-----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, BHMpWQYcGoGaxv717GeVNMn4smEiuqGGYGseedJbrLTwN48BM1IAkOK8wcPu9ma3 ZB7p3ZYa20HE0AL2upBfqA== 0000950124-06-002450.txt : 20060503 0000950124-06-002450.hdr.sgml : 20060503 20060503171252 ACCESSION NUMBER: 0000950124-06-002450 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060503 DATE AS OF CHANGE: 20060503 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: 06804825 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 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: 06804826 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 10-Q 1 k04805e10vq.txt QUARTERLY REPORT FOR PERIOD ENDED MARCH 31, 2006 ================================================================================ 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 MARCH 31, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _________
Commission Registrant; State of Incorporation; IRS Employer File Number Address; and Telephone Number Identification No. - ----------- ------------------------------------------ ------------------ 1-9513 CMS ENERGY CORPORATION 38-2726431 (A Michigan Corporation) One Energy Plaza, Jackson, Michigan 49201 (517) 788-0550 1-5611 CONSUMERS ENERGY COMPANY 38-0442310 (A Michigan Corporation) One Energy Plaza, Jackson, Michigan 49201 (517) 788-0550
Indicate by check mark whether the Registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes |X| No [ ] Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. CMS ENERGY CORPORATION: Large accelerated filer [X] Accelerated filer [ ] Non-Accelerated filer [ ] CONSUMERS ENERGY COMPANY: Large accelerated filer [ ] Accelerated filer [ ] Non-Accelerated filer [X] Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). CMS ENERGY CORPORATION: Yes [ ] No [X] CONSUMERS ENERGY COMPANY: Yes [ ] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock at April 28, 2006: CMS ENERGY CORPORATION: CMS Energy Common Stock, $.01 par value 221,147,846 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 MARCH 31, 2006 This combined Form 10-Q is separately filed by CMS Energy Corporation and Consumers Energy Company. Information contained herein relating to each individual registrant is filed by such registrant on its own behalf. Accordingly, except for its subsidiaries, Consumers Energy Company makes no representation as to information relating to any other companies affiliated with CMS Energy Corporation. TABLE OF CONTENTS
Page -------- Glossary................................................................................................ 3 PART I: FINANCIAL INFORMATION CMS Energy Corporation Management's Discussion and Analysis Executive Overview........................................................................... CMS - 1 Forward-Looking Statements and Risk Factors.................................................. CMS - 2 Results of Operations........................................................................ CMS - 5 Critical Accounting Policies................................................................. CMS - 10 Capital Resources and Liquidity.............................................................. CMS - 14 Outlook...................................................................................... CMS - 16 Implementation of New Accounting Standards................................................... CMS - 23 Consolidated Financial Statements Consolidated Statements of Income ........................................................... CMS - 24 Consolidated Statements of Cash Flows........................................................ CMS - 27 Consolidated Balance Sheets.................................................................. CMS - 28 Consolidated Statements of Common Stockholders' Equity....................................... CMS - 30 Condensed Notes to Consolidated Financial Statements (Unaudited): 1. Corporate Structure and Accounting Policies............................................. CMS - 31 2. Contingencies........................................................................... CMS - 33 3. Financings and Capitalization........................................................... CMS - 48 4. Earnings Per Share...................................................................... CMS - 50 5. Financial and Derivative Instruments.................................................... CMS - 51 6. Retirement Benefits..................................................................... CMS - 57 7. Asset Retirement Obligations............................................................ CMS - 58 8. Executive Incentive Compensation........................................................ CMS - 60 9. Equity Method Investments............................................................... CMS - 62 10. Reportable Segments..................................................................... CMS - 63
1 TABLE OF CONTENTS (CONTINUED)
Page -------- Consumers Energy Company Management's Discussion and Analysis Executive Overview........................................................................... CE - 1 Forward-Looking Statements and Risk Factors.................................................. CE - 2 Results of Operations........................................................................ CE - 4 Critical Accounting Policies................................................................. CE - 8 Capital Resources and Liquidity.............................................................. CE - 11 Outlook...................................................................................... CE - 13 Implementation of New Accounting Standards................................................... CE - 19 Consolidated Financial Statements Consolidated Statements of Income............................................................ CE - 20 Consolidated Statements of Cash Flows........................................................ CE - 21 Consolidated Balance Sheets.................................................................. CE - 22 Consolidated Statements of Common Stockholder's Equity....................................... CE - 24 Condensed Notes to Consolidated Financial Statements (Unaudited): 1. Corporate Structure and Accounting Policies.............................................. CE - 27 2. Contingencies............................................................................ CE - 28 3. Financings and Capitalization............................................................ CE - 39 4. Financial and Derivative Instruments..................................................... CE - 40 5. Retirement Benefits...................................................................... CE - 45 6. Asset Retirement Obligations............................................................. CE - 47 7. Executive Incentive Compensation......................................................... CE - 48 8. Reportable Segments...................................................................... CE - 50 Quantitative and Qualitative Disclosures about Market Risk.............................................. CO - 1 Controls and Procedures................................................................................. CO - 1 PART II: OTHER INFORMATION Item 1. Legal Proceedings...................................................................... CO - 2 Item 1A. Risk Factors............................................................................. CO - 5 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds............................ CO - 7 Item 3. Defaults Upon Senior Securities........................................................ CO - 7 Item 4. Submission of Matters to a Vote of Security Holders.................................... CO - 7 Item 5. Other Information...................................................................... CO - 7 Item 6. Exhibits............................................................................... CO - 7 Signatures........................................................................................ CO - 8
2 GLOSSARY Certain terms used in the text and financial statements are defined below AFUDC.............................. Allowance for Funds Used During Construction ALJ................................ Administrative Law Judge APB................................ Accounting Principles Board APB Opinion No. 18................. APB Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock" ARO................................ Asset retirement obligation Attorney General................... Michigan Attorney General Bay Harbor......................... a residential/commercial real estate area located near Petoskey, Michigan. In 2002, CMS Energy sold its interest in Bay Harbor. bcf................................ One billion cubic feet of gas Big Rock........................... Big Rock Point nuclear power plant, owned by Consumers Board of Directors................. Board of Directors of CMS Energy CEO................................ Chief Executive Officer CFO................................ Chief Financial Officer CFTC............................... Commodity Futures Trading Commission Clean Air Act...................... Federal Clean Air Act, as amended CMS Energy......................... CMS Energy Corporation, the parent of Consumers and Enterprises CMS Energy Common Stock or common stock..................... Common stock of CMS Energy, par value $.01 per share CMS ERM............................ CMS Energy Resource Management Company, formerly CMS MST, a subsidiary of Enterprises CMS Field Services................. CMS Field Services Inc., formerly a wholly owned subsidiary of CMS Gas Transmission. The sale of this subsidiary closed in July 2003. CMS Gas Transmission............... CMS Gas Transmission Company, a subsidiary of Enterprises CMS Generation..................... CMS Generation Co., a subsidiary of Enterprises CMS International Ventures......... CMS International Ventures, LLC, a subsidiary of Enterprises CMS Midland........................ CMS Midland Inc., a subsidiary of Consumers that has a 49 percent ownership interest in the MCV Partnership CMS MST............................ CMS Marketing, Services and Trading Company, a wholly owned subsidiary of Enterprises, whose name was changed to CMS ERM effective January 2004 CMS Oil and Gas.................... CMS Oil and Gas Company, formerly a subsidiary of Enterprises Consumers.......................... Consumers Energy Company, a subsidiary of CMS Energy CPEE............................... Companhia Paulista de Energia Eletrica, a subsidiary of Enterprises
3 Customer Choice Act................ Customer Choice and Electricity Reliability Act, a Michigan statute enacted in June 2000 DCCP............................... Defined Company Contribution Plan Detroit Edison..................... The Detroit Edison Company, a non-affiliated company 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 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 Enterprises........................ CMS Enterprises Company, a subsidiary of CMS Energy EPA................................ U. S. Environmental Protection Agency EPS................................ Earnings per share ERISA.............................. Employee Retirement Income Security Act Exchange Act....................... Securities Exchange Act of 1934, as amended FASB............................... Financial Accounting Standards Board FASB Interpretation No. 46(R)...... Revised FASB Interpretation No. 46, Consolidation of Variable Interest Entities FERC............................... Federal Energy Regulatory Commission FIN 47............................. FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations FMB................................ First Mortgage Bonds FMLP............................... First Midland Limited Partnership, a partnership that holds a lessor interest in the MCV Facility and an indirect subsidiary of Consumers FTR................................ Financial transmission right GAAP............................... Generally Accepted Accounting Principles GasAtacama......................... An integrated natural gas pipeline and electric generating plant located in Argentina and Chile, which includes 702 miles of natural gas pipeline and a 720 MW gross capacity power plant GCR................................ Gas cost recovery GVK................................ GVK Facility, a 250 MW gas fired power plant located in South Central India, in which CMS Generation formerly held a 33 percent interest IRS................................ Internal Revenue Service Jorf Lasfar........................ The 1,356 MW coal-fueled power plant in Morocco, jointly owned by CMS Generation and ABB Energy Ventures, Inc. Jubail............................. A 240 MW natural gas cogeneration power plant located in Saudi Arabia, in which CMS Generation owns a 25 percent interest
4 kWh................................ Kilowatt-hour (a unit of power equal to one thousand watt hours) Ludington.......................... Ludington pumped storage plant, jointly owned by Consumers and Detroit Edison mcf................................ One thousand cubic feet of gas MCV Facility....................... A natural gas-fueled, combined-cycle cogeneration facility operated by the MCV Partnership MCV Partnership.................... Midland Cogeneration Venture Limited Partnership in which Consumers has a 49 percent interest through CMS Midland MCV PPA............................ The Power Purchase Agreement between Consumers and the MCV Partnership with a 35-year term commencing in March 1990, as amended, and as interpreted by the Settlement Agreement dated as of January 1, 1999 between the MCV Partnership and Consumers. MD&A............................... Management's Discussion and Analysis MDEQ............................... Michigan Department of Environmental Quality METC............................... Michigan Electric Transmission Company, LLC Midwest Energy Market.............. An energy market developed by the MISO to provide day-ahead and real-time market information and centralized dispatch for market participants MISO............................... Midwest Independent Transmission System Operator, Inc. MPSC............................... Michigan Public Service Commission MW................................. Megawatt (a unit of power equal to one million watts) NEIL............................... Nuclear Electric Insurance Limited, an industry mutual insurance company owned by member utility companies Neyveli............................ CMS Generation Neyveli Ltd, a 250 MW lignite-fired power station located in Neyveli, Tamil Nadu, India, in which CMS International Ventures holds a 50 percent interest NMC................................ Nuclear Management Company, LLC, formed in 1999 by Northern States Power Company (now Xcel Energy Inc.), Alliant Energy, Wisconsin Electric Power Company, and Wisconsin Public Service Company to operate and manage nuclear generating facilities owned by the four utilities NOL................................ Net Operating Loss NRC................................ Nuclear Regulatory Commission NYMEX.............................. New York Mercantile Exchange OPEB............................... Postretirement benefit plans other than pensions for retired employees Palisades.......................... Palisades nuclear power plant, which is owned by Consumers
5 Panhandle.......................... Panhandle Eastern Pipe Line Company, including its subsidiaries Trunkline, Pan Gas Storage, Panhandle Storage, and Panhandle Holdings. Panhandle was a wholly owned subsidiary of CMS Gas Transmission. The sale of this subsidiary closed in June 2003. PCB................................ Polychlorinated biphenyl Pension Plan....................... The trusteed, non-contributory, defined benefit pension plan of Panhandle, Consumers and CMS Energy PJM RTO............................ Pennsylvania-Jersey-Maryland Regional Transmission Organization Price-Anderson Act................. Price Anderson Act, enacted in 1957 as an amendment to the Atomic Energy Act of 1954, as revised and extended over the years. This act stipulates between nuclear licensees and the U.S. government the insurance, financial responsibility, and legal liability for nuclear accidents. PSCR............................... Power supply cost recovery PURPA.............................. Public Utility Regulatory Policies Act of 1978 RCP................................ Resource Conservation Plan ROA................................ Retail Open Access RRP................................ Renewable Resources Program SAB No. 107........................ Staff Accounting Bulletin No. 107, Share-Based Payment SEC................................ U.S. Securities and Exchange Commission Section 10d(4) Regulatory Asset.... Regulatory asset as described in Section 10d(4) of the Customer Choice Act, as amended Securitization..................... A financing method authorized by statute and approved by the MPSC which allows a utility to sell its right to receive a portion of the rate payments received from its customers for the repayment of Securitization bonds issued by a special purpose entity affiliated with such utility SENECA............................. Sistema Electrico del Estado Nueva Esparta C.S., a subsidiary of Enterprises SERP............................... Supplemental Executive Retirement Plan SFAS............................... Statement of Financial Accounting Standards SFAS No. 5......................... SFAS No. 5, "Accounting for Contingencies" SFAS No. 71........................ SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" SFAS No. 87........................ SFAS No. 87, "Employers' Accounting for Pensions" SFAS No. 88........................ SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits" SFAS No. 98........................ SFAS No. 98, "Accounting for Leases" SFAS No. 106....................... SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" SFAS No. 115....................... SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" SFAS No. 123(R).................... SFAS No. 123 (revised 2004), "Share-Based Payment" SFAS No. 132(R).................... SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits" SFAS No. 133....................... SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted" SFAS No. 143....................... SFAS No. 143, "Accounting for Asset Retirement Obligations" Shuweihat.......................... A power and desalination plant of Emirates CMS Power Company, in which CMS Generation holds a 20 percent interest
6 Special Committee.................. A special committee of independent directors, established by CMS Energy's Board of Directors, to investigate matters surrounding round-trip trading Stranded Costs..................... Costs incurred by utilities in order to serve their customers in a regulated monopoly environment, which may not be recoverable in a competitive environment because of customers leaving their systems and ceasing to pay for their costs. These costs could include owned and purchased generation and regulatory assets. Superfund.......................... Comprehensive Environmental Response, Compensation and Liability Act Takoradi........................... A 200 MW open-cycle combustion turbine crude oil power plant located in Ghana, in which CMS Generation owns a 90 percent interest Taweelah........................... Al Taweelah A2, a power and desalination plant of Emirates CMS Power Company, in which CMS Generation holds a 40 percent interest Trunkline.......................... CMS Trunkline Gas Company, LLC, formerly a subsidiary of CMS Panhandle Holdings, LLC
7 (This page intentionally left blank) 8 CMS Energy Corporation CMS ENERGY CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS This MD&A is a consolidated report of CMS Energy and Consumers. The terms "we" and "our" as used in this report refer to CMS Energy and its subsidiaries as a consolidated entity, except where it is clear that such term means only CMS Energy. This MD&A has been prepared in accordance with the instructions to Form 10-Q and Item 303 of Regulation S-K. This MD&A should be read in conjunction with the MD&A contained in CMS Energy's Form 10-K for the year ended December 31, 2005. EXECUTIVE OVERVIEW CMS Energy is an energy company operating primarily in Michigan. We are the parent holding company of Consumers and Enterprises. Consumers is a combination electric and gas utility company serving Michigan's Lower Peninsula. Enterprises, through various subsidiaries and equity investments, is engaged in domestic and international diversified energy businesses including independent power production, electric distribution, and natural gas transmission, storage, and processing. We manage our businesses by the nature of services each provides and operate principally in three business segments: electric utility, gas utility, and enterprises. We earn our revenue and generate cash from operations by providing electric and natural gas utility services, electric power generation, gas distribution, transmission, storage, and processing. Our businesses are affected primarily by: - weather, especially during the traditional heating and cooling seasons, - economic conditions, primarily in Michigan, - regulation and regulatory issues that affect our gas and electric utility operations, - energy commodity prices, - interest rates, and - our debt credit rating. During the past two years, our business strategy has involved improving our balance sheet and maintaining focus on our core strength: utility operations and service. Our primary focus with respect to our non-utility businesses has been to optimize cash flow and further reduce our business risk and leverage through the sale of non-strategic assets, and to improve earnings and cash flow from the businesses we retain. Although most of our asset sales program is complete, we still may sell certain remaining businesses or assets as opportunities arise. We are working to reduce Parent debt. In the first quarter of 2006, we retired $74 million of CMS Energy senior notes. We also have invested $200 million in Consumers and Consumers extinguished, through a legal defeasance, $129 million of 9 percent related party notes. Working capital and cash flow continue to be a challenge for us. Natural gas prices continue to be volatile and much higher than in recent years. Although our natural gas purchases are recoverable from our utility customers, higher priced natural gas stored as inventory requires additional liquidity due to the lag in cost recovery. In addition to causing working capital issues for us, historically high natural gas prices caused the MCV Partnership to reevaluate the economics of operating the MCV Facility and to record an impairment charge in 2005. While we have fully impaired our ownership interest in the MCV Partnership, continued high gas prices could result in an impairment of our ownership interest in the FMLP. CMS-1 CMS Energy Corporation Due to the impairment of the MCV Facility and operating losses from mark-to-market adjustments on derivative instruments, the equity held by Consumers and the minority interest owners in the MCV Partnership has decreased significantly and is now negative. As the MCV Partnership recognizes future losses, we will assume an additional 7 percent of the MCV Partnership's negative equity, which is a portion of the limited partners' negative equity, in addition to our proportionate share. Since projected future gas prices continue to threaten the viability of the MCV Facility, we are evaluating various alternatives in order to develop a new long-term strategy with respect to the MCV Facility. The MCV Partnership is working aggressively to reduce costs, improve operations, and enhance cash flows. Going forward, our strategy will continue to focus on: - managing cash flow issues, - reducing parent company debt, - maintaining and growing earnings, and - positioning us to make investments that complement our strengths. As we execute our strategy, we will need to overcome a sluggish Michigan economy that has been further hampered by recent negative developments in Michigan's automotive industry and limited growth in the non-automotive sectors of our economy. These negative effects will be offset somewhat by the reduction we are experiencing in ROA load in our service territory. At March 31, 2006, alternative electric suppliers were providing 348 MW of generation service to ROA customers. This is 4 percent of our total distribution load and represents a decrease of 61 percent compared to March 31, 2005. It is, however, difficult to predict future ROA customer trends. Finally, successful execution of our strategy will require continuing earnings and cash flow contributions from our Enterprises businesses. FORWARD-LOOKING STATEMENTS AND INFORMATION This Form 10-Q and other written and oral statements that we make contain forward-looking statements as defined in Rule 3b-6 under the Securities Exchange Act of 1934, as amended, Rule 175 under the Securities Act of 1933, as amended, and relevant legal decisions. Our intention with the use of such words as "may," "could," "anticipates," "believes," "estimates," "expects," "intends," "plans," and other similar words is to identify forward-looking statements that involve risk and uncertainty. We designed this discussion of potential risks and uncertainties to highlight important factors that may impact our business and financial outlook. We have no obligation to update or revise forward-looking statements regardless of whether new information, future events, or any other factors affect the information contained in the statements. These forward-looking statements are subject to various factors that could cause our actual results to differ materially from the results anticipated in these statements. Such factors include our inability to predict and/or control: - capital and financial market conditions, including the price of CMS Energy Common Stock, and the effect of such market conditions on the Pension Plan, interest rates, and access to the capital markets, including availability of financing to CMS Energy, Consumers, or any of their affiliates, and the energy industry, - market perception of the energy industry, CMS Energy, Consumers, or any of their affiliates, - credit ratings of CMS Energy, Consumers, or any of their affiliates, CMS-2 CMS Energy Corporation - currency fluctuations, transfer restrictions, and exchange controls, - factors affecting utility and diversified energy operations such as unusual weather conditions, catastrophic weather-related damage, unscheduled generation outages, maintenance or repairs, environmental incidents, or electric transmission or gas pipeline system constraints, - international, national, regional, and local economic, competitive, and regulatory policies, conditions and developments, - adverse regulatory or legal decisions, including those related to environmental laws and regulations, and potential environmental remediation costs associated with such decisions, including