-----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, BepnKDiKZ1SC7K32juUxyPQrcbMTmKsf1jrDLy7WAyHWXfA+xuT3un1rDSe61Qmu qFmygRxfoilssh0TZgvSKg== 0000950124-04-003655.txt : 20040806 0000950124-04-003655.hdr.sgml : 20040806 20040806172447 ACCESSION NUMBER: 0000950124-04-003655 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040806 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: 1934 Act SEC FILE NUMBER: 001-05611 FILM NUMBER: 04958918 BUSINESS ADDRESS: STREET 1: ONE ENERGY PLAZA CITY: JACKSON STATE: MI ZIP: 49201 BUSINESS PHONE: 5177881031 MAIL ADDRESS: STREET 1: ONE ENERGY PLAZA 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: 1934 Act SEC FILE NUMBER: 001-09513 FILM NUMBER: 04958917 BUSINESS ADDRESS: STREET 1: ONE ENERGY PLAZA CITY: JACKSON STATE: MI ZIP: 49201 BUSINESS PHONE: 5177881031 MAIL ADDRESS: STREET 1: ONE ENERGY PLAZA CITY: JACKSON STATE: MI ZIP: 49201 10-Q 1 k87244e10vq.txt QUARTERLY REPORT FOR PERIOD ENDED JUNE 30, 2004 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from_____to Commission Registrant; State of Incorporation; IRS Employer File Number Address; and Telephone Number Identification No. - -------------------------------------------------------------------------------- 1-9513 CMS ENERGY CORPORATION 38-2726431 (A Michigan Corporation) One Energy Plaza, Jackson, Michigan 49201 (517) 788-0550 1-5611 CONSUMERS ENERGY COMPANY 38-0442310 (A Michigan Corporation) One Energy Plaza, Jackson, Michigan 49201 (517) 788-0550 Indicate by check mark whether the Registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the Registrants are accelerated filers (as defined in Rule 12b-2 of the Exchange Act). CMS ENERGY CORPORATION: Yes [X] No [ ] CONSUMERS ENERGY COMPANY: Yes [ ] No [X] Number of shares outstanding of each of the issuer's classes of common stock at July 31, 2004: CMS ENERGY CORPORATION: CMS Energy Common Stock, $.01 par value 161,277,622 CONSUMERS ENERGY COMPANY, $10 par value, privately held by CMS Energy Corporation 84,108,789 ================================================================================ CMS ENERGY CORPORATION AND CONSUMERS ENERGY COMPANY QUARTERLY REPORTS ON FORM 10-Q TO THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION FOR THE QUARTER ENDED JUNE 30, 2004 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.................................................................................................. 4 PART I: FINANCIAL INFORMATION CMS Energy Corporation Management's Discussion and Analysis Executive Overview.............................................................................. CMS - 1 Restatement of 2003 Financial Statements........................................................ CMS - 2 Consolidation of Variable Interest Entities..................................................... CMS - 2 Forward-Looking Statements and Risk Factors..................................................... CMS - 2 Results of Operations........................................................................... CMS - 4 Critical Accounting Policies.................................................................... CMS - 12 Capital Resources and Liquidity................................................................. CMS - 24 Outlook......................................................................................... CMS - 27 New Accounting Standards........................................................................ CMS - 39 Consolidated Financial Statements Consolidated Statements of Income (Loss)........................................................ CMS - 42 Consolidated Statements of Cash Flows........................................................... CMS - 44 Consolidated Balance Sheets..................................................................... CMS - 46 Consolidated Statements of Common Stockholders' Equity.......................................... CMS - 48 Condensed Notes to Consolidated Financial Statements: 1. Corporate Structure and Accounting Policies................................................ CMS - 49 2. Discontinued Operations, Other Asset Sales, Impairments, and Restructuring................. CMS - 52 3. Uncertainties.............................................................................. CMS - 57 4. Financings and Capitalization.............................................................. CMS - 81 5. Earnings Per Share and Dividends........................................................... CMS - 85 6. Financial and Derivative Instruments....................................................... CMS - 87 7. Retirement Benefits........................................................................ CMS - 92 8. Equity Method Investments.................................................................. CMS - 94 9. Reportable Segments........................................................................ CMS - 95 10. Asset Retirement Obligations............................................................... CMS - 96 11. Implementation of New Accounting Standards................................................. CMS - 98
2 TABLE OF CONTENTS (CONTINUED)
Page ---- Consumers Energy Company Management's Discussion and Analysis Executive Overview.............................................................................. CE - 1 Consolidation of the MCV Partnership and the FLMP............................................... CE - 2 Forward-Looking Statements and Risk Factors..................................................... CE - 2 Results of Operations......................................................................... CE - 4 Critical Accounting Policies.................................................................... CE - 8 Capital Resources and Liquidity................................................................. CE - 16 Outlook......................................................................................... CE - 19 New Accounting Standards........................................................................ CE - 28 Consolidated Financial Statements Consolidated Statements of Income............................................................... CE - 31 Consolidated Statements of Cash Flows........................................................... CE - 32 Consolidated Balance Sheets..................................................................... CE - 34 Consolidated Statements of Common Stockholder's Equity.......................................... CE - 36 Condensed Notes to Consolidated Financial Statements: 1. Corporate Structure and Accounting Policies................................................. CE - 39 2. Uncertainties............................................................................... CE - 42 3. Financings and Capitalization............................................................... CE - 60 4. Financial and Derivative Instruments........................................................ CE - 63 5. Retirement Benefits......................................................................... CE - 67 6. Asset Retirement Obligations................................................................ CE - 68 7. Implementation of New Accounting Standards.................................................. CE - 70 Quantitative and Qualitative Disclosures about Market Risk................................................ CO - 1 Controls and Procedures................................................................................... CO - 1 PART II: OTHER INFORMATION Item 1. Legal Proceedings............................................................................ CO - 1 Item 4. Submission of Matters to a Vote of Security Holders.......................................... CO - 5 Item 5. Other Information............................................................................ CO - 6 Item 6. Exhibits and Reports on Form 8-K............................................................. CO - 6 Signatures........................................................................................... CO - 8
3 GLOSSARY Certain terms used in the text and financial statements are defined below Accumulated Benefit Obligation..................... The liabilities of a pension plan based on service and pay to date. This differs from the Projected Benefit Obligation that is typically disclosed in that it does not reflect expected future salary increases. AEP................................................ American Electric Power, a non-affiliated company ALJ................................................ Administrative Law Judge Alliance RTO....................................... Alliance Regional Transmission Organization Alstom............................................. Alstom Power Company APB................................................ Accounting Principles Board APB Opinion No. 18................................. APB Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock" APT................................................ Australian Pipeline Trust ARO................................................ Asset retirement obligation 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 CEO................................................ Chief Executive Officer CFO................................................ Chief Financial Officer 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, the parent of Consumers and Enterprises CMS Energy Common Stock or common stock..................................... Common stock of CMS Energy, par value $.01 per share CMS ERM............................................ CMS Energy Resource Management Company, formerly CMS MST, a subsidiary of Enterprises CMS Field Services................................. CMS Field Services, formerly a wholly owned subsidiary of CMS Gas Transmission. The sale of this subsidiary closed in July 2003. CMS Gas Transmission............................... CMS Gas Transmission Company, a subsidiary of Enterprises CMS 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 wholly owned subsidiary of Enterprises, whose name was changed to CMS ERM effective January 2004
4 CMS Oil and Gas.................................... CMS Oil and Gas Company, formerly a subsidiary of Enterprises CMS PEPS........................................... CMS Energy Premium Equity Participating Security Units (CMS Energy Trust III) CMS Pipeline Assets................................ CMS Enterprises pipeline assets in Michigan and Australia CMS Viron.......................................... CMS Viron Energy Services, formerly a wholly owned subsidiary of CMS MST. The sale of this subsidiary closed in June 2003. Common Stock....................................... All classes of Common Stock of CMS Energy and each of its subsidiaries, or any of them individually, at the time of an award or grant under the Performance Incentive Stock Plan Consumers.......................................... Consumers Energy Company, a subsidiary of CMS Energy Consumers Funding.................................. Consumers Funding LLC, a wholly-owned special purpose subsidiary of Consumers for the issuance of securitization bonds dated November 8, 2001 Consumers Receivables Funding II................... Consumers Receivables Funding II LLC, a wholly-owned subsidiary of Consumers Court of Appeals................................... Michigan Court of Appeals CPEE............................................... Companhia Paulista de Energia Eletrica, a subsidiary of Enterprises Customer Choice Act................................ Customer Choice and Electricity Reliability Act, a Michigan statute enacted in June 2000 that allows all retail customers choice of alternative electric suppliers as of January 1, 2002, provides for full recovery of net stranded costs and implementation costs, establishes a five percent reduction in residential rates, establishes rate freeze and rate cap, and allows for Securitization Detroit Edison..................................... The Detroit Edison Company, a non-affiliated company DIG................................................ Dearborn Industrial Generation, LLC, a wholly owned subsidiary of CMS Generation DOE................................................ U.S. Department of Energy DOJ................................................ U.S. Department of Justice Dow................................................ The Dow Chemical Company, a non-affiliated company EBITDA............................................. Earnings before income taxes, depreciation, and amortization EISP............................................... Executive Incentive Separation Plan EITF............................................... Emerging Issues Task Force EITF Issue No. 02-03............................... Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities El Chocon.......................................... Hidroelectrica El Chocon, S.A., a 1,320 MW hydroelectric generating complex in Argentina, in which CMS Energy holds a 17.23 percent ownership interest. Enterprises........................................ CMS Enterprises Company, a subsidiary of CMS Energy EPA................................................ U. S. Environmental Protection Agency EPS................................................ Earnings per share ERISA.............................................. Employee Retirement Income Security Act Ernst & Young...................................... Ernst & Young LLP Exchange Act....................................... Securities Exchange Act of 1934, as amended FASB............................................... Financial Accounting Standards Board
5 FASB Staff Position, No. 106-1..................... Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (January 12, 2004) FASB Staff Position, No. 106-2..................... Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (May 19, 2004) FERC............................................... Federal Energy Regulatory Commission FMB................................................ First Mortgage Bonds FMLP............................................... First Midland Limited Partnership, a partnership that holds a lessor interest in the MCV facility Ford............................................... Ford Motor Company GasAtacama......................................... An integrated natural gas pipeline and electric generation project located in Argentina and Chile which includes 702 miles of natural gas pipeline and a 720 MW gross capacity power plant GCR................................................ Gas cost recovery GEII............................................... General Electric International Inc. Goldfields......................................... A pipeline business located in Australia, in which CMS Energy holds a 39.7 percent ownership interest Guardian........................................... Guardian Pipeline, LLC, in which CMS Gas Transmission owned a one-third interest Health Care Plan................................... The medical, dental, and prescription drug programs offered to eligible employees of Consumers and CMS Energy HL Power........................................... H.L. Power Company, a California Limited Partnership, owner of the Honey Lake generation project in Wendel, California Integrum........................................... Integrum Energy Ventures, LLC IPP................................................ Independent Power Production JOATT.............................................. Joint Open Access Transmission Tariff Jorf Lasfar........................................ The 1,356 MW coal-fueled power plant in Morocco, jointly owned by CMS Generation and ABB Energy Ventures, Inc. Karn............................................... D.E Karn/J.C. Weadock Generating Complex, which is owned by Consumers Energy kWh................................................ Kilowatt-hour LIBOR.............................................. London Inter-Bank Offered Rate 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 held a 50 percent ownership interest LNG................................................ Liquefied natural gas Ludington.......................................... Ludington pumped storage plant, jointly owned by Consumers and Detroit Edison
6 Marysville......................................... CMS Marysville Gas Liquids Company, a Michigan corporation and a former subsidiary of CMS Gas Transmission that held a 100 percent interest in Marysville Fractionation Partnership and a 51 percent interest in St. Clair Underground Storage Partnership mcf................................................ Thousand cubic feet MCV Expansion, LLC................................. An agreement entered into with General Electric Company to expand the MCV Facility 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 METC............................................... Michigan Electric Transmission Company, formerly a subsidiary of Consumers and now an indirect subsidiary of Trans-Elect Michigan Power..................................... CMS Generation Michigan Power, LLC, owner of the Kalamazoo River Generating Station and the Livingston Generating Station MISO............................................... Midwest Independent System Operator Moody's............................................ Moody's Investors Service, Inc. MPSC............................................... Michigan Public Service Commission MSBT............................................... Michigan Single Business Tax MTH................................................ Michigan Transco Holdings, Limited Partnership MW................................................. Megawatts NEIL............................................... Nuclear Electric Insurance Limited, an industry mutual insurance company owned by member utility companies NMC................................................ Nuclear Management Company, LLC, formed in 1999 by Northern States Power Company (now Xcel Energy Inc.), Alliant Energy, Wisconsin Electric Power Company, and Wisconsin Public Service Company to operate and manage nuclear generating facilities owned by the four utilities NERC............................................... North American Electric Reliability Council NRC................................................ Nuclear Regulatory Commission NYMEX.............................................. New York Mercantile Exchange OATT............................................... Open Access Transmission Tariff OPEB............................................... Postretirement benefit plans other than pensions for retired employees Palisades.......................................... Palisades nuclear power plant, which is owned by Consumers
7 Panhandle.......................................... Panhandle Eastern Pipe Line Company, including its subsidiaries Trunkline, Pan Gas Storage, Panhandle Storage, and Panhandle Holdings. Panhandle was a wholly owned subsidiary of CMS Gas Transmission. The sale of this subsidiary closed in June 2003. Parmelia........................................... A business located in Australia comprised of a pipeline, processing facilities, and a gas storage facility, a subsidiary of CMS Gas Transmission PCB................................................ Polychlorinated biphenyl Pension Plan....................................... The trusteed, non-contributory, defined benefit pension plan of Panhandle, Consumers and CMS Energy PJM RTO............................................ Pennsylvania-Jersey-Maryland Regional Transmission Organization Powder River....................................... CMS Oil & Gas previously owned a significant interest in coalbed methane fields or projects developed within the Powder River Basin which spans the border between Wyoming and Montana. The Powder River properties have been sold. PPA................................................ The Power Purchase Agreement between Consumers and the MCV Partnership with a 35-year term commencing in March 1990, as amended, and as interpreted by the Settlement Agreement dated as of January 1, 1999 between the MCV and Consumers. Price Anderson Act................................. Price Anderson Act, enacted in 1957 as an amendment to the Atomic Energy Act of 1954, as revised and extended over the years. This act stipulates between nuclear licensees and the U.S. government the insurance, financial responsibility, and legal liability for nuclear accidents. PSCR............................................... Power supply cost recovery PUHCA.............................................. Public Utility Holding Company Act of 1935 PURPA.............................................. Public Utility Regulatory Policies Act of 1978 RCP................................................ Resource Conservation Plan ROA................................................ Retail Open Access RTO................................................ Regional Transmission Organization Rouge.............................................. Rouge Steel Industries SCP................................................ Southern Cross Pipeline in Australia, in which CMS Gas Transmission holds a 45 percent ownership interest SEC................................................ U.S. Securities and Exchange Commission Securitization..................................... A financing method authorized by statute and approved by the MPSC which allows a utility to sell its right to receive a portion of the rate payments received from its customers for the repayment of Securitization bonds issued by a special purpose entity affiliated with such utility SENECA............................................. Sistema Electrico del Estado Nueva Esparta, C.A., a subsidiary of Enterprises SERP............................................... Supplemental Executive Retirement Plan SFAS............................................... Statement of Financial Accounting Standards SFAS No. 5......................................... SFAS No. 5, "Accounting for Contingencies" SFAS No. 52........................................ SFAS No. 52, "Foreign Currency Translation"
8 SFAS No. 71........................................ SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" SFAS No. 87........................................ SFAS No. 87, "Employers' Accounting for Pensions" SFAS No. 88........................................ SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits" SFAS No. 98 ....................................... SFAS No. 98, "Accounting for Leases" SFAS No. 106....................................... SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" SFAS No. 107....................................... Disclosures about Fair Value of Financial Instruments SFAS No. 115....................................... SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" SFAS No. 123....................................... SFAS No. 123, "Accounting for Stock-Based Compensation" SFAS No. 128....................................... SFAS No. 128, "Earnings per Share" SFAS No. 133....................................... SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted" SFAS No. 143....................................... SFAS No. 143, "Accounting for Asset Retirement Obligations" SFAS No. 144....................................... SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" SFAS No. 148....................................... SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" SFAS No. 149....................................... SFAS No. 149, "Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities" SFAS No. 150....................................... SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" Southern Union..................................... Southern Union Company, a non-affiliated company Special Committee.................................. A special committee of independent directors, established by CMS Energy's Board of Directors, to investigate matters surrounding round-trip trading Stranded Costs..................................... Costs incurred by utilities in order to serve their customers in a regulated monopoly environment, which may not be recoverable in a competitive environment because of customers leaving their systems and ceasing to pay for their costs. These costs could include owned and purchased generation and regulatory assets. Superfund.......................................... Comprehensive Environmental Response, Compensation and Liability Act Taweelah........................................... Al Taweelah A2, a power and desalination plant of Emirates CMS Power Company, in which CMS Generation holds a 40 percent interest TEPPCO............................................. Texas Eastern Products Pipeline Company, LLC Toledo Power....................................... Toledo Power Company, the 135 MW coal and fuel oil power plant located on Cebu Island, Phillipines, in which CMS Generation held a 47.5 percent interest. Transition Costs................................... Stranded Costs, as defined, plus the costs incurred in the transition to competition
9 Trunkline.......................................... Trunkline Gas Company, LLC, formerly a subsidiary of CMS Panhandle Holdings, LLC Trunkline LNG...................................... Trunkline LNG Company, LLC, formerly a subsidiary of LNG Holdings, LLC Trust Preferred Securities......................... Securities representing an undivided beneficial interest in the assets of statutory business trusts, the interests of which 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 VEBA Trusts........................................ VEBA (voluntary employees' beneficiary association) trust accounts established to specifically set aside employer contributed assets to pay for future expenses of the OPEB plan
10 (This page intentionally left blank) 11 CMS Energy Corporation CMS ENERGY CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS This MD&A is a combined report of CMS Energy and Consumers. The terms "we" and "our" as used in this report refer to CMS Energy and its subsidiaries as a combined entity, except where it is made clear that such term means only CMS Energy. EXECUTIVE OVERVIEW CMS Energy is an integrated energy company with a business strategy focused primarily in Michigan. We are the parent holding company of Consumers and Enterprises. Consumers is a combination electric and gas utility company serving Michigan's Lower Peninsula. Enterprises, through various subsidiaries and equity investments, is engaged in domestic and international diversified energy businesses including: independent power production and natural gas transmission, storage and processing. We manage our businesses by the nature of services each provides and operate principally in three business segments: electric utility, gas utility, and enterprises. We earn our revenue and generate cash from operations by providing electric and natural gas utility services, electric power generation, gas transmission, storage, and processing. Our businesses are affected by weather, especially during the key heating and cooling seasons, economic conditions, particularly in Michigan, regulation and regulatory issues that primarily affect our gas and electric utility operations, interest rates, our debt credit rating, and energy commodity prices. Our strategy involves rebuilding our balance sheet and refocusing on our core strength: superior utility operation and service. Over the next few years, we expect this strategy to reduce our parent company debt substantially, improve our debt ratings, grow earnings at a mid-single digit rate, restore a meaningful dividend, and position the company to make new investments consistent with our strengths. In the near term, our new investments will focus on the utility. We face important challenges in the future. We continue to lose industrial and commercial customers to alternative electric suppliers without receiving compensation for stranded costs caused by the lost sales. As of July 2004, we have lost 858 MW or 11 percent of our electric load to these alternative electric suppliers. Based on current trends, we predict load loss by year-end to be in the range of 900 MW to 1,100 MW. However, no assurance can be made that the actual load loss will be greater or less than that range. Existing state legislation encourages competition and provides for recovery of stranded costs, but the MPSC has not yet authorized stranded cost recovery. We continue to seek resolution of this issue. In July 2004, several bills were introduced into the Michigan Senate that could change Michigan's Customer Choice Act. Further, higher natural gas prices have harmed the economics of the MCV Partnership and we are seeking approval from the MPSC to change the way the facility is used. Our proposal would reduce gas consumption by an estimated 30 to 40 bcf per year while improving the MCV Partnership's financial performance with no change to customer rates. A portion of the benefits from the proposal will support additional renewable resource development in Michigan. Resolving the issue is critical for our shareowners and customers. Our gas business faces market and regulatory uncertainties relating to gas costs. We attempt to minimize these uncertainties by fully recovering what we spend to purchase the gas through the GCR process. We CMS-1 CMS Energy Corporation currently have a GCR year 2003-2004 reconciliation on file with the MPSC. We are focused on further reducing our business risk and leverage, while growing the equity base of our company. Much of our asset sales program is complete; we are engaged in selling the remaining businesses that are not strategic to us. This creates volatility in earnings as we recognize foreign currency translation account losses at the time of sale, but it is the right strategic direction for our company. We are also working to resolve outstanding litigation that stemmed from energy trading and gas index price reporting activities in 2001 and earlier. Our business plan is targeted at predictable earnings growth and debt reduction. We are now over a year into our plan to reduce, by about half, the debt of CMS Energy over a five-year period. The result of these efforts will be a strong, reliable energy company that will be poised to take advantage of opportunities for further growth. RESTATEMENT OF 2003 FINANCIAL STATEMENTS Our financial statements as of and for the three and six months ended June 30, 2003, as presented in this Form 10-Q, have been restated for the following matters that were disclosed previously in Note 19, Quarterly Financial and Common Stock Information (Unaudited), in our 2003 Form 10-K/A: - International Energy Distribution, which includes SENECA and CPEE, is no longer considered "discontinued operations," due to a change in our expectations as to the timing of the sales, - certain derivative accounting corrections at our equity affiliates, and - the net loss recorded in the second quarter of 2003 relating to the sale of Panhandle, reflected as Discontinued Operations, was understated by approximately $14 million, net of tax. CONSOLIDATION OF VARIABLE INTEREST ENTITIES Under Revised FASB Interpretation No. 46, we are the primary beneficiary of several entities, most notably the MCV Partnership and the FMLP. As a result, we have consolidated the assets, liabilities, and activities of these entities into our financial statements as of and for the three and six months ended June 30, 2004. These entities are reported as equity method investments in our financial statements as of and for the three and six months ended June 30, 2003. Therefore, the consolidation of these entities had no impact on our consolidated net income for the three and six months ended June 30, 2004. For additional details, see Note 11, Implementation of New Accounting Standards. FORWARD-LOOKING STATEMENTS AND RISK FACTORS This Form 10-Q and other written and oral statements that we make contain forward-looking statements as defined in Rule 3b-6 of the Exchange Act, as amended, Rule 175 of the Securities Act of 1933, as amended, and relevant legal decisions. Our intention with the use of such words as "may," "could," "anticipates," "believes," "estimates," "expects," "intends," "plans," and other similar words is to identify forward-looking statements that involve risk and uncertainty. We designed this discussion of potential CMS-2 CMS Energy Corporation risks and uncertainties to highlight important factors that may impact our business and financial outlook. We have no obligation to update or revise forward-looking statements regardless of whether new information, future events or any other factors affect the information contained in the statements. These forward-looking statements are subject to various factors that could cause our actual results to differ materially from the results anticipated in these statements. Such factors include our inability to predict and/or control: - the efficient sale of non-strategic or under-performing domestic or international assets and discontinuation of certain operations, - capital and financial market conditions, including the price of CMS Energy Common Stock and the effect of such market conditions on the Pension Plan, interest rates, and availability of financing to CMS Energy, Consumers, or any of their affiliates, and the energy industry, - ability to access the capital markets successfully, - market perception of the energy industry, CMS Energy, Consumers, or any of their affiliates, - credit ratings of CMS Energy, Consumers, or any of their affiliates, - currency fluctuations, transfer restrictions, and exchange controls, - factors affecting utility and diversified energy operations such as unusual weather conditions, catastrophic weather-related damage, unscheduled generation outages, maintenance or repairs, environmental incidents, or electric transmission or gas pipeline system constraints, - international, national, regional, and local economic, competitive, and regulatory policies, conditions and developments, - adverse regulatory or legal decisions, including environmental laws and regulations, - the impact of adverse natural gas prices on the MCV Partnership investment, regulatory decisions concerning the MCV Partnership RCP, and regulatory decisions that limit our recovery of capacity and fixed energy payments, - federal regulation of electric sales and transmission of electricity including re-examination by federal regulators of the market-based sales authorizations by which our subsidiaries participate in wholesale power markets without price restrictions, and proposals by the FERC to change the way it currently lets our subsidiaries and other public utilities and natural gas companies interact with each other, - energy markets, including the timing and extent of unanticipated changes in commodity prices for oil, coal, natural gas, natural gas liquids, electricity, and certain related products due to lower or higher demand, shortages, transportation problems, or other developments, - potential disruption, expropriation or interruption of facilities or operations due to accidents, war, terrorism, or changing political conditions and the ability to obtain or maintain insurance coverage for such events, CMS-3 CMS Energy Corporation - nuclear power plant performance, decommissioning, policies, procedures, incidents, and regulation, including the availability of spent nuclear fuel storage, - technological developments in energy production, delivery, and usage, - achievement of capital expenditure and operating expense goals, - changes in financial or regulatory accounting principles or policies, - outcome, cost, and other effects of legal and administrative proceedings, settlements, investigations and claims, including particularly claims, damages, and fines resulting from round-trip trading and inaccurate commodity price reporting, including investigations by the DOJ regarding round-trip trading and price reporting, - limitations on our ability to control the development or operation of projects in which our subsidiaries have a minority interest, - disruptions in the normal commercial insurance and surety bond markets that may increase costs or reduce traditional insurance coverage, particularly terrorism and sabotage insurance and performance bonds, - other business or investment considerations that may be disclosed from time to time in CMS Energy's or Consumers' SEC filings or in other publicly issued written documents, and - other uncertainties that are difficult to predict, and many of which are beyond our control. RESULTS OF OPERATIONS Our business plan focuses on strengthening our balance sheet and improving financial liquidity through debt reduction and aggressive cost management. The sale of non-strategic and under-performing assets has generated cash to reduce debt, reduced business risk, and will provide for more predictable future earnings. CMS ENERGY CONSOLIDATED RESULTS OF OPERATIONS
In Millions (except for per share amounts) - -------------------------------------------------------------------------------- Restated Three months ended June 30 2004 2003 Change - -------------------------------------------------------------------------------- Net Income (Loss) Available to Common Stock $ 16 $ (65) $ 81 Basic Earnings (Loss) Per Share $0.10 $(0.45) $0.55 Diluted Earnings (Loss) Per Share $0.10 $(0.45) $0.55 - ------------------------------------------------------------------------------- Electric utility $ 27 $ 35 $ (8) Gas utility 1 5 (4) Enterprises 38 8 30 Corporate interest and other (50) (60) 10 Discontinued operations - (53) 53 - ------------------------------------------------------------------------------- CMS Energy Net Income (Loss) Available to Common Stock $ 16 $ (65) $ 81 ===============================================================================
CMS-4 CMS Energy Corporation For the three months ended June 30, 2004, our net income was $16 million, compared to a loss of $65 million for the three months ended June 30, 2003. The $81 million increase in net income primarily reflects: - the absence of a $53 million loss from discontinued operations recorded in 2003, comprised mainly of the loss on the sale of Panhandle, - the absence of a $31 million deferred tax asset valuation reserve established in 2003, - an $11 million increase in mark-to-market valuation adjustments on interest rate swaps and power contracts, and - a $6 million reduction in funded benefits expense primarily due to the OPEB plans accounting for the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the positive impact of prior year pension plan contributions on pension plan asset returns. These increases were partially offset by: - the absence of a $30 million Michigan Single Business Tax refund received in 2003, and - a reduction in the Utility's net income resulting primarily from industrial and commercial customers choosing different electricity suppliers and decreased gas deliveries caused primarily by milder weather. For further information, see the individual results of operations for each CMS Energy business segment within this MD&A.
In Millions (except for per share amounts) - -------------------------------------------------------------------------------- Restated Six months ended June 30 2004 2003 Change - -------------------------------------------------------------------------------- Net Income Available to Common Stock $ 9 $ 17 $ (8) Basic Earnings Per Share $0.06 $0.12 $(0.06) Diluted Earnings Per Share $0.06 $0.14 $(0.08) - -------------------------------------------------------------------------------- Electric utility $ 75 $ 86 $ (11) Gas utility 57 59 (2) Enterprises (23) 29 (52) Corporate interest and other (98) (111) 13 Discontinued operations (2) (22) 20 Accounting changes - (24) 24 - -------------------------------------------------------------------------------- CMS Energy Net Income Available to Common Stock $ 9 $ 17 $ (8) ================================================================================
For the six months ended June 30, 2004, our net income was $9 million, compared to net income of $17 million for the six months ended June 30, 2003. The $8 million decrease in income reflects: - an $81 million charge to earnings related to the sale of Loy Yang, - the absence of a $30 million Michigan Single Business Tax refund received in 2003, and - a reduction in the Utility's net income resulting primarily from industrial and commercial customers choosing different electricity suppliers and decreased gas deliveries caused primarily by milder weather. CMS-5 CMS Energy Corporation These decreases were partially offset by: - the exclusion in 2004 of a $24 million charge for changes in accounting that occurred in the first quarter of 2003, - the absence of a $31 million deferred tax asset valuation reserve established in 2003, - the decrease of $20 million in the net loss from discontinued operations resulting from the sale of Panhandle and other businesses in 2003, - a $31 million increase in mark-to-market valuation adjustments on interest rate swaps and power contracts, and - a $13 million reduction in funded benefits expense primarily due to the OPEB plans accounting for the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the positive impact of prior year pension plan contributions on pension plan asset returns. For further information, see the individual results of operations for each CMS Energy business segment within this MD&A. ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions - -------------------------------------------------------------------------------------- June 30 2004 2003 Change - -------------------------------------------------------------------------------------- Three months ended $27 $35 $ (8) Six months ended $75 $86 $(11) ======================================================================================
Three Months Ended Six Months Ended Reasons for the change: June 30, 2004 vs. 2003 June 30, 2004 vs. 2003 - -------------------------------------------------------------------------------------- Electric deliveries $(10) $(20) Power supply costs and related revenue (2) (8) Other operating expenses, non-commodity revenue and other income 13 26 General taxes (14) (10) Fixed charges - (6) Income taxes 5 7 - -------------------------------------------------------------------------------------- Total change $ (8) $(11) ======================================================================================
ELECTRIC DELIVERIES: Electric deliveries, including transactions with other wholesale marketers, other electric utilities, and customers choosing alternative suppliers increased 0.7 billion kWh or 7.2 percent and 1.0 billion kWh or 5.4 percent for the three and six months ended June 30, 2004 versus the same periods in 2003. The corresponding increases in electric delivery revenue for both periods were offset by tariff revenue reductions and decreased sales margins from deliveries to customers choosing alternative electric suppliers. The tariff revenue reductions, which began January 1, 2004, were equivalent to the Big Rock nuclear decommissioning surcharge in effect when our electric retail rates were frozen from June 2000 through December 31, 2003. The tariff revenue reductions were reclassified for capped customers as increases to PSCR revenues. The increased PSCR revenues helped negate possible losses attributable to the CMS-6 CMS Energy Corporation underrecovery of PSCR costs for these customers, primarily the residential and small commercial classes. In fact, the revenue reclassification contributed to the overrecovery of PSCR revenues in excess of PSCR costs in these customer classes for the three and six months ended June 30, 2004. In 2004, to the extent we have PSCR overrecoveries, the overrecovery must be reserved for possible future refund. The tariff revenue reductions have decreased electric delivery revenues by approximately $9 million in the second quarter of 2004, and $18 million in the first six months of 2004 versus 2003. The tariff revenue reductions are expected to decrease electric delivery revenues by $35 million for the full year of 2004 versus the full year of 2003. For the three and six months ended June 30, 2004, the overall decline in electric delivery revenues was offset partially by increased sales to residential customers due to warmer weather versus the same periods in 2003. POWER SUPPLY COSTS AND RELATED REVENUE: In 2003, our power supply cost rate of recovery was a fixed amount per kWh, as required under the Customer Choice Act. Therefore, power supply-related revenue in excess of actual power supply costs increased operating income. By contrast, if power supply-related revenues had been less than actual power supply costs, the impact would have decreased operating income. In 2004, our recovery of power supply costs is no longer fixed, but is instead restricted to a pre-defined limit for certain customer classes. The customer classes that have a pre-defined limit, or cap, on the level of power supply costs they can be charged are primarily the residential and small commercial customer classes. In 2004, to the extent our power supply-related revenues are in excess of actual power supply costs, this former benefit is reserved for possible future refund. This change in the treatment of excess power supply revenues over power supply costs decreased operating income for the three and six months ended June 30, 2004 versus the same periods in 2003. OTHER OPERATING EXPENSES, NON-COMMODITY REVENUE AND OTHER INCOME: In the three months ended June 30, 2004, other operating expenses decreased $1 million, non-commodity revenue increased $1 million, and other income increased $11 million versus the same period in 2003. The increase in other income relates primarily to interest income recognized in relation to capital expenditures in excess of depreciation as allowed by the Customer Choice Act. This Act also enabled us to defer depreciation expense on the excess of capital expenditures over our depreciation base, contributing to a reduction in operating expenses for the second quarter of 2004 versus the same period in 2003. Higher other operating expenses substantially offset the reduction in electric depreciation expense. In the six months ended June 30, 2004, other operating expenses decreased $6 million and other income increased $20 million versus the same period in 2003. The increase in other income relates primarily to interest income recognized in relation to capital expenditures in excess of depreciation, as allowed by the Customer Choice Act. Operating expense decreases reflect lower benefit costs and our ability to defer depreciation expense on the excess of capital expenditures over our depreciation base, as allowed by the Customer Choice Act. GENERAL TAXES: General taxes increased in the three and six months ended June 30, 2004 versus the same periods in 2003 primarily due to reductions in the MSBT expense in 2003. The 2003 reduction was primarily due to CMS Energy having received approval to file consolidated tax returns for the years 2000 and 2001. The taxable income for these years was lower than the amount used to make estimated MSBT payments. These returns were filed in the second quarter of 2003. CMS-7 CMS Energy Corporation FIXED CHARGES: Fixed charges increased in the six months ended June 30, 2004 versus the same periods in 2003 due to higher average debt levels, partially offset by a reduction in the average rates of interest. The average rate of interest dropped 79 basis points and 60 basis points for the three and six month periods ended June 30, 2004 versus the same periods in 2003. INCOME TAXES: In the three and six months ended June 30, 2004, income taxes decreased versus the same periods in 2003 primarily due to lower earnings by the electric utility, and the OPEB Medicare Part D federal subsidy that is exempt from federal taxation. GAS UTILITY RESULTS OF OPERATIONS
In Millions - ---------------------------------------------------------------------------------------------- June 30 2004 2003 Change - ---------------------------------------------------------------------------------------------- Three months ended $ 1 $ 5 $ (4) Six months ended $57 $59 $ (2) ==============================================================================================
Three Months Ended Six Months Ended Reasons for the change: June 30, 2004 vs. 2003 June 30, 2004 vs. 2003 - ---------------------------------------------------------------------------------------------- Gas deliveries $(7) $(21) Gas rate increase 2 11 Gas wholesale and retail services and other gas revenues 1 3 Operation and maintenance - (2) General taxes, depreciation, and other income (3) 3 Fixed charges (2) (6) Income taxes 5 10 - ---------------------------------------------------------------------------------------------- Total change $(4) $(2) ==============================================================================================
GAS DELIVERIES: For the three months ended June 30, 2004, the more profitable non-transportation gas deliveries decreased 4.9 bcf or 13.6 percent primarily due to milder weather. The less profitable transportation gas deliveries increased 5.2 bcf or 21.0 percent due to increased MCV Facility generation. Overall, gas deliveries, including miscellaneous transportation, increased 0.3 bcf or 0.5 percent versus the same period in 2003. For the six months ended June 30, 2004, gas deliveries, including miscellaneous transportation, decreased 6.7 bcf or 2.9 percent versus the same period in 2003 primarily due to milder weather. GAS RATE INCREASE: In December 2003, the MPSC issued an interim gas rate order authorizing a $19 million annual increase to gas tariff rates. As a result of this order, gas revenues increased for the three and six months ended June 30, 2004 versus the same periods in 2003. GAS WHOLESALE AND RETAIL SERVICES AND OTHER GAS REVENUES: For the three and six months ended June 30, 2004, wholesale and retail services and other gas revenues increased primarily due to increased gas transportation and storage revenues versus the same periods in 2003. CMS-8 CMS Energy Corporation OPERATION AND MAINTENANCE: For the six months ended June 30, 2004, increased expenditures on safety, reliability, and customer service were offset partially by reduced benefit costs compared to the same period in 2003. GENERAL TAXES, DEPRECIATION, AND OTHER INCOME: For the three months ended June 30, 2004 versus the same period in 2003, general tax expense increased $5 million due to higher MSBT expense and depreciation expense decreased $2 million. The increase in MSBT expense is primarily due to CMS Energy having received approval to file consolidated tax returns for the years 2000 and 2001. The taxable income for these years was lower than the amount used to make estimated MSBT payments. These returns were filed in the second quarter of 2003. The reduced depreciation expense relates to decreases in depreciation rates authorized by the MPSC's December 2003 interim rate order. For the six months ended June 30, 2004, general tax expense increased $4 million due to higher MSBT expense, depreciation expense decreased $8 million, and other income decreased $1 million versus the same period in 2003. The increase in MSBT expense is primarily due to CMS Energy having received approval to file consolidated tax returns for the years 2000 and 2001. The taxable income for these years was lower than the amount used to make estimated MSBT payments. These returns were filed in the second quarter of 2003. The reduced depreciation expense relates to decreases in depreciation rates authorized by the MPSC's December 2003 interim rate order. FIXED CHARGES: Fixed charges increased in the three and six months ended June 30, 2004 versus the same periods in 2003 due to higher average debt levels, partially offset by a reduction in the average rate of interest. The average rate of interest dropped 79 basis points and 60 basis points for the three and six month periods ended June 30, 2004 versus the same periods in 2003. INCOME TAXES: For the three and six months ended June 30, 2004 versus the same periods in 2003, income taxes decreased due to the income tax treatment of items related to plant, property, and equipment as required by past MPSC rulings, the decreased earnings of the gas utility, and the OPEB Medicare Part D federal subsidy that is exempt from federal taxation. CMS-9 CMS Energy Corporation ENTERPRISES RESULTS OF OPERATIONS
In Millions - -------------------------------------------------------------------------------------------------- June 30 2004 2003 Change - -------------------------------------------------------------------------------------------------- Three months ended $ 38 $ 8 $ 30 Six months ended $(23) $29 $ (52) ==================================================================================================
Three Months Ended Six Months Ended Reasons for the change: June 30, 2004 vs. 2003 June 30, 2004 vs. 2003 - -------------------------------------------------------------------------------------------------- Results of FASB Interpretation No. 46 Entities $ (5) $(11) Reasons for change excluding FIN No. 46: Operating revenues (50) (403) Cost of gas and purchased power 61 436 Earnings from equity method investees 10 (2) Operation and maintenance 8 9 General taxes, depreciation, and other income (3) 2 Asset impairment charges 3 (127) Fixed charges 19 18 Income taxes (13) 26 - -------------------------------------------------------------------------------------------------- Total change $ 30 $(52) ==================================================================================================
FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: Due to the implementation of FIN No. 46, certain equity investments included in equity earnings in 2003, were determined to be variable interest entities and are now consolidated in our results of operations for 2004. The net decrease in earnings, due to the results of these entities, was $5 million for the three months ended June 30, 2004 and $11 million for the six months ended June 30, 2004. These decreases were primarily due to increased fuel and dispatch costs for 2004. OPERATING REVENUES AND COST OF GAS AND PURCHASED POWER: For the three months ended June 30, 2004, operating revenues and related cost of gas and purchased power decreased versus the same period in 2003 due to the continued streamlining of CMS ERM. For the six months ended June 30, 2004, operating revenues and related cost of gas and purchased power decreased versus the same period in 2003. The decrease was primarily the result of the sale of CMS ERM Wholesale Gas and Power contracts and the absence of mark-to-market valuation adjustments associated with these contracts. EARNINGS FROM EQUITY METHOD INVESTEES: Earnings from equity method investees increased due to mark-to-market valuation adjustments related to interest rate swaps of $21 million for the three months ended June 30, 2004 and $15 million for the six months ended June 30, 2004 versus the same periods in 2003. The increase from interest rate swaps was offset partially by the impact of the Argentine government's natural gas export restrictions on the results of GasAtacama, and a deferred tax credit at Jorf Lasfar in 2003. CMS-10 CMS Energy Corporation OPERATION AND MAINTENANCE: For the three and six months ended June 30, 2004, operation and maintenance expense decreased versus the same period of 2003. Lower expenses in 2004 were primarily due to streamlining and business reduction at CMS ERM. GENERAL TAXES, DEPRECIATION AND OTHER INCOME, NET: For the three months ended June 30, 2004, general tax, depreciation and other income decreased operating income versus the same period in 2003, primarily as a result of foreign exchange losses offset partially by lower depreciation and general taxes due to the streamlining and business reduction at CMS ERM. For the six months ended June 30, 2004, general tax, depreciation and other income increased operating income versus the same period in 2003, as a result of lower depreciation and general taxes due to the streamlining and business reduction at CMS ERM. ASSET IMPAIRMENT CHARGES: For the three months ended June 30, 2004, there were no asset impairment charges versus the same period in 2003, which included $3 million of asset impairment charges primarily at International Energy Distribution. For the six months ended June 30, 2004, asset impairment charges increased versus the same period in 2003 due to an impairment charge recorded in 2004 to recognize the reduction in fair value of Loy Yang. FIXED CHARGES: For the three and six months ended June 30, 2004, versus the same periods in 2003, fixed charges decreased due to lower average debt levels and lower average interest rates primarily resulting from the payoff of a short-term revolving credit line held by CMS Enterprises during 2003. INCOME TAXES: For the three months ended June 30, 2004, income taxes increased versus the same period in 2003 primarily due to higher earnings. For the six months ended June 30, 2004, income taxes decreased versus the same period in 2003 due to the impairment charge for Loy Yang. OTHER RESULTS OF OPERATIONS In Millions - ----------------------------------------------------------------------------
June 30 2004 2003 Change - ---------------------------------------------------------------------------- Three months ended $(50) $ (60) $ 10 Six months ended $(98) $(111) $ 13 ============================================================================
For the three months ended June 30, 2004, corporate interest expense and other net expenses were $50 million, a decrease of $10 million from the three months ended June 30, 2003. The decrease reflects the absence of a $24 million deferred tax asset valuation reserve established in 2003 and also reflects $10 million of lower interest expense. This decrease was offset partially by the absence in 2004 of a $20 million MSBT refund amount that we received in 2003 and a $4 million increase in operating expenses that were not billed to subsidiaries. For the six months ended June 30, 2004, corporate interest and other net expenses were $98 million, a decrease of $13 million from the six months ended June 30, 2003. The decrease reflects the absence of a $24 million deferred tax asset valuation reserve established in 2003 and $8 million of lower interest expense. This decrease was offset partially by the absence of a $20 million MSBT refund in 2003. CMS-11 CMS Energy Corporation OTHER: At June 30, 2004, Discontinued Operations includes Parmelia. At June 30, 2003, Discontinued Operations included CMS Field Services, Marysville, and Parmelia. For additional details, see Note 2, Discontinued Operations, Other Asset Sales, Impairments, and Restructuring. A $24 million loss for the cumulative effect of changes in accounting principle was recognized in the first quarter of 2003; $23 million was due to EITF Issue No. 02-03; $1 million was due to SFAS No. 143. CRITICAL ACCOUNTING POLICIES The following accounting policies are important to an understanding of our results of operations and financial condition and should be considered an integral part of our MD&A: - use of estimates in accounting for long-lived assets, contingencies, and equity method investments, - accounting for the effects of industry regulation, - accounting for financial and derivative instruments, - accounting for international operations and foreign currency, - accounting for pension and postretirement benefits, - accounting for asset retirement obligations, and - accounting for nuclear decommissioning costs. For additional accounting policies, see Note 1, Corporate Structure and Accounting Policies. USE OF ESTIMATES AND ASSUMPTIONS In preparing our financial statements, we use estimates and assumptions that may affect reported amounts and disclosures. Accounting estimates are used for asset valuations, depreciation, amortization, financial and derivative instruments, employee benefits, and contingencies. For example, we estimate the rate of return on plan assets and the cost of future health-care benefits to determine our annual pension and other postretirement benefit costs. There are risks and uncertainties that may cause actual results to differ from estimated results, such as changes in the regulatory environment, competition, foreign exchange, regulatory decisions, and lawsuits. LONG-LIVED ASSETS AND EQUITY METHOD INVESTMENTS: Our assessment of the recoverability of long-lived assets and equity method investments involves critical accounting estimates. Tests of impairment are performed periodically if certain conditions that are other than temporary exist that may indicate the carrying value may not be recoverable. Of our total assets, recorded at $15.307 billion at June 30, 2004, 61 percent represent long-lived assets and equity method investments that are subject to this type of analysis. We base our evaluations of impairment on such indicators as: - the nature of the assets, - projected future economic benefits, - domestic and foreign regulatory and political environments, - state and federal regulatory and political environments, - historical and future cash flow and profitability measurements, and - other external market conditions or factors. CMS-12 CMS Energy Corporation If an event occurs or circumstances change in a manner that indicates the recoverability of a long-lived asset should be assessed, we evaluate the asset for impairment. An asset held-in-use is evaluated for impairment by calculating the undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. If the undiscounted future cash flows are less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We estimate the fair market value of the asset utilizing the best information available. This information includes quoted market prices, market prices of similar assets, and discounted future cash flow analyses. An asset considered held-for-sale is recorded at the lower of its carrying amount or fair value, less cost to sell. We also assess our ability to recover the carrying amounts of our equity method investments. This assessment requires us to determine the fair values of our equity method investments. The determination of fair value is based on valuation methodologies including discounted cash flows and the ability of the investee to sustain an earnings capacity that justifies the carrying amount of the investment. We also consider the existence of CMS Energy guarantees on obligations of the investee or other commitments to provide further financial support. If the fair value is less than the carrying value and the decline in value is considered to be other than temporary, an appropriate write-down is recorded. Our assessments of fair value using these valuation methodologies represent our best estimates at the time of the reviews and are consistent with our internal planning. The estimates we use can change over time. If fair values were estimated differently, they could have a material impact on our financial statements. In March 2004, we reduced the carrying amount of our investment in Loy Yang to reflect its fair value. We completed the sale of Loy Yang in April 2004. For additional details on asset sales, see Note 2, Discontinued Operations, Other Asset Sales, Impairments, and Restructuring. We are still pursuing the sale of our remaining non-strategic and under-performing assets, including some assets that were not determined to be impaired. Upon the sale of these assets, the proceeds realized may be materially different from the remaining carrying values. Even though these assets have been identified for sale, we cannot predict when, or make any assurances that, these asset sales will occur. Further, we cannot predict the amount of cash or the value of consideration that may be received. CONTINGENCIES: We are involved in various regulatory and legal proceedings that arise in the ordinary course of our business. We record a liability for contingencies based upon our assessment that the occurrence is probable and, where determinable, an estimate of the liability amount. The recording of estimated liabilities for contingencies is guided by the principles in SFAS No. 5. We consider many factors in making these assessments, including history and the specifics of each matter. The most significant of these contingencies are our electric and gas environmental estimates, which are discussed in the "Outlook" section included in this MD&A, and the potential underrecoveries from our power purchase contract with the MCV Partnership. MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990 and to supply electricity and steam to Dow. We hold a 49 percent partnership interest in the MCV Partnership, and a 35 percent lessor interest in the MCV Facility. Under our PPA with the MCV Partnership, we pay a capacity charge based on the availability of the MCV Facility whether or not electricity is actually delivered to us; a variable energy charge for kWh delivered to us; and a fixed energy charge based on availability up to 915 MW and based on delivery for the remaining 325 MW of contract capacity. The cost that we incur under the MCV Partnership PPA exceeds the CMS-13 CMS Energy Corporation recovery amount allowed by the MPSC. As a result, we estimate cash underrecoveries of capacity and fixed energy payments will aggregate $206 million from 2004 through 2007. For capacity and fixed energy payments billed by the MCV Partnership after September 15, 2007, and not recovered from customers, we expect to claim relief under a regulatory out provision under the MCV Partnership PPA. This provision obligates Consumers to pay the MCV Partnership only those capacity and energy charges that the MPSC has authorized for recovery from electric customers. The effect of any such action would be to: - reduce cash flow to the MCV Partnership, which could have an adverse effect on our investment, and - eliminate our underrecoveries for capacity and fixed energy payments. Further, under the PPA, variable energy payments to the MCV Partnership are based on the cost of coal burned in our coal plants and our operations and maintenance expenses. However, the MCV Partnership's costs of producing electricity are tied to the cost of natural gas. Because natural gas prices have increased substantially in recent years and the price the MCV Partnership can charge us for energy has not, the MCV Partnership's financial performance has been affected adversely. As a result of returning to the PSCR process on January 1, 2004, we returned to dispatching the MCV Facility on a fixed load basis, as permitted by the MPSC, in order to maximize recovery from electric customers of our capacity and fixed energy payments. This fixed load dispatch increases the MCV Facility's output and electricity production costs, such as natural gas. As the spread between the MCV Facility's variable electricity production costs and its energy payment revenue widens, the MCV Partnership's financial performance and our investment in the MCV Partnership is and will be affected adversely. In February 2004, we filed the RCP with the MPSC that is intended to help conserve natural gas and thereby improve our investment in the MCV Partnership, without raising the costs paid by our electric customers. The plan's primary objective is to dispatch the MCV Facility on the basis of natural gas market prices, which will reduce the MCV Facility's annual production of electricity and, as a result, reduce the MCV Facility's consumption of natural gas by an estimated 30 to 40 bcf. This decrease in the quantity of high-priced natural gas consumed by the MCV Facility will benefit Consumers' ownership interest in the MCV Partnership. Presently, we are in settlement discussions with the parties to the RCP filing. However, in July 2004, several qualifying facilities filed for a stay on the RCP proceeding in the Ingham County Circuit Court after their previous attempt to intervene on the proceeding was denied by the MPSC. Hearings on the stay are scheduled for August 11, 2004. We cannot predict if or when the MPSC will approve the RCP or the outcome of the Ingham County Circuit Court hearings. The two most significant variables in the analysis of the MCV Partnership's future financial performance are the forward price of natural gas for the next 20 years and the MPSC's decision in 2007 or beyond related to limiting our recovery of capacity and fixed energy payments. Natural gas prices have been volatile historically. Presently, there is no consensus in the marketplace on the price or range of future prices of natural gas. Even with an approved RCP, if gas prices continue at present levels or increase, the economics of operating the MCV Facility may be adverse enough to require us to recognize an impairment of our investment in the MCV Partnership. We presently cannot predict the impact of these issues on our future earnings, cash flows, or on the value of our investment in the MCV Partnership. For additional details on the MCV Partnership, see Note 3, Uncertainties, "Other Consumers' Electric Utility Uncertainties - The Midland Cogeneration Venture." CMS-14 CMS Energy Corporation ACCOUNTING FOR FINANCIAL AND DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES, AND MARKET RISK INFORMATION FINANCIAL INSTRUMENTS: We account for investments in debt and equity securities using SFAS No. 115. Debt and equity securities can be classified into one of three categories: held-to-maturity, trading, or available-for-sale securities. Our debt securities are classified as held-to-maturity securities and are reported at cost. Our investments in equity securities are classified as available-for-sale securities. They are reported at fair value, with any unrealized gains or losses resulting from changes in fair value reported in equity as part of accumulated other comprehensive income and are excluded from earnings unless such changes in fair value are determined to be other than temporary. Unrealized gains or losses resulting from changes in the fair value of our nuclear decommissioning investments are reflected in Regulatory Liabilities. The fair value of our equity securities is determined from quoted market prices. DERIVATIVE INSTRUMENTS: We use the criteria in SFAS No. 133, as amended and interpreted, to determine if certain contracts must be accounted for as derivative instruments. The rules for determining whether a contract meets the criteria for derivative accounting are numerous and complex. Moreover, significant judgment is required to determine whether a contract requires derivative accounting, and similar contracts can sometimes be accounted for differently. If a contract is accounted for as a derivative instrument, it is recorded in the financial statements as an asset or a liability, at the fair value of the contract. The recorded fair value of the contract is then adjusted quarterly to reflect any change in the market value of the contract, a practice known as marking the contract to market. Changes in the fair value of a derivative (that is, gains or losses) are reported either in earnings or accumulated other comprehensive income depending on whether the derivative qualifies for special hedge accounting treatment. The types of contracts we typically classify as derivative instruments are interest rate swaps, foreign currency exchange contracts, electric call options, gas fuel futures and options, gas fuel contracts containing volume optionality, fixed priced weather-based gas supply call options, fixed price gas supply call and put options, gas futures, gas and power swaps, and forward purchases and sales. We generally do not account for electric capacity and energy contracts, gas supply contracts, coal and nuclear fuel supply contracts, or purchase orders for numerous supply items as derivatives. The majority of our contracts are not subject to derivative accounting because they qualify for the normal purchases and sales exception of SFAS No. 133, or are not derivatives because there is not an active market for the commodity. Certain of our electric capacity and energy contracts are not accounted for as derivatives due to the lack of an active energy market in the state of Michigan, as defined by SFAS No. 133, and the significant transportation costs that would be incurred to deliver the power under the contracts to the closest active energy market at the Cinergy hub in Ohio. If an active market develops in the future, we may be required to account for these contracts as derivatives. The mark-to-market impact on earnings related to these contracts could be material to our financial statements. Additionally, the MCV Partnership uses natural gas fuel contracts to buy gas as fuel for generation, and to manage gas fuel costs. The MCV Partnership believes that its long-term natural gas contracts, which do not contain volume optionality, qualify under SFAS No. 133 for the normal purchases and normal sales exception. Therefore, these contracts are currently not recognized at fair value on the balance sheet. Should significant changes in the level of the MCV Facility operational dispatch or purchases of long-term gas occur, the MCV Partnership would be required to re-evaluate its accounting treatment for these long- CMS-15 CMS Energy Corporation term gas contracts. This re-evaluation may result in recording mark-to-market activity on some contracts, which could add to earnings volatility. To determine the fair value of contracts that are accounted for as derivative instruments, we use a combination of quoted market prices and mathematical valuation models. Valuation models require various inputs, including forward prices, volatilities, interest rates, and exercise periods. Changes in forward prices or volatilities could change significantly the calculated fair value of certain contracts. At June 30, 2004, we assumed a market-based interest rate of 1 percent (a rate that is not significantly different than the LIBOR rate) and volatility rates ranging between 54 percent and 161 percent to calculate the fair value of our electric and gas options. At June 30, 2004, we assumed market-based interest rates ranging between 1.37 percent and 4.50 percent and volatility rates ranging between 24 percent and 44 percent to calculate the fair value of the gas fuel derivative contracts held by the MCV Partnership. TRADING ACTIVITIES: CMS ERM enters into and owns energy contracts that are related to activities considered an integral part of CMS Energy's ongoing operations. The intent of holding these energy contracts is to optimize the financial performance of our owned generating assets and to fulfill contractual obligations. These contracts are classified as trading activities in accordance with EITF Issue No. 02-03 and are accounted for using the criteria defined in SFAS No. 133. Energy trading contracts that meet the definition of a derivative are recorded as assets or liabilities in the financial statements at the fair value of the contracts. Gains or losses arising from changes in fair value of these contracts are recognized into earnings in the period in which the changes occur. Energy trading contracts that do not meet the definition of a derivative are accounted for as executory contracts (i.e., on an accrual basis). The market prices we use to value our energy trading contracts reflect our consideration of, among other things, closing exchange and over-the-counter quotations. In certain contracts, long-term commitments may extend beyond the period in which market quotations for such contracts are available. Mathematical models are developed to determine various inputs into the fair value calculation including price and other variables that may be required to calculate fair value. Realized cash returns on these commitments may vary, either positively or negatively, from the results estimated through application of the mathematical model. Market prices are adjusted to reflect the impact of liquidating our position in an orderly manner over a reasonable period of time under present market conditions. In connection with the market valuation of our energy trading contracts, we maintain reserves for credit risks based on the financial condition of counterparties. We also maintain credit policies that management believes will minimize its overall credit risk with regard to our counterparties. Determination of our counterparties' credit quality is based upon a number of factors, including credit ratings, disclosed financial condition, and collateral requirements. Where contractual terms permit, we employ standard agreements that allow for netting of positive and negative exposures associated with a single counterparty. Based on these policies, our current exposures, and our credit reserves, we do not anticipate a material adverse effect on our financial position or results of operations as a result of counterparty nonperformance. CMS-16 CMS Energy Corporation The following tables provide a summary of the fair value of our energy trading contracts as of June 30, 2004: In Millions - ------------------------------------------------------------------------------------------------- Fair value of contracts outstanding as of December 31, 2003 $ 15 Fair value of new contracts when entered into during the period (a) (3) Changes in fair value attributable to changes in valuation techniques and assumptions - Contracts realized or otherwise settled during the period (11) Other changes in fair value (b) 9 - ------------------------------------------------------------------------------------------------- Fair value of contracts outstanding as of June 30, 2004 $ 10 =================================================================================================
(a) Reflects only the initial premium payments/(receipts) for new contracts. No unrealized gains or losses were recognized at the inception of any new contracts. (b) Reflects changes in price and net increase/(decrease) of forward positions as well as changes to mark-to-market and credit reserves.
