-----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, KQnR9lvQoMc7yB3eos36qokS6eDmjHLHEfiro5ls04KqTfMyjLC9i2vTZcWAcciC 5y6m1YlZ8Sq9baqI++D5tg== 0000201533-98-000088.txt : 19980817 0000201533-98-000088.hdr.sgml : 19980817 ACCESSION NUMBER: 0000201533-98-000088 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 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: 98688777 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: 98688778 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 2ND QTR FORM 10-Q 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 June 30, 1998 OR [ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission Registrant; State of Incorporation; IRS Employer File Number Address; and Telephone Number Identification No. 1-9513 CMS ENERGY CORPORATION 38-2726431 (A Michigan Corporation) Fairlane Plaza South, Suite 1100 330 Town Center Drive, Dearborn, Michigan 48126 (313)436-9200 1-5611 CONSUMERS ENERGY COMPANY 38-0442310 (A Michigan Corporation) 212 West Michigan Avenue, Jackson, Michigan 49201 (517)788-0550 Indicate by check mark whether the Registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes X No Number of shares outstanding of each of the issuer's classes of common stock at July 31, 1998: CMS Energy Corporation: CMS Energy Common Stock, $.01 par value 101,838,224 CMS Energy Class G Common Stock, no par value 8,355,817 Consumers Energy Company, $10 par value, privately held by CMS Energy 84,108,789 CMS Energy Corporation and Consumers Energy Company Quarterly reports on Form 10-Q to the Securities and Exchange Commission for the Quarter Ended June 30, 1998 This combined Form 10-Q is separately filed by CMS Energy Corporation and Consumers Energy Company. Information contained herein relating to each individual registrant is filed by such registrant on its own behalf. Accordingly, except for its subsidiaries, Consumers Energy Company makes no representation as to information relating to any other companies affiliated with CMS Energy Corporation. TABLE OF CONTENTS Page Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 PART I: CMS Energy Corporation Management's Discussion and Analysis . . . . . . . . . . . . . . . 8 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 . . . . . . . . . . . . . 47 Consumers Energy Company Management's Discussion and Analysis . . . . . . . . . . . . . . . 48 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 LIHEAP . . . . . . . . . . . . . Low Income Home Energy Assistance Program Loy Yang . . . . . . . . . . . . The 2,000 MW brown coal fueled Loy Yang A power plant and an associated coal mine in Victoria, Australia, in which CMS Generation holds a 50 percent ownership interest Ludington. . . . . . . . . . . . Ludington pumped storage plant, jointly owned by Consumers and Detroit Edison mcf. . . . . . . . . . . . . . . Thousand cubic feet MCV Facility . . . . . . . . . . A natural gas-fueled, combined-cycle cogeneration facility operated by the MCV Partnership MCV Partnership. . . . . . . . . Midland Cogeneration Venture Limited Partnership in which Consumers has a 49 percent interest through CMS Midland MD&A . . . . . . . . . . . . . . Management's Discussion and Analysis MichCon. . . . . . . . . . . . . Michigan Consolidated Gas Company Michigan Gas Storage . . . . . . Michigan Gas Storage Company, a subsidiary of Consumers Mbbls. . . . . . . . . . . . . . Thousand barrels MMbbls . . . . . . . . . . . . . Million barrels MMBtu. . . . . . . . . . . . . . Million British thermal unit MMcf . . . . . . . . . . . . . . Million cubic feet Moss Bluff . . . . . . . . . . . Moss Bluff Gas Storage Systems, a partnership that owns a gas storage facility MPSC . . . . . . . . . . . . . . Michigan Public Service Commission MW . . . . . . . . . . . . . . . Megawatts Natural Gas Act. . . . . . . . . Federal Natural Gas Act NGL. . . . . . . . . . . . . . . Natural gas liquids Nitrotec . . . . . . . . . . . . Nitrotec Corporation, a propriety gas technology company in which CMS Gas Transmission owns an equity interest NRC. . . . . . . . . . . . . . . Nuclear Regulatory Commission Order 888 and Order 889 . . . . .FERC final rules issued on April 24, 1996 Outstanding Shares . . . . . . . Outstanding shares of Class G Common Stock Palisades. . . . . . . . . . . . Palisades nuclear power plant, owned by Consumers PCBs . . . . . . . . . . . . . . Poly chlorinated biphenyls Pension Plan . . . . . . . . . . The trusteed, non-contributory, defined benefit pension plan of Consumers and CMS Energy PPA. . . . . . . . . . . . . . . The Power Purchase Agreement between Consumers and the MCV Partnership with a 35-year term commencing in March 1990 ppm. . . . . . . . . . . . . . . Parts per million PSCR . . . . . . . . . . . . . . Power supply cost recovery PUHCA. . . . . . . . . . . . . . Public Utility Holding Company Act of 1935 Qualifying Facility. . . . . . . A facility that produces electricity or steam and electricity and meets the ownership and technical requirements of PURPA Retained Interest Shares . . . . Authorized but unissued shares of Class G Common Stock not held by holders of the Outstanding Shares and attributable to the Retained Interest SEC. . . . . . . . . . . . . . . Securities and Exchange Commission Securitization . . . . . . . . . A financing authorized by statute in which the statutorily assured flow of revenues from a portion of the rates charged by a utility to its customers is set aside and pledged as security for the repayment of rate reduction bonds issued by a special purpose entity affiliated with such utility SERP . . . . . . . . . . . . . . Supplemental Executive Retirement Plan Senior Credit Facilities . . . . $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 (This page intentionally left blank) 8 CMS Energy Corporation Management's Discussion and Analysis The MD&A of this Form 10-Q should be read along with the MD&A and other parts of CMS Energy's 1997 Form 10-K and the restated financial information in a Form 8-K dated July 30, 1998. This MD&A also refers to, and in some sections specifically incorporates by reference from, CMS Energy's Condensed Notes to Consolidated Financial Statements and should be read in conjunction with such Statements and Notes. This report contains forward-looking statements, as defined by the Private Securities Litigation Reform Act of 1995, that include without limitation, discussions as to expectations, beliefs, plans, objectives and future financial performance, or assumptions underlying or concerning matters discussed in this report. Refer to the Forward-Looking Information section of this MD&A for some important factors that could cause actual results or outcomes to differ materially from those addressed in the forward-looking discussions. CMS Energy is the parent holding company of Consumers and Enterprises. Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan and is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Enterprises is engaged in several domestic and international energy-related businesses including: acquisition, development and operation of independent power production facilities; oil and gas exploration and production; storage, transmission and processing of natural gas; energy marketing, services and trading; and international energy distribution. RESULTS OF OPERATIONS CMS Energy Consolidated Earnings In Millions, Except Per Share Amounts June 30 1998 1997(b) Change ------- ------ ------- Three months ended Consolidated Net Income $ 65 $ 47 $ 18 Net Income Attributable to Common Stocks: CMS Energy 64 45 19 Class G 1 2 (1) Earnings Per Average Common Share: CMS Energy Basic .63 .48 .15 Diluted .62 .48 .14 Class G Basic and Diluted .12 .16 (.04) Six months ended (a) Consolidated Net Income $153 $125 $ 28 Net Income Attributable to Common Stocks: CMS Energy 143 114 29 Class G 10 11 (1) Earnings Per Average Common Share: CMS Energy Basic 1.42 1.21 .21 Diluted 1.39 1.20 .19 Class G Basic and Diluted 1.20 1.34 (.14) Twelve months ended (a) Consolidated Net Income $272 $218 $ 54 Net Income Attributable to Common Stocks: CMS Energy 258 206 52 Class G 14 12 2 Earnings Per Average Common Share: CMS Energy Basic 2.60 2.19 .41 Diluted 2.57 2.18 .39 Class G Basic and Diluted 1.71 1.52 .19 ====== ===== ===== (a) Includes the cumulative effect of an accounting change for property taxes which increased net income attributable to CMS Energy Common Stock $43 million ($.40 per share - basic and diluted) and Class G Common Stock $12 million ($.36 per share - basic and diluted). Refer to the discussion below for further information. (b) Restated as a result of change in method of accounting for investments in oil and gas properties. Refer to the discussion below and Note 1 for further information. The combined effects of the changes in accounting for oil and gas investments resulted in decreases to net income of $7 million ($.07 per share), $13 million ($.13 per share) and $22 million ($.24 per share) for the three months, six months and twelve months ended June 30, 1997, respectively. The following discussion of earnings variations compares the results of this year's periods to the restated results of last year's periods. CMS Energy's earnings for the second quarter of 1998 increased from the comparable period in 1997 as a result of (1) an increase in earnings from international independent power production plant operations and from the MCV Partnership and a gain on the sale of a biomass project power purchase agreement, and (2) lower operating expenses, higher oil volumes and gas prices, partially offset by lower oil prices in the oil and gas exploration and production business. Partially offsetting these increases were (1) lower earnings from the international energy distribution business due to losses incurred in new project investments and higher operating expenses and (2) increased interest on long-term debt due to higher amounts of debt outstanding. CMS Energy's earnings for the six months ended June 30, 1998 increased from the comparable period in 1997 as a result of (1) Consumers' one-time change in accounting for the recognition of property tax expense from a calendar-year basis to a fiscal-year basis which resulted in a benefit of $66 million ($43 million after-tax), (2) Consumers' increased electric sales partially offset by increased operating and maintenance expenses, (3) a gain on the sale of Petal Gas Storage Company by the gas transmission, storage and processing business, (4) increased income from the international independent power production business and from the MCV Partnership, and a gain on the sale of a biomass project power purchase agreement, and (5) lower oil and gas exploration and production operating expenses. Partially offsetting these increases were (1) Consumers' decreased gas deliveries due to record warm 1998 temperatures, (2) an increased provision for underrecoveries under the PPA of $37 million ($24 million after-tax) due to higher than expected plant availability of the MCV Facility, (3) lower earnings from international energy distribution businesses and (4) increased interest on long-term debt due to higher amounts of debt outstanding. For further information on past and future underrecoveries under the PPA, see Power Purchases from the MCV Partnership in Note 2. The increase in consolidated net income for the twelve months ended June 30, 1998 compared to the same period in 1997 reflects (1) Consumers' change in accounting for property taxes as discussed above and a $9 million adjustment of Consumers' prior years' income taxes associated with non-taxable earnings on nuclear decommissioning trust funds, (2) Consumers' increased electric sales partially offset by increased operating and maintenance expenses, (3) an increase in international plants earnings and operating fees from the independent power production business, increased earnings from the MCV Partnership, and a gain on the sale of a biomass project power purchase agreement, (4) a gain on the sale of Petal Gas Storage Company and a gain on the sale of Australian gas reserves in the gas transmission, storage and processing business and (5) an increase in oil production and recognition of a gain on the sale of CMS NOMECO's entire interest in oil and gas properties in Yemen. Partially offsetting these increases were the (1) recognition of Consumers' after-tax loss associated with the underrecovery of power costs under the PPA as discussed above, (2) Consumers' decreased gas deliveries due to warmer weather during the first half of 1998 (3) lower oil prices in the oil and gas exploration and production business, (4) a scheduled decrease in the industry expertise service fee income earned in connection with Loy Yang and (5) increased interest on long-term debt due to higher amounts of debt outstanding. For further information, see the individual results of operations for each CMS Energy business segment in this MD&A. Consumers' Electric Business Unit Results of Operations Electric Pretax Operating Income: In Millions Three Months Six Months Twelve Months Ended June 30 Ended June 30 Ended June 30 Change Compared to Prior Year 1998 vs 1997 1998 vs 1997 1998 vs 1997 ----------- -------------- ------------ Sales (including special contract discounts) $ 5 $ 12 $ 12 Other non-commodity revenue 1 (1) - Operations and maintenance 1 10 35 General taxes and depreciation (4) (5) (18) ----- ----- ----- Total change $ 3 $ 16 $ 29 ===== ===== ===== Electric Deliveries: Total electric deliveries increased 8.0 percent for the three months ended June 30, 1998 over the same period in 1997. The increase includes a 2.9 percent increase in deliveries to ultimate customers, primarily within the commercial and industrial classes, and a 5.1 percent increase in intersystem and wholesale customer deliveries. For the six months ended June 30, 1998, total electric deliveries increased 7.2 percent over the comparable 1997 period. Deliveries to ultimate customers were up 2.1 percent, mainly from increased deliveries to commercial and industrial classes, with the remaining 5.1 percent attributable to an increase in sales between utility systems and wholesale deliveries. For the twelve months ended June 30, 1998, total electric deliveries increased 5.3 percent over the comparable 1997 period. The increase is primarily attributable to an increase in intersystem deliveries and a 1.3 percent increase in deliveries to ultimate customers, primarily within the industrial class. Power Costs: In Millions June 30 1998 1997 Change ----- ----- ----- Three months ended $ 312 $ 270 $ 42 Six months ended 583 552 31 Twelve months ended 1,170 1,119 51 ===== ===== ===== Power costs increased for all the reported periods ended June 30, 1998 compared to 1997. Both internal generation and power purchases from outside sources increased during these periods to meet increased sales demand. Uncertainties: CMS Energy's financial position may be affected by a number of trends or uncertainties that have had, or CMS Energy reasonably expects will have a materially favorable or unfavorable impact on net sales, revenues, or income from continuing electric operations. Such uncertainties are: 1) environmental liabilities arising from compliance with various federal, state and local environmental laws and regulations, including potential liability or expenses relating to the Michigan Natural Resources and Environmental Protection Act and Superfund; 2) capital expenditures for compliance with the Clean Air Act; 3) suits by various parties relating to the effect of so-called stray voltage on certain livestock; 4) suits by two independent power producers alleging antitrust violations and economic losses due to special electric contracts signed by Consumers; 5) cost recovery relating to the MCV Facility, nuclear plant investments and an experimental direct-access program; 6) electric industry restructuring; 7) after-tax cash underrecoveries associated with power purchases from the MCV Partnership; and 8) Big Rock decommissioning issues and ongoing issues relating to the storage of spent fuel and the operating life of Palisades. For detailed information about these trends or uncertainties see Note 2, "Consumers' Electric Business Unit Contingencies-Electric Environmental Matters", "Consumers' Electric Business Unit Contingencies-Stray Voltage", "Consumers' Electric Business Unit Contingencies-Anti-Trust", "Other Consumers' Electric Business Unit Uncertainties-Power Purchases from the MCV Partnership", "Consumers' Electric Business Unit Rate Matters- Electric Restructuring", "Consumers' Electric Business Unit Rate Matters-Electric Proceedings" and " Other Consumers' Electric Business Unit Uncertainties-Nuclear Matters", incorporated by reference herein. For information about Consumers' electricity option contracts, see Note 5, "Risk Management Activities and Derivatives Transactions-Commodity Price Hedges", incorporated by reference herein. Consumers Gas Group Results of Operation In Millions Three Months Six Months Twelve Months Ended June 30 Ended June 30 Ended June 30 Change Compared to Prior Year 1998 vs 1997 1998 vs 1997 1998 vs 1997 ------------- ----------- ----------- Sales $ (5) $(18) $(21) Gas wholesale and retail service activities - (3) (6) Operations and maintenance (1) (9) 6 General taxes, depreciation and other 4 4 5 ----- ----- ----- Total change $ (2) $(26) $(16) ===== ===== ===== Gas Deliveries: System deliveries for the three month period ended June 30, 1998, including miscellaneous transportation, totaled 61 bcf, a decrease of 15 bcf or 19 percent compared to the three month period ended June 30, 1997. Deliveries for the six month period ended June 30, 1998, including miscellaneous transportation, totaled 208 bcf, a decrease of 37 bcf or 15 percent compared to the six month period ended June 30, 1997. For the twelve month period ended June 30, 1998, deliveries including miscellaneous transportation, totaled 383 bcf, a decrease of 41 bcf or 10 percent compared to the twelve month period ended June 30, 1997. The decreased deliveries for three month, six month and twelve month periods ended reflect warmer temperatures primarily for the first quarter of 1998. Cost of Gas Sold: In Millions June 30 1998 1997 Change ----- ----- ----- Three months ended $ 74 $118 $ (44) Six Months ended 338 432 (94) Twelve months ended 600 729 (129) ===== ===== ===== The cost decreases for the three month, six month and twelve month periods ended June 30, 1998 were the result of decreased sales and lower gas costs reflecting warmer temperatures during the winter heating seasons. Uncertainties: CMS Energy's financial position may be affected by a number of trends or uncertainties that have had, or CMS Energy reasonably expects will have, a materially favorable or unfavorable impact on net sales or revenues or income from continuing gas operations. Such uncertainties are: 1) potential environmental costs at a number of sites including sites formerly housing manufactured gas plant facilities; 2) ongoing litigation relating to a pricing dispute with gas producers; and 3) a statewide experimental gas transportation pilot program. For detailed information about these uncertainties see Note 2, "Consumers' Gas Group Contingencies-Gas Environmental Matters", "Consumers' Gas Group Matters-GCR Matters", and "Consumers' Gas Group Matters-Gas Restructuring", incorporated by reference herein. For information about Consumers' gas forward contracts, see Note 5, "Risk Management Activities and Derivatives Transactions-Commodity Price Hedges", incorporated by reference herein. Independent Power Production Results of Operations Pretax Operating Income: Pretax operating income for the three months ended June 30, 1998 increased $25 million (100 percent) over the comparable period in 1997. This increase primarily reflects increased operating income from international plants earnings and fees, increased earnings from the MCV Partnership, lower net operating expenses and a $12 million gain on the sale of a biomass project power purchase agreement. Pretax operating income for the six months ended June 30, 1998 increased $31 million (89 percent) over the comparable period in 1997, primarily reflecting an increase in international plants earnings and operating fees, increased earnings from the MCV Partnership and a $12 million gain on the sale of a biomass project power purchase agreement. Pretax operating income for the twelve months ended June 30, 1998 increased $57 million (81 percent) from the comparable period in 1997, primarily reflecting increased operating income resulting from increased international earnings, construction management fees earned in connection with Jorf Lasfar, increased earnings from the MCV Partnership and a $12 million gain on the sale of a biomass project power purchase agreement, partially offset by lower industry expertise service fee income earned in connection with Loy Yang. Oil and Gas Exploration and Production Results of Operations Pretax Operating Income: Pretax operating income for the three months ended June 30, 1998 increased $4 million (133 percent) from the comparable period in 1997. This increase is the result of higher oil production, higher gas prices and decreased exploration expenses, partially offset by sharply lower oil prices. Pretax operating income for the six months ended June 30, 1998 increased $6 million (200 percent) over the comparable period in 1997 due to lower exploration expenses, increased oil production and higher gas prices, partially offset by reduced oil prices. Pretax operating income for the twelve months ended June 30,1998 increased $14 million (78 percent) from the comparable period in 1997, primarily due to increased oil production, lower exploration expenses and a gain on the sale of CMS NOMECO's entire interest in oil and gas properties in Yemen, partially offset by sharply lower oil prices and decreased gas production. CMS NOMECO changed its method of accounting effective January 1, 1998 for oil and gas operations from the full cost method to the successful efforts method. CMS NOMECO believes that the successful efforts method will minimize asset write-offs caused by periodic price swings, which may not be representive of overall or long-term markets, and will allow its results of operations to be more easily compared to other oil and gas companies. Nitrotec Corporation, in which CMS Gas Transmission has an equity investment, also elected to convert effective January 1, 1998 from the full cost method of accounting to the successful efforts method of accounting. All prior period financial statements have been restated to conform with successful efforts accounting. The effect, after tax, of the change in accounting method as of December 31, 1997, was a reduction to retained earnings of $175 million for CMS NOMECO and $15 million for CMS Gas Transmission, primarily attributable to a decrease in net plant and property and deferred tax liability of $270 million and $95 million, respectively, for CMS NOMECO and a $15 million decrease in CMS Gas Transmission's equity investment in Nitrotec Corporation. The combined effects of the changes in accounting method resulted in an increase in net income of $5 million ($.06 per share) for the three months ended March 31, 1998, and a decrease of $6 million ($.06 per share) for the three months ended March 31, 1997; see Note 6. Natural Gas Transmission, Storage and Processing Results of Operations Pretax Operating Income: Pretax operating income for the three months ended June 30, 1998 increased $2 million (29 percent) over the comparable period in 1997, primarily as a result of a gain on the sale of Australian gas reserves, lower operating expenses and higher earnings from domestic and international operations. Pretax operating income for the six months ended June 30, 1998 increased $6 million (38 percent) over the comparable 1997 period primarily reflecting a gain in the first quarter of 1998 on the sale of Petal Gas Storage Company, a gain on the sale of Australian gas reserves, and lower operating expenses, partially offset by a gain in the first quarter of 1997 on the sale of a portion of the Ames gas gathering system. Pretax operating income for the twelve months ended June 30, 1998 increased $9 million (38 percent) over the comparable period in 1997, reflecting a gain on the sale of Petal Gas Storage Company, a gain on the sale of Australian gas reserves, and increased earnings attributable to domestic and international operations. Marketing, Services and Trading Results of Operations Pretax Operating Income: CMS MST's 1998 results compared to prior year reflect management's substantial and continued commitment of resources to develop and capture the opening of the electric and energy management markets. Wholesale electric marketing volumes reached 3,384,000 MW for the six months ended June 30, 1998 compared to none for the comparable period in 1997. Pretax operating income for the twelve months ended June 30, 1998 decreased $8 million from the comparable period in 1997, primarily reflecting lower gas margins and higher costs reflecting management's continuing commitment to future electric and energy management growth. Gas marketed for end users totaled 156 bcf and 79 bcf for the six months ended June 30, 1998 and 1997, respectively. Energy management service revenues for the six months ended June 30, 1998 increased 80 percent over the comparable 1997 period. Market Risk Information CMS Energy is exposed to market risk including, but not limited to, changes in interest rates, currency exchange rates, and certain commodity and equity prices. Derivative instruments including, but not limited to, futures contracts, swaps, options and forward contracts may be used to manage these exposures. Derivatives are principally used as hedges and not for trading purposes. During the second 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 (including current maturities) was $4.4 billion at June 30, 1998 with a fair value (including current maturities) of $4.4 billion. The fair value of CMS Energy's financial derivative instruments at June 30, 1998, with a notional amount of $803 million, was $2 million, representing the amount that CMS Energy would have paid to terminate these agreements on June 30, 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 June 30, 1998. Limitations of the Sensitivity Model: Management does not believe that a sensitivity analysis alone provides an accurate or reliable method for monitoring and controlling risk. Therefore, CMS Energy and its subsidiaries rely on the experience and judgement of senior management and traders to revise strategies and adjust positions as they deem necessary. Losses in excess of the amounts determined could occur if market rates or prices exceed the 10 percent shift used for the analysis. The model assumes that the maximum exposure associated with purchased options is limited to premiums paid. The model assumes that the Trust Preferred Securities are not converted into CMS Energy Common Stock. If the conversion occurred, the $173 million of Trust Preferred Securities would be discharged through the issuance of 4.2 million shares of CMS Energy Common Stock. The model also does not quantify short-term exposure to hypothetically adverse price fluctuations in inventories. For a discussion of accounting policies related to derivative transactions, see Note 5. CAPITAL RESOURCES AND LIQUIDITY Cash Position, Investing and Financing CMS Energy's primary ongoing source of operating cash is dividends from subsidiaries. In the second quarter of 1998, Consumers paid a $50 million common dividend to CMS Energy. In July 1998, Consumers declared a $44 million common dividend to be paid in August 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 $309 million and $358 million for the first six months of 1998 and 1997, respectively. The $49 million decrease resulted primarily from a decrease of $47 million in Consumers' sale of accounts receivable and a $29 million net decrease reflecting the cumulative effect of the accounting change for property taxes and an increased provision for underrecoveries under the PPA, both of which are noncash items. These decreases were partially offset by increases in consolidated net income and deferred income taxes. 