but not limited to Bay Harbor, - potentially adverse regulatory treatment and/or regulatory lag concerning a number of significant questions presently before the MPSC including: - recovery of Clean Air Act costs and other environmental and safety-related expenditures, - power supply and natural gas supply costs when oil prices and other fuel prices are rapidly increasing, - timely recognition in rates of additional equity investments in Consumers, - adequate and timely recovery of additional electric and gas rate-based investments, - adequate and timely recovery of higher MISO energy costs, and - recovery of Stranded Costs incurred due to customers choosing alternative energy suppliers, - the impact of adverse natural gas prices on the MCV Partnership and FMLP investments, the impact of losses at FMLP, regulatory decisions that limit recovery capacity and fixed energy payments, and our ability to develop a new long-term strategy with respect to the MCV Facility, - if Consumers is successful in exercising the regulatory out clause of the MCV PPA, the negative impact on the MCV Partnership's financial performance, as well as a triggering of the MCV Partnership's ability to terminate the MCV PPA, and the effects on our ability to purchase capacity to serve our customers and recover the cost of these purchases, - federal regulation of electric sales and transmission of electricity, including periodic re-examination by federal regulators of the market-based sales authorizations in wholesale power markets without price restrictions, - energy markets, including availability of capacity and the timing and extent of changes in commodity prices for oil, coal, natural gas, natural gas liquids, electricity and certain related products due to lower or higher demand, shortages, transportation problems, or other developments, - our ability to collect accounts receivable from our gas customers due to high natural gas prices, - potential for the Midwest Energy Market to develop into an active energy market in the state of Michigan, which may lead us to account for certain electric energy contracts as derivatives, CMS-3 CMS Energy Corporation - the GAAP requirement that we utilize mark-to-market accounting on certain energy commodity contracts and interest rate swaps, which may have, in any given period, a significant positive or negative effect on earnings, which could change dramatically or be eliminated in subsequent periods and could add to earnings volatility, - the effect on our electric utility of the direct and indirect impacts of the continued economic downturn experienced by our automotive and automotive parts manufacturing customers, - potential disruption, expropriation or interruption of facilities or operations due to accidents, war, terrorism, or changing political conditions and the ability to obtain or maintain insurance coverage for such events, - changes in available gas supplies or Argentine government regulations that could restrict natural gas exports to our GasAtacama electric generating plant and the operating and financial effects of the restrictions, - nuclear power plant performance, decommissioning, policies, procedures, incidents, and regulation, including the availability of spent nuclear fuel storage, - technological developments in energy production, delivery, and usage, - achievement of capital expenditure and operating expense goals, - changes in financial or regulatory accounting principles or policies, - changes in tax laws or new IRS interpretations of existing tax laws, - outcome, cost, and other effects of legal and administrative proceedings, settlements, investigations and claims, including particularly claims, damages, and fines resulting from round-trip trading and inaccurate commodity price reporting, including investigations by the DOJ regarding round-trip trading and price reporting, - limitations on our ability to control the development or operation of projects in which our subsidiaries have a minority interest, - disruptions in the normal commercial insurance and surety bond markets that may increase costs or reduce traditional insurance coverage, particularly terrorism and sabotage insurance and performance bonds, - the efficient sale of non-strategic or under-performing domestic or international assets and discontinuation of certain operations, - other business or investment considerations that may be disclosed from time to time in CMS Energy's or Consumers' SEC filings, or in other publicly issued written documents, and - other uncertainties that are difficult to predict, and many of which are beyond our control. For additional information regarding these and other uncertainties, see the "Outlook" section included in this MD&A, Note 2, Contingencies, and Part II, Item 1A. Risk Factors. CMS-4 CMS Energy Corporation RESULTS OF OPERATIONS CMS ENERGY CONSOLIDATED RESULTS OF OPERATIONS
In Millions (except for per share amounts) --------------------------- Three months ended March 31 2006 2005 Change - --------------------------- ------- ------ -------- Net Income (Loss) Available to Common Stockholders $ (27) $ 150 $ (177) Basic Earnings (Loss) Per Share $(0.12) $ 0.77 $ (0.89) Diluted Earnings (Loss) Per Share $(0.12) $ 0.74 $ (0.86) ------ ------ -------- Electric Utility $ 29 $ 33 $ (4) Gas Utility 37 58 (21) Enterprises (Includes MCV Partnership and FMLP interests) (49) 105 (154) Corporate Interest and Other (45) (46) 1 Discontinued Operations 1 - 1 ------ ------ -------- Net Income (Loss) Available to Common Stockholders $ (27) $ 150 $ (177) ====== ====== ========
For the three months ended March 31, 2006, net loss available to common stockholders was $27 million compared to net income of $150 million for 2005. The decrease reflects mark-to-market losses in 2006 on certain long-term gas contracts and associated financial hedges at the MCV Partnership compared to mark-to-market gains in 2005. Further contributing to the decrease were mark-to-market losses at CMS ERM and a reduction in net income from our gas utility primarily due to lower, weather-driven sales. Specific changes to net income (loss) available to common stockholders for the three months ended March 31, 2006 versus 2005 are:
In Millions ----------- - - decrease in earnings from our ownership interest in the MCV Partnership primarily due to a decrease in the fair value of certain long-term gas contracts and financial hedges, $ (125) - - decrease in net income from CMS ERM primarily due to mark-to-market losses recorded in 2006 versus gains recorded in 2005, (24) - - decrease in net income from our gas utility primarily due to a reduction in deliveries resulting from warmer weather in 2006, (21) - - decrease in net income from other Enterprises' subsidiaries due to an increase in operating and maintenance expense and higher interest expense, (5) - - decrease in net income from our electric utility primarily due to increased operating expenses and a reduction in income from the regulatory return on capital expenditures, offset partially by an increase in revenue from an electric rate order, (4) - - decrease in corporate interest and other expenses, and 1 - - gains related to discontinued operations. 1 ------ Total Change $ (177) ======
CMS-5 CMS Energy Corporation ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions ------------------------ March 31 2006 2005 Change - -------- ------ ------ -------- Three months ended $ 29 $ 33 $ (4) Reasons for the change: Electric deliveries $ 59 Power supply costs and related revenue 9 Other operating expenses, other income and non-commodity revenue (59) Regulatory return on capital expenditures (13) Interest charges 1 Income taxes (1) ------- Total change $ (4) =======
ELECTRIC DELIVERIES: Electric deliveries decreased 0.1 billion kWh or 1.6 percent in the first quarter of 2006 versus 2005 primarily due to warmer weather. Despite lower electric deliveries, electric delivery revenue increased primarily due to an electric rate order, increased surcharge revenue, and the return to full-service rates of customers previously using an alternative energy supplier. In December 2005, the MPSC issued an order authorizing an annual rate increase of $86 million for service rendered on and after January 11, 2006. As a result of this order, electric delivery revenues increased $20 million in the first quarter of 2006 versus 2005. Effective January 1, 2006, we started collecting a surcharge that the MPSC authorized under Section 10d(4) of the Customer Choice Act. This surcharge increased electric delivery revenue by $11 million in the first quarter of 2006 versus 2005. In addition, on January 1, 2006, we began recovering customer choice transition costs from our residential customers, thereby increasing electric delivery revenue by another $3 million in 2006 versus 2005. The Customer Choice Act allows all of our electric customers to buy electric generation service from us or from an alternative electric supplier. At March 31, 2006, alternative electric suppliers were providing 348 MW of generation service to ROA customers. This amount represents a decrease of 61 percent compared to March 31, 2005. The return of former ROA customers to full-service rates increased electric revenues $13 million in the first quarter of 2006 versus 2005. POWER SUPPLY COSTS AND RELATED REVENUE: In 2005, power supply costs exceeded power supply revenue due to rate caps for our residential customers. Our inability to recover fully these power supply costs resulted in a $9 million reduction to electric pretax income. Rate caps for our residential customers expired on December 31, 2005. The absence of rate caps allows us to record power supply revenue to offset fully our power supply costs in 2006. OTHER OPERATING EXPENSES, OTHER INCOME AND NON-COMMODITY REVENUE: In the first quarter of 2006, other operating expenses increased $62 million, other income increased $5 million, and non-commodity revenue decreased $2 million versus 2005. CMS-6 CMS Energy Corporation The increase in other operating expenses reflects higher operating and maintenance expense, customer service expense, depreciation and amortization expense, and pension and benefit expense. Operating and maintenance expense increased primarily due to costs related to a planned refueling outage at our Palisades nuclear plant, and higher overhead line maintenance and $7 million of storm restoration costs. Higher customer service expense reflects contributions, which started in January 2006 pursuant to a December 2005 MPSC order, to a fund that provides energy assistance to low-income customers. Depreciation and amortization expense increased due to higher plant in service and greater amortization of certain regulatory assets. Pension and benefit expense reflects changes in actuarial assumptions and the latest collective bargaining agreement between the Utility Workers Union of America and Consumers. The increase in other income is primarily due to the absence, in 2006, of expenses recorded in 2005 associated with the early retirement of debt. The decrease in non-commodity revenue is primarily due to lower revenue from services provided to METC in 2006 versus 2005. REGULATORY RETURN ON CAPITAL EXPENDITURES: The $13 million decrease is due to lower income associated with recording a return on capital expenditures in excess of our depreciation base as allowed by the Customer Choice Act. In December 2005, the MPSC issued an order that authorized us to recover $333 million of Section 10d(4) costs. The order authorized recovery of a lower level of costs versus the level used to record 2005 income. INTEREST CHARGES: In the first quarter of 2006 versus 2005, interest charges decreased due to lower average debt levels and a 13 basis point reduction in the average interest rate. INCOME TAXES: In the first quarter of 2006, income taxes increased versus 2005 primarily due to the adjustment of certain deferred tax balances. GAS UTILITY RESULTS OF OPERATIONS
In Millions ------------------ March 31 2006 2005 Change - -------- ---- ---- ------ Three months ended $ 37 $ 58 $ (21) Reasons for the change: Gas deliveries $ (31) Gas wholesale and retail services, other gas revenue and other income 5 Operation and maintenance (3) Depreciation and other deductions (3) Income taxes 11 ----- Total change $ (21) =====
GAS DELIVERIES: In the first quarter of 2006 versus 2005, gas deliveries, including miscellaneous transportation to end-use customers, decreased 21.9 bcf or 15.1 percent. The decrease in gas deliveries is primarily due to warmer weather in the first quarter of 2006 versus 2005 and increased conservation efforts in response to higher gas prices. Average temperatures in the first quarter of 2006 were 16.7 percent warmer than the same period last year. CMS-7 CMS Energy Corporation GAS WHOLESALE AND RETAIL SERVICES, OTHER GAS REVENUE AND OTHER INCOME: In the first quarter of 2006 versus 2005, the $5 million increase is related primarily to increased gas wholesale and retail services revenue. OPERATION AND MAINTENANCE: In the first quarter of 2006, operation and maintenance expenses increased versus 2005 primarily due to higher pension and benefit expense and customer service expense. Pension and benefit expense reflects changes in actuarial assumptions and the latest collective bargaining agreement between the Utility Workers Union of America and Consumers. Customer service expense increased primarily due to higher uncollectible accounts expense. DEPRECIATION AND OTHER DEDUCTIONS: In the first quarter of 2006, depreciation expense increased versus 2005 primarily due to higher plant in service. INCOME TAXES: In the first quarter of 2006, income taxes decreased versus 2005 primarily due to lower earnings by the gas utility. ENTERPRISES RESULTS OF OPERATIONS
In Millions -------------------------- March 31 2006 2005 Change - -------- ------ ------ -------- Three months ended $ (49) $ 105 $ (154) Reasons for the change: Operating revenues $ 37 Cost of gas and purchased power (102) Fuel costs mark-to-market at MCV (365) Earnings from equity method investees 5 Gain on sale of assets (3) Operation and maintenance (17) General taxes, depreciation, and other income 32 Fixed charges (11) Minority interest 181 Income taxes 89 ------- Total change $ (154) =======
OPERATING REVENUES: For the three months ended March 31, 2006, operating revenues increased primarily due to the impact of increased customer demand on deliveries and increased third-party gas sales. These increases were offset partially by mark-to-market losses on gas contracts at CMS ERM. COST OF GAS AND PURCHASED POWER: For the three months ended March 31, 2006, the cost of gas and purchased power decreased operating earnings. The decrease is due to higher gas prices and an increase in fuel purchases in order to meet customer demand. CMS-8 CMS Energy Corporation FUEL COSTS MARK-TO-MARKET AT MCV: For the three months ended March 31, 2006, the fuel costs mark-to-market adjustments of certain long-term gas contracts and financial hedges at the MCV Partnership decreased operating earnings due to slightly decreased gas prices, compared to mark-to-market gains in 2005. The 2005 gains were primarily due to the marking-to-market of certain long term gas contracts and financial hedges at the MCV Partnership that, as a result of the implementation of the RCP, no longer qualified as normal purchases or cash flow hedges. EARNINGS FROM EQUITY METHOD INVESTEES: Equity earnings for the three months ended March 31, 2006 increased by $5 million versus 2005. Contributing to the increase was $4 million from Neyveli, which recorded lower earnings in 2005 due to a penalty on coal purchase commitments and a forced outage, $3 million from GasAtacama due to a renegotiated power contract, and $2 million in earnings and mark-to-market gains at Jubail, which achieved commercial operations in September 2005. These increases were offset by lower earnings at Jorf Lasfar primarily due to a scheduled outage, higher deferred tax expenses, and lower fuel cost recoveries. GAIN ON SALE OF ASSETS: For the three months ended March 31, 2006, there were no gains or losses on asset sales versus a $3 million gain in 2005 from the sale of our interest in GVK in India. OPERATION AND MAINTENANCE: For the three months ended March 31, 2006, operation and maintenance expenses increased versus 2005. The increase in 2006 was primarily due to increased operating costs at CPEE and Takoradi, as well as higher development costs. GENERAL TAXES, DEPRECIATION, AND OTHER INCOME: For the three months ended March 31, 2006, the net of general tax expense, depreciation, and other income increased operating income compared to 2005. This is primarily due to lower depreciation expense at the MCV Partnership resulting from the impairment of property, plant, and equipment and lower accretion expense related to prepaid gas contracts at CMS ERM. FIXED CHARGES: For the three months ended March 31, 2006, fixed charges increased versus 2005 due to higher interest expense resulting from an increase in subsidiary debt and interest rates, offset partially by lower expenses at the MCV Partnership. MINORITY INTEREST: For the three months ended March 31, 2006, minority owners of our subsidiaries shared a portion of the losses at our subsidiaries. The allocation of these losses to minority owners decreased our net loss in 2006. In 2005, minority owners shared in the profits of our subsidiaries and the amount of income attributed to them reduced our net income. The losses in 2006 and gains in 2005 were primarily due to activities at the MCV Partnership. INCOME TAXES: For the three months ended March 31, 2006, income tax expense decreased versus 2005. The decrease was due to lower earnings in 2006, primarily due to mark-to-market losses in 2006 versus gains in 2005. CORPORATE INTEREST AND OTHER RESULTS OF OPERATIONS
In Millions ------------------------ March 31 2006 2005 Change - -------- ------ ------ ------ Three months ended $ (45) $(46) $ 1
For the three months ended March 31, 2006, corporate interest and other net expenses was $45 million, a decrease of $1 million versus 2005. The decrease reflects a reduction in interest expense due to lower debt levels, lower other expenses allocated from the utility and the absence of additional tax expense recorded in CMS-9 CMS Energy Corporation 2005. These decreases were offset partially by premiums paid for the repurchase of a portion of CMS Energy's 9.875 percent senior notes and higher legal fees. DISCONTINUED OPERATIONS: For the three months ended March 31, 2006, net income from Discontinued Operations was $1 million. Income from 2006 primarily reflects the expiration of a tax contingency. There was no income or loss from discontinued operations for the three months ended March 31, 2005. CRITICAL ACCOUNTING POLICIES The following accounting policies are important to an understanding of our results of operations and financial condition and should be considered an integral part of our MD&A. USE OF ESTIMATES AND ASSUMPTIONS In preparing our financial statements, we use estimates and assumptions that may affect reported amounts and disclosures. We use accounting estimates for asset valuations, depreciation, amortization, financial and derivative instruments, employee benefits, and contingencies. For example, we estimate the rate of return on plan assets and the cost of future health-care benefits to determine our annual pension and other postretirement benefit costs. There are risks and uncertainties that may cause actual results to differ from estimated results, such as changes in the regulatory environment, competition, foreign exchange, regulatory decisions, and lawsuits. CONTINGENCIES: We are involved in various regulatory and legal proceedings that arise in the ordinary course of our business. We record a liability for contingencies based upon our assessment that a loss is probable and the amount of loss can be reasonably estimated. The recording of estimated liabilities for contingencies is guided by the principles in SFAS No. 5. We consider many factors in making these assessments, including the history and specifics of each matter. The amount of income taxes we pay is subject to ongoing audits by federal, state, and foreign tax authorities, which can result in proposed assessments. Our estimate for the potential outcome for any uncertain tax issue is highly judgmental. We believe we have provided adequately for any likely outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved or when statutes of limitation on potential assessments expire. As a result, our effective tax rate may fluctuate significantly on a quarterly basis. ACCOUNTING FOR FINANCIAL AND DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES, AND MARKET RISK INFORMATION FINANCIAL INSTRUMENTS: We account for investments in debt and equity securities using SFAS No. 115. For additional details on accounting for financial instruments, see Note 5, Financial and Derivative Instruments. DERIVATIVE INSTRUMENTS: We use the criteria in SFAS No. 133 to determine if certain contracts must be accounted for as derivative instruments. Except as noted within this section, there have been no material changes to the accounting for derivative instruments since the year ended December 31, 2005. For additional details on accounting for derivatives, see Note 5, Financial and Derivative Instruments. CMS-10 CMS Energy Corporation To determine the fair value of our derivatives, we use information from external sources (i.e., quoted market prices and third-party valuations), if available. For certain contracts, this information is not available and we use mathematical valuation models to value our derivatives. These models require various inputs and assumptions, including commodity market prices and volatilities, as well as interest rates and contract maturity dates. Changes in forward prices or volatilities could significantly change the calculated fair value of our derivative contracts. The cash returns we actually realize on these contracts may vary, either positively or negatively, from the results that we estimate using these models. As part of valuing our derivatives at market, we maintain reserves, if necessary, for credit risks arising from the financial condition of counterparties. The following table summarizes the interest rate and volatility rate assumptions we used to value these contracts at March 31, 2006:
Interest Rates (%) Volatility Rates (%) ------------------ -------------------- Long-term gas contracts associated with the MCV Partnership 4.83 - 5.34 28 - 50 Gas-related option contracts 4.70 46 - 47 Electricity-related option contracts 4.70 79 - 119
Establishment of the Midwest Energy Market: In 2005, the MISO began operating the Midwest Energy Market. As a result, the MISO now centrally dispatches electricity and transmission service throughout much of the Midwest and provides day-ahead and real-time energy market information. At this time, we believe that the establishment of this market does not represent the development of an active energy market in Michigan, as defined by SFAS No. 133. However, as the Midwest Energy Market matures, we will continue to monitor its activity level and evaluate whether or not an active energy market may exist in Michigan. If an active market develops in the future, some of our electric purchases and sales contracts may qualify as derivatives. However, we believe that we will be able to apply the normal purchases and sales exception of SFAS No. 133 to these contracts and, therefore, will not be required to mark these contracts to market. Implementation of the RCP: As a result of implementing the RCP in 2005, a significant portion of the MCV Partnership's long-term gas contracts no longer qualify as normal purchases because the gas will not be used to generate electricity or steam. Accordingly, these contracts are accounted for as derivatives, with changes in fair value recorded in earnings each quarter. Additionally, certain of the MCV Partnership's natural gas futures and swap contracts, which are used to hedge variable-priced long-term gas contracts, no longer qualify for cash flow hedge accounting and we record any changes in their fair value in earnings each quarter. As a result of recording the changes in fair value of these long-term gas contracts and the related futures and swaps to earnings, the MCV Partnership has recognized a $156 million loss for the three months ended March 31, 2006. This loss is before consideration of tax effects and minority interest and is included in the total Fuel costs mark-to-market at MCV on our Consolidated Statements of Income (Loss). Because of the volatility of the natural gas market, the MCV Partnership expects future earnings volatility on both its long-term gas contracts and its futures, options, and swap contracts, since gains and losses will be recorded each quarter. We have recorded derivative assets totaling $100 million associated with the fair value of these contracts on our Consolidated Balance Sheets at March 31, 2006. We expect almost all of these assets, which represent cumulative net mark-to-market gains, to reverse as losses through earnings during 2006 and 2007 as the gas is purchased and the futures, options, and swaps settle, with the remainder reversing between 2008 and 2011. Due to the impairment of the MCV Facility and subsequent losses, the value of the equity held by all of the owners of the MCV Partnership has decreased significantly and is now negative. Since we are one of the general partners of the MCV Partnership, we have recognized a portion of the limited partners' negative CMS-11 CMS Energy Corporation equity. As the MCV Partnership recognizes future losses from the reversal of these derivative assets, we will continue to assume a portion of the limited partners' share of those losses, in addition to our proportionate share. CMS ERM CONTRACTS: CMS ERM enters into and owns energy contracts as a part of activities considered to be an integral part of CMS Energy's ongoing operations. There have been no material changes to the accounting for CMS ERM's contracts since the year ended December 31, 2005. We include the fair value of the derivative contracts held by CMS ERM in either Price risk management assets or Price risk management liabilities on our Consolidated Balance Sheets. The following tables provide a summary of these contracts at March 31, 2006:
In Millions ----------------------------- Non- Trading Trading Total ------- ------- ----- Fair value of contracts outstanding at December 31, 2005 $ (63) $ 100 $ 37 Fair value of new contracts when entered into during the period (a) - - - Contracts realized or otherwise settled during the period 6 (13) (7) Other changes in fair value (b) (5) (25) (30) ------- ------- ----- Fair value of contracts outstanding at March 31, 2006 $ (62) $ 62 $ - ======= ======= =====
(a) Reflects only the initial premium payments (receipts) for new contracts. No unrealized gains or losses were recognized at the inception of any new contracts. (b) Reflects changes in price and net increase (decrease) of forward positions as well as changes to present value and credit reserves.
