not engage in a contract interpretation that violated the act and that the contract between the DOE and the utilities provided a potentially adequate remedy if the DOE failed to fulfill its obligations. In February 1998, utilities and state regulatory parties to the lawsuits filed various motions designed to persuade the appellate court to grant further relief against DOE. In May 1998, the court issued an order granting the motion to consolidate the various lawsuits and denied all other motions. Further litigation before the courts or administrative proceedings before the DOE on this subject is likely as the utilities and their state regulatory agencies strive to secure the benefits of the Nuclear Waste Policy Act. Item 6. Exhibits and Reports on Form 8-K (a) List of Exhibits (4)(a) - Consumers: First Supplemental Indenture dated as of May 1, 1998, between Consumers and The Chase Manhattan Bank, as Trustee (4)(b) - Consumers: Seventy-second Supplemental Indenture dated as of May 1, 1998, between Consumers and The Chase Manhattan Bank, as Trustee (12) - CMS Energy: Statements regarding computation of Ratio of Earnings to Fixed Charges (15) - CMS Energy: Letter of Independent Public Accountant (18) - Consumers: Letter re change in accounting principles (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 There have been no Current Reports on Form 8-K since the filing of CMS Energy Corporation's and Consumers Energy Company's Annual Report on Form 10-K for the year ended December 31, 1997. 75 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: May 15, 1998 By A. M. Wright____________________ Alan M. Wright Senior Vice President, Chief Financial Officer and Treasurer CONSUMERS ENERGY COMPANY (Registrant) Dated: May 15, 1998 By A. M. Wright ____________________ Alan M. Wright Senior Vice President and Chief Financial Officer EX-4 2 CONSUMERS FIRST SUPPLEMENTAL INDENTURE FIRST SUPPLEMENTAL INDENTURE dated as of May 1, 1998 ____________________ This First Supplemental Indenture, dated as of the 1st day of May, 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 banking corporation (hereinafter called the "Trustee") and having its principal Corporate Trust 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 First Supplemental Indenture in order to supplement and amend the Original Indenture by, among other things, establishing the form and terms of two series of Notes to be known as the Company's "Senior Notes, 6.20%Reset Put Securities, Series A, Due 2008" (the "Series A REPS"), and the Company's "Senior Notes, 6.20%Reset Put Securities, Series B, Due 2008" (the "Series B REPS" and collectively with the Series A REPS, the "REPS") Company's providing for the issuance of the REPS and amending and adding certain provisions thereof for the benefit of the Holders of the REPS; and WHEREAS, the Company and the Trustee desire to enter into this First 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 First Supplemental Indenture; and WHEREAS, all things necessary to make this First 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 FIRST SUPPLEMENTAL INDENTURE WITNESSETH: For and in consideration of the premises and the purchase of the REPS 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 REPS, as follows: ARTICLE I STANDARD PROVISIONS; DEFINITIONS SECTION 1.01. STANDARD PROVISIONS. The Original Indenture together with this First 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 Exhibits A or B hereto are defined in the Indenture and are used herein with the same meanings as in the Indenture. ARTICLE II DESIGNATION AND TERMS OF THE REPS; FORMS SECTION 2.01. ESTABLISHMENT OF SERIES. There are hereby created a series of Notes to be known and designated as the "Senior Notes, 6.20% Reset Put Securities, Series A, Due 2008" and "Senior Notes, 6.20% Reset Put Securities, Series B, Due 2008, respectively, each such series limited in aggregate principal amount (except as contemplated in Section 2.05(c) of the Indenture) to $250,000,000. The form and terms of the REPS are established in the form of Notes attached hereto as Exhibits A and B. ARTICLE III ADDITIONAL EVENTS OF DEFAULT WITH RESPECT TO THE REPS SECTION 3.01 DEFINITION. All of the events specified in clauses (1) through (6) of Section 8.01(a) of the Original Indenture shall be "Events of Default" with respect to the REPS. In addition, the following event that shall have occurred and be continuing shall be an additional Event of Default with respect to each series of REPS: (7) default in the payment of the Put Price (as defined in each form of REPS attached hereto) at or prior to the Coupon Reset Date. ARTICLE IV MANDATORY PUT SECTION 4.01. MANDATORY PUT OPTION OF THE TRUSTEE. The Trustee agrees to exercise the Mandatory Put on behalf of the Holders of the REPS as provided in each form of REPS set forth in Exhibits A and B hereto and to take such other action as is contemplated in such form to be taken by the Trustee. ARTICLE V SUPPLEMENTAL INDENTURES SECTION 5.01. EFFECT ON ORIGINAL INDENTURE. This First Supplemental Indenture is a supplement to the Original Indenture. As supplemented by this First Supplemental Indenture, the Original Indenture is in all respects ratified, approved and confirmed, and the Original Indenture and this First Supplemental Indenture shall together constitute one and the same instrument. ARTICLE VI MISCELLANEOUS SECTION 6.01. COUNTERPARTS. This First 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 6.02. 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 First Supplemental Indenture. SECTION 6.03. GOVERNING LAW. This First 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 First 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 (Corporate Seal) THE CHASE MANHATTAN BANK, AS TRUSTEE By: /s/ Glenn G. McKeever ________________________________ Name: Glenn G. McKeever Title: Vice President Attest: /s/ Wanda Eiland Wanda Eiland Trust Officer (Corporate Seal) STATE OF MICHIGAN ) )SS. COUNTY OF WAYNE ) On th 1st day of May, 1998, before me personally came ALAN M. WRIGHT, to me known, who, being by me duly sworn, did depose and say that he resides at Ann Arbor, Michigan; that he is Senior Vice President and Chief Financial Officer of Consumers Energy Company, a Michigan corporation, and which executed the foregoing First Supplemental Indenture that he knows the seal of said corporation; that the seal affixed to said First Supplemental Indenture is such corporate seal; that it was so affixed by authority of the Board of Directors of said corporation; and that he signed his name thereto by like authority. /s/ Sherry Ann White - ------------------------------ Sherry Ann White Notary Public Wayne County, Michigan My Commission Expires: March 7, 2002 EXHIBIT A REGISTERED REGISTERED THIS NOTE IS A GLOBAL NOTE REGISTERED IN THE NAME OF THE DEPOSITARY (REFERRED TO HEREIN) OR A NOMINEE THEREOF AND, UNLESS AND UNTIL IT IS EXCHANGED IN WHOLE OR IN PART FOR THE INDIVIDUAL NOTES REPRESENTED HEREBY, THIS GLOBAL NOTE MAY NOT BE TRANSFERRED EXCEPT AS A WHOLE BY THE DEPOSITARY TO A NOMINEE OF THE DEPOSITARY OR BY A NOMINEE OF THE DEPOSITARY TO THE DEPOSITARY OR ANOTHER NOMINEE OF THE DEPOSITARY OR BY THE DEPOSITARY OR ANY SUCH NOMINEE TO A SUCCESSOR DEPOSITARY OR A NOMINEE OF SUCH SUCCESSOR DEPOSITARY. UNLESS THIS GLOBAL NOTE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITORY TRUST COMPANY (55 WATER STREET, NEW YORK, NEW YORK), TO THE TRUSTEE FOR REGISTRATION OF TRANSFER, EXCHANGE OR PAYMENT, AND ANY CERTIFICATE IS REGISTERED IN THE NAME OF CEDE & CO. OR SUCH OTHER NAME AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITARY TRUST COMPANY (AND ANY PAYMENT IS MADE TO CEDE & CO., OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITARY TRUST COMPANY) ANY TRANSFER, PLEDGE OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL SINCE THE REGISTERED OWNER HEREOF, CEDE & CO., HAS AN INTEREST THEREIN. THIS NOTE (OR ITS PREDECESSOR) HAS NOT BEEN REGISTERED UNDER THE U.S. SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED WITHIN THE UNITED STATES OR TO, OR FOR THE ACCOUNT OR BENEFIT OF, U.S. PERSONS, EXCEPT AS SET FORTH IN THE SECOND SENTENCE HEREOF. BY ITS ACQUISITION HEREOF OR OF A BENEFICIAL INTEREST HEREIN, THE HOLDER (1) REPRESENTS THAT (A) IT IS A "QUALIFIED INSTITUTIONAL BUYER" (AS DEFINED IN RULE 144A UNDER THE SECURITIES ACT) (A "QIB"), (B) IT IS ACQUIRING THIS NOTE IN AN OFFSHORE TRANSACTION IN COMPLIANCE WITH REGULATION S UNDER THE SECURITIES ACT OR (C) IT IS AN INSTITUTIONAL "ACCREDITED INVESTOR" (AS DEFINED IN RULE 501(A) (1), (2), (3) OR (7) OF REGULATION D UNDER THE SECURITIES ACT (AN "IAI"), (2) AGREES THAT IT WILL NOT RESELL OR OTHERWISE TRANSFER THIS NOTE EXCEPT (A) TO CONSUMERS OR ANY OF ITS SUBSIDIARIES, (B) TO A PERSON WHOM THE SELLER REASONABLY BELIEVES IS A QIB PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QIB IN A TRANSACTION MEETING THE REQUIREMENTS OF RULE 144A, (C) IN AN OFFSHORE TRANSACTION MEETING THE REQUIREMENTS OF RULE 903 OR 904 OF THE SECURITIES ACT, (D) IN A TRANSACTION MEETING THE REQUIREMENTS OF RULE 144 UNDER THE SECURITIES ACT, (E) TO AN IAI THAT, PRIOR TO SUCH TRANSFER, FURNISHES THE TRUSTEE A SIGNED LETTER CONTAINING CERTAIN REPRESENTATIONS AND AGREEMENTS RELATING TO THE TRANSFER OF THIS NOTE (THE FORM OF WHICH CAN BE OBTAINED FROM THE TRUSTEE) AND, IF SUCH TRANSFER IS IN RESPECT OF AN AGGREGATE PRINCIPAL AMOUNT OF NOTES LESS THAN $250,000, AN OPINION OF COUNSEL ACCEPTABLE TO CONSUMERS THAT SUCH TRANSFER IS IN COMPLIANCE WITH THE SECURITIES ACT, (F) IN ACCORDANCE WITH ANOTHER EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT (AND BASED UPON AN OPINION OF COUNSEL ACCEPTABLE TO CONSUMERS) OR (G) PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT AND, IN EACH CASE, IN ACCORDANCE WITH THE APPLICABLE SECURITIES LAWS OF ANY STATE OF THE UNITED STATES OR ANY OTHER APPLICABLE JURISDICTION AND (3) AGREES THAT IT WILL DELIVER TO EACH PERSON TO WHOM THIS NOTE OR AN INTEREST HEREIN IS TRANSFERRED A NOTICE SUBSTANTIALLY TO THE EFFECT OF THIS LEGEND. AS USED HEREIN, THE TERMS "OFFSHORE TRANSACTION", "U.S. PERSONS" AND "UNITED STATES" HAVE THE MEANINGS GIVEN TO THEM BY RULE 902 OF REGULATION S UNDER THE SECURITIES ACT. THE INDENTURE CONTAINS A PROVISION REQUIRING THE TRUSTEE TO REFUSE TO REGISTER ANY TRANSFER OF THIS NOTE IN VIOLATION OF THE FOREGOING. CONSUMERS ENERGY COMPANY SENIOR NOTE, 6.20% RESET PUT SECURITIES, SERIES A, DUE 2008 CUSIP: NUMBER: 1 ORIGINAL ISSUE DATE: May 1, 1998 PRINCIPAL AMOUNT: INTEREST RATE: To but excluding MATURITY DATE: May 1, 2008, subject May 1, 2003, 6.20%. From and to mandatory repayment of principal including May 1, 2003, at the to the existing Holder hereof Coupon Reset Rate, as described pursuant to the Call Option or on the reverse of this Note. Mandatory Put described on the reverse of this Note. CONSUMERS ENERGY COMPANY, a corporation of the State of Michigan (the "COMPANY"), for value received hereby promises to pay to Cede & Co. or registered assigns, the principal sum of DOLLARS on the Maturity Date set forth above, and to pay interest thereon from May 1, 1998 or from the most recent Interest Payment Date to which interest has been paid or duly provided for, semiannually in arrears on May 1 and November 1 in each year, commencing November 1, 1998, at the per annum Interest Rate set forth above, until but excluding May 1, 2003 (the "Coupon Reset Date"), whereupon the interest rate will be reset to the Coupon Reset Rate as set forth on the reverse hereof (provided that during the continuation of a Registration Default, as defined in the Registration Rights Agreement dated as of May 1, 1998 among the Company, Morgan Stanley & Co. Incorporated, Chase Securities Inc., First Chicago Capital Markets, Inc. and Salomon Brothers Inc. (i) the Interest Rate shall be 6.45% per annum, until but excluding the Coupon Reset Date, and (ii) shall be a rate equal