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 $467 million and $912 million for the first six months of 1998 and 1997, respectively. The decrease of $445 million primarily reflects decreased investments in international projects. CMS Energy's 1998 expenditures for its utility and international businesses were $181 million and $292 million, respectively, compared to $171 million and $711 million, respectively, during 1997. Financing Activities: CMS Energy's consolidated net cash provided by financing activities totaled $319 million and $549 million for the first six months of 1998 and 1997, respectively. The decrease of $230 million in net cash provided by financing activities resulted from an $800 million increase in the issuance of new securities (see table below), offset by increases in the retirement of bonds and other long-term debt ($427 million) and the repayment of bank loans ($552 million). In Millions Distribution/ Principal Month Issued Maturity Interest Rate Amount Use of Proceeds ------------ --------- ------------ ------- --------------- CMS Energy GTNs Series D (1) (1) 6.8% (1) $ 104 General corporate purposes Extendible Tenor Rate Adjusted Securities January 2005 7.0% 180 Pay down borrowings -------- $284 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 Senior Notes (2) May 2008 6.2%(3) 250 Pay down First Mortgage Bonds and Long-Term Bank Debt Senior Notes (2) June 2018 6.5%(4) 200 Pay down First Mortgage Bonds and general corporate purposes Long-Term Bank Debt May 2001-2003 6.05%(5) 225 Pay down Long-Term Bank Debt ------------ Total through June 30, 1998 $1,434 (1) GTNs are issued from time to time with various maturities. The rate shown herein is a weighted average interest rate. (2) The Senior Notes are secured by Consumers' First Mortgage Bonds issued contemporaneously in a similar amount. (3) The interest rate may be reset in May 2003. (4) The interest rate will be reset in June 2005. (5) The interest rate is variable; weighted average interest rate upon original issuance was 6.05 percent. As of June 30, 1998, CMS Energy had an aggregate $302 million in securities registered for future issuance and sale. CMS Energy also has Senior Credit Facilities, unsecured lines of credit and letters of credit as sources of funds needed to fulfill, in whole or in part, material commitments for capital expenditures. For detailed information, see "Short-Term and Long-Term Financing, and Capitalization-CMS Energy" in Note 3, incorporated by reference herein. Consumers has FERC authorization to issue securities and guarantees. Consumers has a credit facility, lines of credit and a trade receivable sale program in place as anticipated sources of funds needed to fulfill, in whole or in part, material commitments for capital expenditures as of June 30, 1998. For detailed information, see "Short-Term and Long-Term Financings, and Capitalization-Consumers" in Note 3, incorporated by reference herein. In February and May 1998, CMS Energy declared and paid $61 million in cash dividends to holders of CMS Energy Common Stock and $5 million in cash dividends to holders of Class G Common Stock. In July 1998, the Board of Directors declared quarterly dividends of $.33 per share on CMS Energy Common Stock and $.325 per share on Class G Common Stock, payable in August 1998. This represents an increase in the annualized dividend on CMS Energy Stock to $1.32 per share from the previous amount of $1.20 per share (a 10 percent increase), and an increase in the annualized dividend on Class G Common Stock to $1.30 per share from the previous dividend of $1.24 per share (a 4.8 percent increase). Other Investing and Financing Matters: At June 30, 1998, the book value per share of CMS Energy Common Stock and Class G Common Stock was $17.57 and $10.92, respectively. CMS Energy has a bank commitment through December 1998 to enter into a $600 million credit agreement to fund investments in power projects. CMS Energy's $400 million, 364-day revolving credit facility expired June 30, 1998, and was not renewed. On August 3, 1998, CMS Energy announced the execution of a merger agreement with Continental Natural Gas, Inc. ("CNGL"), a $185 million (assets) energy company engaged in gathering, processing, purchasing and marketing natural gas and natural gas liquids in Oklahoma and Texas. Approximately $65 million of CMS Energy Common Stock will be issued to acquire 100 percent of CNGL's common stock and approximately $90 million of CNGL debt will be assumed in the transaction, which is intended to be accounted for as a pooling of interests. The merger agreement is subject to ratification by the holders of a majority of CNGL's common stock and certain regulatory filings. The transaction is expected to close in the fourth quarter of 1998. 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 $3.8 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 398 469 400 Oil and gas exploration and production 110 160 175 Natural gas transmission and storage 241 61 100 International energy distribution 141 125 100 Marketing, services and trading 50 25 30 ----- ----- ----- $1,375 $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 Note 2. CMS Energy currently plans investments from 1998 to 2000: (1) for oil and gas exploration and production operations, primarily in North and South America, offshore West Africa and North Africa; (2) for independent power production operations to pursue acquisitions and development of electric generating plants in the United States, Latin America, Asia, Australia, the Pacific Rim region, North Africa and the Middle East; (3) to continue development of non-utility natural gas storage, gathering and pipeline operations of CMS Gas Transmission, both domestic and international; (4) to acquire, develop and expand international energy distribution businesses; and (5) to provide gas, electric, oil and coal marketing, risk management and energy management services throughout the United States and eventually worldwide. These estimates are prepared for planning purposes and are subject to revision. OUTLOOK As the deregulation and privatization of the energy industry takes place in the United States and internationally, CMS Energy has positioned itself to be a leading international energy infrastructure company developing and operating energy facilities and providing energy services in major world growth markets. CMS Energy provides a complete range of international energy expertise from energy production to consumption. Beyond 1998 it intends to continue to grow its businesses by finding opportunities to invest in additional energy infrastructures and to capitalize on being a major, full-service energy company. CMS Energy will seek to increase its involvement in energy projects by pursuing opportunities in oil and gas exploration and production projects, natural gas pipelines, storage and processing facilities, power generation, and electric and gas distribution systems around the world. In addition, CMS Energy will focus more on marketing energy services and trading to take advantage of continued growth opportunities in both the domestic and international markets. International Operations Outlook CMS Energy will continue to grow internationally by investing in multiple projects in several countries as well as by developing synergistic projects across its lines of business. CMS Energy believes these integrated projects will create more opportunities and greater value than individual investments. Also, CMS Energy will achieve this growth through strategic partnering where appropriate. To improve the focus of its international energy businesses, CMS Energy has separated its development efforts from the operations of its assets. CMS Energy conducts its development efforts from offices in four regions of the world: Dearborn, Michigan for The Americas - Northern Hemisphere; Buenos Aires for The Americas - Southern Hemisphere; London for Africa and the Middle East; and Singapore for Asia. CMS Energy's development efforts will focus on countries where there are multiple investment opportunities across its businesses, high energy growth expectations, defined legal and regulatory structures, and economic policies that support private investment. CMS Energy will continue to create value by using the extensive knowledge and experience it has gained in the United States over the past century, to gain competitive positions in these countries. CMS Energy structures its investments to minimize operational and financial risks. These risks are mitigated when operating internationally by working with local partners, utilizing multi-lateral financing institutions, procuring political risk insurance and hedging foreign currency exposure where appropriate. Consumers' Electric Business Unit Outlook Growth: Consumers expects average annual growth of two and one-half percent per year in electric system deliveries over the next five years, absent the impact of restructuring on the industry and its regulation in Michigan. Abnormal weather, changing economic conditions, or the developing competitive market for electricity may affect actual electric sales in future periods. Electric Restructuring: Consumers' 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 of terminating their contracts early. FERC Orders 888 and 889, as amended, require utilities to provide direct access to the interstate transmission grid for wholesale transactions. Consumers and Detroit Edison disagree on the effect of the orders on the Michigan Electric Power Coordination Center pool. Consumers proposes to maintain the benefits of the pool, through at least December 2000, while Detroit Edison contends that the pool agreement should be terminated immediately. Among Consumers' alternatives in the event of the pool being terminated would be joining an independent system operator. FERC has indicated this preference for structuring the operations of the electric transmission grid. As discussed in the Form 10-K, several orders were issued and numerous appeals are pending at the Court of Appeals relating to the restructuring of the electric utility industry since June 1997. Consumers cannot predict the outcome or timing of these matters. For material changes relating to the restructuring of the electric utility industry see "Electric Business Unit Rate Matters - Electric Restructuring" in Note 2, incorporated by reference herein. Electric Application of SFAS 71: Consumers applies the utility accounting standard, SFAS 71, that recognizes the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities related to the generation, transmission and distribution operations of its business in its financial statements. Consumers believes that the generation segment of its business is still subject to rate regulation based upon its present obligation to continue providing generation service to its customers, and the lack of definitive deregulation orders. If rate recovery of generation-related costs becomes unlikely or uncertain, whether due to competition or regulatory action, this accounting standard may no longer apply to the generation segment of Consumers' business. According to Emerging Issues Task Force Issue 97-4, Deregulation of the Pricing of Electricity - Issues Related to the Application of FASB Statements No. 71 and 101, Consumers can continue to carry its generation-related regulatory assets or liabilities for the part of the business being deregulated if deregulatory legislation or an MPSC rate order allows the collection of cash flows from its regulated transmission and distribution customers to recover these specific costs or settle obligations. Because the February 1998 MPSC order allows Consumers to fully recover its transition costs, Consumers believes that even if it was to discontinue application of SFAS 71 for the generation segment of its business, its regulatory assets, including those related to generation, are probable of future recovery from the regulated portion of the business. At June 30, 1998, Consumers had $261 million of generation-related net regulatory assets recorded on its balance sheet, and a net investment in generation facilities of $1.3 billion included in electric plant and property. For further information regarding electric restructuring, see "Restructuring" above. 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. In 1997, LIHEAP provided approximately $64 million in heating assistance to about 312,000 Michigan households, with approximately 13 percent of the funds going to Consumers' customers. Congress provided approximately $54 million in funding for Michigan for 1998. In June 1998, the House Labor, Health and Human Services Appropriations Subcommittee voted to propose elimination of LIHEAP for fiscal year 1999. In July 1998, the full Committee accepted the subcommittee proposal (which eliminates LIHEAP). The full House of Representatives is expected to vote on this bill before October 1, 1998. Many interested parties, including the Senate Labor and Human Resources Committee, are working to restore funding for the program; however, Consumers cannot predict the legislative outcome of funding for this program. Gas Application of SFAS 71: Based on a regulated utility accounting standard, SFAS 71, Consumers may defer certain costs to the future and record regulatory assets, based on the recoverability of those costs through the MPSC's approval. Consumers has evaluated its regulatory assets related to its gas business, and believes that sufficient regulatory assurance exists to provide for the recovery of these deferred costs. OTHER MATTERS New Accounting Standards In 1998, the FASB issued SFAS 132, Employers' Disclosures about Pensions and Other Postretirement Benefits. This standard requires expanded disclosure effective for 1998. Also in 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which will be effective for 1999. CMS Energy does not expect the application of these standards to materially affect its financial position, liquidity or results of operations. In addition, in 1998, the FASB issued SFAS 133, Accounting for Derivative Instruments and Hedging Activities, which requires that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. SFAS 133 is effective for fiscal years beginning after June 15, 1999. CMS Energy has not yet quantified the impacts of adopting SFAS 133 on its financial statements and has not determined the timing of or method of adoption of SFAS 133. However, SFAS 133 could increase volatility in earnings and other comprehensive income. Computer Modifications For Year 2000 CMS Energy uses 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 generating plant outages. In 1995, CMS Energy began modifying its own computer software systems by dividing programs requiring modification between critical and noncritical programs. All essential 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. There can be no guarantee, however, that these costs, plans or time estimates will be achieved, and actual results could differ materially. Specific factors that may cause such material differences include, but are not limited to, the availability of personnel trained in this area, the ability to locate and correct all relevant computer code, and the year 2000 readiness of CMS Energy's vendors, large customers and other third parties with whom it does business. Because of the integrated nature of CMS Energy's business with other energy companies, utilities, jointly owned facilities operated by other entities, and business conducted with suppliers and large customers, CMS Energy may be indirectly affected by year 2000 compliance complications. At this time, CMS Energy is unable to anticipate the magnitude of the operational or financial impact on CMS Energy of year 2000 issues. Foreign Currency Translation CMS Energy adjusts common stockholders' equity to reflect foreign currency translation adjustments for the operation of long-term investments in foreign countries. As of June 30, 1998 the cumulative foreign currency translation adjustment was $123 million relating primarily to the U.S. and Australian dollar exchange rate fluctuations related to Loy Yang. Although management 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, CMS Energy has hedged its exposure to the Australian dollar. CMS Energy uses forward exchange contracts and collared options to hedge certain receivables, payables, long-term debt and equity value relating to foreign investments. The notional amount of the outstanding foreign exchange contracts was $595 million at June 30, 1998, which includes $550 million for Australian foreign exchange contracts. Forward-Looking Information Forward-looking information is included throughout this report. This report also describes material contingencies in the Notes to the Consolidated Financial Statements and should be read accordingly. Some important factors that could cause actual results or outcomes to differ are set forth in CMS Energy's 1997 Form 10-K, "Management's Discussion and Analysis, Forward-Looking Information." (This page intentionally left blank) 23 CMS Energy Corporation Consolidated Statements of Income (Unaudited)
Three Months Ended Six Months Ended Twelve Months Ended June 30 1998 1997* 1998 1997* 1998 1997* In Millions, Except Per Share Amounts Operating Revenue Electric utility $ 649 $ 598 $1,261 $1,218 $2,558 $2,492 Gas utility 170 220 599 718 1,085 1,242 Independent power production 75 42 119 71 216 105 Natural gas transmission, storage and processing 22 26 49 52 93 82 Oil and gas exploration and production 19 20 31 37 87 147 Marketing, services and trading 196 114 443 213 922 339 Other 1 2 4 8 9 18 ------ ------ ------ ------ ------ ------ 1,132 1,022 2,506 2,317 4,970 4,425 ------ ------ ------ ------ ------ ------ Operating Expenses Operation Fuel for electric generation 85 75 164 149 334 311 Purchased power - related parties 144 146 290 297 592 600 Purchased and interchange power 88 53 142 115 270 226 Cost of gas sold 182 223 645 621 1,335 1,042 Other 248 172 460 348 853 747 ------ ------ ------ ------ ------ ------ 747 669 1,701 1,530 3,384 2,926 Maintenance 42 41 79 82 171 182 Depreciation, depletion and amortization 107 106 235 234 468 446 General taxes 48 48 106 109 208 206 ------ ------ ------ ------ ------ ------ 944 864 2,121 1,955 4,231 3,760 ------ ------ ------ ------ ------ ------ Pretax Operating Income (Loss) Electric utility 107 104 226 210 448 419 Gas utility 21 23 75 101 127 143 Independent power production 50 25 66 35 127 70 Natural gas transmission, storage and processing 9 7 22 16 33 24 Oil and gas exploration and production 7 3 9 3 32 18 Marketing, services and trading 1 - - 1 (7) 1 Other (7) (4) (13) (4) (21) (10) ------ ------ ------ ------ ------ ------ 188 158 385 362 739 665 ------ ------ ------ ------ ------ ------ Other Income (Deductions) Loss on MCV power purchases - - (37) - (37) - Accretion income 1 2 3 4 7 9 Accretion expense (4) (4) (8) (9) (17) (17) Other, net 3 1 6 2 2 - ------ ------ ------ ------ ------ ------ - (1) (36) (3) (45) (8) ------ ------ ------ ------ ------ ------ Fixed Charges Interest on long-term debt 78 67 154 127 300 241 Other interest 13 12 25 22 52 46 Capitalized interest (7) (4) (11) (6) (18) (9) Preferred dividends 5 7 10 14 21 28 Preferred securities distributions 8 3 16 5 29 9 ------ ------ ------ ------ ------ ------ 97 85 194 162 384 315 ------ ------ ------ ------ ------ ------ Income Before Income Taxes 91 72 155 197 310 342 Income Taxes 26 25 45 72 81 124 ------ ------ ------ ------ ------ ------ Consolidated Net Income before cumulative effect of change in accounting principle 65 47 110 125 229 218 Cumulative effect of change in accounting for property taxes, net of $23 tax (Note 1) - - 43 - 43 - ------ ------ ------ ------ ------ ------ Consolidated Net Income $ 65 $ 47 $ 153 $ 125 $ 272 $ 218 ====== ====== ====== ====== ====== ======
Three Months Ended Six Months Ended Twelve Months Ended June 30 1998 1997* 1998 1997* 1998 1997* In Millions, Except Per Share Amounts Net Income Attributable to Common Stocks CMS Energy $ 64 $ 45 $ 143 $ 114 $ 258 $ 206 Class G $ 1 $ 2 $ 10 $ 11 $ 14 $ 12 ------ ------ ------ ------ ------ ------ Average Common Shares Outstanding CMS Energy 101 95 101 95 99 94 Class G 8 8 8 8 8 8 ------ ------ ------ ------ ------ ------ Basic Earnings Per Average Common Share Before Change in Accounting Principle CMS Energy $ .63 $ .48 $ 1.02 $ 1.21 $ 2.20 $ 2.19 Class G $ .12 $ .16 $ .84 $ 1.34 $ 1.35 $ 1.52 ------ ------ ------ ------ ------ ------ Cumulative Effect of Change in Accounting Principle, Net of Tax, Per Average Common Share CMS Energy $ - $ - $ .40 $ - $ .40 $ - Class G $ - $ - $ .36 $ - $ .36 $ - ------ ------ ------ ------ ------ ------ Basic Earnings Per Average Common Share CMS Energy $ .63 $ .48 $ 1.42 $ 1.21 $ 2.60 $ 2.19 Class G $ .12 $ .16 $ 1.20 $ 1.34 $ 1.71 $ 1.52 ------ ------ ------ ------ ------ ------ Diluted Earnings Per Average Common Share CMS Energy $ .62 $ .48 $ 1.39 $ 1.20 $ 2.57 $ 2.18 Class G $ .12 $ .16 $ 1.20 $ 1.34 $ 1.71 $ 1.52 ------ ------ ------ ------ ------ ------ Dividends Declared Per Common Share CMS Energy $ .30 $ .27 $ .60 $ .54 $ 1.20 $ 1.08 Class G $ .31 $ .295 $ .62 $ .59 $ 1.24 $ 1.18 ------ ------ ------ ------ ------ ------ * Restated, see Note 1. The accompanying condensed notes are an integral part of these statements.