Fair Value of Non-Trading Contracts at March 31, 2006 In Millions - ---------------------------------------------------------------------------------------------------- Maturity (in years) Total ------------------------------------------- Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5 - -------------------- ---------- ----------- ------ ------ -------------- Prices actively quoted $ - $ - $ - $ - $ - Prices obtained from external sources or based on models and other valuation methods (62) (11) (18) (31) (2) ----- ----- ------ ---- ---- Total $ (62) $ (11) $ (18) $(31) $ (2) ===== ===== ====== ==== ====
Fair Value of Trading Contracts at March 31, 2006 In Millions - ---------------------------------------------------------------------------------------------------- Maturity (in years) Total ------------------------------------------- Source of Fair Value Fair Value Less than 1 1 to 3 4 to 5 Greater than 5 - -------------------- ---------- ----------- ------ ------ -------------- Prices actively quoted $ (55) $ (13) $ (42) $ - $ - Prices obtained from external sources or based on models and other valuation methods 117 29 55 31 2 ----- ------ ------ ---- ---- Total $ 62 $ 16 $ 13 $ 31 $ 2 ===== ====== ====== ==== ====
MARKET RISK INFORMATION: The following is an update of our risk sensitivities since December 31, 2005. These sensitivities indicate the potential loss in fair value, cash flows, or future earnings from our financial instruments, including our derivative contracts, assuming a hypothetical adverse change in market rates or prices of 10 percent. Changes in excess of the amounts shown in the sensitivity analyses could occur if changes in market rates or prices exceed the 10 percent shift used for the analyses. CMS-12 CMS Energy Corporation Interest Rate Risk Sensitivity Analysis (assuming an adverse change in market interest rates of 10 percent):
In Millions ---------------------------------- March 31, 2006 December 31, 2005 -------------- ----------------- Variable-rate financing - before-tax annual earnings exposure $ 2 $ 4 Fixed-rate financing - potential REDUCTION in fair value (a) 220 223
(a) Fair value exposure could only be realized if we repurchased all of our fixed-rate financing. Certain equity method investees have entered into interest rate swaps. These instruments are not required to be included in the sensitivity analysis, but can have an impact on financial results. Commodity Price Risk Sensitivity Analysis (assuming an adverse change in market prices of 10 percent):
In Millions ----------------------------------- March 31, 2006 December 31, 2005 -------------- ----------------- Potential REDUCTION in fair value: Non-trading contracts Gas supply option contracts $ - $ 1 CMS ERM gas forward contracts 1 - Derivative contracts associated with the MCV Partnership: Long-term gas contracts 26 39 Gas futures, options, and swaps 41 48 Trading contracts Electricity-related option contracts 1 2 Electricity-related swaps 11 13 Gas-related option contracts 1 1 Gas-related swaps and futures 3 4
Investment Securities Price Risk Sensitivity Analysis (assuming an adverse change in market prices of 10 percent):
In Millions ---------------------------------- March 31, 2006 December 31, 2005 --------------- ----------------- Potential REDUCTION in fair value of available-for-sale equity securities (primarily SERP investments): $ 5 $ 5
Consumers maintains trust funds, as required by the NRC, for the purpose of funding certain costs of nuclear plant decommissioning. At March 31, 2006 and December 31, 2005, these funds were invested primarily in equity securities, fixed-rate, fixed-income debt securities, and cash and cash equivalents, and are recorded at fair value on our Consolidated Balance Sheets. These investments are exposed to price fluctuations in equity markets and changes in interest rates. Because the accounting for nuclear plant decommissioning recognizes that costs are recovered through Consumers' electric rates, fluctuations in equity prices or interest rates do not affect our earnings or cash flows. For additional details on market risk and derivative activities, see Note 5, Financial and Derivative Instruments. CMS-13 CMS Energy Corporation OTHER Other accounting policies important to an understanding of our results of operations and financial condition include: - accounting for long-lived assets and equity method investments, - accounting for the effects of industry regulation, - accounting for pension and OPEB, - accounting for asset retirement obligations, and - accounting for nuclear decommissioning costs. These accounting policies were disclosed in our 2005 Form 10-K and there have been no material changes. CAPITAL RESOURCES AND LIQUIDITY Factors affecting our liquidity and capital requirements are: - results of operations, - capital expenditures, - energy commodity costs, - contractual obligations, - regulatory decisions, - debt maturities, - credit ratings, - working capital needs, and - collateral requirements. During the summer months, we purchase natural gas and store it for resale primarily during the winter heating season. Although our prudent natural gas purchases are recoverable from our customers, the amount paid for natural gas stored as inventory requires additional liquidity due to the timing of the cost recoveries. We have credit agreements with our commodity suppliers and those agreements contain terms that have resulted in margin calls. Additional margin calls or other credit support may be required if agency ratings are lowered or if market conditions remain unfavorable relative to our obligations to those parties. Our current financial plan includes controlling operating expenses and capital expenditures and evaluating market conditions for financing opportunities. Due to the adverse impact of the MCV Partnership asset impairment charge recorded in 2005, Consumers' ability to issue FMB as primary obligations or as collateral for financing is expected to be limited to $298 million through September 30, 2006. After September 30, 2006, Consumers' ability to issue FMB in excess of $298 million is based on achieving a two-times FMB interest coverage ratio. We believe the following items will be sufficient to meet our liquidity needs: - our current level of cash and revolving credit facilities, - our ability to access junior secured and unsecured borrowing capacity in the capital markets, and - our anticipated cash flows from operating and investing activities. We have not made a specific determination concerning the reinstatement of common stock dividends. The Board of Directors may reconsider or revise its dividend policy based upon certain conditions, including our results of operations, financial condition, and capital requirements, as well as other relevant factors. CMS-14 CMS Energy Corporation CASH POSITION, INVESTING, AND FINANCING Our operating, investing, and financing activities meet consolidated cash needs. At March 31, 2006, $824 million consolidated cash was on hand, which includes $66 million of restricted cash and $242 million from entities consolidated pursuant to FASB Interpretation No. 46(R). Our primary ongoing source of cash is dividends and other distributions from our subsidiaries. For the three months ended March 31, 2006, Consumers paid $40 million in common stock dividends to CMS Energy. SUMMARY OF CONSOLIDATED STATEMENTS OF CASH FLOWS:
In Millions --------------- Three months ended March 31 2006 2005 - --------------------------- ----- ----- Net cash provided by (used in): Operating activities $ 173 $ 262 Investing activities (42) (8) ----- ----- Net cash provided by operating and investing activities 131 254 Financing activities (221) 17 Effect of exchange rates on cash 1 - ----- ----- Net Increase (Decrease) in Cash and Cash Equivalents $ (89) $ 271 ===== =====
OPERATING ACTIVITIES: For the three months ended March 31, 2006, net cash provided by operating activities was $173 million, a decrease of $89 million versus 2005. This was due to the timing of payments for higher priced gas used during the heating season and other timing differences. INVESTING ACTIVITIES: For the three months ended March 31, 2006, net cash used in investing activities was $42 million, an increase of $34 million versus 2005. This was primarily due to the absence of short-term investment proceeds of $109 million and the absence of proceeds from asset sales of $21 million in 2006, offset by a release of restricted cash of $128 million in February 2006, which we used to extinguish long-term debt-related parties. FINANCING ACTIVITIES: For the three months ended March 31, 2006, net cash used in financing activities was $221 million, an increase of $238 million versus 2005. This was primarily due to a decrease in proceeds from debt issuances of $691 million, offset by fewer debt retirements of $452 million. For additional details on long-term debt activity, see Note 3, Financings and Capitalization. OBLIGATIONS AND COMMITMENTS DIVIDEND RESTRICTIONS: For details on dividend restrictions, see Note 3, Financings and Capitalization. OFF-BALANCE SHEET ARRANGEMENTS: CMS Energy and certain of its subsidiaries enter into various arrangements in the normal course of business to facilitate commercial transactions with third parties. These arrangements include indemnifications, letters of credit, surety bonds, and financial and performance guarantees. For details on guarantee arrangements, see Note 2, Contingencies, "Other Contingencies - FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." REVOLVING CREDIT FACILITIES: For details on revolving credit facilities, see Note 3, Financings and Capitalization. CMS-15 CMS Energy Corporation SALE OF ACCOUNTS RECEIVABLE: For details on the sale of accounts receivable, see Note 3, Financings and Capitalization. OUTLOOK CORPORATE OUTLOOK Over the next few years, our business strategy will focus on reducing parent company debt, growing earnings, and positioning us to make new investments that complement our strengths. ELECTRIC UTILITY BUSINESS OUTLOOK GROWTH: Summer 2005 temperatures were higher than historical averages, leading to increased demand from electric customers. In 2006, we project electric deliveries will decline less than one percent from 2005 levels. This short-term outlook assumes a stabilizing economy and normal weather conditions throughout the remainder of the year. Over the next five years, we expect electric deliveries to grow at an average rate of about one and one-half percent per year. However, such growth is dependent on a modestly growing customer base and a stabilizing Michigan economy. This growth rate includes both full-service sales and delivery service to customers who choose to buy generation service from an alternative electric supplier, but excludes transactions with other wholesale market participants and other electric utilities. This growth rate reflects a long-range expected trend of growth. Growth from year to year may vary from this trend due to customer response to fluctuations in weather conditions and changes in economic conditions, including utilization and expansion or contraction of manufacturing facilities. ELECTRIC RESERVE MARGIN: We are planning for a reserve margin of approximately 11 percent for summer 2006, or supply resources equal to 111 percent of projected firm summer peak load. Of the 2006 supply resources target of 111 percent, we expect to meet approximately 97 percent from our electric generating plants and long-term power purchase contracts, and approximately 14 percent from other contractual arrangements. Through a combination of owned capacity and purchases, we have supply resources in place to cover approximately 110 percent of the projected firm summer peak load for 2006. We have purchased capacity and energy contracts covering partially the estimated reserve margin requirements for 2007 through 2010. As a result, we have recognized an asset of $72 million for unexpired capacity and energy contracts at March 31, 2006. ELECTRIC TRANSMISSION EXPENSES: The METC, which provides electric transmission service to us, increased substantially the transmission rates it charges us in 2006. The increased rates are subject to refund and to reduction based on the outcome of hearings at the FERC scheduled for September 2006. We are attempting to recover these costs through our 2006 PSCR plan case. In December 2005, the MPSC issued an order that temporarily excluded a portion of the increased costs from our 2006 PSCR charge. In April 2006, the MPSC Staff filed briefs in the 2006 PSCR case recommending that the MPSC approve recovery of all filed costs, including those temporarily excluded in the December 2005 order. The PSCR process allows recovery of all reasonable and prudent power supply costs. However, we cannot predict when full recovery of these transmission costs will commence. To the extent that we incur and are unable to collect these increased costs in a timely manner, our cash flows from electric utility operations will be affected negatively. For additional details, see Note 2, Contingencies, "Consumers' Electric Utility Rate Matters - Power Supply Costs." INDUSTRIAL REVENUE OUTLOOK: Our electric utility customer base includes a mix of residential, commercial, and diversified industrial customers, the largest segment of which is the automotive industry. In November CMS-16 CMS Energy Corporation 2005, General Motors Corporation, a large industrial customer of Consumers, announced plans to reduce certain manufacturing operations in Michigan. However, since the targeted operations are outside of our service territory, we do not anticipate a significant impact on electric utility revenue. In March 2006, Delphi Corporation, also a large industrial customer of Consumers, announced plans to sell or close all but one of their manufacturing operations in Michigan as part of their bankruptcy restructuring. Our electric utility operations are not dependent upon a single customer, or even a few customers, and customers in the automotive sector constitute 4 percent of our total electric revenue. In addition, returning industrial customers will benefit our electric utility revenue. However, we cannot predict the impact of these restructuring plans or possible future actions by other industrial customers. THE ELECTRIC CAPACITY NEED FORUM: In January 2006, the MPSC Staff issued a report on future electric capacity in the state of Michigan. The report indicated that existing generation resources are adequate in the short term, but could be insufficient to maintain reliability standards by 2009. The report also indicated that new coal-fired baseload generation may be needed by 2011. The MPSC Staff recommended an approval and bid process for new power plants. To address revenue stability risks, the Staff also recommended a special reliability charge a utility would assess on all electric distribution customers. In April 2006, the governor of Michigan issued an executive directive calling for the development of a comprehensive energy plan for the state of Michigan. The directive calls for the Chairman of the MPSC, working in cooperation with representatives from the public and private sectors, to make recommendations on Michigan's energy policy by the end of 2006. We will continue to participate as the MPSC addresses future electric capacity needs. ELECTRIC UTILITY BUSINESS UNCERTAINTIES Several electric business trends or uncertainties may affect our financial results and condition. These trends or uncertainties have, or we reasonably expect could have, a material impact on revenues or income from continuing electric operations. ELECTRIC ENVIRONMENTAL ESTIMATES: Our operations are subject to environmental laws and regulations. Costs to operate our facilities in compliance with these laws and regulations generally have been recovered in customer rates. Clean Air: Compliance with the federal Clean Air Act and resulting regulations has been, and will continue to be, a significant focus for us. The Nitrogen Oxide State Implementation Plan requires significant reductions in nitrogen oxide emissions. To comply with the regulations, we expect to incur capital expenditures totaling $819 million. As of March 2006, we incurred $616 million in capital expenditures to comply with the federal Clean Air Act and resulting regulations and anticipate that the remaining $203 million of capital expenditures will be made in 2006 through 2011. In addition to modifying coal-fired electric generating plants, our compliance plan includes the use of nitrogen oxide emission allowances until all of the control equipment is operational in 2011. The nitrogen oxide emission allowance annual expense is projected to be $6 million per year, which we expect to recover from our customers through the PSCR process. The allowances and their costs are accounted for as inventory. The allowance inventory is expensed at the rolling average cost as the coal-fired electric generating plants emit nitrogen oxide. In March 2005, the EPA adopted the Clean Air Interstate Rule that requires additional coal-fired electric generating plant emission controls for nitrogen oxides and sulfur dioxide. The rule involves a two-phase program to reduce emissions of nitrogen oxides by 63 percent and sulfur dioxide by 71 percent from 2003 levels by 2015. We plan to meet this rule by year round operations of our selective catalytic control technology units to meet nitrogen oxide targets and installation of flue gas desulfurization scrubbers at an estimated cost of $960 million. CMS-17 CMS Energy Corporation Also in March 2005, the EPA issued the Clean Air Mercury Rule, which requires initial reductions of mercury emissions from coal-fired electric generating plants by 2010 and further reductions by 2018. The Clean Air Mercury Rule establishes a cap-and-trade system for mercury emissions that is similar to the system used in the Clean Air Interstate Rule. The industry has not reached a consensus on the technical methods for curtailing mercury emissions. However, we anticipate our capital and operating costs for mercury emissions reductions required by the Clean Air Mercury Rule to be significantly less than what was required for selective catalytic reduction technology used for nitrogen oxide compliance. In April 2006, Michigan's governor announced a plan that would result in mercury emissions reductions of 90 percent by 2015. This plan adopts the Federal Clean Air Mercury Rule through its first phase, which ends in 2010. After the year 2010, the mercury emissions reduction standards outlined in the governor's plan become more stringent than those included in the Federal Clean Air Mercury Rule. If implemented as proposed, we anticipate the costs to comply with the governor's plan will exceed Federal Clean Air Mercury Rule compliance costs. We will work with the MDEQ on the details of these rules. Several legislative proposals 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 of these rules and their effect on our operations and financial results. To the extent that greenhouse gas emission reduction rules come into effect, the mandatory emissions reduction requirements could have far-reaching and significant implications for the energy sector. We cannot estimate the potential effect of federal or state level greenhouse gas policy on our future consolidated results of operations, cash flows, or financial position due to the uncertain nature of the policies at this time. However, we stay abreast of greenhouse gas policy developments and will continue to assess and respond to their potential implications on our business operations. Water: In March 2004, the EPA issued rules that govern electric generating plant cooling water intake systems. The rules require significant reduction in fish killed by operating equipment. Some of our facilities will be required to comply with the new rules by 2007. We are performing the required studies to determine the most cost-effective solutions for compliance. For additional details on electric environmental matters, see Note 2, Contingencies, "Consumers' Electric Utility Contingencies - Electric Environmental Matters." COMPETITION AND REGULATORY RESTRUCTURING: The Customer Choice Act allows all of our electric customers to buy electric generation service from us or from an alternative electric supplier. At March 31, 2006, alternative electric suppliers were providing 348 MW of generation service to ROA customers. This is 4 percent of our total distribution load and represents a decrease of 61 percent compared to March 31, 2005. It is difficult to predict future ROA customer trends. Section 10d(4) Regulatory Assets: In December 2005, the MPSC issued an order that authorized us to recover $333 million in Section 10d(4) costs. Instead of collecting these costs evenly over five years, the order instructed us to collect 10 percent of the regulatory asset total in the first year, 15 percent in the second year, and 25 percent in the third, fourth, and fifth years. In January 2006, we filed a petition for rehearing with the MPSC that disputed the aspect of the order dealing with the timing of our collection of these costs. In April 2006, the MPSC issued an order that denied our petition for rehearing. Through and Out Rates: In December 2004, we began paying a transitional charge pursuant to a FERC order eliminating regional "through and out" rates. Although the transitional charge ended in March 2006, there are hearings scheduled for May 2006 at the FERC to discuss these charges. These hearings could result in refunds or additional transitional charges to us. In April 2006, we filed an agreement with the FERC between the PJM RTO transmission owners and Consumers concerning these transitional charges. If approved by the FERC, the agreement would resolve all issues regarding transitional charges for Consumers and eliminate the potential for refunds or additional transitional charges to Consumers. We cannot predict the outcome of this matter. For additional details and material changes relating to the restructuring of the electric utility industry and CMS-18 CMS Energy Corporation electric rate matters, see Note 2, Contingencies, "Consumers' Electric Utility Restructuring Matters," and "Consumers' Electric Utility Rate Matters." OTHER ELECTRIC UTILITY BUSINESS UNCERTAINTIES MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990. We hold a 49 percent partnership interest in the MCV Partnership, and a 35 percent lessor interest in the MCV Facility. Under the MCV PPA, variable energy payments to the MCV Partnership are based on the cost of coal burned at our coal plants and our operation and maintenance expenses. However, the MCV Partnership's costs of producing electricity are tied to the cost of natural gas. Natural gas prices have increased substantially in recent years and throughout 2005. In 2005, the MCV Partnership reevaluated the economics of operating the MCV Facility and recorded an impairment charge. If natural gas prices remain at present levels or increase, the operations of the MCV Facility would be adversely affected and could result in the MCV Partnership failing to meet its obligations under the sale and leaseback transactions and other contracts. We are evaluating various alternatives in order to develop a new long-term strategy with respect to the MCV Facility. Further, the cost that we incur under the MCV PPA exceeds the recovery amount allowed by the MPSC. As a result, we estimate cash underrecoveries of capacity and fixed energy payments of $55 million in 2006 and $39 million in 2007. However, Consumers' direct savings from the RCP, after allocating a portion to customers, are used to offset a portion of our capacity and fixed energy underrecoveries expense. After September 15, 2007, we expect to claim relief under the regulatory out provision in the MCV PPA, thereby limiting our capacity and fixed energy payments to the MCV Partnership to the amounts that we collect from our customers. The effect of any such action would be to: - reduce cash flow to the MCV Partnership, which could have an adverse effect on the MCV Partnership's financial performance, and - eliminate our underrecoveries of capacity and fixed energy payments. The MCV Partnership has indicated that it may take issue with our exercise of the regulatory out clause after September 15, 2007. We believe that the clause is valid and fully effective, but cannot assure that it will prevail in the event of a dispute. If we are successful in exercising the regulatory out clause, the MCV Partnership has the right to terminate the MCV PPA. The MPSC's future actions on the capacity and fixed energy payments recoverable from customers subsequent to September 15, 2007 may affect negatively the financial performance of the MCV Partnership. If the MCV Partnership terminates the MCV PPA, we would be required to replace the lost capacity to maintain an adequate electric reserve margin. This could involve entering into a new PPA and / or entering into electric capacity contracts on the open market. We cannot predict our ability to enter into such contracts at a reasonable price. We are also unable to predict regulatory approval of the terms and conditions of such contracts, or that the MPSC would allow full recovery of our incurred costs. For additional details on the MCV Partnership, see Note 2, Contingencies, "Other Consumers' Electric Utility Contingencies - The Midland Cogeneration Venture." NUCLEAR MATTERS: Big Rock: Decommissioning of the site is nearing completion. Demolition of the last remaining plant structure, the containment building, and removal of remaining underground utilities and temporary office structures is expected to be completed by the summer of 2006. Final radiological surveys will then be completed to ensure that the site meets all requirements for free, unrestricted release in accordance with the NRC approved License Termination Plan (LTP) for the project. We anticipate NRC CMS-19 CMS Energy Corporation approval to return approximately 475 acres of the site, including the area formerly occupied by the nuclear plant, to a natural setting for unrestricted use by early 2007. We expect another area of approximately 105 acres encompassing the Big Rock Independent Spent Fuel Storage Installation (ISFSI), where eight casks loaded with spent fuel and other high-level radioactive material are stored, to be returned to a natural state within approximately two years from the date the DOE finishes removing the spent fuel from Big Rock also in accordance with the LTP. Palisades: The amount of spent nuclear fuel at Palisades exceeds the plant's temporary onsite wet storage pool capacity. We are using dry casks for temporary onsite dry storage to supplement the wet storage pool capacity. As of March 2006, we have loaded 29 dry casks with spent nuclear fuel. Palisades' current license from the NRC expires in 2011. In March 2005, the NMC, which operates the Palisades plant, applied for a 20-year license renewal for the plant on behalf of Consumers. We expect a decision from the NRC on the license renewal application in 2007. In December 2005, we announced plans to sell the Palisades nuclear plant and enter into a long-term power purchase agreement with the new owner. Subject to review of the terms that are realized through a bidding process, we believe a sale is the best option for our company, as it will reduce risk and improve cash flow while retaining the benefits of the plant for customers. The Palisades sale will use a competitive bid process, providing interested companies certain options to bid on the plant, as well as the related decommissioning liabilities and trust funds assets, and spent nuclear fuel at Palisades and Big Rock. Any sale will be subject to various approvals, including regulatory approvals of a long-term contract for us to purchase power from the plant, and various other contingencies. We expect to complete the sale in 2007. For additional details on nuclear plant decommissioning at Big Rock and Palisades, see Note 2, Contingencies, "Other Consumers' Electric Utility Contingencies - Nuclear Plant Decommissioning." GAS UTILITY BUSINESS OUTLOOK GROWTH: In 2006, we project gas deliveries will decline by four percent, on a weather-adjusted basis, from 2005 levels due to increased conservation and overall economic conditions in the State of Michigan. Over the next five years, we expect gas deliveries to be relatively flat. Actual gas deliveries in future periods may be affected by: - fluctuations in weather patterns, - use by independent power producers, - competition in sales and delivery, - changes in gas commodity prices, - Michigan economic conditions, - the price of competing energy sources or fuels, and - gas consumption per customer. GAS UTILITY BUSINESS UNCERTAINTIES Several gas business trends or uncertainties may affect our future financial results and financial condition. These trends or uncertainties could have a material impact on revenues or income from gas operations. GAS ENVIRONMENTAL ESTIMATES: We expect to incur investigation and remedial action costs at a number of sites, including 23 former manufactured gas plant sites. For additional details, see Note 2, Contingencies, "Consumers' Gas Utility Contingencies - Gas Environmental Matters." CMS-20 CMS Energy Corporation GAS COST RECOVERY: The GCR process is designed to allow us to recover all of our purchased natural gas costs if incurred under reasonable and prudent policies and practices. The MPSC reviews these costs, policies, and practices for prudency in annual plan and reconciliation proceedings. For additional details on gas cost recovery, see Note 2, Contingencies, "Consumers' Gas Utility Rate Matters - Gas Cost Recovery." 2001 GAS DEPRECIATION CASE: In October and December 2004, the MPSC issued Opinions and Orders in our gas depreciation case, which: - reaffirmed the previously-ordered $34 million reduction in our depreciation expense, - required us to undertake a study to determine why our plant removal costs are in excess of other regulated Michigan natural gas utilities, and - required us to file a study report with the MPSC Staff on or before December 31, 2005. We filed the study report with the MPSC Staff on December 29, 2005. We are also required to file our next gas depreciation case within 90 days after the MPSC issuance of a final order in the pending case related to ARO accounting. We cannot predict when the MPSC will issue a final order in the ARO accounting case. If the depreciation case order is issued after the gas general rate case order, we proposed to incorporate its results into the gas general rates using a surcharge mechanism. 