to the sum of the Coupon Reset Rate and .25% from and after the Coupon Reset Date). No interest shall accrue on the Maturity Date, so long as the principal amount of this Global Note is paid on the Maturity Date. The interest so payable and punctually paid or duly provided for on any such Interest Payment Date will, as provided in the Indenture, be paid to the Person in whose name this Note is registered at the close of business on the Regular Record Date for such interest, which shall be the April 15 or October 15, as the case may be, next preceding such Interest Payment Date; provided that interest payable on the Maturity Date set forth above or, if applicable, acceleration, shall be payable to the Person to whom principal shall be payable. Except as otherwise provided in the Indenture (as defined below), 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 and shall be paid to the Person in whose name this Note is 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 Noteholders not fewer than ten days prior to such Special Record Date. Unless the certificate of authentication hereon has been executed by the Trustee, directly or through an Authenticating Agent by manual signature of an authorized officer, this Global Note shall not be entitled to any benefit under the Indenture or be valid or obligatory for any purpose. All terms used in this Global Note which are defined in the Indenture shall have the meanings assigned to them in the Indenture unless otherwise indicated herein. IN WITNESS WHEREOF, the Company has caused this instrument to be duly executed. CONSUMERS ENERGY COMPANY Dated: May 1, 1998 By: _________________________________ Title: Senior Vice President and Chief Financial Officer Attest: _____________________________ Title: Vice President and Secretary TRUSTEE'S CERTIFICATE OF AUTHENTICATION This Note is one of the Notes of the series herein designated, described or provided for in the within-mentioned Indenture. THE CHASE MANHATTAN BANK, As Trustee By: _____________________________ Authorized Officer This Global Note is a global security in respect of a duly authorized issue of Senior Notes, 6.20% Reset Put Securities, Series A, Due 2008, (the "NOTES OF THIS SERIES", which term includes any Global Notes representing such Notes) of the Company issued and to be issued under an Indenture dated as of February 1, 1998, between the Company and The Chase Manhattan Bank, as trustee (the "TRUSTEE", which term includes any successor Trustee under the Indenture) and indentures supplemental thereto (collectively, the "INDENTURE"). Under the Indenture, one or more series of notes may be issued and, as used herein, the term "Notes" refers to the Notes of this Series and any other outstanding series of Notes. Reference is hereby made to the Indenture for a more complete statement of the respective rights, limitations of rights, duties and immunities thereunder of the Company, the Trustee and the Noteholders and of the terms upon which the Notes are and are to be authenticated and delivered. This Global Note has been issued in respect of the series designated on the first page hereof, limited in aggregate principal amount to $250,000,000. Prior to the Release Date (as hereinafter defined), the Notes will be secured by first mortgage bonds (the "SENIOR NOTE FIRST 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 successor trustee to City Bank Farmers Trust Company (the "MORTGAGE TRUSTEE"), as supplemented and modified (collectively, the "FIRST MORTGAGE"). Reference is made to the First Mortgage and the Indenture for a description of the rights of the Trustee as holder of the Senior Note First 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 First 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 Note First 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 Note First Mortgage Bonds) issued under the First Mortgage have been retired through payment, redemption or otherwise at, before or after the maturity thereof (the "Release Date"), the Senior Note First 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 Note First Mortgage Bonds held by the Trustee, but in no event prior to the Release Date to amount less than the aggregate outstanding principal amount of the series of Notes initially issued contemporaneously with such Senior Note First Mortgage Bonds. Each Note of this Series shall be dated and issued as of the date of its authentication by the Trustee and shall bear an Original Issue Date. Each Note or Global Note issued upon transfer, exchange or substitution of such Note or Global Note shall bear the Original Issue Date of such transferred, exchanged or substituted Note or Global Note, as the case may be. The Notes will not be subject to redemption prior to the Maturity Date. On the Coupon Reset Date (i) if all of the Notes are purchased on such date by the Callholder pursuant to its Call Option (as defined below), the Notes shall bear interest from and including the Coupon Reset Date to but excluding Maturity Date at the Coupon Reset Rate determined in accordance with the Coupon Reset Process described below (subject to payment of additional interest of .25% per annum during the continuation of a Registration Default as provided on the face hereof), or (ii) the Notes shall be purchased by the Company pursuant to the exercise of the Mandatory Put (as defined below) by the Trustee on behalf of the Holders of the Notes. The Notes will mature on the Maturity Date. On the Coupon Reset Date, the Holder hereof will be entitled to receive 100% of the principal amount hereof from either (i) the Callholder (who shall make such payment to the Trustee for the benefit of the Holders), if the Callholder purchases this Note pursuant to the Call Option, or (ii) in the event the Callholder does not exercise the Call Option or fails for any reason to pay the Call Price (as defined below) to the Trustee when required, from Consumers following the exercise of the Mandatory Put by the Trustee for and on behalf of the holders of the Notes. By giving notice to the Trustee as described below (the "Call Notice"), the Company, as initial Callholder, or any assignee of the Call Option as Callholder, has the right to purchase the Notes, in whole but not in part, on the Coupon Reset Date (the "Call Option"), at a price equal to 100% of the principal amount thereof (the "Call Price") (interest accrued to but excluding the Coupon Reset Date will be paid by the Company on such date to the Holder hereof on the most recent Regular Record Date). The Callholder will be required to give the Call Notice to the Trustee, in writing, prior to 4:00 p.m., New York City time, no later than ninety calendar days prior to the Coupon Reset Date. The Call Notice must contain the requisite delivery details, including the identity of the Callholder's account with The Depository Trust Company ("DTC"). If the Callholder exercises the Call Option, (a) not later than 2:00 p.m., New York City time, on the Business Day prior to the Coupon Reset Date the Callholder shall pay the amount of the Call Price in immediately available funds to the Trustee for payment thereof to the Holders of the Notes (including, if applicable, the Holder hereof) on the Coupon Reset Date and (ii) the Holder hereof will be required to deliver and will be deemed to have delivered this Note to the Callholder against payment therefor on the Coupon Reset Date through the facilities of DTC. The Call Notice may be revoked by the Callholder at any time prior to 2:00 p.m., New York City time, on the Business Day prior to the Coupon Reset Date. The Callholder is not required to exercise the Call Option, and no Holder of the Notes or any interest therein shall have any right or claim against the Callholder as a result of the Callholder's decision whether or not to exercise the Call Option or performance or non-performance of its obligations with respect thereto. The Callholder may at any time assign its rights and obligations under its Call Option; provided, however, that (i) such rights and obligations are assigned in whole and not in part and (ii) it provides the Trustee and the Company with notice of such assignment contemporaneously with such assignment. Upon receipt of notice of assignment, the Trustee will treat the assignee as Callholder for all purposes hereunder. The Callholder may assign its rights under the Call Option without notice to, or consent of, the Holders of the Notes (including, if applicable, the Holder hereof). The Call Option provides for certain circumstances under which such Call Option may be terminated (as described below). If the Call Option is not exercised or if the Callholder fails to pay the Call Price to the Trustee at or prior to the required time for any reason or if the Call Option otherwise terminates, the Trustee will exercise the right of the Holders of the Notes (including the Holder hereof) to require the Company to purchase the Notes, in whole but not in part (the "Mandatory Put"), on the Coupon Reset Date at a price equal to 100% of the principal amount thereof ("Put Price"), plus accrued but unpaid interest to but excluding the Coupon Reset Date, in each case, to be paid by the Company to the Holders of the Notes (including, if applicable, the Holder hereof) in immediately available funds on the Coupon Reset Date. If the Trustee exercises the Mandatory Put, then the Company will deliver the Put Price in immediately available funds to the Trustee by no later than 12:00 noon, New York City time, on the Coupon Reset Date and the Holders of the Notes will be required to deliver and will be deemed to have delivered the Notes to the Company against payment therefor on the Coupon Reset Date through the facilities of DTC. By its purchase of a Note, each Holder irrevocably agrees that the Trustee shall exercise the Mandatory Put for or on behalf of the Holder of the Notes as provided herein. No Holder of any Note or any interest therein has the right to consent or object to the exercise of the Trustee's duties under the Mandatory Put. In anticipation of the exercise of the Call Option or Mandatory Put on the Coupon Reset Date, notice of delivery of all Notes on the Coupon Reset Date against payment of the Call Price or Put Price (the "Delivery Notice") shall be given by mail not less than 30 nor more than 60 days prior to the Coupon Reset Date (which, as long as the Notes are held in the book-entry only system, will be DTC (or its nominee) or a successor depositary (the "Depositary")); provided, however, that the failure to duly give such Delivery Notice by mail, or any defect therein, shall not affect the validity of any proceedings for the delivery of any Notes. The Trustee will notify the Holders of Notes once it is determined whether the Call Price or the Put Price will be delivered on the Coupon Reset Date. Interest on the Notes accrues to, but excludes, the Coupon Reset Date. Pursuant to the terms of a Calculation Agency Agreement, dated as of May 1, 1998 between the Company and Morgan Stanley & Co. Incorporated, Morgan Stanley & Co. Incorporated (or its successors or assigns) will be the Calculation Agent. If the Callholder timely exercises its Call Option, and the Call Option does not otherwise terminate in accordance with its terms, then the Company and the Calculation Agent shall complete the following steps (the "Coupon Reset Process") in order to determine the interest rate to be paid on the Notes, from and including such Coupon Reset Date, to but excluding the Maturity Date (the "Coupon Reset Rate"). (a) The Company will provide the Calculation Agent with (i) a list (the "Dealer List"), no later than five Business Days prior to the Coupon Reset Date, containing the names and addresses of three dealers, one of which shall be Morgan Stanley & Co. Incorporated, from which it desires the Calculation Agent to obtain Bids (as