25 CMS Energy Corporation Consolidated Balance Sheets
ASSETS June 30 June 30 1998 December 31 1997* (Unaudited) 1997* (Unaudited) In Millions Plant and Property (At Cost) Electric $ 6,579 $ 6,491 $ 6,467 Gas 2,478 2,528 2,467 Oil and gas properties (successful efforts method) 1,280 1,237 1,179 Other 171 168 99 ------- ------- ------- 10,508 10,424 10,212 Less accumulated depreciation, depletion and amortization 5,667 5,541 5,381 ------- ------- ------- 4,841 4,883 4,831 Construction work-in-progress 307 261 281 ------- ------- ------- 5,148 5,144 5,112 ------- ------- ------- Investments Independent power production 890 792 846 Natural gas transmission, storage and processing 305 241 224 International energy distribution 259 255 65 First Midland Limited Partnership (Note 2) 247 242 237 Midland Cogeneration Venture Limited Partnership (Note 2) 189 171 148 Other 36 45 23 ------- ------- ------- 1,926 1,746 1,543 ------- ------- ------- Current Assets Cash and temporary cash investments at cost, which approximates market 230 69 53 Accounts receivable and accrued revenue, less allowances of $7, $7 and $9, respectively (Note 3) 509 495 353 Inventories at average cost Gas in underground storage 178 197 125 Materials and supplies 89 87 95 Generating plant fuel stock 35 35 28 Deferred income taxes 2 38 28 Prepayments and other 214 235 133 ------- ------- ------- 1,257 1,156 815 ------- ------- ------- Non-current Assets Nuclear decommissioning trust funds 521 486 443 Postretirement benefits 389 404 419 Abandoned Midland Project 83 93 103 Other 534 479 429 ------- ------- ------- 1,527 1,462 1,394 ------- ------- ------- Total Assets $ 9,858 $ 9,508 $ 8,864 ======= ======= =======
STOCKHOLDERS' INVESTMENT AND LIABILITIES June 30 June 30 1998 December 31 1997* (Unaudited) 1997* (Unaudited) In Millions Capitalization Common stockholders' equity $ 1,877 $ 1,787 $ 1,635 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) 173 173 173 Long-term debt 4,294 3,272 3,077 Non-current portion of capital leases 78 75 89 ------- ------- ------- 6,880 5,765 5,430 ------- ------- ------- Current Liabilities Current portion of long-term debt and capital leases 126 643 690 Notes payable 255 382 246 Accounts payable 302 398 286 Accrued taxes 160 272 191 Accounts payable - related parties 114 80 65 Accrued interest 56 51 50 Power purchases (Note 2) 47 47 47 Accrued refunds 11 12 7 Other 178 190 171 ------- ------- ------- 1,249 2,075 1,753 ------- ------- ------- Non-current Liabilities Deferred income taxes 693 648 599 Postretirement benefits 504 514 524 Power purchases (Note 2) 146 133 157 Deferred investment tax credit 146 151 156 Regulatory liabilities for income taxes, net 59 54 81 Other 181 168 164 ------- ------- ------- 1,729 1,668 1,681 ------- ------- ------- Commitments and Contingencies (Note 2) Total Stockholders' Investment and Liabilities $ 9,858 $ 9,508 $ 8,864 ======= ======= ======= (a) The primary asset of Consumers Power Company Financing I is $103 million principal amount of 8.36 percent subordinated deferrable interest notes due 2015 from Consumers. The primary asset of Consumers Energy Company Financing II is $124 million principal amount of 8.20 percent subordinated deferrable interest notes due 2027 from Consumers. (b) The primary asset of CMS Energy Trust I is $178 million principal amount of 7.75 percent convertible subordinated debentures due 2027 from CMS Energy. * Restated, see Note 1. The accompanying condensed notes are an integral part of these statements.
27 CMS Energy Corporation Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended Twelve Months Ended June 30 1998 1997* 1998 1997* In Millions Cash Flows from Operating Activities Consolidated net income $ 153 $ 125 $ 272 $ 218 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear decommissioning of $25, $24, $50 and $49, respectively) 235 234 468 446 Deferred income taxes and investment tax credit 84 16 92 43 Loss on MCV power purchases 37 - 37 - Capital lease and debt discount amortization 29 22 51 41 Accretion expense 8 9 17 17 Accretion income - abandoned Midland project (3) (4) (7) (9) Cumulative effect of accounting change for property taxes (66) - (66) - Undistributed earnings of related parties (34) (20) (72) (40) Power purchases (32) (30) (64) (66) Other 3 (6) (1) 16 Changes in other assets and liabilities (105) 12 (152) (138) ------ ------ ------ ------ Net cash provided by operating activities 309 358 575 528 ------ ------ ------ ------ Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (289) (342) (625) (745) Investments in partnerships and unconsolidated subsidiaries (162) (534) (458) (564) Cost to retire property, net (44) (11) (61) (31) Investments in nuclear decommissioning trust funds (25) (24) (50) (49) Other (42) (14) (43) (4) Proceeds from sale of property 68 13 104 77 Proceeds from nuclear decommissioning trust funds 27 - 27 - ------ ------ ------ ------ Net cash used in investing activities (467) (912) (1,106) (1,316) ------ ------ ------ ------ Cash Flows from Financing Activities Proceeds from bank loans, notes and bonds 1,554 581 2,187 629 Issuance of common stock 30 30 224 109 Repayment of bank loans (574) (22) (581) (31) Retirement of bonds and other long-term debt (476) (49) (948) (86) Increase (decrease) in notes payable, net (127) (87) 9 138 Payment of common stock dividends (66) (56) (129) (111) Payment of capital lease obligations (22) (21) (45) (39) Proceeds from preferred securities - 173 113 173 Retirement of common stock - - (2) (1) Retirement of preferred stock - - (120) - ----- ------ ------ ------ Net cash provided by financing activities 319 549 708 781 ------ ------ ------ ------ Net Increase (Decrease) in Cash and Temporary Cash Investments 161 (5) 177 (7) Cash and Temporary Cash Investments, Beginning of Period 69 58 53 60 ------ ------ ------ ------ Cash and Temporary Cash Investments, End of Period $ 230 $ 53 $ 230 $ 53 ====== ====== ====== ====== Other cash flow activities and non-cash investing and financing activities were: Cash transactions Interest paid (net of amounts capitalized) $ 160 $ 135 $ 318 $ 267 Income taxes paid (net of refunds) 31 46 52 83 Non-cash transactions Nuclear fuel placed under capital lease $ 15 $ 3 $ 16 $ 31 Other assets placed under capital leases 7 3 10 5 ====== ====== ====== ====== All highly liquid investments with an original maturity of three months or less are considered cash equivalents. *Restated, see Note 1. The accompanying condensed notes are an integral part of these statements.
28 CMS Energy Corporation Consolidated Statements of Common Stockholders' Equity (Unaudited)
Three Months EndedSix Months EndedTwelve Months Ended June 30 1998 1997* 1998 1997* 1998 1997* In Millions Common Stock At beginning and end of period $ 1 $ 1 $ 1 $ 1 $ 1 $ 1 ------ ------ ------ ------ ------ ------ Other Paid-in Capital At beginning of period 2,287 2,062 2,267 2,045 2,075 1,967 Common stock reacquired - - - - (2) (1) Common stock issued: CMS Energy 9 12 27 28 216 104 Class G 1 1 3 2 8 5 ------ ------ ------ ------ ------ ------ At end of period 2,297 2,075 2,297 2,075 2,297 2,075 ------ ------ ------ ------ ------ ------ Revaluation Capital At beginning of period (3) (6) (6) (6) (6) (8) Change in unrealized investment-gain (loss) (a) (3) - - - - 2 ------ ------ ------ ------- ----- ------ At end of period (6) (6) (6) (6) (6) (6) ------ ------ ------ ------- ----- ------ Foreign Currency Translation At beginning of period (94) - (96) - - - Change in foreign currency translation (a) (29) - (27) - (123) - ------ ------ ------ ------ ------ ------ At end of period (123) - (123) - (123) - ------ ------ ------ ------ ------ ------ Retained Earnings (Deficit) At beginning of period (324) (454) (379) (504) (435) (542) Consolidated net income 65 47 153 125 272 218 Common stock dividends declared: CMS Energy (31) (26) (61) (52) (118) (102) Class G (2) (2) (5) (4) (11) (9) ------ ------ ------ ------- ----- ------ At end of period (292) (435) (292) (435) (292) (435) ------ ------ ------ ------- ----- ------ Total Common Stockholders' Equity $1,877 $1,635 $1,877 $1,635 $1,877 $1,635 ====== ====== ====== ===== ====== ====== (a) Disclosure of Comprehensive Income: Revaluation capital Unrealized investment- gain(loss), net of tax $2, $-, $-,$-, $- and $(1), respectively $ (3) $ - $ - $ - $ - $ 2 Foreign currency translation (29) - (27) - (123) - Consolidated net income 65 47 153 125 272 218 ------ ------ ------ ------ ----- ------ Total Consolidated Comprehensive Income $ 33 $ 47 $ 126 $ 125 $ 149 $ 220 ====== ====== ====== ======= ===== ====== * Restated, see Note 1. 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 and the restated financial information in a Form 8-K dated July 30, 1998 of CMS Energy Corporation, which include the Reports of Independent Public Accountants. Certain prior year amounts have been reclassified to conform with the presentation in the current year. In the opinion of management, the unaudited information herein reflects all adjustments necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. 1: Corporate Structure, Basis of Presentation And Changes of Significant Accounting Policies Corporate Structure and Basis of Presentation CMS Energy is the parent holding company of Consumers and Enterprises. Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan and is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Enterprises is engaged in several domestic and international energy-related businesses including: acquisition, development and operation of independent power production facilities; oil and gas exploration and production; transmission, storage, and processing of natural gas; energy marketing, services and trading; and international energy distribution. CMS Energy uses the equity method of accounting for investments in companies and partnerships where it has more than a 20 percent but less than a majority ownership interest and includes these results in operating income. For the three, six and twelve month periods ended June 30, 1998, undistributed equity earnings were $17 million, $34 million and $72 million, respectively, and $9 million, $20 million and $40 million for the three, six and twelve month periods ended June 30, 1997. Foreign currency translation adjustments relating to the operation of CMS Energy's long-term investments in foreign countries are included in common stockholders' equity. As of June 30, 1998 the cumulative foreign currency translation adjustment was $123 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. Change in Method of Accounting For Investments in Oil and Gas Properties CMS NOMECO elected to convert effective January 1, 1998 from the full cost method to the successful efforts method of accounting for its investments in oil and gas properties. CMS NOMECO believes this accounting change will more accurately present the results of its exploration and development activities and minimize asset write-offs caused by periodic price swings, which may not be representative of overall or long-term markets. In addition, the FASB has stated a preference for the use of successful efforts accounting. Nitrotec Corporation, in which CMS Gas Transmission has an equity investment, also elected to convert effective January 1, 1998 from the full cost method of accounting to the successful efforts method of accounting. Accordingly, all prior period financial statements have been restated to conform with successful efforts accounting. The effect, after tax, of the change in accounting method as of December 31, 1997, was a reduction to retained earnings of $175 million for CMS NOMECO and $15 million for CMS Gas Transmission, primarily attributable to a decrease in net plant and property and deferred tax liability of $270 million and $95 million, respectively, for CMS NOMECO and a $15 million decrease in CMS Gas Transmission's equity investment in Nitrotec Corporation. The combined effects of the changes in accounting method resulted in an increase in net income of $5 million ($.06 per share) for the three months ended March 31, 1998, and a decrease in net income of $6 million ($.06 per share) for the three months ended March 31,1997; see Note 6. For the three, six and twelve months ended June 30, 1997, the combined effects of the changes in accounting method resulted in decreases to net income of $7 million ($.07 per share), $13 million ($.13 per share), and $22 million ($.24 per share), respectively. Oil and Gas Properties CMS NOMECO utilizes the successful efforts method of accounting for its investments in oil and gas properties. CMS NOMECO capitalizes the costs of property acquisitions, successful exploratory wells, all development costs, and support equipment and facilities when incurred. It expenses unsuccessful exploratory wells when they are determined to be non-productive. CMS NOMECO also charges to expense production costs, overhead, and all exploration costs other than exploratory drilling as incurred. Depreciation, depletion and amortization of proved oil and gas properties is determined on a field-by-field basis using the unit-of-production method over the life of the remaining proved reserves. 2: Uncertainties Consumers' Electric Business Unit Contingencies Electric Environmental Matters: The Clean Air Act limits emissions of sulfur dioxide and nitrogen oxides and requires emissions monitoring. Consumers' coal-fueled electric generating units burn low-sulfur coal and are currently operating at or near the sulfur dioxide emission limits that will be effective in the year 2000. During the past few years, in order to comply with the Act, Consumers incurred capital expenditures totaling $46 million to install equipment at certain generating units. Consumers estimates capital expenditures for 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, following completion of the Ozone Transport Assessment Group process and requests by 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 would reduce nitrogen oxide emissions, as early as 2002, to only 32 percent of levels allowed for the year 2000 under current regulations. The EPA is expected to issue final regulations in the fall of 1999. The State of Michigan will have one year after final regulations are issued to implement the 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 June 30, 1998, Consumers has accrued $3 million for its estimated Superfund liability. While decommissioning Big Rock, Consumers found that some areas of the plant have coatings that contain both metals and PCBs. Consumers does not believe that any facility in the United States currently accepts the radioactive portion of that waste. The cost of removal and disposal is currently unknown. These costs would constitute part of the cost to decommission the plant, and will be paid from the decommissioning fund. Consumers is studying the extent of the contamination and reviewing options. Stray Voltage: Various parties have sued Consumers relating to the effect of so-called stray voltage on certain livestock. Claimants contend that stray voltage results when low-level electrical currents present in grounded electrical systems are diverted from their intended path. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns. It also has an ongoing mitigation program to modify the service of all customers with livestock. In December 1997, the Michigan Supreme Court remanded for further proceedings a 1994 Michigan trial court decision that refused to allow the claims of over 200 named plaintiffs to be joined in a single action. The trial court dismissed all of the plaintiffs except the first-named plaintiff, allowing the others to re-file separate actions. Of the original plaintiffs, only 49 re-filed separate cases. All of those 49 cases have been resolved. The Michigan Supreme Court remanded the matter, finding that the proper remedy for misjoinder was not dismissal, but to automatically allow each case to go forward separately. Consumers filed a motion for reconsideration with the Michigan Supreme Court, which was denied. As a result, 21 individual plaintiffs 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 June 30, 1998, Consumers had 5 individual stray voltage lawsuits awaiting trial court action, unrelated to the cases above. At year end 1997, Consumers had 12 such lawsuits awaiting trial court action. Anti-Trust: In October 1997, two independent power producers sued Consumers and CMS Energy in a federal court. The suit alleges antitrust violations relating to contracts which Consumers entered into with some of its customers and claims relating to power facilities. The plaintiffs claim damages of $100 million (which a court can treble in antitrust cases as provided by law). 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. Consumers' Electric Business Unit Rate Matters Electric Proceedings: In 1996, the MPSC issued a final order that authorized Consumers to recover costs associated with the purchase of the additional 325 MW of MCV Facility capacity (see "Power Purchases from the MCV Partnership" in this Note) and recover its nuclear plant investment by increasing prospective annual nuclear plant depreciation expense by $18 million, with a corresponding decrease in fossil-fueled generating plant depreciation expense. It also established an experimental direct-access program. Customers having a maximum demand of at least 2 MW are eligible to purchase generation services directly from any eligible third-party power supplier and Consumers would transmit the power for a fee. The 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 Commission's order allowed existing special contracts to fill 410 MW of the load. Although the issue is still subject to MPSC review, it is Consumers' position that 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 further restructuring orders in October 1997 and in January and February 1998. These orders provide for: 1) the recovery of estimated Transition Costs of $1.755 billion through a charge to all direct-access customers until the end of the transition period in 2007, subject to an adjustment through a true-up mechanism; 2) the commencement of the phase-in of direct access in 1998; 3) the suspension of the power supply cost recovery clause; and 4) all customers to be free to choose power suppliers on January 1, 2002. See "Other Electric Uncertainties" below for further information regarding the effect of the PSCR suspension on the recovery of MCV Facility capacity charges. 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 and recovered via a charge approved by the MPSC. Nuclear decommissioning costs will also continue to be collected through a separate surcharge to all customers. Consumers expects Michigan legislative consideration of the entire subject of electric industry restructuring in 1998. To be acceptable to Consumers, the legislation would have to provide for full recovery of Transition Costs. Consumers expects the legislature to review all of the policy choices made by the MPSC during the restructuring proceedings to assure that they are in accord with those that the legislature believes should be paramount. There are numerous appeals pending at the Court of Appeals relating to the MPSC's restructuring orders, including appeals by Consumers and Detroit Edison. Consumers believes that the MPSC lacks statutory authority to mandate industry restructuring, and its appeal is limited to this jurisdictional issue. As a result of an informal process involving consultations with MPSC staff and other interested parties, as directed in the MPSC's February 1998 order, Consumers submitted to the MPSC in June 1998 its plan for implementing direct access. The primary issues addressed in the plan are: 1) the implementation schedule; 2) the direct access service options available to customers and suppliers; 3) the process and requirements for customers and others to obtain direct access service; and 4) the roles and responsibilities for Consumers, customers and suppliers. Under the schedule in the plan, Consumers will, over the 1998-2001 period, phase-in 750 MW of electric capacity for direct access to customers. In 1998, 300 MW of direct access for bidding will be open, and an additional 150 MW will open for each year from 1999 to 2001. This plan is consistent with the previous orders regarding the phase-in process. Due to the time required for the MPSC to review the plan, Consumers does not believe direct access will commence prior to the fourth quarter of 1998. For further information regarding the effects of the restructuring on accounting methods, see Consumers' Electric Business Unit Outlook - Electric Application of SFAS 71 in the MD&A. CMS Energy cannot predict the outcome or timing of electric restructuring on CMS Energy's financial position, liquidity, or results of operations. Other Consumers' Electric Business Unit Uncertainties The Midland Cogeneration Venture: The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990 and to supply electricity and steam to Dow. Consumers, through two wholly owned subsidiaries, holds the following assets related to the MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through FMLP, a 35 percent lessor interest in the MCV Facility. Summarized Statements of Income for CMS Midland and CMS Holdings- In Millions - ---------------------------------------------------------------- Three Months Six Months Twelve Months Ended Ended Ended - ---------------------------------------------------- ----------- June 30 1998 1997 1998 1997 1998 1997 - ---------------------------------------------------------------- Pretax operating income $13 $10 $23 $18 $51 $46 Income taxes and other 4 3 7 5 16 14 - ---------------------------------------------------------------- Net income $ 9 $ 7 $16 $13 $35 $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 "Electric Restructuring" in this Note), 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 June 30, 1998 and December 31,1997, the after-tax present value of the PPA liability totaled $126 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 $5 million, partially offset by after-tax cash underrecoveries of $20 million. The undiscounted after-tax amount associated with the liability totaled $176 million at June 30, 1998. The after-tax cash underrecoveries are currently based on the assumption that the MCV Facility will be available to generate electricity 91.5 percent of the time over its expected life. For the first six months of 1998 the MCV Facility was available 99 percent of the time, resulting in $11 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 $34 $22 $21 $20 $19 ================================================================ Consumers bases the above estimated underrecoveries, in part, on an estimate of the future availability of the