2005 GAS RATE CASE: In July 2005, we filed an application with the MPSC seeking a 12 percent authorized return on equity along with a $132 million annual increase in our gas delivery and transportation rates. As part of this filing, we also requested interim rate relief of $75 million. The MPSC Staff and intervenors filed interim rate relief testimony on October 31, 2005. In its testimony, the MPSC Staff recommended granting interim rate relief of $38 million. In February 2006, the MPSC Staff recommended granting final rate relief of $62 million. The MPSC Staff proposed that $17 million of this amount be contributed to a low income energy efficiency fund. The MPSC Staff also recommended reducing our return on common equity to 11.15 percent, from our current 11.4 percent. In March 2006, the MPSC Staff revised its recommended final rate relief to $71 million. As of April 2006, the MPSC has not acted on our interim or final rate relief requests. In April 2006, we revised our request for final rate relief downward to $118 million. ENTERPRISES OUTLOOK We are evaluating new development opportunities outside of our current asset base to determine whether they fit within our business strategy. These and other investment opportunities for Enterprises will be considered for risk, rate of return, and consistency with our business strategy. Meanwhile, we plan to continue restructuring our Enterprises business with the objective of narrowing the focus of our operations to primarily North America and the Middle East/North Africa. We will continue to sell designated assets and investments that are not consistent with this focus. The percentage of our future earnings relating to our equity method investments may increase and our total future earnings may depend more significantly upon the performance of those investments. For summarized financial information of our equity method investments, see Note 9, Equity Method Investments. UNCERTAINTIES: The results of operations and the financial position of our diversified energy businesses may be affected by a number of trends or uncertainties. Those that could have a material impact on our income, cash flows, or balance sheet and credit improvement include: - our ability to sell or to improve the performance of assets and businesses in accordance with our CMS-21 CMS Energy Corporation business plan, - changes in exchange rates or in local economic or political conditions, particularly in Argentina, Venezuela, Brazil, and the Middle East, - changes in foreign taxes or laws or in governmental or regulatory policies that could reduce significantly the tariffs charged and revenues recognized by certain foreign subsidiaries, or increase expenses, - imposition of stamp taxes on South American contracts that could increase project expenses substantially, - impact of any future rate cases, FERC actions, or orders on regulated businesses, - impact of ratings downgrades on our liquidity, operating costs, and cost of capital, - impact of changes in commodity prices and interest rates on certain derivative contracts that do not qualify for hedge accounting and must be marked to market through earnings, - changes in available gas supplies or Argentine government regulations that could restrict natural gas exports to our GasAtacama electric generating plant, and - impact of indemnity and environmental remediation obligations at Bay Harbor. GASATACAMA: On March 24, 2004, the Argentine government authorized the restriction of exports of natural gas to Chile, giving priority to domestic demand in Argentina. This restriction could have a detrimental effect on GasAtacama's earnings since GasAtacama's gas-fired electric generating plant is located in Chile and uses Argentine gas for fuel. From April through December 2004, Bolivia agreed to export 4 million cubic meters of gas per day to Argentina, which allowed Argentina to minimize its curtailments to Chile. Argentina and Bolivia extended the term of that agreement through December 31, 2006. With the Bolivian gas supply, Argentina relaxed its export restrictions to GasAtacama, currently allowing GasAtacama to receive approximately 50 percent of its contracted gas quantities at its electric generating plant. On May 1, 2006, the Bolivian government announced its intention to nationalize the natural gas industry. At this point in time, it is not possible to predict the outcome of these events and their effect on the earnings of GasAtacama. At March 31, 2006, the value of our investment in GasAtacama was $378 million. SENECA: SENECA operates an electric utility on Margarita Island, Venezuela under a Concession Agreement with the Venezuelan Ministry of Energy and Petroleum (MEP). The Concession Agreement provides for semi-annual customer tariff adjustments for the effects of inflation and foreign exchange variations. The last tariff adjustment occurred in December 2003. In 2003, the MEP-approved a fuel subsidy to offset partially the lower tariff revenue. This fuel subsidy expired on December 31, 2004. SENECA has informed the MEP that it will continue to apply the fuel subsidy as a credit against a portion of its fuel bills from its fuel supplier, Deltaven, a governmental body regulated by the MEP. SENECA has not received any response from the MEP. Deltaven has continued to deliver fuel without interruption. We are informed that the MEP is examining our financial relief proposal. The outcome is uncertain since all alternatives are still being explored. If timely financial relief is not approved, the liquidity of SENECA and the value of our investment in SENECA would be impacted adversely. OTHER OUTLOOK MCV PARTNERSHIP NEGATIVE EQUITY: Due to the impairment of the MCV Facility and operating losses from mark-to-market adjustments on derivative instruments, the value of the equity held by Consumers and by all of the owners of the MCV Partnership has decreased significantly and is now negative. Since Consumers is one of the general partners of the MCV Partnership, we have recognized a portion of the limited partners' negative equity. As the MCV Partnership recognizes future losses, we will continue to assume a portion of the limited partners' share of those losses, in addition to our proportionate share. CMS-22 CMS Energy Corporation LITIGATION AND REGULATORY INVESTIGATION: We are the subject of an investigation by the DOJ regarding round-trip trading transactions by CMS MST. Also, we are named as a party in various litigation matters including, but not limited to, securities class action lawsuits, a class action lawsuit alleging ERISA violations, and several lawsuits regarding alleged false natural gas price reporting and price manipulation. Additionally, the SEC is investigating the actions of former CMS Energy subsidiaries in relation to Equatorial Guinea. For additional details regarding these and other matters, see Note 2, Contingencies and Part II, Item 1. Legal Proceedings. PENSION REFORM: Both branches of Congress passed legislation aimed at reforming pension plans. The U.S. Senate passed The Pension Security and Transparency Act in November 2005 and The House of Representatives passed the Pension Protection Act of 2005 in December 2005. At the core of both bills are changes in the calculation of pension plan funding requirements effective for plan years beginning in 2007, with interest rate relief extended until then, and an increase in premiums paid to the Pension Benefit Guaranty Corporation (PBGC). The latter was addressed through the broader budget reconciliation bill, which raises the PBGC flat-rate premiums from $19 to $30 per participant per year beginning in 2006. Although the Senate and House bills are similar, they do contain a number of technical differences, including differences in the time period allowed for interest rate and asset smoothing, the interest rate used to calculate lump sum payments, and the criteria used to determine whether a plan is "at-risk," which requires higher contribution levels. The Senate and the House plan to work out the differences between the two bills in a joint conference. The timing, however, of a final pension reform bill is unknown. IMPLEMENTATION OF NEW ACCOUNTING STANDARDS SFAS NO. 123(R) AND SAB NO. 107, SHARE-BASED PAYMENT: SFAS No. 123(R) requires companies to use the fair value of employee stock options and similar awards at the grant date to value the awards. SFAS No. 123(R) was effective for us on January 1, 2006. We elected to adopt the modified prospective method recognition provisions of this Statement instead of retrospective restatement. We adopted the fair value method of accounting for share-based awards effective December 2002. Therefore, SFAS No. 123(R) did not have a significant impact on our results of operations when it became effective. We applied the additional guidance provided by SAB No. 107 upon implementation of SFAS No. 123(R). For additional details, see Note 8, Executive Incentive Compensation. PROPOSED ACCOUNTING STANDARD On March 31, 2006, the FASB released an Exposure Draft of a proposed SFAS entitled "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans." The proposed SFAS would amend SFAS Nos. 87, 88, 106, and 132(R) and is expected to be effective for us on December 31, 2006. The most significant requirement stated in the proposed SFAS is the balance sheet recognition of the underfunded portion of our defined benefit postretirement plans at the date of adoption. We expect that Consumers will be allowed to apply SFAS No. 71 and recognize the underfunded portion as a regulatory asset. If we determine that SFAS No. 71 does not apply our equity could be reduced significantly. We are in the process of determining the impact of this proposed SFAS on our financial statements. CMS-23 CMS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF INCOME (LOSS) (UNAUDITED)
THREE MONTHS ENDED ------------------ MARCH 31 2006 2005 - -------- ------- ------- In Millions, Except Per Share Amounts OPERATING REVENUE $ 2,032 $ 1,845 EARNINGS FROM EQUITY METHOD INVESTEES 36 31 OPERATING EXPENSES Fuel for electric generation 225 177 Fuel costs mark-to-market at MCV 156 (209) Purchased and interchange power 150 95 Cost of gas sold 946 839 Other operating expenses 279 234 Maintenance 80 58 Depreciation, depletion and amortization 162 156 General taxes 78 75 ------- ------- 2,076 1,425 ------- ------- OPERATING INCOME (LOSS) (8) 451 OTHER INCOME (DEDUCTIONS) Accretion expense (2) (5) Gain on asset sales, net - 3 Interest and dividends 17 10 Regulatory return on capital expenditures 3 16 Foreign currency losses, net - (1) Other income 7 8 Other expense (9) (7) ------- ------- 16 24 ------- ------- FIXED CHARGES Interest on long-term debt 119 122 Interest on long-term debt - related parties 4 10 Other interest 7 4 Capitalized interest (2) (1) Preferred dividends of subsidiaries 1 1 ------- ------- 129 136 ------- ------- INCOME (LOSS) BEFORE MINORITY INTERESTS (121) 339 MINORITY INTERESTS (OBLIGATIONS), NET (68) 113 ------- ------- INCOME (LOSS) BEFORE INCOME TAXES (53) 226 INCOME TAX EXPENSE (BENEFIT) (28) 74 ------- ------- INCOME (LOSS) FROM CONTINUING OPERATIONS (25) 152 INCOME FROM DISCONTINUED OPERATIONS, NET OF $1 TAX EXPENSE IN 2006 1 - ------- ------- NET INCOME (LOSS) (24) 152 PREFERRED DIVIDENDS 3 2 ------- ------- NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ (27) $ 150 ======= =======
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CMS-24
THREE MONTHS ENDED ------------------ MARCH 31 2006 2005 - -------- ------- ------- In Millions, Except Per Share Amounts CMS ENERGY NET INCOME (LOSS) Net Income (Loss) Available to Common Stockholders $ (27) $ 150 ======= ======= BASIC EARNINGS (LOSS) PER AVERAGE COMMON SHARE Income (Loss) from Continuing Operations $ (0.13) $ 0.77 Gain from Discontinued Operations 0.01 - ------- ------- Net Income (Loss) Attributable to Common Stock $ (0.12) $ 0.77 ======= ======= DILUTED EARNINGS (LOSS) PER AVERAGE COMMON SHARE Income (Loss) from Continuing Operations $ (0.13) $ 0.74 Gain from Discontinued Operations 0.01 - ------- ------- Net Income (Loss) Attributable to Common Stock $ (0.12) $ 0.74 ======= ======= DIVIDENDS DECLARED PER COMMON SHARE $ - $ - ------- -------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CMS-25 CMS Energy Corporation (This page intentionally left blank) CMS-26 CMS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED ------------------ MARCH 31 2006 2005 - -------- ----- ----- In Millions CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ (24) $ 152 Adjustments to reconcile net income (loss) to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear 162 156 decommissioning of $1 per period) Deferred income taxes and investment tax credit (29) 68 Minority interests (obligations), net (68) 113 Fuel costs mark-to-market at MCV 156 (209) Regulatory return on capital expenditures (3) (16) Capital lease and other amortization 11 10 Accretion expense 2 5 Distributions from related parties less than earnings (15) (2) Gain on the sale of assets - (3) Changes in other assets and liabilities: Increase in accounts receivable and accrued revenues (202) (317) Decrease in inventories 377 418 Decrease in accounts payable (111) (25) Decrease in accrued expenses (63) (79) Decrease in MCV gas supplier funds on deposit (90) (15) Decrease (increase) in other current and non-current assets 96 (29) Increase (decrease) in other current and non-current liabilities (26) 35 ----- ----- Net cash provided by operating activities $ 173 $ 262 ----- ----- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (excludes assets placed under capital lease) $(129) $(149) Cost to retire property (25) (27) Restricted cash and restricted short-term investments 127 11 Investment in Electric Restructuring Implementation Plan - (1) Investments in nuclear decommissioning trust funds (17) (1) Proceeds from nuclear decommissioning trust funds 4 7 Proceeds from short-term investments - 295 Purchase of short-term investments - (186) Maturity of MCV restricted investment securities held-to-maturity 28 126 Purchase of MCV restricted investment securities held-to-maturity (26) (126) Proceeds from sale of assets - 21 Other investing (4) 22 ----- ----- Net cash used in investing activities $ (42) $ (8) ----- ----- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from notes, bonds, and other long-term debt $ 13 $ 704 Issuance of common stock 6 6 Retirement of bonds and other long-term debt (226) (678) Payment of preferred stock dividends (3) (2) Payment of capital lease and financial lease obligations (3) (3) Debt issuance costs, financing fees, and other (8) (10) ----- ----- Net cash provided by (used in) financing activities $(221) $ 17 ----- ----- EFFECT OF EXCHANGE RATES ON CASH 1 - ----- ----- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ (89) $ 271 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 847 669 ----- ----- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 758 $ 940 ===== =====
THE ACCOMPANYING CONDENSED NOTES ARE AN INTREGAL PART OF THESE STATEMENTS. CMS-27 CMS ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS
MARCH 31 2006 DECEMBER 31 (UNAUDITED) 2005 ----------- ----------- In Millions ASSETS PLANT AND PROPERTY (AT COST) Electric utility $ 8,266 $ 8,204 Gas utility 3,165 3,151 Enterprises 1,054 1,068 Other 31 25 --------- --------- 12,516 12,448 Less accumulated depreciation, depletion and amortization 5,166 5,123 --------- --------- 7,350 7,325 Construction work-in-progress 548 520 --------- --------- 7,898 7,845 --------- --------- INVESTMENTS Enterprises 746 712 Other 10 13 --------- --------- 756 725 --------- --------- CURRENT ASSETS Cash and cash equivalents at cost, which approximates market 758 847 Restricted cash and restricted short-term investments 66 198 Accounts receivable, notes receivable and accrued revenue, less allowances of $32 and $31, respectively 1,017 824 Accounts receivable and notes receivable - related parties 67 54 Inventories at average cost Gas in underground storage 702 1,069 Materials and supplies 92 96 Generating plant fuel stock 104 110 Price risk management assets 73 113 Regulatory assets - postretirement benefits 19 19 Derivative instruments 121 242 Deferred property taxes 166 160 Prepayments and other 129 167 --------- --------- 3,314 3,899 --------- --------- NON-CURRENT ASSETS Regulatory Assets Securitized costs 549 560 Additional minimum pension 399 399 Postretirement benefits 110 116 Customer Choice Act 213 222 Other 481 484 Price risk management assets 127 165 Nuclear decommissioning trust funds 576 555 Goodwill 30 27 Notes receivable - related parties 186 187 Notes receivable 195 187 Other 716 649 --------- --------- 3,582 3,551 --------- --------- TOTAL ASSETS $ 15,550 $ 16,020 ========= =========
CMS-28 STOCKHOLDERS' INVESTMENT AND LIABILITIES
MARCH 31 2006 DECEMBER 31 (UNAUDITED) 2005 ----------- ----------- In Millions CAPITALIZATION Common stockholders' equity Common stock, authorized 350.0 shares; outstanding 221.0 shares and 220.5 shares, respectively $ 2 $ 2 Other paid-in capital 4,445 4,436 Accumulated other comprehensive loss (286) (288) Retained deficit (1,855) (1,828) -------- -------- 2,306 2,322 Preferred stock of subsidiary 44 44 Preferred stock 261 261 Long-term debt 6,714 6,800 Long-term debt - related parties 178 178 Non-current portion of capital and finance lease obligations 309 308 -------- -------- 9,812 9,913 -------- -------- MINORITY INTERESTS 354 333 -------- -------- CURRENT LIABILITIES Current portion of long-term debt, capital and finance leases 319 316 Current portion of long-term debt - related parties - 129 Accounts payable 398 511 Accounts payable - related parties 2 1 Accrued interest 123 145 Accrued taxes 282 331 Price risk management liabilities 68 80 Current portion of gas supply contract obligations 10 10 Deferred income taxes 60 55 MCV gas supplier funds on deposit 103 193 Other 261 342 -------- -------- 1,626 2,113 -------- -------- NON-CURRENT LIABILITIES Regulatory Liabilities Regulatory liabilities for cost of removal 1,152 1,120 Income taxes, net 464 455 Other regulatory liabilities 231 178 Postretirement benefits 401 382 Deferred income taxes 253 297 Deferred investment tax credit 65 67 Asset retirement obligation 499 496 Price risk management liabilities 132 161 Gas supply contract obligations 56 61 Other 505 444 -------- -------- 3,758 3,661 -------- -------- COMMITMENTS AND CONTINGENCIES (Notes 2, 3 and 5) TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $ 15,550 $ 16,020 ======== ========
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CMS-29 CMS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY (UNAUDITED)
THREE MONTHS ENDED MARCH 31 2006 2005 - -------- ------- ------- In Millions COMMON STOCK At beginning and end of period $ 2 $ 2 ------- ------- OTHER PAID-IN CAPITAL At beginning of period 4,436 4,140 Common stock issued 8 6 Common stock reissued 1 1 ------- ------- At end of period 4,445 4,147 ------- ------- ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Minimum Pension Liability At beginning of period (19) (17) Minimum pension liability adjustments (a) - - ------- ------- At end of period (19) (17) ------- ------- Investments At beginning of period 9 9 Unrealized gain (loss) on investments (a) 2 (1) ------- ------- At end of period 11 8 ------- ------- Derivative Instruments At beginning of period 35 (9) Unrealized gain (loss) on derivative instruments (a) (4) 18 Reclassification adjustments included in net income (loss) (a) (1) (8) ------- ------- At end of period 30 1 ------- ------- Foreign Currency Translation At beginning of period (313) (319) Other foreign currency translations (a) 5 4 ------- ------- At end of period (308) (315) ------- ------- At end of period (286) (323) ------- ------- RETAINED DEFICIT At beginning of period (1,828) (1,734) Net income (loss) (a) (24) 152 Preferred stock dividends declared (3) (2) ------- ------- At end of period (1,855) (1,584) ------- ------- TOTAL COMMON STOCKHOLDERS' EQUITY $ 2,306 $ 2,242 ======= ======= (a) DISCLOSURE OF OTHER COMPREHENSIVE INCOME (LOSS): Minimum pension liability adjustments $ - $ - Investments Unrealized gain (loss) on investments, net of tax of $(1) in 2006 and $- in 2005 2 (1) Derivative Instruments Unrealized gain (loss) on derivative instruments, net of tax of $(5) in 2006 and $9 in 2005 (4) 18 Reclassification adjustments included in net income (loss), net of tax of $(1) in 2006 and $(6) in 2005 (1) (8) Foreign currency translation, net 5 4 Net income (loss) (24) 152 ------- ------- Total Other Comprehensive Income (Loss) $ (22) $ 165 ======= =======
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CMS-30 CMS Energy Corporation CMS ENERGY CORPORATION CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) These interim Consolidated Financial Statements have been prepared by CMS Energy in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. As such, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. Certain prior year amounts have been reclassified to conform to the presentation in the current year. In management's opinion, the unaudited information contained in this report reflects all adjustments of a normal recurring nature necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. The Condensed Notes to Consolidated Financial Statements and the related Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and related Notes contained in CMS Energy's Form 10-K for the year ended December 31, 2005. Due to the seasonal nature of CMS Energy's operations, the results as presented for this interim period are not necessarily indicative of results to be achieved for the fiscal year. 1: CORPORATE STRUCTURE AND ACCOUNTING POLICIES CORPORATE STRUCTURE: CMS Energy is an integrated energy company operating primarily in Michigan. We are the parent holding company of Consumers and Enterprises. Consumers is a combination electric and gas utility company serving Michigan's Lower Peninsula. Enterprises, through various subsidiaries and equity investments, is engaged in domestic and international diversified energy businesses including independent power production, electric distribution, and natural gas transmission, storage and processing. We manage our businesses by the nature of services each provides and operate principally in three business segments: electric utility, gas utility, and enterprises. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include CMS Energy, Consumers, Enterprises, and all other entities in which we have a controlling financial interest or of which we are the primary beneficiary, in accordance with FASB Interpretation No. 46(R). We use the equity method of accounting for investments in companies and partnerships that are not consolidated, where we have significant influence over operations and financial policies, but are not the primary beneficiary. We eliminate intercompany transactions and balances. USE OF ESTIMATES: We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. We are required to make estimates using assumptions that may affect the reported amounts and disclosures. Actual results could differ from those estimates. We are required to record estimated liabilities in the consolidated financial statements when it is probable that a loss will be incurred in the future as a result of a current event, and when an amount can be reasonably estimated. We have used this accounting principle to record estimated liabilities as discussed in Note 2, Contingencies. REVENUE RECOGNITION POLICY: We recognize revenues from deliveries of electricity and natural gas, and the transportation, processing, and storage of natural gas when services are provided. Sales taxes are recorded as liabilities and are not included in revenues. Revenues on sales of marketed electricity, natural gas, and other energy products are recognized at delivery. Mark-to-market changes in the fair CMS-31 CMS Energy Corporation values of energy trading contracts that qualify as derivatives are recognized as revenues in the periods in which the changes occur. ACCOUNTING FOR MISO TRANSACTIONS: CMS ERM accounts for MISO transactions on a net basis for each of the generating units for which CMS ERM sells power. CMS ERM allocates other fixed costs associated with MISO settlements back to the generating units and records billing adjustments when invoices are received. Consumers accounts for MISO transactions on a net basis for all of its generating units combined. Consumers records billing adjustments when invoices are received and also records an expense accrual for future adjustments based on historical experience. INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY: Our subsidiaries and affiliates whose functional currency is not the U.S. dollar translate their assets and liabilities into U.S. dollars at the exchange rates in effect at the end of the fiscal period. We translate revenue and expense accounts of such subsidiaries and affiliates into U.S. dollars at the average exchange rates that prevailed during the period. These foreign currency translation adjustments are shown in the stockholders' equity section on our Consolidated Balance Sheets. Exchange rate fluctuations on transactions denominated in a currency other than the functional currency, except those that are hedged, are included in determining net income. At March 31, 2006, the cumulative Foreign Currency Translation component of stockholders' equity is $308 million, which primarily represents currency losses in Argentina and Brazil. The foreign currency loss due to the unfavorable exchange rate of the Argentine peso using an exchange rate of 3.139 pesos per U.S. dollar was $265 million, net of tax. The net foreign currency loss due to the unfavorable exchange rate of the Brazilian real using an exchange rate of 2.205 reals per U.S. dollar was $45 million, net of tax. LONG-LIVED ASSETS AND EQUITY METHOD INVESTMENTS: Our assessment of the recoverability of long-lived assets and equity method investments involves critical accounting estimates. We periodically perform tests of impairment if certain conditions that are other than temporary exist that may indicate the carrying value may not be recoverable. Of our total assets, recorded at $15.550 billion at March 31, 2006, 56 percent represent long-lived assets and equity method investments that are subject to this type of analysis. In February 2005, we sold our interest in GVK, a 250 MW gas-fired power plant located in South Central India, for gross cash proceeds of $21 million. OTHER INCOME AND OTHER EXPENSE: The following tables show the components of Other income and Other expense:
In Millions -------------------- Three months ended March 31 2006 2005 - --------------------------- ------ ------ Other income Interest and dividends - related parties $ 2 $ 2 Electric restructuring return 1 1 Return on stranded and security costs 1 1 Refund of surety bond premium 1 - Reduction of contingent liability - 3 All other 2 1 ------ ------ Total other income $ 7 $ 8 ====== ======
CMS-32 CMS Energy Corporation
In Millions --------------------- Three months ended March 31 2006 2005 - --------------------------- ------ ------ Other expense Investment write-down $ - $ (1) Loss on reacquired and extinguished debt (5) (5) Civic and political expenditures (1) (1) Donations (1) - All other (2) - ------ ------ Total other expense $ (9) $ (7) ====== ======