Fair Value of Contracts at June 30, 2004 In Millions - ------------------------------------------------------------------------------------------ Total Maturity (in years) ----------------------------------------------- Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5 - ------------------------------------------------------------------------------------------ Prices actively quoted $ (28) $ (1) $ (12) $ (15) $- Prices based on models and other valuation methods 38 8 18 12 - - ------------------------------------------------------------------------------------------ Total $ 10 $ 7 $ 6 $ (3) $- ==========================================================================================
MARKET RISK INFORMATION: We are exposed to market risks including, but not limited to, changes in interest rates, commodity prices, currency exchange rates, and equity security prices. We manage these risks using established policies and procedures, under the direction of both an executive oversight committee consisting of senior management representatives and a risk committee consisting of business-unit managers. We may use various contracts to manage these risks, including swaps, options, futures, and forward contracts. Contracts used to manage market risks may be considered derivative instruments that are subject to derivative and hedge accounting pursuant to SFAS No. 133. We intend that any gains or losses on these contracts will be offset by an opposite movement in the value of the item at risk. Risk management contracts are classified as either trading or other than trading. These contracts contain credit risk if the counterparties, including financial institutions and energy marketers, fail to perform under the agreements. We minimize such risk by performing financial credit reviews using, among other things, publicly available credit ratings of such counterparties. We perform sensitivity analyses to assess the potential loss in fair value, cash flows, or future earnings based upon a hypothetical 10 percent adverse change in market rates or prices. We do not believe that sensitivity analyses alone provide an accurate or reliable method for monitoring and controlling risks. Therefore, we use our experience and judgment to revise strategies and modify assessments. Changes in excess of the amounts determined in sensitivity analyses could occur if market rates or prices exceed the 10 percent shift used for the analyses. These risk sensitivities are shown in "Interest Rate Risk," "Commodity Price Risk," "Trading Activity Commodity Price Risk," "Currency Exchange Risk," and "Equity Securities Price Risk" within this section. CMS-17 CMS Energy Corporation Interest Rate Risk: We are exposed to interest rate risk resulting from issuing fixed-rate and variable-rate financing instruments, and from interest rate swap agreements. We use a combination of these instruments to manage this risk as deemed appropriate, based upon market conditions. These strategies are designed to provide and maintain a balance between risk and the lowest cost of capital. Interest Rate Risk Sensitivity Analysis (assuming a 10 percent adverse change in market interest rates):
In Millions - ------------------------------------------------------------------------------------------------------------- June 30, 2004 December 31, 2003 - ------------------------------------------------------------------------------------------------------------- Variable-rate financing - before tax annual earnings exposure $ 1 $ 1 Fixed-rate financing - potential loss in fair value (a) 240 242 =============================================================================================================
(a) Fair value exposure could only be realized if we repurchased all of our fixed-rate financing. As discussed in "Electric Utility Business Uncertainties - Competition and Regulatory Restructuring - Securitization" within this MD&A, we have filed an application with the MPSC to securitize certain expenditures. Upon final approval, we intend to use the proceeds from the Securitization to retire higher-cost debt, which could include a portion of our current fixed-rate debt. We do not believe that any adverse change in debt price and interest rates would have a material adverse effect on either our consolidated financial position, results of operations, or cash flows. Certain equity method investees have issued interest rate swaps. These instruments are not required to be included in the sensitivity analysis, but can have an impact on financial results. Commodity Price Risk: For purposes other than trading, we enter into electric call options, fixed-priced weather-based gas supply call options, and fixed-priced gas supply call and put options. Electric call options are purchased to protect against the risk of fluctuations in the market price of electricity, and to ensure a reliable source of capacity to meet our customers' electric needs. Purchased electric call options give us the right, but not the obligation, to purchase electricity at predetermined fixed prices. Purchases of gas supply call options and weather-based gas supply call options, coupled with the sale of gas supply put options, are used to purchase reasonably priced gas supply. Purchases of gas supply call options give us the right, but not the obligation, to purchase gas supply at predetermined fixed prices. Gas supply put options sold give third-party suppliers the right, but not the obligation, to sell gas supply to us at predetermined fixed prices. At June 30, 2004, we held fixed-priced weather-based gas supply call options and fixed-price gas supply call and put options. The MCV Partnership uses natural gas fuel contracts to buy gas as fuel for generation, and to manage gas fuel costs. Some of these contracts contain volume optionality and, therefore, are treated as derivative instruments. Also, the MCV Partnership enters into natural gas futures contracts, option contracts, and over-the-counter swap transactions in order to hedge against unfavorable changes in the market price of natural gas in future months when gas is expected to be needed. These financial instruments are being used principally to secure anticipated natural gas requirements necessary for projected electric and steam sales, and to lock in sales prices of natural gas previously obtained in order to optimize the MCV Partnership's existing gas supply, storage, and transportation arrangements. CMS-18 CMS Energy Corporation Commodity Price Risk Sensitivity Analysis (assuming a 10 percent adverse change in market prices):
In Millions - ------------------------------------------------------------------------------------------------- June 30, 2004 December 31, 2003 - ------------------------------------------------------------------------------------------------- Potential reduction in fair value: Gas supply option contracts $ 7 $ 1 Derivative contracts associated with Consumers' investment in the MCV Partnership: Gas fuel contracts 21 N/A Gas fuel futures, options, and swaps 38 N/A =================================================================================================
During the six months ended June 30, 2004, we entered into additional weather-based gas supply call options, as well as gas supply call and put option contracts. As a result, the potential reduction in the fair value increased from December 31, 2003 as shown in the table above. We did not perform a sensitivity analysis for the derivative contracts held by the MCV Partnership as of December 31, 2003 because the MCV Partnership was not consolidated into our financial statements until March 31, 2004, as discussed in Note 11, Implementation of New Accounting Standards. Trading Activity Commodity Price Risk: We are exposed to market fluctuations in the price of energy commodities. We employ established policies and procedures to manage these risks and may use various commodity derivatives, including futures, options, and swap contracts. The prices of these energy commodities can fluctuate because of, among other things, changes in the supply of and demand for the commodities. Trading Activity Commodity Price Risk Sensitivity Analysis (assuming a 10 percent adverse change in market prices):
In Millions - ------------------------------------------------------------------------------- June 30, 2004 December 31, 2003 - ------------------------------------------------------------------------------- Potential reduction in fair value: Gas-related swaps and forward contracts $ 3 $ 3 Electricity-related forward contracts 2 2 Electricity-related call option contracts 2 1 ===============================================================================
Currency Exchange Risk: We are exposed to currency exchange risk arising from investments in foreign operations as well as various international projects in which we have an equity interest and which have debt denominated in U.S. dollars. We typically use forward exchange contracts and other risk mitigating instruments to hedge currency exchange rates. The impact of hedges on our investments in foreign operations is reflected in accumulated other comprehensive income as a component of the foreign currency translation adjustment on the Consolidated Balance Sheets. Gains or losses from the settlement of these hedges are maintained in the foreign currency translation adjustment until we sell or liquidate the investments on which the hedges were taken. At June 30, 2004, we had no foreign exchange hedging contracts outstanding. As of June 30, 2004, the total foreign currency translation adjustment was a net loss of $327 million, which included a net hedging loss of $25 million, net of tax, related to settled contracts. Equity Securities Price Risk: We are exposed to price risk associated with investments in equity securities. As discussed in "Financial Instruments" within this section, our investments in equity securities are CMS-19 CMS Energy Corporation classified as available-for-sale securities. They are reported at fair value, with any unrealized gains or losses resulting from changes in fair value reported in equity as part of accumulated other comprehensive income and are excluded from earnings unless such changes in fair value are determined to be other than temporary. Unrealized gains or losses resulting from changes in the fair value of our nuclear decommissioning investments are reflected in Regulatory Liabilities. Our debt securities are classified as held-to-maturity securities and have original maturity dates of approximately one year or less. Because of the short maturity of these instruments, their carrying amounts approximate their fair values. Equity Securities Price Risk Sensitivity Analysis (assuming a 10 percent adverse change in market prices):
In Millions - ------------------------------------------------------------------------------------ June 30, 2004 December 31, 2003 - ------------------------------------------------------------------------------------ Potential reduction in fair value: Nuclear decommissioning investments $ 54 $ 57 Other available-for-sale investments 7 7 ====================================================================================
For additional details on market risk and derivative activities, see Note 6, Financial and Derivative Instruments. INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY We have investments in energy-related projects in selected markets around the world. As a result of a change in business strategy, we have been selling certain foreign investments. For additional details on the divestiture of foreign investments, see Note 2, Discontinued Operations, Other Asset Sales, Impairments, and Restructuring. BALANCE SHEET: Our subsidiaries and affiliates whose functional currency is other than the U.S. dollar translate their assets and liabilities into U.S. dollars at the exchange rates in effect at the end of the fiscal period. Gains or losses that result from this translation and gains or losses on long-term intercompany foreign currency transactions are reflected as a component of stockholders' equity in our Consolidated Balance Sheets as "Foreign Currency Translation." As of June 30, 2004, cumulative foreign currency translation decreased stockholders' equity by $327 million. We translate the revenue and expense accounts of these subsidiaries and affiliates into U.S. dollars at the average exchange rate during the period. Australia: The Foreign Currency Translation component of stockholders' equity at December 31, 2003 included an approximate $110 million unrealized net foreign currency translation loss related to our investment in Loy Yang. In March 2004, we recognized the foreign currency translation loss in earnings as a component of the Loy Yang impairment of approximately $81 million, recorded as a result of the sale of Loy Yang that was completed in April 2004. At June 30, 2004, the net foreign currency loss due to the exchange rate of the Australian dollar recorded in the Foreign Currency Translation component of stockholders' equity using an exchange rate of 1.45 Australian dollars per U.S. dollar was $4 million. This foreign currency translation loss relates primarily to our SCP and Parmelia investments. We are currently pursuing the sale of these investments. CMS-20 CMS Energy Corporation Argentina: In January 2002, the Republic of Argentina enacted the Public Emergency and Foreign Exchange System Reform Act. This law repealed the fixed exchange rate of one U.S. dollar to one Argentine peso, converted all dollar-denominated utility tariffs and energy contract obligations into pesos at the same one-to-one exchange rate, and directed the President of Argentina to renegotiate such tariffs. Effective April 30, 2002, we adopted the Argentine peso as the functional currency for our Argentine investments. We had used previously the U.S. dollar as the functional currency. As a result, we translated the assets and liabilities of our Argentine entities into U.S. dollars using an exchange rate of 3.45 pesos per U.S. dollar, and recorded an initial charge to the Foreign Currency Translation component of stockholders' equity of $400 million. While we cannot predict future peso-to-U.S. dollar exchange rates, we do expect that these non-cash charges reduce substantially the risk of further material balance sheet impacts when combined with anticipated proceeds from international arbitration currently in progress, political risk insurance, and the eventual sale of these assets. At June 30, 2004, the net foreign currency loss due to the unfavorable exchange rate of the Argentine peso recorded in the Foreign Currency Translation component of stockholders' equity using an exchange rate of 2.97 pesos per U.S. dollar was $263 million. This amount also reflects the effect of recording, at December 31, 2002, U.S. income taxes on temporary differences between the book and tax bases of foreign investments, including the foreign currency translation associated with our Argentine investments. INCOME STATEMENT: We use the U.S. dollar as the functional currency of subsidiaries operating in highly inflationary economies and of subsidiaries that meet the U.S. dollar functional currency criteria outlined in SFAS No. 52. Gains and losses that arise from transactions denominated in a currency other than the U.S. dollar, except those that are hedged, are included in determining net income. HEDGING STRATEGY: We may use forward exchange and option contracts to hedge certain receivables, payables, long-term debt, and equity value relating to foreign investments. The purpose of our foreign currency hedging activities is to reduce risk associated with adverse changes in currency exchange rates that could affect cash flow materially. These contracts would not subject us to risk from exchange rate movements because gains and losses on such contracts are inversely correlated with the losses and gains, respectively, on the assets and liabilities being hedged. ACCOUNTING FOR THE EFFECTS OF INDUSTRY REGULATION Because we are involved in a regulated industry, regulatory decisions affect the timing and recognition of revenues and expenses. We use SFAS No. 71 to account for the effects of these regulatory decisions. As a result, we may defer or recognize revenues and expenses differently than a non-regulated entity. For example, items that a non-regulated entity normally would expense, we may record as regulatory assets if the actions of the regulator indicate such expenses will be recovered in future rates. Conversely, items that non-regulated entities may normally recognize as revenues, we may record as regulatory liabilities if the actions of the regulator indicate they will require such revenues be refunded to customers. Judgment is required to determine the recoverability of items recorded as regulatory assets and liabilities. As of June 30, 2004, we had $1.125 billion recorded as regulatory assets and $1.502 billion recorded as regulatory liabilities. For additional details on industry regulation, see Note 1, Corporate Structure and Accounting Policies, "Utility Regulation." CMS-21 CMS Energy Corporation ACCOUNTING FOR PENSION AND OPEB Pension: We have established external trust funds to provide retirement pension benefits to our employees under a non-contributory, defined benefit Pension Plan. We have implemented a cash balance plan for certain employees hired after June 30, 2003. We use SFAS No. 87 to account for pension costs. 401(k): In our efforts to reduce costs, the employer's match for the 401(k) plan was suspended effective September 1, 2002. The employer's match for the 401(k) plan is scheduled to resume on January 1, 2005. OPEB: We provide postretirement health and life benefits under our OPEB plan to substantially all our retired employees. We use SFAS No. 106 to account for other postretirement benefit costs. Liabilities for both pension and OPEB are recorded on the balance sheet at the present value of their future obligations, net of any plan assets. The calculation of the liabilities and associated expenses requires the expertise of actuaries. Many assumptions are made including: - life expectancies, - present-value discount rates, - expected long-term rate of return on plan assets, - rate of compensation increases, and - anticipated health care costs. Any change in these assumptions can change significantly the liability and associated expenses recognized in any given year. The following table provides an estimate of our pension cost, OPEB cost, and cash contributions for the next three years:
In Millions - ---------------------------------------------------------------------------------- Expected Costs Pension Cost OPEB Cost Contributions - ---------------------------------------------------------------------------------- 2004 $21 $30 $ 63 2005 55 38 80 2006 75 34 114 ==================================================================================
Actual future pension cost and contributions will depend on future investment performance, changes in future discount rates, and various other factors related to the populations participating in the Pension Plan. As of June 30, 2004, we have a prepaid pension asset of $398 million, $20 million of which is in Other current assets on our Consolidated Balance Sheet. Lowering the expected long-term rate of return on the Pension Plan assets by 0.25 percent (from 8.75 percent to 8.50 percent) would increase estimated pension cost for 2004 by $2 million. Lowering the discount rate by 0.25 percent (from 6.25 percent to 6.00 percent) would increase estimated pension cost for 2004 by $4 million. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act) was signed into law in December 2003. The Act establishes a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy, which is exempt from federal taxation, to sponsors of retiree health care benefit plans that provide a benefit that is actuarially equivalent to Medicare Part D. We believe our plan is actuarially equivalent to Medicare Part D and have incorporated retroactively the CMS-22 CMS Energy Corporation effects of the subsidy into our financial statements as of June 30, 2004 in accordance with FASB Staff Position No. SFAS 106-2. We remeasured our obligation as of December 31, 2003 to incorporate the impact of the Act, which resulted in a reduction to the accumulated postretirement benefit obligation of $158 million. The remeasurement resulted in a reduction of OPEB cost of $6 million for the three months ended June 30, 2004, $12 million for the six months ended June 30, 2004, and an expected total reduction of $24 million for 2004. For additional details on postretirement benefits, see Note 7, Retirement Benefits and Note 11, Implementation of New Accounting Standards. ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS SFAS No. 143 became effective January 2003. It requires companies to record the fair value of the cost to remove assets at the end of their useful lives, if there is a legal obligation to remove them. We have legal obligations to remove some of our assets, including our nuclear plants, at the end of their useful lives. As required by SFAS No. 71, we accounted for the implementation of this standard by recording regulatory assets and liabilities for regulated entities instead of a cumulative effect of a change in accounting principle. The fair value of ARO liabilities has been calculated using an expected present value technique. This technique reflects assumptions, such as costs, inflation, and profit margin that third parties would consider to assume the settlement of the obligation. Fair value, to the extent possible, should include a market risk premium for unforeseeable circumstances. No market risk premium was included in our ARO fair value estimate since a reasonable estimate could not be made. If a reasonable estimate of fair value cannot be made in the period the ARO is incurred, such as for assets with indeterminate lives, the liability is recognized when a reasonable estimate of fair value can be made. Generally, transmission and distribution assets have indeterminate lives. Retirement cash flows cannot be determined and there is a low probability of a retirement date. Therefore, no liability has been recorded for these assets. Also, no liability has been recorded for assets that have insignificant cumulative disposal costs, such as substation batteries. The measurement of the ARO liabilities for Palisades and Big Rock are based on decommissioning studies, which largely utilize third-party cost estimates. For additional details on ARO, see Note 10, Asset Retirement Obligations. ACCOUNTING FOR NUCLEAR DECOMMISSIONING COSTS The MPSC and the FERC regulate the recovery of costs to decommission our Big Rock and Palisades nuclear plants. We have established external trust funds to finance the decommissioning of both plants. We record the trust fund balances as a non-current asset on our balance sheet. Our decommissioning cost estimates for the Big Rock and Palisades plants assume: - each plant site will be restored to conform to the adjacent landscape, - all contaminated equipment and material will be removed and disposed of in a licensed burial facility, and - the site will be released for unrestricted use. Independent contractors with expertise in decommissioning have helped us develop decommissioning cost estimates. Various inflation rates for labor, non-labor, and contaminated equipment disposal costs are used to escalate these cost estimates to the future decommissioning cost. A portion of future decommissioning CMS-23 CMS Energy Corporation cost will result from the failure of the DOE to remove fuel from the sites, as required by the Nuclear Waste Policy Act of 1982. The decommissioning trust funds include equities and fixed income investments. Equities will be converted to fixed income investments during decommissioning, and fixed income investments are converted to cash as needed. In December 2000, funding of the Big Rock trust fund stopped because the MPSC-authorized decommissioning surcharge collection period expired. The funds provided by the trusts, additional customer surcharges, and potential funds from the DOE litigation are all required to cover fully the decommissioning costs. The costs of decommissioning these sites and the adequacy of the trust funds could be affected by: - variances from expected trust earnings, - a lower recovery of costs from the DOE and lower rate recovery from customers, and - changes in decommissioning technology, regulations, estimates, or assumptions. Based on current projections, the current level of funds provided by the trusts is not adequate to fully fund the decommissioning of Big Rock or Palisades. This is due in part to the DOE's failure to accept the spent nuclear fuel on schedule, and lower returns on the trust funds. We are attempting to recover our additional costs for storing spent nuclear fuel through litigation. We will also seek additional relief from the MPSC. For additional details on nuclear decommissioning, see Note 3, Uncertainties, "Other Consumers' Electric Utility Uncertainties - Nuclear Plant Decommissioning" and "Nuclear Matters." CAPITAL RESOURCES AND LIQUIDITY Our liquidity and capital requirements are a function of our results of operations, capital expenditures, contractual obligations, debt maturities, working capital needs, and collateral requirements. During the summer months, we purchase natural gas and store it for resale primarily during the winter heating season. The market price for natural gas has increased. Although our natural gas purchases are recoverable from our customers, the amount paid for natural gas stored as inventory could require additional liquidity due to the timing of the cost recoveries. In addition, a few of our commodity suppliers have requested advance payment or other forms of assurances, including margin calls, in connection with maintenance of ongoing deliveries of gas and electricity. Our current financial plan includes controlling our operating expenses and capital expenditures, evaluating market conditions for financing opportunities, and selling assets that are not consistent with our strategy. The sale of assets is expected to generate cash in 2004; however, it is not critical to the maintenance of sufficient corporate liquidity. We believe our current level of cash and borrowing capacity, along with anticipated cash flows from operating and investing activities, will be sufficient to meet our liquidity needs through 2005. We have not made a specific determination concerning the reinstatement of the payment of common stock dividends. The Board of Directors may reconsider or revise its dividend policy based upon certain conditions, including our results of operations, financial condition, and capital requirements, as well as other relevant factors. CASH POSITION, INVESTING, AND FINANCING Our operating, investing, and financing activities meet consolidated cash needs. At June 30, 2004, $909 million consolidated cash was on hand, which includes $213 million of restricted cash. For additional details on cash equivalents and restricted cash, see Note 1, Corporate Structure and Accounting Policies. CMS-24 CMS Energy Corporation Our primary ongoing source of cash is dividends and other distributions from our subsidiaries, including proceeds from asset sales. For the first six months of 2004, Consumers paid $105 million in common stock dividends and Enterprises paid $133 million in common stock dividends and other distributions to CMS Energy. SUMMARY OF CASH FLOWS:
In Millions - ----------------------------------------------------------------------------------- Six months ended June 30 2004 2003 - ----------------------------------------------------------------------------------- Net cash provided by (used in): Operating activities $ 481 $147 Investing activities (214) 292 Financing activities (276) 125 Effect of exchange rates on cash (1) 2 - ----------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents $ (10) $566 ===================================================================================
OPERATING ACTIVITIES: For the six months ended June 30, 2004, net cash provided by operating activities increased $334 million compared to the six months ended June 30, 2003 primarily due to an increase in accounts payable and accrued expenses of $364 million. The increase in accounts payable is mainly a result of the purchase of natural gas at higher prices and fewer suppliers requiring advanced payments for gas purchases. Also, CMS ERM had a minimal change in accounts payable in 2004 versus a large decrease in 2003 resulting from the sale of the wholesale gas and power books. Accrued expenses increased as a result of the Revised FASB Interpretation No. 46 consolidation of the MCV Partnership and the FMLP, a smaller decrease in accrued taxes, and an increase in accrued refunds relating to our 2002-2003 GCR case and potential overrecoveries from our return to the PSCR process. For additional details regarding the PSCR process refer to "Electric Utility Business Uncertainties - PSCR" within this MD&A. Additionally, net cash provided by operating activities increased as a result of a decrease in inventories of $83 million primarily resulting from gas sales at higher prices combined with lower volumes of gas purchased. This was offset by a greater increase in accounts receivable and accrued revenue of $43 million largely due to lower sales of accounts receivable resulting from our improved liquidity. INVESTING ACTIVITIES: For the six months ended June 30, 2004, net cash from investing activities decreased $506 million primarily due to a decrease in asset sale proceeds of $660 million. This change was offset by a decrease in capital expenditures of $24 million and a decrease in the amount of cash restricted of $155 million. In 2004, $12 million in cash was restricted compared to $167 million restricted in 2003. For additional details on restricted cash, see Note 1, Corporate Structure and Accounting Policies, "Cash Equivalents and Restricted Cash." FINANCING ACTIVITIES: For the six months ended June 30, 2004, net cash from financing activities decreased $401 million primarily due to a decrease of $397 million in net proceeds from borrowings. For additional details on long-term debt activity, see Note 4, Financings and Capitalization. CMS-25 CMS Energy Corporation OBLIGATIONS AND COMMITMENTS REGULATORY AUTHORIZATION FOR FINANCINGS: Consumers issues short and long-term securities under the FERC's authorization. For additional details of Consumers' existing authorization, see Note 4, Financings and Capitalization. LONG-TERM DEBT: The components of long-term debt are presented in Note 4, Financings and Capitalization. SHORT-TERM FINANCINGS: At June 30, 2004, CMS Energy had $207 million available, Consumers had $376 million available, and the MCV Partnership had $50 million available in short-term credit facilities. The facilities are available for general corporate purposes, working capital, and letters of credit. As of August 3, 2004, CMS Energy obtained an amended and restated $300 million secured revolving credit facility to replace both their $190 million facility and $185 million letter of credit facility. As of August 3, 2004, Consumers obtained an amended and restated $500 million secured revolving credit facility to replace their $400 million facility. The amended facilities carry three-year terms and provide for lower interest rates. Additional details on short-term financings are presented in Note 4, Financings and Capitalization. OFF-BALANCE SHEET ARRANGEMENTS: Non-recourse Debt: Our share of unconsolidated debt associated with partnerships and joint ventures in which we have a minority interest is non-recourse and totals $1.491 billion at June 30, 2004. The reduction in this amount from March 31, 2004 is primarily due to the sale of Loy Yang, whose non-recourse debt totaled $1.226 billion. The timing of the payments of non-recourse debt only affects the cash flow and liquidity of the partnerships and joint ventures. Sale of Accounts Receivable: Under a revolving accounts receivable sales program, we may sell up to $325 million of certain accounts receivable. For additional details, see Note 4, Financings and Capitalization. CONTINGENT COMMITMENTS: Our contingent commitments include guarantees, indemnities, and letters of credit. Guarantees represent our guarantees of performance, commitments, and liabilities of our consolidated and unconsolidated subsidiaries, partnerships, and joint ventures. Indemnities are agreements to reimburse other companies, such as an insurance company, if those companies have to complete our contractual performance in a third-party contract. Banks, on our behalf, issue letters of credit guaranteeing payment to a third party. Letters of credit substitute the bank's credit for ours and reduce credit risk for the third-party beneficiary. We monitor and approve these obligations and believe it is unlikely that we would be required to perform or otherwise incur any material losses associated with these guarantees. Our off-balance sheet commitments at June 30, 2004, expire as follows: CMS-26 CMS Energy Corporation
Commercial Commitments In Millions - ---------------------------------------------------------------------------------------------------------------------- Commitment Expiration - ---------------------------------------------------------------------------------------------------------------------- 2009 and Total 2004 2005 2006 2007 2008 Beyond - ---------------------------------------------------------------------------------------------------------------------- Off-balance sheet: Guarantees $ 199 $ 6 $ 36 $ 5 $ - $ - $ 152 Surety bonds and other indemnifications (a) 28 1 - - - - 27 Letters of Credit (b) 235 23 184 5 5 5 13 - ---------------------------------------------------------------------------------------------------------------------- Total $ 462 $ 30 $ 220 $ 10 $ 5 $ 5 $ 192 ======================================================================================================================
(a) The surety bonds are continuous in nature. The need for the bonds is determined on an annual basis. (b) At June 30, 2004, we had $169 million of cash held as collateral for letters of credit. The cash that collateralizes the letters of credit is included in Restricted cash on the Consolidated Balance Sheets. DIVIDEND RESTRICTIONS: Under the provisions of its articles of incorporation, at June 30, 2004, Consumers had $396 million of unrestricted retained earnings available to pay common stock dividends. However, covenants in Consumers' debt facilities cap common stock dividend payments at $300 million in a calendar year. Consumers is also under an annual dividend cap of $190 million imposed by the MPSC during the current interim gas rate relief period. For the six months ended June 30, 2004, CMS Energy received $105 million of common stock dividends from Consumers. Our amended and restated $300 million credit facility restricts payments of dividends on our common stock during a 12-month period to $75 million, dependent on the aggregate amounts of unrestricted cash and unused commitments under the facility. For additional details on the cap on common stock dividends payable during the current interim gas rate relief period, see Note 3, Uncertainties, "Consumers' Gas Utility Rate Matters - 2003 Gas Rate Case." OUTLOOK CORPORATE OUTLOOK During 2004, we are continuing to implement a utility-plus strategy that focuses on growing a healthy utility and divesting under-performing or other non-strategic assets. The strategy is designed to generate cash to pay down debt, reduce business risk, and provide for more predictable future operating revenues and earnings. Consistent with our utility-plus strategy, we are pursuing the sale of non-strategic and under-performing assets. Some of these assets are recorded at estimates of their current fair value. Upon the sale of these assets, the proceeds realized may be different from the recorded values if market conditions have changed. Even though these assets have been identified for sale, we cannot predict when, nor make any assurance that, these sales will occur. We anticipate that the cash proceeds from these sales, if any, will be used to retire existing debt. As we continue to implement our utility-plus strategy and further reduce our ownership of non-utility assets, the percentage of our future earnings relating to our larger equity method investments, including CMS-27 CMS Energy Corporation Jorf Lasfar, may increase and our total future earnings may depend more significantly upon the performance of those investments. For additional details, see Note 8, Equity Method Investments. ELECTRIC UTILITY BUSINESS OUTLOOK GROWTH: Over the next five years, we expect electric deliveries to grow at an average rate of approximately two percent per year based primarily on a steadily growing customer base and economy. This growth rate includes both full service sales and delivery service to customers who choose to buy generation service from an alternative electric supplier, but excludes transactions with other wholesale market participants and other electric utilities. This growth rate reflects a long-range expected trend of growth. Growth from year to year may vary from this trend due to customer response to fluctuations in weather conditions and changes in economic conditions, including utilization and expansion of manufacturing facilities. We experienced less growth than expected in 2003 as a result of cooler than normal summer weather and a decline in manufacturing activity in Michigan. In 2004, we project electric deliveries to grow approximately two percent. This short-term outlook for 2004 assumes higher levels of manufacturing activity than in 2003 and normal weather conditions during the remainder of the year. ELECTRIC UTILITY BUSINESS UNCERTAINTIES Several electric business trends or uncertainties may affect our financial results and condition. These trends or uncertainties have, or we reasonably expect could have, a material impact on revenues or income from continuing electric operations. Such trends and uncertainties include: Environmental - increasing capital expenditures and operating expenses for Clean Air Act compliance, and - potential environmental liabilities arising from various environmental laws and regulations, including potential liability or expenses relating to the Michigan Natural Resources and Environmental Protection Acts and Superfund. Restructuring - response of the MPSC and Michigan legislature to electric industry restructuring issues, - ability to meet peak electric demand requirements at a reasonable cost, without market disruption, - ability to recover any of our net Stranded Costs under the regulatory policies being followed by the MPSC, - effects of lost electric supply load to alternative electric suppliers, and - status as an electric transmission customer instead of an electric transmission owner. Regulatory - effects of recommendations as a result of the August 14, 2003 blackout, including increased regulatory requirements and new legislation, - effects of the FERC supply margin assessment requirements for electric market-based rate authority, - responses from regulators regarding the storage and ultimate disposal of spent nuclear fuel, and - recovery of nuclear decommissioning costs. For additional details, see "Accounting for Nuclear Decommissioning Costs" within this MD&A. CMS-28 CMS Energy Corporation Other - effects of commodity fuel prices such as natural gas and coal, - pending litigation filed by PURPA qualifying facilities, and - other pending litigation. For additional details about these trends or uncertainties, see Note 3, Uncertainties. ELECTRIC ENVIRONMENTAL ESTIMATES: Our operations are subject to environmental laws and regulations. Costs to operate our facilities in compliance with these laws and regulations generally have been recovered in customer rates. Compliance with the federal Clean Air Act and resulting regulations has been, and will continue to be, a significant focus for us. The Title I provisions of the Clean Air Act require significant reductions in nitrogen oxide emissions. To comply with the regulations, we expect to incur capital expenditures totaling $771 million. The key assumptions included in the capital expenditure estimate include: - construction commodity prices, especially construction material and labor, - project completion schedules, - cost escalation factor used to estimate future years' costs, and - allowance for funds used during construction (AFUDC) rate. Our current capital cost estimates include an escalation rate of 2.6 percent and an AFUDC capitalization rate of 8.9 percent. As of June 30, 2004, we have incurred $489 million in capital expenditures to comply with these regulations and anticipate that the remaining $282 million of capital expenditures will be made between 2004 and 2009. These expenditures include installing catalytic reduction technology at some of our coal-fired electric plants. In addition to modifying the coal-fired electric plants, we expect to purchase nitrogen oxide emissions credits for years 2004 through 2008. The cost of these credits is estimated to average $8 million per year and is accounted for as inventory. The EPA has alleged that some utilities have incorrectly classified plant modifications as "routine maintenance" rather than seek modification permits from the EPA. We have received and responded to information requests from the EPA on this subject. We believe that we have properly interpreted the requirements of "routine maintenance." If our interpretation is found to be incorrect, we may be required to install additional pollution controls at some or all of our coal-fired electric plants and potentially pay fines. Additionally the viability of certain plants remaining in operation could be called into question. The EPA has proposed a Clean Air Interstate Rule that would require additional coal-fired electric plant emission controls for nitrogen oxides and sulfur dioxide. If implemented, this rule would potentially require expenditures equivalent to those efforts in progress required to reduce nitrogen oxide emissions under the Title I provisions of the Clean Air Act. The rule proposes a two-phase program to reduce emissions of sulfur dioxide by 70 percent and nitrogen oxides by 65 percent by 2015. Additionally, the EPA also proposed two alternative sets of rules to reduce emissions of mercury and nickel from coal-fired and oil-fired electric plants. Until the proposed environmental rules are finalized, an accurate cost of compliance cannot be determined. Several bills have been introduced in the United States Congress that would require reductions in emissions of greenhouse gases. We cannot predict whether any federal mandatory greenhouse gas CMS-29 CMS Energy Corporation emission reduction rules ultimately will be enacted, or the specific requirements of any such rules if they were to become law. To the extent that greenhouse gas emission reduction rules come into effect, such mandatory emissions reduction requirements could have far-reaching and significant implications for the energy sectors. We cannot estimate the potential effect of United States federal or state level greenhouse gas policy on future consolidated results of operations, cash flows, or financial position due to the speculative nature of the policy. We stay abreast of and engage in the greenhouse gas policy developments and will continue to assess and respond to their potential implications on our business operations. In March 2004, the EPA changed the rules that govern generating plant cooling water intake systems. The new rules require significant reduction in fish killed by operating equipment. Some of our facilities will be required to comply by 2006. We are studying the rules to determine the most cost-effective solutions for compliance. For additional details on electric environmental matters, see Note 3, Uncertainties, "Consumers' Electric Utility Contingencies - Electric Environmental Matters." COMPETITION AND REGULATORY RESTRUCTURING: Michigan's Customer Choice Act and other developments will continue to result in increased competition in the electric business. Generally, increased competition reduces profitability and threatens market share for generation services. As of January 1, 2002, the Customer Choice Act allowed all of our electric customers to buy electric generation service from us or from an alternative electric supplier. As a result, alternative electric suppliers for generation services have entered our market. As of July 2004, alternative electric suppliers are providing 858 MW of generation supply to ROA customers. This amount represents 11 percent of our distribution load and an increase of 49 percent compared to July 2003. Based on current trends, we predict load loss by year-end to be in the range of 900 MW to 1,100 MW. However, no assurance can be made that the actual load loss will not be greater or less than that range. In July 2004, as a result of legislative hearings, several bills were introduced into the Michigan Senate that could change Michigan's Customer Choice Act. The proposals include: - requiring that rates be based on cost of service, - establishing a defined Stranded Cost calculation method, - allowing customers who stay with or switch to alternative electric suppliers after December 31, 2005 to return to utility services, and requiring them to pay current market rates upon return, - establishing reliability standards that all electric suppliers must follow, - requiring utilities and alternative suppliers to maintain a 15 percent power reserve margin, - creating a service charge to fund the Low Income and Energy Efficiency Fund, - giving kindergarten through twelfth-grade schools a discount of 10 percent to 20 percent on electric rates, and - authorizing a service charge payable by all customers for meeting Clean Air Act requirements. Securitization: In March 2003, we filed an application with the MPSC seeking approval to issue additional Securitization bonds. In June 2003, the MPSC issued a financing order authorizing the issuance of Securitization bonds in the amount of $554 million. We filed for rehearing and clarification on a number of features in the financing order. If and when the MPSC issues an order with favorable terms, then the order will become effective upon our acceptance. CMS-30 CMS Energy Corporation Stranded Costs: To the extent we experience net Stranded Costs as determined by the MPSC, the Customer Choice Act allows us to recover such costs by collecting a transition surcharge from customers who switch to an alternative electric supplier. We cannot predict whether the Stranded Cost recovery method adopted by the MPSC will be applied in a manner that will offset fully any associated margin loss. In 2002 and 2001, the MPSC issued orders finding that we experienced zero net Stranded Costs from 2000 to 2001. The MPSC also declined to resolve numerous issues regarding the net Stranded Cost methodology in a way that would allow a reliable prediction of the level of Stranded Costs for future years. We currently are in the process of appealing these orders with the Michigan Court of Appeals and the Michigan Supreme Court. In March 2003, we filed an application with the MPSC seeking approval of net Stranded Costs incurred in 2002, and for approval of a net Stranded Cost recovery charge. Our net Stranded Costs incurred in 2002, including the cost of money, are estimated to be $47 million with the issuance of Securitization bonds that include Clean Air Act investments, or $104 million without the issuance of Securitization bonds that include Clean Air Act investments. Once the MPSC issues a final financing order on Securitization, we will know the amount of our request for net Stranded Cost recovery for 2002. In July 2004, the ALJ issued a proposal for decision in our 2002 net Stranded Cost case, which recommended that the MPSC find that we incurred net Stranded Costs of $12 million. This recommendation includes the cost of money through July 2004 and excludes Clean Air Act investments. In April 2004, we filed an application with the MPSC seeking approval of net Stranded Costs incurred in 2003. We also requested interim relief for 2003 net Stranded Costs, but the ALJ declined to set a schedule that would allow consideration of the interim request. In July 2004, we revised our request for approval of 2003 Stranded Costs incurred, including the cost of money, to $69 million with the issuance of Securitization bonds that include Clean Air Act investments, or $128 million without the issuance of Securitization bonds that include Clean Air Act investments. In July 2004, the MPSC Staff issued a position on our 2003 net Stranded Cost application, which resulted in a Stranded Cost calculation of $52 million. The amount includes the cost of money, but excludes Clean Air Act investments. We cannot predict how the MPSC will rule on our requests for the recovery of Stranded Costs. Therefore, we have not recorded regulatory assets to recognize the future recovery of such costs. Implementation Costs: Following an appeal and remand of initial MPSC orders relating to 1999 implementation costs, the MPSC authorized the recovery of all previously approved implementation costs for the years 1997 through 2001 by surcharges on all customers' bills phased in as rate caps expire. Authorized recoverable implementation costs totaled $88 million. This total includes carrying costs through 2003. Additional carrying costs will be added until collection occurs. For additional information on rate caps, see "Rate Caps" within this section. Our applications for $7 million of implementation costs for 2002 and $1 million for 2003 are presently pending approval by the MPSC. Included in the 2002 request is $5 million related to our former participation in the development of the Alliance RTO. Although we believe these implementation costs and associated cost of money are fully recoverable in accordance with the Customer Choice Act, we cannot predict the amounts the MPSC will approve as recoverable. In addition to seeking MPSC approval for these costs, we are pursuing authorization at the FERC for the MISO to reimburse us for approximately $8 million, for implementation costs related to our former participation in the development of the Alliance RTO which includes the $5 million pending approval by CMS-31 CMS Energy Corporation the MPSC as part of 2002 implementation costs recovery. These costs have generally either been expensed or approved as recoverable implementation costs by the MPSC. The FERC has denied our request for reimbursement and we are appealing the FERC ruling at the United States Court of Appeals for the District of Columbia. We cannot predict the outcome of the appeal process or the ultimate amount, if any, we will collect for Alliance RTO development costs. Security Costs: The Customer Choice Act, as amended, allows for recovery of new and enhanced security costs, as a result of federal and state regulatory security requirements incurred before January 1, 2006. All retail customers, except customers of alternative electric suppliers, would pay these charges. In April 2004, we filed a security cost recovery case with the MPSC for $25 million of costs for which regulatory treatment has not yet been granted through other means. The requested amount includes reasonable and prudent security enhancements through December 31, 2005. As of June 30, 2004, we have $7 million in security costs recorded as a regulatory asset. The costs are for enhanced security and insurance because of federal and state regulatory security requirements imposed after the September 11, 2001 terrorist attacks. In July 2004, a settlement was reached with the parties to the case, which would provide for full recovery of the requested security costs over a five-year period beginning in 2004. We are presently awaiting approval from the MPSC. We cannot predict how the MPSC will rule on our request for the recoverability of security costs. Rate Caps: The Customer Choice Act imposes certain limitations on electric rates that could result in us being unable to collect our full cost of conducting business from electric customers. Such limitations include: - rate caps effective through December 31, 2004 for small commercial and industrial customers, and - rate caps effective through December 31, 2005 for residential customers. As a result, we may be unable to maintain our profit margins in our electric utility business during the rate cap periods. In particular, if we need to purchase power supply from wholesale suppliers while retail rates are capped, the rate restrictions may preclude full recovery of purchased power and associated transmission costs. PSCR: The PSCR process provides for the reconciliation of actual power supply costs with power supply revenues. This process provides for recovery of all reasonable and prudent power supply costs actually incurred by us, including the actual cost for fuel, and purchased and interchange power. In September 2003, we submitted a PSCR filing to the MPSC that reinstates the PSCR process for customers whose rates are no longer frozen or capped as of January 1, 2004. The proposed PSCR charge allows us to recover a portion of our increased power supply costs from large commercial and industrial customers and, subject to the overall rate caps, from other customers. We estimate the recovery of increased power supply costs from large commercial and industrial customers to be approximately $30 million in 2004. As allowed under current regulation, we self-implemented the proposed PSCR charge on January 1, 2004. The revenues received from the PSCR charge are also subject to subsequent reconciliation at the end of the year after actual costs have been reviewed for reasonableness and prudence. We cannot predict the outcome of this reconciliation proceeding. Special Contracts: We entered into multi-year electric supply contracts with certain industrial and commercial customers. The contracts provide electricity at specially negotiated prices, usually at a discount from tariff prices. As of July 2004, special contracts for approximately 630 MW of load are in place, most of which are in effect through 2005. These include, new special contracts with Dow Corning CMS-32 CMS Energy Corporation and Hemlock Semi-Conductor for 101 MW of load, which received final approval from the MPSC in May 2004 and special contracts with several hospitals totaling 52 MW of load, which received approval from the MPSC in July 2004. We cannot predict whether additional special contracts will be necessary, advisable, or approved. Transmission Sale: In May 2002, we sold our electric transmission system for $290 million to MTH. We are currently in arbitration with MTH regarding property tax items used in establishing the selling price of our electric transmission system. An unfavorable outcome could result in a reduction of sale proceeds previously recognized by approximately $2 million to $3 million. There are multiple proceedings and a proposed rulemaking pending before the FERC regarding transmission pricing mechanisms and standard market design for electric bulk power markets and transmission. The results of these proceedings and proposed rulemakings could affect significantly: - transmission cost trends, - delivered power costs to us, and - delivered power costs to our retail electric customers. The financial impact of such proceedings, rulemaking, and trends are not quantifiable currently. In addition, we are evaluating whether or not there may be impacts on electric reliability associated with the outcomes of these various transmission related proceedings. For example, Commonwealth Edison Company received approval from the FERC to join the PJM RTO effective May 1, 2004 and American Electric Power Service Corporation received approval from the FERC to join the PJM RTO effective October 1, 2004. These integrations could create different patterns of flow and power within the Midwest area and could affect adversely our ability to provide reliable service to our customers. August 14, 2003 Blackout: On August 14, 2003, the electric transmission grid serving parts of the Midwest and the Northeast experienced a significant disturbance that impacted electric service to millions of homes and businesses. As a result, federal and state investigations regarding the cause of the blackout were conducted. These investigations resulted in the NERC and the U.S. and Canadian Power System Outage Task Force releasing electric operations recommendations. Few of the recommendations apply directly to us, since we are not a transmission owner. However, the recommendations could result in increased transmission costs to us and require upgrades to our distribution system. The financial impacts of these recommendations are not quantifiable currently. We have complied with an MPSC order requiring Michigan utilities and transmission companies to submit a report concerning relay settings on their systems by May 10, 2004. In July 2004, the MPSC closed the docket concerning the investigation into the August 14, 2003 blackout. Also, we have complied with the FERC order requiring entities that own, operate, or control designated transmission facilities to report on their vegetation management practices by June 17, 2004. This FERC order affected a total of six miles of high voltage lines located on or adjacent to some generating plant properties. For additional details and material changes relating to the rate matters and restructuring of the electric utility industry, see Note 3, Uncertainties, "Consumers' Electric Utility Restructuring Matters," and "Consumers' Electric Utility Rate Matters." UNIT OUTAGE: In June 2004, our 638 MW Karn Unit 4 facility located in Essexville, Michigan experienced a failure on the exciter. The exciter is a device that provides the magnetic field to the main CMS-33 CMS Energy Corporation electric generator. Replacement of the exciter is expected to take several months. In the interim we have installed a temporary replacement, which is rented from Detroit Edison. However, under the agreement, Detroit Edison can recall the exciter at any time. To hedge against 235 MW of this risk and ensure adequate reserve margins during the summer peak periods, we have entered into two short-term capacity contracts. As of July 2004, the rented exciter has been installed and the Karn unit is operating effectively. The financial impacts of the unit outage are not currently quantifiable. FERC SUPPLY MARGIN ASSESSMENT: In April 2004, the FERC adopted two new generation market power screens and modified measures to mitigate market power where it is found. The screens will apply to all initial market-based rate applications and reviews on an interim basis, which occur every three years. Based on preliminary reviews, we believe that we will pass the established screens. PERFORMANCE STANDARDS: Electric distribution performance standards developed by the MPSC became effective in February 2004. The standards relate to restoration after outages, safety, and customer services. The MPSC order calls for financial penalties in the form of customer credits if the standards for the duration and frequency of outages are not met. We met or exceeded all approved standards for year-end results for both 2002 and 2003. As of June 2004, we are in compliance with the acceptable level of performance. We are a member of an industry coalition that has appealed the customer credit portion of the performance standards to the Michigan Court of Appeals. We cannot predict the likely effects of the financial penalties, if any, nor can we predict the outcome of the appeal. Likewise, we cannot predict our ability to meet the standards in the future or the cost of future compliance. For additional details on performance standards, see Note 3, Uncertainties, "Consumers' Electric Utility Rate Matters - Performance Standards." GAS UTILITY BUSINESS OUTLOOK GROWTH: Over the next five years, we expect gas deliveries to grow at an average rate of less than one percent per year. Actual gas deliveries in future periods may be affected by: - fluctuations in weather patterns, - use by independent power producers, - competition in sales and delivery, - Michigan economic conditions, - gas consumption per customer, and - increases in gas commodity prices. In February 2004, we filed an application with the MPSC for a Certificate of public convenience and necessity for the construction of a 25-mile gas transmission pipeline in northern Oakland County. The project is necessary to meet peak load beginning in the winter of 2005 through 2006. If we are unable to construct the pipeline due to local opposition, we will need to pursue more costly alternatives or possibly curtail serving the system's load growth in that area. CMS-34 CMS Energy Corporation GAS UTILITY BUSINESS UNCERTAINTIES Several gas business trends or uncertainties may affect our financial results and conditions. These trends or uncertainties could have a material impact on net sales, revenues, or income from gas operations. The trends and uncertainties include: Environmental - potential environmental remediation costs at a number of sites, including sites formerly housing manufactured gas plant facilities. Regulatory - inadequate regulatory response to applications for requested rate increases, and - response to increases in gas costs, including adverse regulatory response and reduced gas use by customers. Other - pipeline integrity maintenance and replacement costs, and - other pending litigation. We sell gas to retail customers under tariffs approved by the MPSC. These tariffs measure the volume of gas delivered to customers (i.e. mcf). However, we purchase gas for resale on a heating value (i.e. Btu) basis. The Btu content of the gas purchased fluctuates and may result in customers using less gas for the same heating requirement. We fully recover our cost to purchase gas through the approved GCR. However, since the customer may use less gas on a volumetric basis, the revenue from the distribution charge (the non-gas cost portion of the customer bill) could be reduced. This could affect adversely our gas utility earnings. The amount of any possible earnings loss due to fluctuating Btu content in future periods cannot be estimated at this time. In September 2002, the FERC issued an order rejecting our filing to assess certain rates for non-physical gas title tracking services we provide. In December 2003, the FERC ruled that no refunds were at issue and we reversed $4 million related to this matter. In January 2004, three companies filed with the FERC for clarification or rehearing of the FERC's December 2003 order. In April 2004, the FERC issued its Order Granting Clarification. In that Order, the FERC indicated that its December 2003 order was in error. It directed us to file within 30 days a fair and equitable title-tracking fee and to make refunds, with interest, to customers based on the difference between the accepted fee and the fee paid. In response to the FERC's April 2004 order, we filed a Request for Rehearing in May 2004. The FERC issued an Order Granting Rehearing for Further Consideration in June 2004. We expect the FERC to issue an order on the merits of this proceeding in the third quarter of 2004. We believe that with respect to the FERC jurisdictional transportation, we have not charged any customers title transfer fees, so no refunds are due. At this time, we cannot predict the outcome of this proceeding. GAS ENVIRONMENTAL ESTIMATES: We expect to incur investigation and remedial action costs at a number of sites, including 23 former manufactured gas plant sites. We expect our remaining remedial action costs to be between $37 million and $90 million. Any significant change in assumptions, such as remediation techniques, nature and extent of contamination, and legal and regulatory requirements, could change the remedial action costs for the sites. For additional details, see Note 3, Uncertainties, "Consumers' Gas Utility Contingencies - Gas Environmental Matters." CMS-35 CMS Energy Corporation GAS COST RECOVERY: The MPSC is required by law to allow us to charge customers for our actual cost of purchased natural gas. The GCR process is designed to allow us to recover all of our gas costs; however, the MPSC reviews these costs for prudency in an annual reconciliation proceeding. GCR YEAR 2002-2003: In March 2004, a settlement agreement was approved by the MPSC that resulted in a GCR disallowance of $11 million for the GCR period. For additional details, see Note 3, Uncertainties, "Consumers' Gas Utility Rate Matters - Gas Cost Recovery." GCR YEAR 2003-2004: In June 2004, we filed a reconciliation of GCR for the 12-months ended March 2004. We proposed to refund to our customers $28 million of overrecovered gas cost, plus interest. The refund will be included in the 2004-2005 GCR plan year. The overrecovery includes the $11 million refund settlement for the 2002-2003 GCR year, as well as refunds received by us from our suppliers and required by the MPSC to be refunded to our customers. GCR PLAN FOR YEAR 2004-2005: In December 2003, we filed an application with the MPSC seeking approval of a GCR plan for the 12-month period of April 2004 through March 2005. The second quarter GCR adjustment resulted in a GCR ceiling price of $6.57. In June 2004, the MPSC issued a final Order in our GCR plan approving a settlement, which included a quarterly mechanism for setting a GCR ceiling price. The mechanism did not change the current ceiling price of $6.57. Actual gas costs and revenues will be subject to an annual reconciliation proceeding. Our GCR factor for the billing month of August is $6.39 per mcf. 2003 GAS RATE CASE: In March 2003, we filed an application with the MPSC for a $156 million annual increase in our gas delivery and transportation rates that included a 13.5 percent return on equity. In September 2003, we filed an update to our gas rate case that lowered the requested revenue increase from $156 million to $139 million and reduced the return on common equity from 13.5 percent to 12.75 percent. The MPSC authorized an interim gas rate increase of $19 million annually. The interim increase is under bond and subject to refund if the final rate relief is a lesser amount. The interim increase order includes a $34 million reduction in book depreciation expense and related income taxes effective only during the period of interim relief. The MPSC order allowed us to increase our rates beginning December 19, 2003. As part of the interim rate order, Consumers agreed to restrict dividend payments to its parent company, CMS Energy, to a maximum of $190 million annually during the period of interim relief. On March 5, 2004, the ALJ issued a Proposal for Decision recommending that the MPSC not rely upon the projected test year data included in our filing, which was supported by the MPSC Staff and the ALJ further recommended that the application be dismissed. In response to the Proposal for Decision, the parties have filed exceptions and replies to exceptions. The MPSC is not bound by the ALJ's recommendation and will review the exceptions and replies to exceptions prior to issuing an order on final rate relief. 2001 GAS DEPRECIATION CASE: In December 2003, we filed an update to our gas utility plant depreciation case originally filed in June 2001. This case is not affected by the 2003 gas rate case interim increase order which reduced book depreciation expense and related income taxes only for the period that we receive the interim relief. The June 2001 depreciation case filing was based on December 2000 plant balances and historical data. The December 2003 filing updates the gas depreciation case to include December 2002 plant balances. The proposed depreciation rates, if approved, would result in an annual increase of $12 million in depreciation expense based on December 2002 plant balances. In June 2004, the ALJ issued a Proposal for Decision recommending adoption of the Michigan Attorney General's proposal to reduce our annual depreciation expense by $52 million. In response to the Proposal for Decision, the parties filed exceptions CMS-36 CMS Energy Corporation and are expected to file replies to exceptions. In our exceptions, we proposed alternative depreciation rates that would result in an annual decrease of $7 million in depreciation expense. The MPSC is not bound by the ALJ's recommendation and will review the exceptions and replies to exceptions prior to issuing an order on final depreciation rates. OTHER CONSUMERS' OUTLOOK CODE OF CONDUCT: In December 2000, the MPSC issued a new code of conduct that applies to utilities and alternative electric suppliers. The code of conduct seeks to prevent financial support, information sharing, and preferential treatment between a utility's regulated and non-regulated services. The new code of conduct is broadly written and could affect our: - retail gas business energy related services, - retail electric business energy related services, - marketing of non-regulated services and equipment to Michigan customers, and - transfer pricing between our departments and affiliates. We appealed the MPSC orders related to the code of conduct and sought a deferral of the orders until the appeal was complete. We also sought waivers available under the code of conduct to continue utility activities that provide approximately $50 million in annual electric and gas revenues. In October 2002, the MPSC denied waivers for three programs including the appliance service plan offered by us, which generated $34 million in gas revenue in 2003. In March 2004, the Michigan Court of Appeals upheld the MPSC's implementation of the code of conduct without modification. We filed an application for leave to appeal with the Michigan Supreme Court, but we cannot predict whether the Michigan Supreme Court will accept the case or the outcome of any appeal. In April 2004, the Michigan Governor signed legislation that allows us to remain in the appliance service business. In June 2004, the MPSC directed the parties to a pending complaint case involving Consumers to file briefs discussing whether the case is affected by the legislation. MCV PARTNERSHIP PROPERTY TAXES: In January 2004, the Michigan Tax Tribunal issued its decision in the MCV Partnership's tax appeal against the City of Midland for tax years 1997 through 2000. The MCV Partnership estimates that the decision will result in a refund to the MCV Partnership of approximately $35 million in taxes plus $9 million of interest. The Michigan Tax Tribunal decision has been appealed to the Michigan Court of Appeals by the City of Midland and the MCV Partnership has filed a cross-appeal at the Michigan Court of Appeals. The MCV Partnership also has a pending case with the Michigan Tax Tribunal for tax years 2001 through 2004. The MCV Partnership cannot predict the outcome of these proceedings; therefore, the above refund (net of approximately $15 million of deferred expenses) has not been recognized in year-to-date 2004 earnings. ENTERPRISES OUTLOOK INDEPENDENT POWER PRODUCTION: We plan to complete the restructuring of our IPP business by narrowing the focus of our operations to primarily North America and the Middle East/North Africa. We will continue to sell designated assets and investments that are under-performing or are not consistent with this focus. CMS ERM: CMS ERM has streamlined its portfolio in order to reduce business risk and outstanding credit guarantees. Our future activities will be centered on fuel procurement activities and merchant power marketing in such a way as to optimize the earnings from our IPP generation assets. CMS-37 CMS Energy Corporation CMS GAS TRANSMISSION: CMS Gas Transmission continues to narrow its scope of existing operations. We plan to continue to sell most of our international assets and businesses. Future operations will be conducted mainly in Michigan. In July 2004, we entered into a definitive agreement to sell our interests in Parmelia and Goldfields to APT for approximately $208 million Australian (approximately $145 million in U.S. dollars). The sale is subject to customary closing conditions. We expect the sale to close in the third quarter of 2004. In July 2003, CMS Gas Transmission completed the sale of CMS Field Services to Cantera Natural Gas, Inc. for gross cash proceeds of approximately $113 million, subject to post closing adjustments, and a $50 million face value note of Cantera Natural Gas, Inc., which is not included in our consolidated financial statements. The note is payable to CMS Energy for up to $50 million, subject to the financial performance of the Fort Union and Bighorn natural gas gathering systems from 2004 through 2008. The financial performance is dependent primarily on the number of new wells connected and transportation volumes, with certain EBITDA thresholds required to be achieved in order for us to receive payments on the note. There may not be enough new wells connected in 2004 to achieve the annual threshold and thus trigger a payment on the note for 2004. UNCERTAINTIES: The results of operations and the financial position of our diversified energy businesses may be affected by a number of trends or uncertainties. Those that could have a material impact on our income, cash flows, or balance sheet and credit improvement include: - our ability to sell or to improve the performance of assets and businesses in accordance with our business plan, - changes in exchange rates or in local economic or political conditions, particularly in Argentina, Venezuela, Brazil, and the Middle East, - changes in foreign laws or in governmental or regulatory policies that could reduce significantly the tariffs charged and revenues recognized by certain foreign subsidiaries, or increase expenses, - imposition of stamp taxes on South American contracts that could increase project expenses substantially, - impact of any future rate cases, FERC actions, or orders on regulated businesses, - impact of ratings downgrades on our liquidity, operating costs, and cost of capital, and - impact of restrictions by the Argentine government on natural gas exports to our GasAtacama plant. OTHER OUTLOOK LITIGATION AND REGULATORY INVESTIGATION: We are the subject of an investigation by the DOJ regarding round-trip trading transactions by CMS MST. Additionally, we are named as a party in various litigation including a shareholder derivative lawsuit, a securities class action lawsuit, a class action lawsuit alleging ERISA violations, several lawsuits regarding alleged false natural gas price reporting, and a lawsuit surrounding the possible sale of CMS Pipeline Assets. For additional details regarding these investigations and litigation, see Note 3, Uncertainties. CMS-38 CMS Energy Corporation NEW ACCOUNTING STANDARDS FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: The FASB issued this Interpretation in January 2003. The objective of the Interpretation is to assist in determining when one party controls another entity in circumstances where a controlling financial interest cannot be properly identified based on voting interests. Entities with this characteristic are considered variable interest entities. The Interpretation requires the party with the controlling financial interest, known as the primary beneficiary, in a variable interest entity to consolidate the entity. On December 24, 2003, the FASB issued Revised FASB Interpretation No. 46. For entities that have not previously adopted FASB Interpretation No. 46, Revised FASB Interpretation No. 46 provided an implementation deferral until the first quarter of 2004. As of and for the quarter ended March 31, 2004, we adopted Revised FASB Interpretation No. 46 for all entities. We determined that we are the primary beneficiary of both the MCV Partnership and the FMLP. We have a 49 percent partnership interest in the MCV Partnership and a 46.4 percent partnership interest in the FMLP. Consumers is the primary purchaser of power from the MCV Partnership through a long-term power purchase agreement. In addition, the FMLP holds a 75.5 percent lessor interest in the MCV Facility, which results in Consumers holding a 35 percent lessor interest in the MCV Facility. Collectively, these interests make us the primary beneficiary of these entities. As such, we consolidated their assets, liabilities, and activities into our financial statements for the first time as of and for the quarter ended March 31, 2004. These partnerships have third-party obligations totaling $728 million at June 30, 2004. Property, plant, and equipment serving as collateral for these obligations has a carrying value of $1.453 billion at June 30, 2004. The creditors of these partnerships do not have recourse to the general credit of CMS Energy. At December 31, 2003, we determined that we are the primary beneficiary of three other entities that are determined to be variable interest entities. We have 50 percent partnership interest in the T.E.S. Filer City Station Limited Partnership, the Grayling Generating Station Limited Partnership, and the Genesee Power Station Limited Partnership. Additionally, we have operating and management contracts and are the primary purchaser of power from each partnership through long-term power purchase agreements. Collectively, these interests make us the primary beneficiary as defined by the Interpretation. Therefore, we consolidated these partnerships into our consolidated financial statements for the first time as of December 31, 2003. These partnerships have third-party obligations totaling $118 million at June 30, 2004. Property, plant, and equipment serving as collateral for these obligations has a carrying value of $169 million as of June 30, 2004. Other than outstanding letters of credit and guarantees of $5 million, the creditors of these partnerships do not have recourse to the general credit of CMS Energy. We also determined that we are not the primary beneficiary of our trust preferred security structures. Accordingly, those entities have been deconsolidated as of December 31, 2003. Company Obligated Trust Preferred Securities totaling $663 million, that were previously included in mezzanine equity, have been eliminated due to deconsolidation. As a result of the deconsolidation, we reflected $684 million of long-term debt - related parties and reflected an investment in related parties of $21 million. We are not required to restate prior periods for the impact of this accounting change. Additionally, we have variable interest entities in which we are not the primary beneficiary. FASB Interpretation No. 46 requires us to disclose certain information about these entities. The chart below details our involvement in these entities at June 30, 2004: CMS-39 CMS Energy Corporation
Investment Total Name (Ownership Nature of the Involvement Balance Operating Agreement Generating Interest) Entity Country Date (In Millions) with CMS Energy Capacity - ------------------------------------------------------------------------------------------------------------------------ Generator United Arab Taweelah (40%) Emirates 1999 $ 93 Yes 777 MW Generator - Under Saudi Jubail (25%) Construction Arabia 2001 $ - Yes 250 MW Generator - Under United Arab Shuweihat (20%) Construction Emirates 2001 $ (16)(a) Yes 1,500 MW - ------------------------------------------------------------------------------------------------------------------------ Total $ 77 2,527 MW ========================================================================================================================
(a) At June 30, 2004, we carried a negative investment in Shuweihat. The balance is comprised of our investment of $3 million reduced by our proportionate share of the negative fair value of derivative instruments of $19 million. We are required to record the negative investment due to our future commitment to make an equity investment in Shuweihat. Our maximum exposure to loss through our interests in these variable interest entities is limited to our investment balance of $77 million, and letters of credit, guarantees, and indemnities relating to Taweelah and Shuweihat totaling $129 million. Included in that total is a letter of credit relating to our required initial investment in Shuweihat of $70 million. We plan to contribute our initial investment when the project becomes commercially operational in 2004. FASB STAFF POSITION, NO. SFAS 106-2, ACCOUNTING AND DISCLOSURE REQUIREMENTS RELATED TO THE MEDICARE PRESCRIPTION DRUG, IMPROVEMENT, AND MODERNIZATION ACT OF 2003: The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act) was signed into law in December 2003. The Act establishes a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy, which is exempt from federal taxation, to sponsors of retiree health care benefit plans that provide a benefit that is actuarially equivalent to Medicare Part D. At December 31, 2003, we elected a one-time deferral of the accounting for the Act, as permitted by FASB Staff Position, No. SFAS 106-1. The final FASB Staff Position, No. SFAS 106-2 supersedes FASB Staff Position, No. SFAS 106-1 and provides further accounting guidance. FASB Staff Position, No. SFAS 106-2 states that for plans that are actuarially equivalent to Medicare Part D, employers' measures of accumulated postretirement benefit obligations and postretirement benefit costs should reflect the effects of the Act. We believe our plan is actuarially equivalent to Medicare Part D and have incorporated retroactively the effects of the subsidy into our financial statements as of June 30, 2004, in accordance with FASB Staff Position, No. SFAS 106-2. We remeasured our obligation as of December 31, 2003 to incorporate the impact of the Act, which resulted in a reduction to the accumulated postretirement benefit obligation of $158 million. The remeasurement resulted in a reduction of OPEB cost of $6 million for the three months ended June 30, 2004, $12 million for the six months ended June 30, 2004, and an expected total reduction of $24 million for 2004. Consumers capitalizes a portion of OPEB cost in accordance with regulatory accounting. As such, the remeasurement resulted in a net reduction of OPEB expense of $4 million, or CMS-40 CMS Energy Corporation $0.03 per share, for the three months ended June 30, 2004, $9 million, or $0.05 per share, for the six months ended June 30, 2004, and an expected total net expense reduction of $17 million for 2004. EITF NO. 03-6, PARTICIPATING SECURITIES AND THE TWO-CLASS METHOD UNDER SFAS NO. 128: EITF No. 03-6, effective June 30, 2004, addresses the treatment of participating securities in earnings per share calculations. This EITF defines participating securities and describes their treatment using a two-class method of calculating earnings per share. Since we have not issued any participating securities, as defined by EITF No. 03-6 and SFAS No. 128, there was no impact on earnings per share upon adoption. NEW ACCOUNTING STANDARDS NOT YET EFFECTIVE PROPOSED EITF NO. 04-8, THE EFFECT OF CONTINGENTLY CONVERTIBLE DEBT ON DILUTED EARNINGS PER SHARE: The Issue addresses when the dilutive effect of contingently convertible debt instruments should be included in diluted earnings per share calculations. At its July 1, 2004 meeting, the EITF reached a consensus that contingently convertible debt instruments should be included in the diluted earnings per share computation (if dilutive) regardless of whether the market price trigger or other contingent features have been met. We currently have a contingently convertible debt instrument and a contingently convertible preferred stock instrument outstanding. Both securities include similar contingent conversion provisions. Including the dilutive effect of these instruments could reduce our diluted earnings per share. For further information on these securities, refer to Note 4, Financings and Capitalization, "Contingently Convertible Securities." The proposed Issue is open for public comment and will be discussed by the EITF at its September 2004 meeting. The tentative effective date for this EITF Issue is for reporting periods ending after December 15, 2004. Prior period earnings per share amounts would be required to be restated. CMS-41 CMS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED RESTATED RESTATED JUNE 30 2004 2003 2004 2003 - --------------------------------------------------------------------------------------------------------- In Millions, Except Per Share Amounts OPERATING REVENUE $ 1,093 $ 1,126 $ 2,847 $ 3,094 EARNINGS FROM EQUITY METHOD INVESTEES 41 50 60 97 OPERATING EXPENSES Fuel for electric generation 184 98 356 206 Purchased and interchange power 80 102 157 341 Purchased power - related parties - 124 - 260 Cost of gas sold 263 298 1,024 1,135 Other operating expenses 224 217 442 415 Maintenance 65 61 122 119 Depreciation, depletion and amortization 108 90 252 218 General taxes 62 7 136 76 Assets impairment charges - 3 125 9 ---------------------------------------- 986 1,000 2,614 2,779 - --------------------------------------------------------------------------------------------------------- OPERATING INCOME 148 176 293 412 OTHER INCOME (DEDUCTIONS) Accretion expense (6) (9) (12) (16) Gain (loss) on asset sales, net 1 (3) 3 (8) Interest and dividends 7 7 14 11 Foreign currency gains (losses), net (3) 5 (6) 11 Other income 15 3 27 6 Other expense (2) (1) (4) (3) ---------------------------------------- 12 2 22 1 - --------------------------------------------------------------------------------------------------------- FIXED CHARGES Interest on long-term debt 126 128 256 225 Interest on long-term debt - related parties 14 - 29 - Other interest 7 11 12 18 Capitalized interest (1) (3) (3) (5) Preferred dividends of subsidiaries 1 1 2 1 Preferred securities distributions - 18 - 36 ---------------------------------------- 147 155 296 275 - --------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES AND MINORITY INTERESTS 13 23 19 138 INCOME TAX EXPENSE (BENEFIT) (7) 34 (10) 73 MINORITY INTERESTS 1 1 12 2 ---------------------------------------- INCOME (LOSS) FROM CONTINUING OPERATIONS 19 (12) 17 63 LOSS FROM DISCONTINUED OPERATIONS, NET OF $- AND $1 TAX BENEFIT IN 2004 AND $3 AND $21 TAX EXPENSE IN 2003 - (53) (2) (22) ---------------------------------------- INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING 19 (65) 15 41 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING, NET OF $13 TAX BENEFIT IN 2003: DERIVATIVES (NOTE 6) - - - (23) ASSET RETIREMENT OBLIGATIONS, SFAS NO. 143 (NOTE 10) - - - (1) ---------------------------------------- - - - (24) ---------------------------------------- NET INCOME (LOSS) 19 (65) 15 17 PREFERRED DIVIDENDS 3 - 6 - ---------------------------------------- NET INCOME (LOSS) AVAILABLE TO COMMON STOCK $ 16 $ (65) $ 9 $ 17 ========================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CMS-42
THREE MONTHS ENDED SIX MONTHS ENDED RESTATED RESTATED JUNE 30 2004 2003 2004 2003 - ------------------------------------------------------------------------------------------------------ In Millions, Except Per Share Amounts CMS ENERGY NET INCOME (LOSS) Net Income (Loss) Available to Common Stock $ 16 $ (65) $ 9 $ 17 ====================================== BASIC EARNINGS (LOSS) PER AVERAGE COMMON SHARE Income (Loss) from Continuing Operations $ 0.10 $ (0.08) $ 0.07 $ 0.43 Loss from Discontinued Operations - (0.37) (0.01) (0.15) Loss from Changes in Accounting - - - (0.16) -------------------------------------- Net Income (Loss) Attributable to Common Stock $ 0.10 $ (0.45) $ 0.06 $ 0.12 ====================================== DILUTED EARNINGS (LOSS) PER AVERAGE COMMON SHARE Income (Loss) from Continuing Operations $ 0.10 $ (0.08) $ 0.07 $ 0.43 Loss from Discontinued Operations - (0.37) (0.01) (0.14) Loss from Changes in Accounting - - - (0.15) -------------------------------------- Net Income (Loss) Attributable to Common Stock $ 0.10 $ (0.45) $ 0.06 $ 0.14 ====================================== DIVIDENDS DECLARED PER COMMON SHARE $ - $ - $ - $ - - ------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CMS-43 CMS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED RESTATED JUNE 30 2004 2003 - ----------------------------------------------------------------------------------------------- In Millions CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 15 $ 17 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear decommissioning of $3 and $3, respectively) 252 218 Loss on disposal of discontinued operations 1 49 Asset impairments (Note 2) 125 9 Capital lease and debt discount amortization 14 12 Accretion expense 12 16 Bad debt expense 5 8 Undistributed earnings from related parties (44) (69) Loss (gain) on the sale of assets (3) 8 Cumulative effect of accounting changes - 24 Changes in other assets and liabilities: Increase in accounts receivable and accrued revenues (112) (69) Decrease (increase) in inventories 81 (2) Increase (decrease) in accounts payable and accrued expenses 66 (298) Deferred income taxes and investment tax credit 44 169 Decrease in other assets 16 91 Increase (decrease) in other liabilities 9 (36) --------------------- Net cash provided by operating activities $ 481 $ 147 - ------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (excludes assets placed under capital lease) $ (237) $ (261) Cost to retire property (37) (35) Restricted cash (12) (167) Investment in Electric Restructuring Implementation Plan (3) (4) Investments in nuclear decommissioning trust funds (3) (3) Proceeds from nuclear decommissioning trust funds 23 18 Maturity of MCV restricted investment securities held-to-maturity 300 - Purchase of MCV restricted investment securities held-to-maturity (300) - Proceeds from sale of assets 66 726 Other investing (11) 18 --------------------- Net cash provided by (used in) investing activities $ (214) $ 292 - ------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from notes, bonds, and other long-term debt $ 9 $ 1,449 Retirement of bonds and other long-term debt (274) (830) Payment of preferred stock dividends (6) - Decrease in notes payable - (487) Payment of capital lease obligations (5) (7) --------------------- Net cash provided by (used in) financing activities $ (276) $ 125 - ------------------------------------------------------------------------------------------------- EFFECT OF EXCHANGE RATES ON CASH (1) 2 - ------------------------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ (10) $ 566 CASH AND CASH EQUIVALENTS FROM EFFECT OF REVISED FASB INTERPRETATION NO. 46 174 - CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 532 351 --------------------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 696 $ 917 =================================================================================================
CMS-44
SIX MONTHS ENDED RESTATED JUNE 30 2004 2003 - ---------------------------------------------------------------------------------------------- In Millions OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES CASH TRANSACTIONS Interest paid (net of amounts capitalized) $ 246 $ 233 Income taxes paid (net of refunds) - (33) OPEB cash contribution 33 40 NON-CASH TRANSACTIONS Other assets placed under capital leases $ 1 $ 10 ==============================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CMS-45 CMS ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS
ASSETS JUNE 30 JUNE 30 2003 2004 DECEMBER 31 RESTATED (UNAUDITED) 2003 (UNAUDITED) - --------------------------------------------------------------------------------------------------------- In Millions PLANT AND PROPERTY (AT COST) Electric utility $ 7,776 $ 7,600 $ 7,465 Gas utility 2,898 2,875 2,805 Enterprises 3,392 895 706 Other 28 32 37 ------------------------------------- 14,094 11,402 11,013 Less accumulated depreciation, depletion and amortization 5,958 4,846 4,777 ------------------------------------- 8,136 6,556 6,236 Construction work-in-progress 392 388 438 ------------------------------------- 8,528 6,944 6,674 - --------------------------------------------------------------------------------------------------------- INVESTMENTS Enterprises 754 724 740 Midland Cogeneration Venture Limited Partnership - 419 422 First Midland Limited Partnership - 224 263 Other 24 23 2 ------------------------------------- 778 1,390 1,427 - --------------------------------------------------------------------------------------------------------- CURRENT ASSETS Cash and cash equivalents at cost, which approximates market 696 532 917 Restricted cash 213 201 205 Accounts receivable, notes receivable and accrued revenue, less allowances of $28, $29 and $17, respectively 531 367 473 Accounts receivable - Energy Resource Management, less allowances of $10, $11 and $9, respectively 36 36 145 Accounts receivable and notes receivable - related parties 60 73 182 Inventories at average cost: Gas in underground storage 665 741 460 Materials and supplies 107 110 102 Generating plant fuel stock 60 41 42 Assets held for sale 14 24 79 Price risk management assets 99 102 101 Regulatory assets 19 19 19 Derivative instruments 114 2 2 Prepayments and other 238 246 308 ------------------------------------- 2,852 2,494 3,035 - --------------------------------------------------------------------------------------------------------- NON-CURRENT ASSETS Regulatory Assets Securitized costs 627 648 669 Postretirement benefits 151 162 174 Abandoned Midland Project 10 10 11 Other 318 266 255 Assets held for sale - 2 213 Price risk management assets 192 177 213 Nuclear decommissioning trust funds 559 575 553 Prepaid pension costs 378 388 - Goodwill 23 25 36 Notes receivable - related parties 231 242 147 Notes receivable 125 125 126 Other 535 390 406 ------------------------------------- 3,149 3,010 2,803 ------------------------------------- TOTAL ASSETS $ 15,307 $ 13,838 $ 13,939 =========================================================================================================
CMS-46 STOCKHOLDERS' INVESTMENT AND LIABILITIES
JUNE 30 JUNE 30 2003 2004 DECEMBER 31 RESTATED (UNAUDITED) 2003 (UNAUDITED) - --------------------------------------------------------------------------------------------------------------- In Millions CAPITALIZATION Common stockholders' equity Common stock, authorized 350.0 shares; outstanding 161.3 shares, 161.1 shares and 144.1 shares, respectively $ 2 $ 2 $ 1 Other paid-in-capital 3,848 3,846 3,608 Accumulated other comprehensive loss (313) (419) (690) Retained deficit (1,835) (1,844) (1,783) --------------------------------------- 1,702 1,585 1,136 Preferred stock of subsidiary 44 44 44 Preferred stock 261 261 - Company-obligated convertible Trust Preferred Securities of subsidiaries - - 393 Company-obligated mandatorily redeemable Trust Preferred Securities of Consumers' subsidiaries - - 490 Long-term debt 5,816 6,020 6,062 Long-term debt - related parties 684 684 - Non-current portion of capital and finance lease obligations 338 58 119 --------------------------------------- 8,845 8,652 8,244 - --------------------------------------------------------------------------------------------------------------- MINORITY INTERESTS 740 73 43 - --------------------------------------------------------------------------------------------------------------- CURRENT LIABILITIES Current portion of long-term debt, capital and finance leases 903 519 544 Accounts payable 358 296 334 Accounts payable - Energy Resource Management 21 21 52 Accounts payable - related parties 2 40 47 Accrued interest 170 130 126 Accrued taxes 239 285 180 Liabilities held for sale 2 2 66 Price risk management liabilities 93 89 93 Current portion of purchase power contracts 13 27 26 Current portion of gas supply contract obligations 30 29 28 Deferred income taxes 29 27 32 Other 301 185 185 --------------------------------------- 2,161 1,650 1,713 - --------------------------------------------------------------------------------------------------------------- NON-CURRENT LIABILITIES Regulatory Liabilities Cost of removal 1,016 983 950 Income taxes, net 321 312 313 Other 165 172 155 Postretirement benefits 252 265 791 Deferred income taxes 651 615 487 Deferred investment tax credit 82 85 87 Asset retirement obligation 407 359 364 Liabilities held for sale - - 45 Price risk management liabilities 188 175 206 Gas supply contract obligations 190 208 221 Power purchase agreement - MCV Partnership - - 14 Other 289 289 306 --------------------------------------- 3,561 3,463 3,939 - --------------------------------------------------------------------------------------------------------------- COMMITMENTS AND CONTINGENCIES (Notes 1, 3 and 4) TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $ 15,307 $ 13,838 $ 13,939 ===============================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CMS-47 CMS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED RESTATED RESTATED JUNE 30 2004 2003 2004 2003 - --------------------------------------------------------------------------------------------------------------------------- In Millions COMMON STOCK At beginning and end of period $ 2 $ 1 $ 2 $ 1 - --------------------------------------------------------------------------------------------------------------------------- OTHER PAID-IN CAPITAL At beginning of period 3,846 3,605 3,846 3,605 Common stock reacquired (1) (1) (1) (1) Common stock issued 3 4 3 4 ------------------------------------------ At end of period 3,848 3,608 3,848 3,608 - --------------------------------------------------------------------------------------------------------------------------- ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Minimum Pension Liability At beginning of period - (241) - (241) Minimum pension liability adjustments (a) - (20) - (20) ------------------------------------------ At end of period - (261) - (261) ------------------------------------------ Investments At beginning of period 9 2 8 2 Unrealized gain (loss) on investments (a) (1) 3 - 3 ------------------------------------------ At end of period 8 5 8 5 ------------------------------------------ Derivative Instruments At beginning of period (13) (29) (8) (31) Unrealized gain (loss) on derivative instruments (a) 22 (14) 19 (7) Reclassification adjustments included in consolidated net income (loss) (a) (3) 21 (5) 16 ------------------------------------------ At end of period 6 (22) 6 (22) ------------------------------------------ Foreign Currency Translation At beginning of period (313) (445) (419) (458) Change in foreign currency translation (a) (14) 33 92 46 ------------------------------------------ At end of period (327) (412) (327) (412) ------------------------------------------ At end of period (313) (690) (313) (690) - --------------------------------------------------------------------------------------------------------------------------- RETAINED DEFICIT At beginning of period (1,851) (1,718) (1,844) (1,800) Net income (loss) (a) 19 (65) 15 17 Preferred stock dividends declared (3) - (6) - Common stock dividends declared - - - - ------------------------------------------ At end of period (1,835) (1,783) (1,835) (1,783) ------------------------------------------ TOTAL COMMON STOCKHOLDERS' EQUITY $ 1,702 $ 1,136 $ 1,702 $ 1,136 =========================================================================================================================== (A) DISCLOSURE OF OTHER COMPREHENSIVE INCOME (LOSS): Minimum Pension Liability Minimum pension liability adjustments, net of tax benefit of $-, $(10), $- and $(10), respectively $ - $ (20) $ - $ (20) Investments Unrealized gain (loss) on investments, net of tax of $-, $1, $- and $1, respectively (1) 3 - 3 Derivative Instruments Unrealized loss on derivative instruments, net of tax (tax benefit) of $2, $(3), $7 and $2, respectively 22 (14) 19 (7) Reclassification adjustments included in net income (loss), net of tax (tax benefit) of $(2), $14, $(3) and $11, respectively (3) 21 (5) 16 Foreign currency translation, net (14) 33 92 46 Net income (loss) 19 (65) 15 17 ------------------------------------------ Total Other Comprehensive Income (Loss) $ 23 $ (42) $ 121 $ 55 ==========================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CMS-48 CMS Energy Corporation CMS ENERGY CORPORATION CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) These interim Consolidated Financial Statements have been prepared by CMS Energy in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. As such, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. Certain prior year amounts have been reclassified to conform to the presentation in the current year. In management's opinion, the unaudited information contained in this report reflects all adjustments of a normal recurring nature necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. The Condensed Notes to Consolidated Financial Statements and the related Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements contained in CMS Energy's Form 10-K/A for the year ended December 31, 2003. Due to the seasonal nature of CMS Energy's operations, the results as presented for this interim period are not necessarily indicative of results to be achieved for the fiscal year. RESTATEMENT OF 2003 FINANCIAL STATEMENTS Our financial statements as of and for the three and six months ended June 30, 2003, as presented in this Form 10-Q, have been restated for the following matters that were disclosed previously in Note 19, Quarterly Financial and Common Stock Information (Unaudited), in our 2003 Form 10-K/A: - International Energy Distribution, which includes SENECA and CPEE, is no longer considered "discontinued operations," due to a change in our expectations as to the timing of the sales, - certain derivative accounting corrections at our equity affiliates, and - the net loss recorded in the second quarter of 2003 relating to the sale of Panhandle, reflected as Discontinued Operations, was understated by approximately $14 million, net of tax. 1: CORPORATE STRUCTURE AND ACCOUNTING POLICIES CORPORATE STRUCTURE: CMS Energy is an integrated energy company with a business strategy focused primarily in Michigan. We are the parent holding company of Consumers and Enterprises. Consumers is a combination electric and gas utility company serving Michigan's Lower Peninsula. Enterprises, through various subsidiaries and equity investments, is engaged in domestic and international diversified energy businesses including: independent power production and natural gas transmission, storage and processing. We manage our businesses by the nature of services each provides and operate principally in three business segments: electric utility, gas utility, and enterprises. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of CMS Energy, Consumers, Enterprises, and all other entities in which we have a controlling financial interest or are the primary beneficiary, in accordance with Revised FASB Interpretation No. 46. The primary beneficiary of a variable interest entity is the party that absorbs or receives a majority of the entity's expected losses or expected residual returns or both as a result of holding variable interests, which are ownership, contractual, or other economic interests. In 2004, we consolidated the MCV CMS-49 CMS Energy Corporation Partnership and the FMLP in accordance with Revised FASB Interpretation No. 46. For additional details, see Note 11, Implementation of New Accounting Standards. We use the equity method of accounting for investments in companies and partnerships that are not consolidated, where we have significant influence over operations and financial policies, but are not the primary beneficiary. Intercompany transactions and balances have been eliminated. USE OF ESTIMATES: We prepare our financial statements in conformity with accounting principles generally accepted in the United States. We are required to make estimates using assumptions that may affect the reported amounts and disclosures. Actual results could differ from those estimates. We are required to record estimated liabilities in the financial statements when it is probable that a loss will be incurred in the future as a result of a current event, and when an amount can be reasonably estimated. We have used this accounting principle to record estimated liabilities as discussed in Note 3, Uncertainties. REVENUE RECOGNITION POLICY: We recognize revenues from deliveries of electricity and natural gas, and the transportation, processing, and storage of natural gas when services are provided. Sales taxes are recorded as liabilities and are not included in revenues. Revenues on sales of marketed electricity, natural gas, and other energy products are recognized at delivery. Mark-to-market changes in the fair values of energy trading contracts that qualify as derivatives are recognized as revenues in the periods in which the changes occur. CAPITALIZED INTEREST: We are required to capitalize interest on certain qualifying assets that are undergoing activities to prepare them for their intended use. Capitalization of interest for the period is limited to the actual interest cost that is incurred, and our non-regulated businesses are prohibited from imputing interest costs on any equity funds. Our regulated businesses are permitted to capitalize an allowance for funds used during construction on regulated construction projects and to include such amounts in plant in service. CASH EQUIVALENTS AND RESTRICTED CASH: All highly liquid investments with an original maturity of three months or less are considered cash equivalents. At June 30, 2004, our restricted cash on hand was $213 million. Restricted cash primarily includes cash collateral for letters of credit to satisfy certain debt agreements and cash dedicated for repayment of Securitization bonds. It is classified as a current asset as the related letters of credit mature within one year and the payments on the related Securitization bonds occur within one year. EARNINGS PER SHARE: Basic and diluted earnings per share are based on the weighted average number of shares of common stock and dilutive potential common stock outstanding during the period. Potential common stock, for purposes of determining diluted earnings per share, includes the effects of dilutive stock options, warrants and convertible securities. The effect on number of shares of such potential common stock is computed using the treasury stock method or the if-converted method, as applicable. For earnings per share computation, see Note 5, Earnings Per Share and Dividends. FINANCIAL INSTRUMENTS: We account for investments in debt and equity securities using SFAS No. 115. Debt and equity securities can be classified into one of three categories: held-to-maturity, trading, or available-for-sale. Our debt securities are classified as held-to-maturity securities and are reported at cost. Our investments in equity securities are classified as available-for-sale securities. They are reported at fair value, with any unrealized gains or losses resulting from changes in fair value reported in equity as part of accumulated other comprehensive income and are excluded from earnings unless such changes in fair value are determined to be other than temporary. Unrealized gains or losses resulting CMS-50 CMS Energy Corporation from changes in the fair value of our nuclear decommissioning investments are reflected in Regulatory Liabilities. The fair value of our equity securities is determined from quoted market prices. For additional details regarding financial instruments, see Note 6, Financial and Derivative Instruments. FOREIGN CURRENCY TRANSLATION: Our subsidiaries and affiliates whose functional currency is not the U.S. dollar translate their assets and liabilities into U.S. dollars at the exchange rates in effect at the end of the fiscal period. We translate revenue and expense accounts of such subsidiaries and affiliates into U.S. dollars at the average exchange rates that prevailed during the period. The gains or losses that result from this process, and gains and losses on intercompany foreign currency transactions that are long-term in nature that we do not intend to settle in the foreseeable future, are shown in the stockholders' equity section in the Consolidated Balance Sheets. For subsidiaries operating in highly inflationary economies, the U.S. dollar is considered to be the functional currency, and transaction gains and losses are included in determining net income. Gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency, except those that are hedged, are included in determining net income. IMPAIRMENT OF INVESTMENTS AND LONG-LIVED ASSETS: We evaluate potential impairments of our investments in long-lived assets other than goodwill based on various analyses, including the projection of undiscounted cash flows, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. If the carrying amount of the asset exceeds its estimated undiscounted future cash flows, an impairment loss is recognized and the asset is written down to its estimated fair value. NUCLEAR FUEL COST: We amortize nuclear fuel cost to fuel expense based on the quantity of heat produced for electric generation. For nuclear fuel used after April 6, 1983, we charge disposal costs to nuclear fuel expense, recover these costs through electric rates, and remit them to the DOE quarterly. We elected to defer payment for disposal of spent nuclear fuel burned before April 7, 1983. As of June 30, 2004, we have recorded a liability to the DOE for $140 million, including interest, which is payable upon the first delivery of spent nuclear fuel to the DOE. The amount of this liability, excluding a portion of interest, was recovered through electric rates. For additional details on disposal of spent nuclear fuel, see Note 3, Uncertainties, "Other Consumers' Electric Utility Uncertainties - Nuclear Matters." OTHER INCOME AND OTHER EXPENSE: The following tables show the components of Other income and Other expense:
In Millions - ----------------------------------------------------------------------------------------- Three Months Ended Six Months Ended -------------------------------------- June 30 2004 2003 2004 2003 - ----------------------------------------------------------------------------------------- Other income Interest and dividends - related parties $ 1 $ 1 $ 2 $ 2 PA141 Return on capital expenditures 9 - 18 - Electric restructuring return 1 2 3 3 Investment sale gain 1 - 1 - All other 3 - 3 1 - ----------------------------------------------------------------------------------------- Total other income $ 15 $ 3 $ 27 $ 6 =========================================================================================
CMS-51 CMS Energy Corporation
In Millions - ----------------------------------------------------------------------------------------- Three Months Ended Six Months Ended -------------------------------------- June 30 2004 2003 2004 2003 - ----------------------------------------------------------------------------------------- Other expense Loss on SERP investment $ (1) $ - $ (1) $ (1) Civic and political expenditures - - (1) (1) All other (1) (1) (2) (1) - ----------------------------------------------------------------------------------------- Total other expense $ (2) $ (1) $ (4) $ (3) =========================================================================================
PROPERTY, PLANT, AND EQUIPMENT: We record property, plant, and equipment at original cost when placed into service. When regulated assets are retired, or otherwise disposed of in the ordinary course of business, the original cost is charged to accumulated depreciation and cost of removal, less salvage is recorded as a regulatory liability. For additional details, see Note 10, Asset Retirement Obligations. An allowance for funds used during construction is capitalized on regulated construction projects. With respect to the retirement or disposal of non-regulated assets, the resulting gains or losses are recognized in income. RECLASSIFICATIONS: Certain prior year amounts have been reclassified for comparative purposes. These reclassifications did not affect consolidated net income for the years presented. UTILITY REGULATION: We account for the effects of regulation based on the regulated utility accounting standard SFAS No. 71. As a result, the actions of regulators affect when we recognize revenues, expenses, assets, and liabilities. SFAS No. 144 imposes strict criteria for retention of regulatory-created assets by requiring that such assets be probable of future recovery at each balance sheet date. Management believes these assets are probable of future recovery. 2: DISCONTINUED OPERATIONS, OTHER ASSET SALES, IMPAIRMENTS, AND RESTRUCTURING Our continued focus on financial improvement has led to discontinuing operations, completing many asset sales, impairing some assets, and incurring costs to restructure our business. Gross cash proceeds received from the sale of assets totaled $66 million for the six months ended June 30, 2004 and $726 million for the six months ended June 30, 2003. CMS-52 CMS Energy Corporation DISCONTINUED OPERATIONS We have discontinued the following operations:
In Millions - ----------------------------------------------------------------------------- Pretax After-tax Business/Project Discontinued Gain(Loss) Gain(Loss) Status - ----------------------------------------------------------------------------- CMS Viron June 2002 $ (14) $ (9) Sold June 2003 Panhandle December 2002 (39) (44) Sold June 2003 CMS Field Services December 2002 (5) (1) Sold July 2003 Marysville June 2003 2 1 Sold November 2003 Parmelia (a) December 2003 -- -- Held for sale - -----------------------------------------------------------------------------
(a) We expect the sale of Parmelia to occur in 2004. In December 2003, we reduced the carrying amount of our Parmelia business by $26 million to reflect fair value. This after-tax loss was reported in discontinued operations in December 2003. At June 30, 2004, "Assets held for sale" includes Parmelia. At December 31, 2003, "Assets held for sale" includes Parmelia, Bluewater Pipeline, and our investment in the American Gas Index Fund. At June 30, 2003, "Assets held for sale" includes CMS Field Services, Marysville, and Parmelia. The major classes of assets and liabilities held for sale on our Consolidated Balance Sheet are as follows:
In Millions - --------------------------------------------------------------------------------------------------- Restated June 30, 2004 December 31, 2003 June 30, 2003 - --------------------------------------------------------------------------------------------------- Assets Cash $ 8 $ 7 $ 2 Accounts receivable 3 2 71 Property, plant and equipment - net - 2 197 Other 3 15 22 - --------------------------------------------------------------------------------------------------- Total assets held for sale $ 14 $ 26 $ 292 =================================================================================================== Liabilities Accounts payable $ 1 $ 2 $ 61 Minority interest - - 44 Other 1 - 6 - --------------------------------------------------------------------------------------------------- Total liabilities held for sale $ 2 $ 2 $ 111 ===================================================================================================
CMS-53 CMS Energy Corporation The following amounts are reflected in the Consolidated Statements of Income, in the Loss From Discontinued Operations line:
In Millions - ----------------------------------------------------------------------------- Restated Three months ended June 30 2004 2003 - ----------------------------------------------------------------------------- Revenues $ 5 $ 250 ============================================================================= Discontinued operations: Pretax income from discontinued operations $ - $ 6 Income tax expense - 4 ----------------------- Income from discontinued operations - 2 Pretax loss on disposal of discontinued operations - (56) Income tax benefit - (1) ----------------------- Loss on disposal of discontinued operations - (55) - ----------------------------------------------------------------------------- Loss from discontinued operations $ - $ (53) =============================================================================
In Millions - ----------------------------------------------------------------------------- Restated Six months ended June 30 2004 2003 - ----------------------------------------------------------------------------- Revenues $ 10 $ 496 ============================================================================= Discontinued operations: Pretax income (loss) from discontinued operations $ (1) $ 46 Income tax expense - 19 ----------------------- Income (loss) from discontinued operations (1) 27 Pretax loss on disposal of discontinued operations (2) (47) Income tax expense (benefit) (1) 2 ----------------------- Loss on disposal of discontinued operations (1) (49) - ----------------------------------------------------------------------------- Loss from discontinued operations $ (2) $ (22) =============================================================================
The loss from discontinued operations includes a reduction in asset values, a provision for anticipated closing costs, and a portion of CMS Energy's interest expense. Interest expense of less than $1 million for the six months ended June 30, 2004 and $21 million for the six months ended June 30, 2003 has been allocated based on a ratio of the expected proceeds for the asset to be sold divided by CMS Energy's total capitalization of each discontinued operation times CMS Energy's interest expense. OTHER ASSET SALES Our other asset sales include the following non-strategic and under-performing assets. The impacts of these sales are included in "Gain (loss) on asset sales, net" in the Consolidated Statements of Income (Loss). For the six months ended June 30, 2004, we sold the following assets that did not meet the definition of, and therefore were not reported as, discontinued operations: CMS-54 CMS Energy Corporation
In Millions - -------------------------------------------------------------- Pretax After-tax Date sold Business/Project Gain Gain - -------------------------------------------------------------- February Bluewater Pipeline (a) $ 1 $ 1 April Loy Yang (b) - - May American Gas Index fund (c) 1 1 Various Other 1 - - -------------------------------------------------------------- Total gain on asset sales $ 3 $ 2 ==============================================================
(a) Bluewater Pipeline is a 24.9 mile pipeline that extends from Marysville, Michigan to Armada, Michigan. (b) In April 2004, we and our partners sold the 2,000 MW Loy Yang power plant and adjacent coal mine in Victoria, Australia for about A$3.5 billion ($2.6 billion in U.S. dollars), including A$145 million for the project equity. Our share of the proceeds, net of transaction costs and closing adjustments, was $44 million. In anticipation of the sale, we recorded an impairment in the first quarter as discussed in "Asset Impairments" within this Note. (c) In May 2004, we sold our interest in the American Gas Index fund for $7 million. For the six months ended June 30, 2003, we sold the following assets that did not meet the definition of, and therefore were not reported as, discontinued operations:
In Millions - -------------------------------------------------------------- Pretax After-tax Date sold Business/Project Gain(Loss) Gain(Loss) - -------------------------------------------------------------- January CMS MST Wholesale Gas $ (6) $ (4) March CMS MST Wholesale Power 2 1 June Guardian Pipeline (4) (3) - -------------------------------------------------------------- Total loss on asset sales $ (8) $ (6) ==============================================================
SUBSEQUENT EVENT: In July 2004, we entered into a definitive agreement to sell our interests in Parmelia and Goldfields to APT for approximately $208 million Australian (approximately $145 million in U.S. dollars). The sale is subject to customary closing conditions. We expect the sale to close in the third quarter of 2004. ASSET IMPAIRMENTS We record an asset impairment when we determine that the expected future cash flows from an asset would be insufficient to provide for recovery of the asset's carrying value. An asset held-in-use is evaluated for impairment by calculating the undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. If the undiscounted future cash flows are less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We estimate the fair market value of the asset utilizing the best information available. This information includes quoted market prices, market prices of similar assets, and discounted future cash flow analyses. The assets written down include both domestic and foreign electric power plants, gas processing facilities, and certain equity method and other investments. In addition, we have written off the carrying value of projects under development that will no longer be pursued. CMS-55 CMS Energy Corporation The table below summarizes our asset impairments:
In Millions - ------------------------------------------------------------------------------------------------- Six months ended June 30 Pretax 2004 After-tax 2004 Pretax 2003 After-tax 2003 - ------------------------------------------------------------------------------------------------- Asset impairments: Enterprises (a) $ - $ - $ 7 $ 4 International Energy Distribution - - 2 1 Loy Yang (b) 125 81 - - - ------------------------------------------------------------------------------------------------- Total asset impairments $ 125 $ 81 $ 9 $ 5 =================================================================================================
(a) Primarily represents an impairment recorded to reflect the fair value of two generators. (b) In the first quarter of 2004, an impairment charge was recorded to recognize the reduction in fair value as a result of the sale of Loy Yang, completed in April 2004, which included a cumulative net foreign currency translation loss of approximately $110 million. RESTRUCTURING AND OTHER COSTS In June 2002, we announced a series of initiatives to reduce our annual operating costs by an estimated $50 million. As such, we: - relocated CMS Energy's corporate headquarters from Dearborn, Michigan to a new combined CMS Energy and Consumers headquarters in Jackson, Michigan in July 2003, - implemented changes to our 401(k) savings program, - implemented changes to our health care plan, and - completed the termination of numerous employees, including five officers. The following tables shows the amount charged to expense for restructuring costs, the payments made, and the unpaid balance of accrued costs for the six months ended June 30, 2004 and June 30, 2003.