defined below) for the purchase of the Notes and (ii) a copy of any other material reasonably requested by the Calculation Agent to facilitate a successful Coupon Reset Process. (b) Within one Business Day following receipt by the Calculation Agent of the Dealer List, the Calculation Agent will provide to each dealer ("Dealer") on the Dealer List (i) a copy of the Offering Memorandum relating to the Notes, (ii) a copy of the form of the Notes and (iii) a written request that each Dealer submit a Bid to the Calculation Agent by 12:00 noon, New York City time, on the third Business Day prior to the Coupon Reset Date (the "Bid Date"). As used herein, "Business Day" means any day other than a Saturday, Sunday or a day on which banking institutions in The City of New York are authorized or obligated by law, executive order or governmental decree to be closed. "Bid" means an irrevocable written offer given by a Dealer for the purchase of all of the Notes, settling on the Coupon Reset Date, and shall be quoted by such Dealer as a stated yield to maturity on the Notes ("Yield to Maturity"). Each Dealer shall also be provided with (A) the Company's name, (B) an estimate of the Purchase Price (which shall be stated as a U.S. dollar amount and be calculated by the Calculation Agent in accordance with clause (c) below), (C) the principal amount and Maturity Date of the Notes and (D) the method by which interest will be calculated on the Notes. (c) The purchase price to be paid by any Dealer for the Notes (the "Purchase Price") shall be equal to (i) the total principal amount of the Notes, plus (ii) a premium (the "Notes Premium") which shall be equal to the excess, if any, on the Coupon Reset Date of (A) the discounted present value to the Coupon Reset Date of a bond with a maturity of May 1, 2008, which has an interest rate of 5.75%, semi-annual interest payments on each May 1 and November 1, commencing November 1, 2003, and a principal amount of $250,000,000 million, and assuming a discount rate equal to the Treasury Rate over (B) $250,000,000. "Treasury Rate" for the Notes means the per annum rate equal to the offer side yield to maturity of the current on-the-run five-year United States Treasury Security per Telerate page 500 ( or any successor page or substitute page as may replace such page on such service), at 11:00 a.m., New York City time, on the 90th calendar day prior to the Coupon Reset Date (or such other time or date that may be agreed upon by Consumers and the Calculation Agent) or, if such rate does not appear on Telerate page 500 ( or any successor page or substitute page as may replace such page on such service) at such time, the rate on GovPX End-of-Day Pricing at 3:00 p.m., New York City time, on such date (or such other time or date that may be agreed upon by Consumers and the Calculation Agent). (d) The Calculation Agent will provide written notice to the Company by 12:30 p.m., New York City time, on the Bid Date, setting forth (i) the names of each of the Dealers from whom the Calculation Agent received Bids on the Bid Date, (ii) the Bid submitted by each such Dealer and (iii) the Purchase Price as determined pursuant to paragraph (c) above. Unless the Call Option has terminated in accordance with its terms, the Calculation Agent will thereafter select from the Bids received the Bid with the lowest Yield to Maturity (the "Selected Bid") and set the Coupon Reset Rate equal to the interest rate which would amortize the Notes Premium fully over the term of the Notes at the Yield to Maturity indicated by the Selected Bid; provided, however, that if the Calculation Agent has not received a timely Bid from a Dealer on the Bid Date, the Selected Bid shall be the lowest of all Bids received by such time, and provided further, that if any two or more of the lowest Bids submitted are equivalent, Consumers shall in its sole discretion select any of such equivalent Bids (and such selected Bid shall be the Selected Bid). In all cases, Morgan Stanley & Co. Incorporated, in its capacity as a dealer, has the right to match the Bid with the lowest Yield to Maturity, whereby Morgan Stanley & Co. Incorporated's Bid becomes the Selected Bid. (e) Immediately after calculating the Coupon Reset Rate, the Calculation Agent will provide written notice to the Company and the Trustee, setting forth the Coupon Reset Rate. At the request of the Holders of any Notes, the Calculation Agent will provide to the Holders the Coupon Reset Rate. The Trustee shall notify the Mortgage Trustee of the Coupon Reset Rate. If the Calculation Agent determines that at any time prior to the sale of the Notes on the Bid Date (i) an Event of Default has occurred and is continuing under Sections 8.01(a)(1), (2), (3) or (4) (other than, with respect to clause (4), any Event of Default resulting from a default under Section 11.01(d) or (e) of the Mortgage ), the Callholder may terminate the Call Option by written notice to the Company and the Trustee; or (ii) an Event of Default has occurred and is continuing under Sections 8.01(a)(4) (to the extent that such Event of Default results from a default under Section 11.04(d) or (e) of the Mortgage), (5) or (6) of the Indenture, the Call Option shall immediately and automatically terminate. In addition, if the Calculation Agent determines that following the Call Notice, (A) the Callholder fails to pay the Call Price by 2:00 p.m., New York City time, on the Business Day prior to the Coupon Reset Date due to the occurrence of a Market Disruption Event (as defined below) or (B) fewer than two Dealers have submitted Bids in a timely manner substantially as provided above, such Call Option will be automatically revoked and terminated, and the Trustee will exercise the Mandatory Put on behalf of the Holders. "Market Disruption Event" shall mean any of the following: (A) a suspension or material limitation in trading in securities generally on the New York Stock Exchange or the establishment of minimum prices on such exchange; (B) a general moratorium on commercial banking activities declared by either federal or New York State authorities; (C) any material adverse change in the existing financial, political or economic conditions in the United States of America; (D) an outbreak or escalation of major hostilities involving the United States of America or a declaration of a national emergency or war by the United States of America; or (E) any material disruption of the U.S. Treasury securities market, U.S. corporate bond market or U.S. federal wire system; provided, in each case, that in the judgment of the Calculation Agent the effect of the foregoing makes it impracticable to conduct the Coupon Reset Process. Interest payments for this Global Note shall be computed and paid on the basis of a 360-day year of twelve 30-day months. If any Interest Payment Date or date on which the principal of this Global Note is required to be paid is not a Business Day, then payment of principal, premium or interest 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 such Interest Payment Date or date on which the principal of, and any premium on, this Global Note is required to be paid and, in the case of timely payment thereof, no interest shall accrue for the period from and after such Interest Payment Date or the date on which the principal and premium of this Global Note is required to be paid. The Company, at its option, and subject to the terms and conditions provided in the Indenture, will be discharged from any and all obligations in respect of the Notes (except for certain obligations including obligations to register the transfer or exchange of Notes, replace stolen, lost or mutilated Notes, maintain paying agencies and hold monies for payment in trust, all as set forth in the Indenture) if the Company deposits with the Trustee money, U.S. Government Obligations which through the payment of interest thereon and principal thereof in accordance with their terms will provide money, or a combination of money and U.S. Government Obligations, in any event in an amount sufficient, without reinvestment, to pay all the principal of and any premium and interest on the Notes on the dates such payments are due in accordance with the terms of the Notes. If an Event of Default shall occur and be continuing, the principal of the Notes may be declared due and payable in the manner and with the effect provided in the Indenture and, upon such declaration, the Trustee shall demand the redemption of the Senior Note First Mortgage Bonds as provided in the Indenture. The Indenture permits, with certain exceptions as therein provided, the amendment thereof and the modifications of the rights and obligations of the Company and the rights of the Noteholders under the Indenture at any time by the Company and the Trustee with the consent of the Holders of not less than a majority in principal amount of the outstanding Notes. Any such consent or waiver by the Holder of this Global Note shall be conclusive and binding upon such Holder and upon all future Holders of this Global Note and of any Note issued upon the registration of transfer hereof or in exchange therefor or in lieu thereof whether or not notation of such consent or waiver is made upon the Note. As set forth in and subject to the provisions of the Indenture, no Holder of any Notes will have any right to institute any proceeding with respect to the Indenture or for any remedy thereunder unless such Holder shall have previously given to the Trustee written notice of a continuing Event of Default with respect to such Notes, the Holders of not less than a majority in principal amount of the outstanding Notes affected by such Event of Default shall have made written request and offered reasonable indemnity to the Trustee to institute such proceeding as Trustee and the Trustee shall have failed to institute such proceeding within 60 days; provided that such limitations do not apply to a suit instituted by the Holder hereof for the enforcement of payment of the principal of and any premium or interest on this Note on or after the respective due dates expressed here. No reference herein to the Indenture and to provisions of this Global Note or of the Indenture shall alter or impair the obligation of the Company, which is absolute and unconditional, to pay the principal of and any premium and interest on this Global Note at the times, places and rates and the coin or currency prescribed in the Indenture. As provided in the Indenture and subject to certain limitations therein set forth, this Global Note may be transferred only as permitted by the legend hereto. The Indenture and the Notes shall be governed by, and construed in accordance with, the laws of the State of Michigan. ABBREVIATIONS The following abbreviations, when used in the inscription on the face of this instrument, shall be construed as though they were written out in full according to applicable laws or regulations: TEN COM -- as tenants UNIF GIFT in common MIN ACT - _____ Custodian ______ (Cust) (Minor) TEN ENT -- as tenants by the Under Uniform Gifts to Minors entireties JT TEN -- as joint tenants with right of survivorship and not as tenants in common ________________________________ State Additional abbreviations may also be used though not in the above list. ___________________ FOR VALUE RECEIVED the undersigned hereby sell(s), assign(s) and transfer(s) unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ Please print or typewrite name and address including postal zip code of assignee ______________________________ the within note and all rights thereunder, hereby irrevocably constituting and appointing attorney to transfer said note on the books of the Company, with full power of substitution in the premises. The undersigned certifies that said Note is being resold, pledged or otherwise transferred as follows: (check one) ___ to the Issuer; ___ to a Person whom the undersigned reasonably believes is a qualified institution within the meaning of Rule 144A under the Securities Act of 1933, as amended (the "Securities Act") purchasing for its own account or for the account of a qualified institutional buyer to whom notice is given that the resale, pledge or other transfer is being made in reliance on Rule 144A; ___ in an offshore transaction in accordance with Rule 903 or 904 of Regulation S under the Securities Act; ___ to an institution that is an "accredited investor" as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act that is acquiring this Note for investment purposes and not for distribution; (attach a copy of an Investment Letter For Institutional Accredited Investors in the form annexed signed by an authorized officer of the transferee); ___ as otherwise permitted by the non-registration legend appearing on this Note; or ___ as otherwise agreed by the Issuer, confirmed in writing to the Trustee, as follows: (describe) __________________________________________________________________________ __________________________________________________________________________ Dated: ______________________ NOTICE: The signature to this assignment must correspond with the name as written upon the face of the within instrument in every particular, without alteration or enlargement or any change whatever.FORM OF INVESTMENT LETTER FOR INSTITUTIONAL ACCREDITED INVESTORS (Transferor, Trustee and Issuer Names and Addresses) Ladies and Gentlemen: In connection with our proposed purchase of Senior Notes, 6.20%, Series A, Due 2008 (the "Notes") issued by Consumers Energy Company ("Issuer"), we confirm that: 1. We have received a copy of the Offering Memorandum (the "Offering Memorandum") relating to the Notes and such other information as we deem necessary in order to make our investment decision. We acknowledge that we have read and agree to the matters stated under the caption NOTICE TO INVESTORS in such Offering Memorandum, and the restrictions on duplication or circulation of, or disclosure relating to, such Offering Memorandum. 2. We understand that any subsequent transfer of the Notes is subject to certain restrictions and conditions set forth in the Indenture relating to Notes (the "Indenture") and that any subsequent transfer of the Notes is subject to certain restrictions and conditions set forth under NOTICE TO INVESTORS in the Offering Memorandum and the undersigned agrees to be bound by, and not to resell, pledge or otherwise transfer the Notes except in compliance with such restrictions and conditions and the Securities Act of 1933, as amended ("Securities Act"). 3. We understand that the offer and sale of the Notes have not been registered under the Securities Act, and that the Notes may not be offered or sold except as permitted in the following sentence. We agree, on our own behalf and on behalf of any accounts for which we are acting as hereinafter stated, that if we sell any Senior Notes, we will do so only (A) to the Issuer, (B) in accordance with Rule 144A under the Securities Act to a "qualified institutional buyer" (as defined therein), (C) to an institutional "accredited investor" (as defined below) that, prior to such transfer, furnishes to the Trustee (as defined in the Indenture) a signed letter containing certain representations and agreements relating to the restrictions on transfer of the Notes (substantially in the form of this letter) and, if such transfer is in respect of an aggregate principal amount of Notes at the time of transfer of less than $250,000, an opinion of counsel acceptable to the Issuer that such transfer is in compliance with the Securities Act, (D) outside the United States in accordance with Rule 903 or 904 of Regulation S under the Securities Act, (E) pursuant to the exemption from registration provided by Rule 144 under the Securities Act (if available), or (F) pursuant to an effective registration statement under the Securities Act, and we further agree to provide to any person purchasing any of the Notes from us a notice advising such purchaser that resales of the Notes are restricted as stated herein. 4. We understand that, on any proposed resale of any Notes, we will be required to furnish to the Trustee and Issuer such certifications, legal opinions and other information as the Trustee and Issuer may reasonably require to confirm that the proposed sale complies with the foregoing restrictions. We further understand that the Notes purchased by us will bear a legend to the foregoing effect. 5. We are an institutional "accredited investor" (as defined in Rule 501(a)(1), (2), (3) or (7) of Regulation D under the Securities Act) and have such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of our investment in the Notes, and we and any accounts for which we are acting are each able to bear the economic risk of our or its investment. 6. We are acquiring the Notes purchased by us for our own account or for one or more accounts (each of which is an institutional "accredited investor") as to each of which we exercise sole investment discretion. You, the Issuer and the Trustee are entitled to rely upon this letter and are irrevocably authorized to produce this letter or a copy hereof to any interested party in any administrative or legal proceeding or official inquiry with respect to the matters covered hereby. Very truly yours, By: ____________________________ Name: Title: EXHIBIT B REGISTERED REGISTERED THIS NOTE IS A GLOBAL NOTE REGISTERED IN THE NAME OF THE DEPOSITARY (REFERRED TO HEREIN) OR A NOMINEE THEREOF AND, UNLESS AND UNTIL IT IS EXCHANGED IN WHOLE OR IN PART FOR THE INDIVIDUAL NOTES REPRESENTED HEREBY, THIS GLOBAL NOTE MAY NOT BE TRANSFERRED EXCEPT AS A WHOLE BY THE DEPOSITARY TO A NOMINEE OF THE DEPOSITARY OR BY A NOMINEE OF THE DEPOSITARY TO THE DEPOSITARY OR ANOTHER NOMINEE OF THE DEPOSITARY OR BY THE DEPOSITARY OR ANY SUCH NOMINEE TO A SUCCESSOR DEPOSITARY OR A NOMINEE OF SUCH SUCCESSOR DEPOSITARY. UNLESS THIS GLOBAL NOTE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITORY TRUST COMPANY (55 WATER STREET, NEW YORK, NEW YORK), TO THE TRUSTEE FOR REGISTRATION OF TRANSFER, EXCHANGE OR PAYMENT, AND ANY CERTIFICATE IS REGISTERED IN THE NAME OF CEDE & CO. OR SUCH OTHER NAME AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITARY TRUST COMPANY (AND ANY PAYMENT IS MADE TO CEDE & CO., OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITARY TRUST COMPANY) ANY TRANSFER, PLEDGE OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL SINCE THE REGISTERED OWNER HEREOF, CEDE & CO., HAS AN INTEREST THEREIN. CONSUMERS ENERGY COMPANY SENIOR NOTE, 6.20% RESET PUT SECURITIES, SERIES B, DUE 2008 CUSIP: NUMBER: ORIGINAL ISSUE DATE: May 1, 1998 PRINCIPAL AMOUNT: INTEREST RATE: To but excluding MATURITY DATE: May 1, 2008, May 1, 2003, 6.20% from and subject to mandatory including May 1, 2003, at the repayment of Coupon Reset Rate, as described principal to the existing on the reverse of this Note. Holder hereof pursuant to the Call Option or Mandatory Put described on the reverse of this Note. CONSUMERS ENERGY COMPANY, a corporation of the State of Michigan (the "COMPANY"), for value received hereby promises to pay to Cede & Co. or registered assigns, the principal sum of DOLLARS on the Maturity Date set forth above, and to pay interest thereon from May 1, 1998 or from the most recent Interest Payment Date to which interest has been paid or duly provided for, semiannually in arrears on May 1 and November 1 in each year, commencing November 1, 1998, at the per annum Interest Rate set forth above, until but excluding May 1, 2003 (the "Coupon Reset Date"), whereupon the interest rate will be reset to the Coupon Reset Rate as set forth on the reverse hereof (provided that during the continuation of a Registration Default, as defined in the Registration Rights Agreement dated as of May 1, 1998 among the Company, Morgan Stanley & Co. Incorporated, Chase Securities Inc., First Chicago Capital Markets, Inc. and Salomon Brothers Inc. (i) the Interest Rate shall be 6.45% per annum, until but excluding the Coupon Reset Date, and (ii) shall be a rate equal to the sum of the Coupon Reset Rate and .25% from and after the Coupon Reset Date). No interest shall accrue on the Maturity Date, so long as the principal amount of this Global Note is paid on the Maturity Date. The interest so payable and punctually paid or duly provided for on any such Interest Payment Date will, as provided in the Indenture, be paid to the Person in whose name this Note is registered the close of business on the Regular Record Date for such interest, which shall be the April 15 or October 15, as the case may be, next preceding such Interest Payment Date; provided that interest payable on the Maturity Date set forth above or, if applicable, acceleration, shall be payable to the Person to whom principal shall be payable. Except as otherwise provided in the Indenture (as defined below), 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 and shall be paid to the Person in whose name this Note is registered at the close of business on the Regular Record Date for such interest, which shall be the April 15 or October 15, as the case may be, next preceding such Interest Payment Date; provided that interest payable on the Maturity Date set forth above or, if applicable, acceleration, shall be payable to the Person to whom principal shall be payable. Except as otherwise provided in the Indenture (as defined below), 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 and shall be paid to the Person in whose name this Note is 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 Noteholders not fewer than ten days prior to such Special Record Date. Unless the certificate of authentication hereon has been executed by the Trustee, directly or through an Authenticating Agent by manual signature of an authorized officer, this Global Note shall not be entitled to any benefit under the Indenture or be valid or obligatory for any purpose. All terms used in this Global Note which are defined in the Indenture shall have the meanings assigned to them in the Indenture unless otherwise indicated herein. IN WITNESS WHEREOF, the Company has caused this instrument to be duly executed. CONSUMERS ENERGY COMPANY Dated: May 1, 1998 By:_________________________ Title: Senior Vice President and Chief Financial Officer Attest:________________________ Title: Vice President and Secretary TRUSTEE'S CERTIFICATE OF AUTHENTICATION This Note is one of the Notes of the series herein designated, described or provided for in the within-mentioned Indenture. THE CHASE MANHATTAN BANK, As Trustee By: ________________________________ Authorized Officer This Global Note is a global security in respect of a duly authorized issue of Senior Notes, 6.20% Reset Put Securities, Series A, Due 2008, (the "NOTES OF THIS SERIES", which term includes any Global Notes representing such Notes) of the Company issued and to be issued under an Indenture dated as of February 1, 1998, between the Company and The Chase Manhattan Bank, as trustee (the "TRUSTEE", which term includes any successor Trustee under the Indenture) and indentures supplemental thereto (collectively, the "INDENTURE"). Under the Indenture, one or more series of notes may be issued and, as used herein, the term "Notes" refers to the Notes of this Series and any other outstanding series of Notes. Reference is hereby made to the Indenture for a more complete statement of the respective rights, limitations of rights, duties and immunities thereunder of the Company, the Trustee and the Noteholders and of the terms upon which the Notes are and are to be authenticated and delivered. This Global Note has been issued in respect of the series designated on the first page hereof, limited in aggregate principal amount to $250,000,000. Prior to the Release Date (as hereinafter defined), the Notes will be secured by first mortgage bonds (the "SENIOR NOTE FIRST 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 successor trustee to City Bank Farmers Trust Company (the "MORTGAGE TRUSTEE"), as supplemented and modified (collectively, the "FIRST MORTGAGE"). Reference is made to the First Mortgage and the Indenture for a description of the rights of the Trustee as holder of the Senior Note First 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 First 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 Note First 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 Note First Mortgage Bonds) issued under the First Mortgage have been retired through payment, redemption or otherwise at, before or after the maturity thereof (the "Release Date"), the Senior Note First 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 Note First Mortgage Bonds held by the Trustee, but in no event prior to the Release Date to amount less than the aggregate outstanding principal amount of the series of Notes initially issued contemporaneously with such Senior Note First Mortgage Bonds. Each Note of this Series shall be dated and issued as of the date of its authentication by the Trustee and shall bear an Original Issue Date. Each Note or Global Note issued upon transfer, exchange or substitution of such Note or Global Note shall bear the Original Issue Date of such transferred, exchanged or substituted Note or Global Note, as the case may be. The Notes will not be subject to redemption prior to the Maturity Date. On the Coupon Reset Date (i) if all of the Notes are purchased on such date by the Callholder pursuant to its Call Option (as defined below), the Notes shall bear interest from and including the Coupon Reset Date to but excluding Maturity Date at the Coupon Reset Rate determined in accordance with the Coupon Reset Process described below (subject to payment of additional interest of .25% per annum during the continuation of a Registration Default as provided on the face hereof), or (ii) the Notes shall be purchased by the Company pursuant to the exercise of the Mandatory Put (as defined below) by the Trustee on behalf of the Holders of the Notes. The Notes will mature on the Maturity Date. On the Coupon Reset Date, the Holder hereof will be entitled to receive 100% of the principal amount hereof from either (i) the Callholder (who shall make such payment to the Trustee for the benefit of the Holders), if the Callholder purchases this Note pursuant to the Call Option, or (ii) in the event the Callholder does not exercise the Call Option or fails for any reason to pay the Call Price (as defined below) to the Trustee when required, from Consumers following the exercise of the Mandatory Put by the Trustee for and on behalf of the holders of the Notes. By giving notice to the Trustee as described below (the "Call Notice"), the Company, as initial Callholder, or any assignee of the Call Option as Callholder, has the right to purchase the Notes, in whole but not in part, on the Coupon Reset Date (the "Call Option"), at a price equal to 100% of the principal amount thereof (the "Call Price") (interest accrued to but excluding the Coupon Reset Date will be paid by the Company on such date to the Holder hereof on the most recent Regular Record Date). The Callholder will be required to give the Call Notice to the Trustee, in writing, prior to 4:00 p.m., New York City time, no later than ninety calendar days prior to the Coupon Reset Date. The Call Notice must contain the requisite delivery details, including the identity of the Callholder's account with The Depository Trust Company ("DTC"). If the Callholder exercises the Call Option, (a) not later than 2:00 p.m., New York City time, on the Business Day prior to the Coupon Reset Date the Callholder shall pay the amount of the Call Price in immediately available funds to the Trustee for payment thereof to the Holders of the Notes (including, if applicable, the Holder hereof) on the Coupon Reset Date and (ii) the Holder hereof will be required to deliver and will be deemed to have delivered this Note to the Callholder against payment therefor on the Coupon Reset Date through the facilities of DTC. The Call Notice may be revoked by the Callholder at any time prior to 2:00 p.m., New York City time, on the Business Day prior to the Coupon Reset Date. The Callholder is not required to exercise the Call Option, and no Holder of the Notes or any interest therein shall have any right or claim against the Callholder as a result of the Callholder's decision whether or not to exercise the Call Option or performance or non-performance of its obligations with respect thereto. The Callholder may at any time assign its rights and obligations under its Call Option; provided, however, that (i) such rights and obligations are assigned in whole and not in part and (ii) it provides the Trustee and the Company with notice of such assignment contemporaneously with such assignment. Upon receipt of notice of assignment, the Trustee will treat the assignee as Callholder for all purposes hereunder. The Callholder may assign its rights under the Call Option without notice to, or consent of, the Holders of the Notes (including, if applicable, the Holder hereof). The Call Option provides for certain circumstances under which such Call Option may be terminated (as described below). If the Call Option is not exercised or if the Callholder fails to pay the Call Price to the Trustee at or prior to the required time for any reason or if the Call Option otherwise terminates, the Trustee will exercise the right of the Holders of the Notes (including the Holder hereof) to require the Company to purchase the Notes, in whole but not in part (the "Mandatory Put"), on the Coupon Reset Date at a price equal to 100% of the principal amount thereof ("Put Price"), plus accrued but unpaid interest to but excluding the Coupon Reset Date, in each case, to be paid by the Company to the Holders of the Notes (including, if applicable, the Holder hereof) in immediately available funds on the Coupon Reset Date. If the Trustee exercises the Mandatory Put, then the Company will deliver the Put Price in immediately available funds to the Trustee by no later than 12:00 noon, New York City time, on the Coupon Reset Date and the Holders of the Notes will be required to deliver and will be deemed to have delivered the Notes to the Company against payment therefor on the Coupon Reset Date through the facilities of DTC. By its purchase of a Note, each Holder irrevocably agrees that the Trustee shall exercise the Mandatory Put for or on behalf of the Holder of the Notes as provided herein. No Holder of any Note or any interest therein has the right to consent or object to the exercise of the Trustee's duties under the Mandatory Put. In anticipation of the exercise of the Call Option or Mandatory Put on the Coupon Reset Date, notice of delivery of all Notes on the Coupon Reset Date against payment of the Call Price or Put Price (the "Delivery Notice") shall be given by mail not less than 30 nor more than 60 days prior to the Coupon Reset Date (which, as long as the Notes are held in the book-entry only system, will be DTC (or its nominee) or a successor depositary (the "Depositary")); provided, however, that the failure to duly give such Delivery Notice by mail, or any defect therein, shall not affect the validity of any proceedings for the delivery of any Notes. The Trustee will notify the Holders of Notes once it is determined whether the Call Price or the Put Price will be delivered on the Coupon Reset Date. Interest on the Notes accrues to, but excludes, the Coupon Reset Date. Pursuant to the terms of a Calculation Agency Agreement, dated as of May 1, 1998 between the Company and Morgan Stanley & Co. Incorporated, Morgan Stanley & Co. Incorporated (or its successors or assigns) will be the Calculation Agent. If the Callholder timely exercises its Call Option, and the Call Option does not otherwise terminate in accordance with its terms, then the Company and the Calculation Agent shall complete the following steps (the "Coupon Reset Process") in order to determine the interest rate to be paid on the Notes, from and including such Coupon Reset Date, to but excluding the Maturity Date (the "Coupon Reset Rate"). (a) The Company will provide the Calculation Agent with (i) a list (the "Dealer List"), no later than five Business Days prior to the Coupon Reset Date, containing the names and addresses of three dealers, one of which shall be Morgan Stanley & Co. Incorporated, from which it desires the Calculation Agent to obtain Bids (as defined below) for the purchase of the Notes and (ii) a copy of any other material reasonably requested by the Calculation Agent to facilitate a successful Coupon Reset Process. (b) Within one Business Day following receipt by the Calculation Agent of the Dealer List, the Calculation Agent will provide to each dealer ("Dealer") on the Dealer List (i) a copy of the Prospectus relating to the Notes, (ii) a copy of the form of the Notes and (iii) a written request that each Dealer submit a Bid to the Calculation Agent by 12:00 noon, New York City time, on the third Business Day prior to the Coupon Reset Date (the "Bid Date"). As used herein, "Business Day" means any day other than a Saturday, Sunday or a day on which banking institutions in The City of New York are authorized or obligated by law, executive order or governmental decree to be closed. "Bid" means an irrevocable written offer given by a Dealer for the purchase of all of the Notes, settling on the Coupon Reset Date, and shall be quoted by such Dealer as a stated yield to maturity on the Notes ("Yield to Maturity"). Each Dealer shall also be provided with (A) the Company's name, (B) an estimate of the Purchase Price (which shall be stated as a U.S. dollar amount and be calculated by the Calculation Agent in accordance with clause (c) below), (C) the principal amount and Maturity Date of the Notes and (D) the method by which interest will be calculated on the Notes. (c) The purchase price to be paid by any Dealer for the Notes (the "Purchase Price") shall be equal to (i) the total principal amount of the Notes, plus (ii) a premium (the "Notes Premium") which shall be equal to the excess, if any, on the Coupon Reset Date of (A) the discounted present value to the Coupon Reset Date of a bond with a maturity of May 1, 2008, which has an interest rate of 5.75%, semi-annual interest payments on each May 1 and November 1, commencing November 1, 2003, and a principal amount of $250,000,000 million, and assuming a discount rate equal to the Treasury Rate over (B) $250,000,000. "Treasury Rate" for the Notes means the per annum rate equal to the offer side yield to maturity of the current on-the-run five-year United States Treasury Security per Telerate page 500 ( or any successor page or substitute page as may replace such page on such service), at 11:00 a.m., New York City time, on the 90th calendar day prior to the Coupon Reset Date (or such other time or date that may be agreed upon by Consumers and the Calculation Agent) or, if such rate does not appear on Telerate page 500 ( or any successor page or substitute page as may replace such page on such service) at such time, the rate on GovPX End-of-Day Pricing at 3:00 p.m., New York City time, on such date (or such other time or date that may be agreed upon by Consumers and the Calculation Agent). (d) The Calculation Agent will provide written notice to the Company by 12:30 p.m., New York City time, on the Bid Date, setting forth (i) the names of each of the Dealers from whom the Calculation Agent received Bids on the Bid Date, (ii) the Bid submitted by each such Dealer and (iii) the Purchase Price as determined pursuant to paragraph (c) above. Unless the Call Option has terminated in accordance with its terms, the Calculation Agent will thereafter select from the Bids received the Bid with the lowest Yield to Maturity (the "Selected Bid") and set the Coupon Reset Rate equal to the interest rate which would amortize the Notes Premium fully over the term of the Notes at the Yield to Maturity indicated by the Selected Bid; provided, however, that if the Calculation Agent has not received a timely Bid from a Dealer on the Bid Date, the Selected Bid shall be the lowest of all Bids received by such time, and provided further, that if any two or more of the lowest Bids submitted are equivalent, Consumers shall in its sole discretion select any of such equivalent Bids (and such selected Bid shall be the Selected Bid). In all cases, Morgan Stanley & Co. Incorporated, in its capacity as a dealer, has the right to match the Bid with the lowest Yield to Maturity, whereby Morgan Stanley & Co. Incorporated's Bid becomes the Selected Bid. (e) Immediately after calculating the Coupon Reset Rate, the Calculation Agent will provide written notice to the Company and the Trustee, setting forth the Coupon Reset Rate. At the request of the Holders of any Notes, the Calculation Agent will provide to the Holders the Coupon Reset Rate. The Trustee shall notify the Mortgage Trustee of the Coupon Reset Rate. If the Calculation Agent determines that at any time prior to the sale of the Notes on the Bid Date (i) an Event of Default has occurred and is continuing under Sections 8.01(a)(1), (2), (3) or (4) (other than, with respect to clause (4), any Event of Default resulting from a default under Section 11.01(d) or (e) of the Mortgage ), the Callholder may terminate the Call Option by written notice to the Company and the Trustee; or (ii) an Event of Default has occurred and is continuing under Sections 8.01(a)(4) (to the extent that such Event of Default results from a default under Section 11.04(d) or (e) of the Mortgage), (5) or (6) of the Indenture, the Call Option shall immediately and automatically terminate. In addition, if the Calculation Agent determines that following the Call Notice, (A) the Callholder fails to pay the Call Price by 2:00 p.m., New York City time, on the Business Day prior to the Coupon Reset Date due to the occurrence of a Market Disruption Event (as defined below) or (B) fewer than two Dealers have submitted Bids in a timely manner substantially as provided above, such Call Option will be automatically revoked and terminated, and the Trustee will exercise the Mandatory Put on behalf of the Holders. "Market Disruption Event" shall mean any of the following: (A) a suspension or material limitation in trading in securities generally on the New York Stock Exchange or the establishment of minimum prices on such exchange; (B) a general moratorium on commercial banking activities declared by either federal or New York State authorities; (C) any material adverse change in the existing financial, political or economic conditions in the United States of America; (D) an outbreak or escalation of major hostilities involving the United States of America or a declaration of a national emergency or war by the United States of America; or (E) any material disruption of the U.S. Treasury securities market, U.S. corporate bond market or U.S. federal wire system; provided, in each case, that in the judgment of the Calculation Agent the effect of the foregoing makes it impracticable to conduct the Coupon Reset Process. Interest payments for this Global Note shall be computed and paid on the basis of a 360-day year of twelve 30-day months. If any Interest Payment Date or date on which the principal of this Global Note is required to be paid is not a Business Day, then payment of principal, premium or interest 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 such Interest Payment Date or date on which the principal of, and any premium on, this Global Note is required to be paid and, in the case of timely payment thereof, no interest shall accrue for the period from and after such Interest Payment Date or the date on which the principal and premium of this Global Note is required to be paid. The Company, at its option, and subject to the terms and conditions provided in the Indenture, will be discharged from any and all obligations in respect of the Notes (except for certain obligations including obligations to register the transfer or exchange of Notes, replace stolen, lost or mutilated Notes, maintain paying agencies and hold monies for payment in trust, all as set forth in the Indenture) if the Company deposits with the Trustee money, U.S. Government Obligations which through the payment of interest thereon and principal thereof in accordance with their terms will provide money, or a combination of money and U.S. Government Obligations, in any event in an amount sufficient, without reinvestment, to pay all the principal of and any premium and interest on the Notes on the dates such payments are due in accordance with the terms of the Notes. If an Event of Default shall occur and be continuing, the principal of the Notes may be declared due and payable in the manner and with the effect provided in the Indenture and, upon such declaration, the Trustee shall demand the redemption of the Senior Note First Mortgage Bonds as provided in the Indenture. The Indenture permits, with certain exceptions as therein provided, the amendment thereof and the modifications of the rights and obligations of the Company and the rights of the Noteholders under the Indenture at any time by the Company and the Trustee with the consent of the Holders of not less than a majority in principal amount of the outstanding Notes. Any such consent or waiver by the Holder of this Global Note shall be conclusive and binding upon such Holder and upon all future Holders of this Global Note and of any Note issued upon the registration of transfer hereof or in exchange therefor or in lieu thereof whether or not notation of such consent or waiver is made upon the Note. As set forth in and subject to the provisions of the Indenture, no Holder of any Notes will have any right to institute any proceeding with respect to the Indenture or for any remedy thereunder unless such Holder shall have previously given to the Trustee written notice of a continuing Event of Default with respect to such Notes, the Holders of not less than a majority in principal amount of the outstanding Notes affected by such Event of Default shall have made written request and offered reasonable indemnity to the Trustee to institute such proceeding as Trustee and the Trustee shall have failed to institute such proceeding within 60 days; provided that such limitations do not apply to a suit instituted by the Holder hereof for the enforcement of payment of the principal of and any premium or interest on this Note on or after the respective due dates expressed here. No reference herein to the Indenture and to provisions of this Global Note or of the Indenture shall alter or impair the obligation of the Company, which is absolute and unconditional, to pay the principal of and any premium and interest on this Global Note at the times, places and rates and the coin or currency prescribed in the Indenture. As provided in the Indenture and subject to certain limitations therein set forth, this Global Note may be transferred only as permitted by the legend hereto. The Indenture and the Notes shall be governed by, and construed in accordance with, the laws of the State of Michigan. ABBREVIATIONS The following abbreviations, when used in the inscription on the face of this instrument, shall be construed as though they were written out in full according to applicable laws or regulations: TEN COM -- as tenants in common UNIF GIFT MIN ACT - _____ Custodian ______ (Cust) (Minor) TEN ENT -- as tenants by the entireties Under Uniform Gifts to Minors JT TEN -- as joint tenants with right of survivorship and not as tenants in common ____________________________ State Additional abbreviations may also be used though not in the above list. ___________________ FOR VALUE RECEIVED the undersigned hereby sell(s), assign(s) and transfer(s) unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ Please print or typewrite name and address including postal zip code of assignee ______________________________ the within note and all rights thereunder, hereby irrevocably constituting and appointing attorney to transfer said note on the books of the Company, with full power of substitution in the premises. Dated: ______________________ NOTICE: The signature to this assignment must correspond with the name as written upon the face of the within instrument in every particular, without alteration or enlargement or any change whatever. EX-4 3 CONSUMERS 72ND SUPPLEMENTAL INDENTURE SEVENTY-SECOND SUPPLEMENTAL INDENTURE Providing among other things for FIRST MORTGAGE BONDS SENIOR NOTES, 6.20% RESET PUT SECURITIES, SERIES A Due May 1, 2008 ______________ Dated as of May 1, 1998 ______________ CONSUMERS ENERGY COMPANY TO THE CHASE MANHATTAN BANK, Trustee Counterpart ______ of 100 1 SEVENTY-SECOND SUPPLEMENTAL INDENTURE, dated as of May 1, 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 ("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, Senior Notes, 6.20% Reset Put Securities, Series A, due May 1, 2008, each of which bonds shall also bear the descriptive title "First Mortgage Bond" (hereinafter provided for and hereinafter sometimes referred to as the "Senior Note Reset Put 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 May 1, 2008; and WHEREAS, the Senior Note Reset Put Bonds shall be issued to the Senior Note Trustee in connection with the issuance by the Company of its Senior Notes, 6.20% Reset Put Securities, Series A, due 2008 (the "Series A Notes"); and WHEREAS each of the registered bonds without coupons of the Senior Note Reset Put 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 NOTE RESET PUT 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 SENIOR NOTES, 6.20% RESET PUT SECURITIES, SERIES A, DUE MAY 1, 2008 No. 1 $250,000,000 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 Two Hundred Fifty Million Dollars on May 1, 2008, and to pay to the registered holder hereof interest on said sum from the latest semi-annual 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 November 1, 1998, in which case from May 1, 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 semi-annual interest payment date to which interest has been paid on the bonds of this series, or if such interest payment date is November 1, 1998, from May 1, 1998), at the rate per annum of 6.20% until but excluding May 1, 2003 (the "Coupon Reset Date") whereupon the interest rate will be reset to be the Coupon Reset Rate determined as set forth on the reverse hereof, provided that during the continuation of a Registration Default, as defined in the Registration Rights Agreement referred to below, the rate shall be (i) 6.45% per annum, until but excluding the Coupon Reset Date and (ii) from and after the Coupon Reset Date, a rate equal to the sum of the Coupon Reset Rate and .25%, until the principal hereof shall have become due and payable, payable on each May 1 and November 1 in each year, commencing November 1, 1998. 