MCV Facility. If the MCV Facility operates at levels above management's estimate over the remainder of the PPA, Consumers will need to recognize losses for future underrecoveries larger than amounts previously recorded. Therefore, Consumers would experience larger amounts of cash underrecoveries than originally anticipated. Management will continue to evaluate the adequacy of the accrued liability considering actual MCV Facility operations. In February 1998, the MCV Partnership filed a claim of appeal from the January 1998 and February 1998 MPSC orders in the electric utility industry restructuring. At the same time, the MCV Partnership filed suit in the U.S. District Court seeking a declaration that the MPSC's failure to provide Consumers and the MCV Partnership a certain source of recovery of capacity payments after 2007 deprived the MCV Partnership of its rights under the Public Utilities Regulatory Policies Act of 1978. The MCV Partnership is seeking to prohibit the MPSC from implementing portions of the order. PSCR Matters Related to Power Purchases from the MCV Partnership- As part of a 1995 decision in the 1993 PSCR reconciliation case, the MPSC disallowed a portion of the costs related to purchases from the MCV Partnership and instead assumed recovery of those costs from wholesale customers. Consumers believed this was contrary to the terms of an earlier 1993 settlement order and appealed. The MCV Partnership and ABATE also filed separate appeals of this order. In November 1996, the Court of Appeals affirmed the MPSC's 1995 decision. The MCV Partnership filed an application for leave to appeal with the Michigan Supreme Court which was denied in January 1998. This matter is now closed. Nuclear Matters: Consumers filed updated decommissioning information with the MPSC in 1995 that estimated decommissioning costs for Big Rock and Palisades. In April 1996, the MPSC issued an order in Consumers' nuclear decommissioning case, which fully supported Consumers' request and did not change the overall surcharge revenues collected from retail customers. The MPSC ordered Consumers to file a report on the adequacy of the surcharge revenues with the MPSC at three-year intervals beginning in 1998. On March 31, 1998, Consumers filed with the MPSC a new decommissioning cost estimate for Big Rock and Palisades of $294 million and $518 million (in 1997 dollars) respectively. The estimated decommissioning costs decreased from previous estimates primarily due to a decrease in offsite burial costs. Consumers recommended a reallocation of its existing surcharge between the two plants on January 1, 1999 to provide additional funds to decommission Big Rock. Consumers filed a revision to its Post Shutdown Activities Report (formerly decommissioning report) with the NRC to reflect the shutdown of Big Rock. Big Rock is being decommissioned. It was closed permanently on August 29, 1997 because management determined that it would be uneconomical to operate in an increasingly competitive environment. Consumers originally scheduled the plant to close May 31, 2000, at the end of the plant's operating license. Plant decommissioning began in September 1997 and may take five to ten years to return the site to its original condition. In January 1997, the NRC issued its Systematic Assessment of Licensee Performance report for Palisades. The report rated all areas as good, unchanged from the previous assessment. Palisades' temporary on-site storage pool for spent nuclear fuel is at capacity. Consequently, Consumers is using NRC-approved steel and concrete vaults, commonly known as "dry casks", for temporary on-site storage. As of June 30, 1998 Consumers had loaded 13 dry storage casks with spent nuclear fuel at Palisades. Consumers plans to load five additional casks at Palisades in 1999 pending approval by the NRC. In June 1997, the NRC approved Consumers' process for unloading spent fuel from a cask at Palisades previously discovered to have minor weld flaws. Consumers intends to transfer the spent fuel to a new transportable cask when one is available. A planned outage for refueling and maintenance at Palisades was completed June 7, 1998. Consumers replaced 60 nuclear fuel assemblies in the plant's reactor during the outage. The NRC requires Consumers to make certain calculations and report to it on the continuing ability of the Palisades reactor vessel to withstand postulated pressurized thermal shock events during its remaining license life, considering the embrittlement of reactor vessel materials over time due to operation in a radioactive environment. Based on continuing analysis of data in December 1996, Consumers received an interim Safety Evaluation Report from the NRC indicating that the reactor vessel can be safely operated through 2003 before reaching the NRC's screening criteria for reactor embrittlement. Consumers believes that with fuel management designed to minimize embrittlement, it can operate Palisades to the end of its license life in the year 2007 without annealing the reactor vessel. Nevertheless, Consumers will continue to monitor the matter. Consumers Gas Group Contingencies Gas Environmental Matters: Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. In 1998 Consumers plans to study indoor air issues at residences on some sites and ground water impacts or surface soil impacts at other sites. On sites where Consumers has received site-wide study plan approvals, it will continue to implement these plans. It will also work toward closure of environmental issues at sites as studies are completed. Data available to Consumers and its continued internal review have resulted in an estimate for all costs related to investigation and remedial action for all 23 sites of between $48 million and $98 million. These estimates are based on undiscounted 1998 costs. As of June 30,1998, 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 techniques, nature and extent of contamination, and legal and regulatory requirements, could affect the estimate of remedial action costs for the sites. According to an MPSC rate order issued in 1996, Consumers will defer and amortize, over a period of ten years, environmental clean-up costs above the amount currently being recovered in rates. Rate recognition of amortization expense will not begin until after a prudence review in a general rate case. The order authorizes current recovery of $1 million annually. Consumers 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. Consumers Gas Group Matters GCR Matters: 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. Gas Restructuring: In December 1997, the MPSC approved Consumers' application to implement a statewide experimental gas transportation pilot program. Consumers' expanded experimental program will extend over a three-year period, eventually allowing 300,000 residential, commercial and industrial retail gas sales customers to choose their gas supplier. The program is voluntary for natural gas customers. Participating customers are being selected on a first-come, first-served basis, up to a limit of 100,000 customers beginning April 1, 1998. As of July 23, 1998 approximately 21,800 customers chose alternative gas suppliers, representing approximately 13 bcf of gas load. Of these alternative gas suppliers, one was a CMS Energy affiliate. Up to 100,000 more customers may be added beginning April 1 of each of the next two years. Customers choosing to remain as sales customers of Consumers will not see a rate change in their natural gas rates. The order allowing the implementation of this program: 1) suspends Consumers' gas cost recovery clause, effective April 1, 1998 for a three-year period, establishing a gas commodity cost at a fixed rate of $2.84 per mcf; 2) establishes an earnings sharing mechanism that will provide for refunds to customers if Consumers' earnings during the three year term of the program exceed certain pre-determined levels; and 3) establishes a gas transportation code of conduct that addresses concerns about the relationship between Consumers and marketers, including its affiliated marketers. This experimental program will allow competing gas suppliers, including marketers and brokers, to market natural gas to a large number of retail customers in direct competition with Consumers. In January 1998, the Attorney General, ABATE and other parties filed claims of appeal regarding the program with the Court of Appeals. For further information regarding the effects of the restructuring on accounting methods, see Consumers' Gas Group Outlook - Application of SFAS 71 in the MD&A. Other Uncertainities CMS Generation Environmental Matters: CMS Generation does not currently expect to incur significant capital costs, if any, at its power facilities to comply with current environmental regulatory standards. Capital Expenditures: CMS Energy estimates capital expenditures, including investments in unconsolidated subsidiaries and new lease commitments, of $1.375 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 June 30, 1998, CMS Energy and Enterprises have guaranteed up to $700 million in contingent obligations of unconsolidated affiliates and related parties. In addition to the matters disclosed in this note, Consumers and certain other subsidiaries of CMS Energy are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies arising from the ordinary course of business. These lawsuits and proceedings may involve personal injury, property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing and other matters. CMS Energy has accrued estimated losses for certain contingencies discussed in this Note. Resolution of these contingencies is not expected to have a material adverse impact on CMS Energy's financial position, liquidity, or results of operations. 3: Short-Term and Long-Term Financings, and Capitalization CMS Energy: CMS Energy's Senior Credit Facilities consist of a $600 million three-year revolving credit facility and a five-year $125 million term loan facility. Additionally, CMS Energy has unsecured lines of credit and letters of credit in an aggregate amount of $163 million. At June 30, 1998, the total amount utilized under the Senior Credit Facilities was $317 million, including $47 million of contingent obligations, and under the unsecured lines of credit and letters of credit was $8 million. At June 30, 1998 CMS Energy has $130 million of Series A GTNs, $125 million of Series B GTNs, $150 million of Series C GTNs, and $182 million of Series D GTNs issued and outstanding with weighted average interest rates of 7.8 percent, 7.9 percent, 7.7 percent, and 7.0 percent, respectively. In January 1998, a Delaware statutory business trust established by CMS Energy sold $180 million of certificates due January 15, 2005 in a public offering. In exchange for those proceeds, CMS Energy sold to the trust $180 million aggregate principal amount of 7 percent Extendible Tenor Rate Adjusted Securities due January 15, 2005. Net proceeds to CMS Energy from the sale totaled $176 million. In March 1998, CMS Energy and an affiliated business trust filed a shelf registration statement with the SEC pursuant to Rule 415 of the Securities Act, for the issuance and the sale of an additional $200 million of CMS Energy Common Stock, Class G Common Stock, subordinated debentures, stock purchase contracts, stock purchase units, and Trust Preferred Securities. The primary asset of CMS Energy Trust I is $178 million principal amount of 7.75 percent convertible subordinated debentures due 2027 from CMS Energy. Consumers: At July 1, 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 June 2000; 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 June 2000, up to $950 million and $200 million for refinancing purposes and for general corporate purposes, respectively. 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 June 30, 1998, a total of $255 million was outstanding at a weighted average interest rate of 6.0 percent, compared with $241 million outstanding at June 30, 1997, at a weighted average interest rate of 6.2 percent. In January 1998, Consumers entered into interest rate swaps totaling $300 million. These swap arrangements have had an immaterial effect on interest expense. Consumers also has in place a $500 million trade receivables sale program. At June 30, 1998 and 1997, receivables sold under the program totaled $236 million and $266 million, respectively. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold. The primary asset of Consumers Power Company Financing I is $103 million principal amount of 8.36 percent subordinated deferrable interest notes due 2015 from Consumers. The primary asset of Consumers Energy Company Financing II is $124 million principal amount of 8.20 percent subordinated deferrable interest notes due 2027 from Consumers. The following table describes the new issuances of long-term financings which have occurred during 1998 through early August 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 (b) 250 Pay down First Mortgage Bonds and Long- Term Bank Debt Senior Notes (a) June 2018 6.5 (c) 200 Pay down First Mortgage Bonds and general corporate purposes Long-Term Bank Debt May 2001-2003 6.05 (d) 225 Pay down Long-Term Bank Debt and general corporate purposes - ------------------------------------------------------------------------- Total $1,150 ========================================================================= (a) The Senior Notes are secured by Consumers First Mortgage Bonds issued contemporaneously in a similar amount. (b) The interest rate may be reset in 2003. (c) The interest rate will be reset in June 2005. (d) The interest rate is variable; weighted average interest rate upon original issuance was 6.05 percent. The following table describes the retirements of long-term financings which have occurred during 1998 through early August 1998. In Millions Month Interest Principal Retired Maturity Rate (%) Amount - -------------------------------------------------------------------- First Mortgage Bonds February 1998 8.75 $248 Long-Term Bank Debt February 1998 6.4 (a) 50 First Mortgage Bonds March 2001-2002 7.5 119 First Mortgage Bonds April 2023 7.375 36 First Mortgage Bonds May 1998 6.875 43 Long-Term Bank Debt May 1998-1999 6.3 (b) 350 First Mortgage Bonds July 1999 8.875 136 - ------------------------------------------------------------------ Total $982 ================================================================== (a) The interest rate was variable; weighted average interest rate at December 31, 1997 was 6.4 percent. (b) The interest rate was variable; weighted average interest rate at March 31, 1998 was 6.3 percent. Consumers had unsecured, variable rate long-term bank debt with an outstanding balance at June 30, 1998 and 1997 of $225 million and $400 million, respectively. At June 30, 1998 and 1997 the debt carried weighted average interest rates of 6.1 percent and 6.2 percent, respectively. In February 1998, Consumers retired $50 million of its $400 million unsecured long-term bank debt. In May 1998, Consumers refinanced the remaining $350 million unsecured long-term bank debt, in part with $225 million unsecured long-term bank debt. To cover the remaining $125 million of bank debt refinancing, in May 1998 Consumers issued $250 million of senior notes due 2008, at an interest rate of 6.2 percent. The $125 million balance of senior notes due 2008 will be used for refunding or repurchasing various First Mortgage Bonds or for general corporate purposes. Under the provisions of its Articles of Incorporation at June 30, 1998, Consumers had $312 million of unrestricted retained earnings available to pay common dividends. In July 1998, Consumers declared a $44 million common dividend to be paid in August 1998. 4: Earnings Per Share and Dividends Earnings per share attributable to Common Stock for the three, six and twelve month periods ended June 30, 1998 reflect the performance of the Consumers Gas Group. The Class G Common Stock has participated in earnings and dividends from its original issue date in July 1995. The allocation of earnings attributable to each class of common stock and the related amounts per share are computed by considering the weighted average number of shares outstanding. Earnings attributable to the Outstanding Shares are equal to Consumers Gas Group net income multiplied by a fraction; the numerator is the weighted average number of Outstanding Shares during the period and the denominator is the weighted average number of Outstanding Shares and Retained Interest Shares during the period. The earnings attributable to Class G Common Stock on a per share basis for the three months ended June 30, 1998 and 1997 are based on 25.27 percent and 24.30 percent, respectively, of the income of Consumers Gas Group. Computation of Earnings Per Share: In Millions, Except Per Share Amounts - ----------------------------------------------------------------- Three Months Six Months Twelve Months Ended Ended Ended June 30 June 30 June 30 1998 1997 1998 1997 1998 1997 - ----------------------------------------------------------------- (b) (a) (b) (a) (b) Net Income Applicable to Basic and Diluted EPS Consolidated Net Income $ 65 $ 47 $153 $125 $272 $218 ` ================================================ Net Income Attributable to Common Stocks: CMS Energy - Basic EPS $ 64 $ 45 $143 $114 $258 $206 Add conversion of 7.75% Trust Preferred Securities (net of tax) 2 - 4 - 9 - ------------------------------------------------ CMS Energy - Diluted EPS $ 66 $ 45 $147 $114 $267 $206 ================================================ Class G: Basic and Diluted EPS $ 1 $ 2 $ 10 $ 11 $ 14 $ 12 ================================================= Average Common Shares Outstanding Applicable to Basic and Diluted EPS CMS Energy: Average Shares - Basic 101 95 101 95 99 94 Add conversion of 7.75% Trust Preferred Securities 4 - 4 - 4 - Options-Treasury Shares 1 1 1 1 1 2 ----------------------------------------------- Average Shares - Diluted 106 96 106 96 104 96 =============================================== Class G: Average Shares Basic and Diluted 8 8 8 8 8 8 ============================================== Earnings Per Average Common Share CMS Energy: Basic $.63 $.48 $1.42 $1.21 $2.60 $2.19 Diluted $.62 $.48 $1.39 $1.20 $2.57 $2.18 Class G: Basic and Diluted $.12 $.16 $1.20 $1.34 $1.71 $1.52 ================================================================= (a) Includes the cumulative effect of an accounting change in the first quarter of 1998 which increased net income attributible to CMS Energy Common Stock $43 million ($.40 per share - basic and diluted) and Class G Common Stock $12 million ($.36 per share - basic and diluted). (b) Restated; see Note 1. In February and May 1998, CMS Energy declared and paid dividends of $.30 per share on CMS Energy Common Stock and $.31 per share on Class G Common Stock. In July 1998, the Board of Directors declared a quarterly dividend of $.33 per share on CMS Energy Common Stock and $.325 per share on Class G Common Stock to be paid in August 1998. 5: Risk Management Activities and Derivatives Transactions CMS Energy and its subsidiaries use a variety of derivative instruments (derivatives), including futures contracts, swaps, options and forward contracts, to manage exposure to fluctuations in commodity prices, interest rates and foreign exchange rates. To qualify for hedge accounting, derivatives must meet the following criteria: (1) the item to be hedged exposes the enterprise to price, interest or exchange rate risk; and (2) the derivative reduces that exposure and is designated as a hedge. Derivative instruments contain credit risk if the counter parties, including financial institutions and energy marketers, fail to perform under the agreements. CMS Energy minimizes such risk by performing financial credit reviews using, among other things, publicly available credit ratings of such counter parties. The risk of nonperformance by the counter parties 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. Consumers uses gas forward contracts and electricity option contracts to limit its risk associated with gas and electricity price increases. In both the gas forward contracts and the electricity option contracts, it is management's intent to take physical delivery of the commodities. For gas forward contracts, Consumers is obligated to take physical delivery of the gas and would incur a significant penalty for nonperformance. At June 30, 1998, Consumers had an exposure to gas price increases if the cost was to exceed $2.84 per mcf for the following volumes: 5 percent of its 1998 requirements; 40 percent of its 1999 requirements; and 65 percent of its 2000 requirements. Additional forward coverage is currently under review. The gas forward contracts currently in place were consummated at prices less than $2.84 per mcf. The contracts are being used to protect against gas price increases in a three-year experimental gas program where Consumers is recovering from its customers $2.84 per mcf of gas delivered. As of June 30, 1998, Consumers had recorded an asset of $4 million to recognize its option contracts to purchase electricity from July through September of 1998. These option contracts were entered into to insure a reliable source of capacity to meet Consumers customers' electricity requirements. Consumers continuously evaluates its daily capacity needs and would sell these option contracts, if marketable, when it has excess daily capacity. If Consumers did not exercise these option contracts because the additional capacity was not needed, and Consumers was unable to sell the option contracts, Consumers' maximum exposure associated with an adverse price change is limited to premiums paid. 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 June 30, 1998, no letter of credit was posted by either party to the agreement. As of June 30, 1998, the fair value of this contract reflected payment due from CMS NOMECO of $12 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 $803 million at June 30, 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 and collared options to hedge certain receivables, payables, long-term debt and equity value relating to foreign investments. The purpose of CMS Energy's foreign currency hedging activities is to protect the company from the risk that U.S. dollar net cash flows resulting from sales to foreign customers and purchases from foreign suppliers and the repayment of non-U.S. dollar borrowings as well as equity reported on the company's balance sheet, may be adversely affected by changes in exchange rates. These contracts do not subject CMS Energy to risk from exchange rate movements because gains and losses on such contracts offset losses and gains, respectively, on assets and liabilities being hedged. The notional amount of the outstanding foreign exchange contracts was $595 million at June 30, 1998, which includes $550 million for Australian foreign exchange contracts. 