In Millions - ------------------------------------------------------------------------------------------------ Involuntary Lease Termination Termination Total - ------------------------------------------------------------------------------------------------ Beginning accrual balance, January 1, 2004 $ 3 $ 6 $ 9 Expense - - - Payments (1) (2) (3) - ------------------------------------------------------------------------------------------------ Ending accrual balance at June 30, 2004 $ 2 $ 4 $ 6 =================================================================================================
CMS-56 CMS Energy Corporation
In Millions - ----------------------------------------------------------------------------------- Involuntary Lease Termination Termination Total - ----------------------------------------------------------------------------------- Beginning accrual balance, January 1, 2003 $ 12 $ 8 $ 20 Expense 3 - 3 Payments (8) - (8) - ----------------------------------------------------------------------------------- Ending accrual balance at June 30, 2003 $ 7 $ 8 $ 15 ===================================================================================
3: UNCERTAINTIES Several business trends or uncertainties may affect our financial results and condition. These trends or uncertainties have, or we reasonably expect could have, a material impact on net sales, revenues, or income from continuing operations. Such trends and uncertainties are discussed in detail below. SEC AND OTHER INVESTIGATIONS: As a result of round-trip trading transactions by CMS MST, CMS Energy's Board of Directors established a Special Committee to investigate matters surrounding the transactions and retained outside counsel to assist in the investigation. The Special Committee completed its investigation and reported its findings to the Board of Directors in October 2002. The Special Committee concluded, based on an extensive investigation, that the round-trip trades were undertaken to raise CMS MST's profile as an energy marketer with the goal of enhancing its ability to promote its services to new customers. The Special Committee found no effort to manipulate the price of CMS Energy Common Stock or affect energy prices. The Special Committee also made recommendations designed to prevent any recurrence of this practice. Previously, CMS Energy terminated its speculative trading business and revised its risk management policy. The Board of Directors adopted, and CMS Energy has implemented the recommendations of the Special Committee. CMS Energy is cooperating with an investigation by the DOJ concerning round-trip trading. CMS Energy is unable to predict the outcome of this matter and what effect, if any, this investigation will have on its business. In March 2004, the SEC approved a cease-and-desist order settling an administrative action against CMS Energy related to round-trip trading. The order did not assess a fine and CMS Energy neither admitted to nor denied the order's findings. The settlement resolved the SEC investigation involving CMS Energy and CMS MST. SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of securities class action complaints were filed against CMS Energy, Consumers, and certain officers and directors of CMS Energy and its affiliates. The complaints were filed as purported class actions in the United States District Court for the Eastern District of Michigan, by shareholders who allege that they purchased CMS Energy's securities during a purported class period. The cases were consolidated into a single lawsuit and an amended and consolidated class action complaint was filed on May 1, 2003. The consolidated complaint contains a purported class period beginning on May 1, 2000 and running through March 31, 2003. It generally seeks unspecified damages based on allegations that the defendants violated United States securities laws and regulations by making allegedly false and misleading statements about CMS Energy's business and financial condition, particularly with respect to revenues and expenses recorded in connection with round-trip trading by CMS MST. The judge issued an opinion and order dated March 31, 2004 in connection with various pending motions, including plaintiffs' motion to amend the complaint and the motions to dismiss the complaint filed by CMS Energy, Consumers and other defendants. The judge directed plaintiffs to file an amended complaint under seal and ordered an expedited hearing on the motion to amend, which was held on May 12, 2004. At the hearing, the judge ordered plaintiffs to file a Second Amended Consolidated Class Action complaint deleting Counts III and CMS-57 CMS Energy Corporation IV relating to purchasers of CMS PEPS, which the judge ordered dismissed with prejudice. Plaintiffs filed this complaint on May 26, 2004. CMS Energy, Consumers, and the individual defendants filed new motions to dismiss on June 21, 2004. A hearing on those motions occurred on August 2, 2004 and the judge has taken the matter under advisement. CMS Energy, Consumers and the individual defendants will defend themselves vigorously but cannot predict the outcome of this litigation. DEMAND FOR ACTIONS AGAINST OFFICERS AND DIRECTORS: In May 2002, the Board of Directors of CMS Energy received a demand, on behalf of a shareholder of CMS Energy Common Stock, that it commence civil actions (i) to remedy alleged breaches of fiduciary duties by certain CMS Energy officers and directors in connection with round-trip trading by CMS MST, and (ii) to recover damages sustained by CMS Energy as a result of alleged insider trades alleged to have been made by certain current and former officers of CMS Energy and its subsidiaries. In December 2002, two new directors were appointed to the Board. The Board formed a special litigation committee in January 2003 to determine whether it is in CMS Energy's best interest to bring the action demanded by the shareholder. The disinterested members of the Board appointed the two new directors to serve on the special litigation committee. In December 2003, during the continuing review by the special litigation committee, CMS Energy was served with a derivative complaint filed on behalf of the shareholder in the Circuit Court of Jackson County, Michigan in furtherance of his demands. The date for CMS Energy and other defendants to answer or otherwise respond to the complaint has been extended to September 1, 2004, subject to such further extensions as may be mutually agreed upon by the parties and authorized by the Court. CMS Energy cannot predict the outcome of this matter. ERISA LAWSUITS: CMS Energy is a named defendant, along with Consumers, CMS MST, and certain named and unnamed officers and directors, in two lawsuits brought as purported class actions on behalf of participants and beneficiaries of the CMS Employees' Savings and Incentive Plan (the Plan). The two cases, filed in July 2002 in United States District Court for the Eastern District of Michigan, were consolidated by the trial judge and an amended consolidated complaint was filed. Plaintiffs allege breaches of fiduciary duties under ERISA and seek restitution on behalf of the Plan with respect to a decline in value of the shares of CMS Energy Common Stock held in the Plan. Plaintiffs also seek other equitable relief and legal fees. The judge issued an opinion and order dated March 31, 2004 in connection with the motions to dismiss filed by CMS Energy, Consumers and the individuals. The judge dismissed certain of the amended counts in the plaintiffs' complaint and denied CMS Energy's motion to dismiss the other claims in the complaint. CMS Energy, Consumers and the individual defendants filed answers to the amended complaint on May 14, 2004. A trial date has not been set, but is expected to be no earlier than late in 2005. CMS Energy and Consumers will defend themselves vigorously but cannot predict the outcome of this litigation. GAS INDEX PRICE REPORTING INVESTIGATION: CMS Energy has notified appropriate regulatory and governmental agencies that some employees at CMS MST and CMS Field Services appeared to have provided inaccurate information regarding natural gas trades to various energy industry publications which compile and report index prices. CMS Energy is cooperating with an ongoing investigation by the DOJ regarding this matter. CMS Energy is unable to predict the outcome of the DOJ investigation and what effect, if any, this investigation will have on its business. GAS INDEX PRICE REPORTING LITIGATION: In August 2003, Cornerstone Propane Partners, L.P. (Cornerstone) filed a putative class action complaint in the United States District Court for the Southern District of New York against CMS Energy and dozens of other energy companies. The court ordered the Cornerstone complaint to be consolidated with similar complaints filed by Dominick Viola and Roberto Calle Gracey. The plaintiffs filed a consolidated complaint on January 20, 2004. The consolidated CMS-58 CMS Energy Corporation complaint alleges that false natural gas price reporting by the defendants manipulated the prices of NYMEX natural gas futures and options. The complaint contains two counts under the Commodity Exchange Act, one for manipulation and one for aiding and abetting violations. CMS Energy is no longer a defendant, however, CMS MST and CMS Field Services are named as defendants. (CMS Energy sold CMS Field Services to Cantera Natural Gas, Inc. but is required to indemnify Cantera Natural Gas, Inc. with respect to this action). In a similar but unrelated matter, Texas-Ohio Energy, Inc. filed a putative class action lawsuit in the United States District Court for the Eastern District of California against a number of energy companies engaged in the sale of natural gas in the United States. CMS Energy is named as a defendant. The complaint alleges defendants entered into a price-fixing conspiracy by engaging in activities to manipulate the price of natural gas in California. The complaint contains counts alleging violations of the Sherman Act, Cartwright Act (a California statute), and the California Business and Profession Code relating to unlawful, unfair and deceptive business practices. There is currently pending in the Nevada federal district court a multi-district court litigation (MDL) matter involving seven complaints originally filed in various state courts in California. These complaints make allegations similar to those in the Texas-Ohio case regarding price reporting, although none contain a Sherman Act claim and some of the defendants in the MDL matter are also defendants in the Texas-Ohio case. Those defendants successfully argued to have the Texas-Ohio case transferred to the MDL proceeding. The plaintiff in the Texas-Ohio case agreed to extend the time for all defendants to answer or otherwise respond until May 28, 2004 and on that date a number of defendants filed motions to dismiss. In order to negotiate possible dismissal and/or substitution of defendants, CMS Energy and two other parent holding company defendants were given further extensions to answer or otherwise respond to the complaint until August 16, 2004. Benscheidt v. AEP Energy Services, Inc., et al., a new class action complaint containing allegations similar to those made in the Texas-Ohio case, albeit limited to California state law claims, was filed in California state court in February 2004. CMS Energy and CMS MST are named as defendants. Defendants filed a notice to remove this action to California federal district court, which was granted, and had it transferred to the MDL proceeding in Nevada. However, the plaintiff is seeking to have the case remanded back to California and until the issue is resolved, no further action will be taken. Three new, virtually identical actions were filed in San Diego Superior Court in July 2004, one by the County of Santa Clara (Santa Clara), one by the County of San Diego (San Diego) and one by the City of and County of San Francisco and the San Francisco City Attorney (collectively San Francisco). Defendants, consisting of a number of energy companies including CMS Energy, CMS MS&T, Cantera Natural Gas and Cantera Gas Company, are alleged to have engaged in false reporting of natural gas price and volume information and sham sales to artificially inflate natural gas retail prices in California. All three complaints allege claims for unjust enrichment and violations of the Cartwright Act, and the San Francisco action also alleges a claim for violation of the California Business and Profession Code relating to unlawful, unfair and deceptive business practices. CMS Energy and the other CMS defendants will defend themselves vigorously, but cannot predict the outcome of these matters. CMS-59 CMS Energy Corporation CONSUMERS' UNCERTAINTIES Several business trends or uncertainties may affect our financial results and condition. These trends or uncertainties have, or we reasonably expect could have, a material impact on revenues or income from continuing electric and gas operations. Such trends and uncertainties include: Environmental - increased capital expenditures and operating expenses for Clean Air Act compliance, and - potential environmental liabilities arising from various environmental laws and regulations, including potential liability or expense relating to the Michigan Natural Resources and Environmental Protection Acts, Superfund, and at former manufactured gas plant facilities. Restructuring - response of the MPSC and Michigan legislature to electric industry restructuring issues, - ability to meet peak electric demand requirements at a reasonable cost, without market disruption, - ability to recover any of our net Stranded Costs under the regulatory policies being followed by the MPSC, - effects of lost electric supply load to alternative electric suppliers, and - status as an electric transmission customer, instead of an electric transmission owner. Regulatory - recovery of nuclear decommissioning costs, - responses from regulators regarding the storage and ultimate disposal of spent nuclear fuel, - inadequate regulatory response to applications for requested rate increases, and - response to increases in gas costs, including adverse regulatory response and reduced gas use by customers. Other - pending litigation regarding PURPA qualifying facilities, and - other pending litigation. CONSUMERS' ELECTRIC UTILITY CONTINGENCIES ELECTRIC ENVIRONMENTAL MATTERS: Our operations are subject to environmental laws and regulations. Costs to operate our facilities in compliance with these laws and regulations generally have been recovered in customer rates. Clean Air: The EPA and the state regulations require us to make significant capital expenditures estimated to be $771 million. As of June 30, 2004, we have incurred $489 million in capital expenditures to comply with the EPA regulations and anticipate that the remaining $282 million of capital expenditures will be made between 2004 and 2009. These expenditures include installing catalytic reduction technology at some of our coal-fired electric plants. Based on the Customer Choice Act, beginning January 2004, an annual return of and on these types of capital expenditures, to the extent they are above depreciation levels, is expected to be recoverable from customers, subject to the MPSC prudency hearing. The EPA has alleged that some utilities have incorrectly classified plant modifications as "routine maintenance" rather than seek modification permits from the EPA. We have received and responded to CMS-60 CMS Energy Corporation information requests from the EPA on this subject. We believe that we have properly interpreted the requirements of "routine maintenance." If our interpretation is found to be incorrect, we may be required to install additional pollution controls at some or all of our coal-fired electric plants and potentially pay fines. Additionally, the viability of certain plants remaining in operation could be called into question. In addition to modifying the coal-fired electric plants, we expect to purchase nitrogen oxide emissions credits for years 2004 through 2008. The cost of these credits is estimated to average $8 million per year and is accounted for as inventory. The credit inventory is expensed as the coal-fired electric plants generate electricity. The price for nitrogen oxide emissions credits is volatile and could change substantially. The EPA has proposed a Clean Air Interstate Rule that would require additional coal-fired electric plant emission controls for nitrogen oxides and sulfur dioxide. If implemented, this rule would potentially require expenditures equivalent to those efforts in progress required to reduce nitrogen oxide emissions under the Title I provisions of the Clean Air Act. The rule proposes a two-phase program to reduce emissions of sulfur dioxide by 70 percent and nitrogen oxides by 65 percent by 2015. Additionally, the EPA also proposed two alternative sets of rules to reduce emissions of mercury and nickel from coal-fired and oil-fired electric plants. Until the proposed environmental rules are finalized, an accurate cost of compliance cannot be determined. Several bills have been introduced in the United States Congress that would require reductions in emissions of greenhouse gases. We cannot predict whether any federal mandatory greenhouse gas emission reduction rules ultimately will be enacted, or the specific requirements of any such rules if they were to become law. To the extent that greenhouse gas emission reduction rules come into effect, such mandatory emissions reduction requirements could have far-reaching and significant implications for the energy sectors. We cannot estimate the potential effect of United States federal or state level greenhouse gas policy on future consolidated results of operations, cash flows or financial position due to the speculative nature of the policy. We stay abreast of and engage in the greenhouse gas policy developments, and will continue to assess and respond to their potential implications on our business operations. Water: In March 2004, the EPA changed the rules that govern generating plant cooling water intake systems. The new rules require significant reduction in fish killed by operating equipment. Some of our facilities will be required to comply by 2006. We are studying the rules to determine the most cost-effective solutions for compliance. Cleanup and Solid Waste: Under the Michigan Natural Resources and Environmental Protection Act, we expect that we will ultimately incur investigation and remedial action costs at a number of sites. We believe that these costs will be recoverable in rates under current ratemaking policies. We are a potentially responsible party at several contaminated sites administered under Superfund. Superfund liability is joint and several, meaning that many other creditworthy parties with substantial assets are potentially responsible with respect to the individual sites. Based on past experience, we estimate that our share of the total liability for the known Superfund sites will be between $1 million and $9 million. As of June 30, 2004, we have recorded a liability for the minimum amount of our estimated Superfund liability. CMS-61 CMS Energy Corporation In October 1998, during routine maintenance activities, we identified PCB as a component in certain paint, grout, and sealant materials at the Ludington Pumped Storage facility. We removed and replaced part of the PCB material. We have proposed a plan to deal with the remaining materials and are awaiting a response from the EPA. LITIGATION: In October 2003, a group of eight PURPA qualifying facilities selling power to us filed a lawsuit in Ingham County Circuit Court. The lawsuit alleges that we incorrectly calculated the energy charge payments made pursuant to power purchase agreements with qualifying facilities. More specifically, the lawsuit alleges that we should be basing the energy charge calculation on the cost of more expensive eastern coal, rather than on the cost of the coal actually burned by us for use in our coal-fired generating plants. We believe we have been performing the calculation in the manner prescribed by the power purchase agreements, and have filed a request with the MPSC (as a supplement to the PSCR plan) that asks the MPSC to review this issue and to confirm that our method of performing the calculation is correct. We filed a motion to dismiss the lawsuit in the Ingham County Circuit Court due to the pending request at the MPSC concerning the PSCR plan case. In February 2004, the judge ruled on the motion and deferred to the primary jurisdiction of the MPSC. This ruling resulted in a dismissal of the circuit court case without prejudice. Although only eight qualifying facilities have raised the issue, the same energy charge methodology is used in the PPA with the MCV Partnership and in approximately 20 additional power purchase agreements with us, representing a total of 1,670 MW of electric capacity. The eight plaintiff qualifying facilities have appealed the dismissal of the circuit court case to the Michigan Court of Appeals. We cannot predict the outcome of this matter. CONSUMERS' ELECTRIC UTILITY RESTRUCTURING MATTERS ELECTRIC RESTRUCTURING LEGISLATION: The Michigan legislature passed electric utility restructuring legislation known as the Customer Choice Act. This Act: - allows all customers to choose their electric generation supplier effective January 1, 2002, - provides a one-time five percent residential electric rate reduction, - froze all electric rates through December 31, 2003, and established a rate cap for residential customers through at least December 31, 2005, and a rate cap for small commercial and industrial customers through at least December 31, 2004, - allows deferred recovery of an annual return of and on capital expenditures in excess of depreciation levels incurred during and before the rate freeze-cap period, - allows for the use of Securitization bonds to refinance qualified costs, - allows recovery of net Stranded Costs and implementation costs incurred as a result of the passage of the act, - requires Michigan utilities to join a FERC-approved RTO or sell their interest in transmission facilities to an independent transmission owner, - requires Consumers, Detroit Edison, and AEP to jointly expand their available transmission capability by at least 2,000 MW, and - establishes a market power supply test that, if not met, may require transferring control of generation resources in excess of that required to serve retail sales requirements. The following summarizes our status under the last three provisions of the Customer Choice Act. First, we chose to sell our interest in our transmission facilities to an independent transmission owner to comply with the Customer Choice Act; for additional details regarding the sale of the transmission facility, see "Transmission Sale" within this section. Second, in July 2002, the MPSC issued an order approving our plan to achieve the increased transmission capacity required under the Customer Choice CMS-62 CMS Energy Corporation Act. We have completed the transmission capacity projects identified in the plan and have submitted verification of this fact to the MPSC. We believe we are in full compliance. Lastly, in September 2003, the MPSC issued an order finding that we are in compliance with the market power supply test set forth in the Customer Choice Act. ELECTRIC ROA: The MPSC approved revised tariffs that establish the rates, terms, and conditions under which retail customers are permitted to choose an electric supplier. These revised tariffs allow ROA customers, upon as little as 30 days notice to us, to return to our generation service at current tariff rates. If any class of customers' (residential, commercial, or industrial) ROA load reaches ten percent of our total load for that class of customers, then returning ROA customers for that class must give 60 days notice to return to our generation service at current tariff rates. However, we may not have capacity available to serve returning ROA customers that is sufficient or reasonably priced. As a result, we may be forced to purchase electricity on the spot market at higher prices than we can recover from our customers during the rate cap periods. We cannot predict the total amount of electric supply load that may be lost to alternative electric suppliers. As of July 2004, alternative electric suppliers are providing 858 MW of load. This amount represents 11 percent of the total distribution load and an increase of 49 percent compared to July 2003. ELECTRIC RESTRUCTURING PROCEEDINGS: Below is a discussion of our electric restructuring proceedings. They are: - Securitization, - Stranded Costs, - implementation costs, - security costs, and - transmission rates. The following chart summarizes the filings with the MPSC. For additional details related to these proceedings, see related sections within this Note. CMS-63 CMS Energy Corporation
Years Years Requested Proceeding Filed Covered Amounts Status - --------------------------------------------------------------------------------------------- Securitization 2003 N/A $1.083 billion Received order from the MPSC authorizing the issuance of Securitization bonds in the amount of $554 million. Pending MPSC order resolving outstanding issues. Stranded Costs 2002-2004 2000-2003 $137 million (a) MPSC ruled that we experienced zero Stranded Costs for 2000 through 2001, which we are appealing. Filings for 2002 and 2003 in the amount of $116 million are still pending MPSC approval. Implementation 1999-2004 1997-2003 $91 million (b) MPSC allowed $68 million for the Costs years 1997-2001, plus $20 million for the cost of money through 2003. Implementation cost filings for 2002 and 2003 in the amount of $8 million, which includes the cost of money through 2003, are still pending MPSC approval. Security Costs 2004 2001-2005 $25 million Pending MPSC approval. As of June 30, 2004, we have recorded $7 million of costs incurred as a regulatory asset. =============================================================================================
(a) Amount includes the cost of money through the year in which we expected to receive recovery from the MPSC and assumes the issuance of Securitization bonds in an amount that includes Clean Air Act investments. If Clean Air Act investments were not included in the issuance of Securitization bonds, Stranded Costs requested would total $304 million. (b) Amounts include the cost of money through year incurred. Securitization: The Customer Choice Act allows for the use of Securitization bonds to refinance certain qualified costs. Since Securitization involves issuing bonds secured by a revenue stream from rates collected directly from customers to service the bonds, Securitization bonds typically have a higher credit rating than conventional utility corporate financing. In 2000 and 2001, the MPSC issued orders authorizing us to issue Securitization bonds. We issued our first Securitization bonds in late 2001. Securitization resulted in: - lower interest costs, and - longer amortization periods for the securitized assets. We will recover the repayment of principal, interest, and other expenses relating to the bond issuance through a Securitization charge and a tax charge that began in December 2001. These charges are subject to an annual true up until one year before the last scheduled bond maturity date, and no more than CMS-64 CMS Energy Corporation quarterly thereafter. The December 2003 true up modified the total Securitization and related tax charges from 1.746 mills per kWh to 1.718 mills per kWh. There will be no impact on customer bills from Securitization for most of our electric customers until the Customer Choice Act cap period expires, and an electric rate case is processed. Securitization charge collections, $25 million for the six months ended June 30, 2004, and $25 million for the six months ended June 30, 2003, are remitted to a trustee. Securitization charge collections are restricted to the repayment of the principal and interest on the Securitization bonds and payment of the ongoing expenses of Consumers Funding. Consumers Funding is legally separate from Consumers. The assets and income of Consumers Funding, including the securitized property, are not available to creditors of Consumers or CMS Energy. In March 2003, we filed an application with the MPSC seeking approval to issue additional Securitization bonds. In June 2003, the MPSC issued a financing order authorizing the issuance of Securitization bonds in the amount of $554 million. This amount relates to Clean Air Act expenditures and associated return on those expenditures through December 31, 2002, ROA implementation costs and previously authorized return on those expenditures through December 31, 2000, and other up front qualified costs related to issuance of the Securitization bonds. In July 2003, we filed for rehearing and clarification on a number of features in the financing order. In December 2003, the MPSC ordered remanded hearings in response to our request for rehearing and clarification. In March 2004, the MPSC conducted the remanded hearings and the matter is presently before the MPSC awaiting a decision. In May 2004, we withdrew our request for approved implementation costs incurred for the years 1998 through 2000 from the Securitization case, as we chose recovery of the approved implementation costs through the use of a surcharge, as described in "Implementation Costs" within this section. However, qualified Clean Air Act costs, after taking out implementation costs, still exceed the $554 million MPSC limit on the amount of securitized bonds. As a result, we did not request a decrease to allowable securitized costs. If and when the MPSC issues an order with favorable terms, then the order will become effective upon our acceptance. Stranded Costs: The Customer Choice Act allows electric utilities to recover their net Stranded Costs, without defining the term. The Act directs the MPSC to establish a method of calculating net Stranded Costs and of conducting related true-up adjustments. In December 2001, the MPSC Staff recommended a methodology, which calculated net Stranded Costs as the shortfall between: - - the revenue required to cover the costs associated with fixed generation assets and capacity payments associated with purchase power agreements, and - - the revenues received from customers under existing rates available to cover the revenue requirement. The MPSC authorizes us to use deferred accounting to recognize the future recovery of costs determined to be stranded. According to the MPSC, net Stranded Costs are to be recovered from ROA customers through a Stranded Cost transition charge. However, the MPSC has not yet allowed such a transition charge. The MPSC has declined to resolve numerous issues regarding the net Stranded Cost methodology in a way that would allow a reliable prediction of the level of Stranded Costs. As a result, we have not recorded regulatory assets to recognize the future recovery of such costs. CMS-65 CMS Energy Corporation The following table outlines the applications filed by us with the MPSC and the status of recovery for these costs:
In Millions - -------------------------------------------------------------------------------------- Requested, without the Requested, with the issuance issuance of Securitization of Securitization bonds that bonds that include Clean Air Year Year include Clean Air Act Act investment and cost of Recoverable Filed Incurred investment and cost of money money amount - -------------------------------------------------------------------------------------- 2002 2000 $12 $ 26 $ - 2002 2001 9 46 - 2003 2002 47 104 Pending 2004 2003 69 128 Pending ======================================================================================
We are currently in the process of appealing the MPSC orders regarding Stranded Costs for 2000 and 2001 with the Michigan Court of Appeals and the Michigan Supreme Court. In June 2004, the MPSC conducted hearings for our 2002 Stranded Cost application. Once a final financing order on Securitization is reached, we will know the amount of our request for net Stranded Cost recovery for 2002. In July 2004, the ALJ issued a proposal for decision in our 2002 net Stranded Cost case, which recommended that the MPSC find that we incurred net Stranded Costs of $12 million. This recommendation includes the cost of money through July 2004 and excludes Clean Air Act investments. The MPSC has scheduled hearings for our 2003 Stranded Cost application for August 2004. In July 2004, the MPSC Staff issued a position on our 2003 net Stranded Cost application, which resulted in a Stranded Cost calculation of $52 million. The amount includes the cost of money, but excludes Clean Air Act investments. We cannot predict how the MPSC will rule on our requests for recoverability of 2002 and 2003 Stranded Costs or whether the MPSC will adopt a Stranded Cost recovery method that will offset fully any associated margin loss from ROA. Implementation Costs: The Customer Choice Act allows electric utilities to recover their implementation costs. The following table outlines the applications filed by us with the MPSC and the status of recovery for these costs:
In Millions - -------------------------------------------------------------------------------- Recoverable, including (b) cost of money through Year Filed Year Incurred Requested Disallowed Allowed 2003 - -------------------------------------------------------------------------------- 1999 1997 & 1998 $ 20 $ 5 $ 15 $22 2000 1999 30 5 25 33 2001 2000 25 5 20 24 2002 2001 8 - 8 9 2003 & 2004 (a) 2002 7 Pending Pending Pending 2004 2003 1 Pending Pending Pending ================================================================================
(a) On March 31, 2004, we requested additional 2002 implementation cost recovery of $5 million related to our former participation in the development of the Alliance RTO. This cost has been expensed; therefore, the amount is not included as a regulatory asset. CMS-66 CMS Energy Corporation (b) Amounts include the cost of money through year incurred. In addition to seeking MPSC approval for these costs, we are pursuing authorization at the FERC for the MISO to reimburse us for approximately $8 million, for implementation costs related to our former participation in the development of the Alliance RTO which includes the $5 million pending approval by the MPSC as part of 2002 implementation costs recovery. These costs have generally either been expensed or approved as recoverable implementation costs by the MPSC. The FERC has denied our request for reimbursement and we are appealing the FERC ruling at the United States Court of Appeals for the District of Columbia. We cannot predict the outcome of the appeal process or the ultimate amount, if any, we will collect for Alliance RTO development costs. The MPSC disallowed certain costs, determining that these amounts did not represent costs incremental to costs already reflected in electric rates. As of June 30, 2004, we incurred and deferred as a regulatory asset $94 million of implementation costs, which includes $25 million associated with the cost of money. We believe the implementation costs and associated cost of money are fully recoverable in accordance with the Customer Choice Act. In June 2004, following an appeal and remand of initial MPSC orders relating to 1999 implementation costs, the MPSC authorized the recovery of all previously approved implementation costs for the years 1997 through 2001 totaling $88 million. This total includes carrying costs through 2003. Additional carrying costs will be added until collection occurs. The implementation costs will be recovered through surcharges over 36-month collection periods and phased in as applicable rate caps expire. We cannot predict the amounts the MPSC will approve as recoverable costs for 2002 and 2003. Security Costs: The Customer Choice Act, as amended, allows for recovery of new and enhanced security costs, as a result of federal and state regulatory security requirements incurred before January 1, 2006. All retail customers, except customers of alternative electric suppliers, would pay these charges. In April 2004, we filed a security cost recovery case with the MPSC for costs for which recovery has not yet been granted through other means. The requested amount includes reasonable and prudent security enhancements through December 31, 2005. The costs are for enhanced security and insurance because of federal and state regulatory security requirements imposed after the September 11 2001 terrorist attacks. In July 2004, a settlement was reached with the parties to the case, which would provide for full recovery of the requested security costs over a five-year period beginning in 2004. We are presently awaiting approval from the MPSC. We cannot predict how the MPSC will rule on our request for the recoverability of security costs. The following table outlines the applications filed by us with the MPSC and the status of recovery for these costs:
In Millions - -------------------------------------------------------------------------------- Regulatory asset as of Year Filed Years Incurred Requested June 30, 2004 Disallowed Allowed - -------------------------------------------------------------------------------- 2004 2001-2005 $ 25 $7 Pending Pending ================================================================================
Transmission Rates: Our application of JOATT transmission rates to customers during past periods is under FERC review. The rates included in these tariffs were applied to certain transmission transactions affecting both Detroit Edison's and our transmission systems between 1997 and 2002. We believe our reserve is sufficient to satisfy our refund obligation to any of our former transmission customers under our former JOATT. TRANSMISSION SALE: In May 2002, we sold our electric transmission system to MTH, a non-affiliated limited partnership whose general partner is a subsidiary of Trans-Elect, Inc. We are currently in CMS-67 CMS Energy Corporation arbitration with MTH regarding property tax items used in establishing the selling price of our electric transmission system. An unfavorable outcome could result in a reduction of sale proceeds previously recognized of approximately $2 million to $3 million. Under an agreement with MTH, our transmission rates are fixed by contract at current levels through December 31, 2005, and are subject to the FERC ratemaking thereafter. However, we are subject to certain additional MISO surcharges, which we estimate to be $10 million in 2004. CONSUMERS' ELECTRIC UTILITY RATE MATTERS PERFORMANCE STANDARDS: Electric distribution performance standards developed by the MPSC became effective in February 2004. The standards relate to restoration after outages, safety, and customer services. The MPSC order calls for financial penalties in the form of customer credits if the standards for the duration and frequency of outages are not met. We met or exceeded all approved standards for year-end results for both 2002 and 2003. As of June 2004, we are in compliance with the acceptable level of performance. We are a member of an industry coalition that has appealed the customer credit portion of the performance standards to the Michigan Court of Appeals. We cannot predict the likely effects of the financial penalties, if any, nor can we predict the outcome of the appeal. Likewise, we cannot predict our ability to meet the standards in the future or the cost of future compliance. POWER SUPPLY COSTS: We were required to provide backup service to ROA customers on a best efforts basis. In October 2003, we provided notice to the MPSC that we would terminate the provision of backup service in accordance with the Customer Choice Act, effective January 1, 2004. To reduce the risk of high electric prices during peak demand periods and to achieve our reserve margin target, we employ a strategy of purchasing electric call options and capacity and energy contracts for the physical delivery of electricity primarily in the summer months and to a lesser degree in the winter months. As of June 30, 2004, we purchased capacity and energy contracts partially covering the estimated reserve margin requirements for 2004 through 2007. As a result, we have recognized an asset of $18 million for unexpired capacity and energy contracts. In March 2004, we filed a summer assessment for meeting 2004 peak load demand as required by the MPSC, stating that our summer 2004 reserve margin target is 11 percent or supply resources equal to 111 percent of projected summer peak load. Presently, we have a reserve margin of 14 percent, or supply resources equal to 114 percent of projected summer peak load for summer 2004. Of the 114 percent, approximately 102 percent is from owned electric generating plants and long-term contracts, and approximately 12 percent is from short-term contracts. This reserve margin met our summer 2004 reserve margin target. The total premium costs of electricity call options and capacity and energy contracts for 2004 is expected to be approximately $12 million, as of July 2004. PSCR: As a result of meeting the transmission capability expansion requirements and the market power test, as discussed within this Note, we have met the requirements under the Customer Choice Act to return to the PSCR process. The PSCR process provides for the reconciliation of actual power supply costs with power supply revenues. This process assures recovery of all reasonable and prudent power supply costs actually incurred by us. In September 2003, we submitted a PSCR filing to the MPSC that reinstates the PSCR process for customers whose rates are no longer frozen or capped as of January 1, 2004. The proposed PSCR charge allows us to recover a portion of our increased power supply costs from large commercial and industrial customers, and subject to the overall rate caps, from other customers. We estimate the recovery of increased power supply costs from large commercial and industrial customers to be approximately $30 million in 2004. As allowed under current regulation, we self-implemented the proposed PSCR charge on January 1, 2004. The revenues received from the PSCR CMS-68 CMS Energy Corporation charge are also subject to subsequent reconciliation at the end of the year after actual costs have been reviewed for reasonableness and prudence. We cannot predict the outcome of this reconciliation proceeding. OTHER CONSUMERS' ELECTRIC UTILITY 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. We hold, through two wholly owned subsidiaries, the following assets related to the MCV Partnership and the MCV Facility: - - CMS Midland owns a 49 percent general partnership interest in the MCV Partnership, and - - CMS Holdings holds, through the FMLP, a 35 percent lessor interest in the MCV Facility. In 2004, we consolidated the MCV Partnership and the FMLP into our consolidated financial statements in accordance with Revised FASB Interpretation No. 46. For additional details, see Note 11, Implementation of New Accounting Standards. Our consolidated retained earnings include undistributed earnings from the MCV Partnership, which at June 30, 2004 are $246 million and at June 30, 2003 are $243 million. Power Supply Purchases from the MCV Partnership: Our annual obligation to purchase capacity from the MCV Partnership is 1,240 MW through the term of the PPA ending in 2025. The PPA requires us to pay, based on the MCV Facility's availability, a levelized average capacity charge of 3.77 cents per kWh and a fixed energy charge. We also pay a variable energy charge based on our average cost of coal consumed for all kWh delivered. Effective January 1999, we reached a settlement agreement with the MCV Partnership that capped capacity payments made on the basis of availability that may be billed by the MCV Partnership at a maximum 98.5 percent availability level. Since January 1993, the MPSC has permitted us to recover capacity charges averaging 3.62 cents per kWh for 915 MW, plus fixed and variable energy charges. Since January 1996, the MPSC has also permitted us to recover capacity charges for the remaining 325 MW of contract capacity with an initial average charge of 2.86 cents per kWh increasing periodically to an eventual 3.62 cents per kWh by 2004 and thereafter. However, due to the frozen retail rates required by the Customer Choice Act, the capacity charge for the 325 MW was frozen at 3.17 cents per kWh until December 31, 2003. Recovery of both the 915 MW and 325 MW portions of the PPA are subject to certain limitations discussed below. In 1992, we recognized a loss and established a liability for the present value of the estimated future underrecoveries of power supply costs under the PPA based on the MPSC cost-recovery orders. The remaining liability associated with the loss totaled $13 million at June 30, 2004 and $40 million at June 30, 2003. We expect the PPA liability to be depleted in late 2004. We estimate that 51 percent of the actual cash underrecoveries for 2004 will be charged to the PPA liability, with the remaining portion charged to operating expense as a result of our 49 percent ownership in the MCV Partnership. We will expense all cash underrecoveries directly to income once the PPA liability is depleted. If the MCV Facility's generating availability remains at the maximum 98.5 percent level, our cash underrecoveries associated with the PPA could be as follows: CMS-69 CMS Energy Corporation
In Millions - ----------------------------------------------------------------------- 2004 2005 2006 2007 - ----------------------------------------------------------------------- Estimated cash underrecoveries at 98.5% $ 56 $ 56 $ 55 $ 39 Amount to be charged to operating expense 29 56 55 39 Amount to be charged to PPA liability 27 - - - =======================================================================
Beginning January 1, 2004, the rate freeze for large industrial customers was no longer in effect and we returned to the PSCR process. Under the PSCR process, we will recover from our customers the approved capacity and fixed energy charges based on availability, up to an availability cap of 88.7 percent as established in previous MPSC orders. Effects on Our Ownership Interest in the MCV Partnership and the MCV Facility: As a result of returning to the PSCR process on January 1, 2004, we returned to dispatching the MCV Facility on a fixed load basis, as permitted by the MPSC, in order to maximize recovery from electric customers of our capacity and fixed energy payments. This fixed load dispatch increases the MCV Facility's output and electricity production costs, such as natural gas. As the spread between the MCV Facility's variable electricity production costs and its energy payment revenue widens, the MCV's Partnership's financial performance and our investment in the MCV Partnership is and will be affected adversely. Under the PPA, variable energy payments to the MCV Partnership are based on the cost of coal burned at our coal plants and our operation and maintenance expenses. However, the MCV Partnership's costs of producing electricity are tied to the cost of natural gas. Because natural gas prices have increased substantially in recent years and the price the MCV Partnership can charge us for energy has not, the MCV Partnership's financial performance has been impacted negatively. Until September 2007, the PPA and settlement agreement require us to pay capacity and fixed energy charges based on the MCV Facility's actual availability up to the 98.5 percent cap. After September 2007, we expect to claim relief under the regulatory out provision in the PPA, limiting our capacity and fixed energy payments to the MCV Partnership to the amount collected from our customers. The MPSC's future actions on the capacity and fixed energy payments recoverable from customers subsequent to September 2007 may affect negatively the earnings of the MCV Partnership and the value of our investment in the MCV Partnership. Resource Conservation Plan: In February 2004, we filed the RCP with the MPSC that is intended to help conserve natural gas and thereby improve our investment in the MCV Partnership. This plan seeks approval to: - dispatch the MCV Facility based on natural gas market prices without increased costs to electric customers, - give Consumers a priority right to buy excess natural gas as a result of the reduced dispatch of the MCV Facility, and - fund $5 million annually for renewable energy sources such as wind power projects. The RCP will reduce the MCV Facility's annual production of electricity and, as a result, reduce the MCV Facility's consumption of natural gas by an estimated 30 to 40 bcf. This decrease in the quantity of high-priced natural gas consumed by the MCV Facility will benefit Consumers' ownership interest in the MCV Partnership. The amount of PPA capacity and fixed energy payments recovered from retail CMS-70 CMS Energy Corporation electric customers would remain capped at 88.7 percent. Therefore, customers will not be charged for any increased power supply costs, if they occur. Consumers and the MCV Partnership have reached an agreement that the MCV Partnership will reimburse Consumers for any incremental power costs incurred to replace the reduction in power dispatched from the MCV Facility. Presently, we are in settlement discussions with the parties to the RCP filing. However, in July 2004, several qualifying facilities filed for a stay on the RCP proceeding in the Ingham County Circuit Court after their previous attempt to intervene on the proceeding was denied by the MPSC. Hearings on the stay are scheduled for August 11, 2004. We cannot predict if or when the MPSC will approve the RCP or the outcome of the Ingham County Circuit Court hearings. The two most significant variables in the analysis of the MCV Partnership's future financial performance are the forward price of natural gas for the next 20 years and the MPSC's decision in 2007 or beyond related to limiting our recovery of capacity and fixed energy payments. Natural gas prices have been volatile historically. Presently, there is no consensus in the marketplace on the price or range of future prices of natural gas. Even with an approved RCP, if gas prices continue at present levels or increase, the economics of operating the MCV Facility may be adverse enough to require us to recognize an impairment of our investment in the MCV Partnership. We presently cannot predict the impact of these issues on our future earnings, cash flows, or on the value of our investment in the MCV Partnership. MCV PARTNERSHIP PROPERTY TAXES: In January 2004, the Michigan Tax Tribunal issued its decision in the MCV Partnership's tax appeal against the City of Midland for tax years 1997 through 2000. The MCV Partnership estimates that the decision will result in a refund to the MCV Partnership of approximately $35 million in taxes plus $9 million of interest. The Michigan Tax Tribunal decision has been appealed to the Michigan Court of Appeals by the City of Midland and the MCV Partnership has filed a cross-appeal at the Michigan Court of Appeals. The MCV Partnership also has a pending case with the Michigan Tax Tribunal for tax years 2001 through 2004. The MCV Partnership cannot predict the outcome of these proceedings; therefore, the above refund (net of approximately $15 million of deferred expenses) has not been recognized in year-to-date 2004 earnings. NUCLEAR PLANT DECOMMISSIONING: Our site-specific decommissioning cost estimates for Big Rock and Palisades assume that each plant site will eventually be restored to conform to the adjacent landscape and all contaminated equipment will be disassembled and disposed of in a licensed burial facility. Decommissioning funding practices approved by the MPSC require us to file a report on the adequacy of funds for decommissioning at three-year intervals. We prepared and filed updated cost estimates for each plant on March 31, 2004. Excluding additional costs for spent nuclear fuel storage, due to the DOE's failure to accept this spent nuclear fuel on schedule, these reports show a decommissioning cost of $361 million for Big Rock and $868 million for Palisades. Since Big Rock is currently in the process of being decommissioned, the estimated cost includes historical expenditures in nominal dollars and future costs in 2003 dollars, with all Palisades costs given in 2003 dollars. In 1999, the MPSC orders for Big Rock and Palisades provided for fully funding the decommissioning trust funds for both sites. In December 2000, funding of the Big Rock trust fund stopped because the MPSC-authorized decommissioning surcharge collection period expired. The MPSC order set the annual decommissioning surcharge for Palisades at $6 million through 2007. Amounts collected from electric retail customers and deposited in trusts, including trust earnings, are credited to a regulatory liability. However, based on current projections, the current levels of funds provided by the trusts are not adequate to fully fund the decommissioning of Big Rock or Palisades. This is due in part to the DOE's failure to accept the spent nuclear fuel and lower returns on the trust funds. We are attempting to recover our additional costs for storing spent nuclear fuel through litigation, as discussed in "Nuclear Matters". CMS-71 CMS Energy Corporation We will also seek additional relief from the MPSC. In the case of Big Rock, excluding the additional nuclear fuel storage costs due to the DOE's failure to accept this spent fuel on schedule, we are currently projecting that the level of funds provided by the trust will fall short of the amount needed to complete the decommissioning by $25 million. At this point in time, we plan to provide the additional amounts needed from our corporate funds and, subsequent to the completion of radiological decommissioning work, seek recovery of such expenditures at the MPSC. We cannot predict how the MPSC will rule on our request. In the case of Palisades, again excluding additional nuclear fuel storage costs due to the DOE's failure to accept this spent fuel on schedule, we have concluded that the existing surcharge needs to be increased to $25 million annually, beginning January 1, 2006, and continue through 2011, our current license expiration date. In June 2004, we filed an application with the MPSC seeking approval to increase the surcharge for recovery of decommissioning costs related to Palisades beginning in 2006. We cannot predict how the MPSC will rule on our request. NUCLEAR MATTERS: Big Rock: With the removal and safe disposal of the reactor vessel, steam drum, and radioactive waste processing systems in 2003, dismantlement of plant systems is nearly complete and demolition of the remaining plant structures is set to begin. The restoration project is on schedule to return approximately 530 acres of the site, including the area formerly occupied by the nuclear plant, to a natural setting for unrestricted use in mid-2006. An additional 30 acres, the area where seven transportable dry casks loaded with spent nuclear fuel and an eighth cask loaded with high-level radioactive waste material are stored, will be returned to a natural state by the end of 2012 if the DOE begins removing the spent nuclear fuel by 2010. The NRC and the Michigan Department of Environmental Quality continue to find all decommissioning activities at Big Rock are being performed in accordance with applicable regulations including license requirements. Palisades: In March 2004, the NRC completed its end-of-cycle plant performance assessment of Palisades. The assessment for Palisades covered the period from January 1, 2003 through December 31, 2003. The NRC determined that Palisades was operated in a manner that preserved public health and safety and fully met all cornerstone objectives. As of June 2004, all inspection findings were classified as having very low safety significance and all performance indicators indicated performance at a level requiring no additional oversight. Based on the plant's performance, only regularly scheduled inspections are planned through September 2005. The amount of spent nuclear fuel exceeds Palisades' temporary onsite storage pool capacity. We are using dry casks for temporary onsite storage. As of June 30, 2004, we have loaded 18 dry casks with spent nuclear fuel and are scheduled to load additional dry casks this summer in order to continue operation. DOE Litigation: In 1997, a U.S. Court of Appeals decision confirmed that the DOE was to begin accepting deliveries of spent nuclear fuel for disposal by January 1998. Subsequent U.S. Court of Appeals litigation, in which we and other utilities participated, has not been successful in producing more specific relief for the DOE's failure to accept the spent nuclear fuel. CMS-72 CMS Energy Corporation There are two court decisions that support the right of utilities to pursue damage claims in the United States Court of Claims against the DOE for failure to take delivery of spent nuclear fuel. Over 60 utilities have initiated litigation in the United States Court of Claims; we filed our complaint in December 2002. In July 2004, the DOE filed an amended answer and motion to dismiss the complaint. If our litigation against the DOE is successful, we anticipate future recoveries from the DOE. The recoveries will be used to pay the cost of spent nuclear fuel storage until the DOE takes possession as required by law. We can make no assurance that the litigation against the DOE will be successful. In July 2002, Congress approved and the President signed a bill designating the site at Yucca Mountain, Nevada, for the development of a repository for the disposal of high-level radioactive waste and spent nuclear fuel. We expect that the DOE will submit, by December 2004, an application to the NRC for a license to begin construction of the repository. The application and review process is estimated to take several years. Spent nuclear fuel complaint: In March 2003, the Michigan Environmental Council, the Public Interest Research Group in Michigan, and the Michigan Consumer Federation filed a complaint with the MPSC, which was served on us by the MPSC in April 2003. The complaint asks the MPSC to initiate a generic investigation and contested case to review all facts and issues concerning costs associated with spent nuclear fuel storage and disposal. The complaint seeks a variety of relief with respect to Consumers, Detroit Edison, Indiana & Michigan Electric Company, Wisconsin Electric Power Company, and Wisconsin Public Service Corporation. The complaint states that amounts collected from customers for spent nuclear fuel storage and disposal should be placed in an independent trust. The complaint also asks the MPSC to take additional actions. In May 2003, Consumers and other named utilities each filed motions to dismiss the complaint. We are unable to predict the outcome of this matter. Insurance: We maintain nuclear insurance coverage on our nuclear plants. At Palisades, we maintain nuclear property insurance from NEIL totaling $2.750 billion and insurance that would partially cover the cost of replacement power during certain prolonged accidental outages. Because NEIL is a mutual insurance company, we could be subject to assessments of up to $27 million in any policy year if insured losses in excess of NEIL's maximum policyholders surplus occur at our, or any other member's, nuclear facility. NEIL's policies include coverage for acts of terrorism. At Palisades, we maintain nuclear liability insurance for third-party bodily injury and off-site property damage resulting from a nuclear hazard for up to approximately $10.761 billion, the maximum insurance liability limits established by the Price-Anderson Act. The United States Congress enacted the Price-Anderson Act to provide financial liability protection for those parties who may be liable for a nuclear accident or incident. Part of the Price-Anderson Act's financial protection is a mandatory industry-wide program where owners of nuclear generating facilities could be assessed if a nuclear incident occurs at any nuclear generating facility. The maximum assessment against us could be $101 million per occurrence, limited to maximum annual installment payments of $10 million. We also maintain insurance under a program that covers tort claims for bodily injury to nuclear workers caused by nuclear hazards. The policy contains a $300 million nuclear industry aggregate limit. Under a previous insurance program providing coverage for claims brought by nuclear workers, we remain responsible for a maximum assessment of up to $6 million. Big Rock remains insured for nuclear liability by a combination of insurance and a NRC indemnity totaling $544 million and a nuclear property insurance policy from NEIL. CMS-73 CMS Energy Corporation Insurance policy terms, limits, and conditions are subject to change during the year as we renew our policies. COMMITMENTS FOR FUTURE PURCHASES: We enter into a number of unconditional purchase obligations that represent normal business operating contracts. These contracts are used to assure an adequate supply of goods and services necessary for the operation of our business and to minimize exposure to market price fluctuations. We believe that these future costs are prudent and reasonably assured of recovery in future rates. Coal Supply and Transportation: We have entered into coal supply contracts with various suppliers and associated rail transportation contracts for our coal-fired generating stations. Under the terms of these agreements, we are obligated to take physical delivery of the coal and make payment based upon the contract terms. Our coal supply contracts expire through 2005, and total an estimated $147 million. Our coal transportation contracts expire through 2007, and total an estimated $108 million. Long-term coal supply contracts have accounted for approximately 60 to 90 percent of our annual coal requirements over the last 10 years. Although future contract coverage is not finalized at this time, we believe that it will be within the historic 60 to 90 percent range. Power Supply, Capacity, and Transmission: As of June 30, 2004, we had future unrecognized commitments to purchase power transmission services under fixed price forward contracts for 2004 and 2005 totaling $8 million. We also had commitments to purchase capacity and energy under long-term power purchase agreements with various generating plants. These contracts require monthly capacity payments based on the plants' availability or deliverability. These payments for 2004 through 2030 total an estimated $3.033 billion, undiscounted. This amount may vary depending upon plant availability and fuel costs. If a plant was not available to deliver electricity to us, then we would not be obligated to make the capacity payment until the plant could deliver. CONSUMERS' GAS UTILITY CONTINGENCIES GAS ENVIRONMENTAL MATTERS: We expect to incur investigation and remedial costs at a number of sites under the Michigan Natural Resources and Environmental Protection Act, a Michigan statute that covers environmental activities including remediation. These sites include 23 former manufactured gas plant facilities. We operated the facilities on these sites for some part of their operating lives. For some of these sites, we have no current ownership or may own only a portion of the original site. We have completed initial investigations at the 23 sites. We will continue to implement remediation plans for sites where we have received MDEQ remediation plan approval. We will also work toward resolving environmental issues at sites as studies are completed. We have estimated our costs for investigation and remedial action at all 23 sites using the Gas Research Institute-Manufactured Gas Plant Probabilistic Cost Model. We expect our remaining costs to be between $37 million and $90 million. The range reflects multiple alternatives with various assumptions for resolving the environmental issues at each site. The estimates are based on discounted 2003 costs using a discount rate of three percent. The discount rate represents a ten-year average of U.S. Treasury bond rates reduced for increases in the consumer price index. We expect to fund most of these costs through insurance proceeds and through the MPSC approved rates charged to our customers. As of June 30, 2004, we have recorded a regulatory liability of $42 million, net of $41 million of expenditures incurred to date, and a regulatory asset of $66 million. Any significant change in assumptions, such as an increase in the number of sites, different remediation techniques, nature and extent of contamination, and legal and regulatory requirements, could affect our estimate of remedial action costs. CMS-74 CMS Energy Corporation In its November 2002 gas distribution rate order, the MPSC authorized us to continue to recover approximately $1 million of manufactured gas plant facilities environmental clean-up costs annually. This amount will continue to be offset by $2 million to reflect amounts recovered from all other sources. We defer and amortize, over a period of 10 years, manufactured gas plant facilities environmental clean-up costs above the amount currently included in rates. Additional amortization of the expense in our rates cannot begin until after a prudency review in a gas rate case. CONSUMERS' GAS UTILITY RATE MATTERS GAS COST RECOVERY: The MPSC is required by law to allow us to charge customers for our actual cost of purchased natural gas. The GCR process is designed to allow us to recover all of our gas costs; however, the MPSC reviews these costs for prudency in an annual reconciliation proceeding. GCR YEAR 2002-2003: In June 2003, we filed a reconciliation of GCR costs and revenues for the 12-months ended March 2003. We proposed to recover from our customers approximately $6 million of underrecovered gas costs using a roll-in methodology. The roll-in methodology incorporates the GCR underrecovery in the next GCR plan year. The approach was approved by the MPSC in a November 2002 order. In January 2004, intervenors filed their positions in our 2002-2003 GCR case. Their positions were that not all of our gas purchasing decisions were prudent during April 2002 through March 2003 and they proposed disallowances. In 2003, we reserved $11 million for a settlement agreement associated with the 2002-2003 GCR disallowance. Interest on the disallowed amount from April 1, 2003 through February 2004, at Consumers' authorized rate of return, increased the cost of the settlement by $1 million. The interest was recorded as an expense in 2003. In February 2004, the parties in the case reached a settlement agreement that resulted in a GCR disallowance of $11 million for the GCR period. The settlement agreement was approved by the MPSC in March 2004. The disallowance is included in our 2003-2004 GCR reconciliation filed in June 2004. GCR YEAR 2003-2004: In June 2004, we filed a reconciliation of GCR for the 12-months ended March 2004. We proposed to refund to our customers $28 million of overrecovered gas cost, plus interest. The refund will be included in the 2004-2005 GCR plan year. The overrecovery includes the $11 million refund settlement for the 2002-2003 GCR year, as well as refunds received by us from our suppliers and required by the MPSC to be refunded to our customers. GCR PLAN FOR YEAR 2004-2005: In December 2003, we filed an application with the MPSC seeking approval of a GCR plan for the 12-month period of April 2004 through March 2005. The second quarter GCR adjustment resulted in a GCR ceiling price of $6.57. In June 2004, the MPSC issued a final Order in our GCR plan approving a settlement, which included a quarterly mechanism for setting a GCR ceiling price. The mechanism did not change the current ceiling price of $6.57. Actual gas costs and revenues will be subject to an annual reconciliation proceeding. Our GCR factor for the billing month of August is $6.39 per mcf. 2003 GAS RATE CASE: In March 2003, we filed an application with the MPSC for a $156 million annual increase in our gas delivery and transportation rates that included a 13.5 percent return on equity. In September 2003, we filed an update to our gas rate case that lowered the requested revenue increase from $156 million to $139 million and reduced the return on common equity from 13.5 percent to 12.75 percent. The MPSC authorized an interim gas rate increase of $19 million annually. The interim increase is under bond and subject to refund if the final rate relief is a lesser amount. The interim increase order includes a $34 million reduction in book depreciation expense and related income taxes CMS-75 CMS Energy Corporation effective only during the period of interim relief. The MPSC order allowed us to increase our rates beginning December 19, 2003. As part of the interim order, Consumers agreed to restrict dividend payments to its parent company, CMS Energy, to a maximum of $190 million annually during the period of interim relief. On March 5, 2004, the ALJ issued a Proposal for Decision recommending that the MPSC not rely upon the projected test year data included in our filing, which was supported by the MPSC Staff and the ALJ further recommended that the application be dismissed. In response to the Proposal for Decision, the parties have filed exceptions and replies to exceptions. The MPSC is not bound by the ALJ's recommendation and will review the exceptions and replies to exceptions prior to issuing an order on final rate relief. 2001 GAS DEPRECIATION CASE: In December 2003, we filed an update to our gas utility plant depreciation case originally filed in June 2001. This case is not affected by the 2003 gas rate case interim increase order that reduced book depreciation expense and related income taxes only for the period that we receive the interim relief. The June 2001 depreciation case filing was based on December 2000 plant balances and historical data. The December 2003 filing updates the gas depreciation case to include December 2002 plant balances. The proposed depreciation rates, if approved, would result in an annual increase of $12 million in depreciation expense based on December 2002 plant balances. In June 2004, the ALJ issued a Proposal for Decision recommending adoption of the Michigan Attorney General's proposal to reduce our annual depreciation expense by $52 million. In response to the Proposal for Decision, the parties filed exceptions and are expected to file replies to exceptions. In our exceptions, we proposed alternative depreciation rates that would result in an annual decrease of $7 million in depreciation expense. The MPSC is not bound by the ALJ's recommendation and will review the exceptions and replies to exceptions prior to issuing an order on final depreciation rates. In September 2002, the FERC issued an order rejecting our filing to assess certain rates for non-physical gas title tracking services we provide. In December 2003, the FERC ruled that no refunds were at issue and we reversed $4 million related to this matter. In January 2004, three companies filed with the FERC for clarification or rehearing of the FERC's December 2003 order. In April 2004, the FERC issued its Order Granting Clarification. In that Order, the FERC indicated that its December 2003 order was in error. It directed us to file within 30 days a fair and equitable title-tracking fee and to make refunds, with interest, to customers based on the difference between the accepted fee and the fee paid. In response to the FERC's April 2004 order, we filed a Request for Rehearing in May 2004. The FERC issued an Order Granting Rehearing for Further Consideration in June 2004. We expect the FERC to issue an order on the merits of this proceeding in the third quarter of 2004. We believe that with respect to the FERC jurisdictional transportation, we have not charged any customers title transfer fees, so no refunds are due. At this time, we cannot predict the outcome of this proceeding. CMS-76 CMS Energy Corporation OTHER UNCERTAINTIES INTEGRUM LAWSUIT: Integrum filed a complaint in Wayne County, Michigan Circuit Court in July 2003 against CMS Energy, Enterprises and APT. Integrum alleges several causes of action against APT, CMS Energy, and Enterprises in connection with an offer by Integrum to purchase the CMS Pipeline Assets. In addition to seeking unspecified money damages, Integrum is seeking an order enjoining CMS Energy and Enterprises from selling, and APT from purchasing, the CMS Pipeline Assets and an order of specific performance mandating that CMS Energy, Enterprises, and APT complete the sale of the CMS Pipeline Assets to APT and Integrum. A certain officer and director of Integrum is a former officer and director of CMS Energy, Consumers, and their subsidiaries. The individual was not employed by CMS Energy, Consumers, or their subsidiaries when Integrum made the offer to purchase the CMS Pipeline Assets. CMS Energy and Enterprises filed a motion to change venue from Wayne County to Jackson County, which was granted. The parties are now awaiting transfer of the file from Wayne County to Jackson County. CMS Energy and Enterprises believe that Integrum's claims are without merit. CMS Energy and Enterprises intend to defend vigorously against this action but they cannot predict the outcome of this litigation. CMS GENERATION-OXFORD TIRE RECYCLING: In an administrative order, the California Regional Water Control Board of the state of California named CMS Generation as a potentially responsible party for the clean up of the waste from the fire that occurred in September 1999 at the Filbin Tire Pile, which the state claims was owned by Oxford Tire Recycling of North Carolina, Inc. CMS Generation reached a settlement with the state, which the court approved, pursuant to which CMS Generation paid the state $5.5 million, $1.6 million of which it had paid the state prior to the settlement. CMS Generation continues to negotiate to have the insurance company pay a portion of the settlement amount, as well as a portion of its attorney fees. At the request of the DOJ in San Francisco, CMS Energy and other parties contacted by the DOJ in San Francisco entered into separate Tolling Agreements with the DOJ in San Francisco in September 2002. The Tolling Agreement stops the running of any statute of limitations during the ninety-day period between September 13, 2002 and (through several extensions of the tolling period) March 30, 2004, to facilitate settlement discussions between all the parties in connection with federal claims arising from the fire at the Filbin Tire Pile. On September 23, 2002, CMS Energy received a written demand from the U.S. Coast Guard for reimbursement of approximately $3.5 million in costs incurred by the U.S. Coast Guard in fighting the fire. It is CMS Energy's understanding that these costs, together with any accrued interest, are the sole basis of any federal claims. CMS Energy has entered into a consent judgment with the U.S. Coast Guard to settle this matter for $475,000 that is awaiting final court approval. DEARBORN INDUSTRIAL GENERATION: In October 2001, Duke/Fluor Daniel (DFD) presented DIG with a change order to their construction contract and filed an action in Michigan state court claiming damages in the amount of $110 million, plus interest and costs, which DFD states represents the cumulative amount owed by DIG for delays DFD believes DIG caused and for prior change orders that DIG previously rejected. DFD also filed a construction lien for the $110 million. DIG, in addition to drawing down on three letters of credit totaling $30 million that it obtained from DFD, has filed an arbitration claim against DFD asserting in excess of an additional $75 million in claims against DFD. The judge in the Michigan state court case entered an order staying DFD's prosecution of its claims in the court case and permitting the arbitration to proceed. DFD has appealed the decision by the judge in the Michigan state court case to stay the litigation. DIG will continue to defend itself vigorously and pursue its claims. DIG cannot predict the outcome of this matter. CMS-77 CMS Energy Corporation DIG NOISE ABATEMENT LAWSUIT: In February 2003, DIG was served with a three-count first amended complaint filed in Wayne County Circuit Court in the matter of Ahmed, et al v. Dearborn Industrial Generation, LLC. The complaint sought damages "in excess of $25,000" and injunctive relief based upon allegations of excessive noise and vibration created by operation of the power plant. The first amended complaint was filed on behalf of six named plaintiffs, all alleged to be adjacent or nearby residents or property owners. The damages alleged were injury to persons and property of the landowners. Certification of a class of "potentially thousands" who have been similarly affected was requested. The parties entered into a settlement agreement on June 25, 2004, whereby DIG will remediate the sound emitted from various pieces of plant equipment to a level below the ambient noise level and pay a substantial portion of plaintiffs' attorney fees and costs. A class will be certified for settlement purposes only and remediation will take approximately 280 days. DIG is seeking proposals for remediation and testing but DIG cannot predict the cost associated with the settlement of this matter. MCV EXPANSION, LLC: Under an agreement entered into with General Electric Company (GE) in October 2002, MCV Expansion, LLC has a remaining contingent obligation to GE in the amount of $2.2 million that may become payable in the fourth quarter of 2004. The agreement provides that this contingent obligation is subject to a pro rata reduction under a formula based upon certain purchase orders being entered into with GE by June 30, 2003. MCV Expansion, LLC anticipates but cannot assure that purchase orders will be executed with GE sufficient to eliminate contingent obligations of $2.2 million. FORMER CMS OIL AND GAS OPERATIONS: A Michigan trial judge granted Star Energy, Inc. and White Pine Enterprises, LLC a declaratory judgment in an action filed in 1999 that claimed Terra Energy Ltd., a former CMS Oil and Gas subsidiary, violated an oil and gas lease and other arrangements by failing to drill wells it had committed to drill. A jury then awarded the plaintiffs a $7.6 million award. Terra appealed this matter to the Michigan Court of Appeals. The Michigan Court of Appeals reversed the trial court judgment with respect to the appropriate measure of damages and remanded the case for a new trial on damages. The trial judge reinstated the judgment against Terra and awarded Terra title to the minerals. Terra has appealed this judgment. Enterprises has an indemnity obligation with regard to losses to Terra that might result from this litigation. GASATACAMA: On March 24, 2004, the Argentine Government authorized the restriction of exports of natural gas to Chile giving priority to domestic demand in Argentina. This restriction could have a detrimental effect on GasAtacama's earnings since GasAtacama's gas-fired power plant is located in Chile and uses Argentine gas for fuel. On April 21, 2004, Argentina and Bolivia signed an agreement in which Bolivian gas producers agreed to supply natural gas to Argentina for six months. Bolivian gas began flowing to Argentina in mid-June and will continue to flow through October 2004. The government of Argentina has also approved an agreement with Argentine producers that should help solve Argentina's long-term gas shortage problems. Additionally, on May 11, 2004, the Argentine Government announced the creation of a state-owned and operated energy company, which intends to make investments in domestic natural gas and electricity infrastructure projects. Currently, management of GasAtacama is working with government officials of Chile and Argentina, as well as meeting with its electricity customers and gas producers, to attempt to mitigate the impact of this situation. At this point, it is not possible to predict the outcome of these events and their effect on the earnings of GasAtacama. ARGENTINA ECONOMIC SITUATION: In January 2002, the Republic of Argentina enacted the Public Emergency and Foreign Exchange System Reform Act. This law repealed the fixed exchange rate of one U.S. dollar to one Argentine peso, converted all dollar-denominated utility tariffs and energy contract obligations into pesos at the same one-to-one exchange rate, and directed the President of Argentina to renegotiate such tariffs. CMS-78 CMS Energy Corporation Effective April 30, 2002, we adopted the Argentine peso as the functional currency for our Argentine investments. We had used previously the U.S. dollar as the functional currency. As a result, we translated the assets and liabilities of our Argentine entities into U.S. dollars using an exchange rate of 3.45 pesos per U.S. dollar, and recorded an initial charge to the Foreign Currency Translation component of stockholders' equity of $400 million. While we cannot predict future peso-to-U.S. dollar exchange rates, we do expect that these non-cash charges reduce substantially the risk of further material balance sheet impacts when combined with anticipated proceeds from international arbitration currently in progress, political risk insurance, and the eventual sale of these assets. At June 30, 2004, the net foreign currency loss due to the unfavorable exchange rate of the Argentine peso recorded in the Foreign Currency Translation component of stockholders' equity using an exchange rate of 2.97 pesos per U.S. dollar was $263 million. This amount also reflects the effect of recording, at December 31, 2002, U.S. income taxes on temporary differences between the book and tax bases of foreign investments, including the foreign currency translation associated with our Argentine investments. LEONARD FIELD DISPUTE: Pursuant to a Consent Judgment entered in Oakland County, Michigan Circuit Court in September 2001, CMS Gas Transmission had 18 months to extract approximately one bcf of pipeline quality natural gas held in the Leonard Field in Addison Township. The Consent Judgment provided for an extension of that period upon certain circumstances. CMS Gas Transmission has complied with the requirements of the Consent Judgment. Addison Township filed a lawsuit in Oakland County Circuit Court against CMS Gas Transmission in February 2004 alleging the Leonard Field was discharging odors in violation of the Consent Judgment. Pursuant to a Stipulated Order entered April 1, 2004, CMS Gas Transmission agreed to certain undertakings to address the odor complaints and further agreed to temporarily cease operations at the Leonard Field during the month of April 2004, the last month provided for in the Consent Judgment. Also, Addison Township was required to grant CMS Gas Transmission an extension to withdraw its natural gas if certain conditions were met. Addison Township denied CMS Gas Transmission's request for an extension on April 5, 2004. CMS Gas Transmission is pursuing its legal remedies and filed a complaint against Addison Township in June 2004. CMS Gas Transmission cannot predict the outcome of this matter, and unless an extension is provided, it will be unable to extract approximately 500,000 mcf of gas remaining in the Leonard Field. CMS ENSENADA CUSTOMER DISPUTE: Pursuant to a long-term power purchase agreement, CMS Ensenada sells power and steam to YPF Repsol at the YPF refinery in La Plata, Argentina. As a result of the so-called "Emergency Laws," payments by YPF Repsol under the power purchase agreement have been converted to pesos at the exchange rate of one U.S. dollar to one Argentine peso. Such payments are currently insufficient to cover CMS Ensenada's operating costs, including quarterly debt service payments to the Overseas Private Investment Corporation (OPIC). Enterprises is party to a Sponsor Support Agreement pursuant to which Enterprises has guaranteed CMS Ensenada's debt service payments to the OPIC up to an amount which is in dispute, but which Enterprises estimated to be approximately $9 million at June 30, 2004. Following a payment made to the OPIC in July 2004, Enterprises now believes this amount to be approximately $7 million. An interim arrangement, which provided CMS Ensenada with payments under the power purchase agreement that covered most, but not all, of CMS Ensenada's operating costs, was agreed to with YPF Repsol in 2002 but expired on December 31, 2003. Efforts to negotiate a new agreement with YPF Repsol have been unsuccessful. As a result, CMS Ensenada initiated two legal actions: (1) an ex parte action in the Argentine commercial CMS-79 CMS Energy Corporation courts, requesting injunctive relief in the form of a temporary increase in the payments by YPF Repsol under the power purchase agreement that would allow CMS Ensenada to continue to operate while seeking a final and permanent resolution; and (2) an arbitration administered by the International Chamber of Commerce seeking a ruling that the application of the Emergency Laws to the power purchase agreement is unconstitutional, or, alternatively, that the arbitral panel reestablish the economic equilibrium of the power purchase agreement, as required by the Emergency Laws taking into account that a significant portion of CMS Ensenada's operating costs are payable in U.S. dollars. In April 2004, the injunctive relief was granted on appeal, but in an amount lower than requested by CMS Ensenada. The injunctive relief expired at the end of May, but the court recently extended the term of relief until the end of the arbitration. OTHER: Certain CMS Gas Transmission and CMS Generation affiliates in Argentina received notice from various Argentine provinces claiming stamp taxes and associated penalties and interest arising from various gas transportation transactions. Although these claims total approximately $24 million, we believe the claims are without merit and will continue to contest them vigorously. CMS Generation does not currently expect to incur significant capital costs at its power facilities for compliance with current U.S. environmental regulatory standards. In addition to the matters disclosed within this Note, Consumers and certain other subsidiaries of CMS Energy are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies arising from the ordinary course of business. These lawsuits and proceedings may involve personal injury, property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing, and other matters. We have accrued estimated losses for certain contingencies discussed within this Note. Resolution of these contingencies is not expected to have a material adverse impact on our financial position, liquidity, or results of operations. CMS-80 CMS Energy Corporation 4: FINANCINGS AND CAPITALIZATION Long-term debt is summarized as follows:
In Millions - ----------------------------------------------------------------------------------------------- June 30, 2004 December 31, 2003 - ----------------------------------------------------------------------------------------------- CMS ENERGY CORPORATION Senior notes $ 2,063 $ 2,063 General term notes 236 496 Extendible tenor rate adjusted securities and other 186 187 ------------- ----------------- Total - CMS Energy Corporation 2,485 2,746 ------------- ----------------- CONSUMERS ENERGY COMPANY First mortgage bonds 1,483 1,483 Senior notes 1,254 1,254 Bank debt and other 468 469 Securitization bonds 412 426 FMLP debt 411 - ------------- ----------------- Total - Consumers Energy Company 4,028 3,632 ------------- ----------------- OTHER SUBSIDIARIES 200 191 ------------- ----------------- Principal amounts outstanding 6,713 6,569 Current amounts (860) (509) Net unamortized discount (37) (40) - ----------------------------------------------------------------------------------------------- Total consolidated long-term debt $ 5,816 $ 6,020 ===============================================================================================
FMLP DEBT: We consolidate the FMLP in accordance with Revised FASB Interpretation No. 46. At June 30, 2004, long-term debt of the FMLP consists of:
In Millions - ------------------------------------------------------------------ Maturity 2004 - ------------------------------------------------------------------ 11.75% subordinated secured notes 2005 $185 13.25% subordinated secured notes 2006 75 6.875% tax-exempt subordinated secured notes 2009 137 6.75% tax-exempt subordinated secured notes 2009 14 - ------------------------------------------------------------------ Total amount outstanding $411 ==================================================================
The FMLP debt is essentially project debt secured by certain assets of the MCV Partnership and the FMLP. The debt is non-recourse to other assets of CMS Energy and Consumers. DEBT MATURITIES: At June 30, 2004, the aggregate annual maturities for long-term debt for the six months ending December 31, 2004 and the next four years are:
In Millions - ----------------------------------------------------- Payments Due - ----------------------------------------------------- 2004 2005 2006 2007 2008 - ---------------------------------------------------- Long-term debt $342 $789 $549 $550 $1,053 =====================================================
CMS-81 CMS Energy Corporation REGULATORY AUTHORIZATION FOR FINANCINGS: Effective July 1, 2004, Consumers received new FERC authorization to issue or guarantee up to $1.1 billion of short-term securities and up to $1.1 billion of short-term first mortgage bonds as collateral for such short-term securities. Effective July 1, 2004, Consumers received new FERC authorization to issue up to $1 billion of long-term securities for refinancing or refunding purposes, $1.5 billion of long-term securities for general corporate purposes, and $2.5 billion of long-term first mortgage bonds to be issued solely as collateral for other long-term securities. SHORT-TERM FINANCINGS: At June 30, 2004, CMS Energy had a $190 million secured revolving credit facility with banks and a $185 million cash-collateralized letter of credit facility with banks. At June 30, 2004, all of the $190 million is available for general corporate purposes and $17 million is available for letters of credit. At June 30, 2004, Consumers had a $400 million secured revolving credit facility with banks. At June 30, 2004, $24 million of letters of credit are issued and outstanding under this facility and $376 million is available for general corporate purposes, working capital, and letters of credit. The MCV Partnership had a $50 million working capital facility available. As of August 3, 2004, CMS Energy obtained an amended and restated $300 million secured revolving credit facility to replace both the $190 million and the $185 million facilities. As of August 3, 2004, Consumers obtained an amended and restated $500 million secured revolving credit facility to replace their $400 million facility. The amended facilities carry three-year terms and provide for lower interest rates. FIRST MORTGAGE BONDS: Consumers secures its first mortgage bonds by a mortgage and lien on substantially all of its property. Its ability to issue and sell securities is restricted by certain provisions in the first mortgage bond indenture, its articles of incorporation, and the need for regulatory approvals under federal law. CAPITAL AND FINANCE LEASE OBLIGATIONS: Our capital leases are comprised mainly of leased service vehicles and office furniture. As of June 30, 2004, capital lease obligations totaled $64 million. In order to obtain permanent financing for the MCV Facility, the MCV Partnership entered into a sale and lease back agreement with a lessor group, which includes the FMLP, for substantially all of the MCV Partnership's fixed assets. In accordance with SFAS No. 98, the MCV Partnership accounted for the transaction as a financing arrangement. As of June 30, 2004, finance lease obligations totaled $317 million, which represents the third-party portion of the MCV Partnership's finance lease obligation. SALE OF ACCOUNTS RECEIVABLE: Under a revolving accounts receivable sales program, we currently sell certain accounts receivable to a wholly owned, consolidated, bankruptcy remote special purpose entity. In turn, the special purpose entity may sell an undivided interest in up to $325 million of the receivables. We sold no receivables at June 30, 2004 and we sold $50 million at June 30, 2003. The Consolidated Balance Sheets exclude these sold amounts from accounts receivable. We continue to service the receivables sold. The purchaser of the receivables has no recourse against our other assets for failure of a debtor to pay when due and the purchaser has no right to any receivables not sold. No gain or loss has been recorded on the receivables sold and we retain no interest in the receivables sold. Certain cash flows received from and paid to us under our accounts receivable sales program are shown below:
In Millions - ------------------------------------------------------------------------------------- Six Months Ended June 30 2004 2003 - ------------------------------------------------------------------------------------- Proceeds from sales (remittance of collections) under the program $ (297) $ (275) Collections reinvested under the program $ 2,645 $2,459 =====================================================================================
CMS-82 CMS Energy Corporation DIVIDEND RESTRICTIONS: Under the provisions of its articles of incorporation, at June 30, 2004, Consumers had $396 million of unrestricted retained earnings available to pay common stock dividends. However, covenants in Consumers' debt facilities cap common stock dividend payments at $300 million in a calendar year. Consumers is also under an annual dividend cap of $190 million imposed by the MPSC during the current interim gas rate relief period. For the six months ended June 30, 2004, CMS Energy received $105 million of common stock dividends from Consumers. Our amended and restated $300 million secured revolving credit facility restricts payments of dividends on our common stock during a 12-month period to $75 million, dependent on the aggregate amounts of unrestricted cash and unused commitments under the facility. For additional details on the cap on common stock dividends payable during the current interim gas rate relief period, see Note 3, Uncertainties, "Consumers' Gas Utility Rate Matters - 2003 Gas Rate Case." FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS: This Interpretation became effective January 2003. It describes the disclosure to be made by a guarantor about its obligations under certain guarantees that it has issued. At the beginning of a guarantee, it requires a guarantor to recognize a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provision of this Interpretation does not apply to some guarantee contracts, such as warranties, derivatives, or guarantees between either parent and subsidiaries or corporations under common control, although disclosure of these guarantees is required. For contracts that are within the recognition and measurement provision of this Interpretation, the provisions were to be applied to guarantees issued or modified after December 31, 2002. The following table describes our guarantees at June 30, 2004:
In Millions - ------------------------------------------------------------------------------------------------------- Issue Expiration Maximum Carrying Recourse Guarantee Description Date Date Obligation Amount(b) Provision(c) - ------------------------------------------------------------------------------------------------------- Indemnifications from asset sales and other agreements(a) Various Various $ 1,147 $ 4 $ - Letters of credit Various Various 235 - - Surety bonds and other indemnifications Various Various 28 - - Other guarantees Various Various 199 - - Nuclear insurance retrospective premiums Various Various 134 - - =======================================================================================================
(a) The majority of this amount arises from routine provisions in stock and asset sales agreements under which we indemnify the purchaser for losses resulting from events such as failure of title to the assets or stock sold by us to the purchaser. We believe the likelihood of a loss for any remaining indemnifications to be remote. (b) The carrying amount represents the fair market value of guarantees and indemnities recorded on our balance sheet that are entered into subsequent to January 1, 2003. (c) Recourse provision indicates the approximate recovery from third parties including assets held as collateral. CMS-83 CMS Energy Corporation The following table provides additional information regarding our guarantees:
Events That Would Require Guarantee Description How Guarantee Arose Performance - ------------------------------------------------------------------------------------------------- Indemnifications from asset Stock and asset sales Findings of misrepresentation, sales and other agreements agreements breach of warranties, and other specific events or circumstances Standby letters of credit Normal operations of coal Noncompliance with power plants environmental regulations Self-insurance requirement Nonperformance Surety bonds Normal operating activity, Nonperformance permits and license Other guarantees Normal operating activity Nonperformance or non-payment by a subsidiary under a related contract Nuclear insurance retrospective Normal operations of nuclear Call by NEIL and premiums plants Price-Anderson Act for nuclear incident ==================================================================================================
We have entered into typical tax indemnity agreements in connection with a variety of transactions including transactions for the sale of subsidiaries and assets, equipment leasing, and financing agreements. These indemnity agreements generally are not limited in amount and, while a maximum amount of exposure cannot be identified, the probability of liability is considered remote. We have guaranteed payment of obligations through letters of credit, indemnities, surety bonds, and other guarantees of unconsolidated affiliates and related parties of $462 million as of June 30, 2004. We monitor and approve these obligations and believe it is unlikely that we would be required to perform or otherwise incur any material losses associated with the above obligations. The off-balance sheet commitments expire as follows:
Commercial Commitments In Millions - ------------------------------------------------------------------------------ Commitment Expiration - ------------------------------------------------------------------------------ 2009 and Total 2004 2005 2006 2007 2008 Beyond - ------------------------------------------------------------------------------ Off-balance sheet: Guarantees $ 199 $ 6 $ 36 $ 5 $ - $ - $ 152 Surety bonds and other 28 1 - - - - 27 indemnifications (a) Letters of Credit (b) 235 23 184 5 5 5 13 - ----------------------------------------------------------------------------- Total $ 462 $ 30 $220 $ 10 $ 5 $ 5 $ 192 =============================================================================
(a) The surety bonds are continuous in nature. The need for the bonds is determined on an annual basis. (b) At June 30, 2004, we had $169 million of cash held as collateral for letters of credit. The cash that collateralizes the letters of credit is included in Restricted cash on the Consolidated Balance Sheets. CONTINGENTLY CONVERTIBLE SECURITIES: At June 30, 2004, we have contingently convertible debt and equity securities outstanding. The significant terms of these securities are as follows: Convertible Senior Notes: Our $150 million 3.375 percent convertible senior notes are putable to CMS Energy by the note holders at par on July 15, 2008, July 15, 2013 and July 15, 2018. The notes are convertible to Common Stock at the option of the holder if the price of our Common Stock remains at or CMS-84 CMS Energy Corporation above $12.81 per share for 20 of 30 consecutive trading days ending on the last trading day of a quarter. The $12.81 price per share may be adjusted if there is a payment or distribution to our Common Stockholders. If conversion were to occur, the notes would be converted into 14.1 million shares of Common Stock based on the initial conversion rate. Convertible Preferred Stock: Our $250 million 4.50 percent cumulative convertible perpetual preferred stock has a liquidation value of $50.00 per share. The security is convertible to Common Stock at the option of the holder if the price of our Common Stock remains at or above $11.87 per share for 20 of 30 consecutive trading days ending on the last trading day of a quarter. On or after December 5, 2008, we may cause the Preferred Stock to convert into Common Stock if the closing price of our Common Stock remains at or above $12.86 for 20 of any 30 consecutive trading days. The $11.87 and $12.86 prices per share may be adjusted if there is a payment or distribution to our Common Stockholders. If conversion were to occur, the securities would be converted into 25.3 million shares of Common Stock based on the initial conversion rate. 5: EARNINGS PER SHARE AND DIVIDENDS The following table presents the basic and diluted earnings per share computations.