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 Senior Notes, 6.20% Reset Put Securities, Series A, due 2008 (the "Series A 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 Series A 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 Series A Notes (and on any Exchange Notes (as such term is defined on the reverse hereof and in the supplemental indenture pursuant to which this bond has been issued (the "Supplemental Indenture") issued in exchange therefor) shall constitute payments on this bond as further provided herein and in 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 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 signature or a facsimile thereof. CONSUMERS ENERGY COMPANY, Dated: May 1, 1998 By ________________________________ Alan M. Wright Senior Vice President and Chief Financial Officer Attest: _________________________ 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 5 [REVERSE] CONSUMERS ENERGY COMPANY FIRST MORTGAGE BOND SENIOR NOTES, 6.20% RESET PUT SECURITIES, SERIES A, DUE MAY 1, 2008 The interest payable on any May 1 and November 1 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 April 15 or October 15, as the case may be, next preceding such interest payment date, or, if such April 15 or October 15 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. The Series A Notes are subject to the Call Option described therein. In the event the Call Option is exercised as set forth in the Series A Notes, this bond shall bear interest from and including the Coupon Reset Date to but excluding May 1, 2008 at the Coupon Reset Rate determined in accordance with the Coupon Reset Process as set forth in the Series A Notes (subject to payment of additional interest of .25% per annum during the continuation of a Registration Default as provided on the face hereof). The Senior Note Trustee shall give written notice to the Trustee that the Call Option has been exercised and the interest rate determined to be the Coupon Reset Rate. Upon payment of the principal of and interest by the Company on the Series A Notes (or Exchange Notes (as defined below) issued in exchange therefor), 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, the Senior Note Reset Put Bonds in a principal amount equal to the principal amount of such Series A Notes (or Exchange Notes) and having both a corresponding maturity date and interest rate shall, to the extent of such payment of principal 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) this bond 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 interest on this bond, 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 Series A 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 (i) the Series A Notes, and (ii) any senior notes issued in exchange therefor pursuant to the Registration Rights Agreement, dated May 1, 1998, between the Company and Morgan Stanley & Co. Incorporated, Chase Securities Inc., First Chicago Capital Markets, Inc. and Salomon Brothers Inc (the "Exchange 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 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 Note Reset Put 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 $250,000,000 principal amount of the Senior Note Reset Put 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 Note Reset Put 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. The Senior Note Reset Put Bonds shall be issued in the aggregate principal amount of $250,000,000, shall mature on May 1, 2008 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 Note Reset Put 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. The Senior Note Reset Put Bonds shall bear interest at a rate of 6.20% per annum until but excluding May 1, 2003 (the "Coupon Reset Date") whereupon the interest rate will be reset to be the Coupon Reset Rate as set forth in the form of Senior Note Reset Put Bonds provided herein, provided that during the continuation of a Registration Default, as defined in the Registration Rights Agreement dated May 1, 1998, between the Company and Morgan Stanley & Co. Incorporated, Chase Securities Inc., First Chicago Capital Markets, Inc. and Salomon Brothers Inc, the rate shall be (i) 6.45% per annum, until but excluding the Coupon Reset Date and (ii) from and after the Coupon Reset Date, a rate equal to the sum of the Coupon Reset Rate and .25%, until the principal thereof shall have become due and payable, payable semi-annually on May 1 and November 1 in each year commencing November 1, 1998. The principal of and the premium, if any, and the interest on said bond 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 by the Company of the principal of and interest on, all or any portion of the Series A Notes (or Exchange Notes (as defined below) issued in exchange therefor), 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, the Senior Note Reset Put Bonds in a principal amount equal to the principal amount of such Series A Notes (or Exchange Notes) and having both a corresponding maturity date and interest rate shall, to the extent of such payment of principal 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 Note Reset Put 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 Series A 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 Note Reset Put 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 Series A Notes and any other series of senior notes from time to time outstanding under the Senior Note Indenture. The Senior Note Reset Put 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 Note Reset Put 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. The Senior Note Reset Put Bonds shall not be redeemable except as set forth in Section 3 hereof. The Senior Note Reset Put 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 Series A Notes (or Exchange Notes), the Senior Note Reset Put 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 Series A Notes (or Exchange 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 the Senior Note Reset Put Bonds. The Company waives any right it may have to prior notice of such redemption under the Indenture. Upon surrender of the Senior Note Reset Put Bonds by the Senior Note Trustee to the Trustee, the Senior Note Reset Put 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 (i) the Series A Notes, and (ii) any Exchange 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 Note Reset Put 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 Note Reset Put Bonds or the holders of any Series A Notes or any Exchange 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 Series A Notes and Exchange 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 Note Reset Put Bonds or the date fixed for redemption or repayment of the Senior Note Reset Put 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 Note Reset Put 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. 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. S-1 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/ Janet Sanders ____________________________ Janet Sanders STATE OF MICHIGAN) ss. COUNTY OF JACKSON) The foregoing instrument was acknowledged before me this 1st day of May, 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 S-2 THE CHASE MANHATTAN BANK, AS TRUSTEE (SEAL) By /s/ Glenn G. McKeever ________________________________ Attest: Vice President /s/ Wanda Eiland ____________________________ Wanda Eiland Trust Officer Signed, sealed and delivered by THE CHASE MANHATTAN BANK in the presence of /s/ Eric S. Butler ____________________________ Eric S. Butler Aministrator /s/ Natalie B. Pesce ____________________________ Natalie B. Pesce Administrator STATE OF NEW YORK) ss. COUNTY OF NEW YORK) The foregoing instrument was acknowledged before me this 1st day May, 1998, by Glenn G. McKeever, a Vice President of THE CHASE MANHATTAN BANK, a New York corporation, on behalf of the corporation. /s/ Annabelle DeLuca _________________________________ Annabelle Deluca, Notary Public [Seal] New York County, New York My Commission Expires: July 15, 1999 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) Three Months Ended Years Ended December 31 March 31, 1998 1997 1996 1995 1994 1993 (b) Earnings as defined (a) Consolidated net income $ 40 $ 268 $ 240 $ 204 $ 179 $ 155 Income taxes 15 117 139 118 92 75 Exclude equity basis subsidiaries (19) (80) (85) (57) (18) (6) Fixed charges as defined, adjusted to exclude capitalized interest of $5, $16, $8, $8, $6, and $5 million for the three months ended March 31, 1998 and for the years ended December 31, 1997, 1996, 1995, 1994 and 1993, respectively 97 357 310 295 249 253 ----- ----- ----- ----- ----- ----- Earnings as defined $ 133 $ 662 $ 604 $ 560 $ 502 $ 477 ===== ===== ===== ===== ===== ===== Fixed charges as defined (a) Interest on long-term debt $ 76 $ 273 $ 230 $ 224 $ 193 $ 204 Estimated interest portion of lease rental 2 8 10 9 9 11 Other interest charges 12 49 43 42 30 32 Preferred securities dividends and distributions 19 67 54 42 36 17 ----- ----- ----- ----- ----- ----- Fixed charges as defined $ 109 $ 397 $ 337 $ 317 $ 268 $ 264 ===== ===== ===== ===== ===== ===== Ratio of earnings to fixed charges and preferred securities dividends and distributions 1.22 1.67 1.79 1.77 1.87 1.81 ===== ===== ===== ===== ===== ===== 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 CMS ENERGY LETTER OF INDEPENDENT PUBLIC ACCOUNTANT 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. 333-34087 and No. 333-48899 its Form 10-Q for the quarter ended March 31, 1998, which includes our report dated May 11, 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, May 11, 1998. EX-18 6 CONSUMERS AA LETTER - CHANGE IN ACCTG PRINCIPLES May 7, 1998 CMS Energy Corporation Fairlane Plaza South Suite 1100 330 Town Center Drive Dearborn, Michigan 48126 Consumers Energy Company 212 West Michigan Avenue Jackson, Michigan 49201 RE: Form 10-Q Report for the Quarter Ended March 31, 1998 To the Boards of Directors: This letter is written to meet the requirements of Regulation S-K calling for a letter from a registrant's independent accountants whenever there has been a change in accounting principle or practice. We have been informed that, as of January 1, 1998, CMS Energy Corporation and Consumers Energy Company (the Companies) changed from a method of accounting for property taxes based on the assessment date to a method based on the fiscal year of the taxing authorities. According to the management of the Companies, this change was made to provide a better matching of property tax expense with both the payment for services and those services provided by the taxing authorities. A complete coordinated set of financial and reporting standards for determining the preferability of accounting principles among acceptable alternative principles has not been established by the accounting profession. Thus, we cannot make an objective determination of whether the change in accounting described in the preceding paragraph is to a preferable method. However, we have reviewed the pertinent factors, including those related to financial reporting, in this particular case on a subjective basis, and our opinion stated below is based on our determination made in this manner. We are of the opinion that the Companies' change in method of accounting is to an acceptable alternative method of accounting, which, based upon the reasons stated for the change and our discussions with you, is also preferable under the circumstances in this particular case. In arriving at this opinion, we have relied on the business judgment and business planning of your management. We have not audited the application of this change to the financial statements of any period subsequent to December 31, 1997. Further, we have not examined and do not express any opinion with respect to your financial statements for the three months ended March 31, 1998. Very truly yours, Arthur Andersen LLP EX-27 7 CMS 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 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 PER-BOOK 4,316 2,957 1,028 1,480 0 9,781 1 2,287 (139) 2,052 393 238 1,493 245 2,262 0 283 0 74 35 2,609 9,781 1,374 38 1,187 1,225 149 30 179 83 96 13 83 33 0 249 .73 .72 EPS for CMS Energy Common Stock $ .73 EPS for Class G Common Stock $1.09