6: Restated Financial Statements - First Quarter 1998 (Unaudited) As a result of the change in the method of accounting for investments in oil and gas properties as discussed in Note 1, certain financial information from the three and twelve months ended March 31, 1998 and 1997 has been restated as detailed below. Income Statement Data (Unaudited) Three Months Ended Twelve Months Ended March 31 1998 1997 1998 1997 - ------------------------------------------------------------------------------ As As As As Reported Restated Reported Restated Reported Restated Reported Restated -------- -------- -------- -------- -------- -------- -------- ------- Operating Revenue $1,374 $1,374 $1,295 $1,295 $4,866 $4,860 $4,345 $4,339 Operating Expenses 1,187 1,177 1,082 1,091 4,146 4,151 3,660 3,675 ------- --------- -------- -------- --------- ------- ------- ------ Pretax Operating Income 187 197 213 204 720 709 685 664 Other Income (Deductions)(36) (36) (2) (2) (46) (46) (11) (11) Fixed Charges 96 97 77 77 368 372 303 306 Income Taxes 15 19 50 47 82 80 135 129 ------ ------ -------- -------- -------- -------- ------ ------ Consolidated Net Income before cumulative effect of change in accounting principle 40 45 84 78 224 211 236 218 Consolidated Net Income $83 $88 $84 $78 $267 $254 $236 $218 Basic Earnings Per Average Common Share CMS Energy $.73 $.79 $.79 $.73 $2.57 $2.45 $2.41 $2.21 Class G $1.09 $1.09 $1.18 $1.18 $1.76 $1.76 $1.53 $1.53 Diluted Earnings Per Average Common Share CMS Energy $.72 $.77 $.78 $.72 $2.55 $2.44 $ 2.39 $2.21 Class G $1.09 $1.09 $1.18 $1.18 $1.76 $1.76 $1.53 $1.53 Balance Sheet Data (Unaudited) March 31 1998 1997 - ------------------------------------------------------------------- As As Reported Restated Reported Restated --------- --------- -------- -------- Assets Current Assets $1,028 $1,023 $ 768 $ 770 Plant and Property,net 5,379 5,114 5,279 5,022 Investments 1,894 1,879 1,023 1,013 Non-current Asset 1,480 1,489 1.332 1,335 -------------------------------------------------- Total Assets $9,781 $9,505 $8,402 $8,140 ====== ====== ====== ====== Liabilities and Equity Current Liabilities $1,506 $1,506 $1,662 $1,662 Non-current Liabilities 1,763 1,672 1,781 1,692 Capitalization 6,512 6,327 4,959 4,786 -------------------------------------------------- Total Liabilities and Equity $9,781 $9,505 $8,402 $8,140 ================================================== 47 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 June 30, 1998 and 1997, the related consolidated statements of income and common stockholders' equity for the three-month, six-month, and twelve-month periods then ended, and the related consolidated statements of cash flows for the six-month and twelve-month periods then ended. These financial statements are the responsibility of the company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet and consolidated statement of preferred stock of CMS Energy Corporation and subsidiaries as of December 31, 1997, and the related consolidated statements of income, common stockholders' equity and cash flows for the year then ended (not presented herein), and, in our report dated July 27, 1998, we expressed an unqualified opinion on those statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 1997, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. Arthur Andersen LLP Detroit, Michigan, August 11, 1998. 48 Consumers Energy Company Management's Discussion and Analysis The MD&A of this Form 10-Q should be read along with the MD&A and other parts of Consumers' 1997 Form 10-K. This MD&A also refers to, and in some sections specifically incorporates by reference, Consumers' Condensed Notes to Consolidated Financial Statements and should be read in conjunction with such Statements and Notes. This report contains forward-looking statements, as defined by the Private Securities Litigation Reform Act of 1995, that include without limitation, discussions as to expectations, beliefs, plans, objectives and future financial performance, or assumptions underlying or concerning matters discussed in this report. Refer to the Forward-Looking Information section of this MD&A for some important factors that could cause actual results or outcomes to differ materially from those addressed in the forward-looking discussions. Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan and is the principal subsidiary of CMS Energy, a holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Results of Operations In Millions June 30 1998 1997 Change ----- ----- ----- Three months ended $ 60 $ 54 $ Six months ended 162 141 21 Twelve months ended 305 258 47 ===== ===== ===== The increase in earnings for the second quarter of 1998 compared with the same 1997 period reflects increased electric sales and improved operating results from the MCV Facility. These earnings were offset by decreased gas deliveries due to warmer 1998 temperatures. The first six months of 1998 were the third warmest since 1864. Net income available to common stockholders after the cumulative effect of a change in accounting for property taxes was $162 million for the first half of 1998 compared with $141 million for the same 1997 period. The increase in earnings for the first half of 1998 reflects revised accounting to recognize property tax expense on the fiscal year basis of the taxing units instead of on a calendar year basis. This one-time change in accounting for property taxes resulted in a benefit of $66 million ($43 million after-tax). Earnings for the first half 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. The increase in earnings for the twelve months ended June 30, 1998 compared with the same 1997 period reflects the change in accounting for property taxes implemented during the first half of 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 June 30, 1998 reflects an adjustment of prior years' income taxes associated with non-taxable earnings on nuclear decommissioning trust funds of $9 million. Partially offsetting these increases were the recognition, in the first half of 1998, of the loss associated with the underrecovery of power costs under the PPA as discussed above, and decreased gas deliveries due to warmer weather during the first half of 1998. For further information concerning results of operations, see the Electric and Gas Utility Results of Operations sections of this MD&A and Power Purchases from the MCV Partnership in Note 2. ELECTRIC UTILITY RESULTS OF OPERATIONS Electric Pretax Operating Income: In Millions June 30 1998 1997 Change ----- ----- ----- Three months ended $ 107 $ 104 $ 3 Six months ended 226 210 16 Twelve months ended 448 419 29 ===== ===== ===== Electric pretax operating income for all the above periods ended June 30, 1998 benefitted from increased sales and control of operation and maintenance costs compared to the same periods in 1997. 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 Six Months Twelve Months Ended June 30 Ended June 30 Ended June 30 Change Compared to Prior Year 1998 vs 1997 1998 vs 1997 1998 vs 1997 --------- --------- -------- Sales (including special contract discounts) $ 5 $ 12 $ 12 Other non-commodity revenue 1 (1) - Operations and maintenance 1 10 35 General taxes and depreciation (4) (5) (18) ----- ----- ----- Total change $ 3 $ 16 $ 29 ===== ===== ===== Electric Deliveries: Total electric deliveries increased 8.0 percent for the three months ended June 30, 1998 over the same period in 1997. The increase includes a 2.9 percent increase in deliveries to ultimate customers, primarily within the commercial and industrial classes, and a 5.1 percent increase in sales between utility systems and wholesale customer deliveries. For the six months ended June 30, 1998, total electric deliveries increased 7.2 percent over the comparable 1997 period. Deliveries to ultimate customers were up 2.1 percent, mainly from increased deliveries to commercial and industrial classes, with the remaining 5.1 percent attributable to an increase in sales between utility systems and wholesale deliveries. For the twelve months ended June 30, 1998, total electric deliveries increased 5.3 percent over the comparable 1997 period. The increase is primarily attributable to an increase in sales between utility systems deliveries and a 1.3 percent increase in deliveries to ultimate customers, primarily within the industrial class. Power Costs: In Millions June 30 1998 1997 Change ----- ----- ----- Three months ended $ 312 $ 270 $ 42 Six months ended 583 552 31 Twelve months ended 1,170 1,119 51 ===== ===== ===== Power costs increased for all the reported periods ended June 30, 1998 compared to 1997. Both internal generation and power purchases from outside sources increased during these periods to meet increased sales demand. Uncertainties: Consumers' financial position may be affected by a number of trends or uncertainties that have had, or Consumers reasonably expects will have, a materially favorable or unfavorable impact on net sales, revenues, or income from continuing electric operations. Such uncertainties are: 1) environmental liabilities arising from compliance with various federal, state and local environmental laws and regulations, including potential liability or expenses relating to the Michigan Natural Resources and Environmental Protection Act and Superfund; 2) capital expenditures for compliance with the Clean Air Act; 3) suits by various parties relating to the effect of so-called stray voltage on certain livestock; 4) suits by two independent power producers alleging antitrust violations and economic losses due to special electric contracts signed by Consumers; 5) cost recovery relating to the MCV Facility and nuclear plant investments and an experimental direct-access program; 6) electric industry restructuring; 7) after-tax cash underrecoveries associated with power purchases from the MCV Partnership; and 8) Big Rock decommissioning issues and ongoing issues relating to the storage of spent fuel and the operating life of Palisades. For detailed information about these trends or uncertainties see Note 2, Uncertainties, "Electric Contingencies-Electric Environmental Matters," "Electric Contingencies-Stray Voltage," "Electric Contingencies-Anti-Trust," "Electric Rate Matters-Electric Proceedings," "Electric Rate Matters-Electric Restructuring," "Other Electric Uncertainties-The Midland Cogeneration Venture-Power Purchases from the MCV Partnership," and "Other Electric Uncertainties-Nuclear Matters," incorporated by reference herein. Consumers uses electricity option contracts to limit its risk associated with electricity price increases. It is management's intent to take physical delivery of the commodity. As of June 30, 1998, Consumers has recorded an asset of $4 million to recognize its option contracts to purchase electricity from July through September of 1998. These option contracts were entered into to insure a reliable source of capacity to meet Consumers customers' electricity requirements. Consumers continuously evaluates its daily capacity needs and would sell these option contracts, if marketable, when it has excess daily capacity. If Consumers did not exercise these option contracts because the additional capacity was not needed and Consumers was unable to sell the option contracts, Consumers' maximum exposure associated with an adverse price change is limited to premiums paid. GAS UTILITY RESULTS OF OPERATIONS Gas Pretax Operating Income: In Millions June 30 1998 1997 Change ----- ----- ----- Three months ended $ 21 $ 23 $ (2) Six months ended 75 101 (26) Twelve months ended 127 143 (16) ===== ===== ===== Gas pretax operating income decreased in the three month, six month and twelve month periods ended June 30, 1998, as a result of reduced gas deliveries due to warmer temperatures during the winter heating seasons. Revenues for wholesale services were also down for the six and twelve month periods ended June 30, 1998 due to the warmer temperature and the elimination of surcharges related to past conservation programs. The decreased gas pretax operating income for the three month and six month periods ended June 30, 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 June 30, 1998 benefited from controlling operations and maintenance expenses. The benefit to gas pretax operating income from reduced costs in general taxes and depreciation for the three month, six month and twelve month periods ended June 30, 1998 is primarily a timing issue related to sales volumes. The following table quantifies these impacts on Pretax Operating Income. In Millions Three Months Six Months Twelve Months Ended June 30 Ended June 30 Ended June 30 Change Compared to Prior Year 1998 vs 1997 1998 vs 1997 1998 vs 1997 ------- ------- ------- Sales $ (5) $(18) $(21) Gas wholesale and retail service activities - (3) (6) Operations and maintenance (1) (9) 6 General taxes, depreciation and other 4 4 5 ----- ----- ----- Total change $ (2) $(26) $(16) ===== ===== ===== Gas Deliveries: System deliveries for the three month period ended June 30, 1998, including miscellaneous transportation, totaled 61 bcf, a decrease of 15 bcf or 19 percent compared to the three month period ended June 30, 1997. Deliveries for the six month period ended June 30, 1998, including miscellaneous transportation, totaled 208 bcf, a decrease of 37 bcf or 15 percent compared to the six month period ended June 30, 1997. For the twelve month period ended June 30, 1998, deliveries including miscellaneous transportation, totaled 383 bcf, a decrease of 41 bcf or 10 percent compared to the twelve month period ended June 30, 1997. The decreased deliveries for three month, six month and twelve month periods ended reflect warmer temperatures primarily for the first quarter of 1998. Cost of Gas Sold: In Millions June 30 1998 1997 Change ----- ----- ----- Three months ended $ 74 $118 $ (44) Six Months ended 338 432 (94) Twelve months ended 600 729 (129) ===== ===== ===== The cost decreases for the three month, six month and twelve month periods ended June 30, 1998 were the result of decreased sales and lower gas costs reflecting warmer temperatures during the winter heating seasons. Uncertainties: Consumers' financial position may be affected by a number of trends or uncertainties that have had, or Consumers reasonably expects will have, a materially favorable or unfavorable impact on net sales or revenues or income from continuing gas operations. Such uncertainties are: 1) potential environmental costs at a number of sites including sites formerly housing manufactured gas plant facilities; 2) ongoing litigation relating to a pricing dispute with gas producers; and 3) a statewide experimental gas transportation pilot program. For detailed information about these uncertainties see Note 2, Uncertainties, "Gas Contingencies-Gas Environmental Matters," "Gas Rate Matters-GCR Matters," and "Gas Rate Matters-Gas Restructuring," incorporated by reference herein. Consumers uses gas forward contracts to limit its risk associated with gas price increases. It is management's intent to take physical delivery of the commodity. For gas forward contracts, Consumers is obligated to take physical delivery of the gas and would incur a significant penalty for nonperformance. At June 30, 1998, Consumers had an exposure to gas price increases if the cost was to exceed $2.84 per mcf for the following volumes: 5 percent of its 1998 requirements; 40 percent of its 1999 requirements; and 65 percent of its 2000 requirements. Additional forward coverage is currently under review. The gas forward contracts currently in place were consummated at prices less than $2.84 per mcf. The contracts are being used to protect against gas price increases in a three-year experimental gas program where Consumers is recovering from its customers $2.84 per mcf of gas delivered. Capital Resources and Liquidity CASH POSITION, INVESTING AND FINANCING Operating Activities: Consumers derives cash from the sale and transportation of natural gas and the generation, transmission and sale of electricity. Cash from operations totaled $322 million and $413 million for the first six months of 1998 and 1997, respectively. The $91 million decrease resulted primarily from a decrease of $47 million in the sale of accounts receivable and to higher summer gas inventory balances because of lower sales resulting from warmer weather. Other items included in income but which had no effect on cash flow were a one-time change in accounting for property taxes resulting in a $66 million ($43 million after-tax) gain and the recognition of a $37 million loss ($24 million after-tax) for the underrecovery of power costs under the PPA. Consumers uses operating cash primarily to maintain and expand electric and gas systems, to retire portions of long-term debt, and to pay dividends. Investing Activities: Cash used in investing activities totaled $(171) million and $(205) million for the first six months of 1998 and 1997, respectively. The change of $34 million was primarily the result of receiving cash of $27 million from the sale of the Marysville Fractionation Partnership and $27 million from the nuclear decommissioning trust funds previously collected from electric customers for decommissioning Big Rock, offset by the payment of $33 million in cost of plant retired. Consumers used the cash primarily for capital expenditures, Financing Activities: Cash provided by financing activities totaled zero for the first six months of 1998 compared to $(201) million used in the first six months of 1997. The change of $201 million is primarily the result of a net increase in cash of $266 million due to refinancing and issuance of Consumers' debt, offset by a $59 million increase in the payment of common stock dividends. Consumers issued $250 million in senior notes in May 1998 and $200 million in senior notes in June 1998. For additional information about these offerings see "Long-Term Financings" in Note 3, incorporated by reference herein. Consumers has FERC authorization to issue securities and guarantees. Consumers has a credit facility, lines of credit and a trade receivable sale program in place as anticipated sources of funds needed to fulfill, in whole or in part, material commitments for capital expenditures. For detailed information about these source of funds, see "Authorization" and "Short-Term Financings" in Note 3. Outlook The following discussions contain forward-looking statements. See the Forward-Looking Information section of this MD&A for some important factors that could cause actual results or outcomes to differ materially from those discussed herein. CAPITAL EXPENDITURES OUTLOOK Consumers estimates the following capital expenditures, including new lease commitments, by company and by business segment over the next three years. These estimates are prepared for planning purposes and are subject to revision. In Millions Years Ended December 31 1998 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 Note 2. 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 of terminating their contracts early. FERC Orders 888 and 889, as amended, require utilities to provide direct-access to the interstate transmission grid for wholesale transactions. Consumers and Detroit Edison disagree on the effect of the orders on the Michigan Electric Power Coordination Center pool. Consumers proposes to maintain the benefits of the pool, through at least December 2000, while Detroit Edison contends that the pool agreement should be terminated immediately. Among Consumers' alternatives in the event of the pool being terminated would be joining an independent system operator. FERC has indicated this preference for structuring the operations of the electric transmission grid. As discussed in the Form 10-K, several orders were issued and numerous appeals are pending at the Court of Appeals relating to the restructuring of the electric utility industry since June 1997. Consumers cannot predict the outcome or timing of these matters. For material changes relating to the restructuring of the electric utility industry see "Electric Rate Matters - Electric Restructuring" in Note 2, incorporated by reference herein. Electric Application of SFAS 71: Consumers applies the utility accounting standard, SFAS 71, that recognizes the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities related to the generation, transmission and distribution operations of its business in its financial statements. Consumers believes that the generation segment of its business is still subject to rate regulation based upon its present obligation to continue providing generation service to its customers, and the lack of definitive deregulation orders. If rate recovery of generation-related costs becomes unlikely or uncertain, whether due to competition or regulatory action, this accounting standard may no longer apply to the generation segment of Consumers' business. According to Emerging Issues Task Force Issue 97-4, Deregulation of the Pricing of Electricity - Issues Related to the Application of FASB Statements No. 71 and 101, Consumers can continue to carry its generation-related regulatory assets or liabilities for the part of the business being deregulated if deregulatory legislation or an MPSC rate order allows the collection of cash flows from its regulated transmission and distribution customers to recover these specific costs or settle obligations. Because the February 1998 MPSC order allows Consumers to fully recover its transition costs, Consumers believes that even if it was to discontinue application of SFAS 71 for the generation segment of its business, its regulatory assets, including those related to generation, are probable of future recovery from the regulated portion of the business. At June 30, 1998, Consumers had $261 million of generation-related net regulatory assets recorded on its balance sheet, and a net investment in generation facilities of $1.3 billion included in electric plant and property. For further information regarding electric restructuring, see "Restructuring" above. GAS BUSINESS OUTLOOK Growth: Consumers currently anticipates gas deliveries, including gas customer choice deliveries (excluding transportation to the MCV Facility and off-system deliveries), to grow at an average annual rate of between one and two percent over the next five years based primarily on a steadily growing customer base. Abnormal weather, alternative energy prices, changes in competitive conditions, and the level of natural gas consumption may affect actual gas deliveries in future periods. Consumers is also offering a variety of energy-related services to its customers focused upon appliance maintenance, home safety and home security. In 1997, LIHEAP provided approximately $64 million in heating assistance to about 312,000 Michigan households, with approximately 13 percent of the funds going to Consumers' customers. Congress provided approximately $54 million in funding for Michigan for 1998. In June 1998, the House Labor, Health and Human Services Appropriations Subcommittee voted to propose elimination of LIHEAP for fiscal year 1999. In July 1998, the full Committee accepted the subcommittee proposal (which eliminates LIHEAP). The full House of Representatives is expected to vote on this bill before October 1, 1998. Many interested parties, including the Senate Labor and Human Resources Committee, are working to restore funding for the program; however, Consumers cannot predict the legislative outcome of funding for this program. Gas Application of SFAS 71: Based on a regulated utility accounting standard, SFAS 71, Consumers may defer certain costs to the future and record regulatory assets, based on the recoverability of those costs through the MPSC's approval. Consumers has evaluated its regulatory assets related to its gas business, and believes that sufficient regulatory assurance exists to provide for the recovery of these deferred costs. Other Matters NEW ACCOUNTING STANDARDS In 1998, the FASB issued SFAS 132, Employers' Disclosures about Pensions and Other Postretirement Benefits. This standard requires expanded disclosure effective for 1998. Also in 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which will be effective for 1999. Consumers does not expect the application of these standards to materially affect its financial position, liquidity or results of operations. In addition, in 1998, the FASB issued SFAS 133, Accounting for Derivative Instruments and Hedging Activities, which requires that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. SFAS 133 is effective for fiscal years beginning after June 15, 1999. Consumers has not yet quantified the impacts of adopting SFAS 133 on its financial statements and has not determined the timing of or method of adoption. 