In Millions, Except Per Share Amounts - --------------------------------------------------------------------------------------------------- Restated Three Months Ended June 30 2004 2003 - --------------------------------------------------------------------------------------------------- EARNINGS ATTRIBUTABLE TO COMMON STOCK: Income (Loss) from Continuing Operations $ 19 $ (12) Less Preferred Dividends (3) - ----------------------------- Income (Loss) from Continuing Operations attributable to Common Stock - Basic $ 16 $ (12) Add conversion of Trust Preferred Securities (net of tax) -(a) -(a) ----------------------------- Income (Loss) from Continuing Operations attributable to Common Stock - Diluted $ 16 $ (12) ============================= AVERAGE COMMON SHARES OUTSTANDING APPLICABLE TO BASIC AND DILUTED EPS CMS Energy: Average Shares - Basic 161.2 144.1 Add conversion of Trust Preferred Securities -(a) -(a) Add dilutive Stock Options and Warrants 0.5(b) -(b) ----------------------------- Average Shares - Diluted 161.7 144.1 ============================= EARNINGS (LOSS) PER AVERAGE COMMON SHARE ATTRIBUTABLE TO COMMON STOCK Basic $ 0.10 $ (0.08) Diluted $ 0.10 $ (0.08) ===================================================================================================
CMS-85 CMS Energy Corporation
In Millions, Except Per Share Amounts - ----------------------------------------------------------------------------------------------------------- Restated Six Months Ended June 30 2004 2003 - ----------------------------------------------------------------------------------------------------------- EARNINGS ATTRIBUTABLE TO COMMON STOCK: Income from Continuing Operations $ 17 $ 63 Less Preferred Dividends (6) - --------------------------------- Income from Continuing Operations attributable to Common Stock - Basic $ 11 $ 63 Add conversion of Trust Preferred Securities (net of tax) -(a) 5(a) --------------------------------- Income from Continuing Operations attributable to Common Stock - Diluted $ 11 $ 68 ================================= AVERAGE COMMON SHARES OUTSTANDING APPLICABLE TO BASIC AND DILUTED EPS CMS Energy: Average Shares - Basic 161.2 144.1 Add conversion of Trust Preferred Securities -(a) 16.6(a) Add dilutive Stock Options and Warrants 0.5(b) -(b) --------------------------------- Average Shares - Diluted 161.7 160.7 ================================= EARNINGS PER AVERAGE COMMON SHARE ATTRIBUTABLE TO COMMON STOCK Basic $ 0.07 $ 0.43 Diluted $ 0.07 $ 0.43 ==========================================================================================================
(a) Due to antidilution, the computation of diluted earnings per share excluded the conversion of Trust Preferred Securities into 4.2 million shares of Common Stock and a $2.2 million reduction of interest expense, net of tax, for the three months ended June 30, 2004 and the three months ended June 30, 2003 and a $4.3 million reduction of interest expense, net of tax, for the six months ended June 30 2004 and the six months ended June 30, 2003. Effective July 2001, we can revoke the conversion rights if certain conditions are met. (b) Since the exercise price was greater than the average market price of the Common Stock, options and warrants to purchase 5.4 million and 5.1 million shares of Common Stock were excluded from the computation of diluted EPS for the three and six months ended June 30, 2004 and the three and six months ended June 30, 2003, respectively. Computation of diluted earnings per share for the three months and the six months ended June 30, 2004 excluded conversion of our $150 million 3.375 percent convertible senior notes and our 5 million shares of 4.50 percent cumulative convertible preferred stock. Both are "contingently convertible" securities and, as of June 30, 2004, none of the stated contingencies have been met. For additional details on these securities, see Note 4, Financings and Capitalization. In January 2003, the Board of Directors suspended the payment of common stock dividends. CMS-86 CMS Energy Corporation 6: FINANCIAL AND DERIVATIVE INSTRUMENTS FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments, and current liabilities approximate their fair values because of their short-term nature. We estimate the fair values of long-term financial instruments based on quoted market prices or, in the absence of specific market prices, on quoted market prices of similar instruments or other valuation techniques. The carrying amount of all long-term financial instruments, except as shown below, approximates fair value. Our held-to-maturity investments consist of debt securities held by the MCV Partnership totaling $140 million as of June 30, 2004. These securities represent funds restricted primarily for future lease payments and are classified as Other Assets on the Consolidated Balance Sheets. These investments have original maturity dates of approximately one year or less and, because of their short maturities, their carrying amounts approximate their fair values. For additional details, see Note 1, Corporate Structure and Accounting Policies.
In Millions - --------------------------------------------------------------------------------------------------------------------------------- June 30 2004 2003 - --------------------------------------------------------------------------------------------------------------------------------- Fair Unrealized Fair Unrealized Cost Value Gain(Loss) Cost Value Gain - --------------------------------------------------------------------------------------------------------------------------------- Long-term debt (a) $6,676 $6,834 $ (158) $6,594 $6,813 $ (219) Long-term debt - related parties (b) 684 644 40 - - - Trust Preferred Securities (b) - - - 883 769 114 Available-for-sale securities: Nuclear decommissioning (c) 434 559 125 453 553 100 SERP 54 66 12 55 61 6 ===============================================================================================================================
(a) Includes a principal amount of $860 million at June 30, 2004 and $532 million at June 30, 2003 relating to current maturities. Settlement of long-term debt is generally not expected until maturity. (b) We determined that we are not the primary beneficiary of our trust preferred security structures. Accordingly, those entities have been deconsolidated as of December 31, 2003. Company Obligated Trust Preferred Securities totaling $663 million that were previously included in mezzanine equity, have been eliminated due to deconsolidation and are reflected in Long-term debt - related parties on the Consolidated Balance Sheets. For additional details, see Note 11, Implementation of New Accounting Standards. In addition, company obligated Trust Preferred Securities totaling $220 million have been converted to Common Stock as of August 2003. (c) On January 1, 2003, we adopted SFAS No. 143 and began classifying our unrealized gains and losses on nuclear decommissioning investments as regulatory liabilities. We previously included the unrealized gains and losses on these investments in accumulated depreciation. DERIVATIVE INSTRUMENTS: We are exposed to market risks including, but not limited to, changes in interest rates, commodity prices, currency exchange rates, and equity security prices. We manage these risks using established policies and procedures, under the direction of both an executive oversight committee consisting of senior management representatives and a risk committee consisting of business-unit managers. We may use various contracts to manage these risks including swaps, options, futures and forward contracts. We intend that any gains or losses on these contracts will be offset by an opposite movement in the value of the item at risk. Risk management contracts are classified as either trading or other than trading. These contracts contain credit risk if the counterparties, including financial institutions and energy CMS-87 CMS Energy Corporation marketers, fail to perform under the agreements. We minimize such risk by performing financial credit reviews using, among other things, publicly available credit ratings of such counterparties. Contracts used to manage interest rate, foreign currency, and commodity price risk may be considered derivative instruments that are subject to derivative and hedge accounting pursuant to SFAS No. 133. If a contract is accounted for as a derivative instrument, it is recorded in the financial statements as an asset or a liability, at the fair value of the contract. The recorded fair value of the contract is then adjusted quarterly to reflect any change in the market value of the contract, a practice known as marking the contract to market. Changes in the fair value of a derivative (that is, gains or losses) are reported either in earnings or accumulated other comprehensive income depending on whether the derivative qualifies for special hedge accounting treatment. For derivative instruments to qualify for hedge accounting under SFAS No. 133, the hedging relationship must be formally documented at inception and be highly effective in achieving offsetting cash flows or offsetting changes in fair value attributable to the risk being hedged. If hedging a forecasted transaction, the forecasted transaction must be probable. If a derivative instrument, used as a cash flow hedge, is terminated early because it is probable that a forecasted transaction will not occur, any gain or loss as of such date is immediately recognized in earnings. If a derivative instrument, used as a cash flow hedge, is terminated early for other economic reasons, any gain or loss as of the termination date is deferred and recorded when the forecasted transaction affects earnings. We use a combination of quoted market prices and mathematical valuation models to determine fair value of those contracts requiring derivative accounting. The ineffective portion, if any, of all hedges is recognized in earnings. The majority of our contracts are not subject to derivative accounting because they qualify for the normal purchases and sales exception of SFAS No. 133, or are not derivatives because there is not an active market for the commodity. Certain of our electric capacity and energy contracts are not accounted for as derivatives due to the lack of an active energy market in the state of Michigan, as defined by SFAS No. 133, and the significant transportation costs that would be incurred to deliver the power under the contracts to the closest active energy market at the Cinergy hub in Ohio. If an active market develops in the future, we may be required to account for these contracts as derivatives. The mark-to-market impact on earnings related to these contracts could be material to the financial statements. Derivative accounting is required for certain contracts used to limit our exposure to commodity price risk and interest rate risk. The following table reflects the fair value of all contracts requiring derivative accounting: CMS-88 CMS Energy Corporation
In Millions - ------------------------------------------------------------------------------------------------------------------------- June 30 2004 2003 - ------------------------------------------------------------------------------------------------------------------------- Fair Unrealized Fair Unrealized Derivative Instruments Cost Value Gain (Loss) Cost Value Gain (Loss) - ------------------------------------------------------------------------------------------------------------------------- Other than trading Electric - related contracts $ - $ - $ - $ 8 $ - $ (8) Gas contracts 3 6 3 2 1 (1) Interest rate risk contracts - (2) (2) - - - Derivative contracts associated with Consumers' investment in the MCV Partnership: Prior to consolidation - - - - 20 20 After consolidation: Gas fuel contracts - 80 80 - - - Gas fuel futures, options, and swaps - 54 54 - - - Trading Electric / gas contracts (5) 10 15 - 15 15 Derivative contracts associated with equity investments in: Shuweihat - (19) (19) - (39) (39) Taweelah (35) (19) 16 - (36) (36) Jorf Lasfar - (10) (10) - (14) (14) Other - (1) (1) - (4) (4) =======================================================================================================================
The fair value of our other than trading derivative contracts is included in Derivative Instruments, Other Assets, or Other Liabilities on the Consolidated Balance Sheets. The fair value of our trading derivative contracts is included in either Price Risk Management Assets or Price Risk Management Liabilities on the Consolidated Balance Sheets. The fair value of derivative contracts associated with our equity investments is included in Enterprises Investments on the Consolidated Balance Sheets. The fair value of derivative contracts associated with our investment in the MCV Partnership for 2003 is included in Investments - Midland Cogeneration Venture Limited Partnership on the Consolidated Balance Sheets. ELECTRIC CONTRACTS: Our electric utility business uses purchased electric call option contracts to meet, in part, our regulatory obligation to serve. This obligation requires us to provide a physical supply of electricity to customers, to manage electric costs, and to ensure a reliable source of capacity during peak demand periods. GAS CONTRACTS: Our gas utility business uses fixed price and index-based gas supply contracts, fixed price weather-based gas supply call options, fixed price gas supply call and put options, and other types of contracts, to meet our regulatory obligation to provide gas to our customers at a reasonable and prudent cost. Unrealized gains and losses associated with these options are reported directly in earnings as part of other income, and then directly offset in earnings and recorded on the balance sheet as a regulatory asset or liability as part of the GCR process. INTEREST RATE RISK CONTRACTS: We use interest rate swaps to hedge the risk associated with forecasted interest payments on variable-rate debt and to reduce the impact of interest rate fluctuations. Most of our interest rate swaps are designated as cash flow hedges. As such, we record changes in the fair value of these contracts in accumulated other comprehensive income unless the swaps are sold. For interest rate swaps that did not qualify for hedge accounting treatment, we record changes in the fair value of these CMS-89 CMS Energy Corporation contracts in Other income. The following table reflects the outstanding floating-to-fixed interest rates swaps:
In Millions - --------------------------------------------------------------------------------- Floating to Fixed Notional Maturity Fair Interest Rate Swaps Amount Date Value - --------------------------------------------------------------------------------- June 30, 2004 $ 26 2005-2006 $ (2) June 30, 2003 3 2006 - =================================================================================
Notional amounts reflect the volume of transactions but do not represent the amount exchanged by the parties to the financial instruments. Accordingly, notional amounts do not necessarily reflect our exposure to credit or market risks. The weighted average interest rate associated with outstanding swaps was approximately 7.3 percent at June 30, 2004 and 9.0 percent at June 30, 2003. There was no ineffectiveness associated with any of the interest rate swaps that qualified for hedge accounting treatment. As of June 30, 2004, we have recorded an unrealized loss of $1 million, net of tax, in accumulated other comprehensive income related to interest rate risk contracts accounted for as cash flow hedges. We expect to reclassify $1 million of this amount as a decrease to earnings during the next 12 months primarily to offset the variable-rate interest expense on hedged debt. Certain equity method investees have issued interest rate swaps to hedge the risk associated with variable-rate debt, as listed in the table under "Derivative Instruments" within this Note. These instruments are not included in this analysis, but can have an impact on financial results. The accounting for these instruments depends on whether they qualify for cash flow hedge accounting treatment. The interest rate swap held by Taweelah and certain interest rate swaps held by Shuweihat do not qualify as cash flow hedges, and therefore, we record our proportionate share of the change in the fair value of these contracts in Earnings from Equity Method Investees. The remainder of these instruments do qualify as cash flow hedges, and we record our proportionate share of the change in the fair value of these contracts in accumulated other comprehensive income. DERIVATIVE CONTRACTS ASSOCIATED WITH CONSUMERS' INVESTMENT IN THE MCV PARTNERSHIP: Gas Fuel Contracts: The MCV Partnership uses natural gas fuel contracts to buy gas as fuel for generation, and to manage gas fuel costs. The MCV Partnership believes that its long-term natural gas contracts, which do not contain volume optionality, qualify under SFAS No. 133 for the normal purchases and normal sales exception. Therefore, these contracts are currently not recognized at fair value on the balance sheet. Should significant changes in the level of the MCV Facility operational dispatch or purchases of long-term gas occur, the MCV Partnership would be required to re-evaluate its accounting treatment for these long-term gas contracts. This re-evaluation may result in recording mark-to-market activity on some contracts, which could add to earnings volatility. At June 30, 2004, the MCV Partnership had six long-term gas contracts that contained both an option and forward component. Because of the option component, these contracts do not qualify for the normal purchases and sales exception and are accounted for as derivatives, with changes in fair value recorded in earnings each quarter. The MCV Partnership expects future earnings volatility on these six contracts, since gains or losses will be recorded on a quarterly basis during the remaining life of approximately four years for these gas contracts. For the six months ended June 30, 2004, the MCV Partnership recorded in Fuel for electric generation a $6 million net gain in earnings associated with these contracts. CMS-90 CMS Energy Corporation Gas Fuel Futures, Options, and Swaps: To manage market risks associated with the volatility of natural gas prices, the MCV Partnership maintains a gas hedging program. The MCV Partnership enters into natural gas futures contracts, option contracts, and over-the-counter swap transactions in order to hedge against unfavorable changes in the market price of natural gas in future months when gas is expected to be needed. These financial instruments are being used principally to secure anticipated natural gas requirements necessary for projected electric and steam sales, and to lock in sales prices of natural gas previously obtained in order to optimize the MCV Partnership's existing gas supply, storage, and transportation arrangements. These financial instruments are accounted for as derivatives under SFAS No. 133. The contracts that are used to secure anticipated natural gas requirements necessary for projected electric and steam sales qualify as cash flow hedges under SFAS No. 133. The MCV Partnership also engages in cost mitigation activities to offset the fixed charges the MCV Partnership incurs in operating the MCV Facility. These cost mitigation activities include the use of futures and options contracts to purchase and/or sell natural gas to maximize the use of the transportation and storage contracts when it is determined that they will not be needed for the MCV Facility operation. Although these cost mitigation activities do serve to offset the fixed monthly charges, these cost mitigation activities are not considered a normal course of business for the MCV Partnership and do not qualify as hedges under SFAS No. 133. Therefore, the mark-to-market gains and losses from these cost mitigation activities are recorded in earnings each quarter. For the six months ended June 30, 2004, the MCV Partnership has recorded an unrealized gain of $24 million in other comprehensive income on those futures contracts that qualify as cash flow hedges, which resulted in a cumulative net gain of $55 million in other comprehensive income as of June 30, 2004. This balance represents natural gas futures, options, and swaps with maturities ranging from July 2004 to December 2009, of which $34 million of this gain is expected to be reclassified as an increase to earnings within the next 12 months. As of June 30, 2004, Consumers' pretax proportionate share of the MCV Partnership's $55 million net gain recorded in other comprehensive income is $27 million, of which $17 million is expected to be reclassified as an increase to earnings within the next 12 months. In addition, for the six months ended June 30, 2004, the MCV Partnership has recorded a net gain of $16 million in earnings from hedging activities related to natural gas requirements for the MCV Facility operations and a net gain of $1 million in earnings from cost mitigation activities. TRADING ACTIVITIES: Through December 31, 2002, our wholesale power and gas trading activities were accounted for under the mark-to-market method of accounting in accordance with EITF Issue No. 98-10. Effective January 1, 2003, EITF Issue No. 98-10 was rescinded and replaced by EITF Issue No. 02-03. As a result, only energy contracts that meet the definition of a derivative under SFAS No. 133 are to be carried at fair value. The impact of this change was recognized as a cumulative effect of a change in accounting principle loss of $23 million, net of tax, for the three month period ended March 31, 2003. During 2003, we sold a majority of our wholesale natural gas and power-trading portfolio, and exited the energy services and retail customer choice business. As a result, our trading activities have been significantly reduced. Our current activities center around entering into energy contracts that are related to the activities considered to be an integral part of our ongoing operations. The intent of holding these energy contracts is to optimize the financial performance of our owned generating assets and to fulfill contractual obligations. These contracts are classified as trading activities in accordance with EITF No. 02-03 and are accounted for using the criteria defined in SFAS No. 133. Energy trading contracts that meet the definition of a derivative are recorded as assets or liabilities in the financial statements at the fair value of the contracts. Gains or losses arising from changes in fair value of these contracts are recognized in earnings as a component of operating revenues in the period in which the changes occur. Energy trading contracts that do not meet the definition of a derivative are accounted for as executory CMS-91 CMS Energy Corporation contracts (i.e., on an accrual basis). The market prices we use to value our energy trading contracts reflect our consideration of, among other things, closing exchange and over-the-counter quotations. In certain contracts, long-term commitments may extend beyond the period in which market quotations for such contracts are available. Mathematical models are developed to determine various inputs into the fair value calculation including price and other variables that may be required to calculate fair value. Realized cash returns on these commitments may vary, either positively or negatively, from the results estimated through application of the mathematical model. Market prices are adjusted to reflect the impact of liquidating our position in an orderly manner over a reasonable period of time under present market conditions. In connection with the market valuation of our energy trading contracts, we maintain reserves for credit risks based on the financial condition of counterparties. We also maintain credit policies that management believes will minimize its overall credit risk with regard to our counterparties. Determination of our counterparties' credit quality is based upon a number of factors, including credit ratings, disclosed financial condition, and collateral requirements. Where contractual terms permit, we employ standard agreements that allow for netting of positive and negative exposures associated with a single counterparty. Based on these policies, our current exposures, and our credit reserves, we do not anticipate a material adverse effect on our financial position or results of operations as a result of counterparty nonperformance. FOREIGN EXCHANGE DERIVATIVES: We may use forward exchange and option contracts to hedge certain receivables, payables, long-term debt, and equity value relating to foreign investments. The purpose of our foreign currency hedging activities is to protect the company from the risk associated with adverse changes in currency exchange rates that could affect cash flow materially. These contracts would not subject us to risk from exchange rate movements because gains and losses on such contracts offset losses and gains, respectively, on assets and liabilities being hedged. At June 30, 2004 and June 30, 2003, we had no outstanding foreign exchange contracts. As of June 30, 2004, Taweelah, one of our equity method investees, held a foreign exchange contract that hedged the foreign currency risk associated with payments to be made under an operating and maintenance service agreement. This contract did not qualify as a cash flow hedge; and therefore, we record our proportionate share of the change in the fair value of the contract in Earnings from Equity Method Investees. 7: RETIREMENT BENEFITS We provide retirement benefits to our employees under a number of different plans, including: - non-contributory, defined benefit Pension Plan, - a cash balance pension plan for certain employees hired after June 30, 2003, - benefits to certain management employees under SERP, - health care and life insurance benefits under OPEB, - benefits to a select group of management under EISP, and - a defined contribution 401(k) plan. Pension Plan: The Pension Plan includes funds for our employees and our non-utility affiliates, including former Panhandle employees. The Pension Plan's assets are not distinguishable by company. CMS-92 CMS Energy Corporation As of June 30, 2004, we have recorded a prepaid pension asset of $398 million, $20 million of which is in Other current assets on our Consolidated Balance Sheet. OPEB: We adopted SFAS No. 106, effective as of the beginning of 1992. Consumers recorded a liability of $466 million for the accumulated transition obligation and a corresponding regulatory asset for anticipated recovery in utility rates. For additional details, see Note 1, Corporate Structure and Accounting Policies, "Utility Regulation." In 1994, the MPSC authorized recovery of the electric utility portion of these costs over 18 years and in 1996, the MPSC authorized recovery of the gas utility portion of these costs over 16 years. We have made contributions of $33 million to our 401(h) and VEBA trust funds in 2004. We plan to make additional contributions of $30 million in 2004. Costs: The following table recaps the costs incurred in our retirement benefits plans:
In Millions - ------------------------------------------------------------------------------------------------------------------ Pension Three Months Ended Six Months Ended - ------------------------------------------------------------------------------------------------------------------ June 30 2004 2003 2004 2003 - ------------------------------------------------------------------------------------------------------------------ Service cost $ 9 $ 9 $ 19 $ 19 Interest expense 18 18 36 37 Expected return on plan assets (27) (21) (54) (41) Amortization of: Net loss 4 3 7 5 Prior service cost 2 2 3 4 ------------------------------------------- Net periodic pension cost $ 6 $ 11 $ 11 $ 24 ==================================================================================================================
In Millions - ----------------------------------------------------------------------------------------------------------------- OPEB Three Months Ended Six Months Ended - ----------------------------------------------------------------------------------------------------------------- June 30 2004 2003 2004 2003 - ----------------------------------------------------------------------------------------------------------------- Service cost $ 5 $ 6 $ 10 $ 11 Interest expense 14 16 29 33 Expected return on plan assets (12) (10) (24) (21) Amortization of: Net loss 3 5 5 10 Prior service cost (2) (2) (5) (4) ------------------------------------------- Net periodic postretirement benefit cost $ 8 $ 15 $ 15 $ 29 =================================================================================================================
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act) was signed into law in December 2003. The Act establishes a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy, which is exempt from federal taxation, to sponsors of retiree health care benefit plans that provide a benefit that is actuarially equivalent to Medicare Part D. We believe our plan is actuarially equivalent to Medicare Part D and have incorporated retroactively the effects of the subsidy into our financial statements as of June 30, 2004 in accordance with FASB Staff Position, No. SFAS 106-2. We remeasured our obligation as of December 31, 2003 to incorporate the impact of the Act, which resulted in a reduction to the accumulated postretirement benefit obligation of $158 million. The remeasurement resulted in a reduction of OPEB cost of $6 million for the three months ended June 30, 2004, $12 million for the six months ended June 30, 2004, and an expected total reduction of $24 million for 2004. The reduction of $24 million includes $7 million in capitalized OPEB costs. For additional details, see Note 11, Implementation of New Accounting Standards. CMS-93 CMS Energy Corporation 8: EQUITY METHOD INVESTMENTS Where ownership is more than 20 percent but less than a majority, we account for certain investments in other companies, partnerships and joint ventures by the equity method of accounting in accordance with APB Opinion No. 18. Net income from these investments included undistributed earnings of $38 million for the three months ended June 30, 2004 and $36 million for the three months ended June 30, 2003 and $44 million for the six months ended June 30, 2004 and $69 million for the six months ended June 30, 2003. The most significant of these investments is our 50 percent interest in Jorf Lasfar, our 45 percent interest in SCP, and our 40 percent interest in Taweelah. Summarized income statement information for our most significant equity method investments is as follows: Income Statement Data
In Millions - --------------------------------------------------------------------------------------------------------- Jorf Three Months Ended June 30, 2004 Lasfar SCP Taweelah Total - --------------------------------------------------------------------------------------------------------- Operating revenue $ 102 $ 18 $ 26 $ 146 Operating expenses (56) (5) (12) (73) ----------------------------------------------- Operating income 46 13 14 73 Other income (expense), net (14) (5) 33 14 ----------------------------------------------- Net income $ 32 $ 8 $ 47 $ 87 =========================================================================================================
In Millions - --------------------------------------------------------------------------------------------------------- Jorf Three Months Ended June 30, 2003 Lasfar SCP Taweelah Total - --------------------------------------------------------------------------------------------------------- Operating revenue $ 91 $ 13 $ 25 $ 129 Operating expenses (43) (4) (9) (56) ----------------------------------------------- Operating income 48 9 16 73 Other expense, net (5) (5) (24) (34) ----------------------------------------------- Net income (loss) $ 43 $ 4 $ (8) $ 39 =========================================================================================================
Income Statement Data
In Millions - --------------------------------------------------------------------------------------------------------- Jorf Six Months Ended June 30, 2004 Lasfar SCP Taweelah Total - --------------------------------------------------------------------------------------------------------- Operating revenue $ 212 $ 37 $ 48 $ 297 Operating expenses (121) (10) (22) (153) ----------------------------------------------- Operating income 91 27 26 144 Other income (expense), net (29) (12) 8 (33) ----------------------------------------------- Net income $ 62 $ 15 $ 34 $ 111 =========================================================================================================
CMS-94 CMS Energy Corporation
In Millions - --------------------------------------------------------------------------------------------------------- Jorf Six Months Ended June 30, 2003 Lasfar SCP Taweelah Total - --------------------------------------------------------------------------------------------------------- Operating revenue $ 181 $ 25 $ 48 $ 254 Operating expenses (86) (8) (18) (112) ----------------------------------------------- Operating income 95 17 30 142 Other expense, net (24) (9) (26) (59) ----------------------------------------------- Net income $ 71 $ 8 $ 4 $ 83 =========================================================================================================
9: REPORTABLE SEGMENTS Our reportable segments consist of business units organized and managed by their products and services. We evaluate performance based upon the net income of each segment. We operate principally in three reportable segments: electric utility, gas utility, and enterprises. The electric utility segment consists of the generation and distribution of electricity in the state of Michigan through our subsidiary, Consumers. The gas utility segment consists of regulated activities associated with the transportation, storage, and distribution of natural gas in the state of Michigan through our subsidiary, Consumers. The enterprises segment consists of: - investing in, acquiring, developing, constructing, managing, and operating non-utility power generation plants and natural gas facilities in the United States and abroad, and - providing gas, oil, and electric marketing services to energy users. The following tables show our financial information by reportable segment. The "Other" net income segment includes corporate interest and other, discontinued operations, and the cumulative effect of accounting changes.
REVENUES In Millions - -------------------------------------------------------------------------------- Restated Three Months Ended June 30 2004 2003 - -------------------------------------------------------------------------------- Electric utility $ 611 $ 602 Gas utility 300 299 Enterprises 182 225 -------------------- $1,093 $1,126 ================================================================================
NET INCOME (LOSS) AVAILABLE TO COMMON STOCK In Millions - -------------------------------------------------------------------------------- Restated Three Months Ended June 30 2004 2003 - -------------------------------------------------------------------------------- Electric utility $ 27 $ 35 Gas utility 1 5 Enterprises 38 8 Other (50) (113) ------------------- $ 16 $ (65) ================================================================================
CMS-95 CMS Energy Corporation
REVENUES In Millions - ----------------------------------------------------------------------------------------- Restated Six Months Ended June 30 2004 2003 - ----------------------------------------------------------------------------------------- Electric utility $1,241 $1,252 Gas utility 1,205 1,088 Enterprises 401 754 -------------------- $2,847 $3,094 ========================================================================================
NET INCOME (LOSS) AVAILABLE TO COMMON STOCK In Millions - ------------------------------------------------------------------------------- Restated Six Months Ended June 30 2004 2003 - ------------------------------------------------------------------------------- Electric utility $ 75 $ 86 Gas utility 57 59 Enterprises (23) 29 Other (100) (157) ------------------- $ 9 $ 17 ==============================================================================
TOTAL ASSETS In Millions - ---------------------------------------------------------------------------------- Restated June 30 2004 2003 - ---------------------------------------------------------------------------------- Electric utility $ 6,935 $ 6,603 Gas utility 2,886 2,586 Enterprises 5,030 4,277 Other 456 473 ---------------------- $15,307 $13,939 ==================================================================================
10: ASSET RETIREMENT OBLIGATIONS SFAS NO. 143: This standard became effective January 2003. It requires companies to record the fair value of the cost to remove assets at the end of their useful life, if there is a legal obligation to do so. We have legal obligations to remove some of our assets, including our nuclear plants, at the end of their useful lives. Before adopting this standard, we classified the removal cost of assets included in the scope of SFAS No. 143 as part of the reserve for accumulated depreciation. For these assets, the removal cost of $448 million that was classified as part of the reserve at December 31, 2002, was reclassified in January 2003, in part, as a: - $364 million ARO liability, - $134 million regulatory liability, - $42 million regulatory asset, and - $7 million net increase to property, plant, and equipment as prescribed by SFAS No. 143. We are reflecting a regulatory asset and liability as required by SFAS No. 71 for regulated entities instead of a cumulative effect of a change in accounting principle. The fair value of ARO liabilities has been calculated using an expected present value technique. This technique reflects assumptions, such as costs, inflation, and profit margin that third parties would CMS-96 CMS Energy Corporation consider to assume the settlement of the obligation. Fair value, to the extent possible, should include a market risk premium for unforeseeable circumstances. No market risk premium was included in our ARO fair value estimate since a reasonable estimate could not be made. If a five percent market risk premium were assumed, our ARO liability would increase by $22 million. If a reasonable estimate of fair value cannot be made in the period the ARO is incurred, such as for assets with indeterminate lives, the liability is to be recognized when a reasonable estimate of fair value can be made. Generally, transmission and distribution assets have indeterminate lives. Retirement cash flows cannot be determined and there is a low probability of a retirement date. Therefore, no liability has been recorded for these assets. Also, no liability has been recorded for assets that have insignificant cumulative disposal costs, such as substation batteries. The measurement of the ARO liabilities for Palisades and Big Rock are based on decommissioning studies that largely utilize third-party cost estimates. In addition, in 2003, we recorded an ARO liability for certain pipelines and non-utility generating plants and a $1 million, net of tax, cumulative effect of change in accounting for accretion and depreciation expense for ARO liabilities incurred prior to 2003. The following tables describe our assets that have legal obligations to be removed at the end of their useful life:
June 30, 2004 In Millions - --------------------------------------------------------------------------------------------------------------------- In Service Trust ARO Description Date Long Lived Assets Fund - --------------------------------------------------------------------------------------------------------------------- Palisades-decommission plant site 1972 Palisades nuclear plant $495 Big Rock-decommission plant site 1962 Big Rock nuclear plant 64 JHCampbell intake/discharge water line 1980 Plant intake/discharge water line - Closure of coal ash disposal areas Various Generating plants coal ash areas - Closure of wells at gas storage fields Various Gas storage fields - Indoor gas services equipment relocations Various Gas meters located inside structures - Closure of gas pipelines Various Gas transmission pipelines - Dismantle natural gas-fired power plant 1997 Gas fueled power plant - =====================================================================================================================
June 30, 2004 In Millions - ------------------------------------------------------------------------- -------------------------------------------------------- ARO Liability ARO ------------------- Cash Flow Liability ARO Description 1/1/03 12/31/03 Incurred Settled Accretion Revisions 6/30/04 - ------------------------------------------------------------------------------------------------------------------------------------ Palisades-decommission $249 $268 $ - $ - $ 10 $ 31 $309 Big Rock-decommission 61 35 - (24) 6 22 39 JHCampbell intake line - - - - - - - Coal ash disposal areas 51 52 - (1) 3 - 54 Wells at gas storage fields 2 2 - - - - 2 Indoor gas services relocations 1 1 - - - - 1 Closure of gas pipelines (a) 8 - - - - - - Natural gas-fired power plant 1 1 - - 1 - 2 ------------------------------------------------------------------------------------ Total $373 $359 $ - $(25) $ 20 $ 53 $407 ==================================================================================================================================
(a) ARO Liability was settled in 2003 as a result of the sales of Panhandle and CMS Field Services. CMS-97 CMS Energy Corporation The Palisades and Big Rock cash flow revisions resulted from new decommissioning reports filed with the MPSC in March 2004. For additional details, see Note 3, Uncertainties, "Other Consumers' Electric Utility Uncertainties - Nuclear Plant Decommissioning." Reclassification of certain types of Cost of Removal: Beginning in December 2003, the SEC requires the quantification and reclassification of the estimated cost of removal obligations arising from other than legal obligations. These cost of removal obligations have been accrued through depreciation charges. We estimate that we had $1.016 billion at June 30, 2004 and $950 million at June 30, 2003 of previously accrued asset removal costs related to our regulated operations arising from other than legal obligations. These obligations, which were previously classified as a component of accumulated depreciation, are now classified as regulatory liabilities in the accompanying Consolidated Balance Sheets. 11: IMPLEMENTATION OF NEW ACCOUNTING STANDARDS FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: The FASB issued this Interpretation in January 2003. The objective of the Interpretation is to assist in determining when one party controls another entity in circumstances where a controlling financial interest cannot be properly identified based on voting interests. Entities with this characteristic are considered variable interest entities. The Interpretation requires the party with the controlling financial interest, known as the primary beneficiary, in a variable interest entity to consolidate the entity. On December 24, 2003, the FASB issued Revised FASB Interpretation No. 46. For entities that have not previously adopted FASB Interpretation No. 46, Revised FASB Interpretation No. 46 provided an implementation deferral until the first quarter of 2004. As of and for the quarter ended March 31, 2004, we adopted Revised FASB Interpretation No. 46 for all entities. We determined that we are the primary beneficiary of both the MCV Partnership and the FMLP. We have a 49 percent partnership interest in the MCV Partnership and a 46.4 percent partnership interest in the FMLP. Consumers is the primary purchaser of power from the MCV Partnership through a long-term power purchase agreement. In addition, the FMLP holds a 75.5 percent lessor interest in the MCV Facility, which results in Consumers holding a 35 percent lessor interest in the MCV Facility. Collectively, these interests make us the primary beneficiary of these entities. As such, we consolidated their assets, liabilities, and activities into our financial statements for the first time as of and for the quarter ended March 31, 2004. These partnerships have third-party obligations totaling $728 million at June 30, 2004. Property, plant, and equipment serving as collateral for these obligations has a carrying value of $1.453 billion at June 30, 2004. The creditors of these partnerships do not have recourse to the general credit of CMS Energy. At December 31, 2003, we determined that we are the primary beneficiary of three other entities that are determined to be variable interest entities. We have 50 percent partnership interest in the T.E.S. Filer City Station Limited Partnership, the Grayling Generating Station Limited Partnership, and the Genesee Power Station Limited Partnership. Additionally, we have operating and management contracts and are the primary purchaser of power from each partnership through long-term power purchase agreements. Collectively, these interests make us the primary beneficiary as defined by the Interpretation. Therefore, we consolidated these partnerships into our consolidated financial statements for the first time as of December 31, 2003. These partnerships have third-party obligations totaling $118 million at June 30, 2004. Property, plant, and equipment serving as collateral for these obligations has a carrying value of $169 million as of June 30, 2004. Other than outstanding letters of credit and guarantees of $5 million, the creditors of these partnerships do not have recourse to the general credit of CMS Energy. CMS-98 CMS Energy Corporation We also determined that we are not the primary beneficiary of our trust preferred security structures. Accordingly, those entities have been deconsolidated as of December 31, 2003. Company Obligated Trust Preferred Securities totaling $663 million, that were previously included in mezzanine equity, have been eliminated due to deconsolidation. As a result of the deconsolidation, we reflected $684 million of long-term debt - related parties and reflected an investment in related parties of $21 million. We are not required to restate prior periods for the impact of this accounting change. Additionally, we have variable interest entities in which we are not the primary beneficiary. FASB Interpretation No. 46 requires us to disclose certain information about these entities. The chart below details our involvement in these entities at June 30, 2004:
- --------------------------------------------------------------------------------------------------------------------------------- Name (Ownership Nature of the Involvement Investment Balance Operating Agreement Total Generating Interest) Entity Country Date (In Millions) with CMS Energy Capacity - --------------------------------------------------------------------------------------------------------------------------------- Taweelah (40%) Generator United Arab 1999 $ 93 Yes 777 MW Emirates Generator - Under Jubail (25%) Construction Saudi Arabia 2001 $ - Yes 250 MW Generator - Under United Arab Shuweihat (20%) Construction Emirates 2001 $ (16)(a) Yes 1,500 MW - ------------------------------------------------------------------------------------------------------------------------------- Total $ 77 2,527 MW ================================================================================================================================
(a) At June 30, 2004, we carried a negative investment in Shuweihat. The balance is comprised of our investment of $3 million reduced by our proportionate share of the negative fair value of derivative instruments of $19 million. We are required to record the negative investment due to our future commitment to make an equity investment in Shuweihat. Our maximum exposure to loss through our interests in these variable interest entities is limited to our investment balance of $77 million, and letters of credit, guarantees, and indemnities relating to Taweelah and Shuweihat totaling $129 million. Included in that total is a letter of credit relating to our required initial investment in Shuweihat of $70 million. We plan to contribute our initial investment when the project becomes commercially operational in 2004. FASB STAFF POSITION, NO. SFAS 106-2, ACCOUNTING AND DISCLOSURE REQUIREMENTS RELATED TO THE MEDICARE PRESCRIPTION DRUG, IMPROVEMENT, AND MODERNIZATION ACT OF 2003: The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act) was signed into law in December 2003. The Act establishes a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy, which is exempt from federal taxation, to sponsors of retiree health care benefit plans that provide a benefit that is actuarially equivalent to Medicare Part D. At December 31, 2003, we elected a one-time deferral of the accounting for the Act, as permitted by FASB Staff Position, No. SFAS 106-1. The final FASB Staff Position, No. SFAS 106-2 supersedes FASB Staff Position, No. SFAS 106-1 and provides further accounting guidance. FASB Staff Position, No. SFAS 106-2 states that for plans that are CMS-99 CMS Energy Corporation actuarially equivalent to Medicare Part D, employers' measures of accumulated postretirement benefit obligations and postretirement benefit costs should reflect the effects of the Act. We believe our plan is actuarially equivalent to Medicare Part D and have incorporated retroactively the effects of the subsidy into our financial statements as of June 30, 2004, in accordance with FASB Staff Position, No. SFAS 106-2. We remeasured our obligation as of December 31, 2003 to incorporate the impact of the Act, which resulted in a reduction to the accumulated postretirement benefit obligation of $158 million. The remeasurement resulted in a reduction of OPEB cost of $6 million for the three months ended June 30, 2004, $12 million for the six months ended June 30, 2004, and an expected total reduction of $24 million for 2004. Consumers capitalizes a portion of OPEB cost in accordance with regulatory accounting. As such, the remeasurement resulted in a net reduction of OPEB expense of $4 million, or $0.03 per share, for the three months ended June 30, 2004, $9 million, or $0.05 per share, for the six months ended June 30, 2004, and an expected total net expense reduction of $17 million for 2004. EITF NO. 03-6, PARTICIPATING SECURITIES AND THE TWO-CLASS METHOD UNDER SFAS NO. 128: EITF No. 03-6, effective June 30, 2004, addresses the treatment of participating securities in earnings per share calculations. This EITF defines participating securities and describes their treatment using a two-class method of calculating earnings per share. Since we have not issued any participating securities, as defined by EITF No. 03-6 and SFAS No. 128, there was no impact on earnings per share upon adoption. CMS-100 Consumers Energy Company CONSUMERS ENERGY COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS In this MD&A, Consumers Energy, which includes Consumers Energy Company and all of its subsidiaries, is at times referred to in the first person as "we," "our" or "us." EXECUTIVE OVERVIEW Consumers, a subsidiary of CMS Energy, a holding company, is a combination electric and gas utility company that provides service to customers in Michigan's Lower Peninsula. Our customer base includes a mix of residential, commercial, and diversified industrial customers, the largest segment of which is the automotive industry. We manage our business by the nature and services each provides and operate principally in two business segments: electric utility and gas utility. Our electric utility operations include the generation, purchase, distribution, and sale of electricity. Our gas utility operations include the purchase, transportation, storage, distribution, and sale of natural gas. We earn our revenue and generate cash from operations by providing electric and natural gas services, electric power generation, gas transmission and storage, and other energy related services. Our businesses are affected by weather, especially during the traditional heating and cooling seasons, economic conditions, regulation and regulatory issues, interest rates, our debt credit rating, and energy commodity prices. Our strategy involves rebuilding our balance sheet and refocusing on our core strength: superior utility operation and service. Over the next few years, we expect this strategy to improve our debt ratings, grow earnings at a mid-single digit rate, and position the company to make new investments. Despite strong financial and operational performance in 2003, we face important challenges in the future. We continue to lose industrial and commercial customers to alternative electric suppliers without receiving compensation for stranded costs caused by the lost sales. As of July 2004, we have lost 858 MW or 11 percent of our electric load to these alternative electric suppliers. Based on current trends, we predict load loss by year-end to be in the range of 900 MW to 1,100 MW. However, no assurance can be made that the actual load loss will not be greater or less than that range. Existing state legislation encourages competition and provides for recovery of stranded costs, but the MPSC has not yet authorized stranded cost recovery. We continue to seek resolution of this issue. In July 2004, several bills were introduced into the Michigan Senate that could change Michigan's Customer Choice Act. Further, higher natural gas prices have harmed the economics of the MCV Partnership and we are seeking approval from the MPSC to change the way the facility is used. Our proposal would reduce gas consumption by an estimated 30 to 40 bcf per year while improving the MCV Partnership's financial performance with no change to customer rates. A portion of the benefits from the proposal will support additional renewable resource development in Michigan. Resolving the issue is critical for our shareowners and customers. Our gas business faces market and regulatory uncertainties relating to gas costs. We attempt to minimize these uncertainties by fully recovering what we spend to purchase the gas through the GCR process. We currently have a GCR year 2003-2004 reconciliation on file with the MPSC. CE-1 Consumers Energy Company We are focused on further reducing our business, financial, and regulatory risks, while growing the equity base of our company. Finally, we are planning to devote more attention to improving business growth. Our business plan is targeted at predictable earnings growth. The result of these efforts will be a strong, reliable utility company that will be poised to take advantage of opportunities for further growth. CONSOLIDATION OF THE MCV PARTNERSHIP AND THE FMLP Under Revised FASB Interpretation No. 46, we are the primary beneficiary of the MCV Partnership and the FMLP. As a result, we have consolidated the assets, liabilities, and activities of these entities into our financial statements as of and for the three and six months ended June 30, 2004. These entities are reported as equity method investments in our financial statements as of and for the three and six months ended June 30, 2003. Therefore, the consolidation of these entities had no impact on our consolidated net income for the three and six months ended June 30, 2004. For additional details, see Note 7, Implementation of New Accounting Standards. FORWARD-LOOKING STATEMENTS AND RISK FACTORS This Form 10-Q and other written and oral statements that we make contain forward-looking statements as defined in Rule 3b-6 of the Securities Exchange Act of 1934, as amended, Rule 175 of the Securities Act of 1933, as amended, and relevant legal decisions. Our intention with the use of words such as "may," "could," "anticipates," "believes," "estimates," "expects," "intends," "plans," and other similar words is to identify forward-looking statements that involve risk and uncertainty. We designed this discussion of potential risks and uncertainties to highlight important factors that may impact our business and financial outlook. We have no obligation to update or revise forward-looking statements regardless of whether new information, future events, or any other factors affect the information contained in the statements. These forward-looking statements are subject to various factors that could cause our actual results to differ materially from the results anticipated in these statements. Such factors include our inability to predict and/or control: - capital and financial market conditions, including the current price of CMS Energy Common Stock and the effect of such market conditions on the Pension Plan, interest rates and availability of financing to Consumers, CMS Energy, or any of their affiliates and the energy industry, - ability to access the capital markets successfully, - market perception of the energy industry, Consumers, CMS Energy, or any of their affiliates, - credit ratings of Consumers, CMS Energy, or any of their affiliates, - factors affecting utility and diversified energy operations such as unusual weather conditions, catastrophic weather-related damage, unscheduled generation outages, maintenance or repairs, environmental incidents, or electric transmission or gas pipeline system constraints, - international, national, regional, and local economic, competitive, and regulatory policies, conditions and developments, CE-2 Consumers Energy Company - adverse regulatory or legal decisions, including environmental laws and regulations, - the impact of adverse natural gas prices on the MCV Partnership investment, regulatory decisions concerning the MCV Partnership RCP, and regulatory decisions that limit our recovery of capacity and fixed energy payments, - federal regulation of electric sales and transmission of electricity including re-examination by federal regulators of our market-based sales authorizations in wholesale power markets without price restrictions, and proposals by the FERC to change the way public utilities and natural gas companies, and their subsidiaries and affiliates, interact with each other, - energy markets, including the timing and extent of unanticipated changes in commodity prices for oil, coal, natural gas, natural gas liquids, electricity, and certain related products due to lower or higher demand, shortages, transportation problems, or other developments, - potential disruption or interruption of facilities or operations due to accidents or terrorism, and the ability to obtain or maintain insurance coverage for such events, - nuclear power plant performance, decommissioning, policies, procedures, incidents, and regulation, including the availability of spent nuclear fuel storage, - technological developments in energy production, delivery, and usage, - achievement of capital expenditure and operating expense goals, - changes in financial or regulatory accounting principles or policies, - outcome, cost, and other effects of legal and administrative proceedings, settlements, investigations and claims, - limitations on our ability to control the development or operation of projects in which our subsidiaries have a minority interest, - disruptions in the normal commercial insurance and surety bond markets that may increase costs or reduce traditional insurance coverage, particularly terrorism and sabotage insurance and performance bonds, - other business or investment considerations that may be disclosed from time to time in Consumers' or CMS Energy's SEC filings, or in other publicly issued written documents, and - other uncertainties that are difficult to predict, and many of which are beyond our control. CE-3 Consumers Energy Company RESULTS OF OPERATIONS NET INCOME AVAILABLE TO COMMON STOCKHOLDER
In Millions - ------------------------------------------------------------------------------- June 30 2004 2003 Change - ------------------------------------------------------------------------------- Three months ended $ 23 $ 40 $(17) Six months ended $128 $139 $(11) ===============================================================================
2004 COMPARED TO 2003: For the three months ended June 30, 2004, our net income decreased $17 million versus the same period in 2003 primarily due to higher MSBT expense, a reduction in electric and gas revenues, and decreased earnings from our investment in the MCV Partnership. Increased MSBT expense lowered net income by $12 million due to a 2003 reduction to reflect CMS Energy receiving approval to file consolidated tax returns for the years 2000 and 2001. These returns were filed during the second quarter of 2003. Decreased electric delivery revenues further reduced net income by $7 million primarily due to tariff revenue reductions and the continued loss of commercial and industrial customers switching to alternative electric suppliers as allowed by the Customer Choice Act. Decreased gas delivery revenues due to warmer weather further reduced net income by $5 million. Also contributing to the decline in net income were lower earnings from the MCV Partnership, reducing net income $4 million. The reduction in the MCV Partnership earnings reflects an increase in non-recoverable fuel costs incurred at the MCV Facility and a decrease in the fair value of certain long-term gas contracts. Partially offsetting these reductions to net income were $10 million in benefits primarily relating to reduced depreciation expense and additional interest income. The Customer Choice Act authorized us to defer electric depreciation on the excess of capital expenditures over our depreciation base and recognize interest income on the excess capital expenditures. Gas depreciation expense also declined in the second quarter of 2004 due to the interim MPSC gas rate order issued in December 2003. For the six months ended June 30, 2004, our net income decreased $11 million versus the same period in 2003. Warmer weather reduced gas delivery revenues, decreasing net income by $14 million. The warmer weather improved electric delivery sales to the higher margin residential sector; however, tariff revenue reductions and the continued loss of customers to alternative electric suppliers as allowed by the Customer Choice Act more than offset this benefit. Electric delivery revenues decreased net income by $13 million. Earnings from our investment in the MCV Partnership declined $10 million primarily due to increases in non-recoverable fuel costs incurred at the MCV Facility and decreases in the fair value of certain long-term gas contracts. Higher general taxes decreased net income $9 million due to a 2003 reduction in MSBT expense to reflect the benefit of CMS Energy receiving approval to file consolidated tax returns for the years 2000 and 2001. Net income was further decreased $8 million due to greater average borrowings, partially offset by a reduction in our average interest rate. In 2003, under provisions of the Customer Choice Act, the excess, or overrecovery of PSCR revenues over PSCR costs benefited net income. In contrast, in 2004 PSCR overrecoveries must be reserved for possible future refund and consequently do not benefit net income. This change in the treatment of PSCR overrecoveries reduced net income $5 million. Partially offsetting these reductions to net income were $27 million in benefits relating primarily to reduced depreciation expense and increases in interest income. The Customer Choice Act authorized us to defer electric depreciation on the excess of capital expenditures over our depreciation base and recognize interest income on the excess capital expenditures. Gas depreciation expense also declined in 2004 due to the interim MPSC gas rate order issued in December 2003. This interim order also authorized a gas rate CE-4 Consumers Energy Company increase that benefited net income by $7 million. Non-commodity gas revenues further increased net income $2 million due to increased gas transportation and storage revenues. Finally, net income benefited from the absence of a $12 million charge taken in 2003. The 2003 charge reflects a decline in the market value of CMS Energy stock held by us. For additional details, see "Electric Utility Results of Operations" and "Gas Utility Results of Operations" within this section and Note 2, Uncertainties. ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions - ------------------------------------------------------------------------------------------------------ June 30 2004 2003 Change - ------------------------------------------------------------------------------------------------------ Three months ended $ 27 $35 $ (8) Six months ended $75 $86 $(11) ======================================================================================================
Three Months Ended Six Months Ended Reasons for the change: June 30, 2004 vs. 2003 June 30, 2004 vs. 2003 - ------------------------------------------------------------------------------------------------------ Electric deliveries $(10) $(20) Power supply costs and related revenue (2) (8) Other operating expenses, non-commodity revenue and other income 13 26 General taxes (14) (10) Fixed charges -- (6) Income taxes 5 7 ----------------------------------------- Total change $ (8) $(11) ======================================================================================================
ELECTRIC DELIVERIES: Electric deliveries, including transactions with other wholesale marketers, other electric utilities, and customers choosing alternative suppliers increased 0.7 billion kWh or 7.2 percent and 1.0 billion kWh or 5.4 percent for the three and six months ended June 30, 2004 versus the same periods in 2003. The corresponding increases in electric delivery revenue for both periods were offset by tariff revenue reductions and decreased sales margins from deliveries to customers choosing alternative electric suppliers. The tariff revenue reductions, which began January 1, 2004, were equivalent to the Big Rock nuclear decommissioning surcharge in effect when our electric retail rates were frozen from June 2000 through December 31, 2003. The tariff revenue reductions were reclassified for capped customers as increases to PSCR revenues. The increased PSCR revenues helped negate possible losses attributable to the underrecovery of PSCR costs for these customers, primarily the residential and small commercial classes. In fact, the revenue reclassification contributed to the overrecovery of PSCR revenues in excess of PSCR costs in these customer classes for the three and six months ended June 30, 2004. In 2004, to the extent we have PSCR overrecoveries, the overrecovery must be reserved for possible future refund. The tariff revenue reductions have decreased electric delivery revenues by approximately $9 million in the second quarter of 2004, and $18 million in the first six months of 2004 versus 2003. The tariff revenue reductions are expected to decrease electric delivery revenues by $35 million for the full year of 2004 versus the full year of 2003. CE-5 Consumers Energy Company For the three and six months ended June 30, 2004, the overall decline in electric delivery revenues was offset partially by increased sales to residential customers due to warmer weather versus the same periods in 2003. POWER SUPPLY COSTS AND RELATED REVENUE: In 2003, our power supply cost rate of recovery was a fixed amount per kWh, as required under the Customer Choice Act. Therefore, power supply-related revenue in excess of actual power supply costs increased operating income. By contrast, if power supply-related revenues had been less than actual power supply costs, the impact would have decreased operating income. In 2004, our recovery of power supply costs is no longer fixed, but is instead restricted to a pre-defined limit for certain customer classes. The customer classes that have a pre-defined limit, or cap, on the level of power supply costs they can be charged are primarily the residential and small commercial customer classes. In 2004, to the extent our power supply-related revenues are in excess of actual power supply costs, this former benefit is reserved for possible future refund. This change in the treatment of excess power supply revenues over power supply costs decreased operating income for the three and six months ended June 30, 2004 versus the same periods in 2003. OTHER OPERATING EXPENSES, NON-COMMODITY REVENUE AND OTHER INCOME: In the three months ended June 30, 2004, other operating expenses decreased $1 million, non-commodity revenue increased $1 million, and other income increased $11 million versus the same period in 2003. The increase in other income relates primarily to interest income recognized in relation to capital expenditures in excess of depreciation, as allowed by the Customer Choice Act. This Act also enabled us to defer depreciation expense on the excess of capital expenditures over our depreciation base, contributing to a reduction in operating expenses for the second quarter of 2004 versus the same period in 2003. Higher other operating expenses substantially offset the reduction in electric depreciation expense. In the six months ended June 30, 2004, other operating expenses decreased $6 million and other income increased $20 million versus the same period in 2003. The increase in other income relates primarily to interest income recognized in relation to capital expenditures in excess of depreciation, as allowed by the Customer Choice Act. Operating expense decreases reflect lower benefit costs and our ability to defer depreciation expense on the excess of capital expenditures over our depreciation base, as allowed by the Customer Choice Act. GENERAL TAXES: General taxes increased in the three and six months ended June 30, 2004 versus the same periods in 2003 primarily due to reductions in the MSBT expense in 2003. The 2003 reduction was primarily due to CMS Energy having received approval to file consolidated tax returns for the years 2000 and 2001. The taxable income for these years was lower than the amount used to make estimated MSBT payments. These returns were filed in the second quarter of 2003. FIXED CHARGES: Fixed charges increased in the six months ended June 30, 2004 versus the same periods in 2003 due to higher average debt levels, partially offset by a reduction in the average rates of interest. The average rate of interest dropped 79 basis points and 60 basis points for the three and six month periods ended June 30, 2004 versus the same periods in 2003. INCOME TAXES: In the three and six months ended June 30, 2004, income taxes decreased versus the same periods in 2003 primarily due to lower earnings by the electric utility, and the OPEB Medicare Part D federal subsidy that is exempt from federal taxation. CE-6 Consumers Energy Company GAS UTILITY RESULTS OF OPERATIONS
In Millions - ------------------------------------------------------------------------------------------------------------- June 30 2004 2003 Change - ------------------------------------------------------------------------------------------------------------- Three months ended $ 1 $ 5 $ (4) Six months ended $57 $59 $ (2) =============================================================================================================
Three Months Ended Six Months Ended Reasons for the change: June 30, 2004 vs. 2003 June 30, 2004 vs. 2003 - ------------------------------------------------------------------------------------------------------------- Gas deliveries $ (7) $(21) Gas rate increase 2 11 Gas wholesale and retail services and other gas revenues 1 3 Operation and maintenance - (2) General taxes, depreciation, and other income (3) 3 Fixed charges (2) (6) Income taxes 5 10 --------------------------------------------------------- Total change $ (4) $ (2) =============================================================================================================
GAS DELIVERIES: For the three months ended June 30, 2004, the more profitable non-transportation gas deliveries decreased 4.9 bcf or 13.6 percent primarily due to milder weather. The less profitable transportation gas deliveries increased 5.2 bcf or 21.0 percent due to increased MCV Facility generation. Overall, gas deliveries, including miscellaneous transportation, increased 0.3 bcf or 0.5 percent versus the same period in 2003. For the six months ended June 30, 2004, gas deliveries, including miscellaneous transportation, decreased 6.7 bcf or 2.9 percent versus the same period in 2003 primarily due to milder weather. GAS RATE INCREASE: In December 2003, the MPSC issued an interim gas rate order authorizing a $19 million annual increase to gas tariff rates. As a result of this order, gas revenues increased for the three and six months ended June 30, 2004 versus the same periods in 2003. GAS WHOLESALE AND RETAIL SERVICES AND OTHER GAS REVENUES: For the three and six months ended June 30, 2004, wholesale and retail services and other gas revenues increased primarily due to increased gas transportation and storage revenues versus the same periods in 2003. OPERATION AND MAINTENANCE: For the six months ended June 30, 2004, increased expenditures on safety, reliability, and customer service were offset partially by reduced benefit costs compared to the same period in 2003. GENERAL TAXES, DEPRECIATION, AND OTHER INCOME: For the three months ended June 30, 2004 versus the same period in 2003, general tax expense increased $5 million due to higher MSBT expense and depreciation expense decreased $2 million. The increase in MSBT expense is primarily due to CMS Energy having received approval to file consolidated tax returns for the years 2000 and 2001. The taxable income for these years was lower than the amount used to make estimated MSBT payments. These returns were filed in the second quarter of 2003. The reduced depreciation expense relates to decreases in CE-7 Consumers Energy Company depreciation rates authorized by the MPSC's December 2003 interim rate order. For the six months ended June 30, 2004, general tax expense increased $4 million due to higher MSBT expense, depreciation expense decreased $8 million, and other income decreased $1 million versus the same period in 2003. The increase in MSBT expense is primarily due to CMS Energy having received approval to file consolidated tax returns for the years 2000 and 2001. The taxable income for these years was lower than the amount used to make estimated MSBT payments. These returns were filed in the second quarter of 2003. The reduced depreciation expense relates to decreases in depreciation rates authorized by the MPSC's December 2003 interim rate order. FIXED CHARGES: Fixed charges increased in the three and six months ended June 30, 2004 versus the same periods in 2003 due to higher average debt levels, partially offset by a reduction in the average rate of interest. The average rate of interest dropped 79 basis points and 60 basis points for the three and six month periods ended June 30, 2004 versus the same periods in 2003. INCOME TAXES: For the three and six months ended June 30, 2004 versus the same periods in 2003, income taxes decreased due to the income tax treatment of items related to plant, property and equipment as required by past MPSC rulings, the decreased earnings of the gas utility, and the OPEB Medicare Part D federal subsidy that is exempt from federal taxation. CRITICAL ACCOUNTING POLICIES The following accounting policies are important to an understanding of our results of operations and financial condition and should be considered an integral part of our MD&A: - use of estimates in accounting for contingencies and equity method investments, - accounting for the effects of regulatory accounting, - accounting for financial and derivative instruments, - accounting for pension and postretirement benefits, - accounting for asset retirement obligations, - accounting for nuclear decommissioning costs, and - accounting for related party transactions. For additional accounting policies, see Note 1, Corporate Structure and Accounting Policies. USE OF ESTIMATES AND ASSUMPTIONS In preparing our financial statements, we use estimates and assumptions that may affect reported amounts and disclosures. Accounting estimates are used for asset valuations, depreciation, amortization, financial and derivative instruments, employee benefits, and contingencies. For example, we estimate the rate of return on plan assets and the cost of future health-care benefits to determine our annual pension and other postretirement benefit costs. There are risks and uncertainties that may cause actual results to differ from estimated results, such as changes in the regulatory environment, competition, regulatory decisions, and lawsuits. CONTINGENCIES: We are involved in various regulatory and legal proceedings that arise in the ordinary course of our business. We record a liability for contingencies based upon our assessment that the occurrence is probable and, where determinable, an estimate of the liability amount. The recording of estimated liabilities for contingencies is guided by the principles in SFAS No. 5. We consider many factors in making these assessments, including history and the specifics of each matter. The most CE-8 Consumers Energy Company significant of these contingencies are our electric and gas environmental estimates, which are discussed in the "Outlook" section included in this MD&A, and the potential underrecoveries from our power purchase contract with the MCV Partnership. MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990 and to supply electricity and steam to Dow. We hold a 49 percent partnership interest in the MCV Partnership, and a 35 percent lessor interest in the MCV Facility. Under our PPA with the MCV Partnership, we pay a capacity charge based on the availability of the MCV Facility whether or not electricity is actually delivered to us; a variable energy charge for kWh delivered to us; and a fixed energy charge based on availability up to 915 MW and based on delivery for the remaining 325 MW of contract capacity. The cost that we incur under the MCV Partnership PPA exceeds the recovery amount allowed by the MPSC. As a result, we estimate cash underrecoveries of capacity and fixed energy payments will aggregate $206 million from 2004 through 2007. For capacity and fixed energy payments billed by the MCV Partnership after September 15, 2007, and not recovered from customers, we expect to claim relief under a regulatory out provision under the MCV Partnership PPA. This provision obligates Consumers to pay the MCV Partnership only those capacity and energy charges that the MPSC has authorized for recovery from electric customers. The effect of any such action would be to: - reduce cash flow to the MCV Partnership, which could have an adverse effect on our investment, and - eliminate our underrecoveries for capacity and fixed energy payments. Further, under the PPA, variable energy payments to the MCV Partnership are based on the cost of coal burned at our coal plants and our operation and maintenance expenses. However, the MCV Partnership's costs of producing electricity are tied to the cost of natural gas. Because natural gas prices have increased substantially in recent years and the price the MCV Partnership can charge us for energy has not, the MCV Partnership's financial performance has been impacted negatively. As a result of returning to the PSCR process on January 1, 2004, we returned to dispatching the MCV Facility on a fixed load basis, as permitted by the MPSC, in order to maximize recovery from electric customers of our capacity and fixed energy payments. This fixed load dispatch increases the MCV Facility's output and electricity production costs, such as natural gas. As the spread between the MCV Facility's variable electricity production costs and its energy payment revenue widens, the MCV Partnership's financial performance and our investment in the MCV Partnership is and will be affected adversely. In February 2004, we filed the RCP with the MPSC that is intended to help conserve natural gas and thereby improve our investment in the MCV Partnership, without raising the costs paid by our electric customers. The plan's primary objective is to dispatch the MCV Facility on the basis of natural gas market prices, which will reduce the MCV Facility's annual production of electricity and, as a result, reduce the MCV Facility's consumption of natural gas by an estimated 30 to 40 bcf. This decrease in the quantity of high-priced natural gas consumed by the MCV Facility will benefit Consumers' ownership interest in the MCV Partnership. Presently, we are in settlement discussions with the parties to the RCP filing. However, in July 2004, several qualifying facilities filed for a stay on the RCP proceeding in the Ingham County Circuit Court after their previous attempt to intervene on the proceeding was denied by the MPSC. Hearings on the stay are scheduled for August 11, 2004. We cannot predict if or when the MPSC will approve the RCP or the outcome of the Ingham County Circuit Court hearings. CE-9 Consumers Energy Company The two most significant variables in the analysis of the MCV Partnership's future financial performance are the forward price of natural gas for the next 20 years and the MPSC's decision in 2007 or beyond related to limiting our recovery of capacity and fixed energy payments. Natural gas prices have been volatile historically. Presently, there is no consensus in the marketplace on the price or range of future prices of natural gas. Even with an approved RCP, if gas prices continue at present levels or increase, the economics of operating the MCV Facility may be adverse enough to require us to recognize an impairment of our investment in the MCV Partnership. We presently cannot predict the impact of these issues on our future earnings, cash flows, or on the value of our investment in the MCV Partnership. For additional details on the MCV Partnership, see Note 2, Uncertainties, "Other Electric Uncertainties - The Midland Cogeneration Venture." ACCOUNTING FOR THE EFFECTS OF INDUSTRY REGULATION Because we are involved in a regulated industry, regulatory decisions affect the timing and recognition of revenues and expenses. We use SFAS No. 71 to account for the effects of these regulatory decisions. As a result, we may defer or recognize revenues and expenses differently than a non-regulated entity. For example, items that a non-regulated entity normally would expense, we may record as regulatory assets if the actions of the regulator indicate such expenses will be recovered in future rates. Conversely, items that non-regulated entities may normally recognize as revenues, we may record as regulatory liabilities if the actions of the regulator indicate they will require such revenues be refunded to customers. Judgment is required to determine the recoverability of items recorded as regulatory assets and liabilities. As of June 30, 2004, we had $1.125 billion recorded as regulatory assets and $1.502 billion recorded as regulatory liabilities. For additional details on industry regulation, see Note 1, Corporate Structure and Accounting Policies, "Utility Regulation." ACCOUNTING FOR FINANCIAL AND DERIVATIVE INSTRUMENTS AND MARKET RISK INFORMATION FINANCIAL INSTRUMENTS: We account for investments in debt and equity securities using SFAS No. 115. Debt and equity securities can be classified into one of three categories: held-to-maturity, trading, or available-for-sale securities. Our debt securities are classified as held-to-maturity securities and are reported at cost. Our investments in equity securities are classified as available-for-sale securities. They are reported at fair value, with any unrealized gains or losses resulting from changes in fair value reported in equity as part of accumulated other comprehensive income and are excluded from earnings unless such changes in fair value are determined to be other than temporary. Unrealized gains or losses resulting from changes in the fair value of our nuclear decommissioning investments are reflected in Regulatory Liabilities. The fair value of our equity securities is determined from quoted market prices. DERIVATIVE INSTRUMENTS: We use the criteria in SFAS No. 133, as amended and interpreted, to determine if certain contracts must be accounted for as derivative instruments. The rules for determining whether a contract meets the criteria for derivative accounting are numerous and complex. Moreover, significant judgment is required to determine whether a contract requires derivative accounting, and similar contracts can sometimes be accounted for differently. CE-10 Consumers Energy Company If a contract is accounted for as a derivative instrument, it is recorded in the financial statements as an asset or a liability at the fair value of the contract. The recorded fair value of the contract is then adjusted quarterly to reflect any change in the market value of the contract, a practice known as marking the contract to market. Changes in the fair value of a derivative (that is, gains or losses) are reported either in earnings or accumulated other comprehensive income, depending on whether the derivative qualifies for special hedge accounting treatment. The types of contracts we typically classify as derivative instruments are interest rate swaps, electric call options, gas fuel futures and options, gas fuel contracts containing volume optionality, fixed priced weather-based gas supply call options, and fixed price gas supply call and put options. We generally do not account for electric capacity and energy contracts, gas supply contracts, coal and nuclear fuel supply contracts, or purchase orders for numerous supply items as derivatives. The majority of our contracts are not subject to derivative accounting because they qualify for the normal purchases and sales exception of SFAS No. 133, or are not derivatives because there is not an active market for the commodity. Our electric capacity and energy contracts are not accounted for as derivatives due to the lack of an active energy market in the state of Michigan, as defined by SFAS No. 133, and the significant transportation costs that would be incurred to deliver the power under the contracts to the closest active energy market at the Cinergy hub in Ohio. If an active market develops in the future, we may be required to account for these contracts as derivatives. The mark-to-market impact on earnings related to these contracts could be material to our financial statements. Additionally, the MCV Partnership uses natural gas fuel contracts to buy gas as fuel for generation, and to manage gas fuel costs. The MCV Partnership believes that its long-term natural gas contracts, which do not contain volume optionality, qualify under SFAS No. 133 for the normal purchases and normal sales exception. Therefore, these contracts are currently not recognized at fair value on the balance sheet. Should significant changes in the level of the MCV Facility operational dispatch or purchases of long-term gas occur, the MCV Partnership would be required to re-evaluate its accounting treatment for these long-term gas contracts. This re-evaluation may result in recording mark-to-market activity on some contracts, which could add to earnings volatility. To determine the fair value of contracts that are accounted for as derivative instruments, we use a combination of quoted market prices and mathematical valuation models. Valuation models require various inputs, including forward prices, volatilities, interest rates, and exercise periods. Changes in forward prices or volatilities could change significantly the calculated fair value of certain contracts. At June 30, 2004, we assumed a market-based interest rate of 1 percent (a rate that is not significantly different than the LIBOR rate) and volatility rates ranging between 60 percent and 71 percent to calculate the fair value of our gas options. At June 30, 2004, we assumed market-based interest rates ranging between 1.37 percent and 4.50 percent and volatility rates ranging between 24 percent and 44 percent to calculate the fair value of the gas fuel derivative contracts held by the MCV Partnership. MARKET RISK INFORMATION: We are exposed to market risks including, but not limited to, changes in interest rates, commodity prices, and equity security prices. We manage these risks using established policies and procedures, under the direction of both an executive oversight committee consisting of senior management representatives and a risk committee consisting of business-unit managers. We may use various contracts to manage these risks, including swaps, options, futures, and forward contracts. Contracts used to manage market risks may be considered derivative instruments that are subject to derivative and hedge accounting pursuant to SFAS No. 133. We intend that any gains or losses on these contracts will be offset by an opposite movement in the value of the item at risk. We enter into all risk CE-11 Consumers Energy Company management contracts for purposes other than trading. These contracts contain credit risk if the counterparties, including financial institutions and energy marketers, fail to perform under the agreements. We minimize such risk by performing financial credit reviews using, among other things, publicly available credit ratings of such counterparties. We perform sensitivity analyses to assess the potential loss in fair value, cash flows, or future earnings based upon a hypothetical 10 percent adverse change in market rates or prices. We do not believe that sensitivity analyses alone provide an accurate or reliable method for monitoring and controlling risks. Therefore, we use our experience and judgment to revise strategies and modify assessments. Changes in excess of the amounts determined in sensitivity analyses could occur if market rates or prices exceed the 10 percent shift used for the analyses. These risk sensitivities are shown in "Interest Rate Risk," "Commodity Price Risk," and "Equity Securities Price Risk" within this section. Interest Rate Risk: We are exposed to interest rate risk resulting from issuing fixed-rate and variable-rate financing instruments, and from interest rate swap agreements. We use a combination of these instruments to manage this risk as deemed appropriate, based upon market conditions. These strategies are designed to provide and maintain a balance between risk and the lowest cost of capital. Interest Rate Risk Sensitivity Analysis (assuming a 10 percent adverse change in market interest rates):
In Millions - ----------------------------------------------------------------------------------------------------------- June 30, 2004 December 31, 2003 - ----------------------------------------------------------------------------------------------------------- Variable-rate financing - before tax annual earnings exposure $ 1 $ 1 Fixed-rate financing - potential loss in fair value (a) 154 154 ===========================================================================================================
(a) Fair value exposure could only be realized if we repurchased all of our fixed-rate financing. As discussed in "Electric Business Uncertainties - Competition and Regulatory Restructuring - Securitization" within this MD&A, we have filed an application with the MPSC to securitize certain expenditures. Upon final approval, we intend to use the proceeds from the Securitization to retire higher-cost debt, which could include a portion of our current fixed-rate debt. We do not believe that any adverse change in debt price and interest rates would have a material adverse effect on either our consolidated financial position, results of operations, or cash flows. Commodity Price Risk: For purposes other than trading, we enter into electric call options, fixed-priced weather-based gas supply call options, and fixed-priced gas supply call and put options. Electric call options are purchased to protect against the risk of fluctuations in the market price of electricity, and to ensure a reliable source of capacity to meet our customers' electric needs. Purchased electric call options give us the right, but not the obligation, to purchase electricity at predetermined fixed prices. Purchases of gas supply call options and weather-based gas supply call options, coupled with the sale of gas supply put options, are used to purchase reasonably priced gas supply. Purchases of gas supply call options give us the right, but not the obligation, to purchase gas supply at predetermined fixed prices. Gas supply put options sold give third-party suppliers the right, but not the obligation, to sell gas supply to us at predetermined fixed prices. At June 30, 2004, we held fixed-priced weather-based gas supply call options and fixed-price gas supply call and put options. The MCV Partnership uses natural gas fuel contracts to buy gas as fuel for generation and to manage gas fuel costs. Some of these contracts contain volume optionality and, therefore, are treated as derivative instruments. Also, the MCV Partnership enters into natural gas futures contracts, option contracts, and over-the-counter swap transactions in order to hedge against CE-12 Consumers Energy Company unfavorable changes in the market price of natural gas in future months when gas is expected to be needed. These financial instruments are being used principally to secure anticipated natural gas requirements necessary for projected electric and steam sales, and to lock in sales prices of natural gas previously obtained in order to optimize the MCV Partnership's existing gas supply, storage, and transportation arrangements. Commodity Price Risk Sensitivity Analysis (assuming a 10 percent adverse change in market prices):
In Millions - ------------------------------------------------------------------------------------------------- June 30, 2004 December 31, 2003 - ------------------------------------------------------------------------------------------------- Potential reduction in fair value: Gas supply option contracts $ 7 $ 1 Derivative contracts associated with Consumers' investment in the MCV Partnership: Gas fuel contracts 21 N/A Gas fuel futures, options, and swaps 38 N/A =================================================================================================
During the six months ended June 30, 2004, we entered into additional weather-based gas supply call options, as well as gas supply call and put option contracts. As a result, the potential reduction in the fair value increased from December 31, 2003, as shown in the table above. We did not perform a sensitivity analysis for the derivative contracts held by the MCV Partnership as of December 31, 2003 because the MCV Partnership was not consolidated into our financial statements until March 31, 2004, as discussed in Note 7, Implementation of New Accounting Standards. Equity Securities Price Risk: We are exposed to price risk associated with investments in equity securities. As discussed in "Financial Instruments" within this section, our investments in equity securities are classified as available-for-sale securities. They are reported at fair value, with any unrealized gains or losses resulting from changes in fair value reported in equity as part of accumulated other comprehensive income and are excluded from earnings unless such changes in fair value are determined to be other than temporary. Unrealized gains or losses resulting from changes in the fair value of our nuclear decommissioning investments are reflected in Regulatory Liabilities. Our debt securities are classified as held-to-maturity securities and have original maturity dates of approximately one year or less. Because of the short maturity of these instruments, their carrying amounts approximate their fair values. Equity Securities Price Risk Sensitivity Analysis (assuming a 10 percent adverse change in market prices):
In Millions - -------------------------------------------------------------------------- June 30, 2004 December 31, 2003 - -------------------------------------------------------------------------- Potential reduction in fair value: Nuclear decommissioning investments $ 54 $ 57 Other available-for-sale investments 4 4 ==========================================================================