RECLASSIFICATIONS: Certain prior year amounts have been reclassified for comparative purposes. These reclassifications did not affect consolidated net income (loss) for the years presented. 2: CONTINGENCIES SEC AND OTHER INVESTIGATIONS: During the period of May 2000 through January 2002, CMS MST engaged in simultaneous, prearranged commodity trading transactions in which energy commodities were sold and repurchased at the same price. These so called round-trip trades had no impact on previously reported consolidated net income, earnings per share, or cash flows but had the effect of increasing operating revenues and operating expenses by equal amounts. CMS Energy is cooperating with an investigation by the DOJ concerning round-trip trading, which the DOJ commenced in May 2002. CMS Energy is unable to predict the outcome of this matter and what effect, if any, this investigation will have on its business. In March 2004, the SEC approved a cease-and-desist order settling an administrative action against CMS Energy related to round-trip trading. The order did not assess a fine and CMS Energy neither admitted nor denied the order's findings. The settlement resolved the SEC investigation involving CMS Energy and CMS MST. Also in March 2004, the SEC filed an action against three former employees related to round-trip trading by CMS MST. One of the individuals has settled with the SEC. CMS Energy is currently advancing legal defense costs for the remaining two individuals, in accordance with existing indemnification policies. Those individuals filed a motion to dismiss the SEC action, which was denied. SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of complaints were filed against CMS Energy, Consumers, and certain officers and directors of CMS Energy and its affiliates. The cases were consolidated into a single lawsuit, which generally seeks unspecified damages based on allegations that the defendants violated United States securities laws and regulations by making allegedly false and misleading statements about CMS Energy's business and financial condition, particularly with respect to revenues and expenses recorded in connection with round-trip trading by CMS MST. In January 2005, the court granted a motion to dismiss Consumers and three of the individual defendants, but denied the motions to dismiss CMS Energy and the 13 remaining individual defendants. The court issued an opinion and order dated March 24, 2006, granting in part and denying in part plaintiffs' amended motion for class certification. The court conditionally certified a class consisting of "[a]ll persons who purchased CMS Common Stock during the period of October 25, 2000 through and including May 17, 2002 and who were damaged thereby." Appeals and motions for reconsideration of the court's ruling have been lodged by the parties. CMS Energy and the individual defendants will defend themselves vigorously in this litigation but cannot predict its outcome. CMS-33 CMS Energy Corporation ERISA LAWSUITS: CMS Energy is a named defendant, along with Consumers, CMS MST, and certain named and unnamed officers and directors, in two lawsuits, filed in July 2002 in United States District Court for the Eastern District of Michigan, brought as purported class actions on behalf of participants and beneficiaries of the CMS Employees' Savings Plan (the Plan). Plaintiffs 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, as well as other equitable relief and legal fees. On March 1, 2006, CMS Energy and Consumers reached an agreement, subject to court and independent fiduciary approval, to settle the lawsuits. The settlement agreement requires a $28 million cash payment by CMS Energy's primary insurer that will be used to pay Plan participants and beneficiaries for alleged losses, as well as any legal fees and expenses. In addition, CMS Energy agreed to certain other steps regarding administration of the Plan. The court issued an order on March 23, 2006, granting preliminary approval of the settlement and scheduling the Fairness Hearing for June 15, 2006. 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, the investigation will have on its business. The CFTC filed a civil injunctive action against two former CMS Field Services employees in Oklahoma federal district court on February 1, 2005. The action alleges the two engaged in reporting false natural gas trade information, and the action seeks to enjoin such acts, compel compliance with the Commodities Exchange Act, and impose monetary penalties. CMS Energy is currently advancing legal defense costs to the two individuals in accordance with existing indemnification policies. BAY HARBOR: As part of the development of Bay Harbor by certain subsidiaries of CMS Energy, which went forward under an agreement with the MDEQ, third parties constructed a golf course and a park over several abandoned cement kiln dust (CKD) piles, left over from the former cement plant operation on the Bay Harbor site. Pursuant to the agreement with the MDEQ, CMS Energy constructed a water collection system and treatment plant to recover seep water from one of the CKD piles. In 2002, CMS Energy sold its interest in Bay Harbor, but retained its obligations under previous environmental indemnifications entered into at the inception of the project. In September 2004, following an eight month shutdown of the treatment plant, the MDEQ issued a notice of noncompliance after finding high-pH seep water in Lake Michigan adjacent to the property. The MDEQ also found higher than acceptable levels of heavy metals, including mercury, in the seep water. In February 2005, the EPA executed an Administrative Order on Consent (AOC) to address problems at Bay Harbor, upon the consent of CMS Land Company (CMS Land), a subsidiary of Enterprises, and CMS Capital, LLC, a subsidiary of CMS Energy. Pursuant to the AOC, the EPA approved a final removal action work plan in July 2005. Among other things, the plan calls for the installation of collection trenches to intercept high pH CKD leachate flow to the lake. Final installation of the trenches in the western-most section has been delayed because of the discovery of CKD on the beach. Regarding these areas, CMS Land submitted an Interim Response Plan on March 21, 2006, which was approved by the EPA on March 30, 2006. In February 2006, CMS Land submitted to the EPA a proposed Remedial Investigation and Feasibility Study for the East Park CKD pile. The EPA approved a schedule for near-term activities, which includes consolidating CKD materials and installing CMS-34 CMS Energy Corporation collection trenches in the East Park leachate release area. The work plan calls for completion of the collection trenches in East Park by November 16, 2006. Several property owners at Bay Harbor made claims for loss or damage to their property. The owner of one parcel has filed a lawsuit in Emmet County Circuit Court against CMS Energy and several of its subsidiaries, as well as Bay Harbor Golf Club Inc., Bay Harbor Company LLC, David C. Johnson, and David V. Johnson, one of the developers at Bay Harbor. Several of these defendants have demanded indemnification from CMS Energy and affiliates for the claims made against them in the lawsuit. CMS Energy is awaiting a decision after a March 28, 2006 hearing on motions filed by it and other defendants to dismiss various counts of the complaint. CMS Land has entered into various access, purchase and settlement agreements with several of the affected landowners at Bay Harbor and continues negotiations with other landowners for access as necessary to implement remediation measures. CMS Land completed the purchase of two unimproved lots and a lot with a house. CMS Energy will defend vigorously any property damage and personal injury claims or lawsuits. CMS Energy has recorded a liability of $85 million for its obligations. An adverse outcome of this matter could, depending on the size of any indemnification obligation or liability under environmental laws, have a potentially significant adverse effect on CMS Energy's financial condition and liquidity and could negatively impact CMS Energy's financial results. CMS Energy cannot predict the ultimate cost or outcome of this matter. CONSUMERS' ELECTRIC UTILITY CONTINGENCIES ELECTRIC ENVIRONMENTAL MATTERS: Our operations are subject to environmental laws and regulations. Costs to operate our facilities in compliance with these laws and regulations generally have been recovered in customer rates. Clean Air: Compliance with the federal Clean Air Act and resulting regulations has been, and will continue to be, a significant focus for us. The Nitrogen Oxide State Implementation Plan requires significant reductions in nitrogen oxide emissions. To comply with the regulations, we expect to incur capital expenditures totaling $819 million. The key assumptions in the capital expenditure estimate include: - construction commodity prices, especially construction material and labor, - project completion schedules, - cost escalation factor used to estimate future years' costs, and - an AFUDC capitalization rate. Our current capital cost estimates include an escalation rate of 2.6 percent and an AFUDC capitalization rate of 8.4 percent. As of March 2006, we incurred $616 million in capital expenditures to comply with the federal Clean Air Act and resulting regulations and anticipate that the remaining $203 million of capital expenditures will be made in 2006 through 2011. These expenditures include installing selective catalytic control reduction technology at four of our coal-fired electric generating plants. In addition to modifying coal-fired electric generating plants, our compliance plan includes the use of nitrogen oxide emission allowances until all of the control equipment is operational in 2011. The nitrogen oxide emission allowance annual expense is projected to be $6 million per year, which we expect to recover from our customers through the PSCR process. The projected annual expense is based on market price forecasts and forecasts of regulatory provisions, known as progressive flow control, that restrict the usage in any given year of allowances banked from previous years. The CMS-35 CMS Energy Corporation allowances and their cost are accounted for as inventory. The allowance inventory is expensed at the rolling average cost as the coal-fired electric generating plants emit nitrogen oxide. In March 2005, the EPA adopted the Clean Air Interstate Rule that requires additional coal-fired electric generating plant emission controls for nitrogen oxides and sulfur dioxide. The rule involves a two-phase program to reduce emissions of nitrogen oxides by 63 percent and sulfur dioxide by 71 percent from 2003 levels by 2015. The final rule will require that we run our selective catalytic control reduction technology units year round beginning in 2009 and may require that we purchase additional nitrogen oxide allowances beginning in 2009. The additional nitrogen oxide allowances are estimated to cost $4 million per year for years 2009 through 2011. In addition to the selective catalytic control reduction technology installed to meet the nitrogen oxide standards, our current plan includes installation of flue gas desulfurization scrubbers. The scrubbers are to be installed by 2014 to meet the Phase I reduction requirements of the Clean Air Interstate Rule, at an estimated cost of $960 million. Our capital cost estimates include an escalation rate of 2.6 percent and an AFUDC capitalization rate of 8.4 percent. We currently have a surplus of sulfur dioxide allowances, which were granted by the EPA and are accounted for as inventory. In January 2006, we sold some of our excess sulfur dioxide allowances for $61 million and recognized the proceeds as a regulatory liability. Also in March 2005, the EPA issued the Clean Air Mercury Rule, which requires initial reductions of mercury emissions from coal-fired electric generating plants by 2010 and further reductions by 2018. The Clean Air Mercury Rule establishes a cap-and-trade system for mercury emissions that is similar to the system used in the Clean Air Interstate Rule. The industry has not reached a consensus on the technical methods for curtailing mercury emissions. However, we anticipate our capital and operating costs for mercury emissions reductions required by the Clean Air Mercury Rule to be significantly less than what was required for selective catalytic reduction technology used for nitrogen oxide compliance. In April 2006, Michigan's governor announced a plan that would result in mercury emissions reductions of 90 percent by 2015. This plan adopts the Federal Clean Air Mercury Rule through its first phase, which ends in 2010. After the year 2010, the mercury emissions reduction standards outlined in the governor's plan become more stringent than those included in the Federal Clean Air Mercury Rule. If implemented as proposed, we anticipate the costs to comply with the governor's plan will exceed Federal Clean Air Mercury Rule compliance costs. We will work with the MDEQ on the details of these rules. In August 2005, the MDEQ filed a Motion to Intervene in a court challenge to certain aspects of EPA's Clean Air Mercury Rule, asserting that the rule is inadequate. In October 2005, the EPA announced it would reconsider certain aspects of the Clean Air Mercury Rule. During the reconsideration process, the court challenge to the rule is on hold. We cannot predict the outcome of this proceeding. The EPA has alleged that some utilities have incorrectly classified plant modifications as "routine maintenance" rather than seeking permits to modify the plant from the EPA. We have received and responded to information requests from the EPA on this subject. We believe that we have properly interpreted the requirements of "routine maintenance." If our interpretation is found to be incorrect, we may be required to install additional pollution controls at some or all of our coal-fired electric generating plants and potentially pay fines. Additionally, the viability of certain plants remaining in operation could be called into question. CMS-36 CMS Energy Corporation Cleanup and Solid Waste: Under the Michigan Natural Resources and Environmental Protection Act, we expect that we will ultimately incur investigation and remedial action costs at a number of sites. We believe that these costs will be recoverable in rates under current ratemaking policies. We are a potentially responsible party at several contaminated sites administered under Superfund. Superfund liability is joint and several, meaning that many other creditworthy parties with substantial assets are potentially responsible with respect to the individual sites. Based on our experience, we estimate that our share of the total liability for the known Superfund sites will be between $2 million and $10 million. At March 31, 2006, we have recorded a liability for the minimum amount of our estimated Superfund liability. In October 1998, during routine maintenance activities, we identified PCB as a component in certain paint, grout, and sealant materials at Ludington. We removed and replaced part of the PCB material. We have proposed a plan to deal with the remaining materials and are awaiting a response from the EPA. MCV Environmental Issue: On July 12, 2004, the MDEQ, Air Control Division, issued the MCV Partnership a Letter of Violation asserting that the MCV Facility violated its Air Use Permit to Install (PTI) by exceeding the carbon monoxide emission limit on the Unit 14 duct burner and failing to maintain certain records in the required format. The MCV Partnership has declared five of the six duct burners in the MCV Facility as unavailable for operational use (which reduces the generation capability of the MCV Facility by approximately 100 MW) and took other corrective action to address the MDEQ's assertions. The one available duct burner was tested in April 2005 and its emissions met permitted levels due to the configuration of that particular unit. The MCV Partnership disagrees with certain of the MDEQ's assertions. The MCV Partnership filed a response in July 2004 to address the Letter of Violation. On December 13, 2004, the MDEQ informed the MCV Partnership that it was pursuing an escalated enforcement action against the MCV Partnership regarding the alleged violations of the MCV Facility's PTI. The MDEQ also stated that the alleged violations are deemed federally significant and, as such, placed the MCV Partnership on the EPA's High Priority Violators List (HPVL). The MDEQ and the MCV Partnership are pursuing voluntary settlement of this matter, which includes establishing a higher carbon monoxide emissions limit on the five duct burners currently unavailable, sufficient to allow the MCV Facility to return those duct burners to service. The settlement would also satisfy state and federal requirements and remove the MCV Partnership from the HPVL. Any such settlement may involve a fine, but at this time, the MDEQ has not stated what, if any, fine they will seek to impose. At this time, we cannot predict the financial impact or outcome of this issue. On July 13, 2004, the MDEQ, Water Division, issued the MCV Facility a Notice Letter asserting the MCV Facility violated its National Pollutant Discharge Elimination System (NPDES) Permit by discharging heated process wastewater into the storm water system, failing to document inspections, and other minor infractions (alleged NPDES violations). In August 2004, the MCV Partnership filed a response to the MDEQ letter covering the remediation for each of the MDEQ's alleged violations. On October 17, 2005, the MDEQ, Water Bureau, issued the MCV Partnership a Compliance Inspection report, which listed several minor violations and concerns that needed to be addressed by the MCV Facility. This report was issued in connection with an inspection of the MCV Facility in September 2005, which was conducted for compliance and review of the Storm Water Pollution Prevention Plans (SWPPP). The MCV Partnership submitted its updated SWPPP on December 1, 2005. The MCV Partnership management believes it has resolved all issues associated with the Notice Letter and Compliance Inspection and does not expect any further MDEQ actions on these matters. CMS-37 CMS Energy Corporation ALLOCATION OF BILLING COSTS: In February 2006, the MPSC issued an order which determined that we violated the MPSC code of conduct by including a bill insert advertising an unregulated service. The MPSC issued a penalty of $45,000 and stated that any subsidy for the use of our billing system arising from past code of conduct violations will be accounted for in our next electric rate case. We cannot predict the outcome or the impact on any future electric rate case. LITIGATION: In October 2003, a group of eight PURPA qualifying facilities (the plaintiffs), which sell power to us, filed a lawsuit in Ingham County Circuit Court. The lawsuit alleged that we incorrectly calculated the energy charge payments made pursuant to power purchase agreements with qualifying facilities. In February 2004, the Ingham County Circuit Court judge deferred to the primary jurisdiction of the MPSC, dismissing the circuit court case without prejudice. The Michigan Court of Appeals upheld this order on the primary jurisdiction question, but remanded the case back on another issue. In February 2005, the MPSC issued an order in the 2004 PSCR plan case concluding that we have been correctly administering the energy charge calculation methodology. The plaintiffs have appealed the MPSC order to the Michigan Court of Appeals. The plaintiffs also filed suit in the United States Court for the Western District of Michigan, which the judge subsequently dismissed. The plaintiffs have appealed the dismissal to the United States Court of Appeals. We cannot predict the outcome of these appeals. CONSUMERS' ELECTRIC UTILITY RESTRUCTURING MATTERS ELECTRIC ROA: The Customer Choice Act allows all of our electric customers to buy electric generation service from us or from an alternative electric supplier. At March 31, 2006, alternative electric suppliers were providing 348 MW of generation service to ROA customers. This is 4 percent of our total distribution load and represents a decrease of 61 percent compared to March 31, 2005. It is difficult to predict future ROA customer trends. STRANDED COSTS: Prior MPSC orders adopted a mechanism pursuant to the Customer Choice Act to provide recovery of Stranded Costs that occur when customers leave our system to purchase electricity from alternative suppliers. In November 2005, we filed an application with the MPSC related to the determination of 2004 Stranded Costs. Applying the Stranded Cost methodology used in prior MPSC orders, we concluded that we experienced zero Stranded Costs in 2004. CONSUMERS' ELECTRIC UTILITY RATE MATTERS POWER SUPPLY COSTS: To reduce the risk of high electric prices during peak demand periods and to achieve our reserve margin target, we employ a strategy of purchasing electric capacity and energy contracts for the physical delivery of electricity primarily in the summer months and to a lesser degree in the winter months. Through a combination of owned capacity and purchases, we have supply resources in place to cover approximately 110 percent of the projected firm summer peak load for 2006. We have purchased capacity and energy contracts covering partially the estimated reserve margin requirements for 2007 through 2010. As a result, we have recognized an asset of $72 million for unexpired capacity and energy contracts at March 31, 2006. At April 2006, we expect the total capacity cost of electric capacity and energy contracts for 2006 to be $18 million. PSCR: The PSCR process allows recovery of reasonable and prudent power supply costs. Revenues from the PSCR charges are subject to reconciliation after actual costs are reviewed for reasonableness and prudence. In September 2005, we submitted our 2006 PSCR plan filing to the MPSC. In November 2005, we submitted an amended 2006 PSCR plan to the MPSC to include higher estimates for certain METC and coal supply costs. In December 2005, the MPSC issued an order that CMS-38 CMS Energy Corporation temporarily excluded these increased costs from our PSCR charge and further reduced the charge by one mill per kWh. We implemented the temporary order in January 2006. If the temporary order remains in effect for the remainder of 2006, it would result in a delay in the recovery of $169 million. In April 2006, the MPSC Staff filed briefs in the 2006 PSCR plan case recommending inclusion of all filed costs in the 2006 PSCR charge, including those temporarily excluded in the December 2005 order. If the MPSC adopts the Staff's recommendation, our underrecovery of PSCR costs in 2006 would be reduced to $67 million. These underrecoveries are due to increased bundled sales and other cost increases beyond those included in the September and November filings. We expect to recover fully all of our PSCR costs. To the extent that we incur and are unable to collect these costs in a timely manner, our cash flows from electric utility operations are affected negatively. In March 2006, we submitted our 2005 PSCR reconciliation filing to the MPSC. We calculated an underrecovery of $33 million for commercial and industrial customers, which we expect to recover fully. We cannot predict the outcome of these PSCR proceedings. OTHER CONSUMERS' ELECTRIC UTILITY CONTINGENCIES THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990. We hold a 49 percent partnership interest in the MCV Partnership, and a 35 percent lessor interest in the MCV Facility. In 2004, we consolidated the MCV Partnership and the FMLP into our consolidated financial statements in accordance with FASB Interpretation No. 46(R). Under the MCV PPA, variable energy payments to the MCV Partnership are based on the cost of coal burned at our coal plants and our operation and maintenance expenses. However, the MCV Partnership's costs of producing electricity are tied to the cost of natural gas. Natural gas prices have increased substantially in recent years and throughout 2005. In 2005, the MCV Partnership reevaluated the economics of operating the MCV Facility and recorded an impairment charge. If natural gas prices remain at present levels or increase, the operations of the MCV Facility would be adversely affected and could result in the MCV Partnership failing to meet its obligations under the sale and leaseback transactions and other contracts. Due to the impairment of the MCV Facility and subsequent losses, the value of the equity held by all of the owners of the MCV Partnership has decreased significantly and is now negative. Since we are one of the general partners of the MCV Partnership, we have recognized a portion of the limited partners' negative equity. At March 31, 2006, the negative minority interest for the other general partners' share, including their portion of the limited partners' negative equity, is $96 million and is included in Other Non-current Assets on our Consolidated Balance Sheets. We are evaluating various alternatives in order to develop a new long-term strategy with respect to the MCV Facility. Further, the cost that we incur under the MCV PPA exceeds the recovery amount allowed by the MPSC. We expense all cash underrecoveries directly to income. We estimate underrecoveries of $55 million in 2006 and $39 million in 2007. Of the 2006 estimate, we expensed $14 million during the three months ended March 31, 2006. However, Consumers' direct savings from the RCP, after allocating a portion to customers, are used to offset our capacity and fixed energy underrecoveries expense. After September 15, 2007, we expect to claim relief under the regulatory out provision in the MCV PPA, thereby limiting our capacity and fixed energy payments to the MCV Partnership to the amounts that we collect from our customers. The MCV Partnership has indicated that it may take issue with our exercise of the regulatory out clause after September 15, 2007. We believe that the clause is valid and fully effective, but cannot assure that it will prevail in the event of a dispute. If we are successful in exercising the regulatory out clause, the MCV Partnership has the right to terminate the MCV PPA. The MPSC's future actions on the capacity and fixed energy payments recoverable from CMS-39 CMS Energy Corporation customers subsequent to September 15, 2007 may affect negatively the financial performance of the MCV Partnership. In January 2005, the MPSC issued an order approving the RCP, with modifications. The RCP allows us to recover the same amount of capacity and fixed energy charges from customers as approved in prior MPSC orders. However, we are able to dispatch the MCV Facility on the basis of natural gas market prices, which reduces the MCV Facility's annual production of electricity and, as a result, reduces the MCV Facility's consumption of natural gas by an estimated 30 to 40 bcf annually. This decrease in the quantity of high-priced natural gas consumed by the MCV Facility benefits our ownership interest in the MCV Partnership. In January 2005, we implemented the RCP. The underlying agreement for the RCP between Consumers and the MCV Partnership extends through the term of the MCV PPA. However, either party may terminate that agreement under certain conditions. In February 2005, a group of intervenors in the RCP case filed for rehearing of the MPSC order approving the RCP. The Attorney General also filed an appeal with the Michigan Court of Appeals. We cannot predict the outcome of these matters. MCV PARTNERSHIP PROPERTY TAXES: In January 2004, the Michigan Tax Tribunal issued its decision in the MCV Partnership's tax appeal against the City of Midland for tax years 1997 through 2000. The City of Midland appealed the decision to the Michigan Court of Appeals, and the MCV Partnership filed a cross-appeal at the Michigan Court of Appeals. The MCV Partnership also has a pending case with the Michigan Tax Tribunal for tax years 2001 through 2005. The MCV Partnership estimates that the 1997 through 2005 tax year cases will result in a refund to the MCV Partnership of $87 million, inclusive of interest, if the decision of the Michigan Tax Tribunal is upheld. In February 2006, the Michigan Court of Appeals largely affirmed the Michigan Tax Tribunal decision, but remanded the case back to the Michigan Tax Tribunal to clarify certain aspects of the Tax Tribunal decision. The remanded proceedings may result in the determination of a greater refund to the MCV Partnership. In April 2006, the City of Midland filed an application for Leave to Appeal with the Michigan Supreme Court. The MCV Partnership filed a response in opposition to that application. The MCV Partnership cannot predict the outcome of these proceedings; therefore, this anticipated refund has not been recognized in earnings. NUCLEAR PLANT DECOMMISSIONING: The MPSC and the FERC regulate the recovery of costs to decommission, or remove from service, our Big Rock and Palisades nuclear plants. Decommissioning funding practices approved by the MPSC require us to file a report on the adequacy of funds for decommissioning at three-year intervals. We prepared and filed updated cost estimates for Big Rock and Palisades in March 2004. Excluding additional costs for spent nuclear fuel storage, due to the DOE's failure to accept this spent nuclear fuel on schedule, these reports show a decommissioning cost of $361 million for Big Rock and $868 million for Palisades. Since Big Rock is currently in the process of decommissioning, this estimated cost includes historical expenditures in nominal dollars and future costs in 2003 dollars, with all Palisades costs given in 2003 dollars. Recently updated cost projections for Big Rock indicate an anticipated decommissioning cost of $390 million as of March 2006. Big Rock: In December 2000, funding of the Big Rock trust fund stopped because the MPSC-authorized decommissioning surcharge collection period expired. In March 2006, we contributed $16 million to the trust fund from our corporate funds. Excluding the additional nuclear fuel storage costs due to the DOE's failure to accept spent fuel on schedule, we are currently projecting that the level of funds provided by the trust for Big Rock will fall short of the amount needed to complete the decommissioning by $36 million. At this time, we plan to provide this additional amount from our CMS-40 CMS Energy Corporation corporate funds, and, subsequent to the completion in 2007 of radiological decommissioning work, seek recovery of such expenditures, in addition to the amount we added to the fund, from some alternative source. We cannot predict the outcome of these efforts. Palisades: Excluding additional nuclear fuel storage costs due to the DOE's failure to accept spent fuel on schedule, we concluded, based on cost estimates filed in March 2004, that the existing Palisades' surcharge of $6 million needed to be increased to $25 million annually, beginning January 2006. A settlement agreement was approved by the MPSC, providing for the continuation of the existing $6 million annual decommissioning surcharge through 2011, our current license expiration date, and for the next periodic review to be filed in March 2007. Amounts collected from electric retail customers and deposited in trusts, including trust earnings, are credited to a regulatory liability. In March 2005, the NMC, which operates the Palisades plant, applied for a 20-year license renewal for the plant on behalf of Consumers. We expect a decision from the NRC on the license renewal application in 2007. At this time, we cannot determine what impact this will have on decommissioning costs or the adequacy of funding. In December 2005, we announced plans to sell Palisades and have begun pursuing this asset divestiture. As a sale is not probable to occur until a firm purchase commitment is entered into with a potential buyer, we have not classified the Palisades assets as held for sale on our Consolidated Balance Sheets. NUCLEAR MATTERS: Nuclear Fuel Cost: We amortize nuclear fuel cost to fuel expense based on the quantity of heat produced for electric generation. For nuclear fuel used after April 6, 1983, we charge certain disposal costs to nuclear fuel expense, recover these costs through electric rates, and remit them to the DOE quarterly. We elected to defer payment for disposal of spent nuclear fuel burned before April 7, 1983. At March 31, 2006, our DOE liability is $147 million. This amount includes interest, which is payable upon the first delivery of spent nuclear fuel to the DOE. The amount of this liability, excluding a portion of interest, was recovered through electric rates. DOE Litigation: In 1997, a U.S. Court of Appeals decision confirmed that the DOE was to begin accepting deliveries of spent nuclear fuel for disposal by January 1998. Subsequent U.S. Court of Appeals litigation, in which we and other utilities participated, has not been successful in producing more specific relief for the DOE's failure to accept the spent nuclear fuel. There are two court decisions that support the right of utilities to pursue damage claims in the United States Court of Claims against the DOE for failure to take delivery of spent nuclear fuel. Over 60 utilities have initiated litigation in the United States Court of Claims. We filed our complaint in December 2002. If our litigation against the DOE is successful, we plan to use any recoveries to pay the cost of spent nuclear fuel storage until the DOE takes possession as required by law. We can make no assurance that the litigation against the DOE will be successful. In 2002, the site at Yucca Mountain, Nevada was designated for the development of a repository for the disposal of high-level radioactive waste and spent nuclear fuel. We expect that the DOE, in due course, will submit a final license application to the NRC for the repository. The application and review process is estimated to take several years. Insurance: We maintain nuclear insurance coverage on our nuclear plants. At Palisades, we maintain nuclear property insurance from NEIL totaling $2.750 billion and insurance that would partially cover the cost of replacement power during certain prolonged accidental outages. Because NEIL is a mutual CMS-41 CMS Energy Corporation insurance company, we could be subject to assessments of up to $28 million in any policy year if insured losses in excess of NEIL's maximum policyholders surplus occur at our, or any other member's, nuclear facility. NEIL's policies include coverage for acts of terrorism. At Palisades, we maintain nuclear liability insurance for third-party bodily injury and off-site property