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 generating plant outages. In 1995, Consumers began modifying its own computer software systems by dividing programs requiring modification between critical and noncritical programs. All essential 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. There can be no guarantee, however, that these costs, plans or time estimates will be achieved, and actual results could differ materially. Specific factors that may cause such material differences include, but are not limited to, the availability of personnel trained in this area, the ability to locate and correct all relevant computer code, and the year 2000 readiness of Consumers' vendors, large customers and other third parties with whom it does business. Because of the integrated nature of Consumers' business with other energy companies, utilities, jointly owned facilities operated by other entities, and business conducted with suppliers and large customers, Consumers may be indirectly affected by year 2000 compliance complications. At this time, Consumers is unable to anticipate the magnitude of the operational or financial impact on Consumers of year 2000 issues. Forward-Looking Information Forward-looking information is included throughout this report. This report also describes material contingencies in the Notes to the Consolidated Financial Statements and should be read accordingly. Some important factors that could cause actual results or outcomes to differ are set forth in Consumers' 1997 Form 10-K, "Management's Discussion and Analysis, Forward-Looking Information." (This page intentionally left blank) 57 Consumers Energy Company Consolidated Statements of Income (Unaudited)
Three Months Ended Six Months Ended Twelve Months Ended June 30 1998 1997 1998 1997 1998 1997 In Millions Operating Revenue Electric $ 649 $ 598 $1,261 $1,218 $2,558 $2,492 Gas 170 220 599 718 1,085 1,242 Other 13 11 23 20 53 50 ------ ------ ------ ------ ------ ------ 832 829 1,883 1,956 3,696 3,784 ------ ------ ------ ------ ------ ------ Operating Expenses Operation Fuel for electric generation 80 71 151 140 308 293 Purchased power - related parties 144 146 290 297 592 600 Purchased and interchange power 88 53 142 115 270 226 Cost of gas sold 74 118 338 432 600 729 Other 130 131 262 260 544 573 ------ ------ ------ ------ ------ ------ 516 519 1,183 1,244 2,314 2,421 Maintenance 42 41 78 80 168 178 Depreciation, depletion and amortization 88 87 198 199 390 379 General taxes 45 45 100 103 197 196 ------ ------ ------ ------ ------ ------ 691 692 1,559 1,626 3,069 3,174 ------ ------ ------ ------ ------ ------ Pretax Operating Income Electric 107 104 226 210 448 419 Gas 21 23 75 101 127 143 Other 13 10 23 19 52 48 ------ ------ ------ ------ ------ ------ 141 137 324 330 627 610 ------ ------ ------ ------ ------ ------ Other Income (Deductions) Loss on MCV power purchases - - (37) - (37) - Dividends and interest from affiliates 4 4 8 9 22 17 Accretion income 1 2 3 4 7 9 Accretion expense (4) (4) (8) (9) (17) (17) Other, net - - 2 - 1 (4) ------ ------ ------ ------ ------ ------ 1 2 (32) 4 (24) 5 ------ ------ ------ ------ ------ ------ Interest Charges Interest on long-term debt 35 35 68 69 137 139 Other interest 8 7 19 16 39 32 Capitalized interest - - - - (1) (1) ------ ------ ------ ------ ------ ------ 43 42 87 85 175 170 ------ ------ ------ ------ ------ ------ Net Income Before Income Taxes 99 97 205 249 428 445 Income Taxes 30 34 67 90 129 151 ------ ------ ------ ------ ------ ------ Net Income before cumulative effect of change in accounting principle 69 63 138 159 299 294 Cumulative effect of change in accounting for property taxes, net of $23 tax (Note 1) - - 43 - 43 - ------ ------ ------ ------ ------ ------ Net Income 69 63 181 159 342 294 Preferred Stock Dividends 5 7 10 14 21 28 Preferred Securities Distributions 4 2 9 4 16 8 ------ ------ ------ ------ ------ ------ Net Income Available to Common Stockholder $ 60 $ 54 $ 162 $ 141 $ 305 $ 258 ====== ====== ====== ====== ====== ====== The accompanying condensed notes are an integral part of these statements.
58 Consumers Energy Company Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended Twelve Months Ended June 30 1998 1997 1998 1997 ------ ------ ------ ------ In Millions Cash Flows from Operating Activities Net income $ 181 $ 159 $ 342 $ 294 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear decommissioning of $25, $24,$50 and $49, respectively) 198 199 390 379 Loss on MCV power purchases 37 - 37 - Capital lease and other amortization 21 21 44 40 Deferred income taxes and investment tax credit 27 16 24 39 Accretion expense 8 9 17 17 Accretion income - abandoned Midland project (3) (4) (7) (9) Undistributed earnings of related parties (24) (20) (50) (50) Cumulative effect of accounting change (66) - (66) - MCV power purchases (32) (30) (64) (66) Changes in other assets and liabilities (25) 63 - (12) ------ ------ ------ ------ Net cash provided by operating activities 322 413 667 632 ------ ------ ------ ------ Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (159) (165) (355) (391) Cost to retire property, net (44) (11) (61) (31) Investments in nuclear decommissioning trust funds (25) (24) (50) (49) Proceeds from nuclear decommissioning trust funds 27 - 27 - Proceeds from the sale of Marysville Fractionation Partnership 27 - 27 - Other 3 (5) 54 (6) ------ ------ ------ ------ Net cash used in investing activities (171) (205) (358) (477) ------ ------ ------ ------ Cash Flows from Financing Activities Proceeds from senior notes 914 - 914 - Retirement of bonds and other long-term debt (622) - (673) (37) Payment of common stock dividends (129) (70) (278) (195) Increase (decrease) in notes payable, net (122) (92) 14 133 Payment of capital lease obligations (22) (21) (46) (39) Payment of preferred stock dividends (10) (14) (25) (28) Preferred securities distributions (9) (4) (16) (8) Retirement of preferred stock - - (118) - Proceeds from preferred securities - - 116 - Contribution from stockholder - - (50) - Proceeds from bank loans - - - 23 ------ ------ ------ ------ Net cash provided by (used in) financing activities - (201) (162) (151) ------ ------ ------ ------ Net Increase in Cash and Temporary Cash Investments 151 7 147 4 Cash and Temporary Cash Investments, Beginning of Period 7 4 11 7 ------ ------ ------ ------ Cash and Temporary Cash Investments, End of Period $ 158 $ 11 $ 158 $ 11 ====== ====== ====== ====== Other cash flow activities and non-cash investing and financing activities were: Cash transactions Interest paid (net of amounts capitalized) $ 83 $ 82 $ 166 $ 127 Income taxes paid (net of refunds) 79 82 113 167 Non-cash transactions Nuclear fuel placed under capital lease $ 15 $ 3 $ 16 $ 31 Other assets placed under capital leases 7 3 10 5 ====== ====== ====== ====== All highly liquid investments with an original maturity of three months or less are considered cash equivalents. The accompanying condensed notes are an integral part of these statements.
59 Consumers Energy Company Consolidated Balance Sheets
ASSETS June 30 June 30 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Plant (At original cost) Electric $6,579 $6,491 $6,467 Gas 2,307 2,322 2,270 Other 23 24 25 ------ ------ ------ 8,909 8,837 8,762 Less accumulated depreciation, depletion and amortization 4,707 4,603 4,490 ------ ------ ------ 4,202 4,234 4,272 Construction work-in-progress 166 145 119 ------ ------ ------ 4,368 4,379 4,391 ------ ------ ------ Investments Stock of affiliates 278 278 302 First Midland Limited Partnership (Note 2) 247 242 237 Midland Cogeneration Venture Limited Partnership (Note 2) 189 171 148 Other - 7 10 ------ ------ ------ 714 698 697 ------ ------ ------ Current Assets Cash and temporary cash investments at cost, which approximates market 158 7 11 Accounts receivable and accrued revenue, less allowances of $5, $6 and $8, respectively (Note 3) 76 82 80 Accounts receivable - related parties 71 62 87 Inventories at average cost Gas in underground storage 178 197 125 Materials and supplies 63 63 75 Generating plant fuel stock 35 35 28 Postretirement benefits 25 25 25 Deferred income taxes - 22 14 Prepayments and other 148 161 78 ------ ------ ------ 754 654 523 ------ ------ ------ Non-current Assets Nuclear decommissioning trust funds 521 486 443 Postretirement benefits 388 404 419 Abandoned Midland Project 83 93 103 Other 248 235 240 ------ ------ ------ 1,240 1,218 1,205 ------ ------ ------ Total Assets $7,076 $6,949 $6,816 ====== ====== ======
STOCKHOLDERS' INVESTMENT AND LIABILITIES June 30 June 30 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 59 58 41 Retained earnings since December 31, 1992 396 363 368 ------ ------ ------ 1,748 1,714 1,754 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 2,159 1,369 1,612 Non-current portion of capital leases 77 74 88 ------ ------ ------ 4,442 3,615 3,910 ------ ------ ------ Current Liabilities Current portion of long-term debt and capital leases 94 579 390 Notes payable 255 377 241 Accrued taxes 154 244 154 Accounts payable 150 171 149 Accounts payable - related parties 76 79 70 Power purchases (Note 2) 47 47 47 Accrued interest 31 32 32 Deferred income taxes 12 - - Accrued refunds 11 12 7 Other 139 136 131 ------ ------ ------ 969 1,677 1,221 ------ ------ ------ Non-current Liabilities Deferred income taxes 680 688 642 Postretirement benefits 474 489 501 Power purchases (Note 2) 146 133 157 Deferred investment tax credit 144 149 154 Regulatory liabilities for income taxes, net 59 54 81 Other 162 144 150 ------ ------ ------ 1,665 1,657 1,685 ------ ------ ------ Commitments and Contingencies (Notes 2) Total Stockholders' Investment and Liabilities $7,076 $6,949 $6,816 ====== ====== ====== (a) The primary asset of Consumers Power Company Financing I is $103 million principal amount of 8.36% subordinated deferrable interest notes due 2015 from Consumers. The primary asset of Consumers Energy Company Financing II is $124 million principal amount of 8.20% subordinated deferrable interest notes due 2027 from Consumers. The accompanying condensed notes are an integral part of these statements.
61 Consumers Energy Company Consolidated Statements of Common Stockholder's Equity (Unaudited)
Three Months Ended Six Months Ended Twelve Months Ended June 30 1998 1997 1998 1997 1998 1997 In Millions Common Stock At beginning and end of period $ 841 $ 841 $ 841 $ 841 $ 841 $ 841 ------ ------ ------ ------ ------ ------ Other Paid-in Capital At beginning of period 452 504 452 504 504 504 Preferred stock reacquired - - - - (2) - Return of stockholder's contribution - - - - (50) - ------ ------ ------ ------ ------ ------ At end of period 452 504 452 504 452 504 ------ ------ ------ ------ ------ ------ Revaluation Capital At beginning of period 65 36 58 37 41 31 Change in unrealized investment - gain (loss) (a) (6) 5 1 4 18 10 ------ ------ ------ ------ ------ ------ At end of period 59 41 59 41 59 41 ------ ------ ------ ------ ------ ------ Retained Earnings At beginning of period 385 384 363 297 368 305 Net income (a) 69 63 181 159 342 294 Common stock dividends declared (49) (70) (129) (70) (277) (195) Preferred stock dividends declared (5) (7) (10(10) (14) (21) (28) Preferred securities distributions (4) (2) (9) (4) (16) (8) ------ ------ ------ ------ ------ ------ At end of period 396 368 396 368 396 368 ------ ------ ------ ------ ------ ------ Total Common Stockholder's Equity $1,748 $1,754 $1,748 $1,754 $1,748 $1,754 ====== ====== ====== ====== ====== ====== (a) Disclosure of Comprehensive Income: Revaluation capital Unrealized investment - gain (loss), net of tax of $(3), $3, $-, $2, $10 and $5, respectively $ (6) $ 5 $ 1 $ 4 $ 18 $ 10 Net income 69 63 181 159 342 294 ------ ------ ------ ------ ------ ------ Total Comprehensive Income $ 63 $ 68 $ 182 $ 163 $ 360 $ 304 ====== ====== ====== ====== ====== ====== 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 Consumers' 1997 Form 10-K that includes the Report of Independent Public Accountants. In the opinion of management, the unaudited information herein reflects all adjustments necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. 1: Corporate Structure and Change of Significant Accounting Policies CORPORATE STRUCTURE Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan and is the principal subsidiary of CMS Energy, a holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. IMPLEMENTATION OF NEW ACCOUNTING STANDARD In 1997, the FASB issued SFAS 130, Reporting Comprehensive Income. This statement, which is effective for 1998 financial statement reporting, establishes standards for reporting and display of comprehensive income and its components. Equity adjustments related to unrealized investment gains and losses (net of tax), along with consolidated net income, comprise comprehensive income. CHANGE IN METHOD OF ACCOUNTING FOR PROPERTY TAXES During the first quarter of 1998, Consumers implemented a change in the method of accounting for property taxes so that such taxes are recognized during the fiscal period of the taxing authority for which the taxes are levied. This change provides a better matching of property tax expense with the services provided by the taxing authorities, and is considered the most acceptable basis of recording property taxes. Prior to 1998, Consumers recorded property taxes monthly during the year following the assessment date (December 31). The cumulative effect of this one-time change in accounting increased other income by $66 million, and earnings, net of tax, by $43 million. The pro forma effect on prior years' consolidated net income of retroactively recording property taxes as if the new method of accounting had been in effect for all periods presented is not material. 2: Uncertainties ELECTRIC CONTINGENCIES Electric Environmental Matters: The Clean Air Act limits emissions of sulfur dioxide and nitrogen oxides and requires emissions monitoring. Consumers' coal-fueled electric generating units burn low-sulfur coal and are currently operating at or near the sulfur dioxide emission limits that will be effective in the year 2000. During the past few years, in order to comply with the Act, Consumers incurred capital expenditures totaling $46 million to install equipment at certain generating units. Consumers estimates capital expenditures for 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, following completion of the Ozone Transport Assessment Group process and requests by 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 would reduce nitrogen oxide emissions, as early as 2002, to only 32 percent of levels allowed for the year 2000 under current regulations. The EPA is expected to issue final regulations in the fall of 1999. The State of Michigan will have one year after final regulations are issued to implement the 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 June 30, 1998, Consumers has accrued $3 million for its estimated Superfund liability. While decommissioning Big Rock, Consumers found that some areas of the plant have coatings that contain both metals and PCBs. Consumers does not believe that any facility in the United States currently accepts the radioactive portion of that waste. The cost of removal and disposal is currently unknown. These costs would constitute part of the cost to decommission the plant, and will be paid from the decommissioning fund. Consumers is studying the extent of the contamination and reviewing options. Stray Voltage: Various parties have sued Consumers relating to the effect of so-called stray voltage on certain livestock. Claimants contend that stray voltage results when low-level electrical currents present in grounded electrical systems are diverted from their intended path. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns. It also has an ongoing mitigation program to modify the service of all customers with livestock. In December 1997, the Michigan Supreme Court remanded for further proceedings a 1994 Michigan trial court decision that refused to allow the claims of over 200 named plaintiffs to be joined in a single action. The trial court dismissed all of the plaintiffs except the first-named plaintiff, allowing the others to re-file separate actions. Of the original plaintiffs, only 49 re-filed separate cases. All of those 49 cases have been resolved. The Michigan Supreme Court remanded the matter, finding that the proper remedy for misjoinder was not dismissal, but to automatically allow each case to go forward separately. Consumers filed a motion for reconsideration with the Michigan Supreme Court, which was denied. As a result, 21 individual plaintiffs 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 June 30, 1998, Consumers had 5 individual stray voltage lawsuits awaiting trial court action, unrelated to the cases above. At year end 1997, Consumers had 12 such lawsuits awaiting trial court action. Anti-Trust: In October 1997, two independent power producers sued Consumers and CMS Energy in a federal court. The suit alleges antitrust violations relating to contracts which Consumers entered into with some of its customers and claims relating to power facilities. The plaintiffs claim damages of $100 million (which a court can treble in antitrust cases as provided by law). 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. ELECTRIC RATE MATTERS Electric Proceedings: In 1996, the MPSC issued a final order that authorized Consumers to recover costs associated with the purchase of the additional 325 MW of MCV Facility capacity (see "Power Purchases from the MCV Partnership" in this Note) and recover its nuclear plant investment by increasing prospective annual nuclear plant depreciation expense by $18 million, with a corresponding decrease in fossil-fueled generating plant depreciation expense. It also established an experimental direct-access program. Customers having a maximum demand of at least 2 MW are eligible to purchase generation services directly from any eligible third-party power supplier and Consumers would transmit the power for a fee. The 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 Commission's order allowed existing special contracts to fill 410 MW of the load. Although the issue is still subject to MPSC review, it is Consumers' position that 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 further restructuring orders in October 1997 and in January and February 1998. These orders provide for: 1) the recovery of estimated Transition Costs of $1.755 billion through a charge to all direct- access customers until the end of the transition period in 2007, subject to an adjustment through a true-up mechanism; 2) the commencement of the phase-in of direct-access in 1998; 3) the suspension of the power supply cost recovery clause; and 4) all customers to be free to choose power suppliers on January 1, 2002. See "Other Electric Uncertainties" below for further information regarding the effect of the PSCR suspension on the recovery of MCV Facility capacity charges. 