For additional details on market risk and derivative activities, see Note 4, Financial and Derivative Instruments. CE-13 Consumers Energy Company ACCOUNTING FOR PENSION AND OPEB Pension: We have established external trust funds to provide retirement pension benefits to our employees under a non-contributory, defined benefit Pension Plan. We implemented a cash balance plan for certain employees hired after June 30, 2003. We use SFAS No. 87 to account for pension costs. 401(k): In our effort to reduce costs, the employer's match for the 401(k) plan was suspended effective September 1, 2002. The employer's match for the 401(k) plan is scheduled to resume on January 1, 2005. OPEB: We provide postretirement health and life benefits under our OPEB plan to substantially all our retired employees. We use SFAS No. 106 to account for other postretirement benefit costs. Liabilities for both pension and OPEB are recorded on the balance sheet at the present value of their future obligations, net of any plan assets. The calculation of the liabilities and associated expenses requires the expertise of actuaries. Many assumptions are made including: - life expectancies, - present value discount rates, - expected long-term rate of return on plan assets, - rate of compensation increases, and - anticipated health care costs. Any change in these assumptions can change significantly the liability and associated expenses recognized in any given year. The following table provides an estimate of our pension cost, OPEB cost, and cash contributions for the next three years:
In Millions - ----------------------------------------------------------------------------------------- Expected Costs Pension Cost OPEB Cost Contributions - ----------------------------------------------------------------------------------------- 2004 $20 $30 $ 62 2005 52 38 78 2006 71 35 110 ========================================================================================
Actual future pension cost and contributions will depend on future investment performance, changes in future discount rates, and various other factors related to the populations participating in the Pension Plan. As of June 30, 2004, we have a prepaid pension asset of $373 million, $20 million of which is in Other current assets on our Consolidated Balance Sheet. Lowering the expected long-term rate of return on the Pension Plan assets by 0.25 percent (from 8.75 percent to 8.50 percent) would increase estimated pension cost for 2004 by $2 million. Lowering the discount rate by 0.25 percent (from 6.25 percent to 6.00 percent) would increase estimated pension cost for 2004 by $4 million. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act) was signed into law in December 2003. The Act establishes a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy, which is exempt from federal taxation, to sponsors of retiree health care benefit plans that provide a benefit that is actuarially equivalent to Medicare Part D. CE-14 Consumers Energy Company We believe our plan is actuarially equivalent to Medicare Part D and have incorporated retroactively the effects of the subsidy into our financial statements as of June 30, 2004 in accordance with FASB Staff Position, No. SFAS 106-2. We remeasured our obligation as of December 31, 2003 to incorporate the impact of the Act, which resulted in a reduction to the accumulated postretirement benefit obligation of $148 million. The remeasurement resulted in a reduction of OPEB cost of $6 million for the three months ended June 30, 2004, $11 million for the six months ended June 30, 2004, and an expected total reduction of $23 million for 2004. For additional details on postretirement benefits, see Note 5, Retirement Benefits, and Note 7, Implementation of New Accounting Standards. ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS SFAS No. 143 became effective January 2003. It requires companies to record the fair value of the cost to remove assets at the end of their useful lives, if there is a legal obligation to remove them. We have legal obligations to remove some of our assets, including our nuclear plants, at the end of their useful lives. As required by SFAS No. 71, we accounted for the implementation of this standard by recording regulatory assets and liabilities instead of a cumulative effect of a change in accounting principle. The fair value of ARO liabilities has been calculated using an expected present value technique. This technique reflects assumptions, such as costs, inflation, and profit margin that third parties would consider to assume the settlement of the obligation. Fair value, to the extent possible, should include a market risk premium for unforeseeable circumstances. No market risk premium was included in our ARO fair value estimate since a reasonable estimate could not be made. If a reasonable estimate of fair value cannot be made in the period the ARO is incurred, such as for assets with indeterminate lives, the liability is recognized when a reasonable estimate of fair value can be made. Generally, transmission and distribution assets have indeterminate lives. Retirement cash flows cannot be determined and there is a low probability of a retirement date. Therefore, no liability has been recorded for these assets. Also, no liability has been recorded for assets that have insignificant cumulative disposal costs, such as substation batteries. The measurement of the ARO liabilities for Palisades and Big Rock are based on decommissioning studies, which largely utilize third-party cost estimates. For additional details on ARO, see Note 6, Asset Retirement Obligations. ACCOUNTING FOR NUCLEAR DECOMMISSIONING COSTS The MPSC and the FERC regulate the recovery of costs to decommission our Big Rock and Palisades nuclear plants. We have established external trust funds to finance the decommissioning of both plants. We record the trust fund balances as a non-current asset on our balance sheet. Our decommissioning cost estimates for the Big Rock and Palisades plants assume: - each plant site will be restored to conform to the adjacent landscape, - all contaminated equipment and material will be removed and disposed of in a licensed burial facility, and - the site will be released for unrestricted use. Independent contractors with expertise in decommissioning have helped us develop decommissioning cost estimates. Various inflation rates for labor, non-labor, and contaminated equipment disposal costs are used to escalate these cost estimates to the future decommissioning cost. A portion of future decommissioning CE-15 Consumers Energy Company cost will result from the failure of the DOE to remove fuel from the sites, as required by the Nuclear Waste Policy Act of 1982. The decommissioning trust funds include equities and fixed income investments. Equities will be converted to fixed income investments during decommissioning, and fixed income investments are converted to cash as needed. In December 2000, funding of the Big Rock trust fund stopped because the MPSC-authorized decommissioning surcharge collection period expired. The funds provided by the trusts, additional customer surcharges, and potential funds from the DOE litigation are all required to cover fully the decommissioning costs. The costs of decommissioning these sites and the adequacy of the trust funds could be affected by: - variances from expected trust earnings, - a lower recovery of costs from the DOE and lower rate recovery from customers, and - changes in decommissioning technology, regulations, estimates, or assumptions. Based on current projections, the current level of funds provided by the trusts is not adequate to fully fund the decommissioning of Big Rock or Palisades. This is due in part to the DOE's failure to accept the spent nuclear fuel on schedule, and lower returns on the trust funds. We are attempting to recover our additional costs for storing spent nuclear fuel through litigation. We will also seek additional relief from the MPSC. For additional details on nuclear decommissioning, see Note 2, Uncertainties, "Other Electric Uncertainties - Nuclear Plant Decommissioning" and "Nuclear Matters." RELATED PARTY TRANSACTIONS We enter into a number of significant transactions with related parties. These transactions include: - issuance of trust preferred securities with Consumers' affiliated companies, - purchases and sales of electricity and gas for generation from Enterprises, - purchase of gas transportation from CMS Bay Area Pipeline, L.L.C., - payment of parent company overhead costs to CMS Energy, and - investment in CMS Energy Common Stock. Transactions involving CMS Energy and its affiliates are generally based on regulated prices, market prices, or competitive bidding. Transactions involving the power supply purchases from certain affiliates of Enterprises are based upon avoided costs under PURPA and competitive bidding. The payment of parent company overhead costs is based on the use of accepted industry allocation methodologies. CAPITAL RESOURCES AND LIQUIDITY Our liquidity and capital requirements are a function of our results of operations, capital expenditures, contractual obligations, debt maturities, working capital needs, and collateral requirements. During the summer months, we purchase natural gas and store it for resale primarily during the winter heating season. The market price for natural gas has increased. Although our natural gas purchases are recoverable from our customers, the amount paid for natural gas stored as inventory could require additional liquidity due to the timing of the cost recoveries. In addition, a few of our commodity suppliers have requested advance payment or other forms of assurances, including margin calls, in connection with maintenance of ongoing deliveries of gas and electricity. CE-16 Consumers Energy Company Our current financial plan includes monitoring our operating expenses and capital expenditures and evaluating market conditions for financing opportunities. We believe our current level of cash and borrowing capacity, along with anticipated cash flows from operating and investing activities, will be sufficient to meet our liquidity needs through 2005. CASH POSITION, INVESTING, AND FINANCING SUMMARY OF CASH FLOWS:
In Millions - ------------------------------------------------------------------------------- Six Months Ended June 30 2004 2003 - ------------------------------------------------------------------------------- Net cash provided by (used in): Operating activities $ 564 $ 189 Investing activities (254) (225) Financing activities (125) (22) ---------------------- Net Increase (Decrease) in Cash and Cash Equivalents $ 185 $ (58) ================================================================================
OPERATING ACTIVITIES: For the six months ended June 30, 2004, net cash provided by operating activities increased $375 million compared to the six months ended June 30, 2003 due to an increase of other liabilities of $174 million resulting from an increase in accrued interest, accrued refunds, and other current liabilities. Accrued interest and other current liabilities increased as a result of the Revised FASB Interpretation No. 46 consolidation of the MCV Partnership and the FMLP. The increase in accrued refunds relates to the $11 million settlement in our 2002-2003 GCR case and potential overrecoveries primarily from our large commercial and industrial customers resulting from our return to the PSCR process. For additional details regarding the PSCR process, refer to "Electric Business Uncertainties - Competition and Regulatory Restructuring - PSCR" within this MD&A. There was an increase in accounts payable of $85 million resulting from the purchase of natural gas at higher prices and fewer suppliers requiring advance payments for gas purchases. In addition, there was a greater decrease in gas inventory of $55 million resulting from sales at higher prices combined with lower volumes of gas purchased. INVESTING ACTIVITIES: For the six months ended June 30, 2004, net cash from investing activities decreased $29 million due to an increase in 2004 versus 2003 capital expenditures of $17 million and a decrease in asset sale proceeds of $15 million resulting from higher 2003 asset sales. FINANCING ACTIVITIES: For the six months ended June 30, 2004, net cash from financing activities decreased $103 million primarily due to a decrease of $131 million in net proceeds from borrowings. For additional details on long-term debt activity, see Note 3, Financings and Capitalization. OBLIGATIONS AND COMMITMENTS REGULATORY AUTHORIZATION FOR FINANCINGS: We issue short and long-term securities under the FERC's authorization. For additional details of our existing authorization, see Note 3, Financings and Capitalization. CE-17 Consumers Energy Company LONG-TERM DEBT: The components of long-term debt are presented in Note 3, Financings and Capitalization. SHORT-TERM FINANCINGS: At June 30, 2004, we had $376 million available and the MCV Partnership had $50 million available in short-term credit facilities. The facilities are available for general corporate purposes, working capital, and letters of credit. As of August 3, 2004, we obtained an amended and restated $500 million secured revolving credit facility to replace our $400 million facility. The amended facility carries a three-year term and provides for lower interest rates. Additional details on short-term financings are presented in Note 3, Financings and Capitalization. OFF-BALANCE SHEET ARRANGEMENTS: Sale of Accounts Receivable: Under a revolving accounts receivable sales program, we may sell up to $325 million of certain accounts receivable. For additional details, see Note 3, Financings and Capitalization. CONTINGENT COMMITMENTS: Our contingent commitments include indemnities and letters of credit. Indemnities are agreements to reimburse other companies, such as an insurance company, if those companies have to complete our contractual performance in a third-party contract. Banks, on our behalf, issue letters of credit guaranteeing payment to a third party. Letters of credit substitute the bank's credit for ours and reduce credit risk for the third-party beneficiary. We monitor and approve these obligations and believe it is unlikely that we would be required to perform or otherwise incur any material losses associated with these guarantees. Our off-balance sheet commitments at June 30, 2004 expire as follows:
Contingent Commitments In Millions - ---------------------------------------------------------------------------------------------------------------- Commitment Expiration -------------------------------------------------------- 2009 and Total 2004 2005 2006 2007 2008 beyond - ---------------------------------------------------------------------------------------------------------------- Off-balance sheet: Surety bonds and other indemnifications (a) $ 8 $ 1 $ - $ - $ - $ - $ 7 Letters of credit 24 8 16 - - - - ================================================================================================================
(a) The surety bonds are continuous in nature. The need for the bonds is determined on an annual basis. DIVIDEND RESTRICTIONS: Under the provisions of our articles of incorporation, at June 30, 2004, we had $396 million of unrestricted retained earnings available to pay common stock dividends. However, covenants in our debt facilities cap common stock dividend payments at $300 million in a calendar year. We are also under an annual dividend cap of $190 million imposed by the MPSC during the current interim gas rate relief period. In February 2004, we paid $78 million and in May 2004, we paid $27 million in common stock dividends to CMS Energy. For additional details on the cap on common stock dividends payable during the current interim gas rate relief period, see Note 2, Uncertainties, "Gas Rate Matters - 2003 Gas Rate Case." CE-18 Consumers Energy Company OUTLOOK ELECTRIC BUSINESS OUTLOOK GROWTH: Over the next five years, we expect electric deliveries to grow at an average rate of approximately two percent per year based primarily on a steadily growing customer base and economy. This growth rate includes both full service sales and delivery service to customers who choose to buy generation service from an alternative electric supplier, but excludes transactions with other wholesale market participants and other electric utilities. This growth rate reflects a long-range expected trend of growth. Growth from year to year may vary from this trend due to customer response to fluctuations in weather conditions and changes in economic conditions, including utilization and expansion of manufacturing facilities. We experienced less growth than expected in 2003 as a result of cooler than normal summer weather and a decline in manufacturing activity in Michigan. In 2004, we project electric deliveries to grow approximately two percent. This short-term outlook for 2004 assumes higher levels of manufacturing activity than in 2003 and normal weather conditions during the remainder of the year. ELECTRIC BUSINESS UNCERTAINTIES Several electric business trends or uncertainties may affect our financial results and condition. These trends or uncertainties have, or we reasonably expect could have, a material impact on revenues or income from continuing electric operations. Such trends and uncertainties include: Environmental - increasing capital expenditures and operating expenses for Clean Air Act compliance, and - potential environmental liabilities arising from various environmental laws and regulations, including potential liability or expenses relating to the Michigan Natural Resources and Environmental Protection Acts and Superfund. Restructuring - response of the MPSC and Michigan legislature to electric industry restructuring issues, - ability to meet peak electric demand requirements at a reasonable cost, without market disruption, - ability to recover any of our net Stranded Costs under the regulatory policies being followed by the MPSC, - effects of lost electric supply load to alternative electric suppliers, and - status as an electric transmission customer instead of an electric transmission owner. Regulatory - effects of recommendations as a result of the August 14, 2003 blackout, including increased regulatory requirements and new legislation, - effects of the FERC supply margin assessment requirements for electric market-based rate authority, - responses from regulators regarding the storage and ultimate disposal of spent nuclear fuel, and - recovery of nuclear decommissioning costs. For additional details, see "Accounting for Nuclear Decommissioning Costs" within this MD&A. CE-19 Consumers Energy Company Other - effects of commodity fuel prices such as natural gas and coal, - pending litigation filed by PURPA qualifying facilities, and - other pending litigation. For additional details about these trends or uncertainties, see Note 2, Uncertainties. ELECTRIC ENVIRONMENTAL ESTIMATES: Our operations are subject to environmental laws and regulations. Costs to operate our facilities in compliance with these laws and regulations generally have been recovered in customer rates. Compliance with the federal Clean Air Act and resulting regulations has been, and will continue to be, a significant focus for us. The Title I provisions of the Clean Air Act require significant reductions in nitrogen oxide emissions. To comply with the regulations, we expect to incur capital expenditures totaling $771 million. The key assumptions included in the capital expenditure estimate include: - construction commodity prices, especially construction material and labor, - project completion schedules, - cost escalation factor used to estimate future years' costs, and - allowance for funds used during construction (AFUDC) rate. Our current capital cost estimates include an escalation rate of 2.6 percent and an AFUDC capitalization rate of 8.9 percent. As of June 30, 2004, we have incurred $489 million in capital expenditures to comply with these regulations and anticipate that the remaining $282 million of capital expenditures will be made between 2004 and 2009. These expenditures include installing catalytic reduction technology at some of our coal-fired electric plants. In addition to modifying the coal-fired electric plants, we expect to purchase nitrogen oxide emissions credits for years 2004 through 2008. The cost of these credits is estimated to average $8 million per year and is accounted for as inventory. The EPA has alleged that some utilities have incorrectly classified plant modifications as "routine maintenance" rather than seek modification permits from the EPA. We have received and responded to information requests from the EPA on this subject. We believe that we have properly interpreted the requirements of "routine maintenance." If our interpretation is found to be incorrect, we may be required to install additional pollution controls at some or all of our coal-fired electric plants and potentially pay fines. Additionally, the viability of certain plants remaining in operation could be called into question. The EPA has proposed a Clean Air Interstate Rule that would require additional coal-fired electric plant emission controls for nitrogen oxides and sulfur dioxide. If implemented, this rule would potentially require expenditures equivalent to those efforts in progress required to reduce nitrogen oxide emissions under the Title I provisions of the Clean Air Act. The rule proposes a two-phase program to reduce emissions of sulfur dioxide by 70 percent and nitrogen oxides by 65 percent by 2015. Additionally, the EPA also proposed two alternative sets of rules to reduce emissions of mercury and nickel from coal-fired and oil-fired electric plants. Until the proposed environmental rules are finalized, an accurate cost of compliance cannot be determined. Several bills have been introduced in the United States Congress that would require reductions in emissions of greenhouse gases. We cannot predict whether any federal mandatory greenhouse gas emission reduction rules ultimately will be enacted, or the specific requirements of any such rules if they were to become law. CE-20 Consumers Energy Company To the extent that greenhouse gas emission reduction rules come into effect, such mandatory emissions reduction requirements could have far-reaching and significant implications for the energy sectors. We cannot estimate the potential effect of United States federal or state level greenhouse gas policy on future consolidated results of operations, cash flows, or financial position due to the speculative nature of the policy. We stay abreast of and engage in the greenhouse gas policy developments and will continue to assess and respond to their potential implications on our business operations. In March 2004, the EPA changed the rules that govern generating plant cooling water intake systems. The new rules require significant reduction in fish killed by operating equipment. Some of our facilities will be required to comply by 2006. We are studying the rules to determine the most cost-effective solutions for compliance. For additional details on electric environmental matters, see Note 2, Uncertainties, "Electric Contingencies - Electric Environmental Matters." COMPETITION AND REGULATORY RESTRUCTURING: Michigan's Customer Choice Act and other developments will continue to result in increased competition in the electric business. Generally, increased competition reduces profitability and threatens market share for generation services. As of January 1, 2002, the Customer Choice Act allowed all of our electric customers to buy electric generation service from us or from an alternative electric supplier. As a result, alternative electric suppliers for generation services have entered our market. As of July 2004, alternative electric suppliers are providing 858 MW of generation supply to ROA customers. This amount represents 11 percent of our distribution load and an increase of 49 percent compared to July 2003. Based on current trends, we predict load loss by year-end to be in the range of 900 MW to 1,100 MW. However, no assurance can be made that the actual load loss will not be greater or less than that range. In July 2004, as a result of legislative hearings, several bills were introduced into the Michigan Senate that could change Michigan's Customer Choice Act. The proposals include: - requiring that rates be based on cost of service, - establishing a defined Stranded Cost calculation method, - allowing customers who stay with or switch to alternative electric suppliers after December 31, 2005 to return to utility services, and requiring them to pay current market rates upon return, - establishing reliability standards that all electric suppliers must follow, - requiring utilities and alternative suppliers to maintain a 15 percent power reserve margin, - creating a service charge to fund the Low Income and Energy Efficiency Fund, - giving kindergarten through twelfth-grade schools a discount of 10 percent to 20 percent on electric rates, and - authorizing a service charge payable by all customers for meeting Clean Air Act requirements. Securitization: In March 2003, we filed an application with the MPSC seeking approval to issue additional Securitization bonds. In June 2003, the MPSC issued a financing order authorizing the issuance of Securitization bonds in the amount of $554 million. We filed for rehearing and clarification on a number of features in the financing order. If and when the MPSC issues an order with favorable terms, then the order will become effective upon our acceptance. Stranded Costs: To the extent we experience net Stranded Costs as determined by the MPSC, the Customer Choice Act allows us to recover such costs by collecting a transition surcharge from customers who switch to an alternative electric supplier. We cannot predict whether the Stranded Cost recovery CE-21 Consumers Energy Company method adopted by the MPSC will be applied in a manner that will offset fully any associated margin loss. In 2002 and 2001, the MPSC issued orders finding that we experienced zero net Stranded Costs from 2000 to 2001. The MPSC also declined to resolve numerous issues regarding the net Stranded Cost methodology in a way that would allow a reliable prediction of the level of Stranded Costs for future years. We currently are in the process of appealing these orders with the Michigan Court of Appeals and the Michigan Supreme Court. In March 2003, we filed an application with the MPSC seeking approval of net Stranded Costs incurred in 2002, and for approval of a net Stranded Cost recovery charge. Our net Stranded Costs incurred in 2002, including the cost of money, are estimated to be $47 million with the issuance of Securitization bonds that include Clean Air Act investments, or $104 million without the issuance of Securitization bonds that include Clean Air Act investments. Once the MPSC issues a final financing order on Securitization, we will know the amount of our request for net Stranded Cost recovery for 2002. In July 2004, the ALJ issued a proposal for decision in our 2002 net Stranded Cost case, which recommended that the MPSC find that we incurred net Stranded Costs of $12 million. This recommendation includes the cost of money through July 2004 and excludes Clean Air Act investments. In April 2004, we filed an application with the MPSC seeking approval of net Stranded Costs incurred in 2003. We also requested interim relief for 2003 net Stranded Costs, but the ALJ declined to set a schedule that would allow consideration of the interim request. In July 2004, we revised our request for approval of 2003 Stranded Costs incurred, including the cost of money, to $69 million with the issuance of Securitization bonds that include Clean Air Act investments, or $128 million without the issuance of Securitization bonds that include Clean Air Act investments. In July 2004, the MPSC Staff issued a position on our 2003 net Stranded Cost application, which resulted in a Stranded Cost calculation of $52 million. The amount includes the cost of money, but excludes Clean Air Act investments. We cannot predict how the MPSC will rule on our requests for the recovery of Stranded Costs. Therefore, we have not recorded regulatory assets to recognize the future recovery of such costs. Implementation Costs: Following an appeal and remand of initial MPSC orders relating to 1999 implementation costs, the MPSC authorized the recovery of all previously approved implementation costs for the years 1997 through 2001 by surcharges on all customers' bills phased in as rate caps expire. Authorized recoverable implementation costs totaled $88 million. This total includes carrying costs through 2003. Additional carrying costs will be added until collection occurs. For additional information on rate caps, see "Rate Caps" within this section. Our applications for $7 million of implementation costs for 2002 and $1 million for 2003 are presently pending approval by the MPSC. Included in the 2002 request is $5 million related to our former participation in the development of the Alliance RTO. Although we believe these implementation costs and associated cost of money are fully recoverable in accordance with the Customer Choice Act, we cannot predict the amounts the MPSC will approve as recoverable. In addition to seeking MPSC approval for these costs, we are pursuing authorization at the FERC for the MISO to reimburse us for approximately $8 million, for implementation costs related to our former participation in the development of the Alliance RTO which includes the $5 million pending approval by the MPSC as part of 2002 implementation costs recovery. These costs have generally either been expensed or approved as recoverable implementation costs by the MPSC. The FERC has denied our request for reimbursement and we are appealing the FERC ruling at the United States Court of Appeals for the District of Columbia. We cannot predict the outcome of the appeal process or the ultimate amount, if CE-22 Consumers Energy Company any, we will collect for Alliance RTO development costs. Security Costs: The Customer Choice Act, as amended, allows for recovery of new and enhanced security costs, as a result of federal and state regulatory security requirements incurred before January 1, 2006. All retail customers, except customers of alternative electric suppliers, would pay these charges. In April 2004, we filed a security cost recovery case with the MPSC for $25 million of costs for which regulatory treatment has not yet been granted through other means. The requested amount includes reasonable and prudent security enhancements through December 31, 2005. As of June 30, 2004, we have $7 million in security costs recorded as a regulatory asset. The costs are for enhanced security and insurance because of federal and state regulatory security requirements imposed after the September 11, 2001 terrorist attacks. In July 2004, a settlement was reached with the parties to the case, which would provide for full recovery of the requested security costs over a five-year period beginning in 2004. We are presently awaiting approval from the MPSC. We cannot predict how the MPSC will rule on our request for the recoverability of security costs. Rate Caps: The Customer Choice Act imposes certain limitations on electric rates that could result in us being unable to collect our full cost of conducting business from electric customers. Such limitations include: - rate caps effective through December 31, 2004 for small commercial and industrial customers, and - rate caps effective through December 31, 2005 for residential customers. As a result, we may be unable to maintain our profit margins in our electric utility business during the rate cap periods. In particular, if we need to purchase power supply from wholesale suppliers while retail rates are capped, the rate restrictions may preclude full recovery of purchased power and associated transmission costs. PSCR: The PSCR process provides for the reconciliation of actual power supply costs with power supply revenues. This process provides for recovery of all reasonable and prudent power supply costs actually incurred by us, including the actual cost for fuel, and purchased and interchange power. In September 2003, we submitted a PSCR filing to the MPSC that reinstates the PSCR process for customers whose rates are no longer frozen or capped as of January 1, 2004. The proposed PSCR charge allows us to recover a portion of our increased power supply costs from large commercial and industrial customers and, subject to the overall rate caps, from other customers. We estimate the recovery of increased power supply costs from large commercial and industrial customers to be approximately $30 million in 2004. As allowed under current regulation, we self-implemented the proposed PSCR charge on January 1, 2004. The revenues received from the PSCR charge are also subject to subsequent reconciliation at the end of the year after actual costs have been reviewed for reasonableness and prudence. We cannot predict the outcome of this reconciliation proceeding. Special Contracts: We entered into multi-year electric supply contracts with certain industrial and commercial customers. The contracts provide electricity at specially negotiated prices, usually at a discount from tariff prices. As of July 2004, special contracts for approximately 630 MW of load are in place, most of which are in effect through 2005. These include, new special contracts with Dow Corning and Hemlock Semi-Conductor for 101 MW of load, which received final approval from the MPSC in May 2004 and special contracts with several hospitals totaling 52 MW of load, which received approval from the MPSC in July 2004. We cannot predict whether additional special contracts will be necessary, advisable, or approved. CE-23 CMS Energy Corporation Transmission Sale: In May 2002, we sold our electric transmission system for $290 million to MTH. We are currently in arbitration with MTH regarding property tax items used in establishing the selling price of our electric transmission system. An unfavorable outcome could result in a reduction of sale proceeds previously recognized by approximately $2 million to $3 million. There are multiple proceedings and a proposed rulemaking pending before the FERC regarding transmission pricing mechanisms and standard market design for electric bulk power markets and transmission. The results of these proceedings and proposed rulemakings could affect significantly: - transmission cost trends, - delivered power costs to us, and - delivered power costs to our retail electric customers. The financial impact of such proceedings, rulemaking, and trends are not quantifiable currently. In addition, we are evaluating whether or not there may be impacts on electric reliability associated with the outcomes of these various transmission related proceedings. For example, Commonwealth Edison Company received approval from the FERC to join the PJM RTO effective May 1, 2004 and American Electric Power Service Corporation received approval from the FERC to join the PJM RTO effective October 1, 2004. These integrations could create different patterns of flow and power within the Midwest area and could affect adversely our ability to provide reliable service to our customers. August 14, 2003 Blackout: On August 14, 2003, the electric transmission grid serving parts of the Midwest and the Northeast experienced a significant disturbance that impacted electric service to millions of homes and businesses. As a result, federal and state investigations regarding the cause of the blackout were conducted. These investigations resulted in the NERC and the U.S. and Canadian Power System Outage Task Force releasing electric operations recommendations. Few of the recommendations apply directly to us, since we are not a transmission owner. However, the recommendations could result in increased transmission costs to us and require upgrades to our distribution system. The financial impacts of these recommendations are not quantifiable currently. We have complied with an MPSC order requiring Michigan utilities and transmission companies to submit a report concerning relay settings on their systems by May 10, 2004. In July 2004, the MPSC closed the docket concerning the investigation into the August 14, 2003 blackout. Also, we have complied with the FERC order requiring entities that own, operate, or control designated transmission facilities to report on their vegetation management practices by June 17, 2004. This FERC order affected a total of six miles of high voltage lines located on or adjacent to some generating plant properties. For additional details and material changes relating to the rate matters and restructuring of the electric utility industry, see Note 2, Uncertainties, "Electric Restructuring Matters," and "Electric Rate Matters." UNIT OUTAGE: In June 2004, our 638 MW Karn Unit 4 facility located in Essexville, Michigan experienced a failure on the exciter. The exciter is a device that provides the magnetic field to the main electric generator. Replacement of the exciter is expected to take several months. In the interim we have installed a temporary replacement, which is rented from Detroit Edison. However, under the agreement, Detroit Edison can recall the exciter at any time. To hedge against 235 MW of this risk and ensure adequate reserve margins during the summer peak periods, we have entered into two short-term capacity contracts. As of July 2004, the rented exciter has been installed and the Karn unit is operating effectively. The financial impacts of the unit outage are not currently quantifiable. CE-24 Consumers Energy Company FERC SUPPLY MARGIN ASSESSMENT: In April 2004, the FERC adopted two new generation market power screens and modified measures to mitigate market power where it is found. The screens will apply to all initial market-based rate applications and reviews on an interim basis, which occur every three years. Based on preliminary reviews, we believe that we will pass the established screens. PERFORMANCE STANDARDS: Electric distribution performance standards developed by the MPSC became effective in February 2004. The standards relate to restoration after outages, safety, and customer services. The MPSC order calls for financial penalties in the form of customer credits if the standards for the duration and frequency of outages are not met. We met or exceeded all approved standards for year-end results for both 2002 and 2003. As of June 2004, we are in compliance with the acceptable level of performance. We are a member of an industry coalition that has appealed the customer credit portion of the performance standards to the Michigan Court of Appeals. We cannot predict the likely effects of the financial penalties, if any, nor can we predict the outcome of the appeal. Likewise, we cannot predict our ability to meet the standards in the future or the cost of future compliance. For additional details on performance standards, see Note 2, Uncertainties, "Electric Rate Matters -Performance Standards." GAS BUSINESS OUTLOOK GROWTH: Over the next five years, we expect gas deliveries to grow at an average rate of less than one percent per year. Actual gas deliveries in future periods may be affected by: - fluctuations in weather patterns, - use by independent power producers, - competition in sales and delivery, - Michigan economic conditions, - gas consumption per customer, and - increases in gas commodity prices. In February 2004, we filed an application with the MPSC for a Certificate of public convenience and necessity for the construction of a 25-mile gas transmission pipeline in northern Oakland County. The project is necessary to meet peak load beginning in the winter of 2005 through 2006. If we are unable to construct the pipeline due to local opposition, we will need to pursue more costly alternatives or possibly curtail serving the system's load growth in that area. GAS BUSINESS UNCERTAINTIES Several gas business trends or uncertainties may affect our financial results and conditions. These trends or uncertainties could have a material impact on net sales, revenues, or income from gas operations. The trends and uncertainties include: Environmental - potential environmental remediation costs at a number of sites, including sites formerly housing manufactured gas plant facilities. CE-25 Consumers Energy Company Regulatory - inadequate regulatory response to applications for requested rate increases, and - response to increases in gas costs, including adverse regulatory response and reduced gas use by customers. Other - pipeline integrity maintenance and replacement costs, and - other pending litigation. We sell gas to retail customers under tariffs approved by the MPSC. These tariffs measure the volume of gas delivered to customers (i.e. mcf). However, we purchase gas for resale on a heating value (i.e. Btu) basis. The Btu content of the gas purchased fluctuates and may result in customers using less gas for the same heating requirement. We fully recover our cost to purchase gas through the approved GCR. However, since the customer may use less gas on a volumetric basis, the revenue from the distribution charge (the non-gas cost portion of the customer bill) could be reduced. This could affect adversely our gas utility earnings. The amount of any possible earnings loss due to fluctuating Btu content in future periods cannot be estimated at this time. In September 2002, the FERC issued an order rejecting our filing to assess certain rates for non-physical gas title tracking services we provide. In December 2003, the FERC ruled that no refunds were at issue and we reversed $4 million related to this matter. In January 2004, three companies filed with the FERC for clarification or rehearing of the FERC's December 2003 order. In April 2004, the FERC issued its Order Granting Clarification. In that Order, the FERC indicated that its December 2003 order was in error. It directed us to file within 30 days a fair and equitable title-tracking fee and to make refunds, with interest, to customers based on the difference between the accepted fee and the fee paid. In response to the FERC's April 2004 order, we filed a Request for Rehearing in May 2004. The FERC issued an Order Granting Rehearing for Further Consideration in June 2004. We expect the FERC to issue an order on the merits of this proceeding in the third quarter of 2004. We believe that with respect to the FERC jurisdictional transportation, we have not charged any customers title transfer fees, so no refunds are due. At this time, we cannot predict the outcome of this proceeding. GAS ENVIRONMENTAL ESTIMATES: We expect to incur investigation and remedial action costs at a number of sites, including 23 former manufactured gas plant sites. We expect our remaining remedial action costs to be between $37 million and $90 million. Any significant change in assumptions, such as remediation techniques, nature and extent of contamination, and legal and regulatory requirements, could change the remedial action costs for the sites. For additional details, see Note 2, Uncertainties, "Gas Contingencies - Gas Environmental Matters." GAS COST RECOVERY: The MPSC is required by law to allow us to charge customers for our actual cost of purchased natural gas. The GCR process is designed to allow us to recover all of our gas costs; however, the MPSC reviews these costs for prudency in an annual reconciliation proceeding. GCR YEAR 2002-2003: In March 2004, a settlement agreement was approved by the MPSC that resulted in a GCR disallowance of $11 million for the GCR period. For additional details, see Note 2, Uncertainties, "Gas Rate Matters - Gas Cost Recovery." GCR YEAR 2003-2004: In June 2004, we filed a reconciliation of GCR for the 12-months ended March 2004. We proposed to refund to our customers $28 million of overrecovered gas cost, plus interest. The refund will be included in the 2004-2005 GCR plan year. The overrecovery includes the $11 million refund settlement for the 2002-2003 GCR year, as well as refunds received by us from our suppliers and CE-26 Consumers Energy Company required by the MPSC to be refunded to our customers. GCR PLAN FOR YEAR 2004-2005: In December 2003, we filed an application with the MPSC seeking approval of a GCR plan for the 12-month period of April 2004 through March 2005. The second quarter GCR adjustment resulted in a GCR ceiling price of $6.57. In June 2004, the MPSC issued a final Order in our GCR plan approving a settlement, which included a quarterly mechanism for setting a GCR ceiling price. The mechanism did not change the current ceiling price of $6.57. Actual gas costs and revenues will be subject to an annual reconciliation proceeding. Our GCR factor for the billing month of August is $6.39 per mcf. 2003 GAS RATE CASE: In March 2003, we filed an application with the MPSC for a $156 million annual increase in our gas delivery and transportation rates that included a 13.5 percent return on equity. In September 2003, we filed an update to our gas rate case that lowered the requested revenue increase from $156 million to $139 million and reduced the return on common equity from 13.5 percent to 12.75 percent. The MPSC authorized an interim gas rate increase of $19 million annually. The interim increase is under bond and subject to refund if the final rate relief is a lesser amount. The interim increase order includes a $34 million reduction in book depreciation expense and related income taxes effective only during the period of interim relief. The MPSC order allowed us to increase our rates beginning December 19, 2003. As part of the interim rate order, we agreed to restrict dividend payments to our parent company, CMS Energy, to a maximum of $190 million annually during the period of interim relief. On March 5, 2004, the ALJ issued a Proposal for Decision recommending that the MPSC not rely upon the projected test year data included in our filing, which was supported by the MPSC Staff and the ALJ further recommended that the application be dismissed. In response to the Proposal for Decision, the parties have filed exceptions and replies to exceptions. The MPSC is not bound by the ALJ's recommendation and will review the exceptions and replies to exceptions prior to issuing an order on final rate relief. 2001 GAS DEPRECIATION CASE: In December 2003, we filed an update to our gas utility plant depreciation case originally filed in June 2001. This case is not affected by the 2003 gas rate case interim increase order which reduced book depreciation expense and related income taxes only for the period that we receive the interim relief. The June 2001 depreciation case filing was based on December 2000 plant balances and historical data. The December 2003 filing updates the gas depreciation case to include December 2002 plant balances. The proposed depreciation rates, if approved, would result in an annual increase of $12 million in depreciation expense based on December 2002 plant balances. In June 2004, the ALJ issued a Proposal for Decision recommending adoption of the Michigan Attorney General's proposal to reduce our annual depreciation expense by $52 million. In response to the Proposal for Decision, the parties filed exceptions and are expected to file replies to exceptions. In our exceptions, we proposed alternative depreciation rates that would result in an annual decrease of $7 million in depreciation expense. The MPSC is not bound by the ALJ's recommendation and will review the exceptions and replies to exceptions prior to issuing an order on final depreciation rates. CE-27 Consumers Energy Company OTHER OUTLOOK CODE OF CONDUCT: In December 2000, the MPSC issued a new code of conduct that applies to utilities and alternative electric suppliers. The code of conduct seeks to prevent financial support, information sharing, and preferential treatment between a utility's regulated and non-regulated services. The new code of conduct is broadly written and could affect our: - retail gas business energy related services, - retail electric business energy related services, - marketing of non-regulated services and equipment to Michigan customers, and - transfer pricing between our departments and affiliates. We appealed the MPSC orders related to the code of conduct and sought a deferral of the orders until the appeal was complete. We also sought waivers available under the code of conduct to continue utility activities that provide approximately $50 million in annual electric and gas revenues. In October 2002, the MPSC denied waivers for three programs including the appliance service plan offered by us, which generated $34 million in gas revenue in 2003. In March 2004, the Michigan Court of Appeals upheld the MPSC's implementation of the code of conduct without modification. We filed an application for leave to appeal with the Michigan Supreme Court, but we cannot predict whether the Michigan Supreme Court will accept the case or the outcome of any appeal. In April 2004, the Michigan Governor signed legislation that allows us to remain in the appliance service business. In June 2004, the MPSC directed the parties to a pending complaint case involving Consumers to file briefs discussing whether the case is affected by the legislation. MCV PARTNERSHIP PROPERTY TAXES: In January 2004, the Michigan Tax Tribunal issued its decision in the MCV Partnership's tax appeal against the City of Midland for tax years 1997 through 2000. The MCV Partnership estimates that the decision will result in a refund to the MCV Partnership of approximately $35 million in taxes plus $9 million of interest. The Michigan Tax Tribunal decision has been appealed to the Michigan Court of Appeals by the City of Midland and the MCV Partnership has filed a cross-appeal at the Michigan Court of Appeals. The MCV Partnership also has a pending case with the Michigan Tax Tribunal for tax years 2001 through 2004. The MCV Partnership cannot predict the outcome of these proceedings; therefore, the above refund (net of approximately $15 million of deferred expenses) has not been recognized in year-to-date 2004 earnings. LITIGATION AND REGULATORY INVESTIGATION: CMS Energy is the subject of various investigations as a result of round-trip trading transactions by CMS MST, including an investigation by the DOJ. Additionally, CMS Energy and Consumers are named as parties in various litigation including a shareholder derivative lawsuit, a securities class action lawsuit, and a class action lawsuit alleging ERISA violations. For additional details regarding these investigations and litigation, see Note 2, Uncertainties. NEW ACCOUNTING STANDARDS FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: The FASB issued this Interpretation in January 2003. The objective of the Interpretation is to assist in determining when one party controls another entity in circumstances where a controlling financial interest cannot be properly identified based on voting interests. Entities with this characteristic are considered variable interest entities. The Interpretation requires the party with the controlling financial interest, known as the primary beneficiary, in a variable interest entity to consolidate the entity. On December 24, 2003, the FASB issued Revised FASB Interpretation No. 46. For entities that have not CE-28 Consumers Energy Company previously adopted FASB Interpretation No. 46, Revised FASB Interpretation No. 46 provided an implementation deferral until the first quarter of 2004. As of and for the quarter ended March 31, 2004, we adopted Revised FASB Interpretation No. 46 for all entities. We determined that we are the primary beneficiary of both the MCV Partnership and the FMLP. We have a 49 percent partnership interest in the MCV Partnership and a 46.4 percent partnership interest in the FMLP. Consumers is the primary purchaser of power from the MCV Partnership through a long-term power purchase agreement. In addition, the FMLP holds a 75.5 percent lessor interest in the MCV Facility, which results in Consumers holding a 35 percent lessor interest in the MCV Facility. Collectively, these interests make us the primary beneficiary of these entities. As such, we consolidated their assets, liabilities, and activities into our financial statements for the first time as of and for the quarter ended March 31, 2004. These partnerships have third-party obligations totaling $728 million at June 30, 2004. Property, plant, and equipment serving as collateral for these obligations has a carrying value of $1.453 billion at June 30, 2004. The creditors of these partnerships do not have recourse to the general credit of CMS Energy. We also determined that we are not the primary beneficiary of our trust preferred security structures. Accordingly, those entities have been deconsolidated as of December 31, 2003. Company Obligated Trust Preferred Securities totaling $490 million, that were previously included in mezzanine equity, have been eliminated due to deconsolidation. As a result of the deconsolidation, we reflected $506 million of long-term debt - related parties and reflected an investment in related parties of $16 million. We are not required to restate prior periods for the impact of this accounting change. FASB STAFF POSITION, NO. SFAS 106-2, ACCOUNTING AND DISCLOSURE REQUIREMENTS RELATED TO THE MEDICARE PRESCRIPTION DRUG, IMPROVEMENT, AND MODERNIZATION ACT OF 2003: The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act) was signed into law in December 2003. The Act establishes a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy, which is exempt from federal taxation, to sponsors of retiree health care benefit plans that provide a benefit that is actuarially equivalent to Medicare Part D. At December 31, 2003, we elected a one-time deferral of the accounting for the Act, as permitted by FASB Staff Position, No. SFAS 106-1. The final FASB Staff Position, No. SFAS 106-2 supersedes FASB Staff Position, No. SFAS 106-1 and provides further accounting guidance. FASB Staff Position, No. SFAS 106-2 states that for plans that are actuarially equivalent to Medicare Part D, employers' measures of accumulated postretirement benefit obligations and postretirement benefit costs should reflect the effects of the Act. We believe our plan is actuarially equivalent to Medicare Part D and have incorporated retroactively the effects of the subsidy into our financial statements as of June 30, 2004, in accordance with FASB Staff Position, No. SFAS 106-2. We remeasured our obligation as of December 31, 2003 to incorporate the impact of the Act, which resulted in a reduction to the accumulated postretirement benefit obligation of $148 million. The remeasurement resulted in a reduction of OPEB cost of $6 million for the three months ended June 30, 2004, $11 million for the six months ended June 30, 2004, and an expected total reduction of $23 million for 2004. Consumers capitalizes a portion of OPEB cost in accordance with regulatory accounting. As such, the remeasurement resulted in a net reduction of OPEB expense of $4 million for the three months ended June 30, 2004, $8 million for the six months ended June 30, 2004, and an expected total net expense reduction of $16 million for 2004. CE-29 Consumers Energy Company (This page intentionally left blank) CE-30 CONSUMERS ENERGY COMPANY CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 2004 2003 2004 2003 - ---------------------------------------------------------------------------------------------------- In Millions OPERATING REVENUE $ 923 $ 902 $ 2,470 $ 2,344 EARNINGS FROM EQUITY METHOD INVESTEES - 18 - 34 OPERATING EXPENSES Fuel for electric generation 170 76 324 156 Purchased and interchange power 50 75 100 157 Purchased power - related parties 15 120 31 252 Cost of gas sold 195 184 858 703 Cost of gas sold - related parties -- -- 1 25 Other operating expenses 177 167 348 327 Maintenance 57 56 107 108 Depreciation, depletion and amortization 98 79 231 195 General taxes 50 24 112 83 ---------------------------------------------- 812 781 2,112 2,006 - ---------------------------------------------------------------------------------------------------- OPERATING INCOME 111 139 358 372 OTHER INCOME (DEDUCTIONS) Accretion expense (1) (2) (2) (4) Interest and dividends 4 2 7 5 Other income 11 2 22 4 Other expense (1) (1) (2) (14) ---------------------------------------------- 13 1 25 (9) - ---------------------------------------------------------------------------------------------------- INTEREST CHARGES Interest on long-term debt 72 51 145 93 Interest on long-term debt - related parties 11 -- 22 -- Other interest 4 3 7 8 Capitalized interest (1) (3) (3) (5) ---------------------------------------------- 86 51 171 96 - ---------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 38 89 212 267 INCOME TAXES 13 37 72 105 MINORITY INTERESTS 1 -- 11 -- ---------------------------------------------- NET INCOME 24 52 129 162 PREFERRED STOCK DIVIDENDS 1 1 1 1 PREFERRED SECURITIES DISTRIBUTIONS -- 11 -- 22 ---------------------------------------------- NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 23 $ 40 $ 128 $ 139 ====================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CE-31 CONSUMERS ENERGY COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30 2004 2003 - -------------------------------------------------------------------------------------------- In Millions CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 129 $ 162 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear decommissioning of $3 and $3, respectively) 231 195 Capital lease and other amortization 13 13 Loss on CMS Energy stock - 12 Distributions from related parties less than earnings - (35) Changes in assets and liabilities: Increase in accounts receivable and accrued revenue (106) (124) Increase (decrease) in accounts payable 44 (41) Decrease in inventories 75 20 Deferred income taxes and investment tax credit 72 74 Decrease in other assets 52 33 Increase (Decrease) in other liabilities 54 (120) -------------------- Net cash provided by operating activities $ 564 $ 189 - -------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (excludes assets placed under capital lease) $ (232) $ (215) Cost to retire property (37) (36) Restricted cash on hand (a) (2) - Investments in Electric Restructuring Implementation Plan (3) (4) Investments in nuclear decommissioning trust funds (3) (3) Proceeds from nuclear decommissioning trust funds 23 18 Maturity of MCV restricted investment securities held-to-maturity 300 - Purchase of MCV restricted investment securities held-to-maturity (300) - Cash proceeds from sale of assets - 15 -------------------- Net cash used in investing activities $ (254) $ (225) - -------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of long term debt $ - $ 1,148 Retirement of long-term debt (14) (574) Payment of common stock dividends (105) (109) Preferred securities distributions - (22) Payment of preferred stock dividends (1) (1) Payment of capital lease obligations (5) (7) Decrease in notes payable, net - (457) -------------------- Net cash used in financing activities $ (125) $ (22) - -------------------------------------------------------------------------------------------- Net Increase (Decrease) in Cash and Cash Equivalents $ 185 $ (58) Cash and Cash Equivalents from Effect of Revised FASB Interpretation No. 46 174 - Cash and Cash Equivalents, Beginning of Period 46 244 -------------------- Cash and Cash Equivalents, End of Period (a) $ 405 $ 186 ============================================================================================
CE-32 OTHER CASH FLOW ACTIVITIES AND NON-CASH INVESTING AND FINANCING ACTIVITIES WERE:
In Millions Six Months Ended June 30 2004 2003 - ------------------------------------------------------------------ CASH TRANSACTIONS Interest paid (net of amounts capitalized) $119 $ 93 Income taxes paid 5 29 OPEB cash contribution 33 36 NON-CASH TRANSACTIONS Other assets placed under capital lease 1 10 =================================================================
(a) Cash and Cash Equivalents decreased $18 million for the six months ended June 30, 2003 from the amount previously reported due to the reclassification of restricted cash. The change in restricted cash is now reflected as an investing activity. THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CE-33 CONSUMERS ENERGY COMPANY CONSOLIDATED BALANCE SHEETS ASSETS
JUNE 30 JUNE 30 2004 DECEMBER 31 2003 (UNAUDITED) 2003 (UNAUDITED) - -------------------------------------------------------------------------------------------------------------------- In Millions PLANT (AT ORIGINAL COST) Electric $ 7,776 $ 7,600 $ 7,465 Gas 2,898 2,875 2,805 Other 2,517 15 21 --------------------------------------- 13,191 10,490 10,291 Less accumulated depreciation, depletion and amortization 5,520 4,417 4,357 --------------------------------------- 7,671 6,073 5,934 Construction work-in-progress 379 375 427 --------------------------------------- 8,050 6,448 6,361 - -------------------------------------------------------------------------------------------------------------------- INVESTMENTS Stock of affiliates 22 20 19 First Midland Limited Partnership - 224 263 Midland Cogeneration Venture Limited Partnership - 419 422 Other 18 18 2 --------------------------------------- 40 681 706 - -------------------------------------------------------------------------------------------------------------------- CURRENT ASSETS Cash and cash equivalents at cost, which approximates market 405 46 186 Restricted cash 20 18 18 Accounts receivable, notes receivable and accrued revenue, less allowances of $8, $8 and $5 respectively 395 257 346 Accounts receivable - related parties 12 4 22 Inventories at average cost Gas in underground storage 664 739 458 Materials and supplies 72 70 74 Generating plant fuel stock 60 41 42 Deferred property taxes 141 143 103 Regulatory assets 19 19 19 Derivative instruments 114 2 2 Other 62 78 87 --------------------------------------- 1,964 1,417 1,357 - -------------------------------------------------------------------------------------------------------------------- NON-CURRENT ASSETS Regulatory Assets Securitized costs 627 648 669 Postretirement benefits 151 162 174 Abandoned Midland Project 10 10 11 Other 318 266 255 Nuclear decommissioning trust funds 559 575 553 Prepaid pension costs 353 364 - Other 337 174 178 --------------------------------------- 2,355 2,199 1,840 --------------------------------------- TOTAL ASSETS $ 12,409 $ 10,745 $ 10,264 ====================================================================================================================
CE-34 STOCKHOLDER'S EQUITY AND LIABILITIES
JUNE 30 JUNE 30 2004 DECEMBER 31 2003 (UNAUDITED) 2003 (UNAUDITED) - -------------------------------------------------------------------------------------------------------------- In Millions CAPITALIZATION Common stockholder's equity Common stock, authorized 125.0 shares; outstanding 84.1 shares for all periods $ 841 $ 841 $ 841 Paid-in capital 682 682 682 Accumulated other comprehensive income (loss) 26 17 (183) Retained earnings since December 31, 1992 544 521 522 --------------------------------------- 2,093 2,061 1,862 Preferred stock 44 44 44 Company-obligated mandatorily redeemable preferred securities of subsidiaries - - 490 Long-term debt 3,564 3,583 3,338 Long-term debt - related parties 506 506 - Non-current portion of capital and finance lease obligations 338 58 119 --------------------------------------- 6,545 6,252 5,853 - -------------------------------------------------------------------------------------------------------------- MINORITY INTERESTS 669 - - - -------------------------------------------------------------------------------------------------------------- CURRENT LIABILITIES Current portion of long-term debt, capital leases and finance leases 487 38 40 Notes payable - related parties 200 200 - Accounts payable 270 200 233 Accrued taxes 161 209 129 Accounts payable - related parties 11 75 62 Current portion of purchase power contract 13 27 26 Deferred income taxes 29 33 39 Other 354 185 206 --------------------------------------- 1,525 967 735 - -------------------------------------------------------------------------------------------------------------- NON-CURRENT LIABILITIES Deferred income taxes 1,307 1,233 993 Regulatory Liabilities Cost of removal 1,016 983 950 Income taxes, net 321 312 313 Other 165 172 155 Postretirement benefits 178 190 597 Asset retirement obligations 405 358 363 Deferred investment tax credit 82 85 87 Power purchase agreement - MCV Partnership - - 14 Other 196 193 204 --------------------------------------- 3,670 3,526 3,676 - -------------------------------------------------------------------------------------------------------------- COMMITMENTS AND CONTINGENCIES (Notes 1, 2, and 5) TOTAL STOCKHOLDER'S EQUITY AND LIABILITIES $ 12,409 $ 10,745 $ 10,264 ==============================================================================================================
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CE-35 CONSUMERS ENERGY COMPANY CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY (UNAUDITED)
Three Months Ended Six Months Ended JUNE 30 2004 2003 2004 2003 - ------------------------------------------------------------------------------------------------------------------------- In Millions COMMON STOCK At beginning and end of period (a) $ 841 $ 841 $ 841 $ 841 - ------------------------------------------------------------------------------------------------------------------------- OTHER PAID-IN CAPITAL At beginning and end of period 682 682 682 682 - ------------------------------------------------------------------------------------------------------------------------- ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Minimum Pension Liability At beginning of period - (185) - (185) Minimum liability pension adjustment (b) - (17) - (17) ------------------------------------------------- At end of period - (202) - (202) ------------------------------------------------- Investments At beginning of period 10 1 9 1 Unrealized gain on investments (c) - 7 1 7 ------------------------------------------------- At end of period 10 8 10 8 ------------------------------------------------- Derivative Instruments At beginning of period 15 9 8 5 Unrealized gain on derivative instruments (c) 4 6 13 13 Reclassification adjustments included in consolidated net (loss) (c) (3) (4) (5) (7) ------------------------------------------------- At end of period 16 11 16 11 - ------------------------------------------------------------------------------------------------------------------------- Total Accumulated Other Comprehensive Income (Loss) 26 (183) 26 (183) - ------------------------------------------------------------------------------------------------------------------------- RETAINED EARNINGS At beginning of period 548 535 521 545 Net Income 24 52 129 162 Cash dividends declared - Common Stock (27) (53) (105) (162) Cash dividends declared - Preferred Stock (1) (1) (1) (1) Preferred securities distributions - (11) - (22) ------------------------------------------------- At end of period 544 522 544 522 - ------------------------------------------------------------------------------------------------------------------------- TOTAL COMMON STOCKHOLDER'S EQUITY $ 2,093 $ 1,862 $ 2,093 $ 1,862 =========================================================================================================================
CE-36
THREE MONTHS ENDED SIX MONTHS ENDED (UNAUDITED) 2004 2003 2004 2003 - ------------------------------------------------------------------------------ --------- --------- --------- --------- (a) Number of shares of common stock outstanding was 84,108,789 for all periods presented (b) Because of the significant change in the makeup of the pension plan due to the sale of Panhandle, SFAS No. 87 required a remeasurement of the obligation at the date of sale. The remeasurement resulted in an additional charge to Accumulated Other Comprehensive Income of approximately $27 million ($17 million after tax) in 2003 as a result of the increase in the additional minimum pension liability (c) Disclosure of Comprehensive Income (Loss): Minimum pension liability adjustment (b) $ - $ (17) $ - $ (17) Investments Unrealized gain on investments, net of tax of $-, $4, $- and $3, respectively - 7 1 7 Derivative Instruments Unrealized gain on derivative instruments, net of tax $3, $3, $7, and $7, respectively 4 6 13 13 Reclassification adjustments included in net income, net of tax benefit $2, $2, $3 and $4, respectively (3) (4) (5) (7) Net income 24 52 129 162 --------- --------- --------- --------- Total Comprehensive Income $ 25 $ 44 $ 138 $ 158 ========= ========= ========= =========
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CE-37 Consumers Energy Company (This page intentionally left blank) CE-38 Consumers Energy Company CONSUMERS ENERGY COMPANY CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) These interim Consolidated Financial Statements have been prepared by Consumers in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. As such, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. Certain prior year amounts have been reclassified to conform to the presentation in the current year. In management's opinion, the unaudited information contained in this report reflects all adjustments of a normal recurring nature necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. The Condensed Notes to Consolidated Financial Statements and the related Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements contained in the Consumers' Form 10-K for the year ended December 31, 2003. Due to the seasonal nature of Consumers' operations, the results as presented for this interim period are not necessarily indicative of results to be achieved for the fiscal year. 1: CORPORATE STRUCTURE AND ACCOUNTING POLICIES CORPORATE STRUCTURE: Consumers, a subsidiary of CMS Energy, a holding company, is a combination electric and gas utility company that provides service to customers in Michigan's Lower Peninsula. Our customer base includes a mix of residential, commercial, and diversified industrial customers, the largest segment of which is the automotive industry. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include Consumers, and all other entities in which we have a controlling financial interest or are the primary beneficiary, in accordance with Revised FASB Interpretation No. 46. The primary beneficiary of a variable interest entity is the party that absorbs or receives a majority of the entity's expected losses or expected residual returns or both as a result of holding variable interests, which are ownership, contractual, or other economic interests. In 2004, we consolidated the MCV Partnership and the FMLP in accordance with Revised FASB Interpretation No. 46. For additional details, see Note 7, Implementation of New Accounting Standards. We use the equity method of accounting for investments in companies and partnerships that are not consolidated, where we have significant influence over operations and financial policies, but are not the primary beneficiary. Intercompany transactions and balances have been eliminated. USE OF ESTIMATES: We prepare our financial statements in conformity with accounting principles generally accepted in the United States. We are required to make estimates using assumptions that may affect the reported amounts and disclosures. Actual results could differ from those estimates. We are required to record estimated liabilities in the financial statements when it is probable that a loss will be incurred in the future as a result of a current event, and when the amount can be reasonably estimated. We have used this accounting principle to record estimated liabilities as discussed in Note 2, Uncertainties. CE-39 Consumers Energy Company REVENUE RECOGNITION POLICY: We recognize revenues from deliveries of electricity and natural gas, and the storage of natural gas when services are provided. Sales taxes are recorded as liabilities and are not included in revenues. CAPITALIZED INTEREST: We are required to capitalize interest on certain qualifying assets that are undergoing activities to prepare them for their intended use. Capitalization of interest for the period is limited to the actual interest cost that is incurred. Our regulated businesses are permitted to capitalize an allowance for funds used during construction on regulated construction projects and to include such amounts in plant in service. CASH EQUIVALENTS AND RESTRICTED CASH: All highly liquid investments with an original maturity of three months or less are considered cash equivalents. At June 30, 2004, our restricted cash on hand was $20 million. Restricted cash primarily includes cash dedicated for repayment of Securitization bonds. It is classified as a current asset as the payments on the related Securitization bonds occur within one year. FINANCIAL INSTRUMENTS: We account for investments in debt and equity securities using SFAS No. 115. Debt and equity securities can be classified into one of three categories: held-to-maturity, trading, or available-for-sale. Our debt securities are classified as held-to-maturity securities and are reported at cost. Our investments in equity securities are classified as available-for-sale securities. They are reported at fair value, with any unrealized gains or losses resulting from changes in fair value reported in equity as part of accumulated other comprehensive income and are excluded from earnings unless such changes in fair value are determined to be other than temporary. Unrealized gains or losses resulting from changes in the fair value of our nuclear decommissioning investments are reflected in Regulatory Liabilities. The fair value of our equity securities is determined from quoted market prices. For additional details regarding financial instruments, see Note 4, Financial and Derivative Instruments. NUCLEAR FUEL COST: We amortize nuclear fuel cost to fuel expense based on the quantity of heat produced for electric generation. For nuclear fuel used after April 6, 1983, we charge disposal costs to nuclear fuel expense, recover these costs through electric rates, and remit them to the DOE quarterly. We elected to defer payment for disposal of spent nuclear fuel burned before April 7, 1983. As of June 30, 2004, we have recorded a liability to the DOE for $140 million, including interest, which is payable upon the first delivery of spent nuclear fuel to the DOE. The amount of this liability, excluding a portion of interest, was recovered through electric rates. For additional details on disposal of spent nuclear fuel, see Note 2, Uncertainties, "Other Electric Uncertainties - Nuclear Matters." OTHER INCOME AND OTHER EXPENSE: The following tables show the components of Other income and Other expense:
In Millions - ------------------------------------------------------------------------------------------ Three Months Ended Six Months Ended --------------------------------------------- June 30 2004 2003 2004 2003 - ------------------------------------------------------------------------------------------ Other income PA 141 Return on Capital Expenditures $ 9 $ - $ 18 $ - Electric restructuring return 1 2 3 3 All other 1 - 1 1 - ------------------------------------------------------------------------------------------ Total other income $ 11 $ 2 $ 22 $ 4 ==========================================================================================
CE-40 Consumers Energy Company
In Millions - ---------------------------------------------------------------------------------------- Three Months Ended Six Months Ended ------------------------------------------------ June 30 2004 2003 2004 2003 - ---------------------------------------------------------------------------------------- Other expense Loss on CMS Energy stock $ - $ - $ - $ (12) Civic and political expenditures - - (1) (1) All other (1) (1) (1) (1) - ---------------------------------------------------------------------------------------- Total other expense $ (1) $ (1) $ (2) $ (14) ===================================== ========= ========= ========= =========
PROPERTY, PLANT, AND EQUIPMENT: We record property, plant, and equipment at original cost when placed into service. When regulated assets are retired, or otherwise disposed of in the ordinary course of business, the original cost is charged to accumulated depreciation and cost of removal, less salvage is recorded as a regulatory liability. For additional details, see Note 6, Asset Retirement Obligations. An allowance for funds used during construction is capitalized on regulated construction projects. With respect to the retirement or disposal of non-regulated assets, the resulting gains or losses are recognized in income. RECLASSIFICATIONS: Certain prior year amounts have been reclassified for comparative purposes. These reclassifications did not affect consolidated net income for the years presented. REPORTABLE SEGMENTS: Our reportable segments are strategic business units organized and managed by the nature of the products and services each provides. We evaluate performance based upon the net income available to the common stockholder of each segment. We operate principally in two segments: electric utility and gas utility. The electric utility segment consists of regulated activities associated with the generation and distribution of electricity in the state of Michigan. The gas utility segment consists of regulated activities associated with the transportation, storage, and distribution of natural gas in the state of Michigan. Accounting policies of the segments are the same as we describe in this Note. Our financial statements reflect the assets, liabilities, revenues, and expenses directly related to the electric and gas segment where it is appropriate. We allocate accounts between the electric and gas segments where common accounts are attributable to both segments. The allocations are based on certain measures of business activities such as revenue, labor dollars, customers, other operation and maintenance and construction expense, leased property, taxes, or functional surveys. For example, customer receivables are allocated based on revenue. Pension provisions are allocated based on labor dollars. The following table shows our financial information by reportable segment. We account for inter-segment sales and transfers at current market prices and eliminate them in consolidated net income available to common stockholder by segment. The "Other" segment includes our consolidated special purpose entity for the sale of trade receivables and our variable interest entities. CE-41 Consumers Energy Company
In Millions - -------------------------------------------------------------------------------------------- Three Months Ended Six Months Ended ---------------------- ---------------------- June 30 2004 2003 2004 2003 - ------------------------------------------ --------- --------- --------- --------- Operating revenue Electric $ 612 $ 603 $ 1,243 $ 1,256 Gas 300 299 1,205 1,088 Other 11 - 22 - --------- --------- --------- --------- Total Operating Revenue $ 923 $ 902 $ 2,470 $ 2,344 ========= ========= ========= ========= Net income available to common stockholder Electric $ 27 $ 35 $ 75 $ 86 Gas 1 5 57 59 Other (5) - (4) (6) --------- --------- --------- --------- Total Net Income $ 23 $ 40 $ 128 $ 139 ========= ========= ========= =========
UTILITY REGULATION: We account for the effects of regulation based on the regulated utility accounting standard SFAS No. 71. As a result, the actions of regulators affect when we recognize revenues, expenses, assets, and liabilities. SFAS No. 144 imposes strict criteria for retention of regulatory-created assets by requiring that such assets be probable of future recovery at each balance sheet date. Management believes these assets are probable of future recovery. 2: UNCERTAINTIES Several business trends or uncertainties may affect our financial results and condition. These trends or uncertainties have, or we reasonably expect could have, a material impact on revenues or income from continuing electric and gas operations. Such trends and uncertainties include: Environmental - increased capital expenditures and operating expenses for Clean Air Act compliance, and - potential environmental liabilities arising from various environmental laws and regulations, including potential liability or expense relating to the Michigan Natural Resources and Environmental Protection Acts, Superfund, and at former manufactured gas plant facilities. Restructuring - response of the MPSC and Michigan legislature to electric industry restructuring issues, - ability to meet peak electric demand requirements at a reasonable cost, without market disruption, - ability to recover any of our net Stranded Costs under the regulatory policies being followed by the MPSC, - effects of lost electric supply load to alternative electric suppliers, and - status as an electric transmission customer, instead of an electric transmission owner. CE-42 Consumers Energy Company Regulatory - recovery of nuclear decommissioning costs, - responses from regulators regarding the storage and ultimate disposal of spent nuclear fuel, - inadequate regulatory response to applications for requested rate increases, and - response to increases in gas costs, including adverse regulatory response and reduced gas use by customers. Other - pending litigation regarding PURPA qualifying facilities, and - other pending litigation. SEC AND OTHER INVESTIGATIONS: As a result of round-trip trading transactions by CMS MST, CMS Energy's Board of Directors established a Special Committee to investigate matters surrounding the transactions and retained outside counsel to assist in the investigation. The Special Committee completed its investigation and reported its findings to the Board of Directors in October 2002. The Special Committee concluded, based on an extensive investigation, that the round-trip trades were undertaken to raise CMS MST's profile as an energy marketer with the goal of enhancing its ability to promote its services to new customers. The Special Committee found no effort to manipulate the price of CMS Energy Common Stock or affect energy prices. The Special Committee also made recommendations designed to prevent any recurrence of this practice. Previously, CMS Energy terminated its speculative trading business and revised its risk management policy. The Board of Directors adopted, and CMS Energy has implemented the recommendations of the Special Committee. CMS Energy is cooperating with an investigation by the DOJ concerning round-trip trading. CMS Energy is unable to predict the outcome of this matter and what effect, if any, this investigation will have on its business. In March 2004, the SEC approved a cease-and-desist order settling an administrative action against CMS Energy related to round-trip trading. The order did not assess a fine and CMS Energy neither admitted nor denied the order's findings. The settlement resolved the SEC investigation involving CMS Energy and CMS MST. SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of securities class action complaints were filed against CMS Energy, Consumers, and certain officers and directors of CMS Energy and its affiliates. The complaints were filed as purported class actions in the United States District Court for the Eastern District of Michigan, by shareholders who allege that they purchased CMS Energy's securities during a purported class period. The cases were consolidated into a single lawsuit and an amended and consolidated class action complaint was filed on May 1, 2003. The consolidated complaint contains a purported class period beginning on May 1, 2000 and running through March 31, 2003. It generally seeks unspecified damages based on allegations that the defendants violated United States securities laws and regulations by making allegedly false and misleading statements about CMS Energy's business and financial condition, particularly with respect to revenues and expenses recorded in connection with round-trip trading by CMS MST. The judge issued an opinion and order dated March 31, 2004 in connection with various pending motions, including plaintiffs' motion to amend the complaint and the motions to dismiss the complaint filed by CMS Energy, Consumers and other defendants. The judge directed plaintiffs to file an amended complaint under seal and ordered an expedited hearing on the motion to amend, which was held on May 12, 2004. At the hearing, the judge ordered plaintiffs to file a Second Amended Consolidated Class Action complaint deleting Counts III and IV relating to purchasers of CMS PEPS, which the judge ordered dismissed with prejudice. Plaintiffs filed this complaint on May 26, 2004. CMS Energy, Consumers, and the individual defendants filed new motions to dismiss on June 21, 2004. A hearing on those motions occurred on August 2, 2004 and the judge has taken the matter under advisement. CMS Energy, Consumers and the individual defendants will CE-43 Consumers Energy Company defend themselves vigorously but cannot predict the outcome of this litigation. ERISA LAWSUITS: CMS Energy is a named defendant, along with Consumers, CMS MST, and certain named and unnamed officers and directors, in two lawsuits brought as purported class actions on behalf of participants and beneficiaries of the CMS Employees' Savings and Incentive Plan (the Plan). The two cases, filed in July 2002 in United States District Court for the Eastern District of Michigan, were consolidated by the trial judge and an amended consolidated complaint was filed. Plaintiffs allege breaches of fiduciary duties under ERISA and seek restitution on behalf of the Plan with respect to a decline in value of the shares of CMS Energy Common Stock held in the Plan. Plaintiffs also seek other equitable relief and legal fees. The judge issued an opinion and order dated March 31, 2004 in connection with the motions to dismiss filed by CMS Energy, Consumers and the individuals. The judge dismissed certain of the amended counts in the plaintiffs' complaint and denied CMS Energy's motion to dismiss the other claims in the complaint. CMS Energy, Consumers and the individual defendants filed answers to the amended complaint on May 14, 2004. A trial date has not been set, but is expected to be no earlier than late in 2005. CMS Energy and Consumers will defend themselves vigorously but cannot predict the outcome of this litigation. ELECTRIC CONTINGENCIES ELECTRIC ENVIRONMENTAL MATTERS: Our operations are subject to environmental laws and regulations. Costs to operate our facilities in compliance with these laws and regulations generally have been recovered in customer rates. Clean Air: The EPA and the state regulations require us to make significant capital expenditures estimated to be $771 million. As of June 30, 2004, we have incurred $489 million in capital expenditures to comply with the EPA regulations and anticipate that the remaining $282 million of capital expenditures will be made between 2004 and 2009. These expenditures include installing catalytic reduction technology at some of our coal-fired electric plants. Based on the Customer Choice Act, beginning January 2004, an annual return of and on these types of capital expenditures, to the extent they are above depreciation levels, is expected to be recoverable from customers, subject to the MPSC prudency hearing. The EPA has alleged that some utilities have incorrectly classified plant modifications as "routine maintenance" rather than seek modification permits from the EPA. We have received and responded to information requests from the EPA on this subject. We believe that we have properly interpreted the requirements of "routine maintenance." If our interpretation is found to be incorrect, we may be required to install additional pollution controls at some or all of our coal-fired electric plants and potentially pay fines. Additionally, the viability of certain plants remaining in operation could be called into question. In addition to modifying the coal-fired electric plants, we expect to purchase nitrogen oxide emissions credits for years 2004 through 2008. The cost of these credits is estimated to average $8 million per year and is accounted for as inventory. The credit inventory is expensed as the coal-fired electric plants generate electricity. The price for nitrogen oxide emissions credits is volatile and could change substantially. The EPA has proposed a Clean Air Interstate Rule that would require additional coal-fired electric plant emission controls for nitrogen oxides and sulfur dioxide. If implemented, this rule would potentially require expenditures equivalent to those efforts in progress required to reduce nitrogen oxide emissions under the Title I provisions of the Clean Air Act. The rule proposes a two-phase program to reduce emissions of sulfur dioxide by 70 percent and nitrogen oxides by 65 percent by 2015. Additionally, the CE-44 Consumers Energy Company EPA also proposed two alternative sets of rules to reduce emissions of mercury and nickel from coal-fired and oil-fired electric plants. Until the proposed environmental rules are finalized, an accurate cost of compliance cannot be determined. Several bills have been introduced in the United States Congress that would require reductions in emissions of greenhouse gases. We cannot predict whether any federal mandatory greenhouse gas emission reduction rules ultimately will be enacted, or the specific requirements of any such rules if they were to become law. To the extent that greenhouse gas emission reduction rules come into effect, such mandatory emissions reduction requirements could have far-reaching and significant implications for the energy sectors. We cannot estimate the potential effect of United States federal or state level greenhouse gas policy on future consolidated results of operations, cash flows or financial position due to the speculative nature of the policy. We stay abreast of and engage in the greenhouse gas policy developments, and will continue to assess and respond to their potential implications on our business operations. Water: In March 2004, the EPA changed the rules that govern generating plant cooling water intake systems. The new rules require significant reduction in fish killed by operating equipment. Some of our facilities will be required to comply by 2006. We are studying the rules to determine the most cost-effective solutions for compliance. Cleanup and Solid Waste: Under the Michigan Natural Resources and Environmental Protection Act, we expect that we will ultimately incur investigation and remedial action costs at a number of sites. We believe that these costs will be recoverable in rates under current ratemaking policies. We are a potentially responsible party at several contaminated sites administered under Superfund. Superfund liability is joint and several, meaning that many other creditworthy parties with substantial assets are potentially responsible with respect to the individual sites. Based on past experience, we estimate that our share of the total liability for the known Superfund sites will be between $1 million and $9 million. As of June 30, 2004, we have recorded a liability for the minimum amount of our estimated Superfund liability. In October 1998, during routine maintenance activities, we identified PCB as a component in certain paint, grout, and sealant materials at the Ludington Pumped Storage facility. We removed and replaced part of the PCB material. We have proposed a plan to deal with the remaining materials and are awaiting a response from the EPA. LITIGATION: In October 2003, a group of eight PURPA qualifying facilities selling power to us filed a lawsuit in Ingham County Circuit Court. The lawsuit alleges that we incorrectly calculated the energy charge payments made pursuant to power purchase agreements with qualifying facilities. More specifically, the lawsuit alleges that we should be basing the energy charge calculation on the cost of more expensive eastern coal, rather than on the cost of the coal actually burned by us for use in our coal-fired generating plants. We believe we have been performing the calculation in the manner prescribed by the power purchase agreements, and have filed a request with the MPSC (as a supplement to the PSCR plan) that asks the MPSC to review this issue and to confirm that our method of performing the calculation is correct. We filed a motion to dismiss the lawsuit in the Ingham County Circuit Court due to the pending request at the MPSC concerning the PSCR plan case. In February 2004, the judge ruled on the motion and deferred to the primary jurisdiction of the MPSC. This ruling resulted in a dismissal of the circuit court case without prejudice. Although only eight qualifying facilities have raised the issue, the same energy charge methodology is used in the PPA with the MCV Partnership and in CE-45 Consumers Energy Company approximately 20 additional power purchase agreements with us, representing a total of 1,670 MW of electric capacity. The eight plaintiff qualifying facilities have appealed the dismissal of the circuit court case to the Michigan Court of Appeals. We cannot predict the outcome of this matter. ELECTRIC RESTRUCTURING MATTERS ELECTRIC RESTRUCTURING LEGISLATION: The Michigan legislature passed electric utility restructuring legislation known as the Customer Choice Act. This Act: - allows all customers to choose their electric generation supplier effective January 1, 2002, - provides a one-time five percent residential electric rate reduction, - froze all electric rates through December 31, 2003, and established a rate cap for residential customers through at least December 31, 2005, and a rate cap for small commercial and industrial customers through at least December 31, 2004, - allows deferred recovery of an annual return of and on capital expenditures in excess of depreciation levels incurred during and before the rate freeze-cap period, - allows for the use of Securitization bonds to refinance qualified costs, - allows recovery of net Stranded Costs and implementation costs incurred as a result of the passage of the act, - requires Michigan utilities to join a FERC-approved RTO or sell their interest in transmission facilities to an independent transmission owner, - requires Consumers, Detroit Edison, and AEP to jointly expand their available transmission capability by at least 2,000 MW, and - establishes a market power supply test that, if not met, may require transferring control of generation resources in excess of that required to serve retail sales requirements. The following summarizes our status under the last three provisions of the Customer Choice Act. First, we chose to sell our interest in our transmission facilities to an independent transmission owner to comply with the Customer Choice Act; for additional details regarding the sale of the transmission facility, see "Transmission Sale" within this section. Second, in July 2002, the MPSC issued an order approving our plan to achieve the increased transmission capacity required under the Customer Choice Act. We have completed the transmission capacity projects identified in the plan and have submitted verification of this fact to the MPSC. We believe we are in full compliance. Lastly, in September 2003, the MPSC issued an order finding that we are in compliance with the market power supply test set forth in the Customer Choice Act. ELECTRIC ROA: The MPSC approved revised tariffs that establish the rates, terms, and conditions under which retail customers are permitted to choose an electric supplier. These revised tariffs allow ROA customers, upon as little as 30 days notice to us, to return to our generation service at current tariff rates. If any class of customers' (residential, commercial, or industrial) ROA load reaches ten percent of our total load for that class of customers, then returning ROA customers for that class must give 60 days notice to return to our generation service at current tariff rates. However, we may not have capacity available to serve returning ROA customers that is sufficient or reasonably priced. As a result, we may be forced to purchase electricity on the spot market at higher prices than we can recover from our customers during the rate cap periods. We cannot predict the total amount of electric supply load that may be lost to alternative electric suppliers. As of July 2004, alternative electric suppliers are providing 858 MW of load. This amount represents 11 percent of the total distribution load and an increase of 49 percent compared to July 2003. CE-46 Consumers Energy Company ELECTRIC RESTRUCTURING PROCEEDINGS: Below is a discussion of our electric restructuring proceedings. They are: - Securitization, - Stranded Costs, - implementation costs, - security costs, and - transmission rates. The following chart summarizes the filings with the MPSC. For additional details related to these proceedings, see related sections within this Note.