EX-27 8 CONSUMERS 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 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 PER-BOOK 4,316 740 541 1,236 0 6,833 841 452 385 1,743 220 238 1,029 245 693 0 249 0 73 35 2,373 6,833 1,052 59 869 928 124 32 156 44 112 10 102 80 0 287 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 March 31 1998 1997 Change ---- ---- ----- Three months ended $36 $39 $(3) Twelve months ended 57 50 7 The decrease in earnings for the three months ended March 31,1998 compared to the same 1997 period reflects increased operation and maintenance expenses and decreased gas deliveries due to warmer 1998 temperatures. Partially offsetting these decreases 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 1998 compared to the 1997 period reflects the change in accounting for property taxes implemented in March 1998 as discussed above. Also benefitting the 1998 period was the recognition of interest income from a related-party property sale. 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. For a further discussion, see Consumers Gas Group Results of Operations in CMS Energy's MD&A. Gas Issues For a discussion of Gas Rate Proceedings, Gas Cost Recovery Matters and Gas Environmental Matters, see Consumers Gas Group Operating Issues 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 three months of 1998 and 1997 totaled $159 million and $157 million, respectively. 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 three months of 1998 and 1997 totaled $22 million and $25 million, respectively. The $3 million decrease in cash used primarily reflects a decrease in capital expenditures. Financing Activities: Cash used in financing activities during the first three months of 1998 and 1997 totaled $133 million and $138 million, respectively. The $5 million decrease in cash used primarily reflects an increase in the retirement of bonds and other long-term debt, and the return of CMS Energy stockholders' contributions, which were more than offset by the proceeds from senior notes. Other Investing and Financing Matters: Consumers has an agreement permitting the sale of certain accounts receivable for up to $500 million. At March 31, 1998, $160 million in receivables remained available for sale under the program. Consumers Gas Group's attributed portion of receivables remaining available for sale totaled $71 million. For further information, see Cash Position, Investing and Financing in CMS Energy's MD&A. Forward-Looking Information For cautionary statements relating to Consumers Gas Group's forward- looking information, see Forward-Looking Information 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) $112 $112 $112 Michigan Gas Storage 3 3 3 ---- ---- ---- $115 $115 $115 ==== ==== ==== (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 forward-looking information, see the Consumers Gas Group Business Outlook discussion in CMS Energy's MD&A. 4 Consumers Gas Group Statements of Income (Unaudited)
Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 In Millions, Except Per Share Amounts Operating Revenue $ 429 $ 498 $1,135 $1,231 ------ ------ ------ ------ Operating Expenses Operation Cost of gas sold 264 314 645 718 Other 46 39 182 190 ------ ------ ------ ------ 310 353 827 908 Maintenance 9 8 34 38 Depreciation, depletion and amortization 36 38 90 88 General taxes 20 21 54 54 ------ ------ ------ ------ 375 420 1,005 1,088 ------ ------ ------ ------ Pretax Operating Income 54 78 130 143 ------ ------ ------ ------ Other Deductions - (1) (2) (6) ------ ------ ------ ------ Fixed Charges Interest on long-term debt 7 7 28 29 Other interest 4 3 14 12 Capitalized interest - - - (1) Preferred dividends 1 1 5 6 ------ ------ ------ ------ 12 11 47 46 ------ ------ ------ ------ Income Before Income Taxes 42 66 81 91 Income Taxes 18 27 36 41 ------ ------ ------ ------ Net Income before cumulative effect of change in accounting principle 24 39 45 50 Cumulative effect of change in accounting for property taxes, net of $6 tax 12 - 12 - ------ ------ ------ ------ Net Income $ 36 $ 39 $ 57 $ 50 ====== ====== ====== ====== Net Income Attributable to CMS Energy Shareholders through Retained Interest $ 27 $ 30 $ 42 $ 39 ------ ------ ------ ------ Net Income Attributable to Class G Shareholders $ 9 $ 9 $ 15 $ 11 ------ ------ ------ ------ Average Class G Common Shares Outstanding 8 8 8 8 ------ ------ ------ ------ Basic and Diluted Earnings Per Average Class G Common Share Before Change in Accounting Principle $ .73 $ 1.18 $ 1.40 $ 1.53 ------ ------ ------ ------ Gain Per Average Class G Common Share From Change in Accounting Principle $ .36 $ - $ .36 $ - ------ ------ ------ ------ Basic and Diluted Earnings Per Average Class G Common Share $ 1.09 $ 1.18 $ 1.76 $ 1.53 ------ ------ ------ ------ Dividend Declared Per Class G Common Share $ .31 $ .295 $1.225 $1.165 ====== ====== ====== ====== The accompanying condensed notes are an integral part of these statements.
5 Consumers Gas Group Statements of Cash Flows (Unaudited)
Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 In Millions Cash Flows from Operating Activities Net income $ 36 $ 39 $ 57 $ 50 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization 36 38 90 88 Capital lease and other amortization 1 1 4 4 Deferred income taxes and investment tax credit 4 4 5 12 Other - (2) 1 (1) Changes in other assets and liabilities 82 77 68 47 ------ ------ ------ ------ Net cash provided by operating activities 159 157 225 200 ------ ------ ------ ------ Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (20) (22) (111) (135) Cost to retire property, net (2) (2) (9) (9) Other - (1) 1 (1) ------ ------ ------ ------ Net cash used in investing activities (22) (25) (119) (145) ------ ------ ------ ------ Cash Flows from Financing Activities Increase (decrease) in notes payable, net (119) (97) (17) 2 Retirement of bonds and other long-term debt (73) (23) (83) (31) Return of CMS Energy stockholders' contribution (16) - (55) - Payment of common stock dividends (10) (10) (40) (38) Repayment of bank loans (10) (6) (11) (6) Payment of capital lease obligations (1) (1) (4) (4) Proceeds from senior notes 94 - 94 - Issuance of common stock 2 1 8 5 Repayment of long-term note - (2) - (2) Retirement of preferred stock - - (26) - Proceeds from long-term note and bank loans - - 25 23 ------ ------ ------ ------ Net cash used in financing activities (133) (138) (109) (51) ------ ------ ------ ------ Net Increase (Decrease) in Cash and Temporary Cash Investments 4 (6) (3) 4 Cash and Temporary Cash Investments, Beginning of Period 2 15 9 5 ------ ------ ------ ------ Cash and Temporary Cash Investments, End of Period $ 6 $ 9 $ 6 $ 9 ====== ====== ====== ====== The accompanying condensed notes are an integral part of these statements.
6 Consumers Gas Group Balance Sheets
ASSETS March 31 March 31 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Plant and Property (At cost) Plant and property $2,346 $2,322 $2,242 Less accumulated depreciation, depletion and amortization 1,264 1,231 1,177 ------ ------ ------ 1,082 1,091 1,065 Construction work-in-progress 27 28 21 ------ ------ ------ 1,109 1,119 1,086 ------ ------ ------ Current Assets Cash and temporary cash investments at cost, which approximates market 6 2 9 Accounts receivable and accrued revenue, less allowances of $3, $3, and $2, respectively (Note 4) 64 53 152 Inventories at average cost Gas in underground storage 79 197 51 Materials and supplies 7 7 8 Deferred income taxes 3 6 5 Trunkline settlement - - 18 Prepayments and other 55 51 36 ------ ------ ------ 214 316 279 ------ ------ ------ Non-current Assets Postretirement benefits 140 142 150 Deferred income taxes 10 6 11 Other 62 61 60 ------ ------ ------ 212 209 221 ------ ------ ------ Total Assets $1,535 $1,644 $1,586 ====== ====== ======
7
STOCKHOLDERS' INVESTMENT AND LIABILITIES March 31 March 31 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Capitalization Common stockholders' equity $ 370 $ 358 $ 400 Preferred stock 52 52 78 Long-term debt 401 333 364 Non-current portion of capital leases 16 16 16 ------ ------ ------ 839 759 858 ------ ------ ------ Current Liabilities Current portion of long-term debt and capital leases 62 118 73 Accrued taxes 76 65 58 Accounts payable 70 94 69 Accrued refunds 8 10 5 Accrued interest 2 4 5 Notes payable - 119 17 Trunkline settlement - - 18 Other 45 44 41 ------ ------ ------ 263 454 286 ------ ------ ------ Non-current Liabilities Regulatory liabilities for income taxes, net 178 173 175 Postretirement benefits 166 168 173 Deferred investment tax credit 25 25 26 Other 64 65 68 ------ ------ ------ 433 431 442 ------ ------ ------ Commitments and Contingencies (Notes 3 and 5) Total Stockholders' Investment and Liabilities $1,535 $1,644 $1,586 ====== ====== ====== The accompanying condensed notes are an integral part of these statements.
8 Consumers Gas Group Statements of Common Stockholders' Equity (Unaudited)
Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 In Millions Common Stock At beginning and end of period $184 $184 $184 $184 ---- ---- ---- ---- Other Paid-in Capital At beginning of period 102 134 135 130 Common stock issued 2 1 8 5 Return of CMS Energy stockholders' contribution (16) - (55) - ---- ---- ---- ---- At end of period 88 135 88 135 ---- ---- ---- ---- Retained Earnings At beginning of period 72 52 81 69 Net income 36 39 57 50 Common stock dividends declared (10) (10) (40) (38) ---- ---- ---- ---- At end of period 98 81 98 81 ---- ---- ---- ---- Total Common Stockholders' Equity $370 $400 $370 $400 ==== ==== ==== ==== 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 5 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. 2: Earnings Per Share and Dividends Earnings (loss) per share for the three month period ended March 31, 1998 and March 31, 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 three months ended March 31, 1998 and 1997, are based on 25.16 percent and 24.29 percent of the income of Consumers Gas Group, respectively. In February 1998, CMS Energy declared and paid dividends of $.31 per share on Class G Common Stock. In April 1998, the Board of Directors declared a quarterly dividend of $.31 per share on Class G Common Stock to be paid in May 1998. 3: Rate Matters For information regarding rate matters directly affecting Consumers Gas Group, see Note 3 in the Consolidated Financial Statements of CMS Energy included and incorporated by reference herein. 4: Short-Term Financings and Capitalization Short-Term Financings: Consumers' short-term financings are discussed in Consolidated Financial Statements of CMS Energy Note 4 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 March 31, 1998 and 1997, is estimated by management to be $150 million and $178 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 4 to the Consolidated Financial Statements of CMS Energy included and incorporated by reference herein. 5: Commitments and Contingencies Capital Expenditures: Consumers Gas Group estimates capital expenditures, including new lease commitments, of $115 million for 1998, 1999 and 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 Gas Environmental Matters and Other discussions in CMS Energy's Note 7 included and incorporated by reference herein. 6: Supplemental Cash Flow Information For purposes of the Statement of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Consumers Gas Group's other cash flow activities and non-cash investing and financing activities were: In Millions Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 ---- ---- ---- ---- Cash transactions Interest paid (net of amounts capitalized) $13 $12 $43 $39 Income taxes paid (net of refunds) 1 - 41 31 Non-cash transactions Assets placed under capital lease $ 1 $ 1 $3 $ 2 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 March 31, 1998 and 1997, and the related statements of income, common stockholders' equity and cash flows for the three-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, May 11, 1998. -----END PRIVACY-ENHANCED MESSAGE-----