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 and recovered via a charge approved by the MPSC. Nuclear decommissioning costs will also continue to be collected through a separate surcharge to all customers. Consumers expects Michigan legislative consideration of the entire subject of electric industry restructuring in 1998. To be acceptable to Consumers, the legislation would have to provide for full recovery of Transition Costs. Consumers expects the legislature to review all of the policy choices made by the MPSC during the restructuring proceedings to assure that they are in accord with those that the legislature believes should be paramount. There are numerous appeals pending at the Court of Appeals relating to the MPSC's restructuring orders, including appeals by Consumers and Detroit Edison. Consumers believes that the MPSC lacks statutory authority to mandate industry restructuring, and its appeal is limited to this jurisdictional issue. As a result of an informal process involving consultations with MPSC staff and other interested parties, as directed in the MPSC's February 1998 order, Consumers submitted to the MPSC in June 1998 its plan for implementing direct-access. The primary issues addressed in the plan are: 1) the implementation schedule; 2) the direct-access service options available to customers and suppliers; 3) the process and requirements for customers and others to obtain direct-access service; and 4) the roles and responsibilities for Consumers, customers and suppliers. Under the schedule in the plan, Consumers will, over the 1998-2001 period, phase-in 750 MW of electric capacity for direct-access to customers. In 1998, 300 MW of direct-access for bidding will be open, and an additional 150 MW will open for each year from 1999 to 2001. This plan is consistent with the previous orders regarding the phase-in process. Due to the time required for the MPSC to review the plan, Consumers does not believe direct-access will commence prior to the fourth quarter of 1998. For further information regarding the effects of the restructuring on accounting methods, see Electric Business Outlook - - Electric Application of SFAS 71 in the MD&A. Consumers cannot predict the outcome or timing of electric restructuring on Consumers' financial position, liquidity, or results of operations. OTHER ELECTRIC UNCERTAINTIES The Midland Cogeneration Venture: The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990 and to supply electricity and steam to Dow. Consumers, through two wholly owned subsidiaries, holds the following assets related to the MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through FMLP, a 35 percent lessor interest in the MCV Facility. Summarized Statements of Income for CMS Midland and CMS Holdings- In Millions Three Months Ended Six Months Ended Twelve Months Ended June 30 1998 1997 1998 1997 1998 1997 ---- ---- ---- ---- ---- ---- Pretax operating income $13 $10 $23 $18 $51 $46 Income taxes and other 4 3 7 5 16 14 ---- ---- ---- ---- ---- ---- Net income $ 9 $ 7 $16 $13 $35 $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 "Electric Restructuring" in this Note), 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 June 30, 1998 and December 31,1997, the after-tax present value of the PPA liability totaled $126 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 $5 million, partially offset by after-tax cash underrecoveries of $20 million. The undiscounted after-tax amount associated with the liability totaled $176 million at June 30, 1998. The after-tax cash underrecoveries are currently based on the assumption that the MCV Facility will be available to generate electricity 91.5 percent of the time over its expected life. For the first six months of 1998 the MCV Facility was available 99 percent of the time, resulting in $11 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 $34 $22 $21 $20 $19 ==== ==== ==== ==== ==== Consumers bases the above estimated underrecoveries, in part, on an estimate of the future availability of the MCV Facility. If the MCV Facility operates at levels above management's estimate over the remainder of the PPA, Consumers will need to recognize losses for future underrecoveries larger than amounts previously recorded. Therefore, Consumers would experience larger amounts of cash underrecoveries than originally anticipated. Management will continue to evaluate the adequacy of the accrued liability considering actual MCV Facility operations. In February 1998, the MCV Partnership filed a claim of appeal from the January 1998 and February 1998 MPSC orders in the electric utility industry restructuring. At the same time, the MCV Partnership filed suit in the U.S. District Court seeking a declaration that the MPSC's failure to provide Consumers and the MCV Partnership a certain source of recovery of capacity payments after 2007 deprived the MCV Partnership of its rights under the Public Utilities Regulatory Policies Act of 1978. The MCV Partnership is seeking to prohibit the MPSC from implementing portions of the order. PSCR Matters Related to Power Purchases from the MCV Partnership- As part of a 1995 decision in the 1993 PSCR reconciliation case, the MPSC disallowed a portion of the costs related to purchases from the MCV Partnership and instead assumed recovery of those costs from wholesale customers. Consumers believed this was contrary to the terms of an earlier 1993 settlement order and appealed. The MCV Partnership and ABATE also filed separate appeals of this order. In November 1996, the Court of Appeals affirmed the MPSC's 1995 decision. The MCV Partnership filed an application for leave to appeal with the Michigan Supreme Court which was denied in January 1998. This matter is now closed. Nuclear Matters: Consumers filed updated decommissioning information with the MPSC in 1995 that estimated decommissioning costs for Big Rock and Palisades. In April 1996, the MPSC issued an order in Consumers' nuclear decommissioning case, which fully supported Consumers' request and did not change the overall surcharge revenues collected from retail customers. The MPSC ordered Consumers to file a report on the adequacy of the surcharge revenues with the MPSC at three-year intervals beginning in 1998. On March 31, 1998, Consumers filed with the MPSC a new decommissioning cost estimate for Big Rock and Palisades of $294 million and $518 million (in 1997 dollars) respectively. The estimated decommissioning costs decreased from previous estimates primarily due to a decrease in offsite burial costs. Consumers recommended a reallocation of its existing surcharge between the two plants on January 1, 1999 to provide additional funds to decommission Big Rock. Consumers filed a revision to its Post Shutdown Activities Report (formerly decommissioning report) with the NRC to reflect the shutdown of Big Rock. Big Rock is being decommissioned. It was closed permanently on August 29, 1997 because management determined that it would be uneconomical to operate in an increasingly competitive environment. Consumers originally scheduled the plant to close May 31, 2000, at the end of the plant's operating license. Plant decommissioning began in September 1997 and may take five to ten years to return the site to its original condition. In January 1997, the NRC issued its Systematic Assessment of Licensee Performance report for Palisades. The report rated all areas as good, unchanged from the previous assessment. Palisades' temporary on-site storage pool for spent nuclear fuel is at capacity. Consequently, Consumers is using NRC-approved steel and concrete vaults, commonly known as "dry casks", for temporary on-site storage. As of June 30, 1998 Consumers had loaded 13 dry storage casks with spent nuclear fuel at Palisades. Consumers plans to load five additional casks at Palisades in 1999 pending approval by the NRC. In June 1997, the NRC approved Consumers' process for unloading spent fuel from a cask at Palisades previously discovered to have minor weld flaws. Consumers intends to transfer the spent fuel to a new transportable cask when one is available. A planned outage for refueling and maintenance at Palisades was completed June 7, 1998. Consumers replaced 60 nuclear fuel assemblies in the plant's reactor during the outage. The NRC requires Consumers to make certain calculations and report to it on the continuing ability of the Palisades reactor vessel to withstand postulated pressurized thermal shock events during its remaining license life, considering the embrittlement of reactor vessel materials over time due to operation in a radioactive environment. Based on continuing analysis of data in December 1996, Consumers received an interim Safety Evaluation Report from the NRC indicating that the reactor vessel can be safely operated through 2003 before reaching the NRC's screening criteria for reactor embrittlement. Consumers believes that with fuel management designed to minimize embrittlement, it can operate Palisades to the end of its license life in the year 2007 without annealing the reactor vessel. Nevertheless, Consumers will continue to monitor the matter. Capital Expenditures: Consumers estimates electric capital expenditures, including new lease commitments, of $320 million for 1998, $265 million for 1999, and $255 million for 2000. For further information, see the Capital Expenditures Outlook section in the MD&A. GAS CONTINGENCIES Gas Environmental Matters: Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. In 1998 Consumers plans to study indoor air issues at residences on some sites and ground water impacts or surface soil impacts at other sites. On sites where Consumers has received site-wide study plan approvals, it will continue to implement these plans. It will also work toward closure of environmental issues at sites as studies are completed. Data available to Consumers and its continued internal review have resulted in an estimate for all costs related to investigation and remedial action for all 23 sites of between $48 million and $98 million. These estimates are based on undiscounted 1998 costs. As of June 30,1998, 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 techniques, nature and extent of contamination, and legal and regulatory requirements, could affect the estimate of remedial action costs for the sites. According to an MPSC rate order issued in 1996, Consumers will defer and amortize, over a period of ten years, environmental clean-up costs above the amount currently being recovered in rates. Rate recognition of amortization expense will not begin until after a prudence review in a general rate case. The order authorizes current recovery of $1 million annually. Consumers 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. GAS RATE MATTERS GCR Matters: 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. Gas Restructuring: In December 1997, the MPSC approved Consumers' application to implement a statewide experimental gas transportation pilot program. Consumers' expanded experimental program will extend over a three-year period, eventually allowing 300,000 residential, commercial and industrial retail gas sales customers to choose their gas supplier. The program is voluntary for natural gas customers. Participating customers are being selected on a first-come, first-served basis, up to a limit of 100,000 customers beginning April 1, 1998. As of July 23, 1998 approximately 21,800 customers chose alternative gas suppliers, representing approximately 13 bcf of gas load. Of these alternative gas suppliers, one was a CMS Energy affiliate. Up to 100,000 more customers may be added beginning April 1 of each of the next two years. Customers choosing to remain as sales customers of Consumers will not see a rate change in their natural gas rates. The order allowing the implementation of this program: 1) suspends Consumers' gas cost recovery clause, effective April 1, 1998 for a three-year period, establishing a gas commodity cost at a fixed rate of $2.84 per mcf; 2) establishes an earnings sharing mechanism that will provide for refunds to customers if Consumers' earnings during the three year term of the program exceed certain pre-determined levels; and 3) establishes a gas transportation code of conduct that addresses concerns about the relationship between Consumers and marketers, including its affiliated marketers. This experimental program will allow competing gas suppliers, including marketers and brokers, to market natural gas to a large number of retail customers in direct competition with Consumers. In January 1998, the Attorney General, ABATE and other parties filed claims of appeal regarding the program with the Court of Appeals. At June 30, 1998, Consumers had an exposure to gas price increases if the cost was to exceed $2.84 per mcf for the following volumes: 5 percent of its 1998 requirements; 40 percent of its 1999 requirements; and 65 percent of its 2000 requirements. Additional forward coverage is currently under review. The forward contracts currently in place were consummated at prices less than $2.84 per mcf. The contracts are being used to hedge Consumers' gas commodity cost increases in a three-year experimental gas program. For further information regarding the effects of the restructuring on accounting methods, see Gas Business Outlook - Application of SFAS 71 in the MD&A. OTHER GAS UNCERTAINTIES Capital Expenditures: Consumers estimates gas capital expenditures, including new lease commitments, of $115 million for 1998, $115 million for 1999, and $115 million for 2000. For further information, see the Capital Expenditures Outlook section in the MD&A. In addition to the matters disclosed in this note, Consumers and certain of its subsidiaries are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies arising from the ordinary course of business. These lawsuits and proceedings may involve personal injury, property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing and other matters. Consumers has accrued estimated losses for certain contingencies discussed in this Note. Resolution of these contingencies is not expected to have a material adverse impact on Consumers' financial position, liquidity, or results of operations. 3: Short-Term Financings and Capitalization Authorization: At July 1, 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 June 2000; 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 June 2000, up to $950 million and $200 million for refinancing purposes and for general corporate purposes, respectively. 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 June 30, 1998, a total of $255 million was outstanding at a weighted average interest rate of 6.0 percent, compared with $241 million outstanding at June 30, 1997, at a weighted average interest rate of 6.2 percent. In January 1998, Consumers entered into interest rate swaps totaling $300 million. These swap arrangements have had an immaterial effect on interest expense. Consumers also has in place a $500 million trade receivables sale program. At June 30, 1998 and 1997, receivables sold under the program totaled $236 million and $266 million, respectively. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold. Capital Stock: The primary asset of Consumers Power Company Financing I is $103 million principal amount of 8.36 percent subordinated deferrable interest notes due 2015 from Consumers. The primary asset of Consumers Energy Company Financing II is $124 million principal amount of 8.20 percent subordinated deferrable interest notes due 2027 from Consumers. Long-Term Financings: The following table describes the new issuances of long-term financings which have occurred during 1998 through early August 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 (b) 250 Pay down First Mortgage Bonds and Long-Term Bank Debt Senior Notes (a) June 2018 6.5 (c) 200 Pay down First Mortgage Bonds and general corporate purposes Long-Term Bank Debt May 2001-2003 6.05 (d) 225 Pay down Long-Term Bank Debt and general corporate purposes ------ Total $1,150 ====== (a) The Senior Notes are secured by Consumers First Mortgage Bonds issued contemporaneously in a similar amount. (b) The interest rate may be reset in 2003. (c) The interest rate will be reset in June 2005. (d) The interest rate is variable; weighted average interest rate upon original issuance was 6.05 percent. The following table describes the retirements of long-term financings which have occurred during 1998 through early August 1998. In Millions Month Interest Principal Retired Maturity Rate (%) Amount ------- -------- ----- ------- First Mortgage Bonds February 1998 8.75 $248 Long-Term Bank Debt February 1998 6.4 (a) 50 First Mortgage Bonds March 2001-2002 7.5 119 First Mortgage Bonds April 2023 7.375 36 First Mortgage Bonds May 1998 6.875 43 Long-Term Bank Debt May 1998-1999 6.3 (b) 350 First Mortgage Bonds July 1999 8.875 136 ---- Total $982 ==== (a) The interest rate was variable; weighted average interest rate at December 31, 1997 was 6.4 percent. (b) The interest rate was variable; weighted average interest rate at March 31, 1998 was 6.3 percent. Consumers had unsecured, variable rate long-term bank debt with an outstanding balance at June 30, 1998 and 1997 of $225 million and $400 million, respectively. At June 30, 1998 and 1997 the debt carried weighted average interest rates of 6.1 percent and 6.2 percent, respectively. In February 1998, Consumers retired $50 million of its $400 million unsecured long-term bank debt. In May 1998, Consumers refinanced the remaining $350 million unsecured long-term bank debt, in part with $225 million unsecured long-term bank debt. To cover the remaining $125 million of bank debt refinancing, in May 1998 Consumers issued $250 million of senior notes due 2008, at an interest rate of 6.2 percent. The $125 million balance of senior notes due 2008 will be used for refunding or repurchasing various First Mortgage Bonds or for general corporate purposes. Under the provisions of its Articles of Incorporation at June 30, 1998, Consumers had $312 million of unrestricted retained earnings available to pay common dividends. In July 1998, Consumers declared a $44 million common dividend to be paid in August 1998. 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 June 30, 1998 and 1997, the related consolidated statements of income and common stockholder's equity for the three-month, six-month, and twelve-month periods then ended, and the related consolidated statements of cash flows for the six-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, August 11, 1998. 73 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK CMS Energy Quantitative and Qualitative Disclosures About Market Risk is contained in PART 1: CMS ENERGY CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS which is incorporated by reference herein. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS For a discussion of certain legal proceedings see Note 2, subsections "Stray Voltage" and "Anti-Trust", of the Condensed Notes to the Consolidated Financial Statements in Part I of this Report, incorporated by reference herein. The discussion is limited to an update of developments that have occurred in various judicial and administrative proceedings, many of which are more fully described in CMS Energy's and Consumers' Form 10-K for the year ended December 31, 1997, and in their Form 10-Q for the quarter ended March 31, 1998. The Condensed Notes also include additional information regarding various pending administrative and judicial proceedings involving rate, operating and environmental matters. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the CMS Energy Annual Meeting of Shareholders held on May 22, 1998, the shareholders ratified the appointment of Arthur Andersen LLP as independent auditors of CMS Energy for the year ended December 31, 1998. The vote was 91,399,366 shares in favor and 345,414 against, with 449,175 abstaining. The CMS Energy shareholders voted against a shareholder's proposal to adopt a five point program addressing Consumers' operating as a "Utility of Choice" and under "Utility of Choice" guidelines. The vote was 2,549,545 shares in favor and 76,358,536 against, with 3,770,814 abstaining. The CMS Energy shareholders also elected all ten nominees for the office of director. The votes for individual nominees were as follows: CMS ENERGY CORPORATION Number of Votes: For Withheld Total William T. McCormick, Jr. 91,441,628 752,327 92,193,955 John M. Deutch 91,480,907 713,048 92,193,955 James J. Duderstadt 91,464,959 728,996 92,193,955 Kathleen R. Flaherty 91,473,241 720,714 92,193,955 Victor J. Fryling 91,486,712 707,243 92,193,955 Earl D. Holton 91,501,516 692,439 92,193,955 William U. Parfet 91,453,119 740,836 92,193,955 Percy A. Pierre 91,474,471 719,484 92,193,955 Kenneth Whipple 91,497,651 696,304 92,193,955 John B. Yasinsky 91,504,196 689,759 92,193,955 Consumers did not solicit proxies for the matters submitted to votes at the contemporaneous May 22, 1998 Consumers' Annual Meeting of Shareholders. All 84,108,789 shares of Consumers Common Stock were voted in favor of re-electing the above-named individuals as directors of Consumers and in favor of ratifying the appointment of Arthur Andersen LLP as independent auditors of Consumers for the year ended December 31, 1998. None of the 441,599 shares of Consumers Preferred Stock were voted at the Annual Meeting. 74 ITEM 5. OTHER INFORMATION A shareholder who intends to submit a proposal for a vote at CMS Energy's 1999 Annual Meeting of Shareholders but which will not be included in CMS Energy's 1999 proxy statement must send the proposal to reach CMS Energy on or before March 6, 1999. The proposals should be addressed to: Mr. Thomas A. McNish, Corporate Secretary, Fairlane Plaza South, Suite 1100, 330 Town Center Drive, Dearborn, Michigan 48126. Failure to timely submit the proposal will allow management to use discretionary voting authority when the proposal is raised at the Annual Meeting. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) LIST OF EXHIBITS (12) - CMS Energy: Statements regarding computation of Ratio of Earnings to Fixed Charges (15)(a) - CMS Energy: Letter of Independent Public Accountant (15)(b) - Consumers: Letter of Independent Public Accountant (27)(a) - CMS Energy: Financial Data Schedule (27)(b) - Consumers: Financial Data Schedule (99) - CMS Energy: Consumers Gas Group Financials (b) REPORTS ON FORM 8-K Current Reports on Form 8-K dated June 23, 1998 and July 30, 1998 were filed by CMS Energy covering matters pursuant to "Item 5. Other Events." 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: August 14, 1998 By Alan M. Wright Senior Vice President and Chief Financial Officer CONSUMERS ENERGY COMPANY (Registrant) Dated: August 14, 1998 By Alan M. Wright Senior Vice President and Chief Financial Officer EX-12 2 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) Six Months Ended Years Ended December 31 June 30, 1998 1997 1996 1995 1994 1993 (b) Earnings as defined (a) Consolidated net income $ 110 $ 244 $ 224 $ 195 $ 177 $ 130 Income taxes 45 108 137 113 91 62 Exclude equity basis subsidiaries (38) (80) (85) (57) (18) (6) Fixed charges as defined, adjusted to exclude capitalized interest of $11, $13, $5, $4, $2, and $2 million for the six months ended June 30, 1998 and for the years ended December 31, 1997, 1996, 1995, 1994 and 1993, respectively 197 360 313 299 253 247 ----- ----- ----- ----- ----- ----- Earnings as defined $ 314 $ 632 $ 589 $ 550 $ 503 $ 433 ===== ===== ===== ===== ===== ===== Fixed charges as defined (a) Interest on long-term debt $ 154 $ 273 $ 230 $ 224 $ 193 $ 204 Estimated interest portion of lease rental 3 8 10 9 9 12 Other interest charges 25 49 43 42 30 25 Preferred securities dividends and distributions 40 67 54 42 36 17 ----- ----- ----- ----- ----- ----- Fixed charges as defined $ 222 $ 397 $ 337 $ 317 $ 268 $ 258 ===== ===== ===== ===== ===== ===== Ratio of earnings to fixed charges and preferred securities dividends and distributions 1.41 1.59 1.75 1.74 1.88 1.68 ===== ===== ===== ===== ===== ===== NOTES: (a) Earnings and fixed charges as defined in instructions for Item 503 of Regulation S-K. (b) Excludes a cumulative effect of change in accounting after-tax gain of $43 million.