- --------------------------------------------------------------------------------------------------- Years Years Requested Proceeding Filed Covered Amounts Status - --------------------------------------------------------------------------------------------------- Securitization 2003 N/A $1.083 billion Received order from the MPSC authorizing the issuance of Securitization bonds in the amount of $554 million. Pending MPSC order resolving outstanding issues. Stranded Costs 2002-2004 2000-2003 $137 million (a) MPSC ruled that we experienced zero Stranded Costs for 2000 through 2001, which we are appealing. Filings for 2002 and 2003 in the amount of $116 million are still pending MPSC approval. Implementation 1999-2004 1997-2003 $91 million (b) MPSC allowed $68 million for the Costs years 1997-2001, plus $20 million for the cost of money through 2003. Implementation cost filings for 2002 and 2003 in the amount of $8 million, which includes the cost of money through 2003, are still pending MPSC approval. Security Costs 2004 2001-2005 $25 million Pending MPSC approval. As of June 30, 2004, we have recorded $7 million of costs incurred as a regulatory asset. ===================================================================================================
(a) Amount includes the cost of money through the year in which we expected to receive recovery from the MPSC and assumes the issuance of Securitization bonds in an amount that includes Clean Air Act investments. If Clean Air Act investments were not included in the issuance of Securitization bonds, Stranded Costs requested would total $304 million. (b) Amounts include the cost of money through year incurred. CE-47 Consumers Energy Company Securitization: The Customer Choice Act allows for the use of Securitization bonds to refinance certain qualified costs. Since Securitization involves issuing bonds secured by a revenue stream from rates collected directly from customers to service the bonds, Securitization bonds typically have a higher credit rating than conventional utility corporate financing. In 2000 and 2001, the MPSC issued orders authorizing us to issue Securitization bonds. We issued our first Securitization bonds in late 2001. Securitization resulted in: - lower interest costs, and - longer amortization periods for the securitized assets. We will recover the repayment of principal, interest, and other expenses relating to the bond issuance through a Securitization charge and a tax charge that began in December 2001. These charges are subject to an annual true up until one year before the last scheduled bond maturity date, and no more than quarterly thereafter. The December 2003 true up modified the total Securitization and related tax charges from 1.746 mills per kWh to 1.718 mills per kWh. There will be no impact on customer bills from Securitization for most of our electric customers until the Customer Choice Act cap period expires, and an electric rate case is processed. Securitization charge collections, $25 million for the six months ended June 30, 2004, and $25 million for the six months ended June 30, 2003, are remitted to a trustee. Securitization charge collections are restricted to the repayment of the principal and interest on the Securitization bonds and payment of the ongoing expenses of Consumers Funding. Consumers Funding is legally separate from Consumers. The assets and income of Consumers Funding, including the securitized property, are not available to creditors of Consumers or CMS Energy. In March 2003, we filed an application with the MPSC seeking approval to issue additional Securitization bonds. In June 2003, the MPSC issued a financing order authorizing the issuance of Securitization bonds in the amount of $554 million. This amount relates to Clean Air Act expenditures and associated return on those expenditures through December 31, 2002, ROA implementation costs and previously authorized return on those expenditures through December 31, 2000, and other up front qualified costs related to issuance of the Securitization bonds. In July 2003, we filed for rehearing and clarification on a number of features in the financing order. In December 2003, the MPSC ordered remanded hearings in response to our request for rehearing and clarification. In March 2004, the MPSC conducted the remanded hearings and the matter is presently before the MPSC awaiting a decision. In May 2004, we withdrew our request for approved implementation costs incurred for the years 1998 through 2000 from the Securitization case, as we chose recovery of the approved implementation costs through the use of a surcharge, as described in "Implementation Costs" within this section. However, qualified Clean Air Act costs, after taking out implementation costs, still exceed the $554 million MPSC limit on the amount of securitized bonds. As a result, we did not request a decrease to allowable securitized costs. If and when the MPSC issues an order with favorable terms, then the order will become effective upon our acceptance. CE-48 Consumers Energy Company Stranded Costs: The Customer Choice Act allows electric utilities to recover their net Stranded Costs, without defining the term. The Act directs the MPSC to establish a method of calculating net Stranded Costs and of conducting related true-up adjustments. In December 2001, the MPSC Staff recommended a methodology, which calculated net Stranded Costs as the shortfall between: - the revenue required to cover the costs associated with fixed generation assets and capacity payments associated with purchase power agreements, and - the revenues received from customers under existing rates available to cover the revenue requirement. The MPSC authorizes us to use deferred accounting to recognize the future recovery of costs determined to be stranded. According to the MPSC, net Stranded Costs are to be recovered from ROA customers through a Stranded Cost transition charge. However, the MPSC has not yet allowed such a transition charge. The MPSC has declined to resolve numerous issues regarding the net Stranded Cost methodology in a way that would allow a reliable prediction of the level of Stranded Costs. As a result, we have not recorded regulatory assets to recognize the future recovery of such costs. The following table outlines the applications filed by us with the MPSC and the status of recovery for these costs:
In Millions - -------------------------------------------------------------------------------------------- Requested, without the Requested, with the issuance issuance of Securitization of Securitization bonds that bonds that include Clean Air Year Year include Clean Air Act Act investment and cost of Recoverable Filed Incurred investment and cost of money money amount - -------------------------------------------------------------------------------------------- 2002 2000 $12 $ 26 $ - 2002 2001 9 46 - 2003 2002 47 104 Pending 2004 2003 69 128 Pending ============================================================================================
We are currently in the process of appealing the MPSC orders regarding Stranded Costs for 2000 and 2001 with the Michigan Court of Appeals and the Michigan Supreme Court. In June 2004, the MPSC conducted hearings for our 2002 Stranded Cost application. Once a final financing order on Securitization is reached, we will know the amount of our request for net Stranded Cost recovery for 2002. In July 2004, the ALJ issued a proposal for decision in our 2002 net Stranded Cost case, which recommended that the MPSC find that we incurred net Stranded Costs of $12 million. This recommendation includes the cost of money through July 2004 and excludes Clean Air Act investments. The MPSC has scheduled hearings for our 2003 Stranded Cost application for August 2004. In July 2004, the MPSC Staff issued a position on our 2003 net Stranded Cost application, which resulted in a Stranded Cost calculation of $52 million. The amount includes the cost of money, but excludes Clean Air Act investments. We cannot predict how the MPSC will rule on our requests for recoverability of 2002 and 2003 Stranded Costs or whether the MPSC will adopt a Stranded Cost recovery method that will offset fully any associated margin loss from ROA. Implementation Costs: The Customer Choice Act allows electric utilities to recover their implementation costs. The following table outlines the applications filed by us with the MPSC and the status of recovery for these costs: CE-49 Consumers Energy Company
In Millions - ----------------------------------------------------------------------------------------------- Recoverable, including (b) cost of money through Year Filed Year Incurred Requested Disallowed Allowed 2003 - ----------------------------------------------------------------------------------------------- 1999 1997 & 1998 $20 $5 $15 $22 2000 1999 30 5 25 33 2001 2000 25 5 20 24 2002 2001 8 - 8 9 2003 & 2004 (a) 2002 7 Pending Pending Pending 2004 2003 1 Pending Pending Pending ===============================================================================================
(a) On March 31, 2004, we requested additional 2002 implementation cost recovery of $5 million related to our former participation in the development of the Alliance RTO. This cost has been expensed; therefore, the amount is not included as a regulatory asset. (b) Amounts include the cost of money through year incurred. In addition to seeking MPSC approval for these costs, we are pursuing authorization at the FERC for the MISO to reimburse us for approximately $8 million, for implementation costs related to our former participation in the development of the Alliance RTO which includes the $5 million pending approval by the MPSC as part of 2002 implementation costs recovery. These costs have generally either been expensed or approved as recoverable implementation costs by the MPSC. The FERC has denied our request for reimbursement and we are appealing the FERC ruling at the United States Court of Appeals for the District of Columbia. We cannot predict the outcome of the appeal process or the ultimate amount, if any, we will collect for Alliance RTO development costs. The MPSC disallowed certain costs, determining that these amounts did not represent costs incremental to costs already reflected in electric rates. As of June 30, 2004, we incurred and deferred as a regulatory asset $94 million of implementation costs, which includes $25 million associated with the cost of money. We believe the implementation costs and associated cost of money are fully recoverable in accordance with the Customer Choice Act. In June 2004, following an appeal and remand of initial MPSC orders relating to 1999 implementation costs, the MPSC authorized the recovery of all previously approved implementation costs for the years 1997 through 2001 totaling $88 million. This total includes carrying costs through 2003. Additional carrying costs will be added until collection occurs. The implementation costs will be recovered through surcharges over 36-month collection periods and phased in as applicable rate caps expire. We cannot predict the amounts the MPSC will approve as recoverable costs for 2002 and 2003. Security Costs: The Customer Choice Act, as amended, allows for recovery of new and enhanced security costs, as a result of federal and state regulatory security requirements incurred before January 1, 2006. All retail customers, except customers of alternative electric suppliers, would pay these charges. In April 2004, we filed a security cost recovery case with the MPSC for costs for which recovery has not yet been granted through other means. The requested amount includes reasonable and prudent security enhancements through December 31, 2005. The costs are for enhanced security and insurance because of federal and state regulatory security requirements imposed after the September 11, 2001 terrorist attacks. In July 2004, a settlement was reached with the parties to the case, which would provide for full recovery of the requested security costs over a five-year period beginning in CE-50 Consumers Energy Company 2004. We are presently awaiting approval from the MPSC. We cannot predict how the MPSC will rule on our request for the recoverability of security costs. The following table outlines the applications filed by us with the MPSC and the status of recovery for these costs:
In Millions - ----------------------------------------------------------------------------- Year Years Regulatory asset as of Filed Incurred Requested June 30, 2004 Disallowed Allowed - ----------------------------------------------------------------------------- 2004 2001-2005 $25 $7 Pending Pending =============================================================================
Transmission Rates: Our application of JOATT transmission rates to customers during past periods is under FERC review. The rates included in these tariffs were applied to certain transmission transactions affecting both Detroit Edison's and our transmission systems between 1997 and 2002. We believe our reserve is sufficient to satisfy our refund obligation to any of our former transmission customers under our former JOATT. TRANSMISSION SALE: In May 2002, we sold our electric transmission system to MTH, a non-affiliated limited partnership whose general partner is a subsidiary of Trans-Elect, Inc. We are currently in arbitration with MTH regarding property tax items used in establishing the selling price of our electric transmission system. An unfavorable outcome could result in a reduction of sale proceeds previously recognized of approximately $2 million to $3 million. Under an agreement with MTH, our transmission rates are fixed by contract at current levels through December 31, 2005, and are subject to the FERC ratemaking thereafter. However, we are subject to certain additional MISO surcharges, which we estimate to be $10 million in 2004. ELECTRIC RATE MATTERS PERFORMANCE STANDARDS: Electric distribution performance standards developed by the MPSC became effective in February 2004. The standards relate to restoration after outages, safety, and customer services. The MPSC order calls for financial penalties in the form of customer credits if the standards for the duration and frequency of outages are not met. We met or exceeded all approved standards for year-end results for both 2002 and 2003. As of June 2004, we are in compliance with the acceptable level of performance. We are a member of an industry coalition that has appealed the customer credit portion of the performance standards to the Michigan Court of Appeals. We cannot predict the likely effects of the financial penalties, if any, nor can we predict the outcome of the appeal. Likewise, we cannot predict our ability to meet the standards in the future or the cost of future compliance. POWER SUPPLY COSTS: We were required to provide backup service to ROA customers on a best efforts basis. In October 2003, we provided notice to the MPSC that we would terminate the provision of backup service in accordance with the Customer Choice Act, effective January 1, 2004. To reduce the risk of high electric prices during peak demand periods and to achieve our reserve margin target, we employ a strategy of purchasing electric call options and capacity and energy contracts for the physical delivery of electricity primarily in the summer months and to a lesser degree in the winter months. As of June 30, 2004, we purchased capacity and energy contracts partially covering the estimated reserve margin requirements for 2004 through 2007. As a result, we have recognized an asset of $18 million for unexpired capacity and energy contracts. In March 2004, we filed a summer assessment for meeting 2004 peak load demand as required by the MPSC, stating that our summer 2004 reserve margin target is 11 percent or supply resources equal to 111 percent of projected summer peak load. Presently, we have a reserve margin of 14 percent, or supply resources equal to 114 percent of CE-51 Consumers Energy Company projected summer peak load for summer 2004. Of the 114 percent, approximately 102 percent is from owned electric generating plants and long-term contracts, and approximately 12 percent is from short-term contracts. This reserve margin met our summer 2004 reserve margin target. The total premium costs of electricity call options and capacity and energy contracts for 2004 is expected to be approximately $12 million, as of July 2004. PSCR: As a result of meeting the transmission capability expansion requirements and the market power test, as discussed with in this Note, we have met the requirements under the Customer Choice Act to return to the PSCR process. The PSCR process provides for the reconciliation of actual power supply costs with power supply revenues. This process assures recovery of all reasonable and prudent power supply costs actually incurred by us. In September 2003, we submitted a PSCR filing to the MPSC that reinstates the PSCR process for customers whose rates are no longer frozen or capped as of January 1, 2004. The proposed PSCR charge allows us to recover a portion of our increased power supply costs from large commercial and industrial customers, and subject to the overall rate caps, from other customers. We estimate the recovery of increased power supply costs from large commercial and industrial customers to be approximately $30 million in 2004. As allowed under current regulation, we self-implemented the proposed PSCR charge on January 1, 2004. The revenues received from the PSCR charge are also subject to subsequent reconciliation at the end of the year after actual costs have been reviewed for reasonableness and prudence. We cannot predict the outcome of this reconciliation proceeding. 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. We hold, through two wholly owned subsidiaries, the following assets related to the MCV Partnership and the MCV Facility: - CMS Midland owns a 49 percent general partnership interest in the MCV Partnership, and - CMS Holdings holds, through the FMLP, a 35 percent lessor interest in the MCV Facility. In 2004, we consolidated the MCV Partnership and the FMLP into our consolidated financial statements in accordance with Revised FASB Interpretation No. 46. For additional details, see Note 7, Implementation of New Accounting Standards. Our consolidated retained earnings include undistributed earnings from the MCV Partnership, which at June 30, 2004 are $246 million and at June 30, 2003 are $243 million. Power Supply Purchases from the MCV Partnership: Our annual obligation to purchase capacity from the MCV Partnership is 1,240 MW through the term of the PPA ending in 2025. The PPA requires us to pay, based on the MCV Facility's availability, a levelized average capacity charge of 3.77 cents per kWh, and a fixed energy charge. We also pay a variable energy charge based on our average cost of coal consumed for all kWh delivered. Effective January 1999, we reached a settlement agreement with the MCV Partnership that capped capacity payments made on the basis of availability that may be billed by the MCV Partnership at a maximum 98.5 percent availability level. Since January 1993, the MPSC has permitted us to recover capacity charges averaging 3.62 cents per kWh for 915 MW, plus fixed and variable energy charges. Since January 1996, the MPSC has also permitted us to recover capacity charges for the remaining 325 MW of contract capacity with an initial average charge of 2.86 cents per kWh increasing periodically to an eventual 3.62 cents per kWh by 2004 CE-52 Consumers Energy Company and thereafter. However, due to the frozen retail rates required by the Customer Choice Act, the capacity charge for the 325 MW was frozen at 3.17 cents per kWh until December 31, 2003. Recovery of both the 915 MW and 325 MW portions of the PPA are subject to certain limitations discussed below. In 1992, we recognized a loss and established a liability for the present value of the estimated future underrecoveries of power supply costs under the PPA based on the MPSC cost-recovery orders. The remaining liability associated with the loss totaled $13 million at June 30, 2004 and $40 million at June 30, 2003. We expect the PPA liability to be depleted in late 2004. We estimate that 51 percent of the actual cash underrecoveries for 2004 will be charged to the PPA liability, with the remaining portion charged to operating expense as a result of our 49 percent ownership in the MCV Partnership. We will expense all cash underrecoveries directly to income once the PPA liability is depleted. If the MCV Facility's generating availability remains at the maximum 98.5 percent level, our cash underrecoveries associated with the PPA could be as follows:
In Millions - ------------------------------------------------------------------ 2004 2005 2006 2007 - ------------------------------------------------------------------ Estimated cash underrecoveries at 98.5% $ 56 $ 56 $ 55 $ 39 Amount to be charged to operating expense 29 56 55 39 Amount to be charged to PPA liability 27 - - - ==================================================================
Beginning January 1, 2004, the rate freeze for large industrial customers was no longer in effect and we returned to the PSCR process. Under the PSCR process, we will recover from our customers the approved capacity and fixed energy charges based on availability, up to an availability cap of 88.7 percent as established in previous MPSC orders. Effects on Our Ownership Interest in the MCV Partnership and the MCV Facility: As a result of returning to the PSCR process on January 1, 2004, we returned to dispatching the MCV Facility on a fixed load basis, as permitted by the MPSC, in order to maximize recovery from electric customers of our capacity and fixed energy payments. This fixed load dispatch increases the MCV Facility's output and electricity production costs, such as natural gas. As the spread between the MCV Facility's variable electricity production costs and its energy payment revenue widens, the MCV's Partnership's financial performance and our investment in the MCV Partnership is and will be affected adversely. Under the PPA, variable energy payments to the MCV Partnership are based on the cost of coal burned at our coal plants and our operation and maintenance expenses. However, the MCV Partnership's costs of producing electricity are tied to the cost of natural gas. Because natural gas prices have increased substantially in recent years and the price the MCV Partnership can charge us for energy has not, the MCV Partnership's financial performance has been impacted negatively. Until September 2007, the PPA and settlement agreement require us to pay capacity and fixed energy charges based on the MCV Facility's actual availability up to the 98.5 percent cap. After September 2007, we expect to claim relief under the regulatory out provision in the PPA, limiting our capacity and fixed energy payments to the MCV Partnership to the amount collected from our customers. The MPSC's future actions on the capacity and fixed energy payments recoverable from customers subsequent to September 2007 may affect negatively the earnings of the MCV Partnership and the value of our investment in the MCV Partnership. CE-53 Consumers Energy Company Resource Conservation Plan: In February 2004, we filed the RCP with the MPSC that is intended to help conserve natural gas and thereby improve our investment in the MCV Partnership. This plan seeks approval to: - dispatch the MCV Facility based on natural gas market prices without increased costs to electric customers, - give Consumers a priority right to buy excess natural gas as a result of the reduced dispatch of the MCV Facility, and - fund $5 million annually for renewable energy sources such as wind power projects. The RCP will reduce the MCV Facility's annual production of electricity and, as a result, reduce the MCV Facility's consumption of natural gas by an estimated 30 to 40 bcf. This decrease in the quantity of high-priced natural gas consumed by the MCV Facility will benefit Consumers' ownership interest in the MCV Partnership. The amount of PPA capacity and fixed energy payments recovered from retail electric customers would remain capped at 88.7 percent. Therefore, customers will not be charged for any increased power supply costs, if they occur. Consumers and the MCV Partnership have reached an agreement that the MCV Partnership will reimburse Consumers for any incremental power costs incurred to replace the reduction in power dispatched from the MCV Facility. Presently, we are in settlement discussions with the parties to the RCP filing. However, in July 2004, several qualifying facilities filed for a stay on the RCP proceeding in the Ingham County Circuit Court after their previous attempt to intervene on the proceeding was denied by the MPSC. Hearings on the stay are scheduled for August 11, 2004. We cannot predict if or when the MPSC will approve the RCP or the outcome of the Ingham County Circuit Court hearings. The two most significant variables in the analysis of the MCV Partnership's future financial performance are the forward price of natural gas for the next 20 years and the MPSC's decision in 2007 or beyond on limiting our recovery of capacity and fixed energy payments. Natural gas prices have been volatile historically. Presently, there is no consensus in the marketplace on the price or range of future prices of natural gas. Even with an approved RCP, if gas prices continue at present levels or increase, the economics of operating the MCV Facility may be adverse enough to require us to recognize an impairment of our investment in the MCV Partnership. We presently cannot predict the impact of these issues on our future earnings, cash flows, or on the value of our investment in the MCV Partnership. MCV PARTNERSHIP PROPERTY TAXES: In January 2004, the Michigan Tax Tribunal issued its decision in the MCV Partnership's tax appeal against the City of Midland for tax years 1997 through 2000. The MCV Partnership estimates that the decision will result in a refund to the MCV Partnership of approximately $35 million in taxes plus $9 million of interest. The Michigan Tax Tribunal decision has been appealed to the Michigan Court of Appeals by the City of Midland and the MCV Partnership has filed a cross-appeal at the Michigan Court of Appeals. The MCV Partnership also has a pending case with the Michigan Tax Tribunal for tax years 2001 through 2004. The MCV Partnership cannot predict the outcome of these proceedings; therefore, the above refund (net of approximately $15 million of deferred expenses) has not been recognized in year-to-date 2004 earnings. NUCLEAR PLANT DECOMMISSIONING: Our site-specific decommissioning cost estimates for Big Rock and Palisades assume that each plant site will eventually be restored to conform to the adjacent landscape and all contaminated equipment will be disassembled and disposed of in a licensed burial facility. Decommissioning funding practices approved by the MPSC require us to file a report on the adequacy of funds for decommissioning at three-year intervals. We prepared and filed updated cost estimates for each plant on March 31, 2004. Excluding additional costs for spent nuclear fuel storage, due to the DOE's failure to accept this spent nuclear fuel on schedule, these reports show a decommissioning cost CE-54 Consumers Energy Company of $361 million for Big Rock and $868 million for Palisades. Since Big Rock is currently in the process of being decommissioned, the estimated cost includes historical expenditures in nominal dollars and future costs in 2003 dollars, with all Palisades costs given in 2003 dollars. In 1999, the MPSC orders for Big Rock and Palisades provided for fully funding the decommissioning trust funds for both sites. In December 2000, funding of the Big Rock trust fund stopped because the MPSC-authorized decommissioning surcharge collection period expired. The MPSC order set the annual decommissioning surcharge for Palisades at $6 million through 2007. Amounts collected from electric retail customers and deposited in trusts, including trust earnings, are credited to a regulatory liability. However, based on current projections, the current levels of funds provided by the trusts are not adequate to fully fund the decommissioning of Big Rock or Palisades. This is due in part to the DOE's failure to accept the spent nuclear fuel and lower returns on the trust funds. We are attempting to recover our additional costs for storing spent nuclear fuel through litigation, as discussed in "Nuclear Matters". We will also seek additional relief from the MPSC. In the case of Big Rock, excluding the additional nuclear fuel storage costs due to the DOE's failure to accept this spent fuel on schedule, we are currently projecting that the level of funds provided by the trust will fall short of the amount needed to complete the decommissioning by $25 million. At this point in time, we plan to provide the additional amounts needed from our corporate funds and, subsequent to the completion of radiological decommissioning work, seek recovery of such expenditures at the MPSC. We cannot predict how the MPSC will rule on our request. In the case of Palisades, again excluding additional nuclear fuel storage costs due to the DOE's failure to accept this spent fuel on schedule, we have concluded that the existing surcharge needs to be increased to $25 million annually, beginning January 1, 2006, and continue through 2011, our current license expiration date. In June 2004, we filed an application with the MPSC seeking approval to increase the surcharge for recovery of decommissioning costs related to Palisades beginning in 2006. We cannot predict how the MPSC will rule on our request. NUCLEAR MATTERS: Big Rock: With the removal and safe disposal of the reactor vessel, steam drum, and radioactive waste processing systems in 2003, dismantlement of plant systems is nearly complete and demolition of the remaining plant structures is set to begin. The restoration project is on schedule to return approximately 530 acres of the site, including the area formerly occupied by the nuclear plant, to a natural setting for unrestricted use in mid-2006. An additional 30 acres, the area where seven transportable dry casks loaded with spent nuclear fuel and an eighth cask loaded with high-level radioactive waste material are stored, will be returned to a natural state by the end of 2012 if the DOE begins removing the spent nuclear fuel by 2010. The NRC and the Michigan Department of Environmental Quality continue to find all decommissioning activities at Big Rock are being performed in accordance with applicable regulations including license requirements. Palisades: In March 2004, the NRC completed its end-of-cycle plant performance assessment of Palisades. The assessment for Palisades covered the period from January 1, 2003 through December 31, 2003. The NRC determined that Palisades was operated in a manner that preserved public health and safety and fully met all cornerstone objectives. As of June 2004, all inspection findings were classified as having very low safety significance and all performance indicators indicated performance at CE-55 Consumers Energy Company a level requiring no additional oversight. Based on the plant's performance, only regularly scheduled inspections are planned through September 2005. The amount of spent nuclear fuel exceeds Palisades' temporary onsite storage pool capacity. We are using dry casks for temporary onsite storage. As of June 30, 2004, we have loaded 18 dry casks with spent nuclear fuel and are scheduled to load additional dry casks this summer in order to continue operation. DOE Litigation: In 1997, a U.S. Court of Appeals decision confirmed that the DOE was to begin accepting deliveries of spent nuclear fuel for disposal by January 1998. Subsequent U.S. Court of Appeals litigation, in which we and other utilities participated, has not been successful in producing more specific relief for the DOE's failure to accept the spent nuclear fuel. There are two court decisions that support the right of utilities to pursue damage claims in the United States Court of Claims against the DOE for failure to take delivery of spent nuclear fuel. Over 60 utilities have initiated litigation in the United States Court of Claims; we filed our complaint in December 2002. In July 2004, the DOE filed an amended answer and motion to dismiss the complaint. If our litigation against the DOE is successful, we anticipate future recoveries from the DOE. The recoveries will be used to pay the cost of spent nuclear fuel storage until the DOE takes possession as required by law. We can make no assurance that the litigation against the DOE will be successful. In July 2002, Congress approved and the President signed a bill designating the site at Yucca Mountain, Nevada, for the development of a repository for the disposal of high-level radioactive waste and spent nuclear fuel. We expect that the DOE will submit, by December 2004, an application to the NRC for a license to begin construction of the repository. The application and review process is estimated to take several years. Spent nuclear fuel complaint: In March 2003, the Michigan Environmental Council, the Public Interest Research Group in Michigan, and the Michigan Consumer Federation filed a complaint with the MPSC, which was served on us by the MPSC in April 2003. The complaint asks the MPSC to initiate a generic investigation and contested case to review all facts and issues concerning costs associated with spent nuclear fuel storage and disposal. The complaint seeks a variety of relief with respect to Consumers, Detroit Edison, Indiana & Michigan Electric Company, Wisconsin Electric Power Company, and Wisconsin Public Service Corporation. The complaint states that amounts collected from customers for spent nuclear fuel storage and disposal should be placed in an independent trust. The complaint also asks the MPSC to take additional actions. In May 2003, Consumers and other named utilities each filed motions to dismiss the complaint. We are unable to predict the outcome of this matter. Insurance: We maintain nuclear insurance coverage on our nuclear plants. At Palisades, we maintain nuclear property insurance from NEIL totaling $2.750 billion and insurance that would partially cover the cost of replacement power during certain prolonged accidental outages. Because NEIL is a mutual insurance company, we could be subject to assessments of up to $27 million in any policy year if insured losses in excess of NEIL's maximum policyholders surplus occur at our, or any other member's, nuclear facility. NEIL's policies include coverage for acts of terrorism. At Palisades, we maintain nuclear liability insurance for third-party bodily injury and off-site property damage resulting from a nuclear hazard for up to approximately $10.761 billion, the maximum insurance liability limits established by the Price-Anderson Act. The United States Congress enacted the Price-Anderson Act to provide financial liability protection for those parties who may be liable for a nuclear accident or incident. Part of the Price-Anderson Act's financial protection is a mandatory industry-wide CE-56 Consumers Energy Company program where owners of nuclear generating facilities could be assessed if a nuclear incident occurs at any nuclear generating facility. The maximum assessment against us could be $101 million per occurrence, limited to maximum annual installment payments of $10 million. We also maintain insurance under a program that covers tort claims for bodily injury to nuclear workers caused by nuclear hazards. The policy contains a $300 million nuclear industry aggregate limit. Under a previous insurance program providing coverage for claims brought by nuclear workers, we remain responsible for a maximum assessment of up to $6 million. Big Rock remains insured for nuclear liability by a combination of insurance and a NRC indemnity totaling $544 million and a nuclear property insurance policy from NEIL. Insurance policy terms, limits, and conditions are subject to change during the year as we renew our policies. COMMITMENTS FOR FUTURE PURCHASES: We enter into a number of unconditional purchase obligations that represent normal business operating contracts. These contracts are used to assure an adequate supply of goods and services necessary for the operation of our business and to minimize exposure to market price fluctuations. We believe that these future costs are prudent and reasonably assured of recovery in future rates. Coal Supply and Transportation: We have entered into coal supply contracts with various suppliers and associated rail transportation contracts for our coal-fired generating stations. Under the terms of these agreements, we are obligated to take physical delivery of the coal and make payment based upon the contract terms. Our coal supply contracts expire through 2005, and total an estimated $147 million. Our coal transportation contracts expire through 2007, and total an estimated $108 million. Long-term coal supply contracts have accounted for approximately 60 to 90 percent of our annual coal requirements over the last 10 years. Although future contract coverage is not finalized at this time, we believe that it will be within the historic 60 to 90 percent range. Power Supply, Capacity, and Transmission: As of June 30, 2004, we had future unrecognized commitments to purchase power transmission services under fixed price forward contracts for 2004 and 2005 totaling $8 million. We also had commitments to purchase capacity and energy under long-term power purchase agreements with various generating plants. These contracts require monthly capacity payments based on the plants' availability or deliverability. These payments for 2004 through 2030 total an estimated $4.537 billion, undiscounted. This amount may vary depending upon plant availability and fuel costs. If a plant was not available to deliver electricity to us, then we would not be obligated to make the capacity payment until the plant could deliver. GAS CONTINGENCIES GAS ENVIRONMENTAL MATTERS: We expect to incur investigation and remedial costs at a number of sites under the Michigan Natural Resources and Environmental Protection Act, a Michigan statute that covers environmental activities including remediation. These sites include 23 former manufactured gas plant facilities. We operated the facilities on these sites for some part of their operating lives. For some of these sites, we have no current ownership or may own only a portion of the original site. We have completed initial investigations at the 23 sites. We will continue to implement remediation plans for sites where we have received MDEQ remediation plan approval. We will also work toward resolving environmental issues at sites as studies are completed. CE-57 Consumers Energy Company We have estimated our costs for investigation and remedial action at all 23 sites using the Gas Research Institute-Manufactured Gas Plant Probabilistic Cost Model. We expect our remaining costs to be between $37 million and $90 million. The range reflects multiple alternatives with various assumptions for resolving the environmental issues at each site. The estimates are based on discounted 2003 costs using a discount rate of three percent. The discount rate represents a ten-year average of U.S. Treasury bond rates reduced for increases in the consumer price index. We expect to fund most of these costs through insurance proceeds and through the MPSC approved rates charged to our customers. As of June 30, 2004, we have recorded a regulatory liability of $42 million, net of $41 million of expenditures incurred to date, and a regulatory asset of $66 million. Any significant change in assumptions, such as an increase in the number of sites, different remediation techniques, nature and extent of contamination, and legal and regulatory requirements, could affect our estimate of remedial action costs. In its November 2002 gas distribution rate order, the MPSC authorized us to continue to recover approximately $1 million of manufactured gas plant facilities environmental clean-up costs annually. This amount will continue to be offset by $2 million to reflect amounts recovered from all other sources. We defer and amortize, over a period of 10 years, manufactured gas plant facilities environmental clean-up costs above the amount currently included in rates. Additional amortization of the expense in our rates cannot begin until after a prudency review in a gas rate case. GAS RATE MATTERS GAS COST RECOVERY: The MPSC is required by law to allow us to charge customers for our actual cost of purchased natural gas. The GCR process is designed to allow us to recover all of our gas costs; however, the MPSC reviews these costs for prudency in an annual reconciliation proceeding. GCR YEAR 2002-2003: In June 2003, we filed a reconciliation of GCR costs and revenues for the 12-months ended March 2003. We proposed to recover from our customers approximately $6 million of underrecovered gas costs using a roll-in methodology. The roll-in methodology incorporates the GCR underrecovery in the next GCR plan year. The approach was approved by the MPSC in a November 2002 order. In January 2004, intervenors filed their positions in our 2002-2003 GCR case. Their positions were that not all of our gas purchasing decisions were prudent during April 2002 through March 2003 and they proposed disallowances. In 2003, we reserved $11 million for a settlement agreement associated with the 2002-2003 GCR disallowance. Interest on the disallowed amount from April 1, 2003 through February 2004, at Consumers' authorized rate of return, increased the cost of the settlement by $1 million. The interest was recorded as an expense in 2003. In February 2004, the parties in the case reached a settlement agreement that resulted in a GCR disallowance of $11 million for the GCR period. The settlement agreement was approved by the MPSC in March 2004. The disallowance is included in our 2003-2004 GCR reconciliation filed in June 2004. GCR YEAR 2003-2004: In June 2004, we filed a reconciliation of GCR for the 12-months ended March 2004. We proposed to refund to our customers $28 million of overrecovered gas cost, plus interest. The refund will be included in the 2004-2005 GCR plan year. The overrecovery includes the $11 million refund settlement for the 2002-2003 GCR year, as well as refunds received by us from our suppliers and required by the MPSC to be refunded to our customers. GCR PLAN FOR YEAR 2004-2005: In December 2003, we filed an application with the MPSC seeking approval of a GCR plan for the 12-month period of April 2004 through March 2005. The second quarter GCR adjustment resulted in a GCR ceiling price of $6.57. In June 2004, the MPSC issued a final Order CE-58 Consumers Energy Company in our GCR plan approving a settlement, which included a quarterly mechanism for setting a GCR ceiling price. The mechanism did not change the current ceiling price of $6.57. Actual gas costs and revenues will be subject to an annual reconciliation proceeding. Our GCR factor for the billing month of August is $6.39 per mcf. 2003 GAS RATE CASE: In March 2003, we filed an application with the MPSC for a $156 million annual increase in our gas delivery and transportation rates that included a 13.5 percent return on equity. In September 2003, we filed an update to our gas rate case that lowered the requested revenue increase from $156 million to $139 million and reduced the return on common equity from 13.5 percent to 12.75 percent. The MPSC authorized an interim gas rate increase of $19 million annually. The interim increase is under bond and subject to refund if the final rate relief is a lesser amount. The interim increase order includes a $34 million reduction in book depreciation expense and related income taxes effective only during the period of interim relief. The MPSC order allowed us to increase our rates beginning December 19, 2003. As part of the interim order, we agreed to restrict dividend payments to our parent company, CMS Energy, to a maximum of $190 million annually during the period of interim relief. On March 5, 2004, the ALJ issued a Proposal for Decision recommending that the MPSC not rely upon the projected test year data included in our filing, which was supported by the MPSC Staff and the ALJ further recommended that the application be dismissed. In response to the Proposal for Decision, the parties have filed exceptions and replies to exceptions. The MPSC is not bound by the ALJ's recommendation and will review the exceptions and replies to exceptions prior to issuing an order on final rate relief. 2001 GAS DEPRECIATION CASE: In December 2003, we filed an update to our gas utility plant depreciation case originally filed in June 2001. This case is not affected by the 2003 gas rate case interim increase order that reduced book depreciation expense and related income taxes only for the period that we receive the interim relief. The June 2001 depreciation case filing was based on December 2000 plant balances and historical data. The December 2003 filing updates the gas depreciation case to include December 2002 plant balances. The proposed depreciation rates, if approved, would result in an annual increase of $12 million in depreciation expense based on December 2002 plant balances. In June 2004, the ALJ issued a Proposal for Decision recommending adoption of the Michigan Attorney General's proposal to reduce our annual depreciation expense by $52 million. In response to the Proposal for Decision, the parties filed exceptions and are expected to file replies to exceptions. In our exceptions, we proposed alternative depreciation rates that would result in an annual decrease of $7 million in depreciation expense. The MPSC is not bound by the ALJ's recommendation and will review the exceptions and replies to exceptions prior to issuing an order on final depreciation rates. In September 2002, the FERC issued an order rejecting our filing to assess certain rates for non-physical gas title tracking services we provide. In December 2003, the FERC ruled that no refunds were at issue and we reversed $4 million related to this matter. In January 2004, three companies filed with the FERC for clarification or rehearing of the FERC's December 2003 order. In April 2004, the FERC issued its Order Granting Clarification. In that Order, the FERC indicated that its December 2003 order was in error. It directed us to file within 30 days a fair and equitable title-tracking fee and to make refunds, with interest, to customers based on the difference between the accepted fee and the fee paid. In response to the FERC's April 2004 order, we filed a Request for Rehearing in May 2004. The FERC issued an Order Granting Rehearing for Further Consideration in June 2004. We expect the FERC to issue an order on the merits of this proceeding in the third quarter of 2004. We believe that with respect to the FERC jurisdictional transportation, we have not charged any customers title transfer fees, so no refunds are due. At this time, we cannot predict the outcome of this proceeding. CE-59 Consumer Energy Company OTHER UNCERTAINTIES In addition to the matters disclosed within this Note, we are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies arising from the ordinary course of business. These lawsuits and proceedings may involve personal injury, property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing, and other matters. We have accrued estimated losses for certain contingencies discussed within this Note. Resolution of these contingencies is not expected to have a material adverse impact on our financial position, liquidity, or results of operations. 3: FINANCINGS AND CAPITALIZATION LONG-TERM DEBT: Long-term debt is summarized as follows:
In Millions - ------------------------------------------------------------------- June 30, 2004 December 31, 2003 - ------------------------------------------------------------------- First mortgage bonds $ 1,483 $ 1,483 Senior notes 1,254 1,254 Bank debt and other 468 469 Securitization bonds 412 426 FMLP debt 411 - -------------------------------- Principal amounts outstanding 4,028 3,632 Current amounts (444) (28) Net unamortized discount (20) (21) - ------------------------------------------------------------------- Total Long-term debt $ 3,564 $ 3,583 ===================================================================
FMLP DEBT: We consolidate the FMLP in accordance with Revised FASB Interpretation No. 46. At June 30, 2004, long-term debt of the FMLP consists of:
In Millions - ------------------------------------------------------------------- Maturity 2004 - ------------------------------------------------------------------- 11.75% subordinated secured notes 2005 $185 13.25% subordinated secured notes 2006 75 6.875% tax-exempt subordinated secured notes 2009 137 6.75% tax-exempt subordinated secured notes 2009 14 - ------------------------------------------------------------------- Total amount outstanding $411 ===================================================================
The FMLP debt is essentially project debt secured by certain assets of the MCV Partnership and the FMLP. The debt is non-recourse to other assets of CMS Energy and Consumers. CE-60 Consumer Energy Company DEBT MATURITIES: At June 30, 2004, the aggregate annual maturities for long-term debt for six months ending December 31, 2004 and the next four years are:
In Millions - ------------------------------------------------------------ Payments Due ------------------------------------- December 31 2004 2005 2006 2007 2008 - ------------------------------------------------------------ Long-term debt $ 129 $ 559 $ 478 $ 59 $ 504 ============================================================
REGULATORY AUTHORIZATION FOR FINANCINGS: Effective July 1, 2004, we received new FERC authorization to issue or guarantee up to $1.1 billion of short-term securities and up to $1.1 billion of short-term first mortgage bonds as collateral for such short-term securities. Effective July 1, 2004, we received new FERC authorization to issue up to $1 billion of long-term securities for refinancing or refunding purposes, $1.5 billion of long-term securities for general corporate purposes, and $2.5 billion of long-term first mortgage bonds to be issued solely as collateral for other long-term securities. SHORT-TERM FINANCINGS: At June 30, 2004, we had a $400 million secured revolving credit facility with banks. At June 30, 2004, $24 million of letters of credit were issued and outstanding under this facility and $376 million was available for general corporate purposes, working capital, and letters of credit. The MCV Partnership had a $50 million working capital facility available. As of August 3, 2004, we obtained an amended and restated $500 million secured revolving credit facility to replace our $400 million facility. The amended facility carries a three-year term and provides for lower interest rates. FIRST MORTGAGE BONDS: We secure our first mortgage bonds by a mortgage and lien on substantially all of our property. Our ability to issue and sell securities is restricted by certain provisions in the first mortgage bond indenture, our articles of incorporation, and the need for regulatory approvals under federal law. CAPITAL AND FINANCE LEASE OBLIGATIONS: Our capital leases are comprised mainly of leased service vehicles and office furniture. As of June 30, 2004, capital lease obligations totaled $64 million. In order to obtain permanent financing for the MCV Facility, the MCV Partnership entered into a sale and lease back agreement with a lessor group, which includes the FMLP, for substantially all of the MCV Partnership's fixed assets. In accordance with SFAS No. 98, the MCV Partnership accounted for the transaction as a financing arrangement. As of June 30, 2004, finance lease obligations totaled $317 million, which represents the third-party portion of the MCV Partnership's finance lease obligation. SALE OF ACCOUNTS RECEIVABLE: Under a revolving accounts receivable sales program, we currently sell certain accounts receivable to a wholly owned, consolidated, bankruptcy remote special purpose entity. In turn, the special purpose entity may sell an undivided interest in up to $325 million of the receivables. We sold no receivables at June 30, 2004 and we sold $50 million at June 30, 2003. The Consolidated Balance Sheets exclude these sold amounts from accounts receivable. We continue to service the receivables sold. The purchaser of the receivables has no recourse against our other assets for failure of a debtor to pay when due and the purchaser has no right to any receivables not sold. No gain or loss has been recorded on the receivables sold and we retain no interest in the receivables sold. CE-61 Consumer Energy Company Certain cash flows received from and paid to us under our accounts receivable sales program are shown below:
In Millions - ------------------------------------------------------------------------------------------ Six Months Ended June 30 2004 2003 - ------------------------------------------------------------------------------------------ Proceeds from sales (remittance of collections) under the program $ (297) $ (275) Collections reinvested under the program $ 2,645 $ 2,459 ==========================================================================================
DIVIDEND RESTRICTIONS: Under the provisions of our articles of incorporation, at June 30, 2004, we had $396 million of unrestricted retained earnings available to pay common stock dividends. However, covenants in our debt facilities cap common stock dividend payments at $300 million in a calendar year. We are also under an annual dividend cap of $190 million imposed by the MPSC during the current interim gas rate relief period. In February 2004, we paid $78 million and in May 2004, we paid $27 million in common stock dividends to CMS Energy. For additional details on the cap on common stock dividends payable during the current interim gas rate relief period, see Note 2, Uncertainties, "Gas Rate Matters - 2003 Gas Rate Case." FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENT FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS: This Interpretation became effective January 2003. It describes the disclosure to be made by a guarantor about its obligations under certain guarantees that it has issued. At the beginning of a guarantee, it requires a guarantor to recognize a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provision of this Interpretation does not apply to some guarantee contracts, such as warranties, derivatives, or guarantees between either parent and subsidiaries or corporations under common control, although disclosure of these guarantees is required. For contracts that are within the recognition and measurement provision of this Interpretation, the provisions were to be applied to guarantees issued or modified after December 31, 2002. The following tables describe our guarantees at June 30, 2004:
In Millions - -------------------------------------------------------------------------------------------------------- Issue Expiration Maximum Carrying Recourse Guarantee Description Date Date Obligation Amount Provision (a) - -------------------------------------------------------------------------------------------------------- Standby letters of credit Various Various $ 24 $ - $ - Surety bonds and other indemnifications Various Various 8 - - Nuclear insurance retrospective premiums Various Various 134 - - ========================================================================================================
(a) Recourse provision indicates the approximate recovery from third parties including assets held as collateral. CE-62 Consumer Energy Company
- --------------------------------------------------------------------------------------------------------------------- Events That Would Require Guarantee Description How Guarantee Arose Performance - --------------------------------------------------------------------------------------------------------------------- Standby letters of credit Normal operations of coal power Noncompliance with environmental plants regulations Natural gas transportation Nonperformance Self-insurance requirement Nonperformance Surety bonds Normal operating activity, permits Nonperformance and license Nuclear insurance retrospective premiums Normal operations of nuclear plants Call by NEIL and Price-Anderson Act for nuclear incident ======================================================================================================================
4: FINANCIAL AND DERIVATIVE INSTRUMENTS FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments, and current liabilities approximate their fair values because of their short-term nature. We estimate the fair values of long-term financial instruments based on quoted market prices or, in the absence of specific market prices, on quoted market prices of similar instruments or other valuation techniques. The carrying amount of all long-term financial instruments, except as shown below, approximates fair value. Our held-to-maturity investments consist of debt securities held by the MCV Partnership totaling $140 million as of June 30, 2004. These securities represent funds restricted primarily for future lease payments and are classified as Other Assets on the Consolidated Balance Sheets. These investments have original maturity dates of approximately one year or less and, because of their short maturities, their carrying amounts approximate their fair values. For additional details, see Note 1, Corporate Structure and Accounting Policies.
In Millions - ---------------------------------------------------------------------------------------------------- June 30 2004 2003 - ------------------------------------------------------------------------ --------------------------- Fair Unrealized Fair Unrealized Cost Value Gain (Loss) Cost Value Gain (Loss) - ------------------------------------------------------------------------ --------------------------- Long-term debt (a) $4,008 $4,088 $ (80) $3,365 $3,529 $ (164) Long-term debt - related parties (b) 506 512 (6) - - - Trust Preferred Securities (b) - - - 490 512 (22) Available-for-sale securities: Common stock of CMS Energy (c) 10 22 12 10 19 9 SERP 17 22 5 17 20 3 Nuclear decommissioning investments (d) 434 559 125 453 553 100 ====================================================================================================
(a) Includes a principal amount of $444 million at June 30, 2004 and $27 million at June 30, 2003 relating to current maturities. Settlement of long-term debt is generally not expected until maturity. (b) We determined that we are not the primary beneficiary of our trust preferred security structures. Accordingly, those entities have been deconsolidated as of December 31, 2003 and are reflected in Long-term debt - related parties on the Consolidated Balance Sheets. For additional details, see Note 7, Implementation of New Accounting Standards. (c) As of June 30, 2004, we held 2.4 million shares of CMS Energy Common Stock. CE-63 Consumer Energy Company (d) On January 1, 2003, we adopted SFAS No. 143 and began classifying our unrealized gains and losses on nuclear decommissioning investments as regulatory liabilities. We previously included the unrealized gains and losses on these investments in accumulated depreciation. DERIVATIVE INSTRUMENTS: We are exposed to market risks including, but not limited to, changes in interest rates, commodity prices, and equity security prices. We manage these risks using established policies and procedures, under the direction of both an executive oversight committee consisting of senior management representatives and a risk committee consisting of business-unit managers. We may use various contracts to manage these risks including swaps, options, and forward contracts. We intend that any gains or losses on these contracts will be offset by an opposite movement in the value of the item at risk. We enter into all risk management contracts for purposes other than trading. These contracts contain credit risk if the counterparties, including financial institutions and energy marketers, fail to perform under the agreements. We minimize such risk by performing financial credit reviews using, among other things, publicly available credit ratings of such counterparties. Contracts used to manage interest rate and commodity price risk may be considered derivative instruments that are subject to derivative and hedge accounting pursuant to SFAS No. 133. If a contract is accounted for as a derivative instrument, it is recorded in the financial statements as an asset or a liability, at the fair value of the contract. The recorded fair value of the contract is then adjusted quarterly to reflect any change in the market value of the contract, a practice known as marking the contract to market. Changes in the fair value of a derivative (that is, gains or losses) are reported either in earnings or accumulated other comprehensive income depending on whether the derivative qualifies for special hedge accounting treatment. For derivative instruments to qualify for hedge accounting under SFAS No. 133, the hedging relationship must be formally documented at inception and be highly effective in achieving offsetting cash flows or offsetting changes in fair value attributable to the risk being hedged. If hedging a forecasted transaction, the forecasted transaction must be probable. If a derivative instrument, used as a cash flow hedge, is terminated early because it is probable that a forecasted transaction will not occur, any gain or loss as of such date is immediately recognized in earnings. If a derivative instrument, used as a cash flow hedge, is terminated early for other economic reasons, any gain or loss as of the termination date is deferred and recorded when the forecasted transaction affects earnings. We use a combination of quoted market prices and mathematical valuation models to determine fair value of those contracts requiring derivative accounting. The ineffective portion, if any, of all hedges is recognized in earnings. The majority of our contracts are not subject to derivative accounting because they qualify for the normal purchases and sales exception of SFAS No. 133, or are not derivatives because there is not an active market for the commodity. Our electric capacity and energy contracts are not accounted for as derivatives due to the lack of an active energy market in the state of Michigan, as defined by SFAS No. 133, and the significant transportation costs that would be incurred to deliver the power under the contracts to the closest active energy market at the Cinergy hub in Ohio. If an active market develops in the future, we may be required to account for these contracts as derivatives. The mark-to-market impact on earnings related to these contracts could be material to the financial statements. CE-64 Consumer Energy Company Derivative accounting is required for certain contracts used to limit our exposure to commodity price risk and interest rate risk. The following table reflects the fair value of all contracts requiring derivative accounting:
In Millions - ------------------------------------------------------------------------------------------------------- June 30 2004 2003 - ------------------------------------------------------------------------------------------------------- Fair Unrealized Fair Unrealized Derivative Instruments Cost Value Gain (Loss) Cost Value Gain (Loss) - ------------------------------------------------------------------------------------------------------- Electric - related contracts $ - $ - $ - $ 8 $ - $ (8) Gas contracts 3 6 3 2 1 (1) Derivative contracts associated with Consumers' investment in the MCV Partnership: Prior to consolidation - - - - 20 20 After consolidation: Gas fuel contracts - 80 80 - - - Gas fuel futures, options, and swaps - 54 54 - - - =======================================================================================================
The fair value of our derivative contracts is included in Derivative Instruments, Other Assets, or Other Liabilities on the Consolidated Balance Sheets. The fair value of derivative contracts associated with our investment in the MCV Partnership for 2003 is included in Investments - Midland Cogeneration Venture Limited Partnership on the Consolidated Balance Sheets. ELECTRIC CONTRACTS: Our electric utility business uses purchased electric call option contracts to meet, in part, our regulatory obligation to serve. This obligation requires us to provide a physical supply of electricity to customers, to manage electric costs, and to ensure a reliable source of capacity during peak demand periods. GAS CONTRACTS: Our gas utility business uses fixed price and index-based gas supply contracts, fixed price weather-based gas supply call options, fixed price gas supply call and put options, and other types of contracts, to meet our regulatory obligation to provide gas to our customers at a reasonable and prudent cost. Unrealized gains and losses associated with these options are reported directly in earnings as part of other income, and then directly offset in earnings and recorded on the balance sheet as a regulatory asset or liability as part of the GCR process. INTEREST RATE RISK CONTRACTS: We frequently use interest rate swaps to hedge the risk associated with forecasted interest payments on variable-rate debt and to reduce the impact of interest rate fluctuations. These interest rate swaps are generally designated as cash flow hedges. As such, we record changes in the fair value of these contracts in accumulated other comprehensive income unless the swaps are sold. As of June 30, 2004 and June 30, 2003, we did not have any interest rate swaps outstanding. DERIVATIVE CONTRACTS ASSOCIATED WITH CONSUMERS' INVESTMENT IN THE MCV PARTNERSHIP: Gas Fuel Contracts: The MCV Partnership uses natural gas fuel contracts to buy gas as fuel for generation, and to manage gas fuel costs. The MCV Partnership believes that its long-term natural gas contracts, which do not contain volume optionality, qualify under SFAS No. 133 for the normal purchases and normal sales exception. Therefore, these contracts are currently not recognized at fair value on the balance sheet. Should significant changes in the level of the MCV Facility operational dispatch or purchases of long-term gas occur, the MCV Partnership would be required to re-evaluate its accounting treatment for these long-term gas contracts. This re-evaluation may result in recording mark- CE-65 Consumer Energy Company to-market activity on some contracts, which could add to earnings volatility. At June 30, 2004, the MCV Partnership had six long-term gas contracts that contained both an option and forward component. Because of the option component, these contracts do not qualify for the normal purchases and sales exception and are accounted for as derivatives, with changes in fair value recorded in earnings each quarter. The MCV Partnership expects future earnings volatility on these six contracts, since gains or losses will be recorded on a quarterly basis during the remaining life of approximately four years for these gas contracts. For the six months ended June 30, 2004, the MCV Partnership recorded in Fuel for electric generation a $6 million net gain in earnings associated with these contracts. Gas Fuel Futures, Options, and Swaps: To manage market risks associated with the volatility of natural gas prices, the MCV Partnership maintains a gas hedging program. The MCV Partnership enters into natural gas futures contracts, option contracts, and over-the-counter swap transactions in order to hedge against unfavorable changes in the market price of natural gas in future months when gas is expected to be needed. These financial instruments are being used principally to secure anticipated natural gas requirements necessary for projected electric and steam sales, and to lock in sales prices of natural gas previously obtained in order to optimize the MCV Partnership's existing gas supply, storage, and transportation arrangements. These financial instruments are accounted for as derivatives under SFAS No. 133. The contracts that are used to secure anticipated natural gas requirements necessary for projected electric and steam sales qualify as cash flow hedges under SFAS No. 133. The MCV Partnership also engages in cost mitigation activities to offset the fixed charges the MCV Partnership incurs in operating the MCV Facility. These cost mitigation activities include the use of futures and options contracts to purchase and/or sell natural gas to maximize the use of the transportation and storage contracts when it is determined that they will not be needed for the MCV Facility operation. Although these cost mitigation activities do serve to offset the fixed monthly charges, these cost mitigation activities are not considered a normal course of business for the MCV Partnership and do not qualify as hedges under SFAS No. 133. Therefore, the mark-to-market gains and losses from these cost mitigation activities are recorded in earnings each quarter. For the six months ended June 30, 2004, the MCV Partnership has recorded an unrealized gain of $24 million in other comprehensive income on those futures contracts that qualify as cash flow hedges, which resulted in a cumulative net gain of $55 million in other comprehensive income as of June 30, 2004. This balance represents natural gas futures, options, and swaps with maturities ranging from July 2004 to December 2009, of which $34 million of this gain is expected to be reclassified as an increase to earnings within the next 12 months. As of June 30, 2004, Consumers' pretax proportionate share of the MCV Partnership's $55 million net gain recorded in other comprehensive income is $27 million, of which $17 million is expected to be reclassified as an increase to earnings within the next 12 months. In addition, for the six months ended June 30, 2004, the MCV Partnership has recorded a net gain of $16 million in earnings from hedging activities related to natural gas requirements for the MCV Facility operations and a net gain of $1 million in earnings from cost mitigation activities. CE-66 Consumer Energy Company 5: RETIREMENT BENEFITS We provide retirement benefits to our employees under a number of different plans, including: - non-contributory, defined benefit Pension Plan, - a cash balance pension plan for certain employees hired after June 30, 2003, - benefits to certain management employees under SERP, - health care and life insurance benefits under OPEB, - benefits to a select group of management under EISP, and - a defined contribution 401(k) plan. Pension Plan: The Pension Plan includes funds for our employees and our non-utility affiliates, including former Panhandle employees. The Pension Plan's assets are not distinguishable by company. As of June 30, 2004, we have recorded a prepaid pension asset of $373 million, $20 million of which is in Other current assets on our Consolidated Balance Sheet. OPEB: We adopted SFAS No. 106, effective as of the beginning of 1992. We recorded a liability of $466 million for the accumulated transition obligation and a corresponding regulatory asset for anticipated recovery in utility rates. For additional details, see Note 1, Corporate Structure and Accounting Policies, "Utility Regulation." In 1994, the MPSC authorized recovery of the electric utility portion of these costs over 18 years and in 1996, the MPSC authorized recovery of the gas utility portion of these costs over 16 years. We have made contributions of $33 million to our 401(h) and VEBA trust funds in 2004. We plan to make additional contributions of $30 million in 2004. Costs: The following table recaps the costs incurred in our retirement benefits plans:
In Millions - ---------------------------------------------------------------------------------- Pension Three Months Ended Six Months Ended - ---------------------------------------------------------------------------------- June 30 2004 2003 2004 2003 - ---------------------------------------------------------------------------------- Service cost $ 9 $ 9 $ 19 $ 19 Interest expense 18 18 36 37 Expected return on plan assets (27) (21) (54) (41) Amortization of: Net loss 4 3 7 5 Prior service cost 2 2 3 4 ------------------------------------- Net periodic pension cost $ 6 $ 11 $ 11 $ 24 ==================================================================================
CE-67 Consumer Energy Company
In Millions - ----------------------------------------------------------------------------------------- OPEB Three Months Ended Six Months Ended - ----------------------------------------------------------------------------------------- June 30 2004 2003 2004 2003 - ----------------------------------------------------------------------------------------- Service cost $ 4 $ 5 $ 9 $ 9 Interest expense 14 16 27 31 Expected return on plan assets (11) (10) (23) (20) Amortization of: Net loss 3 4 6 9 Prior service cost (2) (2) (4) (3) ------------------------------------- Net periodic postretirement benefit cost $ 8 $ 13 $ 15 $ 26 =========================================================================================
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act) was signed into law in December 2003. The Act establishes a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy, which is exempt from federal taxation, to sponsors of retiree health care benefit plans that provide a benefit that is actuarially equivalent to Medicare Part D. We believe our plan is actuarially equivalent to Medicare Part D and have incorporated retroactively the effects of the subsidy into our financial statements as of June 30, 2004 in accordance with FASB Staff Position, No. SFAS 106-2. We remeasured our obligation as of December 31, 2003 to incorporate the impact of the Act, which resulted in a reduction to the accumulated postretirement benefit obligation of $148 million. The remeasurement resulted in a reduction of OPEB cost of $6 million for the three months ended June 30, 2004, $11 million for the six months ended June 30, 2004, and an expected total reduction of $23 million for 2004. The reduction of $23 million includes $7 million in capitalized OPEB costs. For additional details, see Note 7, Implementation of New Accounting Standards. 6: ASSET RETIREMENT OBLIGATIONS SFAS NO. 143: This standard became effective January 2003. It requires companies to record the fair value of the cost to remove assets at the end of their useful life, if there is a legal obligation to do so. We have legal obligations to remove some of our assets, including our nuclear plants, at the end of their useful lives. Before adopting this standard, we classified the removal cost of assets included in the scope of SFAS No. 143 as part of the reserve for accumulated depreciation. For these assets, the removal cost of $448 million that was classified as part of the reserve at December 31, 2002, was reclassified in January 2003, in part, as a: - $364 million ARO liability, - $134 million regulatory liability, - $42 million regulatory asset, and - $7 million net increase to property, plant, and equipment as prescribed by SFAS No. 143. We are reflecting a regulatory asset and liability as required by SFAS No. 71 for regulated entities instead of a cumulative effect of a change in accounting principle. The fair value of ARO liabilities has been calculated using an expected present value technique. This technique reflects assumptions, such as costs, inflation, and profit margin that third parties would consider to assume the settlement of the obligation. Fair value, to the extent possible, should include a CE-68 Consumer Energy Company market risk premium for unforeseeable circumstances. No market risk premium was included in our ARO fair value estimate since a reasonable estimate could not be made. If a five percent market risk premium were assumed, our ARO liability would increase by $22 million. If a reasonable estimate of fair value cannot be made in the period the ARO is incurred, such as for assets with indeterminate lives, the liability is to be recognized when a reasonable estimate of fair value can be made. Generally, transmission and distribution assets have indeterminate lives. Retirement cash flows cannot be determined and there is a low probability of a retirement date. Therefore, no liability has been recorded for these assets. Also, no liability has been recorded for assets that have insignificant cumulative disposal costs, such as substation batteries. The measurement of the ARO liabilities for Palisades and Big Rock are based on decommissioning studies that largely utilize third-party cost estimates. The following tables describe our assets that have legal obligations to be removed at the end of their useful life.