damage resulting from a nuclear energy hazard for up to approximately $10.761 billion, the maximum insurance liability limits established by the Price-Anderson Act. Part of the Price-Anderson Act's financial protection is a mandatory industry-wide program under which owners of nuclear generating facilities could be assessed if a nuclear incident occurs at any nuclear generating facility. The maximum assessment against us could be $101 million per occurrence, limited to maximum annual installment payments of $15 million. We also maintain insurance under a program that covers tort claims for bodily injury to nuclear workers caused by nuclear hazards. The policy contains a $300 million nuclear industry aggregate limit. Under a previous insurance program providing coverage for claims brought by nuclear workers, we remain responsible for a maximum assessment of up to $6 million. This requirement will end December 31, 2007. Big Rock remains insured for nuclear liability 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. CONSUMERS' GAS UTILITY CONTINGENCIES GAS ENVIRONMENTAL MATTERS: We expect to incur investigation and remediation costs at a number of sites under the Michigan Natural Resources and Environmental Protection Act, a Michigan statute that covers environmental activities including remediation. These sites include 23 former manufactured gas plant facilities. We operated the facilities on these sites for some part of their operating lives. For some of these sites, we have no current ownership or may own only a portion of the original site. In 2005, we estimated our remaining costs to be between $29 million and $71 million, based on 2005 discounted costs, using a discount rate of three percent. The discount rate represents a 10-year average of U.S. Treasury bond rates reduced for increases in the consumer price index. We expect to fund most of these costs through proceeds derived from a settlement with insurers and MPSC-approved rates. At March 31, 2006, we have a liability of $28 million, net of $54 million of expenditures incurred to date, and a regulatory asset of $60 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. CONSUMERS' GAS UTILITY RATE MATTERS GAS COST RECOVERY: The GCR process is designed to allow us to recover all of our purchased natural gas costs if incurred under reasonable and prudent policies and practices. The MPSC reviews these costs, policies, and practices for prudency in annual plan and reconciliation proceedings. GCR reconciliation for year 2004-2005: In March 2006, a settlement was reached and submitted to the MPSC for approval for our 2004-2005 GCR year reconciliation. The settlement is for a $2 million net overrecovery for the GCR year; it includes interest through March 2005 and refunds that we CMS-42 CMS Energy Corporation received from our suppliers that are required to be refunded to our customers. In April 2006, the MPSC approved the settlement; the settlement amount will be rolled into the 2005-2006 GCR year. GCR plan for year 2005-2006: In November 2005, the MPSC issued an order for our 2005-2006 GCR Plan year, which resulted in approval of a settlement agreement and established a fixed price cap of $10.10 for the December 2005 through March 2006 billing period. We were able to maintain our billing GCR factor below the authorized level for that period. The order was appealed to the Michigan Court of Appeals by one intervenor. No action has been taken by the Court of Appeals on the merits of the appeal and we are unable to predict the outcome. GCR plan for year 2006-2007: In December 2005, we filed an application with the MPSC seeking approval of a GCR plan for the 12-month period of April 2006 through March 2007. Our request proposed using a GCR factor consisting of: - a base GCR ceiling factor of $11.10 per mcf, plus - a quarterly GCR ceiling price adjustment contingent upon future events. Our GCR factor for the billing month of May 2006 is $9.07 per mcf. 2001 GAS DEPRECIATION CASE: In October and December 2004, the MPSC issued Opinions and Orders in our gas depreciation case, which: - reaffirmed the previously-ordered $34 million reduction in our depreciation expense, - required us to undertake a study to determine why our plant removal costs are in excess of other regulated Michigan natural gas utilities, and - required us to file a study report with the MPSC Staff on or before December 31, 2005. We filed the study report with the MPSC Staff on December 29, 2005. We are also required to file our next gas depreciation case within 90 days after the MPSC issuance of a final order in the pending case related to ARO accounting. We cannot predict when the MPSC will issue a final order in the ARO accounting case. If the depreciation case order is issued after the gas general rate case order, we proposed to incorporate its results into the gas general rates using a surcharge mechanism. 2005 GAS RATE CASE: In July 2005, we filed an application with the MPSC seeking a 12 percent authorized return on equity along with a $132 million annual increase in our gas delivery and transportation rates. As part of this filing, we also requested interim rate relief of $75 million. The MPSC Staff and intervenors filed interim rate relief testimony on October 31, 2005. In its testimony, the MPSC Staff recommended granting interim rate relief of $38 million. In February 2006, the MPSC Staff recommended granting final rate relief of $62 million. The MPSC Staff proposed that $17 million of this amount be contributed to a low income energy efficiency fund. The MPSC Staff also recommended reducing our return on common equity to 11.15 percent, from our current 11.4 percent. In March 2006, the MPSC Staff revised its recommended final rate relief to $71 million. As of April 2006, the MPSC has not acted on our interim or final rate relief requests. In April 2006, we revised our request for final rate relief downward to $118 million. CMS-43 CMS Energy Corporation OTHER CONTINGENCIES EQUATORIAL GUINEA TAX CLAIM: CMS Energy received a request for indemnification from Perenco, the purchaser of CMS Oil and Gas. The indemnification claim relates to the sale by CMS Energy of its oil, gas and methanol projects in Equatorial Guinea and the claim of the government of Equatorial Guinea that $142 million in taxes is owed it in connection with that sale. Based on information currently available, CMS Energy and its tax advisors have concluded that the government's tax claim is without merit, and Perenco has submitted a response to the government rejecting the claim. CMS Energy cannot predict the outcome of this matter. GAS INDEX PRICE REPORTING LITIGATION: CMS Energy, CMS MST, CMS Field Services, Cantera Natural Gas, Inc. (the company that purchased CMS Field Services) and Cantera Gas Company are named as defendants in various lawsuits arising as a result of false natural gas price reporting. Allegations include manipulation of NYMEX natural gas futures and options prices, price-fixing conspiracies, and artificial inflation of natural gas retail prices in California, Tennessee and Kansas. In February 2006, CMS MST and CMS Field Services reached an agreement to settle a similar action that had been filed in New York. The $6.975 million settlement, to be paid by CMS MST and for which CMS Energy established a reserve in the fourth quarter of 2005, is subject to court approval. CMS Energy and the other CMS Energy defendants will defend themselves vigorously against these matters but cannot predict their outcome. DEARBORN INDUSTRIAL GENERATION: In October 2001, Duke/Fluor Daniel, the primary construction contractor for the DIG facility (DFD), presented DIG with a change order to their construction contract and filed an action in Michigan state court against DIG, claiming contractual damages in the amount of $110 million, plus interest and costs. DFD also filed a construction lien for the $110 million. DIG is contesting both of the claims made by DFD. In addition to drawing down on three letters of credit totaling $30 million that it obtained from DFD, DIG 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. The arbitration hearing began October 10, 2005 and is scheduled to continue through mid-2006. DIG will continue to defend itself vigorously and pursue its claims. CMS Energy cannot predict the outcome of this matter. FORMER CMS OIL AND GAS OPERATIONS: A Michigan trial judge granted Star Energy, Inc. and White Pine Enterprises, LLC a declaratory judgment in an action filed in 1999 that claimed Terra Energy Ltd., a former CMS Oil and Gas subsidiary, violated an oil and gas lease and other arrangements by failing to drill wells it had committed to drill. A jury then awarded the plaintiffs a $7.6 million award. Appeals were filed of the original verdict and a subsequent decision of the court on remand. The court of appeals issued an opinion on May 26, 2005 remanding the case to the trial court for a new trial on damages. At a status conference on April 10, 2006, the judge set a six-month discovery period and instructed Terra to file a motion to compel arbitration under the arbitration provision in the leases at issue. Terra believes there is no basis for such a motion and has not filed it. No trial date has been set. Enterprises has an indemnity obligation with regard to losses to Terra that might result from this litigation. CMS ENSENADA CUSTOMER DISPUTE: Pursuant to a long-term power purchase agreement, CMS Ensenada sells power and steam to YPF Repsol at the YPF refinery in La Plata, Argentina. As a result of the so-called "Emergency Laws," payments by YPF Repsol under the power purchase agreement have been converted to pesos at the exchange rate of one U.S. dollar to one Argentine peso. Such payments are currently insufficient to cover CMS Ensenada's operating costs, including quarterly debt CMS-44 CMS Energy Corporation service payments to the Overseas Private Investment Corporation (OPIC). Enterprises is party to a Sponsor Support Agreement pursuant to which Enterprises has guaranteed CMS Ensenada's debt service payments to OPIC up to an amount which is in dispute, but which Enterprises estimates to be approximately $7 million. The Argentine commercial court granted injunctive relief to CMS Ensenada pursuant to an ex parte action, and such relief will remain in effect until completion of arbitration on the matter, to be administered by the International Chamber of Commerce. The arbitration hearing was held in July 2005 and a decision from the arbitration panel is expected in the second quarter of 2006. ARGENTINA: As part of its energy privatization incentives, Argentina directed CMS Gas Transmission to calculate tariffs in U.S. dollars, then convert them to pesos at the prevailing exchange rate, and to adjust tariffs every six months to reflect changes in inflation. Starting in early 2000, Argentina suspended the inflation adjustments. In January 2002, the Republic of Argentina enacted the Public Emergency and Foreign Exchange System Reform Act. This law repealed the fixed exchange rate of one U.S. dollar to one Argentine peso, converted all dollar-denominated utility tariffs and energy contract obligations into pesos at the same one-to-one exchange rate, and directed the Government of Argentina to renegotiate such tariffs. CMS Gas Transmission began arbitration proceedings against the Republic of Argentina (Argentina) under the auspices of the International Centre for the Settlement of Investment Disputes (ICSID) in mid-2001, citing breaches by Argentina of the Argentine-U.S. Bilateral Investment Treaty (BIT). In May 2005, an ICSID tribunal concluded, among other things, that Argentina's economic emergency did not excuse Argentina from liability for violations of the BIT. The ICSID tribunal found in favor of CMS Gas Transmission, and awarded damages of U.S. $133 million, plus interest. The ICSID Convention provides that either party may seek annulment of the award based upon five possible grounds specified in the Convention. Argentina's Application for Annulment was formally registered by ICSID on September 27, 2005 and will be considered by a newly constituted panel. On December 28, 2005, certain insurance underwriters paid the sum of $75 million to CMS Gas Transmission in respect of their insurance obligations resulting from non-payment of the ICSID award. The payment, plus interest, is subject to repayment by CMS Gas Transmission in the event that the ICSID award is annulled. Pending the outcome of the annulment proceedings, CMS Energy recorded the $75 million payment as deferred revenue at December 31, 2005. IRS RULING AND AUDIT: In August 2005, the IRS issued Revenue Ruling 2005-53 and regulations to provide guidance with respect to the use of the "simplified service cost" method of tax accounting. We use this tax accounting method, generally allowed by the IRS under section 263A of the Internal Revenue Code, with respect to the allocation of certain corporate overheads to the tax basis of self-constructed utility assets. Under the IRS guidance, significant issues with respect to the application of this method remain unresolved and subject to dispute. However, the effect of the IRS's position may be to require CMS Energy either (1) to repay all or a portion of previously received tax benefits, or (2) to add back to taxable income, half in each of 2005 and 2006, all or a portion of previously deducted overheads. The IRS is currently auditing CMS Energy and recently notified us that it intends to propose an adjustment to 2001 taxable income disallowing our simplified service cost deduction. The impact of this matter on future earnings, cash flows, or our present NOL carryforwards remains uncertain, but could be material. CMS Energy cannot predict the outcome of this matter. CMS-45 CMS Energy Corporation OTHER: In addition to the matters disclosed within this Note, Consumers and certain other subsidiaries of CMS Energy are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies arising from the ordinary course of business. These lawsuits and proceedings may involve personal injury, property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing, and other matters. We have accrued estimated losses for certain contingencies discussed within this Note. Resolution of these contingencies is not expected to have a material adverse impact on our financial position, liquidity, or future results of operations. FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS: The Interpretation requires the guarantor, upon issuance of a guarantee, to recognize a liability for the fair value of the obligation it undertakes in issuing the guarantee. The following table describes our guarantees at March 31, 2006:
In Millions -------------------------------------------------------------------- Issue Expiration Maximum Carrying Guarantee Description Date Date Obligation Amount - --------------------- ------------ ---------- ---------- -------- Indemnifications from asset sales and other agreements (a) October 1995 Indefinite $1,147 $ 1 Standby letters of credit and loans (b) Various Various through 129 - May 2010 Surety bonds and other indemnifications Various Indefinite 20 - Other guarantees (c) Various Various through 217 1 September 2027 Nuclear insurance retrospective premiums Various Indefinite 135 -
(a) The majority of this amount arises from routine provisions in stock and asset sales agreements under which we indemnify the purchaser for losses resulting from events such as claims resulting from tax disputes and the failure of title to the assets or stock sold by us to the purchaser. We believe the likelihood of a loss for any remaining indemnifications to be remote. (b) Standby letters of credit include letters of credit issued under an amended credit agreement with Citicorp USA, Inc. The amended credit agreement is supported by a guaranty issued by certain subsidiaries of CMS Energy. At March 31, 2006, letters of credit issued on behalf of unconsolidated affiliates totaling $67 million were outstanding. (c) Maximum obligation includes $85 million related to MCV non-performance under a steam and electric power agreement with Dow. CMS-46 CMS Energy Corporation The following table provides additional information regarding our guarantees:
Guarantee Description How Guarantee Arose Events That Would Require Performance - --------------------- ------------------- ------------------------------------- Indemnifications from asset sales and Stock and asset sales agreements Findings of misrepresentation, other agreements breach of warranties, and other specific events or circumstances Standby letters of credit Normal operations of coal power Noncompliance with environmental plants regulations and inadequate response to demands for corrective action Nonperformance Natural gas transportation Nonperformance Self-insurance requirement Non-payment by CMS Energy and Standby letters of credit and loans Credit Agreement Enterprises of obligations under the credit agreement Surety bonds and other indemnifications Normal operating activity, permits Nonperformance and licenses Other guarantees Normal operating activity Nonperformance or non-payment by a subsidiary under a related contract MCV Partnership's nonperformance or Agreement to provide power and steam non-payment under a related contract to Dow Bay Harbor remediation efforts Partnership's nonperformance Owners exercising put options requiring us to purchase property Nuclear insurance retrospective premiums Normal operations of nuclear plants Call by NEIL and Price-Anderson Act for nuclear incident
Project Financing: We enter into various project-financing security arrangements such as equity pledge agreements and share mortgage agreements to provide financial or performance assurance to third parties on behalf of certain unconsolidated affiliates. Expiration dates for these agreements vary from March 2015 to June 2020 or terminate upon payment or cancellation of the obligation. Non-payment or other act of default by an unconsolidated affiliate would trigger enforcement of the security. If we were required to perform under these agreements, the maximum amount of our obligation under these agreements would be equal to the value of the shares relinquished to the guaranteed party at the time of default. At March 31, 2006, none of our guarantees contained provisions allowing us to recover, from third parties, any amount paid under the guarantees. We enter into agreements containing tax and other indemnification provisions in connection with a variety of transactions. While we are unable to estimate the maximum potential obligation related to these indemnities, we consider the likelihood that we would be required to perform or incur significant losses related to these indemnities and the guarantees listed in the preceding tables to be remote. CMS-47 CMS Energy Corporation 3: FINANCINGS AND CAPITALIZATION Long-term debt is summarized as follows:
In Millions --------------------------------------- March 31, 2006 December 31, 2005 -------------- ----------------- CMS ENERGY CORPORATION Senior notes $ 2,273 $ 2,347 Other long-term debt 2 2 ---------- ---------- Total - CMS Energy Corporation 2,275 2,349 ---------- ---------- CONSUMERS ENERGY COMPANY First mortgage bonds 3,175 3,175 Senior notes and other 853 852 Securitization bonds 362 369 ---------- ---------- Total - Consumers Energy Company 4,390 4,396 ---------- ---------- OTHER SUBSIDIARIES 359 363 ---------- ---------- TOTAL PRINCIPAL AMOUNTS OUTSTANDING 7,024 7,108 Current amounts (292) (289) Net unamortized discount (18) (19) ---------- ---------- Total Long-term debt $ 6,714 $ 6,800 ========== ==========
DEBT RETIREMENTS: The following is a summary of significant long-term debt retirements during the three months ended March 31, 2006:
Principal Interest (in millions) Rate (%) Retirement Date Maturity Date ------------- --------- --------------- ------------- CMS ENERGY Senior notes $ 74 9.875 January through October 2007 March 2006 CONSUMERS Long-term debt - related parties 129 9.000 February 2006 June 2031 ----- TOTAL $ 203 =====
REVOLVING CREDIT FACILITIES: The following secured revolving credit facilities with banks are available at March 31, 2006:
In Millions Outstanding ----------- Amount of Amount Letters-of- Amount Company Expiration Date Facility Borrowed Credit Available ------- --------------- --------- -------- ----------- ----------- CMS Energy May 18, 2010 $ 300 $ - $ 115 $ 185 Consumers March 30, 2007 300 - - 300 Consumers May 18, 2010 500 - 36 464 MCV Partnership August 26, 2006 50 - 2 48
In March 2006, Consumers entered into a short-term secured revolving credit agreement with banks. This facility provides $300 million of funds for working capital and other general corporate purposes. DIVIDEND RESTRICTIONS: Our amended and restated $300 million secured revolving credit facility restricts payments of dividends on our common stock during a 12-month period to $150 million, CMS-48 CMS Energy Corporation dependent on the aggregate amounts of unrestricted cash and unused commitments under the facility. Under the provisions of its articles of incorporation, at March 31, 2006, Consumers had $149 million of unrestricted retained earnings available to pay common stock dividends. Covenants in Consumers' debt facilities cap common stock dividend payments at $300 million in a calendar year. For the three months ended March 31, 2006, we received $40 million of common stock dividends from Consumers. Also, the provisions of the Federal Power Act and the Natural Gas Act effectively restrict dividends to the amount of Consumers' retained earnings. CAPITAL AND FINANCE LEASE OBLIGATIONS: Our capital leases are comprised mainly of leased service vehicles, power purchase agreements and office furniture. At March 31, 2006, capital lease obligations totaled $57 million. In order to obtain permanent financing for the MCV Facility, the MCV Partnership entered into a sale and lease back agreement with a lessor group, which includes the FMLP, for substantially all of the MCV Partnership's fixed assets. In accordance with SFAS No. 98, the MCV Partnership accounted for the transaction as a financing arrangement. At March 31, 2006, finance lease obligations totaled $279 million, which represents the third-party portion of the MCV Partnership's finance lease obligation. SALE OF ACCOUNTS RECEIVABLE: Under a revolving accounts receivable sales program, Consumers currently sells certain accounts receivable to a wholly owned, consolidated, bankruptcy remote special purpose entity. In turn, the special purpose entity may sell an undivided interest in up to $325 million of the receivables. The special purpose entity sold no receivables at March 31, 2006 and $325 million of receivables at December 31, 2005. Consumers continues to service the receivables sold to the special purpose entity. The purchaser of the receivables has no recourse against Consumers' other assets for failure of a debtor to pay when due and no right to any receivables not sold. Consumers has neither recorded a gain or loss on the receivables sold nor retained interest in the receivables sold. Certain cash flows under Consumers' accounts receivable sales program are shown in the following table:
In Millions ---------------------- Three months ended March 31 2006 2005 - --------------------------- ------- ------- Net cash flow as a result of accounts receivable financing $ (325) $ (304) Collections from customers $ 1,817 $ 1,592
CONTINGENTLY CONVERTIBLE SECURITIES: In March 2006, the $11.87 per share trigger price contingency was met for our $250 million 4.50 percent contingently convertible preferred stock and the $12.81 per share trigger price contingency was met for our $150 million 3.375 percent contingently convertible senior notes. The price of our common stock remained at or above the applicable trigger price for 20 of 30 consecutive trading days ended on the last trading day of the calendar quarter, satisfying the contingency. As a result, these securities are convertible at the option of the security holders for the three months ending June 30, 2006, with the principal or par amount payable in cash. Because the 3.375 percent contingently convertible senior notes are convertible, they hold the characteristics of a current liability. Therefore, we classify them as Current portion of long-term debt, where they will remain during the period that they are outstanding and convertible. As of April 2006, none of the security holders have notified us of their intention to convert these securities. CMS-49 CMS Energy Corporation 4: EARNINGS PER SHARE The following table presents the basic and diluted earnings per share computations based on Income (Loss) from Continuing Operations:
In Millions, Except Per Share Amounts ------------------------------------- Three Months Ended March 31 2006 2005 - --------------------------- ------- ------- EARNINGS AVAILABLE TO COMMON STOCKHOLDERS Income (Loss) from Continuing Operations $ (25) $ 152 Less Preferred Dividends (3) (2) ------- ------- Income (Loss) from Continuing Operations Available to Common Stockholders - Basic $ (28) $ 150 Add conversion of Convertible Debentures (net of tax) - 2 ------- ------- Income (Loss) from Continuing Operations Available to Common Stockholders - Diluted $ (28) $ 152 ======= ======= AVERAGE COMMON SHARES OUTSTANDING APPLICABLE TO BASIC AND DILUTED EPS Weighted Average Shares - Basic 219.1 195.3 Add dilutive impact of Contingently Convertible Securities - 6.1 Add conversion of Convertible Debentures - 4.2 Add dilutive Stock Options and Warrants - 0.7 ------- ------- Weighted Average Shares - Diluted 219.1 206.3 ======= ======= EARNINGS (LOSS) PER AVERAGE COMMON SHARE AVAILABLE TO COMMON STOCKHOLDERS Basic $ (0.13) $ 0.77 Diluted $ (0.13) $ 0.74 ======= =======
Contingently Convertible Securities: Due to accounting EPS dilution principles, there was no impact to diluted EPS from our contingently convertible securities for the three months ended March 31, 2006. Assuming positive income from continuing operations, our contingently convertible securities dilute EPS to the extent that the conversion value, which is based on the average market price of our common stock, exceeds the principal or par value. Had there been positive income from continuing operations for the three months ended March 31, 2006, our contingently convertible securities would have contributed an additional 10.4 million shares to the calculation of diluted EPS. For additional details on our contingently convertible securities, see Note 3, Financings and Capitalization. Stock Options and Warrants: Due to accounting EPS dilution principles, there was no impact to diluted EPS from stock options and warrants for the three months ended March 31, 2006. Had there been positive income from continuing operations for the three months ended March 31, 2006, stock options and warrants would have contributed an additional 0.5 million shares to the calculation of diluted EPS. Unvested restricted stock would have contributed an additional 0.9 million shares to the calculation of diluted EPS. At March 31, 2006, the exercise price was greater than the average market price of our common stock for 1.9 million stock options. These stock options were excluded from the diluted EPS calculation, but have the potential to dilute EPS in the future. CMS-50 CMS Energy Corporation Convertible Debentures: Due to accounting EPS dilution principles, for the three months ended March 31, 2006, there was no impact to diluted EPS from our 7.75 percent convertible subordinated debentures. Using the if-converted method, the debentures would have: - increased the numerator of diluted EPS by $2 million from an assumed reduction of interest expense, net of tax, and - increased the denominator of diluted EPS by 4.2 million shares. We can revoke the conversion rights if certain conditions are met. 5: FINANCIAL AND DERIVATIVE INSTRUMENTS FINANCIAL INSTRUMENTS: The carrying amounts of cash, short-term investments, and current liabilities approximate their fair values because of their short-term nature. We estimate the fair values of long-term financial instruments based on quoted market prices or, in the absence of specific market prices, on quoted market prices of similar instruments, or other valuation techniques. The cost and fair value of our long-term financial instruments are as follows:
In Millions ------------------------------------------------------------------------------- March 31, 2006 December 31, 2005 ------------------------------------ ------------------------------------ Fair Unrealized Fair Unrealized Cost Value Gain (Loss) Cost Value Gain (Loss) ------ ------ ----------- ------ ------ ----------- Long-term debt, including current amounts $7,006 $7,086 $ (80) $7,089 $7,315 $ (226) Long-term debt - related parties, including current amounts 178 145 33 307 280 27 Available-for-sale securities: SERP: Equity securities 35 51 16 34 49 15 Debt securities 17 16 (1) 17 17 - Nuclear decommissioning investments: Equity securities 136 261 125 134 252 118 Debt securities 301 301 - 287 291 4