EX-15 3 AUDITOR LETTER - CMS ENERGY 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, No. 333-48899, and No. 333-60795 its Form 10-Q for the quarter ended June 30, 1998, which includes our report dated August 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, August 11, 1998. EX-15 4 AUDITOR LETTER - CONSUMERS ARTHUR ANDERSEN LLP Exhibit(15) To Consumers Energy Corporation: We are aware that Consumers Energy Corporation has incorporated by reference in its Registration Statements No. 333-58943 and No. 333-59953 its Form 10-Q for the quarter ended June 30, 1998, which includes our report dated August 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, August 11, 1998. EX-27 5 CMS ENERGY - FINANCIAL DATA SCHEDULE
UT THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE STATEMENT OF INCOME, STATEMENT OF CASH FLOWS, BALANCE SHEET, AND STATEMENT OF COMMON STOCKHOLDERS' EQUITY, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000811156 CMS ENERGY CORPORATION 1,000,000 6-MOS DEC-31-1998 JAN-01-1998 JUN-30-1998 PER-BOOK 4,350 2,724 1,257 1,527 0 9,858 1 2,297 (292) 1,877 393 238 1,551 255 2,743 0 88 0 78 38 2,468 9,858 2,506 68 2,121 2,189 317 30 347 168 179 26 153 66 0 309 1.42 1.39 EPS for CMS Energy Common Stock $1.42 EPS for Class G Common Stock $1.20
EX-27 6 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 6-MOS DEC-31-1998 JAN-01-1998 JUN-30-1998 PER-BOOK 4,350 732 754 1,240 0 7,076 841 452 396 1,748 220 238 995 255 1,164 0 56 0 77 38 2,344 7,076 1,883 90 1,559 1,649 234 34 268 87 181 19 162 129 0 322 0 0
EX-99 7 CONSUMERS GAS GROUP 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 June 30 1998 1997 Change ---- ---- ------ Three months ended $ 4 $ 5 $ (1) Six months ended 40 44 (4) Twelve months ended 56 50 6 The decreases in earnings for the three months and six months ended June 30, 1998 compared to the same 1997 periods reflect decreased gas deliveries due to warmer 1998 temperatures and higher operations expense related to growth in retail services programs. The first six months of 1998 were the third warmest since 1864. Revenues were down for the six month period ended June 30, 1998 due to the elimination of surcharges related to past conservation programs. Partially offsetting the decrease for the six month period ended June 30, 1998 was the benefit resulting from an accounting change for property taxes. The recognition of property tax expense was changed from expensing on a calendar year basis to a fiscal year basis which resulted in a benefit of $18 million ($12 million after-tax). This one-time benefit helped to offset the warmest winter since 1880. The increase in earnings for the twelve months ended June 30, 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. Gas Issues For a discussion of Consumers Gas Group operating issues, see Consumers Gas Group Results of Operations-Uncertainties in CMS Energy's MD&A. Cash Position, Investing and Financing Operating Activities: Consumers Gas Group's cash requirements are met by its operating and financing activities. Consumers Gas Group's cash from operations is derived mainly from Consumers' sale and transportation of natural gas. Cash from operations for the first six months of 1998 and 1997 totaled $139 million and $208 million, respectively. The $69 million decrease is due primarily to higher summer gas inventory balances because of lower sales resulting from warmer weather, the noncash effect of the property tax accounting change and a decrease in the sale of accounts receivable. 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 six months of 1998 and 1997 totaled $52 million and $56 million, respectively. The $4 million decrease in cash used primarily reflects a decrease in capital expenditures. Financing Activities: Cash used in financing activities during the first six months of 1998 and 1997 totaled $37 million and $135 million, respectively. The $98 million decrease in cash used primarily reflects an increase in the proceeds from senior notes, partially offset by an increase in the retirement of bonds and other long-term debt and the return of CMS Energy stockholders' contributions. Other Investing and Financing Matters: Consumers has an agreement permitting the sale of certain accounts receivable for up to $500 million. At June 30, 1998, receivables sold under the program totaled $236 million. Consumers Gas Group's attributed portion of receivables sold under the program totaled $40 million. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold. For detailed information, see "Short-Term and Long-Term Financings, and Capitalization" in CMS Energy's Note 3. Forward-Looking Information For cautionary statements relating to Consumers Gas Group's forward-looking information, see the Forward-Looking Information section in CMS Energy's MD&A. Capital Expenditures: CMS Energy estimates the following capital expenditures for Consumers Gas Group, including new lease commitments, over the next three years. These estimates are prepared for planning purposes and are subject to revision. In Millions Years Ended December 31 1998 1999 2000 ---- ---- ---- Gas utility (a) $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 the outlook of Consumers Gas Group, see the Consumers Gas Group Outlook discussion in CMS Energy's MD&A. (This page intentionally left blank) Consumers Gas Group Statements of Income (Unaudited)
Three Months Ended Six Months Ended Twelve Months Ended June 30 1998 1997 1998 1997 1998 1997 In Millions, Except Per Share Amounts Operating Revenue $ 170 $ 220 $ 599 $ 718 $1,085 $1,242 ------ ------ ------ ------ ------ ------ Operating Expenses Operation Cost of gas sold 74 118 338 432 600 729 Other 44 43 90 82 183 186 ------ ------ ------ ------ ------ ------ 118 161 428 514 783 915 Maintenance 8 8 16 16 34 38 Depreciation, depletion and amortization 14 17 51 55 89 91 General taxes 9 11 29 32 52 55 ------ ------ ------ ------ ------ ------ 149 197 524 617 958 1,099 ------ ------ ------ ------ ------ ------ Pretax Operating Income 21 23 75 101 127 143 ------ ------ ------ ------ ------ ------ Other Deductions - - - (1) (1) (5) ------ ------ ------ ------ ------ ------ Fixed Charges Interest on long-term debt 7 7 14 14 28 29 Other interest 4 3 8 6 15 13 Capitalized interest - - - - - (1) Preferred stock dividends 1 2 2 3 4 6 ------ ------ ------ ------ ------ ------ 12 12 24 23 47 47 ------ ------ ------ ------ ------ ------ Income Before Income Taxes 9 11 51 77 79 91 Income Taxes 5 6 23 33 35 41 ------ ------ ------ ------ ------ ------ Net Income before cumulative effect of change in accounting principle 4 5 28 44 44 50 Cumulative effect of change in accounting for property taxes, net of $6 tax - - 12 - 12 - ------ ------ ------ ------ ------ ------ Net Income $ 4 $ 5 $ 40 $ 44 $ 56 $ 50 ====== ====== ====== ====== ====== ====== Net Income Attributable to CMS Energy Shareholders through Retained Interest $ 3 $ 3 $ 30 $ 33 $ 42 $ 38 ------ ------ ------ ------ ------ ------ Net Income Attributable to Class G Shareholders $ 1 $ 2 $ 10 $ 11 $ 14 $ 12 ------ ------ ------ ------ ------ ------ Average Class G Common Shares Outstanding 8 8 8 8 8 8 ------ ------ ------ ------ ------ ------ Basic and Diluted Earnings Per Average Class G Common Share Before Change in Accounting Principle $ .12 $ .16 $ .84 $ 1.34 $ 1.35 $ 1.52 ------ ------ ------ ------ ------ ------ Cumulative Effect of Change in Accounting Principle, Net of Tax, Per Average Class G Common Share $ - $ - $ .36 $ - $ .36 $ - ------ ------ ------ ------ ------ ------ Basic and Diluted Earnings Per Average Class G Common Share $ .12 $ .16 $ 1.20 $ 1.34 $ 1.71 $ 1.52 ------ ------ ------ ------ ------ ------ Dividend Declared Per Class G Common Share $ .31 $ .295 $ .62 $ .59 $ 1.24 $ 1.18 ====== ====== ====== ====== ====== ====== The accompanying condensed notes are an integral part of these statements. /TABLE 5 Consumers Gas Group Statements of Cash Flows (Unaudited)
Six Months Ended Twelve Months Ended June 30 1998 1997 1998 1997 In Millions Cash Flows from Operating Activities Net income $ 40 $ 44 $ 56 $ 50 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization 51 55 89 91 Deferred income taxes and investment tax credit 11 7 9 13 Capital lease and other amortization 2 1 5 2 Cumulative effect of accounting change for property taxes (18) - (18) - Other - (1) - - Changes in other assets and liabilities 53 102 13 42 ------ ------ ------ ------ Net cash provided by operating activities 139 208 154 198 ------ ------ ------ ------ Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (49) (51) (111) (135) Cost to retire property, net (4) (4) (9) (9) Other 1 (1) 2 (1) ------ ------ ------ ------ Net cash used in investing activities (52) (56) (118) (145) ------ ------ ------ ------ Cash Flows from Financing Activities Proceeds from senior notes 182 - 182 - Issuance of common stock 3 2 8 5 Retirement of bonds and other long-term debt (123) (30) (133) (38) Increase (decrease) in notes payable, net (55) (85) 35 6 Return of CMS Energy stockholders' contribution (21) - (60) - Payment of common stock dividends (20) (19) (41) (38) Payment of capital lease obligations (3) (1) (6) (2) Proceeds from long-term note - - 25 - Proceeds from bank loans - - - 23 Repayment of long-term note - (2) - (2) Retirement of preferred stock - - (26) - ------ ------ ------ ------ Net cash used in financing activities (37) (135) (16) (46) ------ ------ ------ ------ Net Increase in Cash and Temporary Cash Investments 50 17 20 7 Cash and Temporary Cash Investments, Beginning of Period 2 15 32 25 ------ ------ ------ ------ Cash and Temporary Cash Investments, End of Period $ 52 $ 32 $ 52 $ 32 ====== ====== ====== ====== Other cash flow activities and non-cash investing and financing activities were: Cash transactions Interest paid (net of amounts capitalized) $ 18 $ 21 $ 39 $ 42 Income taxes paid (net of refunds) 24 25 39 40 Non-cash transactions Assets placed under capital lease $ 3 $ 1 $ 5 $ 2 ====== ====== ====== ====== All highly liquid investments with an original maturity of three months or less are considered cash equivalents. The accompanying condensed notes are an integral part of these statements.
6 Consumers Gas Group Balance Sheets
ASSETS June 30 June 30 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Plant and Property (At cost) Plant and property $2,307 $2,322 $2,270 Less accumulated depreciation, depletion and amortization 1,215 1,231 1,202 ------ ------ ------ 1,092 1,091 1,068 Construction work-in-progress 29 28 22 ------ ------ ------ 1,121 1,119 1,090 ------ ------ ------ Current Assets Cash and temporary cash investments at cost, which approximates market52 2 32 Accounts receivable and accrued revenue, less allowances of $3, $3, and $2, respectively (Note 3) 14 53 72 Inventories at average cost Gas in underground storage 178 197 125 Materials and supplies 6 7 8 Deferred income taxes - 6 3 Prepayments and other 46 51 27 ------ ------ ------ 296 316 267 ------ ------ ------ Non-current Assets Postretirement benefits 137 142 148 Deferred income taxes 10 6 12 Other 61 61 60 ------ ------ ------ 208 209 220 ------ ------ ------ Total Assets $1,625 $1,644 $1,577 ====== ====== ======
STOCKHOLDERS' INVESTMENT AND LIABILITIES June 30 June 30 1998 December 31 1997 (Unaudited) 1997 (Unaudited) In Millions Capitalization Common stockholders' equity $ 360 $ 358 $ 397 Preferred stock 52 52 78 Long-term debt 486 333 356 Non-current portion of capital leases 16 16 16 ------ ------ ------ 914 759 847 ------ ------ ------ Current Liabilities Current portion of long-term debt and capital leases 27 118 82 Notes payable 64 119 29 Accounts payable 74 94 86 Accrued taxes 45 65 44 Accrued refunds 8 10 5 Accrued interest 6 4 4 Deferred income taxes 3 - - Other 43 44 40 ------ ------ ------ 270 454 290 ------ ------ ------ Non-current Liabilities Regulatory liabilities for income taxes, net 180 173 177 Postretirement benefits 164 168 172 Deferred investment tax credit 25 25 26 Other 72 65 65 ------ ------ ------ 441 431 440 ------ ------ ------ Commitments and Contingencies (Note 4) Total Stockholders' Investment and Liabilities $1,625 $1,644 $1,577 ====== ====== ====== The accompanying condensed notes are an integral part of these statements.
8 Consumers Gas Group Statements of Common Stockholders' Equity (Unaudited)
Three Months Ended Six Months Ended Twelve Months Ended June 30 1998 1997 1998 1997 1998 1997 In Millions Common Stock At beginning and end of period $184 $184 $184 $184 $184 $184 ---- ---- ---- ---- ---- ---- Other Paid-in Capital At beginning of period 88 135 102 134 136 131 Common stock issued 1 1 3 2 8 5 Return of CMS Energy stockholders' contribution (5) - (21) - (60) - ---- ---- ---- ---- ---- ---- At end of period 84 136 84 136 84 136 ---- ---- ---- ---- ---- ---- Retained Earnings At beginning of period 98 81 72 52 77 65 Net income 4 5 40 44 56 50 Common stock dividends declared (10) (9) (20) (19) (41) (38) ---- ---- ---- ---- ---- ---- At end of period 92 77 92 77 92 77 ---- ---- ---- ---- ---- ---- Total Common Stockholders' Equity $360 $397 $360 $397 $360 $397 ==== ==== ==== ==== ==== ==== The accompanying condensed notes are an integral part of these statements.
9 Consumers Gas Group Condensed Notes to Financial Statements 1: Corporate Structure CMS Energy is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. For further information regarding the businesses of CMS Energy, see the Notes to Consolidated Financial Statements of CMS Energy included and incorporated by reference herein. CMS Energy has issued shares of Class G Common Stock. This class of common stock reflects the separate performance of the gas distribution, storage and transportation businesses conducted by Consumers and Michigan Gas Storage Company, a subsidiary of Consumers (collectively, Consumers Gas Group). For further information regarding the nature and issuance of the Class G Common Stock, see Note 4 to the Consolidated Financial Statements of CMS Energy included and incorporated by reference herein. These Financial Statements and their related Notes should be read along with the Financial Statements and Notes contained in the 1997 Annual Report of CMS Energy that includes the Report of Independent Public Accountants, included and incorporated by reference herein. 2: Earnings Per Share and Dividends Earnings per share for the three month period ended June 30, 1998 and June 30, 1997 reflect the performance of Consumers Gas Group. The Class G Common Stock has participated in earnings and dividends since its original issue date in July 1995. The earnings (loss) attributable to Class G Common Stock and the related amounts per share are computed by considering the weighted average number of shares of Class G Common Stock outstanding. Earnings attributable to outstanding Class G Common Stock are equal to Consumers Gas Group's net income multiplied by a fraction; the numerator is the weighted average number of Outstanding Shares during the period, and the denominator is the weighted average number of Outstanding Shares and Retained Interest Shares during the period. The earnings attributable to Class G Common Stock on a per share basis, for the six months ended June 30, 1998 and 1997, are based on 25.27 percent and 24.30 percent of the income of Consumers Gas Group, respectively. In February and May 1998, CMS Energy declared and paid dividends of $.31 per share on Class G Common Stock. In July 1998, the Board of Directors declared a quarterly dividend of $.325 per share on Class G Common Stock to be paid in August 1998. This represents an increase in the annualized dividend on Class G Common Stock to $1.30 per share from the previous dividend of $1.24 per share (a 4.8 percent increase). 3: Short-Term And Long-Term Financings, and Capitalization Short-Term Financings: Consumers' short-term financings are discussed in Consolidated Financial Statements of CMS Energy Note 3 included and incorporated by reference herein. Consumers generally manages its short-term financings on a centralized consolidated basis. The portion of receivables sold attributable to Consumers Gas Group at June 30, 1998 and 1997, is estimated by management to be $40 million and $58 million, respectively. Accounts receivable and accrued revenue in the balance sheets have been reduced to reflect receivables sold. The portions of short-term debt and receivables sold attributable to Consumers Gas Group reflect the high utilization of short-term borrowing to finance the purchase of gas for storage in the summer and fall periods. The allocation of short-term financings and related interest charges to Consumers Gas Group generally follows the ratio of gas utility assets to total Consumers' assets. Additionally, the carrying costs for Consumers' sales of certain of its accounts receivable under its trade receivable purchase and sale agreement generally are allocated to Consumers Gas Group based on the ratio of customer revenues contributed by Consumers' gas customers to total Consumers' revenue. As a result of the centralized management of short-term financing, the amounts allocated to Consumers Gas Group are further adjusted in both the seasonal gas inventory build-up period (second and third quarters) and the high seasonal gas sales period (first and fourth quarters) to more closely reflect the higher short-term financing requirements of the inventory build-up period and conversely the lower financing requirements during the higher sales periods. Management believes these allocations to be reasonable. Capital Stock and Long-Term Debt: Consumers Gas Group's capital stock and long-term debt, including debt resulting from the sale of Trust Preferred Securities, have been allocated based on the ratio of gas utility assets (including common assets attributed to the gas utility segment) to total Consumers' assets. Management believes these measurements are reasonable. For information regarding the long-term debt and capital stock of CMS Energy and Consumers, see Note 3 to the Consolidated Financial Statements of CMS Energy included and incorporated by reference herein. 4: Commitments and Contingencies Capital Expenditures: Consumers Gas Group estimates capital expenditures, including new lease commitments, of $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 Consumers Gas Group Contingencies and Consumers Gas Group Matters in CMS Energy's Note 2 included and incorporated by reference herein. 11 ARTHUR ANDERSEN LLP Report of Independent Public Accountants To CMS Energy Corporation: We have reviewed the accompanying balance sheets of CONSUMERS GAS GROUP (representing a business unit of Consumers Energy Company and its wholly- owned subsidiary, Michigan Gas Storage Company) as of June 30, 1998 and 1997, the related statements of income and common stockholders' equity for the three-month, six-month, and twelve-month periods then ended, and the related statements of cash flows for the six-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, August 11, 1998. -----END PRIVACY-ENHANCED MESSAGE-----