June 30, 2004 In Millions - ----------------------------------------------------------------------------------------------------------------------- In Service Trust ARO Description Date Long Lived Assets Fund - ----------------------------------------------------------------------------------------------------------------------- Palisades - decommission plant site 1972 Palisades nuclear plant $495 Big Rock - decommission plant site 1962 Big Rock nuclear plant 64 JHCampbell intake/discharge water line 1980 Plant intake/discharge water line - Closure of coal ash disposal areas Various Generating plants coal ash areas - Closure of wells at gas storage fields Various Gas storage fields - Indoor gas services equipment relocations Various Gas meters located inside structures - =======================================================================================================================
June 30, 2004 In Millions - ------------------------------------------------------------------------------------------------------------- ARO Liability ARO ------------- Cash flow Liability ARO Description 1/1/03 12/31/03 Incurred Settled Accretion Revisions 6/30/04 - ------------------------------------------------------------------------------------------------------------- Palisades - decommission $249 $268 $ - $ - $ 10 $ 31 $309 Big Rock - decommission 61 35 - (24) 6 22 39 JHCampbell intake line - - - - - - - Coal ash disposal areas 51 52 - (1) 3 - 54 Wells at gas storage fields 2 2 - - - - 2 Indoor gas services relocations 1 1 - - - - 1 ------------------------------------------------------------------- Total $364 $358 $ - $(25) $ 19 $ 53 $405 =============================================================================================================
The Palisades and Big Rock cash flow revisions resulted from new decommissioning reports filed with the MPSC in March 2004. For additional details, see Note 2, Uncertainties, "Other Electric Uncertainties - Nuclear Plant Decommissioning." Reclassification of certain types of Cost of Removal: Beginning in December 2003, the SEC requires the quantification and reclassification of the estimated cost of removal obligations arising from other than legal obligations. These cost of removal obligations have been accrued through depreciation charges. We estimate that we had $1.016 billion at June 30, 2004 and $950 million at June 30, 2003 of previously accrued asset removal costs related to our regulated operations arising from other than legal obligations. These obligations, which were previously classified as a component of accumulated CE-69 Consumer Energy Company depreciation, are now classified as regulatory liabilities in the accompanying Consolidated Balance Sheets. 7: IMPLEMENTATION OF NEW ACCOUNTING STANDARDS FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES: The FASB issued this Interpretation in January 2003. The objective of the Interpretation is to assist in determining when one party controls another entity in circumstances where a controlling financial interest cannot be properly identified based on voting interests. Entities with this characteristic are considered variable interest entities. The Interpretation requires the party with the controlling financial interest, known as the primary beneficiary, in a variable interest entity to consolidate the entity. On December 24, 2003, the FASB issued Revised FASB Interpretation No. 46. For entities that have not previously adopted FASB Interpretation No. 46, Revised FASB Interpretation No. 46 provided an implementation deferral until the first quarter of 2004. As of and for the quarter ended March 31, 2004, we adopted Revised FASB Interpretation No. 46 for all entities. We determined that we are the primary beneficiary of both the MCV Partnership and the FMLP. We have a 49 percent partnership interest in the MCV Partnership and a 46.4 percent partnership interest in the FMLP. Consumers is the primary purchaser of power from the MCV Partnership through a long-term power purchase agreement. In addition, the FMLP holds a 75.5 percent lessor interest in the MCV Facility, which results in Consumers holding a 35 percent lessor interest in the MCV Facility. Collectively, these interests make us the primary beneficiary of these entities. As such, we consolidated their assets, liabilities, and activities into our financial statements for the first time as of and for the quarter ended March 31, 2004. These partnerships have third-party obligations totaling $728 million at June 30, 2004. Property, plant, and equipment serving as collateral for these obligations has a carrying value of $1.453 billion at June 30, 2004. The creditors of these partnerships do not have recourse to the general credit of CMS Energy. We also determined that we are not the primary beneficiary of our trust preferred security structures. Accordingly, those entities have been deconsolidated as of December 31, 2003. Company Obligated Trust Preferred Securities totaling $490 million, that were previously included in mezzanine equity, have been eliminated due to deconsolidation. As a result of the deconsolidation, we reflected $506 million of long-term debt - related parties and reflected an investment in related parties of $16 million. We are not required to restate prior periods for the impact of this accounting change. FASB STAFF POSITION, NO. SFAS 106-2, ACCOUNTING AND DISCLOSURE REQUIREMENTS RELATED TO THE MEDICARE PRESCRIPTION DRUG, IMPROVEMENT, AND MODERNIZATION ACT OF 2003: The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act) was signed into law in December 2003. The Act establishes a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy, which is exempt from federal taxation, to sponsors of retiree health care benefit plans that provide a benefit that is actuarially equivalent to Medicare Part D. At December 31, 2003, we elected a one-time deferral of the accounting for the Act, as permitted by FASB Staff Position, No. SFAS 106-1. The final FASB Staff Position, No. SFAS 106-2 supersedes FASB Staff Position, No. SFAS 106-1 and provides further accounting guidance. FASB Staff Position, No. SFAS 106-2 states that for plans that are actuarially equivalent to Medicare Part D, employers' measures of accumulated postretirement benefit obligations and postretirement benefit costs should reflect the effects of the Act. CE-70 Consumer Energy Company We believe our plan is actuarially equivalent to Medicare Part D and have incorporated retroactively the effects of the subsidy into our financial statements as of June 30, 2004, in accordance with FASB Staff Position, No. SFAS 106-2. We remeasured our obligation as of December 31, 2003 to incorporate the impact of the Act, which resulted in a reduction to the accumulated postretirement benefit obligation of $148 million. The remeasurement resulted in a reduction of OPEB cost of $6 million for the three months ended June 30, 2004, $11 million for the six months ended June 30, 2004, and an expected total reduction of $23 million for 2004. Consumers capitalizes a portion of OPEB cost in accordance with regulatory accounting. As such, the remeasurement resulted in a net reduction of OPEB expense of $4 million for the three months ended June 30, 2004, $8 million for the six months ended June 30, 2004, and an expected total net expense reduction of $16 million for 2004. CE-71 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK CMS ENERGY Quantitative and Qualitative Disclosures about Market Risk is contained in PART I: CMS Energy Corporation's Management's Discussion and Analysis, which is incorporated by reference herein. CONSUMERS Quantitative and Qualitative Disclosures about Market Risk is contained in PART I: Consumers Energy Company's Management's Discussion and Analysis, which is incorporated by reference herein. ITEM 4. CONTROLS AND PROCEDURES CMS ENERGY Disclosure Controls and Procedures: CMS Energy's management, with the participation of its CEO and CFO, has evaluated the effectiveness of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, CMS Energy's CEO and CFO have concluded that, as of the end of such period, its disclosure controls and procedures are effective. Internal Control Over Financial Reporting: There have not been any changes in CMS Energy's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting. CONSUMERS Disclosure Controls and Procedures: Consumers' management, with the participation of its CEO and CFO, has evaluated the effectiveness of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, Consumers' CEO and CFO have concluded that, as of the end of such period, its disclosure controls and procedures are effective. Internal Control Over Financial Reporting: There have not been any changes in Consumers' internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The discussion below is limited to an update of developments that have occurred in various judicial and administrative proceedings, many of which are more fully described in CMS Energy's and Consumers' Forms 10-K/A for the year ended December 31, 2003. Reference is also made to the CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, in particular, Note 3, Uncertainties for CMS Energy and Note 2, Uncertainties for Consumers, included herein for additional information regarding various pending administrative and judicial proceedings involving rate, operating, regulatory and environmental matters. CO-1 CMS ENERGY SEC REQUEST On August 5, 2004, CMS Energy received a request from the SEC that CMS Energy voluntarily produce all documents and data relating to the SEC's inquiry into payments made to the government and officials of the government of Equatorial Guinea. CMS Energy will fully cooperate with the SEC in its inquiry. From 1991 through January 3, 2002, subsidiaries of CMS Energy held interests in, and beginning in 1995 operated, hydrocarbon production and processing facilities and a methanol plant in Equatorial Guinea. On January 3, 2002, CMS Energy sold all its Equatorial Guinea holdings. The SEC's inquiry follows an investigation and public hearing conducted by the United States Senate Permanent Subcommittee on Investigations, which reviewed the U.S. banking transactions of various foreign governments, including that of Equatorial Guinea. The investigation and hearing also reviewed the operations of certain U.S. oil companies in Equatorial Guinea. There were no findings of violations of the U.S. Foreign Corrupt Practices Act by the U.S. oil companies in the report of the Minority Staff of the Subcommittee, the only report issued to date as a result of the hearing. The Subcommittee did find that oil companies operating in Equatorial Guinea may have contributed to corrupt practices in that country. SEC INVESTIGATION In March 2004, the SEC approved a cease-and-desist order settling an administrative action against CMS Energy related to round-trip trading. The order did not assess a fine and CMS Energy neither admitted nor denied the order's findings. The settlement resolved the SEC investigation involving CMS Energy and CMS MST. In March 2004, the SEC also filed an action against three former employees related to round-trip trading by CMS MST. One of the individuals has settled with the SEC. CMS Energy is currently advancing legal defense costs for the remaining two individuals in accordance with existing indemnification policies. DEMAND FOR ACTIONS AGAINST OFFICERS AND DIRECTORS In May 2002, the Board of Directors of CMS Energy received a demand, on behalf of a shareholder of CMS Energy Common Stock, that it commence civil actions (i) to remedy alleged breaches of fiduciary duties by certain CMS Energy officers and directors in connection with round-trip trading by CMS MST, and (ii) to recover damages sustained by CMS Energy as a result of alleged insider trades alleged to have been made by certain current and former officers of CMS Energy and its subsidiaries. In December 2002, two new directors were appointed to the Board. The Board formed a special litigation committee in January 2003 to determine whether it is in CMS Energy's best interest to bring the action demanded by the shareholder. The disinterested members of the Board appointed the two new directors to serve on the special litigation committee. In December 2003, during the continuing review by the special litigation committee, CMS Energy was served with a derivative complaint filed on behalf of the shareholder in the Circuit Court of Jackson County, Michigan in furtherance of his demands. The date for CMS Energy and other defendants to answer or otherwise respond to the complaint has been extended to September 1, 2004, subject to such further extensions as may be mutually agreed upon by the parties and authorized by the Court. CMS Energy cannot predict the outcome of this matter. INTEGRUM LAWSUIT Integrum filed a complaint in Wayne County, Michigan Circuit Court in July 2003 against CMS Energy, Enterprises and APT. Integrum alleges several causes of action against APT, CMS Energy, and Enterprises in connection with an offer by Integrum to purchase the CMS Pipeline Assets. In addition to seeking unspecified money damages, Integrum is seeking an order enjoining CMS Energy and Enterprises from selling, and APT from purchasing, the CMS Pipeline Assets and an order of specific performance mandating that CMS Energy, Enterprises, and APT complete the sale of the CMS Pipeline Assets to APT and Integrum. A certain officer and director of Integrum is a former officer and director of CMS Energy, Consumers, and their subsidiaries. The individual was not employed by CMS Energy, Consumers, or their subsidiaries when Integrum made the offer to purchase the CMS Pipeline Assets. CMS Energy and Enterprises filed a motion to change venue from Wayne County to Jackson County, which was granted. The parties are now awaiting transfer of the file from Wayne County to Jackson County. CMS Energy and Enterprises believe that Integrum's claims are without merit. CMS Energy and Enterprises intend to defend vigorously against this action but they cannot predict the outcome of this litigation. CO-2 GAS INDEX PRICE REPORTING LITIGATION In August 2003, Cornerstone Propane Partners, L.P. ("Cornerstone") filed a putative class action complaint in the United States District Court for the Southern District of New York against CMS Energy and dozens of other energy companies. The court ordered the Cornerstone complaint to be consolidated with similar complaints filed by Dominick Viola and Roberto Calle Gracey. The plaintiffs filed a consolidated complaint on January 20, 2004. The consolidated complaint alleges that false natural gas price reporting by the defendants manipulated the prices of NYMEX natural gas futures and options. The complaint contains two counts under the Commodity Exchange Act, one for manipulation and one for aiding and abetting violations. CMS Energy is no longer a defendant, however, CMS MST and CMS Field Services are named as defendants. (CMS Energy sold CMS Field Services to Cantera Natural Gas, Inc. but is required to indemnify Cantera Natural Gas, Inc. with respect to this action.) In a similar but unrelated matter, Texas-Ohio Energy, Inc. filed a putative class action lawsuit in the United States District Court for the Eastern District of California against a number of energy companies engaged in the sale of natural gas in the United States. CMS Energy is named as a defendant. The complaint alleges defendants entered into a price-fixing conspiracy by engaging in activities to manipulate the price of natural gas in California. The complaint contains counts alleging violations of the Sherman Act, Cartwright Act (a California statute), and the California Business and Profession Code relating to unlawful, unfair and deceptive business practices. There is currently pending in the Nevada federal district court a multi district court litigation ("MDL") matter involving seven complaints originally filed in various state courts in California. These complaints make allegations similar to those in the Texas-Ohio case regarding price reporting, although none contain a Sherman Act claim and some of the defendants in the MDL matter are also defendants in the Texas-Ohio case. Those defendants successfully argued to have the Texas-Ohio case transferred to the MDL proceeding. The plaintiff in the Texas-Ohio case agreed to extend the time for all defendants to answer or otherwise respond until May 28, 2004 and on that date a number of defendants filed motions to dismiss. In order to negotiate possible dismissal and/or substitution of defendants, CMS Energy and two other parent holding company defendants were given further extensions to answer or otherwise respond to the complaint to August 16, 2004. Benscheidt v. AEP Energy Services, Inc., et al., a new class action complaint containing allegations similar to those made in the Texas-Ohio case, albeit limited to California state law claims, was filed in California state court in February 2004. CMS Energy and CMS MST are named as defendants. Defendants filed a notice to remove this action to California federal district court, which was granted, and had it transferred to the MDL proceeding in Nevada. However, the plaintiff is seeking to have the case remanded back to California and until the issue is resolved, no further action will be taken. Three new, virtually identical actions were filed in San Diego Superior Court in July, 2004, one by the County of Santa Clara ("Santa Clara"), one by the County of San Diego (San Diego) and one by the City of and County of San Francisco and the San Francisco City Attorney (collectively "San Francisco"). Defendants, consisting of a number of energy companies including CMS Energy, CMS MS&T, Cantera Natural Gas and Cantera Gas Company, are alleged to have engaged in false reporting of natural gas price and volume information and sham sales to artificially inflate natural gas retail prices in California. All three complaints allege claims for unjust enrichment and violations of the Cartwright Act, and the San Francisco action also alleges a claim for violation of the California Business and Profession Code relating to unlawful, unfair and deceptive business practices. CMS Energy and the other CMS defendants will defend themselves vigorously but cannot predict the outcome of these matters. CO-3 LEONARD FIELD DISPUTE Pursuant to a Consent Judgment entered in Oakland County, Michigan Circuit Court in September 2001, CMS Gas Transmission had 18 months to extract approximately one bcf of pipeline quality natural gas held in the Leonard Field in Addison Township. The Consent Judgment provided for an extension of that period upon certain circumstances. CMS Gas Transmission has complied with the requirements of the Consent Judgment. Addison Township filed a lawsuit in Oakland County Circuit Court against CMS Gas Transmission in February 2004 alleging the Leonard Field was discharging odors in violation of the Consent Judgment. Pursuant to a Stipulated Order entered April 1, 2004, CMS Gas Transmission agreed to certain undertakings to address the odor complaints and further agreed to temporarily cease operations at the Leonard Field during the month of April 2004, the last month provided for in the Consent Judgment. Also, Addison Township was required to grant CMS Gas Transmission an extension to withdraw its natural gas if certain conditions were met. Addison Township denied CMS Gas Transmission's request for an extension on April 5, 2004. CMS Gas Transmission is pursuing its legal remedies and filed a complaint against Addison Township in June 2004. CMS Gas Transmission cannot predict the outcome of this matter, and unless an extension is provided, it will be unable to extract approximately 500,000 mcf of gas remaining in the Leonard Field. CMS ENERGY AND CONSUMERS ERISA LAWSUITS CMS Energy is a named defendant, along with Consumers, CMS MST, and certain named and unnamed officers and directors, in two lawsuits brought as purported class actions on behalf of participants and beneficiaries of the CMS Employees' Savings and Incentive Plan (the "Plan"). The two cases, filed in July 2002 in United States District Court for the Eastern District of Michigan, were consolidated by the trial judge and an amended consolidated complaint was filed. Plaintiffs allege breaches of fiduciary duties under ERISA and seek restitution on behalf of the Plan with respect to a decline in value of the shares of CMS Energy Common Stock held in the Plan. Plaintiffs also seek other equitable relief and legal fees. The judge issued an opinion and order dated March 31, 2004 in connection with the motions to dismiss filed by CMS Energy, Consumers and the individuals. The judge dismissed certain of the amended counts in the plaintiffs' complaint and denied CMS Energy's motion to dismiss the other claims in the complaint. CMS Energy, Consumers and the individual defendants filed answers to the amended complaint on May 14, 2004. A trial date has not been set, but is expected to be no earlier than late in 2005. CMS Energy and Consumers will defend themselves vigorously but cannot predict the outcome of this litigation. SECURITIES CLASS ACTION LAWSUITS Beginning on May 17, 2002, a number of securities class action complaints were filed against CMS Energy, Consumers, and certain officers and directors of CMS Energy and its affiliates. The complaints were filed as purported class actions in the United States District Court for the Eastern District of Michigan, by shareholders who allege that they purchased CMS Energy's securities during a purported class period. The cases were consolidated into a single lawsuit and an amended and consolidated class action complaint was filed on May 1, 2003. The consolidated complaint contains a purported class period beginning on May 1, 2000 and running through March 31, 2003. It generally seeks unspecified damages based on allegations that the defendants violated United States securities laws and regulations by making allegedly false and misleading statements about CMS Energy's business and financial condition, particularly with respect to revenues and expenses recorded in connection with round-trip trading by CMS MST. The judge issued an opinion and order dated March 31, 2004 in connection with various pending motions, including plaintiffs' motion to amend the complaint and the motions to dismiss the complaint CO-4 filed by CMS Energy, Consumers and other defendants. The judge directed plaintiffs to file an amended complaint under seal and ordered an expedited hearing on the motion to amend, which was held on May 12, 2004. At the hearing, the judge ordered plaintiffs to file a Second Amended Consolidated Class Action complaint deleting Counts III and IV relating to purchasers of CMS PEPS, which the judge ordered dismissed with prejudice. Plaintiffs filed this complaint on May 26, 2004. CMS Energy, Consumers, and the individual defendants filed new motions to dismiss on June 21, 2004 and a hearing on those motions is scheduled for August 2004. CMS Energy, Consumers and the individual defendants will defend themselves vigorously but cannot predict the outcome of this litigation. ENVIRONMENTAL MATTERS CMS Energy, Consumers and their subsidiaries and affiliates are subject to various federal, state and local laws and regulations relating to the environment. Several of these companies have been named parties to various actions involving environmental issues. Based on their present knowledge and subject to future legal and factual developments, CMS Energy and Consumers believe that it is unlikely that these actions, individually or in total, will have a material adverse effect on their financial condition. See CMS Energy's and Consumers' MANAGEMENT'S DISCUSSION AND ANALYSIS and CMS Energy's and Consumers' CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the CMS Energy Annual Meeting of Shareholders held on May 28, 2004, the CMS Energy shareholders voted upon five proposals, as follows: - Ratification of the appointment of Ernst & Young LLP as independent auditors of CMS Energy for the year ending December 31, 2004, with a vote of 135,549,550 shares in favor, 2,206,503 against and 1,148,674 abstentions; - Amendments to the Performance Incentive Stock Plan, with a vote of 85,615,290 shares in favor, 17,204,621 against and 1,794,973 abstentions; - Permitting awards under the Incentive Compensation Plans and related contractual arrangements to become income tax deductible by the company, with a vote of 124,938,186 shares in favor, 12,172,123 against and 1,794,735 abstentions; - Amending the Restated Articles of Incorporation to increase the number of authorized shares of common stock and re-designate authorized but unissued Class G common stock into shares of common stock, with a vote of 130,280,753 shares in favor, 6,673,547 against and 1,950,741 abstentions; - Election of eleven members to the Board of Directors. The votes for individual nominees were as follows: CO-5 CMS ENERGY
Number of Votes: For Withheld Total - ----------------------- ----------- ---------- ----------- Merribel S. Ayres 134,750,679 4,137,455 138,888,134 Earl D. Holton 132,968,087 5,920,047 138,888,134 David W. Joos 134,215,407 4,672,727 138,888,134 Michael T. Monahan 134,251,381 4,636,753 138,888,134 Joseph F. Paquette, Jr. 110,514,698 28,373,436 138,888,134 William U. Parfet 133,106,221 5,781,913 138,888,134 Percy A. Pierre 133,725,594 5,162,540 138,888,134 S. Kinnie Smith, Jr. 134,179,371 4,708,763 138,888,134 Kenneth L. Way 133,340,836 5,547,298 138,888,134 Kenneth Whipple 134,312,812 4,575,322 138,888,134 John B. Yasinsky 132,916,761 5,971,373 138,888,134
CONSUMERS Consumers did not solicit proxies for the matters submitted to votes at the contemporaneous May 28, 2004 Consumers' Annual Meeting of Shareholders. All 84,108,789 shares of Consumers Common Stock were voted in favor of electing the above-named individuals as directors of Consumers and in favor of the remaining proposals for Consumers. None of the 441,599 shares of Consumers Preferred Stock were voted at the Annual Meeting. ITEM 5. OTHER INFORMATION A shareholder who wishes to submit a proposal for consideration at the CMS Energy 2005 Annual Meeting pursuant to the applicable rules of the SEC must send the proposal to reach CMS Energy's Corporate Secretary on or before December 24, 2004. In any event if CMS Energy has not received written notice of any matter to be proposed at that meeting by March 9, 2005, the holders of the proxies may use their discretionary voting authority on any such matter. The proposals should be addressed to: Corporate Secretary, CMS Energy, One Energy Plaza, Jackson, Michigan 49201. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) LIST OF EXHIBITS (10)(a) General Waiver and Release Agreement (10)(b) CMS Energy Corporation Policy on Change In Control Agreements and Employment Contracts (31)(a) CMS Energy Corporation's certification of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (31)(b) CMS Energy Corporation's certification of the CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (31)(c) Consumers Energy Company's certification of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (31)(d) Consumers Energy Company's certification of the CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 CO-6 (32)(a) CMS Energy Corporation's certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (32)(b) Consumers Energy Company's certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (B) REPORTS ON FORM 8-K CMS ENERGY During the second quarter of 2004, CMS Energy filed or furnished the following Current Reports on Form 8-K: - 8-K filed on April 14, 2004 covering matters pursuant to Item 5, Other Events; - 8-K furnished on May 6, 2004 covering matters pursuant to Item 12, Results of Operations and Financial Condition (including a Summary of Consolidated Earnings, Summarized Comparative Balance Sheets, Summarized Statements of Cash Flows, and a Summary of Consolidated Earnings - Reconciliations of GAAP Net Income (Loss) to Non-GAAP Ongoing Net Income); and - 8-K filed on June 3, 2004 covering matters pursuant to Item 5, Other Events. CONSUMERS During the second quarter of 2004, Consumers filed or furnished the following Current Reports on Form 8-K: - 8-K furnished on May 6, 2004 covering matters pursuant to Item 12, Results of Operations and Financial Condition (including a Summary of Consolidated Earnings, Summarized Comparative Balance Sheets, Summarized Statements of Cash Flows, and a Summary of Consolidated Earnings - Reconciliations of GAAP Net Income (Loss) to Non-GAAP Ongoing Net Income); and - 8-K filed on June 3, 2004 covering matters pursuant to Item 5, Other Events. CO-7 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 5, 2004 By: /s/ Thomas J. Webb -------------------------------------- Thomas J. Webb Executive Vice President and Chief Financial Officer CONSUMERS ENERGY COMPANY (Registrant) Dated: August 5, 2004 By: /s/ Thomas J. Webb -------------------------------------- Thomas J. Webb Executive Vice President and Chief Financial Officer CO-8 CMS ENERGY AND CONSUMERS EXHIBITS EXHIBIT NUMBER DESCRIPTION - ------ ----------- (10)(a) General Waiver and Release Agreement (10)(b) CMS Energy Corporation Policy on Change In Control Agreements and Employment Contracts (31)(a) CMS Energy Corporation's certification of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (31)(b) CMS Energy Corporation's certification of the CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (31)(c) Consumers Energy Company's certification of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (31)(d) Consumers Energy Company's certification of the CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (32)(a) CMS Energy Corporation's certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (32)(b) Consumers Energy Company's certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
EX-10.(A) 2 k87244exv10wxay.txt GENERAL WAIVER AND RELEASE AGREEMENT EXHIBIT 10(a) GENERAL WAIVER AND RELEASE AGREEMENT This GENERAL WAIVER AND RELEASE AGREEMENT ("Agreement"), made as of the 27th day of May, 2004, pursuant to Michigan law, among PRESTON D. HOPPER (the "Executive"), an individual, and CONSUMERS ENERGY COMPANY, a Michigan corporation (the "Company") and CMS ENERGY CORPORATION, a Michigan corporation, is a general waiver and release of all claims against the Company, CMS Energy Corporation and all of their subsidiaries and affiliates (collectively the "CMS Companies"). WHEREAS, upon termination of his employment, Executive is eligible for the payment of certain severance benefits under Paragraph 6 of an Employment Agreement, dated as of December 10, 1999 between Executive and CMS Energy Corporation, provided that "any payment under this provision shall be contingent upon the Executive's execution of a waiver and release of all liability by the Company and its agents at the time of termination;" WHEREAS, the parties have recognized that the facts and circumstances surrounding Executive's cessation of employment with the Company are unusual and not exactly contemplated by the terms of some of the applicable benefit plans and programs, thus requiring interpretation and application of language and producing different possible outcomes unless the parties agree to a mutually satisfactory resolution of any open issues; WHEREAS, the parties hereto have agreed upon the level of severance benefits due under said Paragraph 6, as previously interpreted by CMS Energy Corporation, and under the Executive Incentive Separation Plan which also requires a release by Executive, with the result that the parties have resolved all potential issues about the interpretation and application of language in applicable benefit plans and programs; and WHEREAS, this General Waiver and Release Agreement satisfies the aforementioned conditions for payment of severance benefits: NOW THEREFORE, in consideration of the covenants undertaken and the releases contained in this Agreement, the Executive and Consumers Energy Company and CMS Energy Corporation, on their own behalf and on behalf of their respective successors and assigns, agree as follows: 1. CESSATION OF EMPLOYMENT Executive agrees that his employment as an employee and officer of all CMS Companies was fully and completely terminated effective as of March 17, 2004. Further, Executive waives any right to object to such termination. The parties agree this was not a termination for cause. 2. MONETARY AND OTHER CONSIDERATION In consideration for the releases and the other covenants in this Agreement, Executive agrees and reaffirms that the only monetary and other consideration to which he is entitled due to the termination of employment is that provided to Executive pursuant to this Agreement. (A) The parties hereto agree that ninety-five percent of the total amount of severance benefits received by Executive pursuant to this Agreement shall be consideration for the General Release and Discharge by Executive (see Section 5), and five percent of the total amount shall be consideration for the Release of Age Discrimination Claims by Executive (see Section 6). (B) Plans and Programs With Vested Rights Following is a list of significant plans and programs where the parties in the spirit of compromise are agreeing upon the scope of Executive's vested rights and are agreeing upon the interpretation of the plans and programs for purposes of this Agreement. Further, the parties to this Agreement stipulate that no other section of this Agreement seeks to otherwise change any of the terms of any of those plans and programs as they would apply to Executive. (1) CMS Energy Corporation Annual Executive Incentive Compensation Plan, initially effective January 1, 1987, as amended and restated effective January 1, 2002 ("Old Incentive Compensation Plan"): The parties agree that Executive has no more money coming to him as a result of awards to Executive under the Old Incentive Compensation Plan except to the extent, if any, Executive has deferred prior awards. The parties agree that whatever Executive may have been entitled to receive under the Old Incentive Compensation Plan has already been paid to him or has been deferred as he has directed. Executive's directions shall continue to be carried out. (2) Pension Plan for Employees of Consumers Energy Company, effective as of September 1, 2000 ("Pension Plan"): The parties agree that Executive's rights under the Pension Plan are governed by the provisions contained in Section VII of the Pension Plan and that Executive can begin to receive his pension on a monthly basis when he reaches age 55. Basically, the amount of Executive's pension will be determined in accordance with the actuarial table contained in Appendix A to the Pension Plan, and further reduced for any survivor options provided to or selected by Executive for which he is eligible. Executive is not eligible to receive his pension as a single sum determined on a present value basis. 2 (3) Supplemental Executive Retirement Plan for Employees of CMS Energy/Consumers Energy Company, effective as of January 1, 2001 ("SERP"): The parties agree that Executive's rights under SERP are governed by the provisions contained in the last sentence of Section VII of SERP and Executive can begin to receive his SERP on a monthly basis when he reaches age 55. Basically, the amount of Executive's SERP will be reduced by the same percentage from the actuarial table contained in Appendix A to the Pension Plan and used to determine his pension, and further reduced for any survivor options provided to or selected by Executive for which he is eligible under SERP. As would be the case if he retired under SERP, Executive cannot receive his SERP as a single sum determined on a present value basis. (4) Annual Officer Incentive Compensation Plan for CMS Energy Corporation and Its Subsidiaries, effective as of January 1, 2003 ("AOIC Plan"): Pursuant to the AOIC Plan, for performance year 2003, the Board had already considered and approved awards under the AOIC Plan prior to March 17, 2004, but no individual award of incentive compensation had yet been paid to any officer, including Executive, as of March 17, 2004, but would have been paid before the end of March. Moreover, Executive's award would be credited to his Salaried Employees Merit Program for 2003 ("SEM Plan") special account for later payment. The Company agrees to take no steps to prevent payment and crediting from taking place for Executive's incentive compensation related to performance year 2003 and further agrees it will allow payment in cash of such credited amount (subject only to state, federal, FICA and other applicable withholding taxes and authorized deductions) to be made from the SEM Plan within 30 days after the signing of this Agreement. Executive agrees he is not entitled to any award under the Plan for all or any portion of the 2004 performance year. (5) CMS Deferred Salary Savings Plan, initially effective as of December 1, 1989, as amended through January 1, 1994 and the Employees' Savings and Incentive Plan of Consumers Energy Company/Employee Stock Ownership Plan of Consumers Energy Company, effective as of January 1, 2001: Executive was 100% vested in the account values in each of the aforementioned plans as of March 17, 2004. All amounts in the accounts will be treated as required in the plan documents, including distribution to Executive in accordance with the payment options selected by him. (6) Under the Stock Plan referenced below in paragraph C(1), certain options were granted to Executive on July 31, 2002 and on August 22, 2003. For only those options, the exercise date is being extended pursuant to Section 6.10 of the Stock Plan so that Executive may exercise those options if he so chooses. The period during which those options may be exercised is a window period that begins at 3 8:00 AM on the 30th day after the signing of this Agreement by both parties and expires at 5:00 PM on the 60th day after the signing of this Agreement by both parties. Aside from allowing the exercise during the window period, all other terms of the options remain as stated in their original awards. Nothing in this Agreement extends any option beyond its original expiration date. (7) Salaried Employees Merit Program for 2003 ("SEM Plan"): Executive had an account balance in the SEM Plan as of March 17, 2004. Distributions under the SEM Plan will be made in March 2005 based on the price of CMS Energy Corporation common stock on January 31, 2005. The Company agrees not to challenge Executive's eligibility to have the aforementioned distribution from his SEM Plan account take place in March 2005. (8) Unused Vacation: The parties agree that Executive shall be paid for 25 days, or 200 hours, of unused vacation at an hourly wage rate based upon Executive's 2004 base pay, 2080 hours per year and eight hours a day. The amount of this payment will be made to Executive within 10 days after signing this Agreement subject to reduction for state, federal, FICA and other applicable withholding taxes and authorized deductions. (9) Health Care, Life Insurance, Long Term Disability: The parties agree that all rights, if any, Executive shall have to continue coverage and receipt of any Health Care, Life Insurance and Long Term Disability benefits will be determined in accordance with the terms and conditions of the Group Health Care Plan for Employees of Consumers Energy, the Term Life Insurance Plan for Salaried Employees of Consumers Energy, any applicable individual long term disability contract and any applicable laws. (C) Plans and Programs Where There Are Forfeitures (1) CMS Energy Corporation Performance Incentive Stock Plan, effective as of December 3, 1999 ("Stock Plan"): As of March 17, 2004, Executive had certain CMS Energy Corporation stock options governed by the Stock Plan which are being forfeited pursuant to the Stock Plan and this Agreement. The total number of options being forfeited is for 83,000 shares of stock. The number of shares subject to forfeiture and their grant date are: 7,000 shares (July 28, 1994), 7,000 shares (July 27, 1995), 9,000 shares (July 25, 1996), 10,000 shares (July 24, 1997), 9,000 shares (July 23, 1998), 14,000 shares (July 22, 1999), 14,000 shares (February 24, 2000), 18,000 shares (February 22, 2001) and 18,000 shares (February 22, 2002). Executive agrees not to contest such forfeiture in exchange for the consideration represented by this Section 2. 4 (2) As of March 17, 2004, Executive also had 27,000 shares of CMS Energy Corporation restricted stock governed by the Stock Plan. In accordance with the provisions of the Stock Plan and this Agreement, all of said shares of restricted stock are being forfeited. Executive agrees not to contest such forfeiture in exchange for the consideration represented by this Section 2. (3) Unless he is an active employee on the payroll of a CMS Company at the time he reaches the age of 55, Executive will not be eligible for retiree health care. Nothing in this Agreement is intended to change that outcome. (D) Severance Benefits (1) Pursuant to the terms of the Executive Incentive Separation Plan, the parties agree that Executive shall receive a monthly payment equal to $5,978.68, which shall be paid to Executive every month in which he also receives a payment under the Pension Plan. If Executive predeceases his spouse after he reaches the age of 55, Executive's spouse shall receive a monthly payment equal to 50% of the payment that Executive is receiving, or $2,989.34. This payment to Executive's spouse shall be made until the month of the death of Executive's spouse. If Executive predeceases his spouse before he reaches the age of 55, the monthly payment to Executive's spouse at the 50% level shall begin with the first month following the month in which Executive would have reached the age of 55 and continue monthly until the month of her death. If Executive's spouse predeceases him, Executive's monthly payment does not "pop up," above the $5,978.68 per month level. Each monthly payment called for by this subparagraph shall be reduced for state, federal, FICA and other applicable withholding taxes and authorized deductions at the time of payment. (2) To resolve the amount of severance benefits due Executive pursuant to Paragraph 6 of the aforementioned Employment Agreement, the parties agree that Executive shall receive a total of $699,984.00. The severance benefits payable pursuant to this subparagraph shall be paid in three installments as follows: $174,996.00 on or about July 1, 2004, $349,992.00 on or about January 5, 2005 (but not before January 1, 2005), and $174,996.00 on or about January 5, 2006 (but not before January 1, 2006). Each payment shall be reduced for state, federal, FICA and other applicable withholding taxes and authorized deductions at the time of payment. If Executive dies before receiving the three installment payments, the payment(s) remaining shall be made to his surviving spouse according to the schedule set forth above. 5 3. RETURN OF COMPANY PROPERTY By signing this Agreement, Executive represents and warrants that he has returned to the Company all of its property and all the property of any of the CMS Companies which Executive had in his possession, provided however that Executive can keep the personal computer assigned for his use once it is cleaned by the Company of all documents belonging to any of the CMS Companies and contains only a basic operating system and Executive's personal attorney files on the hard drive. Prior to cleaning, the Company will retain copies of documents which need to be retained pursuant to Company document retention policies. Specifically, Executive expressly agrees to return, within 10 days after signing this Agreement, all originals and copies of documents which he may have in his possession in connection with the business and affairs of any CMS Company. Notwithstanding the foregoing, property or documents of CMS Companies, if any, in Executive's possession due to arrangements made in connection with ongoing or pending litigation or investigations are not covered by this paragraph. Executive shall provide a written certification of compliance with this section of the Agreement on or about the 30th day after signing this Agreement. 4. PROPRIETARY MATERIALS AND INFORMATION (A) Executive acknowledges that by reason of his position with the CMS Companies he has been given access to "Proprietary Materials and Information" respecting the Company's business affairs and the business affairs of the CMS Companies. Executive represents that he has held all such information confidential and will continue to do so, and that Executive will not use such information for any business (which term herein includes a partnership, firm, corporation or any other entity) without the prior written consent of the Company. Because of the temporal nature of such materials and information, the requirements of this paragraph shall expire on May 27, 2005. (B) For purposes of this Agreement, "Proprietary Materials and Information" includes, by way of example and not limitation, notes, letters, internal company memoranda, records, reports, recordings, records of conversations and other information concerning the Company's business affairs and the business affairs of the CMS Companies which Executive obtained by virtue of the Executive's position and which was not disseminated to the public during the term of the Executive's employment. It also includes the contents of Executive's personal computer and the non-original copies of documents contained in Executive's office files. (C) Executive further agrees not to testify or act in any capacity as a paid or unpaid expert witness, advisor or consultant on behalf of any person, individual, partnership, firm, corporation or any other person or entity that has or may have any claim, demand, action, suit, cause of action, or judgment against the Company or any of the CMS Companies. The intent of this paragraph is to preclude Executive from voluntarily 6 participating in commercial litigation against any of the CMS companies. Notwithstanding the foregoing, this paragraph does not prevent Executive from offering sworn testimony after being served a valid subpoena. 5. GENERAL RELEASE AND DISCHARGE BY EXECUTIVE In consideration of the payments and commitments made by the Company to the Executive (described in Section 2 above), the Executive on his own behalf, and his descendants, ancestors, dependents, heirs, executors, administrators, assigns, and successors, and each of them, hereby covenants not to sue and fully releases and discharges the Company, CMS Energy Corporation, and all of their subsidiaries and affiliates, past and present, and each of them as well as its and their trustees, directors, officers, agents, attorneys, insurers, employees, stockholders, representatives, assigns, and successors, past and present, and each of them, hereinafter together and collectively referred to as "Releasees," with respect to and from any and all claims, wages, demands, rights, liens, agreements, contracts, covenants, actions, suits, causes of action, obligations, debts, costs, expenses, attorneys' fees, damages, judgments, orders and liabilities of whatever kind or nature in law, equity or otherwise, whether now known or unknown, suspected or unsuspected, and whether or not concealed or hidden, which the Executive now owns or holds or has at any time heretofore owned or held as against said Releasees, arising out of or in any way connected with the Executive's employment relationship with the Company or the Releasees, or the Executive's termination of employment or any other transactions, occurrences, acts or omissions or any loss, damage or injury whatever, known or unknown, suspected or unsuspected, resulting from any act or omission by or on the part of said Releasees, or any of them, committed or omitted prior to the date of this Agreement, including but not limited to, claims based on any express or implied contract of employment which may have been alleged to exist between the Company, the Releasees and the Executive, Title VII of the Civil Rights Act of 1964, 42 U.S.C. Section 2000e, et seq, as amended, the Civil Rights Act of 1991, P. L. 102-1 66, the Elliott-Larsen Civil Rights Act, MCLA Section 37.2101, et seq, the Rehabilitation Act of 1973, 29 U.S.C. Section 701, et seq, as amended, the Americans with Disabilities Act of 1990, 42 U.S.C. Section 12206, et seq, as amended, (or the Persons with Disabilities Civil Rights Act, MCLA Section 37.1101, et seq, as amended, or any other federal, state or local law, rule, regulation or ordinance, and claims for severance pay, sick leave, vacation pay and holiday pay, except as provided in the sentences that follow. Nothing in this Agreement is intended to, nor do the Executive, the Company and CMS Energy Corporation, waive the right to enforce this Agreement pursuant to Section 14 below. Further, this release does not relate to claims Executive may have accrued through March 17, 2004 under benefit programs available to all employees under the general benefit plan descriptions, under descriptions contained in particular plans or contracts applicable to members of Executive's paygrade and under the Pension Plan and SERP, provided, however, that determinations made with respect to the particular plans described in Section 2 of this Agreement are final and shall not be changed. Finally, this release does not relate to Executive's rights and claims for indemnification. 7 6. RELEASE OF AGE DISCRIMINATION CLAIMS BY EXECUTIVE In consideration for the consideration described in Section 2 above, the Company and the Executive further agree that this Agreement releases and discharges the Company and the Releasees from each, every and all liability to the Executive for any damage to person or property whatsoever, whether now known or unknown, apparent or not yet discovered, foreseen or unforeseen, developed or undeveloped, resulting or to result from claims of age discrimination occurring prior to the date of this Agreement under the Age Discrimination in Employment Act of 1967 ("ADEA"), 29 U.S.C. Section 621, et seq, as amended by the Older Workers Benefit Protection Act of 1990. The Executive specifically acknowledges for purposes of this provision that: (1) the Executive has been advised by the Company to consult with an attorney prior to signing this release under the Age Discrimination in Employment Act, as amended; (2) the Executive has been given 21 days to consider the release; and (3) the Executive may revoke this Agreement within 7 days of signing this Agreement. In the event of such a revocation, the Executive will repay to the Company all funds already received pursuant to Section 2 hereof and waive his rights to receive any additional funds under this Agreement. Such a revocation, to be effective, must be in writing and either (i) postmarked within 7 days of execution of this Agreement and addressed to the attention of John F. Drake, CMS Energy Corporation, at One Energy Plaza, Jackson, Michigan 49201, or (ii) hand delivered to John F. Drake within 7 days of execution of this Agreement. Executive understands that if revocation is made by mail, mailing by certified mail, return receipt requested, is recommended to show proof of mailing. IF EXECUTIVE SIGNS THIS AGREEMENT PRIOR TO THE END OF THE 21 DAY PERIOD, EXECUTIVE CERTIFIES THAT THE EXECUTIVE KNOWINGLY AND VOLUNTARILY DECIDED TO SIGN THE AGREEMENT AFTER CONSIDERING IT LESS THAN 21 DAYS AND HIS DECISION TO DO SO WAS NOT INDUCED BY ANY OF THE CMS COMPANIES THROUGH FRAUD, MISREPRESENTATION OR A THREAT TO WITHDRAW OR ALTER THE OFFER OF THE SEVERANCE BENEFITS PAYABLE UNDER THIS AGREEMENT PRIOR TO THE EXPIRATION OF THE 21 DAY TIME PERIOD. The release provided for in this Section 6 shall not be effective or enforceable until after the revocation period has passed. 7. NO ADMISSION OF LIABILITY The consideration advanced herein by the Company and all other CMS Companies is in full settlement of all claims by the Executive with respect to his employment relationship and does not constitute an admission of liability by the Company, CMS Energy Corporation, and all of their subsidiaries and affiliates. The consideration has been advanced as a compromise to avoid expense and any potential controversy with Executive. The covenants undertaken by the Executive do not constitute an admission of liability to any CMS Company by the Executive. 8 8. CONFIDENTIALITY (A) Executive agrees that the terms and conditions of this Agreement shall remain confidential as between the parties and that the Executive shall not disclose them to any other person except Executive's legal counsel, financial and/or tax advisors, future employer(s), and members of his immediate family. Executive shall also be allowed to disclose the terms and conditions to other persons after he has requested and received the express consent of the Company for such disclosure. (B) Without limiting the generality of the foregoing, neither the Company, CMS Energy Corporation nor the Executive will respond to or in any way participate in or contribute to any public discussion, notice or other publicity concerning or in any way relating to the terms and conditions of this Agreement or the circumstances surrounding Executive's termination of employment. Notwithstanding the foregoing sentence, the Company and all of the CMS Companies and the Executive shall be allowed to make such filings regarding the terms and conditions of this Agreement with the appropriate regulatory bodies, as may be required or advisable in the their sole discretion, including the submission of this Agreement as an exhibit to such filings. (C) Without limiting the generality of the foregoing, the Executive specifically agrees that he and the persons to whom he is allowed to make disclosure pursuant to paragraph (A) above shall not disclose detailed information regarding the contents of this Agreement to any current or former employee of any CMS Company. Executive and the CMS Companies may acknowledge, however, than an agreement has been reached by the parties. 9. GOVERNING LAW AND SEVERABILITY OF INVALID PROVISIONS This Agreement will be governed by and construed in accordance with the laws of the State of Michigan, without regard to its conflicts of law principles. Further, if any provision of this Agreement is held invalid, the invalidity shall not affect other provisions or applications of the Agreement, which can be given effect without the invalid provisions or applications, and to this end the provisions of this Agreement are declared to be severable. 10. FULL UNDERSTANDING AND VOLUNTARY ACCEPTANCE In entering this Agreement, the Company, CMS Energy Corporation and the Executive represent that they have had the opportunity to consult with attorneys of their own choice, that the Company, CMS Energy Corporation and the Executive have read the terms of this Agreement and that those terms are fully understood and voluntarily accepted by them. The parties further 9 represent that this Agreement contains the entire Agreement between the parties and that neither party has made any promise, inducement or agreement not herein expressed. 11. COOPERATION WITH COMPANY ON INVESTIGATIONS AND LAWSUITS When requested, Executive agrees to fully and unconditionally cooperate with the Company, CMS Energy Corporation and all other CMS Companies, by making himself available at reasonable times and for reasonable periods of time, in any pending or future civil or criminal investigations, claims or lawsuits by any governmental, regulatory or legislative body or by any other person, where it is determined by the Company that Executive has information that may be useful in the matter at issue. Any reasonable out-of-pocket expenses incurred in complying with this Section shall be reimbursed to Executive. Further, Executive shall be reimbursed for all reasonable business expenses of the kind that are customarily reimbursed by the Company to its Executives, when incurred by him in connection with the cooperation to be provided under this section of this Agreement. Nothing in this section and in this Agreement provides to the Company the right to direct or determine the defense(s) which the Executive might assert in response to any complaint or charges brought against the Executive as an individual. 12. DISCLOSURE TO STATE OR FEDERAL AGENCIES OR COURTS Nothing in this Agreement is to be construed as prohibiting either the Executive or any of the CMS Companies from freely providing any truthful information to a state or federal agency or court when requested or required to do so by such agency or court or when otherwise permitted by law to provide such information to them. 13. LITIGATION In the event of litigation or other proceeding ("Litigation") by Executive against the Company or any of the Releasees about matters that have been released under this Agreement, Executive agrees to repay to the Company and CMS Energy Corporation the consideration advanced under Section 2 above, prior to the commencement of Litigation and to pay to the Company and the Releasees all costs and expenses of defending against the Litigation incurred by the Company and Releasees, and those associated with them, including reasonable attorneys fees. Notwithstanding the foregoing, this section is not intended to preclude the offset of the portion of the consideration received under Section 2 related to the release of an ADEA claim, in lieu of the repayment of said ADEA consideration by Executive, if Executive commences litigation pursuant to ADEA. Moreover, a dispute and arbitration covered by Section 14 of this Agreement, including the enforcement by Executive of any arbitration award is not litigation within the scope of this Section 13. 10 14. ARBITRATION The parties agree that any disputes between them relating to the formation, breach, interpretation and application of this Agreement and not settled by the parties shall be submitted to final and binding arbitration. (A) Arbitration proceedings shall be conducted in Jackson, Michigan on at least ten (10) business days' written notice to the parties. Such proceedings shall be conducted in accordance with the Commercial Arbitration Rules of the American Arbitration Association (except as may be specified otherwise herein). (B) There shall be only one arbitrator, having knowledge and experience with employment law. If the parties cannot agree upon the arbitrator, each party shall select a representative qualified to be the arbitrator, and the two representatives shall select the arbitrator. If either party fails to select a representative, the other party may seek to have the Federal District Judge having the highest authority in the Federal District in which Jackson, Michigan is situated to appoint a person meeting the qualification requirements specified herein to serve as the arbitrator. If the judge with the highest seniority does not immediately appoint someone, the party may make such request of the next senior judge(s) (in descending order of authority) until a qualified arbitrator is appointed. (C) Each party shall be entitled to reasonable discovery through requests for admission, requests for production of documents and by depositions of not more than 10 individuals, and by no other means; and discovery procedures shall be utilized only for the discovery of relevant admissible evidence or information reasonably calculated to lead to the discovery of relevant admissible evidence, and shall not place an undue burden on the party from whom discovery is sought. (D) All discovery shall be completed, and the arbitration hearing shall commence within 90 days after appointment of the arbitrator; and absent a finding by the arbitrator of exceptional circumstances, the hearing shall be completed and an award setting forth the findings and reasoning for the arbitrator's decision, shall be rendered within 60 days after the conclusion of the hearing. (E) The arbitrator shall not have authority to fashion a remedy that includes consequential, exemplary or punitive damages of any type whatsoever, and the arbitrator is hereby prohibited from awarding injunctive relief of any kind, whether mandatory or prohibitory. (F) The award shall be final and binding on all parties and shall not be subject to court review. However, it may be enforced in any court of competent jurisdiction. 11 (G) The costs of the arbitration proceeding, which shall include the arbitrator's bill for services in connection with the arbitration proceeding, will be apportioned equally between the parties and each party shall pay its own attorney fees, experts' fees and any other expenses incurred in connection with the preparation for or conduct of the proceeding. 15. CANCELLATION OF PRIOR AGREEMENTS This Agreement sets forth the entire agreement of the parties hereto with respect to the subject matters contained herein and supersedes, cancels, voids and renders of no further force and effect any and all employment agreements, change of control agreements and other similar agreements, representations, promises, covenants, communications and arrangements, whether oral or written, between the Company and the Executive, CMS Energy Corporation and the Executive, and any one of the CMS Companies and the Executive that may have been executed or made prior to the date of this Agreement and which also may address the subject matters contained herein, including but not by way of limitation, the Employment Agreement, dated December 10, 1999, between the Executive and CMS Energy Corporation including Paragraph 8 thereof. However, see Subsection 17(A) of this Agreement with respect to said Paragraph 8. 16. MODIFICATION This Agreement shall not be varied, altered, modified, canceled, changed, or in any way amended except by mutual agreement of the parties in a written instrument executed by the parties hereto or their legal representatives. 17. INDEMNIFICATION AND INSURANCE (A) Paragraph 8 of the Employment Agreement, dated December 10, 1999, between the Executive and CMS Energy Corporation reads as follows: "8. Indemnification. The Company [CMS Energy Corporation] shall cause the Executive to be insured under its Directors and Officers Liability Insurance policy, if any, during his Employment Period and for a period of not less than five years after the termination of the Executive's employment for any reason whatsoever. In addition to insurance and any other indemnification available to the Executive as an Officer, the Company [CMS Energy Corporation] shall indemnify, to the extent permitted by applicable law, the Executive for settlements, judgments and reasonable expenses in connection with activities arising from services rendered by Executive as a Director or Officer of the Company [CMS Energy Corporation] or any affiliated 12 company and shall, to the extent permitted by law, advance to the Executive all reasonable costs and expenses in defense of any claim or cause of action arising out of or pertaining to the Executive's employment with CMS [CMS Energy Corporation] or the Company [CMS Energy Corporation]." Executive and CMS Energy Corporation restate Paragraph 8 as part of this Agreement with the understanding that (i) the restated paragraph represents an agreement between Executive and CMS Energy Corporation only and does not bind Consumers Energy Company and any other CMS Company to do anything; (ii) Executive is acknowledging when he signs this Agreement that he has been placed on notice of the difficulty CMS Energy Corporation may have in arranging coverage during the referenced five year period in future commercial insurance markets; and (iii) CMS Energy Corporation will be required to use its best efforts to arrange such coverage. (B) With respect to Consumers Energy Company and the CMS Companies other than CMS Energy Corporation, nothing in this Agreement shall be construed to alter, modify or limit Executive's rights (i) pursuant to applicable statutes, articles of incorporation, by-laws, common law and resolutions of the Boards of Consumers Energy Company or any of the CMS Companies to seek or obtain indemnification from said company respecting defense costs, judgments and other liabilities and (ii) to assert a claim for reimbursement under any potentially applicable directors and officers liability insurance policy which covers his service with said companies. Further, if Executive suffers actual monetary damage as a result of a lack of directors and officers liability insurance coverage with respect to his service with said companies, that will be a proper subject for arbitration under Section 14 of this Agreement, provided Executive has also been unsuccessful in asserting his rights and having his actual monetary damage reimbursed pursuant to clause (i) of this Subsection and provided further that Section 14 of this Agreement shall not be used, unless mutually agreed to at the time by the parties in writing, as a vehicle for resolving in connection with litigation and investigations pending at the time his employment was terminated on March 17, 2004 (x) Executive's claims for final discharge of any obligation to repay to CMS Energy Corporation moneys being advanced to him and (y) Executive's claims for indemnification by CMS Energy Corporation. Executive will not be allowed pursuant to Section 14 to recover more than the actual monetary damage he suffers after receipt of reimbursement from other sources. 13 18. COUNTERPARTS This Agreement may be executed in one (1) or more counterparts, each of which shall be deemed to be an original, but all of which together will constitute one and the same Agreement. Signatures transmitted via facsimile shall be regarded by the parties as original signatures. Signed as of this 27th day of May, 2004. /s/ Preston D. Hopper ---------------------------------------- Executive: Preston D. Hopper CONSUMERS ENERGY COMPANY By: /s/ John F. Drake ------------------------------------- CMS ENERGY CORPORATION By: /s/ S. Kinnie Smith, Jr. ------------------------------------ 14 EX-10.(B) 3 k87244exv10wxby.txt CHANGE IN CONTROL AGREEMENTS AND EMPLOYMENT CONTRACTS EXHIBIT 10(b) CMS ENERGY CORPORATION POLICY ON CHANGE IN CONTROL AGREEMENTS AND EMPLOYMENT CONTRACTS As of November 2003, pursuant to past practice, CMS Energy Corporation has in place various forms of change in control agreements and/or employment contracts with 29 current officers of CMS Energy Corporation ("CMS") and its subsidiaries. In the case of recent hires or promotions, these are unwritten commitments resulting from past practice. This entire situation has been subject to review and recommendations by the Organization and Compensation Committee of the Board of Directors (Committee). Effective January 29, 2004, the policy with respect to these matters will be as follows: A. Tier I - - Existing Senior Officers The 15 existing senior officers shall be offered for execution the form of the Executive Severance Agreement for Senior Officers (the "Tier I Agreement") that was recommended by the Committee and approved by the Board on January 29, 2004. The Tier I Agreement provides for change-in-control severance benefits when there is a change in control of CMS and general severance benefits outside of such a change in control. To encourage senior officers with existing agreements that are in writing to exchange their existing agreements for the Tier I Agreement, the initial term of the Tier I Agreement is set at three years and an alternative paragraph would be added to provide the officer with the right to extend the term. B. Tier II - - Existing Junior Officers The 14 existing junior officers shall be offered for execution the form of Officer Severance Agreement (the "Tier II Agreement") that was recommended by the Committee and approved by the Board on January 29, 2004. The Tier II Agreement provides for change-in-control severance benefits when there is a change in control of CMS and general severance benefits outside of such a change in control, but at reduced levels as compared to senior officers. Like the Tier I Agreement, the Tier II Agreement is terminable after three years. As is the case with senior officers, the same alternative paragraph on the term is available for the Tier II Agreement for junior officers with existing agreements that are in writing. C. Tier III - - New Officers In the future, a more limited number of new officers, namely those occupying the positions of chief executive officer, chief operating officer, chief financial officer and president of CMS Energy Corporation and president of Consumers Energy Company or alternatively, the president of the electric SBU and the president of the gas SBU of Consumers Energy Company, (whether hired from outside or promoted from within) shall be eligible for, and be offered for execution, the form of Change-in-Control Agreement (the "Tier III Agreement") that was recommended by the Committee and approved by the Board on January 29, 2004 and which provides change-in-control severance benefits when there is a change in control of CMS. The Tier III Agreement is for a two-year term with renewal options. New officers (whether hired from outside or promoted from within) in positions other than those identified above in this policy shall not be offered the Tier III Agreement unless the Committee has first approved the necessity or advisability of such an offer. In addition, the CIC excludes the provision of any general severance benefits for situations not involving a change in control. Those benefits, if they are provided at all and if they are to be different to those generally available to the employee population as a whole, would only be provided in a separate contract with the new officer that had been approved by the Committee prior to its execution. D. Exclusive Policy The Board authorizes no other policy with respect to the provision of change-in-control severance benefits and provision of general severance benefits to officers of CMS Energy Corporation and its subsidiaries.
EXECUTIVE OFFICER FORM OF SEVERANCE AGREEMENT Ken Whipple Tier III Glenn P. Barba Tier II John F. Drake Tier I Thomas W. Elward Tier I Carl L. English Tier I (through 7/31/04) David W. Joos Tier I David G. Mengebier Tier I John G. Russell Tier I S. Kinnie Smith, Jr. Tier I Thomas J. Webb Tier I
EXECUTIVE SEVERANCE AGREEMENT FOR SENIOR OFFICERS TIER I CONTENTS - --------------------------------------------------------------------------- Article 1. Establishment, Term, and Purpose 1 Article 2. Definitions 2 Article 3. Severance Benefits 7 Article 4. Other Terminations 12 Article 5. Noncompetition and Confidentiality 13 Article 6. Excise Tax Equalization Payment 15 Article 7. Dispute Resolution and Notice 16 Article 8. Successors and Assignment 16 Article 9. Miscellaneous 17
EXECUTIVE SEVERANCE AGREEMENT THIS EXECUTIVE SEVERANCE AGREEMENT ("Agreement") is made, entered into, and is effective as of ______ , 2004 (hereinafter referred to as the "Effective Date"), by and between,________________ , a Michigan corporation, (hereinafter referred to as the "Employer") and ___________________________ (hereinafter referred to as the "Executive"). WHEREAS, the Board of Directors of CMS Energy Corporation has approved entering into severance agreements with certain key executives as being necessary and advisable for the success of CMS Energy Corporation; WHEREAS, the Executive is currently employed at __________________, by the Employer in a key management position as _______________________________; WHEREAS, the Board of Directors of CMS Energy Corporation wants to provide the Executive with a measure of financial security in the event of certain terminations of employment; and WHEREAS, both the Employer and the Executive are desirous that any proposal involving Change in Control as defined in this Agreement will be considered by the Executive objectively and with reference only to the business interests of CMS Energy Corporation and its shareholders. NOW, THEREFORE, in consideration of the foregoing and of the mutual covenants and agreements of the parties set forth in this Agreement and of other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intended to be legally bound, agree as follows: ARTICLE 1. ESTABLISHMENT, TERM, AND PURPOSE This Agreement will commence on the Effective Date and shall continue in effect for three (3) full years through March _____, 2007. However, at the end of such three (3) year period and, if extended, at the end of each additional year thereafter, the term of this Agreement shall be extended automatically for one (1) additional year, unless the Executive delivers written notice six (6) months prior to the end of such term, or extended term, to the Committee, stating that the Agreement will not be extended by Executive. In such case, the Agreement will terminate at the end of the term, or extended term, then in progress. However, in the event of a Change in Control (as defined in Section 2.7 herein) of CMS Energy Corporation, the term of this Agreement shall automatically be extended for two (2) years from the date of the Change in Control if the current term of the Agreement has less than two (2) full years remaining until its expiration. If the term of this Agreement is not extended, the Employer is not obligated to pay any severance benefits under Section 3.2 for a Change in Control that happens after the expiration of the term and is not obligated to pay any severance benefits under Section 3.3 with respect to any other termination that happens after the expiration of the term. ARTICLE 2. DEFINITIONS Whenever used in this Agreement, the following terms shall have the meanings set forth below and, when the meaning is intended, the initial letter of the word is capitalized. 2.1 "AFFILIATE" shall have the meaning set forth in Rule 12B-2 promulgated under Section 12 of the Exchange Act. 2.2 "BASE SALARY" means the greater of the Executive's full annual rate of salary, whether or not any portion thereof is paid on a deferred basis, at: (i) the Effective Date of Termination, or (ii) at the date of the Change in Control. It does not include any incentive compensation in any form, bonuses of any type or any other form of monetary or nonmonetary compensation other than salary. 2.3 "BENEFICIAL OWNER" shall have the meaning ascribed to such term in Rule 13d-3 of the General Rules and Regulations under the Exchange Act. 2.4 "BENEFICIARY" means the persons or entities designated or deemed designated by the Executive pursuant to Section 9.5 herein. 2.5 "BOARD" means the Board of Directors of CMS Energy Corporation. 2.6 "CAUSE" shall be determined solely by the Committee in the exercise of good faith and reasonable judgment, and shall mean the occurrence of any one or more of the following: (a) The willful and continued failure by the Executive to substantially perform his or her duties of employment (other than any such failure resulting from the Executive's Disability), after a written demand for substantial performance is delivered to the Executive that specifically identifies the manner in which the Committee believes that the Executive has not substantially performed his or her duties, and the Executive has failed to remedy the situation within a reasonable period of time specified by the Committee which shall not be less than 30 days; or (b) The Executive's arrest for committing an act of fraud, embezzlement, theft, or other act constituting a felony involving moral turpitude; or (c) The willful engaging by the Executive in misconduct materially and demonstrably injurious to CMS Energy Corporation or its Affiliates, monetarily or otherwise. However, for purposes of clauses (a) and (c), no act or failure to act on the Executive's part shall be considered "willful" unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that his or her action or omission was in the best interest of CMS Energy Corporation or its Affiliates. 2.7 "CHANGE IN CONTROL" means a change in control of CMS Energy Corporation, and shall be deemed to have occurred upon the first to occur of any of the following events: (a) Any Person is or becomes the Beneficial Owner, directly or indirectly, of securities of CMS Energy Corporation (not including in the securities beneficially owned by such Person any securities acquired directly from CMS Energy Corporation or its Affiliates) representing twenty-five percent (25%) or more of the combined voting power of CMS Energy Corporation's then outstanding securities, excluding any Person who becomes such a Beneficial Owner in connection with a transaction described in clause (i) of paragraph (c) below; or (b) The following individuals cease for any reason to constitute a majority of directors then serving: individuals who, on the Effective Date, constitute the Board and any new director (other than a director whose initial assumption of office is in connection with an actual or threatened election contest, including but not limited to a consent solicitation, relating to the election of directors of CMS Energy Corporation) whose appointment or election by the Board or nomination for election by CMS Energy Corporation's stockholders was approved or recommended by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors on the Effective Date or whose appointment, election or nomination for election was previously so approved or recommended; or (c) The consummation of a merger or consolidation of CMS Energy Corporation or any direct or indirect subsidiary of CMS Energy Corporation with any other corporation or other entity, other than: (i) any such merger or consolidation which involves either CMS Energy Corporation or any such subsidiary and would result in the voting securities of CMS Energy Corporation outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or any parent thereof), in combination with the ownership of any trustee or other fiduciary holding securities under an employee benefit plan of CMS Energy Corporation or its Affiliates, at least sixty percent (60%) of the combined voting power of the voting securities of CMS Energy Corporation or the surviving entity or any parent thereof outstanding immediately after such merger or consolidation and immediately following which the individuals who comprise the Board immediately prior thereto constitute at least a majority of the board of directors of CMS Energy Corporation, the entity surviving such merger or consolidation or, if CMS Energy Corporation or the entity surviving such merger is then a subsidiary, the ultimate parent thereof; or (ii) a merger or consolidation effected to implement a recapitalization of CMS Energy Corporation (or similar transaction) in which no Person is or becomes the Beneficial Owner, directly or indirectly, of securities of CMS Energy Corporation (not including in the securities beneficially owned by such Person any securities acquired directly from CMS Energy Corporation or its Affiliates) representing twenty-five percent (25%) or more of the combined voting power of CMS Energy Corporation's then outstanding securities; or (d) Either (1) the stockholders of CMS Energy Corporation approve a plan of complete liquidation or dissolution of CMS Energy Corporation, or (2) there is consummated an agreement for the sale, transfer or disposition by CMS Energy Corporation of all or substantially all of CMS Energy Corporation's assets (or any transaction having a similar effect). For purposes of clause (d)(2), (i) the sale, transfer or disposition of a majority of the shares of common stock of Consumers Energy Company shall constitute a sale, transfer or disposition of substantially all of the assets of CMS Energy Corporation and (ii) the sale, transfer or disposition of subsidiaries or affiliates of CMS Energy Corporation, singly or in combinations, or their assets, only qualifies as a Change in Control if it satisfies the substantiality test contained in that clause and the Board of CMS Energy Corporation's determination in that regard is final. In addition, for purposes of clause (d)(2), the sale, transfer or disposition of assets has to be in a transaction or series of transactions closing within six months after the closing of the first transaction in the series, other than with an entity in which at least 60% of the combined voting power of the voting securities is owned by stockholders of CMS Energy Corporation in substantially the same proportions as their ownership of CMS Energy Corporation immediately prior to such transaction or transactions and immediately following which the individuals who comprise the Board immediately prior thereto constitute at least a majority of the board of directors of the entity to which such assets are sold, transferred or disposed or, if such entity is a subsidiary, the ultimate parent thereof. Notwithstanding the foregoing clauses (a), (c) and (d), a "Change in Control" shall not be deemed to have occurred by virtue of the consummation of any transaction or series of integrated transactions closing within six months after the closing of the first transaction in the series immediately following which the record holders of the common stock of CMS Energy Corporation immediately prior to such transaction or series of transactions continue to have substantially the same proportionate ownership in an entity which owns all or substantially all of the assets of CMS Energy Corporation immediately following such transaction or series of transactions. 2.8 "CODE" means the United States Internal Revenue Code of 1986, as amended, and any successors thereto. 2.9 "COMMITTEE" means the Organization and Compensation Committee of the Board of CMS Energy Corporation or any other committee appointed by the Board of CMS Energy Corporation to perform the functions of the Organization and Compensation Committee. 2.10 "DISABILITY" means for all purposes of this Agreement, the incapacity of the Executive, due to injury, illness, disease, or bodily or mental infirmity, which causes the Executive not to engage in the performance of a substantial or material portion of the Executive's usual duties of employment associated with such Executive's position. Such Disability shall be determined based on competent medical advice. 2.11 "EFFECTIVE DATE" means the date of this Agreement as specified in the opening sentence of this Agreement. 2.12 "EFFECTIVE DATE OF TERMINATION" means the date on which a Qualifying Termination occurs, as provided under Section 2.17 hereunder, which triggers the payment of Severance Benefits hereunder. 2.13 "EXCHANGE ACT" means the United States Securities Exchange Act of 1934, as amended. 2.14 "GOOD REASON" exists only on the date of a Change in Control or during the twenty-four (24) months which follow a Change in Control and shall mean, without the Executive's express written consent, the occurrence of any one or more of the following: (a) The assignment to the Executive of duties materially inconsistent with the Executive's position (including status, offices, titles, and reporting requirements), authority, or responsibilities as in effect on the Effective Date, or any action by the Employer which results in a diminution of the Executive's position, authority, duties, or responsibilities as constituted as of the Effective Date (excluding an isolated, insubstantial, and inadvertent action which is remedied by the Employer promptly after receipt of notice thereof given by the Executive); or (b) Reducing the Executive's Base Salary; or (c) Reducing the Executive's targeted annual incentive opportunity; or (d) Failing to maintain the Executive's participation in a long-term incentive plan in a manner that is consistent with the Executive's position, authority, or responsibilities; or (e) Failing to maintain the Executive's amount of benefits under, or relative level of participation in, employee benefit or retirement plans, policies, practices, or arrangements of a material nature available to employees of CMS Energy Corporation and its Affiliates and in which the Executive participates as of the Effective Date; or (f) A material breach of this Agreement by the Employer which is not remedied by the Employer within ten (10) business days of receipt of written notice of such breach delivered by the Executive to the Committee; or (g) Any successor company fails or refuses to assume the obligations owed to Executive under this Agreement in their entirety, as required by Section 8.1 hereunder; or (h) The Executive is required to be based at a location in excess of thirty-five (35) miles from the location of the Executive's principal job location or office immediately prior to a Change in Control except for required travel on the Employer's or CMS Energy Corporation's business to an extent substantially consistent with the Executive's prior business travel obligations; or (i) The Executive ceases being an executive officer of a company (other than by reason of death, Disability or Cause) whose common stock is publicly owned if immediately prior to the Change in Control the Executive was an executive officer of a company whose common stock was publicly owned. For purposes of applying clauses (a) through (i) of this Agreement, the Executive's Retirement shall not constitute a waiver of the Executive's rights with respect to any circumstance constituting Good Reason, and the Executive's continued employment shall not constitute a waiver of the Executive's rights with respect to any circumstance constituting Good Reason or constitute Executive's consent to the circumstances constituting Good Reason unless Executive has provided express written consent to the circumstance that would otherwise constitute Good Reason under this Agreement. Finally, for purposes of implementing this Agreement, any claim by Executive that Good Reason exists shall be presumed to be correct unless the Committee determines by clear and convincing evidence that Good Reason does not exist, which evidence shall be presented by the person disputing the claim that Good Reason exists. 2.15 "NOTICE OF TERMINATION" shall be provided for a Qualifying Termination and shall mean a written notice which shall indicate the specific termination provision in this Agreement relied upon, and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. The notice shall provide a specific date on which a Qualifying Termination has occurred and is effective for purposes of this Agreement. 2.16 "PERSON" shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, including a "group" as provided in Section 13(d). 2.17 "QUALIFYING TERMINATION" MEANS: (a) An involuntary termination of the Executive's employment by the Employer on the date of a Change in Control or during the twenty-four (24) months which follow a Change in Control for reasons other than death, Disability, Retirement, or Cause pursuant to a Notice of Termination delivered to the Executive by the Employer; or (b) A voluntary termination by the Executive for Good Reason on the date of a Change in Control or during the twenty-four (24) months which follow a Change in Control pursuant to a Notice of Termination delivered to the Employer by the Executive. (c) A termination (not involving death, Disability, Retirement or Cause), which takes place before the date of a Change in Control or after the first twenty-four (24) months immediately following a Change in Control, pursuant to a Notice of Termination delivered to Executive or pursuant to a request that Executive submit a resignation as an officer. A termination for failure of the Executive to comply in material respects with CMS Energy's Code of Conduct and Statement of Ethics Handbook (June 2003 edition) or other corporate policies, as the handbook and those documents may be amended from time to time, does not satisfy the definition of a Qualifying Termination under this clause (c). 2.18 "RELEASE DATE" occurs after the delivery of the Notice of Termination required by Section 2.15 and means the date on which the release contained in Exhibit A to this Agreement is first provided to Executive for signature. 2.19 "RETIREMENT" shall have the meanings ascribed under the terms of the pension plan applicable to Executive and entitled "Pension Plan for Employees of Consumers Energy Company," dated September 1, 2000, as amended, other than under Section 7 thereof, or under the successor or replacement of such pension plan if it is then no longer in effect. 2.20 "SERP" shall mean the retirement plan applicable to Executive and entitled "Supplemental Executive Retirement Plan for Employees of CMS Energy/Consumers Energy Company," dated May 1, 1998, as amended, or under the successor or replacement of such retirement plan if it is then no longer in effect. 2.21 "SEVERANCE BENEFITS" means the payment of Change-in-Control Severance Benefits or General Severance Benefits as provided in Article 3 herein. ARTICLE 3. SEVERANCE BENEFITS 3.1 RIGHT TO SEVERANCE BENEFITS. (a) CHANGE-IN-CONTROL SEVERANCE BENEFITS. The Executive shall be entitled to receive from the Employer Change-in-Control Severance Benefits, as described in Section 3.2 herein, if a Qualifying Termination of the Executive's employment satisfying the definitions contained in Section 2.17(a) or (b) has occurred on the date of a Change in Control of CMS Energy Corporation or within twenty-four (24) months immediately following a Change in Control of CMS Energy Corporation. Further, Executive's Retirement under the pension plan and SERP shall not constitute a waiver of the Executive's rights with respect to receipt of Change-in-Control Severance Benefits. Nor shall benefits received for Retirement under the pension plan and SERP (or any replacement or successor plans thereto) be used as an offset to the level of Change-in-Control Severance Benefits owed to Executive. (b) GENERAL SEVERANCE BENEFITS. The Executive shall be entitled to receive from the Employer General Severance Benefits, as described in Section 3.3 herein, if the Executive's employment is terminated for reasons satisfying the definition contained in Section 2.17(c) and such termination has occurred either before a Change of Control of CMS Energy Corporation or during the period that begins after the expiration of twenty-four (24) months immediately following a Change in Control of CMS Energy Corporation. Further, Executive's Retirement under the pension plan and SERP shall not constitute a waiver of the Executive's rights with respect to receipt of General Severance Benefits. Nor shall benefits received for Retirement under the pension plan and SERP (or any replacement or successor plans thereto) be used as an offset to the level of General Severance Benefits owed to Executive. (c) NO SEVERANCE BENEFITS. Other than in a situation involving a Retirement, the Executive shall not be entitled to receive Severance Benefits if the Executive's employment with the Employer ends for reasons other than a Qualifying Termination. (d) GENERAL RELEASE. As a condition precedent to receiving Severance Benefits under Section 3.3 herein, the Executive shall be obligated to execute and deliver to the Employer on a timely basis duplicate originals of a general release of claims in the form included as Exhibit A hereto. (e) WAIVER AND RELEASE. The Executive's act of accepting payment of Severance Benefits payable under Section 3.2 of this Agreement shall constitute and is deemed an express waiver, release and discharge by Executive of any and all claims for damages or other remedies, regardless of when they arose or when they are discovered, against CMS Energy Corporation and its Affiliates arising out of or in any way connected with Executive's employment relationship with them or the termination of such employment relationship except for claims and rights of Executive preserved under Section 3.2 of this Agreement and applicable rights to indemnification. (f) NO DUPLICATION OF SEVERANCE BENEFITS. If the Executive becomes entitled to Change-in-Control Severance Benefits, the benefits provided for under Section 3.2 hereunder shall be in lieu of all other benefits provided to the Executive under the provisions of this Agreement including, but not limited to, the benefits under Section 3.3. Likewise, if the Executive becomes entitled to General Severance Benefits, the benefits provided under Section 3.3 hereunder shall be in lieu of all other benefits provided to the Executive under the provisions of this Agreement including, but not limited to, the benefits under Section 3.2. If the Executive receives either Change-in-Control Severance Benefits under Section 3.2 or General Severance Benefits under Section 3.3, any other severance benefits received by employees not covered by this Agreement to which the Executive is entitled will be subtracted from the Severance Benefits paid pursuant to this Agreement. 3.2 DESCRIPTION OF CHANGE-IN-CONTROL SEVERANCE BENEFITS. In the event the Executive becomes entitled to receive Change-in-Control Severance Benefits, as provided in Section 3.1(a) herein, the Employer shall provide the Executive with the following: (a) A lump-sum amount paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Executive, as applicable, of a Notice of Termination, equal to the sum of the Executive's unpaid Base Salary, accrued vacation pay, unreimbursed business expenses, and unreimbursed allowances owed to the Executive through and including the Effective Date of Termination. (b) A lump-sum amount, paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Executive, as applicable, of a Notice of Termination, equal to two (2) times the sum of the following: (A) the Executive's Base Salary and (B) the greater of the Executive's: (i) annual target bonus opportunity in the year in which the Qualifying Termination occurs or (ii) the actual annual bonus payment paid or due to be paid the Executive in respect of the year prior to the year in which the Qualifying Termination occurs. (c) A lump-sum amount, paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Executive, as applicable, of a Notice of Termination, equal to the Executive's then current target bonus opportunity established under the bonus plan in which the Executive is then participating, for the plan year in which the Qualifying Termination occurs, adjusted on a pro rata basis for the number of days that have elapsed to the Effective Date of Termination during the bonus plan year in which the Qualifying Termination occurs. (d) A lump-sum amount, paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Executive, as applicable, of a Notice of Termination, equal to one (1) times the sum of the following: (A) the Executive's Base Salary and (B) the greater of the Executive's: (i) annual target bonus opportunity in the year in which the Qualifying Termination occurs or (ii) the actual annual bonus payment paid or due to be paid the Executive in respect of the year prior to the year in which the Qualifying Termination occurs. Such amount shall be consideration for the Executive entering into the noncompete agreement as described in Section 5(a). (e) Equivalent payment to Executive in a lump sum amount within forty-five (45) calendar days following delivery of the Notice of Termination for continued medical coverage for a period of thirty-six (36) months. Such equivalent payment shall be computed based on the same coverage level as in effect for Executive under the general health care plan available to all employees on the Effective Date of Termination by providing a lump sum payment of the Employer's portion of the monthly COBRA premium in effect on the Effective Date of Termination times thirty-six (36). Nothing herein amends or provides Executive any rights to health care coverage other than as provided in the applicable group health care plan. If the Executive has waived coverage under the applicable group health care plan, no equivalent payment shall be made under this Agreement. (f) Immediate extension (as allowable by Section 6.10 of Article VI of the plan entitled "CMS Energy Corporation Performance Incentive Stock Plan," dated December 3, 1999, as amended) by one year after the Effective Date of Termination of the period for Executive to exercise any outstanding stock options or stock appreciation rights granted by the Committee to Executive pursuant to said Article VI. Otherwise, the terms of said plan shall govern and be applied. (g) Immediate vesting and distribution to Executive (as allowable by the second sentence of Section 7.2(h) of Article VII of the plan entitled "CMS Energy Corporation Performance Incentive Stock Plan," dated December 3, 1999, as amended) within forty-five (45) days after delivery of the Notice of Termination of all outstanding shares of restricted stock previously awarded to Executive pursuant to said Article VII. For any award of restricted stock to which there are future performance goals attached, the number of shares distributed to Executive shall assume that the goals have been achieved in full and the award fully earned based on target performance without deductions or additions to the number of shares then held by Executive. For any award of restricted stock that is tenure based, the number of shares distributed to Executive shall assume that all requirements with respect to tenure are satisfied by Executive. Otherwise, the terms of said plan shall govern and be applied. (h) For an Executive included in SERP, the Executive's retirement benefits under the SERP will become fully vested as of the Effective Date of Termination and shall not be subject to further vesting requirements or to any forfeiture provisions. In addition, said Executive shall be provided the following: (i) an additional thirty-six (36) months of Preference Service (as defined in SERP) for purposes of the SERP in accordance with Section III(1) of SERP, subject, however, to the total of Preference Service plus Accredited Service being limited to a maximum of thirty-five (35) years under SERP, and (ii) only the amounts paid to Executive pursuant to clauses (a), (b), (c) and (d) of this Section 3.2 shall be considered a "severance payment under an employment agreement" for purposes of computing Final Executive Pay under SERP. Since the Executive is over the age of 55, the provisions of the last complete paragraph of Section V(3) of SERP shall not be operative. The enhanced SERP benefits under this Section 3.2(h) shall be in lieu of any Change-in-Control enhancements provided for in the SERP. (i) For purposes of (1) Retirement, (2) SERP and (3) benefits not expressly discussed in clauses (a) through (h) of this Section 3.2, but which are available to the general employee population or available only to officers and implemented with contracts with third parties, the benefit plan descriptions covering all employees and the retirement plan and SERP plan descriptions and contracts with third parties covering officers in place at the time of the Effective Date of Termination control Executive's treatment under those plans and contracts. For any other benefits only available to officers, if those benefits are not expressly discussed in clauses (a) through (h) of this Section 3.2, those benefits are terminated for Executive as of the Effective Date of Termination. 3.3 DESCRIPTION OF GENERAL SEVERANCE BENEFITS. In the event the Executive becomes entitled to receive General Severance Benefits as provided in Section 3.1(b) herein, the Employer shall provide the Executive with the following: (a) A lump-sum amount paid within fifteen (15) calendar days following delivery to the Executive of a Notice of Termination with respect to a Qualifying Termination as described in Section 2.17 (c) of this Agreement, equal to the sum of the Executive's unpaid Base Salary, accrued vacation pay, unreimbursed business expenses, and unreimbursed allowances owed to the Executive through and including the Effective Date of Termination. (b) An amount, paid following the Release Date on an installment basis over a period of twelve (12) months on a twice a month schedule in accordance with the normal payroll procedures of the Employer, equal to two (2) times the sum of: (A) the Executive's Base Salary and (B) the greater of the Executive's: (i) annual target bonus opportunity in the year in which the Qualifying Termination occurs or (ii) the actual annual bonus payment paid or due to be paid the Executive in respect of the year prior to the year in which the Qualifying Termination occurs. The first of the twenty-four (24) installment payments called for by this section shall be made within forty-five (45) days following the Release Date. (c) A lump-sum amount, paid within forty-five (45) calendar days following the Release Date, equal to the Executive's then current target bonus opportunity established under the bonus plan in which the Executive is then participating, for the plan year in which the Qualifying Termination occurs, adjusted on a pro rata basis for the number of days that have elapsed to the Effective Date of Termination during the bonus plan year in which the Qualifying Termination occurs. (d) Equivalent payment to Executive in a lump-sum amount within forty-five (45) days following the Release Date for continued medical coverage for a period of twenty-four (24) months. Such equivalent payment shall be computed based on the same coverage level as in effect for Executive under the general health care plan available to all employees on the Effective Date of Termination by providing a lump-sum payment of the Employer's portion of the monthly COBRA premium in effect on the Effective Date of Termination times twenty-four (24). Nothing herein amends or provides Executive any rights to health care coverage other than as provided in the applicable group health care plan. If the Executive has waived coverage under the applicable group health care plan, no equivalent payment shall be made under this Agreement. (e) Outstanding stock options and stock appreciation rights previously granted by the Committee to Executive pursuant to Article VI of the plan entitled "CMS Energy Corporation Performance Incentive Stock Plan," dated December 3, 1999, as amended, shall be treated as a "termination of employment" in accordance with Section 6.10 of Article VI, provided however that Employee will not be eligible to seek or receive from the Committee any extensions of the period for their exercise. For outstanding shares of restricted stock held by Executive, they shall be forfeited to CMS Energy Corporation in accordance with the provisions of the first sentence of Section 7.2(h) of Article VII of said plan.) For purposes of (1) Retirement, (2) SERP and (3) benefits not expressly discussed in clauses (a) through (d) of this Section 3.3, but which are available to the general employee population or available only to officers and implemented with contracts with third parties, the benefit plan descriptions covering all employees and the retirement plan and SERP plan descriptions and contracts with third parties covering officers in place at the time of the Effective Date of Termination control Executive's treatment under those plans and contracts. For any other benefits only available to officers, if those benefits are not expressly discussed in clauses (a) through (d) of this Section 3.3, those benefits are terminated for Executive as of the Effective Date of Termination. ARTICLE 4. OTHER TERMINATIONS 4.1 TERMINATION FOR DISABILITY. If the Executive's employment is terminated with the Employer due to Disability, the Executive's benefits shall be determined in accordance with the Employer's retirement, insurance, and other applicable plans and programs then in effect. 4.2 TERMINATION FOR RETIREMENT OR DEATH. If the Executive's employment with the Employer is terminated by reason of his Retirement or death, the Executive's benefits shall be determined in accordance with the Employer's retirement and SERP plans, survivor's benefits, insurance, and other applicable programs then in effect. 4.3 TERMINATION FOR CAUSE OR BY EMPLOYER OR THE EXECUTIVE FOR OTHER THAN GOOD REASON. If the Executive's employment is terminated either: (a) by the Employer for Cause as defined in Section 2.6 of this Agreement; or (b) voluntarily by the Executive for reasons other than those specified in Section 2.14 herein, or (c) by the Employer for the reasons stated in the last sentence of Section 2.17(c) of this Agreement, the Employer shall pay the Executive the sum of any unpaid Base Salary, accrued vacation, unreimbursed business expenses and unreimbursed allowances owed to the Executive through the effective date of termination. The terms of the benefit plan descriptions, compensation plan descriptions and contracts with third parties covering officers shall control the disposition to Executive and timing of all other amounts to which the Executive may be entitled, and neither the Employer nor CMS Energy Corporation nor any of its Affiliates shall have any further obligations to the Executive thereunder as a result of the existence of this Agreement. No other severance benefits of any type shall be made available to Executive. Notwithstanding the above, if the Executive's employment terminates pursuant to this Section 4.3, the Executive shall be bound by the provisions contained in Article 5(a), 5(b), 5(c), 5(d), and 5(e) hereof. 4.4 NOTICE OF TERMINATION. Any termination of the Executive's employment in accordance with Section 4.3 of this Agreement shall be communicated by Notice of Termination delivered to the other party, which shall include a specific date on which the termination has occurred and is effective. ARTICLE 5. NONCOMPETITION AND CONFIDENTIALITY In the event the Executive becomes entitled to receive Change-in-Control Severance Benefits as provided in Section 3.2 herein or General Severance Benefits as provided in Section 3.3 herein, the following shall apply: (a) NONCOMPETITION. During the term of employment and for a period of twelve (12) months after the Effective Date of Termination, the Executive shall not: (i) directly or indirectly act in concert or conspire with any person employed by CMS Energy Corporation or any of its Affiliates in order to engage in or prepare to engage in or to have a financial or other interest in any business which is a Direct Competitor (as defined below); or (ii) serve as an employee, agent, partner, shareholder, director or consultant for, or in any other capacity participate, engage, or have a financial or other interest in any business which is a Direct Competitor (provided, however, that notwithstanding anything to the contrary contained in this Agreement, the Executive may own up to two percent (2%) of the outstanding shares of the capital stock of a company whose securities are registered under Section 12 of the Exchange Act. For purposes of this Agreement, the term "Direct Competitor" shall mean any person or entity engaged in the business of selling electric power or natural gas at retail within the State of Michigan. The Committee also reserves the right to designate, prior to the termination date specified in a Notice of Termination, any Person that it believes, in good faith, is a significant competitive threat to CMS Energy Corporation or its Affiliates. (b) CONFIDENTIALITY. The Employer has advised the Executive and the Executive acknowledges that it is the policy of CMS Energy Corporation and its Affiliates to maintain as secret and confidential all Protected Information (as defined below), and that Protected Information has been and will be developed at substantial cost and effort to CMS Energy Corporation and its Affiliates. The Executive shall not at any time, directly or indirectly, divulge, furnish, or make accessible to any person, firm, corporation, association, or other entity (other than as may be required in the regular course of the Executive's employment), nor use in any manner, either during the term of employment or after termination, for any reason, any Protected Information, or cause any such information of CMS Energy Corporation and its Affiliates to enter the public domain. For purposes of this Agreement, "Protected Information" means trade secrets, confidential and proprietary business information of CMS Energy Corporation and its Affiliates and any other information of CMS Energy Corporation and its Affiliates, including, but not limited to, customer lists (including potential customers), sources of supply, processes, plans, materials, pricing information, internal memoranda, marketing plans, internal policies, and products and services which may be developed from time to time by CMS Energy Corporation and its Affiliates and their agents or employees, including the Executive; provided, however, that information that is in the public domain (other than as a result of a breach of this Agreement), approved for release by CMS Energy Corporation or its Affiliates or lawfully obtained from third parties who are not bound by a confidentiality agreement with CMS Energy Corporation or its Affiliates, is not Protected Information. Notwithstanding the foregoing, nothing in this subsection is to be construed as prohibiting Executive from freely providing information to a state or federal agency, legislative body or one of its committees or a court with jurisdiction when Executive is requested or required to do so by such entity. (c) NONSOLICITATION. During the term of employment and for a period of twelve (12) months after the Effective Date of Termination, the Executive shall not: (i) employ or retain or solicit for employment or arrange to have any other person, firm, or other entity employ or retain or solicit for employment or otherwise participate in the employment or retention of any person who is an employee or consultant of CMS Energy Corporation or its Affiliates; or (ii) solicit suppliers or customers of CMS Energy Corporation or its Affiliates or induce any such person to terminate their relationship with them. (d) COOPERATION. Executive agrees to fully and unconditionally cooperate with CMS Energy Corporation and its Affiliates and their attorneys in connection with any and all lawsuits, claims, investigations, or similar proceedings that have been or could be asserted at any time arising out of or related in any way to Executive's employment or activities on behalf of CMS Energy Corporation and its Affiliates. (e) NONDISPARAGEMENT. At all times, the Executive agrees not to disparage CMS Energy Corporation or its Affiliates or otherwise make comments harmful to their reputations. While receiving any payments pursuant to this Agreement, Executive further agrees not to testify or act in any capacity as a paid or unpaid expert witness, advisor or consultant on behalf of any person, individual, partnership, firm, corporation or any other person or entity that has or may have any claim, demand, action, suit, cause of action, or judgment against CMS Energy Corporation or its Affiliates, or from agreeing to do so after the payments under this Agreement have ceased. Further, CMS Energy Corporation and its Affiliates agree not to disparage Executive or otherwise make comments harmful to Executive's reputation. Notwithstanding the foregoing, nothing in this Section prohibits Executive or representatives of CMS Energy Corporation or its Affiliates from testifying truthfully under oath in any judicial, administrative or legislative proceedings or in any arbitration, mediation or other similar proceedings. ARTICLE 6. EXCISE TAX EQUALIZATION PAYMENT 6.1 EXCISE TAX EQUALIZATION PAYMENT. In the event that the Executive becomes entitled to Severance Benefits or any other payment or benefit under this Agreement, or under any other agreement, plan or arrangement for which Executive is eligible with (1) the Employer, (2) any Person whose actions result in a Change in Control, or (3) CMS Energy Corporation or any of its Affiliates (all of such payments and benefits collectively referred to as the "Total Payments"), and if all or any part of the Total Payments will be subject to the tax (the "Excise Tax") imposed by Sections 280G and 4999 of the Code (or any similar tax that may hereafter be imposed), the Employer shall pay to the Executive in cash an additional amount (the "Gross-Up Payment") such that the net amount retained by the Executive after deduction of any Excise Tax upon the Total Payments and any federal, state, and local income tax, penalties, interest, and Excise Tax upon the Gross-Up Payment provided for by this Section 6.1 (including FICA and FUTA), shall be equal to the Total Payments. Such payment shall be made by the Employer to the Executive within forty-five (45) calendar days following the Effective Date of Termination. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made, and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the Effective Date of Termination, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. 6.2 SUBSEQUENT RECALCULATION. In the event the Internal Revenue Service adjusts the computation under Section 6.1 herein so that the Executive did not receive the greatest net benefit, the Employer shall reimburse the Executive for the full amount necessary to make the Executive whole, plus interest on the reimbursed amount at 120% of the rate provided in section 1274(b)(2)(B) of the Code. In the event that the Excise Tax is finally determined to be less than the amount taken into account hereunder in calculating the Gross-Up Payment, the Executive shall repay the Employer within thirty (30) business days following the time that the amount of such reduction in the Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to such reduction (plus that portion of the Gross-Up Payment attributable to the Excise Tax and federal, state and local income and employment taxes imposed on the Gross-Up Payment being repaid by the Executive) to the extent that such repayment results in a reduction in the Excise Tax and a dollar-for-dollar reduction in the Executive's taxable income and wages for purposes of federal, state and local income and employment taxes, plus interest on the amount of such repayment at 120% of the rate provided in section 1274(b)(2)(B) of the Code. ARTICLE 7. DISPUTE RESOLUTION AND NOTICE 7.1 DISPUTE RESOLUTION. Any dispute or controversy between the parties arising under or in connection with this Agreement shall be settled by final and binding arbitration after first being submitted in writing to the Committee for attempted resolution. If that does not result in mutually agreeable resolution, the arbitration proceeding shall be conducted before a single arbitrator selected by the parties to be conducted in Jackson, Michigan. The arbitration will be conducted in accordance with the rules of the American Arbitration Association then in effect and be finished within ninety (90) days after the selection of the arbitrator. The arbitrator shall not have authority to fashion a remedy that includes consequential, exemplary or punitive damages of any type whatsoever, and the arbitrator is hereby prohibited from awarding injunctive relief of any kind, whether mandatory or prohibitory. Judgment may be entered on the award of the arbitrators in any court having competent jurisdiction. The parties shall share equally the cost of the arbitrator and of conducting the arbitration proceeding, but each party shall bear the cost of its own legal counsel and experts and other out-of-pocket expenditures. 7.2 NOTICE. Any notices, requests, demands, or other communications provided for by this Agreement shall be in writing and sent by registered or certified mail to the Executive at the last address he or she has filed in writing with the Employer or, in the case of the Employer, at One Energy Plaza, Jackson, Michigan 49201, Attention: Corporate Secretary. Notices, requests, demands or other communications may also be delivered by messenger, courier service or other electronic means and are sufficient if actually received by the party for whom it is intended. ARTICLE 8. SUCCESSORS AND ASSIGNMENT 8.1 SUCCESSORS. Any successor (whether direct or indirect, by purchase, merger, reorganization, consolidation, acquisition of property or stock, liquidation, or otherwise) to the business of CMS Energy Corporation or purchaser of all or substantially all of the assets of CMS Energy Corporation shall be required to expressly assume and agree to perform under this Agreement in the same manner and to the same extent that the Employer would be required to perform if no such succession had taken place. Failure to obtain such assumption and agreement prior to the effectiveness of any such succession or asset sale shall entitle the Executive to the Change-in-Control Severance Benefits specified in Section 3.2 of this Agreement. The effective date of the succession or the sale shall be deemed the date of delivery to Executive of the Notice of Termination for purposes of administering Section 3.2. Regardless of whether such agreement is executed, this Agreement shall be binding upon any successor in accordance with the operation of law. 8.2 ASSIGNMENT BY THE EXECUTIVE. This Agreement shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees, and legatees. If the Executive dies while any amount would still be payable to him or her hereunder had he or she continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's Beneficiary. If the Executive has not named a Beneficiary, then such amounts shall be paid to the Executive's devisee, legatee, or other designee, or if there is no such designee, to the Executive's estate. ARTICLE 9. MISCELLANEOUS 9.1 EMPLOYMENT STATUS. The employment of the Executive by the Employer is "at will" and may be terminated by either the Executive or the Employer at any time, subject to applicable law. Further, Executive has no right to be an officer of CMS Energy Corporation or any of its Affiliates and serves as an officer entirely at the discretion of the Board. 9.2 ENTIRE AGREEMENT. This Agreement supersedes any prior agreements or understandings, oral or written, between the parties hereto, with respect to the subject matter hereof, and constitutes the entire agreement of the parties with respect thereto. Without limiting the generality of the foregoing sentence, this Agreement completely supersedes, cancels, voids and renders of no further force and effect any and all employment agreements, change in control agreements, and other similar agreements, communications, representations, promises, covenants and arrangements, whether oral or written, between the Employer and Executive and between the Executive and CMS Energy Corporation or any of its Affiliates that may have taken place or been executed prior to the Effective Date of this Agreement and which may address the subject matters contained herein, including but not by way of limitation Employment Agreement between CMS Energy Corporation and Executive dated the 13th day of March, 2000. 9.3 SEVERABILITY. In the event that any provision or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, the remaining provisions of this Agreement shall be unaffected thereby and shall remain in full force and effect. 9.4 TAX WITHHOLDING. The Employer may withhold from any benefits payable under this Agreement any authorized deductions and all federal, state, city, or other taxes as may be required pursuant to any law or governmental regulation or ruling. 9.5 BENEFICIARIES. The Executive may designate one (1) or more persons or entities as the primary and/or contingent beneficiaries of any amounts to be received under this Agreement. Such designation must be in the form of a signed writing on a form provided by the Employer. The Executive may make or change such designation at any time. 9.6 PAYMENT OBLIGATION ABSOLUTE. Except as provided in the last sentence of this paragraph, the Employer's and CMS Energy Corporation's obligations to make the payments and provide the benefits to Executive specified herein shall be absolute and unconditional, and shall not be affected by any circumstances, including, without limitation, any offset, counterclaim, recoupment, defense, or other right which the Employer, CMS Energy Corporation or any of its Affiliates may have against the Executive or anyone else. All amounts payable by the Employer hereunder shall be paid without notice or demand. Each and every payment made hereunder by the Employer shall be final, but subject to the provisions of the next sentence. If the Executive should seek to bypass arbitration and litigate about this Agreement or the subject matters addressed herein in a state or federal court, Executive agrees (i) at least 10 days prior to filing in court to tender back to the Employer all cash consideration paid to Executive under this Agreement prior thereto and (ii) any payments due Executive under this Agreement after said tender shall be suspended until said litigation is finally resolved. The Executive shall not be obligated to seek other employment in mitigation of the amounts payable or arrangements made under any provision of this Agreement, and the obtaining of any such other employment shall in no event effect any reduction of the Employer's obligations to make the payments and arrangements required to be made under this Agreement. 9.7 CONTRACTUAL RIGHTS TO BENEFITS. Subject to approval and ratification by the Committee, this Agreement establishes and vests in the Executive a contractual right to the benefits to which he or she is entitled hereunder. However, nothing herein contained shall require or be deemed to require, or prohibit or be deemed to prohibit, the Employer to segregate, earmark, or otherwise set aside any funds or other assets, in trust or otherwise, to provide for any payments to be made or required hereunder. 9.8 MODIFICATION. This Agreement shall not be varied, altered, modified, canceled, changed, or in any way amended except by mutual agreement of the parties in a written instrument executed by the parties hereto or their legal representatives. 9.9 COUNTERPARTS. This Agreement may be executed in one (1) or more counterparts, each of which shall be deemed to be an original, but all of which together will constitute one and the same Agreement. Signatures transmitted via facsimile shall be regarded by the parties as original signatures. 9.10 APPLICABLE LAW. This Agreement shall be governed and construed in accordance with the laws of the State of Michigan, without regard to its conflicts of laws principles. IN WITNESS WHEREOF, the parties have executed this Agreement as of this day of ________, 2004. EXECUTIVE: By:________________________________ Signature: ____________________________ Its: _____________________________ Printed Name: _________________________ OFFICER SEVERANCE AGREEMENT TIER II CONTENTS - -------------------------------------------------------------------------- Article 1. Establishment, Term, and Purpose 1 Article 2. Definitions 2 Article 3. Severance Benefits 7 Article 4. Other Terminations 13 Article 5. Noncompetition and Confidentiality 13 Article 6. Excise Tax Equalization Payment 15 Article 7. Dispute Resolution and Notice 16 Article 8. Successors and Assignment 17 Article 9. Miscellaneous 18
OFFICER SEVERANCE AGREEMENT THIS OFFICER SEVERANCE AGREEMENT ("Agreement") is made, entered into, and is effective as of _____, 2004 (hereinafter referred to as the "Effective Date"), by and between ________________, a Michigan corporation, (hereinafter referred to as the "Employer") and ____________________________ (hereinafter referred to as the "Officer"). WHEREAS, the Board of Directors of CMS Energy Corporation has approved entering into severance agreements with certain key officers as being necessary and advisable for the success of CMS Energy Corporation; WHEREAS, the Officer is currently employed at ____________________, by the Employer in a key management position as ___________________________; WHEREAS, the Board of Directors of CMS Energy Corporation wants to provide the Officer with a measure of financial security in the event of certain terminations of employment; and WHEREAS, both the Employer and the Officer are desirous that any proposal involving Change in Control as defined in this Agreement will be considered by the Officer objectively and with reference only to the business interests of CMS Energy Corporation and its shareholders. NOW, THEREFORE, in consideration of the foregoing and of the mutual covenants and agreements of the parties set forth in this Agreement and of other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intended to be legally bound, agree as follows: ARTICLE 1. ESTABLISHMENT, TERM, AND PURPOSE This Agreement will commence on the Effective Date and shall continue in effect for two (2) full years through March ____, 2006. However, at the end of such two (2) year period and, if extended, at the end of each additional year thereafter, the term of this Agreement shall be extended automatically for one (1) additional year, unless the Committee delivers written notice six (6) months prior to the end of such term, or extended term, to the Officer, stating that the Agreement will not be extended. In such case, the Agreement will terminate at the end of the term, or extended term, then in progress. However, in the event of a Change in Control (as defined in Section 2.7 herein) of CMS Energy Corporation, the term of this Agreement shall automatically be extended for two (2) years from the date of the Change in Control if the current term of the Agreement has less than two (2) full years remaining until its expiration. If the term of this agreement is not extended, the Employer is not obligated to pay any severance benefits under Section 3.2 for a Change in Control that happens after the expiration of the term and is not obligated to pay any severance benefits under Section 3.3 with respect to any other termination that happens after the expiration of the term. ARTICLE 2. DEFINITIONS Whenever used in this Agreement, the following terms shall have the meanings set forth below and, when the meaning is intended, the initial letter of the word is capitalized. 2.1 "AFFILIATE" shall have the meaning set forth in Rule 12B-2 promulgated under Section 12 of the Exchange Act. 2.2 "BASE SALARY" means the greater of the Officer's full annual rate of salary, whether or not any portion thereof is paid on a deferred basis, at: (i) the Effective Date of Termination, or (ii) at the date of the Change in Control. It does not include any incentive compensation in any form, bonuses of any type or any other form of monetary or nonmonetary compensation other than salary. 2.3 "BENEFICIAL OWNER" shall have the meaning ascribed to such term in Rule 13d-3 of the General Rules and Regulations under the Exchange Act. 2.4 "BENEFICIARY" means the persons or entities designated or deemed designated by the Officer pursuant to Section 9.5 herein. 2.5 "BOARD" means the Board of Directors of CMS Energy Corporation. 2.6 "CAUSE" shall be determined solely by the Committee in the exercise of good faith and reasonable judgment, and shall mean the occurrence of any one or more of the following: (a) The willful and continued failure by the Officer to substantially perform his or her duties of employment (other than any such failure resulting from the Officer's Disability), after a written demand for substantial performance is delivered to the Officer that specifically identifies the manner in which the Committee believes that the Officer has not substantially performed his or her duties, and the Officer has failed to remedy the situation within a reasonable period of time specified by the Committee which shall not be less than 30 days; or (b) The Officer's arrest for committing an act of fraud, embezzlement, theft, or other act constituting a felony involving moral turpitude; or (e) The willful engaging by the Officer in misconduct materially and demonstrably injurious to CMS Energy Corporation or its Affiliates, monetarily or otherwise. However, for purposes of clauses (a) and (c), no act or failure to act on the Officer's part shall be considered "willful" unless done, or omitted to be done, by the Officer not in good faith and without reasonable belief that his or her action or omission was in the best interest of CMS Energy Corporation or its Affiliates. 2.7 "CHANGE IN CONTROL" means a change in control of CMS Energy Corporation, and shall be deemed to have occurred upon the first to occur of any of the following events: (a) Any Person is or becomes the Beneficial Owner, directly or indirectly, of securities of CMS Energy Corporation (not including in the securities beneficially owned by such Person any securities acquired directly from CMS Energy Corporation or its Affiliates) representing twenty-five percent (25%) or more of the combined voting power of CMS Energy Corporation's then outstanding securities, excluding any Person who becomes such a Beneficial Owner in connection with a transaction described in clause (i) of paragraph (c) below; or (b) The following individuals cease for any reason to constitute a majority of directors then serving: individuals who, on the Effective Date, constitute the Board and any new director (other than a director whose initial assumption of office is in connection with an actual or threatened election contest, including but not limited to a consent solicitation, relating to the election of directors of CMS Energy Corporation) whose appointment or election by the Board or nomination for election by CMS Energy Corporation's stockholders was approved or recommended by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors on the Effective Date or whose appointment, election or nomination for election was previously so approved or recommended; or (c) The consummation of a merger or consolidation of CMS Energy Corporation or any direct or indirect subsidiary of CMS Energy Corporation with any other corporation or other entity, other than: (i) any such merger or consolidation which involves either CMS Energy Corporation or any such subsidiary and would result in the voting securities of CMS Energy Corporation outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or any parent thereof), in combination with the ownership of any trustee or other fiduciary holding securities under an employee benefit plan of CMS Energy Corporation or its Affiliates, at least sixty percent (60%) of the combined voting power of the voting securities of CMS Energy Corporation or the surviving entity or any parent thereof outstanding immediately after such merger or consolidation and immediately following which the individuals who comprise the Board immediately prior thereto constitute at least a majority of the board of directors of CMS Energy Corporation, the entity surviving such merger or consolidation or, if CMS Energy Corporation or the entity surviving such merger is then a subsidiary, the ultimate parent thereof; or (ii) a merger or consolidation effected to implement a recapitalization of CMS Energy Corporation (or similar transaction) in which no Person is or becomes the Beneficial Owner, directly or indirectly, of securities of CMS Energy Corporation (not including in the securities beneficially owned by such Person any securities acquired directly from CMS Energy Corporation or its Affiliates) representing twenty-five percent (25%) or more of the combined voting power of CMS Energy Corporation's then outstanding securities; or (d) Either (1) the stockholders of CMS Energy Corporation approve a plan of complete liquidation or dissolution of CMS Energy Corporation, or (2) there is consummated an agreement for the sale, transfer or disposition by CMS Energy Corporation of all or substantially all of CMS Energy Corporation's assets (or any transaction having a similar effect). For purposes of clause (d)(2), (i) the sale, transfer or disposition of a majority of the shares of common stock of Consumers Energy Company shall constitute a sale, transfer or disposition of substantially all of the assets of CMS Energy Corporation and (ii) the sale, transfer or disposition of subsidiaries or affiliates of CMS Energy Corporation, singly or in combinations, or their assets, only qualifies as a Change in Control if it satisfies the substantiality test contained in that clause and the Board of CMS Energy Corporation's determination in that regard is final. In addition, for purposes of clause (d)(2), the sale, transfer or disposition of assets has to be in a transaction or series of transactions closing within six months after the closing of the first transaction in the series, other than with an entity in which at least 60% of the combined voting power of the voting securities is owned by stockholders of CMS Energy Corporation in substantially the same proportions as their ownership of CMS Energy Corporation immediately prior to such transaction or transactions and immediately following which the individuals who comprise the Board immediately prior thereto constitute at least a majority of the board of directors of the entity to which such assets are sold, transferred or disposed or, if such entity is a subsidiary, the ultimate parent thereof. Notwithstanding the foregoing clauses (a), (c) and (d), a "Change in Control" shall not be deemed to have occurred by virtue of the consummation of any transaction or series of integrated transactions closing within six months after the closing of the first transaction in the series immediately following which the record holders of the common stock of CMS Energy Corporation immediately prior to such transaction or series of transactions continue to have substantially the same proportionate ownership in an entity which owns all or substantially all of the assets of CMS Energy Corporation immediately following such transaction or series of transactions. 2.8 "CODE" means the United States Internal Revenue Code of 1986, as amended, and any successors thereto. 2.9 "COMMITTEE" means the Organization and Compensation Committee of the Board of CMS Energy Corporation or any other committee appointed by the Board of CMS Energy Corporation to perform the functions of the Organization and Compensation Committee. 2.10 "DISABILITY" means for all purposes of this Agreement, the incapacity of the Officer, due to injury, illness, disease, or bodily or mental infirmity, which causes the Officer not to engage in the performance of a substantial or material portion of the Officer's usual duties of employment associated with such Officer's position. Such Disability shall be determined based on competent medical advice. 2.11 "EFFECTIVE DATE" means the date of this Agreement as specified in the opening sentence of this Agreement. 2.12 "EFFECTIVE DATE OF TERMINATION" means the date on which a Qualifying Termination occurs, as provided under Section 2.17 hereunder, which triggers the payment of Severance Benefits hereunder. 2.13 "EXCHANGE ACT" means the United States Securities Exchange Act of 1934, as amended. 2.14 "GOOD REASON" exists only on the date of a Change in Control or during the twenty-four (24) months which follow a Change in Control and shall mean, without the Officer's express written consent, the occurrence of any one or more of the following: (a) The assignment to the Officer of duties materially inconsistent with the Officer's position (including status, offices, titles, and reporting requirements), authority, or responsibilities as in effect on the Effective, or any action by the Employer which results in a diminution of the Officer's position, authority, duties, or responsibilities as constituted as of the Effective Date (excluding an isolated, insubstantial, and inadvertent action which is remedied by the Employer promptly after receipt of notice thereof given by the Officer); or (b) Reducing the Officer's Base Salary; or (c) Reducing the Officer's targeted annual incentive opportunity; or (d) Failing to maintain the Officer's participation in a long-term incentive plan in a manner that is consistent with the Officer's position, authority, or responsibilities; or (e) Failing to maintain the Officer's amount of benefits under or relative level of participation in employee benefit or retirement plans, policies, practices, or arrangements of a material nature available to employees of CMS Energy Corporation and its Affiliates and in which the Officer participates as of the Effective Date; or (f) A material breach of this Agreement by the Employer which is not remedied by the Employer within ten (10) business days of receipt of written notice of such breach delivered by the Officer to the Committee; or (g) Any successor company fails or refuses to assume the obligations owed to Officer under this Agreement in their entirety, as required by Section 8.1 hereunder; or (h) The Officer is required to be based at a location in excess of thirty-five (35) miles from the location of the Officer's principal job location or office immediately prior to a Change in Control except for required travel on the Employer's or CMS Energy Corporation's business to an extent substantially consistent with the Officer's prior business travel obligations; or (i) The Officer ceases being an officer of a company (other than by reason of death, Disability or Cause) whose common stock is publicly owned if immediately prior to the Change in Control the Officer was an officer of a company whose common stock was publicly owned. For purposes of applying clauses (a) through (i) of this Agreement, the Officer's Retirement shall not constitute a waiver of the Officer's rights with respect to any circumstance constituting Good Reason, and the Officer's continued employment shall not constitute a waiver of the Officer's rights with respect to any circumstance constituting Good Reason or constitute Officer's consent to the circumstances constituting Good Reason unless Officer has provided express written consent to the circumstance that would otherwise constitute Good Reason under this Agreement. Finally, for purposes of implementing this Agreement, any claim by Officer that Good Reason exists shall be presumed to be correct unless the Committee determines by clear and convincing evidence that Good Reason does not exist, which evidence shall be presented by the person disputing the claim that Good Reason exists. 2.15 "NOTICE OF TERMINATION" shall be provided for a Qualifying Termination and shall mean a written notice which shall indicate the specific termination provision in this Agreement relied upon, and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Officer's employment under the provision so indicated. The notice shall provide a specific date on which a Qualifying Termination has occurred and is effective for purposes of this Agreement. 2.16 "PERSON" shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, including a "group" as provided in Section 13(d). 2.17 "QUALIFYING TERMINATION" MEANS: (a) An involuntary termination of the Officer's employment by the Employer on the date of a Change in Control or during the twenty-four (24) months which follow a Change in Control for reasons other than death, Disability, Retirement, or Cause pursuant to a Notice of Termination delivered to the Officer by the Employer; or (b) A voluntary termination by the Officer for Good Reason on the date of a Change in Control or during the twenty-four (24) months which follow a Change in Control pursuant to a Notice of Termination delivered to the Employer by the Officer. (c) A termination (not involving death, Disability, Retirement or Cause), which takes place before the date of a Change in Control or after the first twenty-four (24) months immediately following a Change in Control, pursuant to a Notice of Termination delivered to Officer or pursuant to a request that Officer submit a resignation as an officer. A termination for failure of the Officer to comply in material respects with CMS Energy's Code of Conduct and Statement of Ethics Handbook (June 2003 edition) or other corporate policies, as the handbook and those documents may be amended from time to time, does not satisfy the definition of a Qualifying Termination under this clause (c). 2.18 "RELEASE DATE" occurs after the delivery of the Notice of Termination required by Section 2.15 and means the date on which the release contained in Exhibit A to this Agreement is first provided to Officer for signature. 2.19 "RETIREMENT" shall have the meanings ascribed under the terms of the pension plan applicable to Officer and entitled "Pension Plan for Employees of Consumers Energy Company," dated September 1, 2000, as amended, other than under Section 7 thereof, or under the successor or replacement of such pension plan if it is then no longer in effect. 2.20 "SERP" shall mean the retirement plan applicable to Officer and entitled "Supplemental Executive Retirement Plan for Employees of CMS Energy/Consumers Energy Company," dated May 1, 1998, as amended, or under the successor or replacement of such retirement plan if it is then no longer in effect. 2.21 "SEVERANCE BENEFITS" means the payment of Change-in-Control Severance Benefits or General Severance Benefits as provided in Article 3 herein. ARTICLE 3. SEVERANCE BENEFITS 3.1 RIGHT TO SEVERANCE BENEFITS. (a) CHANGE-IN-CONTROL SEVERANCE BENEFITS. The Officer shall be entitled to receive from the Employer Change-in-Control Severance Benefits, as described in Section 3.2 herein, if a Qualifying Termination of the Officer's employment satisfying the definitions contained in Section 2.17(a) or (b) has occurred on the date of a Change in Control of CMS Energy Corporation or within twenty-four (24) months immediately following a Change in Control of CMS Energy Corporation. Further, Officer's Retirement under the pension plan and SERP shall not constitute a waiver of the Officer's rights with respect to receipt of Change-in-Control Severance Benefits. Nor shall benefits received for Retirement under the pension plan and SERP (or any replacement or successor plans thereto) be used as an offset to the level of Change-in-Control Severance Benefits owed to Officer. (b) GENERAL SEVERANCE BENEFITS. The Officer shall be entitled to receive from the Employer General Severance Benefits, as described in Section 3.3 herein, if the Officer's employment is terminated for reasons satisfying the definition contained in Section 2.17(c) and such termination has occurred either before a Change of Control of CMS Energy Corporation or during the period that begins after the expiration of twenty-four (24) months immediately following a Change in Control of CMS Energy Corporation. Further, Officer's Retirement under the pension plan and SERP shall not constitute a waiver of the Officer's rights with respect to receipt of General Severance Benefits. Nor shall benefits received for Retirement under the pension plan and SERP (or any replacement or successor plans thereto) be used as an offset to the level of General Severance Benefits owed to Officer. (c) NO SEVERANCE BENEFITS. Other than in a situation involving a Retirement, the Officer shall not be entitled to receive Severance Benefits if the Officer's employment with the Employer ends for reasons other than a Qualifying Termination. (d) GENERAL RELEASE. As a condition precedent to receiving Severance Benefits under Section 3.3 herein, the Officer shall be obligated to execute and deliver to the Employer on a timely basis duplicate originals of a general release of claims in the form included as Exhibit A hereto. (e) WAIVER AND RELEASE. The Officer's act of accepting payment of Severance Benefits payable under Section 3.2 of this Agreement shall constitute and is deemed an express waiver, release and discharge by Officer of any and all claims for damages or other remedies, regardless of when they arose or when they are discovered, against CMS Energy Corporation and its Affiliates arising out of or in any way connected with Officer's employment relationship with them or the termination of such employment relationship except for claims and rights of Officer preserved under Section 3.2 of this Agreement and applicable rights to indemnification. (f) NO DUPLICATION OF SEVERANCE BENEFITS. If the Officer becomes entitled to Change-in-Control Severance Benefits, the benefits provided for under Section 3.2 hereunder shall be in lieu of all other benefits provided to the Officer under the provisions of this Agreement including, but not limited to, the benefits under Section 3.3. Likewise, if the Officer becomes entitled to General Severance Benefits, the benefits provided under Section 3.3 hereunder shall be in lieu of all other benefits provided to the Officer under the provisions of this Agreement including, but not limited to, the benefits under Section 3.2. If the Officer receives either Change-in-Control Severance Benefits under Section 3.2 or General Severance Benefits under Section 3.3, any other severance benefits received by employees not covered by this Agreement to which the Officer is entitled will be subtracted from the Severance Benefits paid pursuant to this Agreement. 3.2 DESCRIPTION OF CHANGE-IN-CONTROL SEVERANCE BENEFITS. In the event the Officer becomes entitled to receive Change-in-Control Severance Benefits, as provided in Section 3.1(a) herein, the Employer shall provide the Officer with the following: (a) A lump-sum amount paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Officer, as applicable, of a Notice of Termination, equal to the sum of the Officer's unpaid Base Salary, accrued vacation pay, unreimbursed business expenses, and unreimbursed allowances owed to the Officer through and including the Effective Date of Termination. (b) A lump-sum amount, paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Officer, as applicable, of a Notice of Termination, equal to one and one half (1.5) times the sum of the following: (A) the Officer's Base Salary and (B) the greater of the Officer's: (i) annual target bonus opportunity in the year in which the Qualifying Termination occurs or (ii) the actual annual bonus payment paid or due to be paid the Officer in respect of the year prior to the year in which the Qualifying Termination occurs. (c) A lump-sum amount, paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Officer, as applicable, of a Notice of Termination, equal to the Officer's then current target bonus opportunity established under the bonus plan in which the Officer is then participating, for the plan year in which the Qualifying Termination occurs, adjusted on a pro rata basis for the number of days that have elapsed to the Effective Date of Termination during the bonus plan year in which the Qualifying Termination occurs. (d) A lump-sum amount, paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Officer, as applicable, of a Notice of Termination, equal to one half (0.5) times the sum of the following: (A) the Officer's Base Salary and (B) the greater of the Officer's: (i) annual target bonus opportunity in the year in which the Qualifying Termination occurs or (ii) the actual annual bonus payment paid or due to be paid the Officer in respect of the year prior to the year in which the Qualifying Termination occurs. Such amount shall be consideration for the Officer entering into the noncompete agreement as described in Section 5(a). (e) Equivalent payment to Officer in a lump sum amount within forty-five (45) calendar days following delivery of the Notice of Termination for continued medical coverage for a period of twenty four (24) months. Such equivalent payment shall be computed based on the same coverage level as in effect for Officer under the general health care plan available to all employees on the Effective Date of Termination by providing a lump sum payment of the Employer's portion of the monthly COBRA premium in effect on the Effective Date of Termination times twenty-four (24). Nothing herein amends or provides Officer any rights to health care coverage other than as provided in the applicable group health care plan. If the Officer has waived coverage under the applicable group health care plan, no equivalent payment shall be made under this Agreement. (f) Immediate extension (as allowable by Section 6.10 of Article VI of the plan entitled "CMS Energy Corporation Performance Incentive Stock Plan," dated December 3, 1999, as amended) by one year after the Effective Date of Termination of the period for Officer to exercise any outstanding stock options or stock appreciation rights granted by the Committee to Officer pursuant to said Article VI. Otherwise, the terms of said plan shall govern and be applied. (g) Immediate vesting and distribution to Officer (as allowable by the second sentence of Section 7.2(h) of Article VII of the plan entitled "CMS Energy Corporation Performance Incentive Stock Plan," dated December 3, 1999, as amended) within forty-five (45) days after delivery of the Notice of Termination of all outstanding shares of restricted stock previously awarded to Officer pursuant to said Article VII. For any award of restricted stock to which there are future performance goals attached, the number of shares distributed to Officer shall assume that the goals have been achieved in full and the award fully earned based on target performance without deductions or additions to the number of shares then held by Officer. For any award of restricted stock that is tenure based, the number of shares distributed to Officer shall assume that all requirements with respect to tenure are satisfied by Officer. Otherwise, the terms of said plan shall govern and be applied. (h) For an Officer included in SERP, the Officer's retirement benefits under the SERP will become fully vested as of the Effective Date of Termination and shall not be subject to further vesting requirements or to any forfeiture provisions. In addition, said Officer shall be provided the following: (i) an additional twenty-four (24) months of Preference Service (as defined in SERP) for purposes of the SERP in accordance with Section III (1) of SERP, subject, however, to the total of Preference Service plus Accredited Service being limited to a maximum of thirty-five (35) years under SERP; (ii) only the amounts paid to Officer pursuant to clauses (a), (b), (c) and (d) of this Section 3.2 shall be considered a "severance payment under an employment agreement" for purposes of computing Final Officer Pay under SERP; and (iii) for an Officer that receives Change-in-Control Severance Benefits under this Agreement within twenty four (24) months prior to attaining the age of 55, Officer shall receive 65% of Officer's Accrued Supplemental Officer Retirement Income under SERP if Officer elects to retire at age 55 notwithstanding the fact that the Effective Date of Termination for Officer pursuant to this Agreement is before he or she attains the age of 55. If it should occur that Officer retires under SERP after the age of 55, clause (iii) of the preceding sentence and the provisions of the last complete paragraph of Section V(3) of SERP shall not be operative. The enhanced SERP benefits under this Section 3.2(h) shall be in lieu of any Change-in-Control enhancements provided for in the SERP. (i) For purposes of (1) Retirement, (2) SERP and (3) benefits not expressly discussed in clauses (a) through (h) of this Section 3.2, but which are available to the general employee population or available only to officers and implemented with contracts with third parties, the benefit plan descriptions covering all employees and the retirement plan and SERP plan descriptions and contracts with third parties covering officers in place at the time of the Effective Date of Termination control Officer's treatment under those plans and contracts. For any other benefits only available to officers, if those benefits are not expressly discussed in clauses (a) through (h) of this Section 3.2, those benefits are terminated for Officer as of the Effective Date of Termination. 3.3 DESCRIPTION OF GENERAL SEVERANCE BENEFITS. In the event the Officer becomes entitled to receive General Severance Benefits as provided in Section 3.1(b) herein, the Employer shall provide the Officer with the following: (a) A lump-sum amount paid within fifteen (15) calendar days following delivery to the Officer of a Notice of Termination with respect to a Qualifying Termination as described in Section 2.17 (c) of this Agreement, equal to the sum of the Officer's unpaid Base Salary, accrued vacation pay, unreimbursed business expenses, and unreimbursed allowances owed to the Officer through and including the Effective Date of Termination. (b) An amount, paid following the Release Date on an installment basis over a period of twelve (12) months on a twice a month schedule in accordance with the normal payroll procedures of the Employer, equal to one (1) times the sum of: (A) the Officer's Base Salary and (B) the greater of the Officer's: (i) annual target bonus opportunity in the year in which the Qualifying Termination occurs or (ii) the actual annual bonus payment paid or due to be paid the Officer in respect of the year prior to the year in which the Qualifying Termination occurs. The first of the twenty-four (24) installment payments called for by this section shall be made within forty-five (45) days following the Release Date. (c) A lump-sum amount, paid within forty-five (45) calendar days following the Release Date, equal to the Officer's then current target bonus opportunity established under the bonus plan in which the Officer is then participating, for the plan year in which the Qualifying Termination occurs, adjusted on a pro rata basis for the number of days that have elapsed to the Effective Date of Termination during the bonus plan year in which the Qualifying Termination occurs. (d) Equivalent payment to Officer in a lump-sum amount within forty-five (45) days following the Release Date for continued medical coverage for a period of twelve (12) months. Such equivalent payment shall be computed based on the same coverage level as in effect for Officer under the general health care plan available to all employees on the Effective Date of Termination by providing a lump-sum payment of the Employer's portion of the monthly COBRA premium in effect on the Effective Date of Termination times twelve (12). Nothing herein amends or provides Officer any rights to health care coverage other than as provided in the applicable group health care plan. If the Officer has waived coverage under the applicable group health care plan, no equivalent payment shall be made under this Agreement. (e) Outstanding stock options and stock appreciation rights previously granted by the Committee to Officer pursuant to Article VI of the plan entitled "CMS Energy Corporation Performance Incentive Stock Plan," dated December 3, 1999, as amended, shall be treated as a "termination of employment" in accordance with Section 6.10 of Article VI, provided however that Employee will not be eligible to seek or receive from the Committee any extensions of the period for their exercise. For outstanding shares of restricted stock held by Officer, they shall be forfeited to CMS Energy Corporation in accordance with the provisions of the first sentence of Section 7.2(h) of Article VII of said plan.) For purposes of (1) Retirement, (2) SERP and (3) benefits not expressly discussed in clauses (a) through (d) of this Section 3.3, but which are available to the general employee population or available only to officers and implemented with contracts with third parties, the benefit plan descriptions covering all employees and the retirement plan and SERP plan descriptions and contracts with third parties covering officers in place at the time of the Effective Date of Termination control Officer's treatment under those plans and contracts. For any other benefits only available to officers, if those benefits are not expressly discussed in clauses (a) through (d) of this Section 3.3, those benefits are terminated for Officer as of the Effective Date of Termination. ARTICLE 4. OTHER TERMINATIONS 4.1 TERMINATION FOR DISABILITY. If the Officer's employment is terminated with the Employer due to Disability, the Officer's benefits shall be determined in accordance with the Employer's retirement, insurance, and other applicable plans and programs then in effect. 4.2 TERMINATION FOR RETIREMENT OR DEATH. If the Officer's employment with the Employer is terminated by reason of his or her Retirement or death, the Officer's benefits shall be determined in accordance with the Employer's retirement and SERP plans, survivor's benefits, insurance, and other applicable programs then in effect. 4.3 TERMINATION FOR CAUSE OR BY EMPLOYER OR THE OFFICER FOR OTHER THAN GOOD REASON. If the Officer's employment is terminated either: (a) by the Employer for Cause as defined in Section 2.6 of this Agreement; or (b) voluntarily by the Officer for reasons other than those specified in Section 2.14 herein, or (c) by the Employer for the reasons stated in the last sentence of Section 2.17(c) of this Agreement, the Employer shall pay the Officer the sum of any unpaid Base Salary, accrued vacation, unreimbursed business expenses and unreimbursed allowances owed to the Officer through the effective date of termination. The terms of the benefit plan descriptions, compensation plan descriptions and contracts with third parties covering officers shall control the disposition to Officer and timing of all other amounts to which the Officer may be entitled, and neither the Employer nor CMS Energy Corporation nor any of its Affiliates shall have any further obligations to the Officer thereunder as a result of the existence of this Agreement. No other severance benefits of any type shall be made available to Officer. Notwithstanding the above, if the Officer's employment terminates pursuant to this Section 4.3, the Officer shall be bound by the provisions contained in Article 5(a), 5(b), 5(c), 5(d), and 5(e) hereof. 4.4 NOTICE OF TERMINATION. Any termination of the Officer's employment in accordance with Section 4.3 of this Agreement shall be communicated by Notice of Termination delivered to the other party, which shall include a specific date on which the termination has occurred and is effective. ARTICLE 5. NONCOMPETITION AND CONFIDENTIALITY In the event the Officer becomes entitled to receive Change-in-Control Severance Benefits as provided in Section 3.2 herein or General Severance Benefits as provided in Section 3.3 herein, the following shall apply: (a) NONCOMPETITION. During the term of employment and for a period of twelve (12) months after the Effective Date of Termination, the Officer shall not: (i) directly or indirectly act in concert or conspire with any person employed by CMS Energy Corporation or any of its Affiliates in order to engage in or prepare to engage in or to have a financial or other interest in any business which is a Direct Competitor (as defined below); or (ii) serve as an employee, agent, partner, shareholder, director or consultant for, or in any other capacity participate, engage, or have a financial or other interest in any business which is a Direct Competitor (provided, however, that notwithstanding anything to the contrary contained in this Agreement, the Officer may own up to two percent (2%) of the outstanding shares of the capital stock of a company whose securities are registered under Section 12 of the Exchange Act. For purposes of this Agreement, the term "Direct Competitor" shall mean any person or entity engaged in the business of selling electric power or natural gas at retail within the State of Michigan. The Committee also reserves the right to designate, prior to the termination date specified in a Notice of Termination, any Person that it believes, in good faith, is a significant competitive threat to CMS Energy Corporation or its Affiliates. (b) CONFIDENTIALITY. The Employer has advised the Officer and the Officer acknowledges that it is the policy of CMS Energy Corporation and its Affiliates to maintain as secret and confidential all Protected Information (as defined below), and that Protected Information has been and will be developed at substantial cost and effort to CMS Energy Corporation and its Affiliates. The Officer shall not at any time, directly or indirectly, divulge, furnish, or make accessible to any person, firm, corporation, association, or other entity (other than as may be required in the regular course of the Officer's employment), nor use in any manner, either during the term of employment or after termination, for any reason, any Protected Information, or cause any such information of CMS Energy Corporation and its Affiliates to enter the public domain. For purposes of this Agreement, "Protected Information" means trade secrets, confidential and proprietary business information of CMS Energy Corporation and its Affiliates and any other information of CMS Energy Corporation and its Affiliates, including, but not limited to, customer lists (including potential customers), sources of supply, processes, plans, materials, pricing information, internal memoranda, marketing plans, internal policies, and products and services which may be developed from time to time by CMS Energy Corporation and its Affiliates and their agents or employees, including the Officer; provided, however, that information that is in the public domain (other than as a result of a breach of this Agreement), approved for release by CMS Energy Corporation or its Affiliates or lawfully obtained from third parties who are not bound by a confidentiality agreement with CMS Energy Corporation or its Affiliates, is not Protected Information. Notwithstanding the foregoing, nothing in this subsection is to be construed as prohibiting Officer from freely providing information to a state or federal agency, legislative body or one of its committees or a court with jurisdiction when Officer is requested or required to do so by such entity. (c) NONSOLICITATION. During the term of employment and for a period of twelve (12) months after the Effective Date of Termination, the Officer shall not: (i) employ or retain or solicit for employment or arrange to have any other person, firm, or other entity employ or retain or solicit for employment or otherwise participate in the employment or retention of any person who is an employee or consultant of CMS Energy Corporation or its Affiliates; or (ii) solicit suppliers or customers of CMS Energy Corporation or its Affiliates or induce any such person to terminate their relationship with them. (d) COOPERATION. Officer agrees to fully and unconditionally cooperate with CMS Energy Corporation and its Affiliates and their attorneys in connection with any and all lawsuits, claims, investigations, or similar proceedings that have been or could be asserted at any time arising out of or related in any way to Officer's employment or activities on behalf of CMS Energy Corporation and its Affiliates. (e) NONDISPARAGEMENT. At all times, the Officer agrees not to disparage CMS Energy Corporation or its Affiliates or otherwise make comments harmful to their reputations. While receiving any payments pursuant to this Agreement, Officer further agrees not to testify or act in any capacity as a paid or unpaid expert witness, advisor or consultant on behalf of any person, individual, partnership, firm, corporation or any other person or entity that has or may have any claim, demand, action, suit, cause of action, or judgment against CMS Energy Corporation or its Affiliates, or from agreeing to do so after the payments under this Agreement have ceased. Further, CMS Energy Corporation and its Affiliates agree not to disparage Officer or otherwise make comments harmful to Officer's reputation. Notwithstanding the foregoing, nothing in this Section prohibits Officer or representatives of CMS Energy Corporation or its Affiliates from testifying truthfully under oath in any judicial, administrative or legislative proceedings or in any arbitration, mediation or other similar proceedings. ARTICLE 6. EXCISE TAX EQUALIZATION PAYMENT 6.1 EXCISE TAX EQUALIZATION PAYMENT. In the event that the Officer becomes entitled to Severance Benefits or any other payment or benefit under this Agreement, or under any other agreement, plan or arrangement for which Officer is eligible with (1) the Employer, (2) any Person whose actions result in a Change in Control, or (3) CMS Energy Corporation or any of its Affiliates (all of such payments and benefits collectively referred to as the "Total Payments"), and if all or any part of the Total Payments will be subject to the tax (the "Excise Tax") imposed by Sections 280G and 4999 of the Code (or any similar tax that may hereafter be imposed), the Employer shall pay to the Officer in cash an additional amount (the "Gross-Up Payment") such that the net amount retained by the Officer after deduction of any Excise Tax upon the Total Payments and any federal, state, and local income tax, penalties, interest, and Excise Tax upon the Gross-Up Payment provided for by this Section 6.1 (including FICA and FUTA), shall be equal to the Total Payments. Such payment shall be made by the Employer to the Officer within forty-five (45) calendar days following the Effective Date of Termination. For purposes of determining the amount of the Gross-Up Payment, the Officer shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made, and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Officer's residence on the Effective Date of Termination, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. 6.2 SUBSEQUENT RECALCULATION. In the event the Internal Revenue Service adjusts the computation under Section 6.1 herein so that the Officer did not receive the greatest net benefit, the Employer shall reimburse the Officer for the full amount necessary to make the Officer whole, plus interest on the reimbursed amount at 120% of the rate provided in section 1274(b)(2)(B) of the Code. In the event that the Excise Tax is finally determined to be less than the amount taken into account hereunder in calculating the Gross-Up Payment, the Officer shall repay the Employer within thirty (30) business days following the time that the amount of such reduction in the Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to such reduction (plus that portion of the Gross-Up Payment attributable to the Excise Tax and federal, state and local income and employment taxes imposed on the Gross-Up Payment being repaid by the Officer) to the extent that such repayment results in a reduction in the Excise Tax and a dollar-for-dollar reduction in the Officer's taxable income and wages for purposes of federal, state and local income and employment taxes, plus interest on the amount of such repayment at 120% of the rate provided in section 1274(b)(2)(B) of the Code. ARTICLE 7. DISPUTE RESOLUTION AND NOTICE 7.1 DISPUTE RESOLUTION. Any dispute or controversy between the parties arising under or in connection with this Agreement shall be settled by final and binding arbitration after first being submitted in writing to the Committee for attempted resolution. If that does not result in mutually agreeable resolution, the arbitration proceeding shall be conducted before a single arbitrator selected by the parties to be conducted in Jackson, Michigan. The arbitration will be conducted in accordance with the rules of the American Arbitration Association then in effect and be finished within ninety (90) days after the selection of the arbitrator. The arbitrator shall not have authority to fashion a remedy that includes consequential, exemplary or punitive damages of any type whatsoever, and the arbitrator is hereby prohibited from awarding injunctive relief of any kind, whether mandatory or prohibitory. Judgment may be entered on the award of the arbitrators in any court having competent jurisdiction. The parties shall share equally the cost of the arbitrator and of conducting the arbitration proceeding, but each party shall bear the cost of its own legal counsel and experts and other out-of-pocket expenditures. 7.2 NOTICE. Any notices, requests, demands, or other communications provided for by this Agreement shall be in writing and sent by registered or certified mail to the Officer at the last address he or she has filed in writing with the Employer or, in the case of the Employer, at One Energy Plaza, Jackson, Michigan 49201, Attention: Corporate Secretary. Notices, requests, demands or other communications may also be delivered by messenger, courier service or other electronic means and are sufficient if actually received by the party for whom it is intended. ARTICLE 8. SUCCESSORS AND ASSIGNMENT 8.1 SUCCESSORS. Any successor (whether direct or indirect, by purchase, merger, reorganization, consolidation, acquisition of property or stock, liquidation, or otherwise) to the business of CMS Energy Corporation or purchaser of all or substantially all of the assets of CMS Energy Corporation shall be required to expressly assume and agree to perform under this Agreement in the same manner and to the same extent that the Employer would be required to perform if no such succession had taken place. Failure to obtain such assumption and agreement prior to the effectiveness of any such succession or asset sale shall entitle the Officer to the Change-in-Control Severance Benefits specified in Section 3.2 of this Agreement. The effective date of the succession or the sale shall be deemed the date of delivery to Officer of the Notice of Termination for purposes of administering Section 3.2. Regardless of whether such agreement is executed, this Agreement shall be binding upon any successor in accordance with the operation of law. 8.2 ASSIGNMENT BY THE OFFICER. This Agreement shall inure to the benefit of and be enforceable by the Officer's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees, and legatees. If the Officer dies while any amount would still be payable to him or her hereunder had he or she continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Officer's Beneficiary. If the Officer has not named a Beneficiary, then such amounts shall be paid to the Officer's devisee, legatee, or other designee, or if there is no such designee, to the Officer's estate. ARTICLE 9. MISCELLANEOUS 9.1 EMPLOYMENT STATUS. The employment of the Officer by the Employer is "at will" and may be terminated by either the Officer or the Employer at any time, subject to applicable law. Further, Officer has no right to be an officer of CMS Energy Corporation or any of its Affiliates and serves as an officer entirely at the discretion of the Board. 9.2 ENTIRE AGREEMENT. This Agreement supersedes any prior agreements or understandings, oral or written, between the parties hereto, with respect to the subject matter hereof, and constitutes the entire agreement of the parties with respect thereto. Without limiting the generality of the foregoing sentence, this Agreement completely supersedes, cancels, voids and renders of no further force and effect any and all employment agreements, change in control agreements, and other similar agreements, communications, representations, promises, covenants and arrangements, whether oral or written, between the Employer and Officer and between the Officer and CMS Energy Corporation or any of its Affiliates that may have taken place or been executed prior to the Effective Date of this Agreement and which may address the subject matters contained herein. 9.3 SEVERABILITY. In the event that any provision or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, the remaining provisions of this Agreement shall be unaffected thereby and shall remain in full force and effect. 9.4 TAX WITHHOLDING. The Employer may withhold from any benefits payable under this Agreement any authorized deductions and all federal, state, city, or other taxes as may be required pursuant to any law or governmental regulation or ruling. 9.5 BENEFICIARIES. The Officer may designate one (1) or more persons or entities as the primary and/or contingent beneficiaries of any amounts to be received under this Agreement. Such designation must be in the form of a signed writing on a form provided by the Employer. The Officer may make or change such designation at any time. 9.6 PAYMENT OBLIGATION ABSOLUTE. Except as provided in the last sentence of this paragraph, the Employer's and CMS Energy Corporation's obligations to make the payments and provide the benefits to Officer specified herein shall be absolute and unconditional, and shall not be affected by any circumstances, including, without limitation, any offset, counterclaim, recoupment, defense, or other right which the Employer, CMS Energy Corporation or any of its Affiliates may have against the Officer or anyone else. All amounts payable by the Employer hereunder shall be paid without notice or demand. Each and every payment made hereunder by the Employer shall be final, but subject to the provisions of the next sentence. If the Officer should seek to bypass arbitration and litigate about this Agreement or the subject matters addressed herein in a state or federal court, Officer agrees (i) at least 10 days prior to filing in court to tender back to the Employer all cash consideration paid to Officer under this Agreement prior thereto and (ii) any payments due Officer under this Agreement after said tender shall be suspended until said litigation is finally resolved. The Officer shall not be obligated to seek other employment in mitigation of the amounts payable or arrangements made under any provision of this Agreement, and the obtaining of any such other employment shall in no event effect any reduction of the Employer's obligations to make the payments and arrangements required to be made under this Agreement. 9.7 CONTRACTUAL RIGHTS TO BENEFITS. Subject to approval and ratification by the Committee, this Agreement establishes and vests in the Officer a contractual right to the benefits to which he or she is entitled hereunder. However, nothing herein contained shall require or be deemed to require, or prohibit or be deemed to prohibit, the Employer to segregate, earmark, or otherwise set aside any funds or other assets, in trust or otherwise, to provide for any payments to be made or required hereunder. 9.8 MODIFICATION. This Agreement shall not be varied, altered, modified, canceled, changed, or in any way amended except by mutual agreement of the parties in a written instrument executed by the parties hereto or their legal representatives. 9.9 COUNTERPARTS. This Agreement may be executed in one (1) or more counterparts, each of which shall be deemed to be an original, but all of which together will constitute one and the same Agreement. Signatures transmitted via facsimile shall be regarded by the parties as original signatures. 9.10 APPLICABLE LAW. This Agreement shall be governed and construed in accordance with the laws of the State of Michigan, without regard to its conflicts of laws principles. IN WITNESS WHEREOF, the parties have executed this Agreement as of this ____day of ___________, 2004. OFFICER: By: ___________________________ Signature: ____________________________ Its: _________________________ Printed Name: ____________________________ CHANGE-IN-CONTROL AGREEMENT TIER III
CONTENTS - ------------------------------------------------------------------------------- Article 1. Establishment, Term, and Purpose 1 Article 2. Definitions 2 Article 3. Severance Benefits 8 Article 4. Other Terminations 11 Article 5. Noncompetition and Confidentiality 11 Article 6. Excise Tax Equalization Payment 13 Article 7. Dispute Resolution and Notice 14 Article 8. Successors and Assignment 14 Article 9. Miscellaneous 15
CHANGE-IN-CONTROL AGREEMENT THIS CHANGE-IN-CONTROL AGREEMENT ("Agreement") is made, entered into, and is effective as of _______ , 2004 (hereinafter referred to as the "Effective Date"), by and between __________, a Michigan corporation, (hereinafter referred to as the "Employer") and _____________________ (hereinafter referred to as the "Executive"). WHEREAS, the Board of Directors of CMS Energy Corporation has approved entering into change-in-control agreements with certain key executives as being necessary and advisable for the success of CMS Energy Corporation; WHEREAS, the Executive is currently employed at _________________, by the Employer in a key management position as Chairman of the Board and Chief Executive Officer; WHEREAS, the Board of Directors of CMS Energy Corporation wants to provide the Executive with a measure of financial security in the event of a change in control of CMS Energy Corporation; and WHEREAS, both the Employer and the Executive are desirous that any proposal involving Change in Control as defined in this Agreement will be considered by the Executive objectively and with reference only to the business interests of CMS Energy Corporation and its shareholders. NOW, THEREFORE, in consideration of the foregoing and of the mutual covenants and agreements of the parties set forth in this Agreement and of other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intended to be legally bound, agree as follows: ARTICLE 1. ESTABLISHMENT, TERM, AND PURPOSE This Agreement will commence on the Effective Date and shall continue in effect for three (3) full years through March ____, 2007. However, at the end of such three (3) year period and, if extended, at the end of each additional year thereafter, the term of this Agreement shall be extended automatically for one (1) additional year, unless the Committee delivers written notice six (6) months prior to the end of such term, or extended term, to the Executive, stating that the Agreement will not be extended. In such case, the Agreement will terminate at the end of the term, or extended term, then in progress. However, in the event of a Change in Control (as defined in Section 2.7 herein) of CMS Energy Corporation, the term of this Agreement shall automatically be extended for two (2) years from the date of the Change in Control if the current term of the Agreement has less than two (2) full years remaining until its expiration. Notwithstanding the foregoing, this Agreement shall automatically terminate and thereafter be of no force and effect at the same time that the First Amended and Restated Employment Agreement, dated as of September 1, 2003, between Executive and CMS Energy Corporation ("Employment Agreement") is terminated pursuant to its Section 6. If the term of this Agreement is not extended or if the Agreement is terminated, the Employer is not obligated to pay any severance benefits under Section 3.2 for a Change in Control that happens after the expiration of the term or after the termination of this Agreement. ARTICLE 2. DEFINITIONS Whenever used in this Agreement, the following terms shall have the meanings set forth below and, when the meaning is intended, the initial letter of the word is capitalized. 2.1 "AFFILIATE" shall have the meaning set forth in Rule 12B-2 promulgated under Section 12 of the Exchange Act. 2.2 "BASE SALARY" means the greater of the Executive's full annual rate of salary, whether or not any portion thereof is paid on a deferred basis, at: (i) the Effective Date of Termination, or (ii) at the date of the Change in Control. It does not include any incentive compensation in any form, bonuses of any type or any other form of monetary or nonmonetary compensation other than salary. 2.3 "BENEFICIAL OWNER" shall have the meaning ascribed to such term in Rule 13d-3 of the General Rules and Regulations under the Exchange Act. 2.4 "BENEFICIARY" means the persons or entities designated or deemed designated by the Executive pursuant to Section 9.5 herein. 2.5 "BOARD" means the Board of Directors of CMS Energy Corporation. 2.6 "CAUSE" shall be determined solely by the Committee in the exercise of good faith and reasonable judgment, and shall mean the occurrence of any one or more of the following: (a) The willful and continued failure by the Executive to substantially perform his or her duties of employment (other than any such failure resulting from the Executive's Disability), after a written demand for substantial performance is delivered to the Executive that specifically identifies the manner in which the Committee believes that the Executive has not substantially performed his or her duties, and the Executive has failed to remedy the situation within a reasonable period of time specified by the Committee which shall not be less than 30 days; or (b) The Executive's arrest for committing an act of fraud, embezzlement, theft, or other act constituting a felony involving moral turpitude; or (c) The willful engaging by the Executive in misconduct materially and demonstrably injurious to CMS Energy Corporation or its Affiliates, monetarily or otherwise. However, for purposes of clauses (a) and (c), no act or failure to act on the Executive's part shall be considered "willful" unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that his or her action or omission was in the best interest of CMS Energy Corporation or its Affiliates. 2.7 "CHANGE IN CONTROL" means a change in control of CMS Energy Corporation, and shall be deemed to have occurred upon the first to occur of any of the following events: (a) Any Person is or becomes the Beneficial Owner, directly or indirectly, of securities of CMS Energy Corporation (not including in the securities beneficially owned by such Person any securities acquired directly from CMS Energy Corporation or its Affiliates) representing twenty-five percent (25%) or more of the combined voting power of CMS Energy Corporation's then outstanding securities, excluding any Person who becomes such a Beneficial Owner in connection with a transaction described in clause (i) of paragraph (c) below; or (b) The following individuals cease for any reason to constitute a majority of directors then serving: individuals who, on the Effective Date, constitute the Board and any new director (other than a director whose initial assumption of office is in connection with an actual or threatened election contest, including but not limited to a consent solicitation, relating to the election of directors of CMS Energy Corporation) whose appointment or election by the Board or nomination for election by CMS Energy Corporation's stockholders was approved or recommended by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors on the Effective Date or whose appointment, election or nomination for election was previously so approved or recommended; or (c) The consummation of a merger or consolidation of CMS Energy Corporation or any direct or indirect subsidiary of CMS Energy Corporation with any other corporation or other entity, other than: (i) any such merger or consolidation which involves either CMS Energy Corporation or any such subsidiary and would result in the voting securities of CMS Energy Corporation outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or any parent thereof), in combination with the ownership of any trustee or other fiduciary holding securities under an employee benefit plan of CMS Energy Corporation or its Affiliates, at least sixty percent (60%) of the combined voting power of the voting securities of CMS Energy Corporation or the surviving entity or any parent thereof outstanding immediately after such merger or consolidation and immediately following which the individuals who comprise the Board immediately prior thereto constitute at least a majority of the board of directors of CMS Energy Corporation, the entity surviving such merger or consolidation or, if CMS Energy Corporation or the entity surviving such merger is then a subsidiary, the ultimate parent thereof; or (ii) a merger or consolidation effected to implement a recapitalization of CMS Energy Corporation (or similar transaction) in which no Person is or becomes the Beneficial Owner, directly or indirectly, of securities of CMS Energy Corporation (not including in the securities beneficially owned by such Person any securities acquired directly from CMS Energy Corporation or its Affiliates) representing twenty-five percent (25%) or more of the combined voting power of CMS Energy Corporation's then outstanding securities; or (d) Either (1) the stockholders of CMS Energy Corporation approve a plan of complete liquidation or dissolution of CMS Energy Corporation, or (2) there is consummated an agreement for the sale, transfer or disposition by CMS Energy Corporation of all or substantially all of CMS Energy Corporation's assets (or any transaction having a similar effect). For purposes of clause (d)(2), (i) the sale, transfer or disposition of a majority of the shares of common stock of Consumers Energy Company shall constitute a sale, transfer or disposition of substantially all of the assets of CMS Energy Corporation and (ii) the sale, transfer or disposition of subsidiaries or affiliates of CMS Energy Corporation, singly or in combinations, or their assets, only qualifies as a Change in Control if it satisfies the substantiality test contained in that clause and the Board of CMS Energy Corporation's determination in that regard is final. In addition, for purposes of clause (d)(2), the sale, transfer or disposition of assets has to be in a transaction or series of transactions closing within six months after the closing of the first transaction in the series, other than with an entity in which at least 60% of the combined voting power of the voting securities is owned by stockholders of CMS Energy Corporation in substantially the same proportions as their ownership of CMS Energy Corporation immediately prior to such transaction or transactions and immediately following which the individuals who comprise the Board immediately prior thereto constitute at least a majority of the board of directors of the entity to which such assets are sold, transferred or disposed or, if such entity is a subsidiary, the ultimate parent thereof. Notwithstanding the foregoing clauses (a), (c) and (d), a "Change in Control" shall not be deemed to have occurred by virtue of the consummation of any transaction or series of integrated transactions closing within six months after the closing of the first transaction in the series immediately following which the record holders of the common stock of CMS Energy Corporation immediately prior to such transaction or series of transactions continue to have substantially the same proportionate ownership in an entity which owns all or substantially all of the assets of CMS Energy Corporation immediately following such transaction or series of transactions. 2.8 "CODE" means the United States Internal Revenue Code of 1986, as amended, and any successors thereto. 2.9 "COMMITTEE" means the Organization and Compensation Committee of the Board of CMS Energy Corporation or any other committee appointed by the Board of CMS Energy Corporation to perform the functions of the Organization and Compensation Committee. 2.10 "DISABILITY" means for all purposes of this Agreement, the incapacity of the Executive, due to injury, illness, disease, or bodily or mental infirmity, which causes the Executive not to engage in the performance of a substantial or material portion of the Executive's usual duties of employment associated with such Executive's position. Such Disability shall be determined based on competent medical advice. 2.11 "EFFECTIVE DATE" means the date of this Agreement as specified in the opening sentence of this Agreement. 2.12 "EFFECTIVE DATE OF TERMINATION" means the date on which a Qualifying Termination occurs, as provided under Section 2.17 hereunder, which triggers the payment of Severance Benefits hereunder. 2.13 "EXCHANGE ACT" means the United States Securities Exchange Act of 1934, as amended. 2.14 "GOOD REASON" exists only on the date of a Change in Control or during the twenty-four (24) months which follow a Change in Control and shall mean, without the Executive's express written consent, the occurrence of any one or more of the following: (a) The assignment to the Executive of duties materially inconsistent with the Executive's position (including status, offices, titles, and reporting requirements), authority, or responsibilities as in effect on the Effective Date, or any action by the Employer which results in a diminution of the Executive's position, authority, duties, or responsibilities as constituted as of the Effective Date (excluding an isolated, insubstantial, and inadvertent action which is remedied by the Employer promptly after receipt of notice thereof given by the Executive); or (b) Reducing the Executive's Base Salary; or (c) Reducing the Executive's targeted annual incentive opportunity; or (d) Failing to maintain the Executive's participation in a long-term incentive plan in a manner that is consistent with the Executive's position, authority, or responsibilities; or (e) Failing to maintain the Executive's amount of benefits under or relative level of participation in employee benefit or retirement plans, policies, practices, or arrangements of a material nature available to employees of CMS Energy Corporation and its Affiliates and in which the Executive participates as of the Effective Date; or (f) A material breach of this Agreement by the Employer which is not remedied by the Employer within ten (10) business days of receipt of written notice of such breach delivered by the Executive to the Committee; or (g) Any successor company fails or refuses to assume the obligations owed to Executive under this Agreement in their entirety, as required by Section 8.1 hereunder; or (h) The Executive is required to be based at a location in excess of thirty-five (35) miles from the location of the Executive's principal job location or office immediately prior to a Change in Control except for required travel on the Employer's or CMS Energy Corporation's business to an extent substantially consistent with the Executive's prior business travel obligations; or (i) The Executive ceases being an executive officer of a company (other than by reason of death, Disability or Cause) whose common stock is publicly owned if immediately prior to the Change in Control the Executive was an executive officer of a company whose common stock was publicly owned. For purposes of applying clauses (a) through (i) of this Agreement, the Executive's Retirement shall not constitute a waiver of the Executive's rights with respect to any circumstance constituting Good Reason, and the Executive's continued employment shall not constitute a waiver of the Executive's rights with respect to any circumstance constituting Good Reason or constitute Executive's consent to the circumstances constituting Good Reason unless Executive has provided express written consent to the circumstance that would otherwise constitute Good Reason under this Agreement. Finally, for purposes of implementing this Agreement, any claim by Executive that Good Reason exists shall be presumed to be correct unless the Committee determines by clear and convincing evidence that Good Reason does not exist, which evidence shall be presented by the person disputing the claim that Good Reason exists. 2.15 "NOTICE OF TERMINATION" shall be provided for a Qualifying Termination and shall mean a written notice which shall indicate the specific termination provision in this Agreement relied upon, and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. The notice shall provide a specific date on which a Qualifying Termination has occurred and is effective for purposes of this Agreement. 2.16 "PERSON" shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, including a "group" as provided in Section 13(d). 2.17 "QUALIFYING TERMINATION" MEANS: (a) An involuntary termination of the Executive's employment by the Employer on the date of a Change in Control or during the twenty-four (24) months which follow a Change in Control for reasons other than death, Disability, Retirement, or Cause pursuant to a Notice of Termination delivered to the Executive by the Employer; or (b) A voluntary termination by the Executive for Good Reason on the date of a Change in Control or during the twenty-four (24) months which follow a Change in Control pursuant to a Notice of Termination delivered to the Employer by the Executive. (c) A termination for failure of the Executive to comply in material respects with CMS Energy's Code of Conduct and Statement of Ethics Handbook (June 2003 edition) or other corporate policies, as the handbook and those documents may be amended from time to time, does not satisfy the definition of a Qualifying Termination under clauses (a) and (b). 2.18 "RETIREMENT" shall have the meanings ascribed under the terms of the pension plan applicable to Executive and entitled "Pension Plan for Employees of Consumers Energy Company," dated September 1, 2000, as amended, other than under Section 7 thereof, or under the successor or replacement of such pension plan if it is then no longer in effect. 2.19 "SERP" shall mean the retirement plan applicable to Executive and entitled "Supplemental Executive Retirement Plan for Employees of CMS Energy/Consumers Energy Company," dated May 1, 1998, as amended, or under the successor or replacement of such retirement plan if it is then no longer in effect. 2.20 "SEVERANCE BENEFITS" means the payment of Change-in-Control Severance Benefits as provided in Article 3 herein. ARTICLE 3. SEVERANCE BENEFITS 3.1 RIGHT TO CHANGE-IN-CONTROL SEVERANCE BENEFITS. (a) CHANGE-IN-CONTROL SEVERANCE BENEFITS. The Executive shall be entitled to receive from the Employer Change-in-Control Severance Benefits, as described in Section 3.2 herein, if a Qualifying Termination of the Executive's employment satisfying the definitions contained in Section 2.17(a) or (b) has occurred on the date of a Change in Control of CMS Energy Corporation or within twenty-four (24) months immediately following a Change in Control of CMS Energy Corporation. Further, Executive's Retirement under the pension plan and SERP shall not constitute a waiver of the Executive's rights with respect to receipt of Change-in-Control Severance Benefits. Nor shall benefits received for Retirement under the pension plan and SERP (or any replacement or successor plans thereto) be used as an offset to the level of Change-in-Control Severance Benefits owed to Executive. (b) NO SEVERANCE BENEFITS. Other than in a situation involving a Retirement, the Executive shall not be entitled to receive Severance Benefits pursuant to this Agreement if the Executive's employment with the Employer ends for reasons other than a Qualifying Termination. (c) WAIVER AND RELEASE. The Executive's act of accepting payment of Severance Benefits payable under Section 3.2 of this Agreement shall constitute and is deemed an express waiver, release and discharge by Executive of any and all claims for damages or other remedies, regardless of when they arose or when they are discovered, against CMS Energy Corporation and its Affiliates arising out of or in any way connected with Executive's employment relationship with them or the termination of such employment relationship except for claims and rights of Executive preserved under Section 3.2 of this Agreement and applicable rights to indemnification. (d) NO DUPLICATION OF SEVERANCE BENEFITS. If the Executive receives Change-in-Control Severance Benefits under Section 3.2, any other severance benefits received by employees not covered by this Agreement to which the Executive is entitled will be subtracted from the Severance Benefits paid pursuant to this Agreement. 3.2 DESCRIPTION OF CHANGE-IN-CONTROL SEVERANCE BENEFITS. In the event the Executive becomes entitled to receive Change-in-Control Severance Benefits, as provided in Section 3.1(a) herein, the Employer shall provide the Executive with the following: (a) A lump-sum amount paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Executive, as applicable, of a Notice of Termination, equal to the sum of the Executive's unpaid Base Salary, accrued vacation pay, unreimbursed business expenses, and unreimbursed allowances owed to the Executive through and including the Effective Date of Termination. (b) A lump-sum amount, paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Executive, as applicable, of a Notice of Termination, equal to two (2) times the sum of the following: (A) the Executive's Base Salary and (B) the greater of the Executive's: (i) annual target bonus opportunity in the year in which the Qualifying Termination occurs or (ii) the actual annual bonus payment paid or due to be paid the Executive in respect of the year prior to the year in which the Qualifying Termination occurs. (c) A lump-sum amount, paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Executive, as applicable, of a Notice of Termination, equal to the Executive's then current target bonus opportunity established under the bonus plan in which the Executive is then participating, for the plan year in which the Qualifying Termination occurs, adjusted on a pro rata basis for the number of days that have elapsed to the Effective Date of Termination during the bonus plan year in which the Qualifying Termination occurs. (d) A lump-sum amount, paid within fifteen (15) calendar days following delivery to the Employer or delivery to the Executive, as applicable, of a Notice of Termination, equal to one (1) times the sum of the following: (A) the Executive's Base Salary and (B) the greater of the Executive's: (i) annual target bonus opportunity in the year in which the Qualifying Termination occurs or (ii) the actual annual bonus payment paid or due to be paid the Executive in respect of the year prior to the year in which the Qualifying Termination occurs. Such amount shall be consideration for the Executive entering into the noncompete agreement as described in Section 5(a). (e) Equivalent payment to Executive in a lump sum amount within forty-five (45) calendar days following delivery of the Notice of Termination for continued medical coverage for a period of thirty-six (36) months. Such equivalent payment shall be computed based on the same coverage level as in effect for Executive under the general health care plan available to all employees on the Effective Date of Termination by providing a lump sum payment of the Employer's portion of the monthly COBRA premium in effect on the Effective Date of Termination times thirty-six (36). Nothing herein amends or provides Executive any rights to health care coverage other than as provided in the applicable group health care plan. If the Executive has waived coverage under the applicable group health care plan, no equivalent payment shall be made under this Agreement. (f) Immediate extension (as allowable by Section 6.10 of Article VI of the plan entitled "CMS Energy Corporation Performance Incentive Stock Plan," dated December 3, 1999, as amended) by one year after the Effective Date of Termination of the period for Executive to exercise any outstanding stock options or stock appreciation rights granted by the Committee to Executive pursuant to said Article VI. Otherwise, the terms of said plan shall govern and be applied. (g) Immediate vesting and distribution to Executive (as allowable by the second sentence of Section 7.2(h) of Article VII of the plan entitled "CMS Energy Corporation Performance Incentive Stock Plan," dated December 3, 1999, as amended) within forty-five (45) days after delivery of the Notice of Termination of all outstanding shares of restricted stock previously awarded to Executive pursuant to said Article VII. For any award of restricted stock to which there are future performance goals attached, the number of shares distributed to Executive shall assume that the goals have been achieved in full and the award fully earned based on target performance without deductions or additions to the number of shares then held by Executive. For any award of restricted stock that is tenure based, the number of shares distributed to Executive shall assume that all requirements with respect to tenure are satisfied by Executive. Otherwise, the terms of said plan shall govern and be applied. (h) For an Executive included in SERP, the Executive's retirement benefits under the SERP will become fully vested as of the Effective Date of Termination and shall not be subject to further vesting requirements or to any forfeiture provisions. In addition, said Executive shall be provided the following: (i) an additional thirty-six (36) months of Preference Service (as defined in SERP) for purposes of the SERP in accordance with Section III(1) of SERP, subject, however, to the total of Preference Service plus Accredited Service being limited to a maximum of thirty-five (35) years under SERP, and (ii) only the amounts paid to Executive pursuant to clauses (a), (b), (c) and (d) of this Section 3.2 shall be considered a "severance payment under an employment agreement" for purposes of computing Final Executive Pay under SERP. Since the Executive is over the age of 55, the provisions of the last complete paragraph of Section V(3) of SERP shall not be operative. The enhanced SERP benefits under this Section 3.2(h) shall be in lieu of any Change-in-Control enhancements provided for in the SERP. (i) For purposes of (1) Retirement, (2) SERP and (3) benefits not expressly discussed in clauses (a) through (h) of this Section 3.2, but which are available to the general employee population or available only to officers and implemented with contracts with third parties, the benefit plan descriptions covering all employees and the retirement plan and SERP plan descriptions and contracts with third parties covering officers in place at the time of the Effective Date of Termination control Executive's treatment under those plans and contracts. For any other benefits only available to officers, if those benefits are not expressly discussed in clauses (a) through (h) of this Section 3.2, those benefits are terminated for Executive as of the Effective Date of Termination. ARTICLE 4. OTHER TERMINATIONS 4.1 TERMINATION FOR RETIREMENT. If the Executive's employment with the Employer is terminated by reason of his Retirement, the Executive's benefits shall be determined in accordance with the Employer's retirement and SERP plans, survivor's benefits, insurance, and other applicable programs then in effect. 4.2 TERMINATION FOR CAUSE UNDER THIS AGREEMENT OR PURSUANT TO SECTION 6 OF THE EMPLOYMENT AGREEMENT OR BY EMPLOYER OR THE EXECUTIVE FOR OTHER THAN GOOD REASON. If the Executive's employment is terminated either: (a) by the Employer for Cause as defined in Section 2.6 of this Agreement; or (b) under the circumstances specified in Section 6 of the Employment Agreement, the Employer shall pay the Executive the compensation provided in Section 7 of the Employment Agreement. The terms of the benefit plan descriptions, compensation plan descriptions and contracts with third parties covering officers shall control the disposition to Executive and timing of all other amounts to which the Executive may be entitled, and neither the Employer nor CMS Energy Corporation nor any of its Affiliates shall have any further obligations to the Executive thereunder as a result of the existence of this Agreement. No other severance benefits of any type shall be made available to Executive. Notwithstanding the above, if the Executive's employment terminates pursuant to this Section 4.2, the Executive shall be bound by the provisions contained in Article 5(a), 5(b), 5(c), 5(d), and 5(e) hereof. 4.3 NOTICE OF TERMINATION. Any termination of the Executive's employment in accordance with Section 4.2 of this Agreement shall be communicated by Notice of Termination delivered to the other party, which shall include a specific date on which the termination has occurred and is effective. ARTICLE 5. NONCOMPETITION AND CONFIDENTIALITY During the term of this Agreement and also in the event the Executive becomes entitled to receive Change-in-Control Severance Benefits as provided in Section 3.2 herein, the following shall apply: (a) SECTION 8 OF THE EMPLOYMENT AGREEMENT. All the provisions of Section 8 of the Employment Agreement shall apply. (b) CONFIDENTIALITY. In addition to the confidentiality provisions contained in Section 8(c) of the Employment Agreement, the Employer has advised the Executive and the Executive acknowledges that it is the policy of CMS Energy Corporation and its Affiliates to maintain as secret and confidential all Protected Information (as defined below), and that Protected Information has been and will be developed at substantial cost and effort to CMS Energy Corporation and its Affiliates. The Executive shall not at any time, directly or indirectly, divulge, furnish, or make accessible to any person, firm, corporation, association, or other entity (other than as may be required in the regular course of the Executive's employment), nor use in any manner, either during the term of employment or after termination, for any reason, any Protected Information, or cause any such information of CMS Energy Corporation and its Affiliates to enter the public domain. For purposes of this Agreement, "Protected Information" means trade secrets, confidential and proprietary business information of CMS Energy Corporation and its Affiliates and any other information of CMS Energy Corporation and its Affiliates, including, but not limited to, customer lists (including potential customers), sources of supply, processes, plans, materials, pricing information, internal memoranda, marketing plans, internal policies, and products and services which may be developed from time to time by CMS Energy Corporation and its Affiliates and their agents or employees, including the Executive; provided, however, that information that is in the public domain (other than as a result of a breach of this Agreement), approved for release by CMS Energy Corporation or its Affiliates or lawfully obtained from third parties who are not bound by a confidentiality agreement with CMS Energy Corporation or its Affiliates, is not Protected Information. Notwithstanding the foregoing, nothing in this subsection is to be construed as prohibiting Executive from freely providing information to a state or federal agency, legislative body or one of its committees or a court with jurisdiction when Executive is requested or required to do so by such entity. (c) COOPERATION. Executive agrees to fully and unconditionally cooperate with CMS Energy Corporation and its Affiliates and their attorneys in connection with any and all lawsuits, claims, investigations, or similar proceedings that have been or could be asserted at any time arising out of or related in any way to Executive's employment or activities on behalf of CMS Energy Corporation and its Affiliates. (d) NONDISPARAGEMENT. At all times, the Executive agrees not to disparage CMS Energy Corporation or its Affiliates or otherwise make comments harmful to their reputations. While receiving any payments pursuant to this Agreement or the Employment Agreement, Executive further agrees not to testify or act in any capacity as a paid or unpaid expert witness, advisor or consultant on behalf of any person, individual, partnership, firm, corporation or any other person or entity that has or may have any claim, demand, action, suit, cause of action, or judgment against CMS Energy Corporation or its Affiliates, or from agreeing to do so after the payments under this Agreement have ceased. Further, CMS Energy Corporation and its Affiliates agree not to disparage Executive or otherwise make comments harmful to Executive's reputation. Notwithstanding the foregoing, nothing in this Section prohibits Executive or representatives of CMS Energy Corporation or its Affiliates from testifying truthfully under oath in any judicial, administrative or legislative proceedings or in any arbitration, mediation or other similar proceedings. ARTICLE 6. EXCISE TAX EQUALIZATION PAYMENT 6.1 EXCISE TAX EQUALIZATION PAYMENT. In the event that the Executive becomes entitled to Severance Benefits or any other payment or benefit under this Agreement, or under the Employment Agreement, or under any other agreement, plan or arrangement for which Executive is eligible with (1) the Employer, (2) any Person whose actions result in a Change in Control, or (3) CMS Energy Corporation or any of its Affiliates (all of such payments and benefits collectively referred to as the "Total Payments"), and if all or any part of the Total Payments will be subject to the tax (the "Excise Tax") imposed by Sections 280G and 4999 of the Code (or any similar tax that may hereafter be imposed), the Employer shall pay to the Executive in cash an additional amount (the "Gross-Up Payment") such that the net amount retained by the Executive after deduction of any Excise Tax upon the Total Payments and any federal, state, and local income tax, penalties, interest, and Excise Tax upon the Gross-Up Payment provided for by this Section 6.1 (including FICA and FUTA), shall be equal to the Total Payments. Such payment shall be made by the Employer to the Executive within forty-five (45) calendar days following the Effective Date of Termination. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made, and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the Effective Date of Termination, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. 6.2 SUBSEQUENT RECALCULATION. In the event the Internal Revenue Service adjusts the computation under Section 6.1 herein so that the Executive did not receive the greatest net benefit, the Employer shall reimburse the Executive for the full amount necessary to make the Executive whole, plus interest on the reimbursed amount at 120% of the rate provided in section 1274(b)(2)(B) of the Code. In the event that the Excise Tax is finally determined to be less than the amount taken into account hereunder in calculating the Gross-Up Payment, the Executive shall repay the Employer within thirty (30) business days following the time that the amount of such reduction in the Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to such reduction (plus that portion of the Gross-Up Payment attributable to the Excise Tax and federal, state and local income and employment taxes imposed on the Gross-Up Payment being repaid by the Executive) to the extent that such repayment results in a reduction in the Excise Tax and a dollar-for-dollar reduction in the Executive's taxable income and wages for purposes of federal, state and local income and employment taxes, plus interest on the amount of such repayment at 120% of the rate provided in section 1274(b)(2)(B) of the Code. ARTICLE 7. DISPUTE RESOLUTION AND NOTICE 7.1 DISPUTE RESOLUTION. Any dispute or controversy between the parties arising under or in connection with this Agreement shall be settled by final and binding arbitration after first being submitted in writing to the Committee for attempted resolution. If that does not result in mutually agreeable resolution, the arbitration proceeding shall be conducted before a single arbitrator selected by the parties to be conducted in Jackson, Michigan. The arbitration will be conducted in accordance with the rules of the American Arbitration Association then in effect and be finished within ninety (90) days after the selection of the arbitrator. The arbitrator shall not have authority to fashion a remedy that includes consequential, exemplary or punitive damages of any type whatsoever, and the arbitrator is hereby prohibited from awarding injunctive relief of any kind, whether mandatory or prohibitory. Judgment may be entered on the award of the arbitrators in any court having competent jurisdiction. The parties shall share equally the cost of the arbitrator and of conducting the arbitration proceeding, but each party shall bear the cost of its own legal counsel and experts and other out-of-pocket expenditures. 7.2 NOTICE. Any notices, requests, demands, or other communications provided for by this Agreement shall be in writing and sent by registered or certified mail to the Executive at the last address he or she has filed in writing with the Employer or, in the case of the Employer, at One Energy Plaza, Jackson, Michigan 49201, Attention: Corporate Secretary. Notices, requests, demands or other communications may also be delivered by messenger, courier service or other electronic means and are sufficient if actually received by the party for whom it is intended. ARTICLE 8. SUCCESSORS AND ASSIGNMENT 8.1 SUCCESSORS. Any successor (whether direct or indirect, by purchase, merger, reorganization, consolidation, acquisition of property or stock, liquidation, or otherwise) to the business of CMS Energy Corporation or purchaser of all or substantially all of the assets of CMS Energy Corporation shall be required to expressly assume and agree to perform under this Agreement in the same manner and to the same extent that the Employer would be required to perform if no such succession had taken place. Failure to obtain such assumption and agreement prior to the effectiveness of any such succession or asset sale shall entitle the Executive to the Change-in-Control Severance Benefits specified in Section 3.2 of this Agreement. The effective date of the succession or the sale shall be deemed the date of delivery to Executive of the Notice of Termination for purposes of administering Section 3.2. Regardless of whether such agreement is executed, this Agreement shall be binding upon any successor in accordance with the operation of law. 8.2 ASSIGNMENT BY THE EXECUTIVE. This Agreement shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees, and legatees. If the Executive dies while any amount would still be payable to him or her hereunder had he or she continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's Beneficiary. If the Executive has not named a Beneficiary, then such amounts shall be paid to the Executive's devisee, legatee, or other designee, or if there is no such designee, to the Executive's estate. ARTICLE 9. MISCELLANEOUS 9.1 EMPLOYMENT STATUS. The employment of the Executive by the Employer is "at will" and may be terminated by either the Executive or the Employer at any time, subject to applicable law. Further, Executive has no right to be an officer of CMS Energy Corporation or any of its Affiliates and serves as an officer entirely at the discretion of the Board. 9.2 ENTIRE AGREEMENT. This Agreement supersedes any prior agreements or understandings, oral or written, between the parties hereto, with respect to the subject matter hereof, and constitutes the entire agreement of the parties with respect thereto. Without limiting the generality of the foregoing sentence, and except for the Employment Agreement which remains in full force and effect unless expressly modified or amended herein, this Agreement completely supersedes, cancels, voids and renders of no further force and effect any and all other employment agreements, change in control agreements, and other similar agreements, communications, representations, promises, covenants and arrangements, whether oral or written, between the Employer and Executive and between the Executive and CMS Energy Corporation or any of its Affiliates that may have taken place or been executed prior to the Effective Date of this Agreement and which may address the subject matters contained herein. Executive expressly agrees that only the first two sentences of Section 9 of the Employment Agreement shall survive the execution of this Agreement and the balance of Section 9 after those first two sentences is superseded in its entirety by this Agreement and no longer has any legal force and effect whatsoever. Executive forever releases the Employer, CMS Energy Corporation, and its affiliates from the duty to comply with the superseded provisions of Section 9. 9.3 SEVERABILITY. In the event that any provision or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, the remaining provisions of this Agreement shall be unaffected thereby and shall remain in full force and effect. 9.4 TAX WITHHOLDING. The Employer may withhold from any benefits payable under this Agreement any authorized deductions and all federal, state, city, or other taxes as may be required pursuant to any law or governmental regulation or ruling. 9.5 BENEFICIARIES. The Executive may designate one (1) or more persons or entities as the primary and/or contingent beneficiaries of any amounts to be received under this Agreement. Such designation must be in the form of a signed writing on a form provided by the Employer. The Executive may make or change such designation at any time. 9.6 PAYMENT OBLIGATION ABSOLUTE. Except as provided in the last sentence of this paragraph, the Employer's and CMS Energy Corporation's obligations to make the payments and provide the benefits to Executive specified herein shall be absolute and unconditional, and shall not be affected by any circumstances, including, without limitation, any offset, counterclaim, recoupment, defense, or other right which the Employer, CMS Energy Corporation or any of its Affiliates may have against the Executive or anyone else. All amounts payable by the Employer hereunder shall be paid without notice or demand. Each and every payment made hereunder by the Employer shall be final, but subject to the provisions of the next sentence. If the Executive should seek to bypass arbitration and litigate about this Agreement or the subject matters addressed herein in a state or federal court, Executive agrees (i) at least 10 days prior to filing in court to tender back to the Employer all cash consideration paid to Executive under this Agreement and the Employment Agreement prior thereto and (ii) any payments due Executive under this Agreement and the Employment Agreement after said tender shall be suspended until said litigation is finally resolved. The Executive shall not be obligated to seek other employment in mitigation of the amounts payable or arrangements made under any provision of this Agreement, and the obtaining of any such other employment shall in no event effect any reduction of the Employer's obligations to make the payments and arrangements required to be made under this Agreement and the Employment Agreement. 9.7 CONTRACTUAL RIGHTS TO BENEFITS. Subject to approval and ratification by the Committee, this Agreement establishes and vests in the Executive a contractual right to the benefits to which he or she is entitled hereunder. However, nothing herein contained shall require or be deemed to require, or prohibit or be deemed to prohibit, the Employer to segregate, earmark, or otherwise set aside any funds or other assets, in trust or otherwise, to provide for any payments to be made or required hereunder. 9.8 MODIFICATION. This Agreement shall not be varied, altered, modified, canceled, changed, or in any way amended except by mutual agreement of the parties in a written instrument executed by the parties hereto or their legal representatives. 9.9 COUNTERPARTS. This Agreement may be executed in one (1) or more counterparts, each of which shall be deemed to be an original, but all of which together will constitute one and the same Agreement. Signatures transmitted via facsimile shall be regarded by the parties as original signatures. 9.10 APPLICABLE LAW. This Agreement shall be governed and construed in accordance with the laws of the State of Michigan, without regard to its conflicts of laws principles. IN WITNESS WHEREOF, the parties have executed this Agreement as of this________ day of _________, 2004. EXECUTIVE: By: ___________________________ Signature: ____________________________ Its: _________________________ Printed Name: ____________________________ EX-31.(A) 4 k87244exv31wxay.txt CMS ENERGY CORPORATION'S CERTIFICATION OF CEO TO SECTION 302 Exhibit (31)(a) CERTIFICATION OF KENNETH WHIPPLE I, Kenneth Whipple, certify that: 1. I have reviewed this quarterly report on Form 10-Q of CMS Energy Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: August 5, 2004 By: /s/ Kenneth Whipple -------------------------------------- Kenneth Whipple Chairman of the Board and Chief Executive Officer EX-31.(B) 5 k87244exv31wxby.txt CMS ENERGY CORPORATION'S CERTIFICATION OF CFO TO SECTION 302 Exhibit (31)(b) CERTIFICATION OF THOMAS J. WEBB I, Thomas J. Webb, certify that: 1. I have reviewed this quarterly report on Form 10-Q of CMS Energy Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: August 5, 2004 By: /s/ Thomas J. Webb -------------------------------------- Thomas J. Webb Executive Vice President and Chief Financial Officer EX-31.(C) 6 k87244exv31wxcy.txt CONSUMERS ENERGY COMPANY'S CERTIFICATION OF CEO TO SECTION 302 Exhibit (31)(c) CERTIFICATION OF KENNETH WHIPPLE I, Kenneth Whipple, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Consumers Energy Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: August 5, 2004 By: /s/ Kenneth Whipple -------------------------------------- Kenneth Whipple Chairman of the Board and Chief Executive Officer EX-31.(D) 7 k87244exv31wxdy.txt CONSUMERS ENERGY COMPANY'S CERTIFICATION OF CFO TO SECTION 302 Exhibit (31)(d) CERTIFICATION OF THOMAS J. WEBB I, Thomas J. Webb, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Consumers Energy Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: August 5, 2004 By: /s/ Thomas J. Webb -------------------------------------- Thomas J. Webb Executive Vice President and Chief Financial Officer EX-32.(A) 8 k87244exv32wxay.txt CMS ENERGY CORPORATION'S CERTIFICATIONS PURSUANT TO SECTION 906 Exhibit (32)(a) CERTIFICATION OF CEO AND CFO PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report on Form 10-Q of CMS Energy Corporation (the "Company") for the quarterly period ended June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Kenneth Whipple, as Chairman of the Board and Chief Executive Officer of the Company, and Thomas J. Webb, as Executive Vice President and Chief Financial Officer of the Company, each hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Kenneth Whipple - --------------------------------------- Name: Kenneth Whipple Title: Chairman of the Board and Chief Executive Officer Date: August 5, 2004 /s/ Thomas J. Webb - --------------------------------------- Name: Thomas J. Webb Title: Executive Vice President and Chief Financial Officer Date: August 5, 2004 EX-32.(B) 9 k87244exv32wxby.txt CONSUMERS ENERGY COMPANY'S CERTIFICATIONS PURSUANT TO SECTION 906 Exhibit (32)(b) CERTIFICATION OF CEO AND CFO PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report on Form 10-Q of Consumers Energy Company (the "Company") for the quarterly period ended June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Kenneth Whipple, as Chairman of the Board and Chief Executive Officer of the Company, and Thomas J. Webb, as Executive Vice President and Chief Financial Officer of the Company, each hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Kenneth Whipple - --------------------------------------- Name: Kenneth Whipple Title: Chairman of the Board and Chief Executive Officer Date: August 5, 2004 /s/ Thomas J. Webb - --------------------------------------- Name: Thomas J. Webb Title: Executive Vice President and Chief Financial Officer Date: August 5, 2004 -----END PRIVACY-ENHANCED MESSAGE-----