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 may use various contracts to manage these risks, including swaps, options, futures, and forward contracts. We enter into these risk management contracts using established policies and procedures, under the direction of both: - an executive oversight committee consisting of senior management representatives, and - a risk committee consisting of business unit managers. Our intention is that any increases or decreases in the value of these contracts will be offset by an opposite change in the value of the item at risk. We classify these contracts as either non-trading or trading. CMS-51 CMS Energy Corporation The contracts we use to manage market risks may qualify as derivative instruments that are subject to derivative and hedge accounting under SFAS No. 133. If a contract is a derivative, it is recorded on the balance sheet at its fair value. We then adjust the resulting asset or liability each quarter to reflect any change in the market value of the contract, a practice known as marking the contract to market. If a derivative qualifies for cash flow hedge accounting treatment, the changes in fair value (gains or losses) are reported in accumulated other comprehensive income; otherwise, the changes are reported in earnings. For a derivative instrument to qualify for hedge accounting: - the relationship between the derivative instrument and the item being hedged must be formally documented at inception, - the derivative instrument must be highly effective in offsetting the hedged item's cash flows or changes in fair value, and - if hedging a forecasted transaction, the forecasted transaction must be probable. If a derivative qualifies for cash flow hedge accounting treatment and gains or losses are recorded in accumulated other comprehensive income, those gains or losses will be reclassified into earnings in the same period or periods the hedged forecasted transaction affects earnings. If a cash flow hedge is terminated early because it is determined that the forecasted transaction will not occur, any gain or loss recorded in accumulated other comprehensive income at that date is recognized immediately in earnings. If a cash flow hedge is terminated early for other economic reasons, any gain or loss as of the termination date is deferred and then reclassified to earnings when the forecasted transaction affects earnings. The ineffective portion, if any, of all hedges is recognized in earnings. To determine the fair value of our derivatives, we use information from external sources (i.e., quoted market prices and third-party valuations), if available. For certain contracts, this information is not available and we use mathematical valuation models to value our derivatives. These models require various inputs and assumptions, including commodity market prices and volatilities, as well as interest rates and contract maturity dates. The cash returns we actually realize on these contracts may vary, either positively or negatively, from the results that we estimate using these models. As part of valuing our derivatives at market, we maintain reserves, if necessary, for credit risks arising from the financial condition of counterparties. The majority of our commodity purchase and sale contracts are not subject to derivative accounting under SFAS No. 133 because: - they do not have a notional amount (that is, a number of units specified in a derivative instrument, such as MW of electricity or bcf of natural gas), - they qualify for the normal purchases and sales exception, or - there is not an active market for the commodity. Our coal purchase contracts are not derivatives because there is not an active market for the coal we purchase. Similarly, certain of our electric capacity and energy contracts are not derivatives due to the lack of an active energy market in Michigan. If active markets for these commodities develop in the future, some of these contracts may qualify as derivatives. For our coal purchase contracts, the resulting mark-to-market impact on earnings could be material. For our electric capacity and energy contracts, we believe that we would be able to apply the normal purchases and sales exception to the majority of these contracts (including the MCV PPA) and, therefore, would not be required to mark these contracts to market. CMS-52 CMS Energy Corporation In 2005, the MISO began operating the Midwest Energy Market. As a result, the MISO now centrally dispatches electricity and transmission service throughout much of the Midwest and provides day-ahead and real-time energy market information. At this time, we believe that the establishment of this market does not represent the development of an active energy market in Michigan, as defined by SFAS No. 133. However, as the Midwest Energy Market matures, we will continue to monitor its activity level and evaluate whether or not an active energy market may exist in Michigan. Derivative accounting is required for certain contracts used to limit our exposure to interest rate risk, commodity price risk, and foreign exchange risk. The following table summarizes our derivative instruments:
In Millions ------------------------------------------------------------------------------ March 31, 2006 December 31, 2005 ------------------------------------ ------------------------------------ Fair Unrealized Fair Unrealized Derivative Instruments Cost Value Gain (Loss) Cost Value Gain (Loss) - ---------------------- ----- ----- ----------- ----- ----- ---------- Non-trading: Gas supply option contracts $ - $ - $ - $ 1 $ (1) $ (2) FTRs - - - - 1 1 Derivative contracts associated with the MCV Partnership: Long-term gas contracts (a) - 93 93 - 205 205 Gas futures, options, and swaps (a) - 144 144 - 223 223 CMS ERM contracts: Non-trading electric / gas contracts - (62) (62) - (63) (63) Trading electric / gas contracts (b) (2) 62 64 (3) 100 103 Derivative contracts associated with equity investments in: Shuweihat - (16) (16) - (20) (20) Taweelah (35) (12) 23 (35) (17) 18 Jorf Lasfar - (7) (7) - (8) (8) Other - 2 2 - 1 1
(a) The fair value of the MCV Partnership's long-term gas contracts and gas futures, options, and swaps has decreased significantly from December 31, 2005 due to a decrease in natural gas prices since that time. (b) The fair value of CMS ERM's trading electric and gas contracts has decreased significantly from December 31, 2005 due to decreases in prices for natural gas and electricity since that time. We record the fair value of our gas supply option contracts, FTRs, and the derivative contracts associated with the MCV Partnership in Derivative instruments, Other assets, or Other liabilities on our Consolidated Balance Sheets. We include the fair value of the derivative contracts held by CMS ERM in either Price risk management assets or Price risk management liabilities on our Consolidated Balance Sheets. The fair value of derivative contracts associated with our equity investments is included in Investments - Enterprises on our Consolidated Balance Sheets. GAS SUPPLY OPTION CONTRACTS: Our gas utility business uses fixed-priced weather-based gas supply call options and fixed-priced gas supply call and put options to meet our regulatory obligation to provide gas to our customers at a reasonable and prudent cost. As part of the GCR process, the mark- CMS-53 CMS Energy Corporation to-market gains and losses associated with these options are reported directly in earnings as part of Other income, and then immediately reversed out of earnings and recorded on the balance sheet as a regulatory asset or liability. FTRs: With the establishment of the Midwest Energy Market, FTRs were established. FTRs are financial instruments that manage price risk related to electricity transmission congestion. An FTR entitles its holder to receive compensation (or, conversely, to remit payment) for congestion-related transmission charges. FTRs are marked-to-market each quarter, with changes in fair value reported to earnings as part of Other income. DERIVATIVE CONTRACTS ASSOCIATED WITH THE MCV PARTNERSHIP: Long-term gas contracts: The MCV Partnership uses long-term gas contracts to purchase and manage the cost of the natural gas it needs to generate electricity and steam. The MCV Partnership believes that certain of these contracts qualify as normal purchases under SFAS No. 133. Accordingly, we have not recognized these contracts at fair value on our Consolidated Balance Sheets at March 31, 2006. The MCV Partnership also holds certain long-term gas contracts that do not qualify as normal purchases because these contracts contain volume optionality. In addition, as a result of implementing the RCP in 2005, a significant portion of long-term gas contracts no longer qualify as normal purchases, because the gas will not be used to generate electricity or steam. Accordingly, all of these contracts are accounted for as derivatives, with changes in fair value recorded in earnings each quarter. For the three months ended March 31, 2006, we recorded a $111 million loss, before considering tax effects and minority interest, associated with the decrease in fair value of these long-term gas contracts. This loss is included in the total Fuel costs mark-to-market at MCV on our Consolidated Statements of Income (Loss). Because of the volatility of the natural gas market, the MCV Partnership expects future earnings volatility on these contracts, since gains and losses will be recorded each quarter. We have recorded derivative assets totaling $93 million associated with the fair value of long-term gas contracts on our Consolidated Balance Sheets at March 31, 2006. We expect almost all of these assets, which represent cumulative net mark-to-market gains, to reverse as losses through earnings during 2006 and 2007 as the gas is purchased, with the remainder reversing between 2008 and 2011. As the MCV Partnership recognizes future losses from the reversal of these derivative assets, we will continue to assume a portion of the limited partners' share of those losses, in addition to our proportionate share. For further details on the RCP, see Note 2, Contingencies, "Other Consumers' Electric Utility Contingencies - The Midland Cogeneration Venture." Gas Futures, Options, and Swaps: The MCV Partnership enters into natural gas futures, options, and over-the-counter swap transactions in order to hedge against unfavorable changes in the market price of natural gas. The MCV Partnership uses these financial instruments to: - ensure an adequate supply of natural gas for the projected generation and sales of electricity and steam, and - manage price risk by fixing the price to be paid for natural gas on some of its long-term gas contracts. At March 31, 2006, the MCV Partnership held natural gas futures, options, and swaps. We have recorded derivative assets totaling $144 million associated with the fair value of these contracts on our Consolidated Balance Sheets at March 31, 2006. Certain of these contracts qualify for cash flow hedge accounting and we record our proportionate share of their mark-to-market gains and losses in CMS-54 CMS Energy Corporation Accumulated other comprehensive loss. The remaining contracts are not cash flow hedges and their mark-to-market gains and losses are recorded to earnings. Those contracts that qualify as cash flow hedges represent $137 million of the total $144 million of futures, options, and swaps held. We have recorded a cumulative net gain of $44 million, net of tax and minority interest, in Accumulated other comprehensive loss at March 31, 2006, representing our proportionate share of the cash flow hedges held by the MCV Partnership. Of this balance, we expect to reclassify $16 million, net of tax and minority interest, as an increase to earnings during the next 12 months as the contracts settle, offsetting the costs of gas purchases, with the remainder to be realized through 2009. There was no ineffectiveness associated with any of these cash flow hedges. The remaining futures, options, and swap contracts, representing $7 million of the total $144 million, do not qualify as cash flow hedges. Prior to the implementation of the RCP, the futures and swap contracts were accounted for as cash flow hedges. Since the RCP was implemented in 2005, these instruments no longer qualify for cash flow hedge accounting and we record any changes in their fair value in earnings each quarter. For the three months ended March 31, 2006, we recorded a $45 million loss, before considering tax effects and minority interest, associated with the decrease in fair value of these instruments. This loss is included in the total Fuel costs mark-to-market at MCV on our Consolidated Statements of Income (Loss). Because of the volatility of the natural gas market, the MCV Partnership expects future earnings volatility on these contracts, since gains and losses will be recorded each quarter. We expect almost all of these futures, options, and swap contracts to be realized during 2006 as the contracts settle, with the remainder to be realized during 2007. For further details on the RCP, see Note 2, Contingencies, "Other Consumers' Electric Utility Contingencies - The Midland Cogeneration Venture." CMS ERM CONTRACTS: CMS ERM enters into and owns energy contracts as a part of activities considered to be an integral part of CMS Energy's ongoing operations. CMS ERM holds certain contracts for the future purchase and sale of natural gas that will result in physical delivery of the commodity at contractual prices. These forward contracts are generally long-term in nature and are classified as non-trading. CMS ERM also uses various financial instruments, including swaps, options, and futures, to manage commodity price risks associated with its forward purchase and sale contracts and with generation assets owned by CMS Energy or its subsidiaries. These financial contracts are classified as trading activities. In accordance with SFAS No. 133, non-trading and trading contracts that qualify as derivatives are recorded at fair value on our Consolidated Balance Sheets. The resulting assets and liabilities are marked to market each quarter, and changes in fair value are recorded in earnings as a component of Operating Revenue. For trading contracts, these gains and losses are recorded net in accordance with EITF Issue No. 02-03. Contracts that do not meet the definition of a derivative are accounted for as executory contracts (that is, on an accrual basis). DERIVATIVE CONTRACTS ASSOCIATED WITH EQUITY INVESTMENTS: At March 31, 2006, some of our equity method investees held: - interest rate contracts that hedged the risk associated with variable-rate debt, and - foreign exchange contracts that hedged the foreign currency risk associated with payments to be made under operating and maintenance service agreements. We record our proportionate share of the change in fair value of these contracts in Accumulated other comprehensive loss if the contracts qualify for cash flow hedge accounting; otherwise, we record our CMS-55 CMS Energy Corporation share in Earnings from Equity Method Investees. FOREIGN EXCHANGE DERIVATIVES: At times, we use forward exchange and option contracts to hedge the equity value relating to investments in foreign operations. These contracts limit the risk from currency exchange rate movements because gains and losses on such contracts offset losses and gains, respectively, on the hedged investments. At March 31, 2006, we had no outstanding foreign exchange contracts. However, the impact of previous hedges on our investments in foreign operations is reflected in Accumulated other comprehensive loss as a component of the foreign currency translation adjustment on our Consolidated Balance Sheets. Gains or losses from the settlement of these hedges are maintained in the foreign currency translation adjustment until we sell or liquidate the hedged investments. At March 31, 2006, our total foreign currency translation adjustment was a net loss of $308 million, which included a net hedging loss of $26 million, net of tax, related to settled contracts. CREDIT RISK: Our swaps, options, and forward contracts contain credit risk, which is the risk that counterparties will fail to perform their contractual obligations. We reduce this risk through established credit policies. For each counterparty, we assess credit quality by using credit ratings, financial condition, and other available information. We then establish a credit limit for each counterparty based upon our evaluation of credit quality. We monitor the degree to which we are exposed to potential loss under each contract and take remedial action, if necessary. CMS ERM and the MCV Partnership enter into contracts primarily with companies in the electric and gas industry. This industry concentration may have an impact on our exposure to credit risk, either positively or negatively, based on how these counterparties are affected by similar changes in economic, weather, or other conditions. CMS ERM and the MCV Partnership typically use industry-standard agreements that allow for netting positive and negative exposures associated with the same counterparty, thereby reducing exposure. These contracts also typically provide for the parties to demand adequate assurance of future performance when there are reasonable grounds for doing so. The following table illustrates our exposure to potential losses at March 31, 2006, if each counterparty within this industry concentration failed to perform its contractual obligations. This table includes contracts accounted for as financial instruments. It does not include trade accounts receivable, derivative contracts that qualify for the normal purchases and sales exception under SFAS No. 133, or other contracts that are not accounted for as derivatives.
In Millions ---------------------------------------------------------------------------------- Net Exposure Net Exposure Exposure from Investment from Investment Before Collateral Net Grade Grade Collateral (a) Held (b) Exposure Companies Companies (%) -------------- ---------- -------- --------------- --------------- CMS ERM $ 88 $ - $ 88 $ 18 (c) 20 MCV Partnership 224 104 120 102 (d) 85
(a) Exposure is reflected net of payables or derivative liabilities if netting arrangements exist. (b) Collateral held includes cash and letters of credit received from counterparties. (c) The majority of the remaining balance of CMS ERM's net exposure was from a counterparty whose credit rating fell below investment grade after December 31, 2005. (d) Approximately half of the remaining balance of the MCV Partnership's net exposure was from CMS-56 CMS Energy Corporation independent natural gas producers/suppliers that do not have published credit ratings. Based on our credit policies, our current exposures, and our credit reserves, we do not expect a material adverse effect on our financial position or future earnings as a result of counterparty nonperformance. 6: 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 between July 1, 2003 and August 31, 2005, - a DCCP for employees hired on or after September 1, 2005, - benefits to certain management employees under SERP, - a defined contribution 401(k) Savings Plan, - benefits to a select group of management under the EISP, and - health care and life insurance benefits under OPEB. Pension Plan: The Pension Plan includes funds for most of our current employees, the employees of our subsidiaries, and Panhandle, a former subsidiary. The Pension Plan's assets are not distinguishable by company. Effective January 11, 2006, the MPSC electric rate order authorized Consumers to include $33 million of electric pension expense in its electric rates. Due to the volatility of these particular costs, the order also established a pension equalization mechanism to track actual costs. If actual pension expenses are greater than the $33 million included in electric rates, the difference will be recognized as a regulatory asset for future recovery from customers. If actual pension expenses are less than the $33 million included in electric rates, the difference will be recognized as a regulatory liability, and refunded to our customers. The difference between pension expense allowed in our electric rates and pension expense under SFAS No. 87 resulted in a $3 million net reduction in pension expense and establishment of a corresponding regulatory asset for the three months ending March 31, 2006. Effective January 11, 2006, the MPSC electric rate order authorized Consumers to include $28 million of electric OPEB expense in its electric rates. Due to the volatility of these particular costs, the order also established an OPEB equalization mechanism to track actual costs. If actual OPEB expenses are greater than the $28 million included in electric rates, the difference will be recognized as a regulatory asset for future recovery from our customers. If actual OPEB expenses are less than the $28 million included in electric rates, the difference will be recognized as a regulatory liability, and refunded to our customers. The difference between OPEB expense allowed in our electric rates and OPEB expense under SFAS No. 106 resulted in less than $1 million net reduction in OPEB expense and establishment of a corresponding regulatory asset for the three months ending March 31, 2006. CMS-57 CMS Energy Corporation Costs: The following table recaps the costs incurred in our retirement benefits plans:
In Millions --------------------------------------------------- Pension OPEB --------------------- --------------------- Three Months Ended March 31 2006 2005 2006 2005 - --------------------------- ------ ------ ------ ------ Service cost $ 12 $ 10 $ 6 $ 6 Interest expense 21 19 16 16 Expected return on plan assets (22) (25) (14) (14) Amortization of: Net loss 11 7 5 4 Prior service cost 2 1 (3) (2) ------ ------ ------ ------ Net periodic cost 24 12 10 10 Regulatory adjustment (3) - - - ------ ------ ------ ------ Net periodic cost after regulatory adjustment $ 21 $ 12 $ 10 $ 10 ====== ====== ====== ======
SERP: On April 1, 2006, we implemented a Defined Contribution Supplemental Executive Retirement Plan (DC SERP) and froze further new participation in the defined benefit SERP. The DC SERP plan provides promoted and newly hired participants benefits ranging from five to 15 percent of total compensation. The DC SERP plan requires a minimum of five years of participation before vesting; our contributions to the plan, if any, will be placed in a grantor trust. The MCV Partnership sponsors defined cost postretirement health care plans that cover all full-time employees, except key management. Participants in the postretirement health care plans become eligible for the benefits if they retire on or after the attainment of age 65 or upon a qualified disability retirement, or if they have 10 or more years of service and retire at age 55 or older. The MCV Partnership's net periodic postretirement health care cost for the three months ended March 31, 2006 and 2005 was less than $1 million. 7: ASSET RETIREMENT OBLIGATIONS SFAS NO. 143: This standard requires companies to record the fair value of the cost to remove assets at the end of their useful life, if there is a legal obligation to remove them. We have legal obligations to remove some of our assets, including our nuclear plants, at the end of their useful lives. The fair value of ARO liabilities has been calculated using an expected present value technique. This technique reflects assumptions such as costs, inflation, and profit margin that third parties would consider to assume the settlement of the obligation. Fair value, to the extent possible, should include a market risk premium for unforeseeable circumstances. No market risk premium was included in our ARO fair value estimate since a reasonable estimate could not be made. If a five percent market risk premium were assumed, our ARO liability would increase by $25 million. If a reasonable estimate of fair value cannot be made in the period in which the ARO is incurred, such as for assets with indeterminate lives, the liability is to be recognized when a reasonable estimate of fair value can be made. Generally, electric and gas transmission and distribution assets have indeterminate lives. Retirement cash flows cannot be determined and there is a low probability of a retirement date. Therefore, no liability has been recorded for these assets or associated obligations related to potential future abandonment. Also, no liability has been recorded for assets that have insignificant cumulative disposal costs, such as substation batteries. The measurement of the ARO CMS-58 CMS Energy Corporation liabilities for Palisades and Big Rock are based on decommissioning studies that largely utilize third-party cost estimates. FASB INTERPRETATION NO. 47, ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT OBLIGATIONS: This Interpretation clarified the term "conditional asset retirement obligation" as used in SFAS No. 143. The term refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event. We determined that abatement of asbestos included in our plant investments qualify as a conditional ARO, as defined by FASB Interpretation No. 47. The following tables describe our assets that have legal obligations to be removed at the end of their useful life:
March 31, 2006 In Millions - ---------------------------------------------------------------------------------------------------------------------------- In Service Trust ARO Description Date Long Lived Assets Fund - --------------- ---------- ----------------- ----- Palisades-decommission plant site 1972 Palisades nuclear plant $554 Big Rock-decommission plant site 1962 Big Rock nuclear plant 22 JHCampbell intake/discharge water line 1980 Plant intake/discharge water line - Closure of coal ash disposal areas Various Generating plants coal ash areas - Closure of wells at gas storage fields Various Gas storage fields - Indoor gas services equipment relocations Various Gas meters located inside structures - Asbestos abatement 1973 Electric and gas utility plant - Natural gas-fired power plant 1997 Gas fueled power plant - Close gas treating plant and gas wells Various Gas transmission and storage -
In Millions -------------------------------------------------------------------------------- ARO ARO Liability Cash flow Liability ARO Description 12/31/05 Incurred Settled Accretion Revisions 3/31/06 - --------------- --------- -------- ------- --------- --------- --------- Palisades-decommission $ 375 $ - $ - $ 6 $ - $ 381 Big Rock-decommission 27 - (4) 1 - 24 JHCampbell intake line - - - - - - Coal ash disposal areas 54 - - 1 - 55 Wells at gas storage fields 1 - - - - 1 Indoor gas services relocations 1 - - - - 1 Natural gas-fired power plant 1 - - - - 1 Close gas treating plant and gas wells 1 - - 1 - 2 Asbestos abatement 36 - (2) - - 34 ------ ------- ------ ------ --- ------ Total $ 496 $ - $ (6) $ 9 $ - $ 499 ====== ======= ====== ====== === ======
In October 2004, the MPSC initiated a generic proceeding to review SFAS No. 143, FERC Order No. 631, Accounting, Financial Reporting, and Rate Filing Requirements for Asset Retirement Obligations, and related accounting and ratemaking issues for MPSC-jurisdictional electric and gas utilities. On December 5, 2005, the ALJ issued a proposal for decision recommending that the MPSC dismiss the proceeding. In March 2006, the MPSC remanded the case to the ALJ for findings and recommendations. We consider the proceeding a clarification of accounting and reporting issues that relate to all Michigan utilities. We cannot predict the outcome of the proceeding. CMS-59 CMS Energy Corporation 8: EXECUTIVE INCENTIVE COMPENSATION We provide a Performance Incentive Stock Plan (the Plan) to key employees and non-employee directors based on their contributions to the successful management of the company. The Plan has a five-year term, expiring in May 2009. All grants awarded under the Plan for the three months ended March 31, 2006 and in 2005 were in the form of restricted stock. Restricted stock awards are outstanding shares to which the recipient has full voting and dividend rights and vest 100 percent after three years of continued employment. Restricted stock awards granted to officers in 2005 and 2004 are also subject to the achievement of specified levels of total shareholder return, including a comparison to a peer group of companies. All restricted stock awards are subject to forfeiture if employment terminates before vesting. However, restricted shares may continue to vest upon retirement or disability and vest fully if control of CMS Energy changes, as defined by the Plan. The Plan also allows for the following types of awards: - stock options, - stock appreciation rights, - phantom shares, and - performance units. For the three months ended March 31, 2006 and in 2005, we did not grant any of these types of awards. Select participants may elect to receive all or a portion of their incentive payments under the Officer's Incentive Compensation Plan in the form of cash, shares of restricted common stock, shares of restricted stock units, or any combination of these. These participants may also receive awards of additional restricted common stock or restricted stock units, provided the total value of these additional grants does not exceed $2.5 million for any fiscal year. Shares awarded or subject to stock options, phantom shares, and performance units may not exceed 6 million shares from June 2004 through May 2009, nor may such awards to any participant exceed 250,000 shares in any fiscal year. We may issue awards of up to 4,943,630 shares of common stock under the Plan at March 31, 2006. Shares for which payment or exercise is in cash, as well as shares or stock options that are forfeited, may be awarded or granted again under the Plan. SFAS NO. 123(R) AND SAB NO. 107, SHARE-BASED PAYMENT: SFAS No. 123(R) was effective for us on January 1, 2006. SFAS No. 123(R) requires companies to use the fair value of employee stock options and similar awards at the grant date to value the awards. Companies must expense this value over the required service period of the awards. As a result, future compensation costs for share-based awards with accelerated service provisions upon retirement will need to be fully expensed by the period in which the employee becomes eligible to retire. At January 1, 2006, unrecognized compensation cost for such share-based awards held by retirement-eligible employees was not material. We elected to adopt the modified prospective method recognition provisions of this Statement instead of retrospective restatement. The modified prospective method applies the recognition provisions to all awards granted or modified after the adoption date of this Statement. We adopted the fair value method of accounting for share-based awards effective December 2002. Therefore, SFAS No. 123(R) CMS-60 CMS Energy Corporation did not have a significant impact on our results of operations when it became effective. The SEC issued SAB No. 107 to express the views of the staff regarding the interaction between SFAS No. 123(R) and certain SEC rules and regulations. Also, the SEC issued SAB No. 107 to provide the staff's views regarding the valuation of share-based payments, including assumptions such as expected volatility and expected term. We applied the additional guidance provided by SAB No. 107 upon implementation of SFAS No. 123(R) with no impact on our consolidated results of operations. The following table summarizes restricted stock activity under the Plan:
Weighted- Average Grant Date Fair Restricted Stock Number of Shares Value - ---------------- ---------------- ------------- Nonvested at December 31, 2005 1,682,056 $ 10.64 Granted 5,500 $ 13.21 Vested (a) - - Forfeited (30,000) $ 10.09 --------- ---------- Nonvested at March 31, 2006 1,657,556 $ 10.66 ========= ==========
(a) No shares vested during the three months ended March 31, 2006 and 2005. We calculate the fair value of restricted shares granted based on the price of our common stock on the grant date and expense the fair value over the required service period. Total compensation cost recognized in income related to restricted stock was $1 million for the three months ended March 31, 2006 and 2005. The total related income tax benefit recognized in income was less than $1 million for the three months ended March 31, 2006 and 2005. At March 31, 2006, there was $11 million of total unrecognized compensation cost related to restricted stock. We expect to recognize this cost over a weighted-average period of 2.1 years. The following table summarizes stock option activity under the Plan:
Weighted- Options Weighted- Average Aggregate Outstanding, Average Remaining Intrinsic Fully Vested, Exercise Contractual Value Stock Options and Exercisable Price Term (In Millions) - ------------- --------------- --------- ----------- ------------- Outstanding at December 31, 2005 3,541,338 $ 21.21 5.4 years $ (24) Granted - - Exercised (43,000) $ 6.84 Cancelled or Expired (342,640) $ 30.90 --------- -------- --------- ----- Outstanding at March 31, 2006 3,155,698 $ 20.35 5.4 years $ (23) ========= ======== ========= =====
Stock options give the holder the right to purchase common stock at a price equal to the fair value of our common stock on the grant date. Stock options are exercisable upon grant, and expire up to CMS-61 \ CMS Energy Corporation 10 years and one month from the grant date. We issue new shares when participants exercise stock options. For the three months ended March 31, 2006, the total intrinsic value of stock options exercised was less than $1 million. Cash received from exercise of these stock options was less than $1 million. Since we utilized tax loss carryforwards, we were not able to realize the excess tax benefits upon exercise of stock options. Therefore, we did not recognize the related excess tax benefits in equity. No stock options were exercised for the three months ended March 31, 2005. 9: EQUITY METHOD INVESTMENTS Where ownership is more than 20 percent but less than a majority, we account for certain investments in other companies, partnerships, and joint ventures by the equity method of accounting in accordance with APB Opinion No. 18. Net income from these investments included undistributed earnings of $15 million for the three months ended March 31, 2006 and $2 million for the three months ended March 31, 2005. The most significant of these investments is our 50 percent interest in Jorf Lasfar. Summarized financial information for Jorf Lasfar is as follows: Income Statement Data
In Millions Three Months Ended March 31, 2006 Jorf Lasfar - --------------------------------- ----------- Operating revenue $ 118 Operating expenses 78 ----- Operating income 40 Other expense, net 15 ----- Net income $ 25 =====
Three Months Ended March 31, 2005 Jorf Lasfar - --------------------------------- ----------- Operating revenue $ 130 Operating expenses 83 ----- Operating income 47 Other expense, net 14 ----- Net income $ 33 =====
CMS-62 CMS Energy Corporation 10: REPORTABLE SEGMENTS Our reportable segments consist of business units organized and managed by their products and services. We evaluate performance based upon the net income of each segment. We operate principally in three reportable segments: electric utility, gas utility, and enterprises. The "Other" segment includes corporate interest and other and discontinued operations. The following tables show our financial information by reportable segment:
In Millions ----------------------- Three Months Ended March 31 2006 2005 - --------------------------- ------- ------- Operating Revenues Electric utility $ 729 $ 628 Gas utility 1,041 992 Enterprises 262 225 ------- ------- $ 2,032 $ 1,845 ======= ======= Net Income (Loss) Available to Common Stockholders Electric utility $ 29 $ 33 Gas utility 37 58 Enterprises (49) 105 Other (44) (46) ------- ------- $ (27) $ 150 ======= =======
March 31, 2006 December 31, 2005 -------------- ----------------- Total Assets Electric utility (a) $ 7,864 $ 7,743 Gas utility (a) 3,193 3,600 Enterprises 3,651 4,130 Other 842 547 ------- ------- $15,550 $16,020 ======= =======
(a) Amounts include a portion of Consumers' other common assets attributable to both the electric and gas utility businesses. CMS-63 CMS Energy Corporation (This page intentionally left blank) CMS-64 Consumers Energy Company CONSUMERS ENERGY COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS In this MD&A, Consumers Energy, which includes Consumers Energy Company and all of its subsidiaries, is at times referred to in the first person as "we," "our" or "us." This MD&A has been prepared in accordance with the instructions to Form 10-Q and Item 303 of Regulation S-K. This MD&A should be read in conjunction with the MD&A contained in Consumers Energy's Form 10-K for the year ended December 31, 2005. EXECUTIVE OVERVIEW Consumers, a subsidiary of CMS Energy, a holding company, is a combination electric and gas utility company serving Michigan's Lower Peninsula. Our customer base includes a mix of residential, commercial, and diversified industrial customers, the largest segment of which is the automotive industry. We manage our business by the nature of services each provides and operate principally in two business segments: electric utility and gas utility. Our electric utility operations include the generation, purchase, distribution, and sale of electricity. Our gas utility operations include the purchase, transportation, storage, distribution, and sale of natural gas. We earn our revenue and generate cash from operations by providing electric and natural gas utility services, electric power generation, gas distribution, transmission, and storage, and other energy related services. Our businesses are affected primarily by: - weather, especially during the traditional heating and cooling seasons, - economic conditions, - regulation and regulatory issues, - energy commodity prices, - interest rates, and - our debt credit rating. During the past two years, our business strategy has involved improving our balance sheet and maintaining focus on our core strength: utility operations and service. We are focused on growing the equity base of our company and have been refinancing our debt to reduce interest rate costs. In 2006, we received $200 million of cash contributions from CMS Energy and we extinguished, through a legal defeasance, $129 million of 9 percent related party notes. Working capital and cash flow continue to be a challenge for us. Natural gas prices continue to be volatile and much higher than in recent years. Although our natural gas purchases are recoverable from our utility customers, higher priced natural gas stored as inventory requires additional liquidity due to the lag in cost recovery. In addition to causing working capital issues for us, historically high natural gas prices caused the MCV Partnership to reevaluate the economics of operating the MCV Facility and to record an impairment charge in 2005. While we have fully impaired our ownership interest in the MCV Partnership, continued high gas prices could result in an impairment of our ownership interest in the FMLP. Due to the impairment of the MCV Facility and operating losses from mark-to-market adjustments on derivative instruments, the equity held by Consumers and the minority interest owners in the MCV CE-1 Consumers Energy Company Partnership has decreased significantly and is now negative. As the MCV Partnership recognizes future losses, we will assume an additional 7 percent of the MCV Partnership's negative equity, which is a portion of the limited partners' negative equity, in addition to our proportionate share. Since projected future gas prices continue to threaten the viability of the MCV Facility, we are evaluating various alternatives in order to develop a new long-term strategy with respect to the MCV Facility. The MCV Partnership is working aggressively to reduce costs, improve operations, and enhance cash flows. Going forward, our strategy will continue to focus on: - managing cash flow issues, - maintaining and growing earnings, and - investing in our utility system to enable us to meet our customer commitments, comply with increasing environmental performance standards, and maintain adequate supply and capacity. As we execute our strategy, we will need to overcome a sluggish Michigan economy that has been further hampered by recent negative developments in Michigan's automotive industry and limited growth in the non-automotive sectors of our economy. These negative effects will be offset somewhat by the reduction we are experiencing in ROA load in our service territory. At March 31, 2006, alternative electric suppliers were providing 348 MW of generation service to ROA customers. This is 4 percent of our total distribution load and represents a decrease of 61 percent compared to March 31, 2005. It is, however, difficult to predict future ROA customer trends. FORWARD-LOOKING STATEMENTS AND INFORMATION This Form 10-Q and other written and oral statements that we make contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Our intention with the use of words such as "may," "could," "anticipates," "believes," "estimates," "expects," "intends," "plans," and other similar words is to identify forward-looking statements that involve risk and uncertainty. We designed this discussion of potential risks and uncertainties to highlight important factors that may impact our business and financial outlook. We have no obligation to update or revise forward-looking statements regardless of whether new information, future events, or any other factors affect the information contained in the statements. These forward-looking statements are subject to various factors that could cause our actual results to differ materially from the results anticipated in these statements. Such factors include our inability to predict and/or control: - capital and financial market conditions, including the price of CMS Energy Common Stock, and the effect of such market conditions on the Pension Plan, interest rates, and access to the capital markets, including availability of financing to Consumers, CMS Energy, or any of their affiliates and the energy industry, - market perception of the energy industry, Consumers, CMS Energy, or any of their affiliates, - credit ratings of Consumers, CMS Energy, or any of their affiliates, - factors affecting utility and diversified energy operations such as unusual weather conditions, catastrophic weather-related damage, unscheduled generation outages, maintenance or repairs, environmental incidents, or electric transmission or gas pipeline system constraints, - international, national, regional, and local economic, competitive, and regulatory policies, conditions and developments, CE-2 Consumers Energy Company - adverse regulatory or legal decisions, including those related to environmental laws and regulations, and potential environmental remediation costs associated with such decisions, - potentially adverse regulatory treatment and/or regulatory lag concerning a number of significant questions presently before the MPSC including: - recovery of Clean Air Act costs and other environmental and safety-related expenditures, - power supply and natural gas supply costs when oil prices and other fuel prices are rapidly increasing, - timely recognition in rates of additional equity investments in Consumers, - adequate and timely recovery of additional electric and gas rate-based investments, - adequate and timely recovery of higher MISO energy costs, and - recovery of Stranded Costs incurred due to customers choosing alternative energy suppliers, - the impact of adverse natural gas prices on the MCV Partnership and FMLP investments, the impact of losses at FMLP, regulatory decisions that limit recovery of capacity and fixed energy payments, and our ability to develop a new long-term strategy with respect to the MCV Facility, - if successful in exercising the regulatory out clause of the MCV PPA, the negative impact on the MCV Partnership's financial performance, as well as a triggering of the MCV Partnership's ability to terminate the MCV PPA, and the effects on our ability to purchase capacity to serve our customers and recover the cost of these purchases, - federal regulation of electric sales and transmission of electricity, including periodic re-examination by federal regulators of our market-based sales authorizations in wholesale power markets without price restrictions, - energy markets, including availability of capacity and the timing and extent of changes in commodity prices for oil, coal, natural gas, natural gas liquids, electricity and certain related products due to lower or higher demand, shortages, transportation problems, or other developments, - our ability to collect accounts receivable from our gas customers due to high natural gas prices, - the GAAP requirement that we utilize mark-to-market accounting on certain energy commodity contracts and interest rate swaps, which may have, in any given period, a significant positive or negative effect on earnings, which could change dramatically or be eliminated in subsequent periods and could add to earnings volatility, - the effect on our electric utility of the direct and indirect impacts of the continued economic downturn experienced by our automotive and automotive parts manufacturing customers, - potential disruption or interruption of facilities or operations due to accidents or terrorism, and the ability to obtain or maintain insurance coverage for such events, - nuclear power plant performance, decommissioning, policies, procedures, incidents, and regulation, including the availability of spent nuclear fuel storage, - technological developments in energy production, delivery, and usage, CE-3 Consumers Energy Company - achievement of capital expenditure and operating expense goals, - changes in financial or regulatory accounting principles or policies, - changes in tax laws or new IRS interpretations of existing tax laws, - outcome, cost, and other effects of legal and administrative proceedings, settlements, investigations and claims, - disruptions in the normal commercial insurance and surety bond markets that may increase costs or reduce traditional insurance coverage, particularly terrorism and sabotage insurance and performance bonds, - other business or investment considerations that may be disclosed from time to time in Consumers' or CMS Energy's SEC filings, or in other publicly issued written documents, and - other uncertainties that are difficult to predict, and many of which are beyond our control. For additional information regarding these and other uncertainties, see the "Outlook" section included in this MD&A, Note 2, Contingencies, and Part II, Item 1A. Risk Factors. RESULTS OF OPERATIONS NET INCOME AVAILABLE TO COMMON STOCKHOLDER
In Millions --------------------------------- Three months ended March 31 2006 2005 Change - --------------------------- ----- ----- ------ Electric $ 29 $ 33 $ (4) Gas 37 58 (21) Other (Includes MCV Partnership interest) (56) 66 (122) ----- ----- ----- Net income available to common stockholder $ 10 $ 157 $(147) ===== ===== =====
For the three months ended March 31, 2006, net income available to our common stockholder was $10 million, compared to $157 million for the three months ended March 31, 2005. The decrease reflects mark-to-market losses in 2006 on certain long-term gas contracts and associated financial hedges at the MCV Partnership compared to mark-to-market gains in 2005. The decrease also reflects a reduction in net income from our gas utility due to lower, weather-driven sales, and higher operating and maintenance costs at our electric utility. Partially offsetting these losses are higher electric utility revenues primarily due to an electric rate increase authorized in December 2005. CE-4 Consumers Energy Company Specific changes to net income available to our common stockholder for 2006 versus 2005 are:
In Millions ----------- - - decrease in earnings from our ownership interest in the MCV Partnership primarily due to a decrease in the fair value of certain long-term gas contracts and financial hedges, $ (125) - - increase in operating expenses primarily due to higher depreciation and amortization expense, higher electric maintenance expense, and higher customer service expense, (44) - - decrease in gas delivery revenue primarily due to warmer weather, (20) - - decrease in return on electric utility capital expenditures in excess of depreciation base as allowed by the Customer Choice Act, (8) - - increase in electric delivery revenue primarily due to the MPSC's December 2005 electric rate order, 38 - - increase in earnings due to the expiration of rate caps that, in 2005, would not allow us to fully recover our power supply costs from our residential customers, and 6 - - increase in other income and interest charges. 6 ------- Total Change $ (147) =======
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions -------------------------- March 31 2006 2005 Change - -------- ---- ---- ------ Three months ended $29 $33 $ (4) Reasons for the change: Electric deliveries $ 59 Power supply costs and related revenue 9 Other operating expenses, other income and non-commodity revenue (59) Regulatory return on capital expenditures (13) Interest charges 1 Income taxes (1) ------ Total change $ (4) ======
ELECTRIC DELIVERIES: Electric deliveries decreased 0.1 billion kWh or 1.6 percent in the first quarter of 2006 versus 2005 primarily due to warmer weather. Despite lower electric deliveries, electric delivery revenue increased primarily due to an electric rate order, increased surcharge revenue, and the return to full-service rates of customers previously using an alternative energy supplier. In December 2005, the MPSC issued an order authorizing an annual rate increase of $86 million for service rendered on and after January 11, 2006. As a result of this order, electric delivery revenues increased $20 million in the first quarter of 2006 versus 2005. Effective January 1, 2006, we started collecting a surcharge that the MPSC authorized under Section 10d(4) of the Customer Choice Act. This surcharge increased electric delivery revenue by $11 million in the first quarter of 2006 versus 2005. In addition, on January 1, 2006, we began recovering customer CE-5 Consumers Energy Company choice transition costs from our residential customers, thereby increasing electric delivery revenue by another $3 million in 2006 versus 2005. The Customer Choice Act allows all of our electric customers to buy electric generation service from us or from an alternative electric supplier. At March 31, 2006, alternative electric suppliers were providing 348 MW of generation service to ROA customers. This amount represents a decrease of 61 percent compared to March 31, 2005. The return of former ROA customers to full-service rates increased electric revenues $13 million in the first quarter of 2006 versus 2005. POWER SUPPLY COSTS AND RELATED REVENUE: In 2005, power supply costs exceeded power supply revenue due to rate caps for our residential customers. Our inability to recover fully these power supply costs resulted in a $9 million reduction to electric pretax income. Rate caps for our residential customers expired on December 31, 2005. The absence of rate caps allows us to record power supply revenue to offset fully our power supply costs in 2006. OTHER OPERATING EXPENSES, OTHER INCOME AND NON-COMMODITY REVENUE: In the first quarter of 2006, other operating expenses increased $62 million, other income increased $5 million, and non-commodity revenue decreased $2 million versus 2005. The increase in other operating expenses reflects higher operating and maintenance expense, customer service expense, depreciation and amortization expense, and pension and benefit expense. Operating and maintenance expense increased primarily due to costs related to a planned refueling outage at our Palisades nuclear plant, and higher overhead line maintenance and $7 million of storm restoration costs. Higher customer service expense reflects contributions, which started in January 2006 pursuant to a December 2005 MPSC order, to a fund that provides energy assistance to low-income customers. Depreciation and amortization expense increased due to higher plant in service and greater amortization of certain regulatory assets. Pension and benefit expense reflects changes in actuarial assumptions and the latest collective bargaining agreement between the Utility Workers Union of America and Consumers. The increase in other income is primarily due to the absence, in 2006, of expenses recorded in 2005 associated with the early retirement of debt. The decrease in non-commodity revenue is primarily due to lower revenue from services provided to METC in 2006 versus 2005. REGULATORY RETURN ON CAPITAL EXPENDITURES: The $13 million decrease is due to lower income associated with recording a return on capital expenditures in excess of our depreciation base as allowed by the Customer Choice Act. In December 2005, the MPSC issued an order that authorized us to recover $333 million of Section 10d(4) costs. The order authorized recovery of a lower level of costs versus the level used to record 2005 income. INTEREST CHARGES: In the first quarter of 2006 versus 2005, interest charges decreased due to lower average debt levels and a 13 basis point reduction in the average interest rate. INCOME TAXES: In the first quarter of 2006, income taxes increased versus 2005 primarily due to the adjustment of certain deferred tax balances. CE-6 Consumers Energy Company GAS UTILITY RESULTS OF OPERATIONS
In Millions ------------------------- March 31 2006 2005 Change - -------- ---- ---- ------ Three months ended $37 $58 $ (21) Reasons for the change: Gas deliveries $ (31) Gas wholesale and retail services, other gas revenue and other income 5 Operation and maintenance (3) Depreciation and other deductions (3) Income taxes 11 ------- Total change $ (21) =======
GAS DELIVERIES: In the first quarter of 2006 versus 2005, gas deliveries, including miscellaneous transportation to end-use customers, decreased 21.9 bcf or 15.1 percent. The decrease in gas deliveries is primarily due to warmer weather in the first quarter of 2006 versus 2005 and increased conservation efforts in response to higher gas prices. Average temperatures in the first quarter of 2006 were 16.7 percent warmer than the same period last year. GAS WHOLESALE AND RETAIL SERVICES, OTHER GAS REVENUE AND OTHER INCOME: In the first quarter of 2006 versus 2005, the $5 million increase is related primarily to increased gas wholesale and retail services revenue. OPERATION AND MAINTENANCE: In the first quarter of 2006, operation and maintenance expenses increased versus 2005 primarily due to higher pension and benefit expense and customer service expense. Pension and benefit expense reflects changes in actuarial assumptions and the latest collective bargaining agreement between the Utility Workers Union of America and Consumers. Customer service expense increased primarily due to higher uncollectible accounts expense. DEPRECIATION AND OTHER DEDUCTIONS: In the first quarter of 2006, depreciation expense increased versus 2005 primarily due to higher plant in service. INCOME TAXES: In the first quarter of 2006, income taxes decreased versus 2005 primarily due to lower earnings by the gas utility. OTHER RESULTS OF OPERATIONS
In Millions ------------------------------ March 31 2006 2005 Change - -------- ---- ---- ------- Three months ended $(56) $ 66 $ (122)
In the first quarter of 2006, other operations net loss was $56 million, a decrease of $122 million versus 2005. The change is primarily due to a $125 million decrease in earnings from our ownership interest in CE-7 Consumers Energy Company the MCV Partnership, primarily due to mark-to-market losses in 2006 on certain long-term gas contracts and associated financial hedges at the MCV Partnership, compared to mark-to-market gains on these contracts in 2005. CRITICAL ACCOUNTING POLICIES The following accounting policies are important to an understanding of our results of operations and financial condition and should be considered an integral part of our MD&A. USE OF ESTIMATES AND ASSUMPTIONS In preparing our financial statements, we use estimates and assumptions that may affect reported amounts and disclosures. We use accounting estimates for asset valuations, depreciation, amortization, financial and derivative instruments, employee benefits, and contingencies. For example, we estimate the rate of return on plan assets and the cost of future health-care benefits to determine our annual pension and other postretirement benefit costs. There are risks and uncertainties that may cause actual results to differ from estimated results, such as changes in the regulatory environment, competition, regulatory decisions, and lawsuits. CONTINGENCIES: We are involved in various regulatory and legal proceedings that arise in the ordinary course of our business. We record a liability for contingencies based upon our assessment that a loss is probable and the amount of loss can be reasonably estimated. The recording of estimated liabilities for contingencies is guided by the principles in SFAS No. 5. We consider many factors in making these assessments, including the history and specifics of each matter. Significant contingencies are discussed in the "Outlook" section included in this MD&A. ACCOUNTING FOR FINANCIAL AND DERIVATIVE INSTRUMENTS AND MARKET RISK INFORMATION FINANCIAL INSTRUMENTS: We account for investments in debt and equity securities using SFAS No. 115. For additional details on accounting for financial instruments, see Note 4, Financial and Derivative Instruments. DERIVATIVE INSTRUMENTS: We use the criteria in SFAS No. 133 to determine if certain contracts must be accounted for as derivative instruments. Except as noted within this section, there have been no material changes to the accounting for derivative instruments since the year ended December 31, 2005. For additional details on accounting for derivatives, see Note 4, Financial and Derivative Instruments. To determine the fair value of our derivatives, we use information from external sources (i.e., quoted market prices and third-party valuations), if available. For certain contracts, this information is not available and we use mathematical valuation models to value our derivatives. These models require various inputs and assumptions, including commodity market prices and volatilities, as well as interest rates and contract maturity dates. Changes in forward prices or volatilities could significantly change the calculated fair value of our derivative contracts. The cash returns we actually realize on these contracts may vary, either positively or negatively, from the results that we estimate using these models. As part of valuing our derivatives at market, we maintain reserves, if necessary, for credit risks arising from the financial condition of counterparties. CE-8 Consumers Energy Company The following table summarizes the interest rate and volatility rate assumptions we used to value these contracts at March 31, 2006:
Interest Rates (%) Volatility Rates (%) ------------------ -------------------- Long-term gas contracts associated with the MCV Partnership 4.83 - 5.34 28 - 50
Establishment of the Midwest Energy Market: In 2005, the MISO began operating the Midwest Energy Market. As a result, the MISO now centrally dispatches electricity and transmission service throughout much of the Midwest and provides day-ahead and real-time energy market information. At this time, we believe that the establishment of this market does not represent the development of an active energy market in Michigan, as defined by SFAS No. 133. However, as the Midwest Energy Market matures, we will continue to monitor its activity level and evaluate whether or not an active energy market may exist in Michigan. If an active market develops in the future, some of our electric purchases and sales contracts may qualify as derivatives. However, we believe that we will be able to apply the normal purchases and sales exception of SFAS No. 133 to these contracts and, therefore, will not be required to mark these contracts to market. Implementation of the RCP: As a result of implementing the RCP in 2005, a significant portion of the MCV Partnership's long-term gas contracts no longer qualify as normal purchases because the gas will not be used to generate electricity or steam. Accordingly, these contracts are accounted for as derivatives, with changes in fair value recorded in earnings each quarter. Additionally, certain of the MCV Partnership's natural gas futures and swap contracts, which are used to hedge variable-priced long-term gas contracts, no longer qualify for cash flow hedge accounting and we record any changes in their fair value in earnings each quarter. As a result of recording the changes in fair value of these long-term gas contracts and the related futures and swaps to earnings, the MCV Partnership has recognized a $156 million loss for the three months ended March 31, 2006. This loss is before consideration of tax effects and minority interest and is included in the total Fuel costs mark-to-market at MCV on our Consolidated Statements of Income. Because of the volatility of the natural gas market, the MCV Partnership expects future earnings volatility on both its long-term gas contracts and its futures, options, and swap contracts, since gains and losses will be recorded each quarter. We have recorded derivative assets totaling $100 million associated with the fair value of these contracts on our Consolidated Balance Sheets at March 31, 2006. We expect almost all of these assets, which represent cumulative net mark-to-market gains, to reverse as losses through earnings during 2006 and 2007 as the gas is purchased and the futures, options, and swaps settle, with the remainder reversing between 2008 and 2011. Due to the impairment of the MCV Facility and subsequent losses, the value of the equity held by all of the owners of the MCV Partnership has decreased significantly and is now negative. Since we are one of the general partners of the MCV Partnership, we have recognized a portion of the limited partners' negative equity. As the MCV Partnership recognizes future losses from the reversal of these derivative assets, we will continue to assume a portion of the limited partners' share of those losses, in addition to our proportionate share. MARKET RISK INFORMATION: The following is an update of our risk sensitivities since December 31, 2005. These sensitivities indicate the potential loss in fair value, cash flows, or future earnings from our financial instruments, including our derivative contracts, assuming a hypothetical adverse change in market rates or prices of 10 percent. Changes in excess of the amounts shown in the sensitivity analyses could occur if changes in market rates or prices exceed the 10 percent shift used for the analyses. CE-9 Consumers Energy Company Interest Rate Risk Sensitivity Analysis (assuming an adverse change in market interest rates of 10 percent):
In Millions --------------------------------------- March 31, 2006 December 31, 2005 -------------- ----------------- Variable-rate financing - before tax annual earnings exposure $ 1 $ 3 Fixed-rate financing - potential REDUCTION in fair value (a) 148 149
(a) Fair value exposure could only be realized if we repurchased all of our fixed-rate financing. Commodity Price Risk Sensitivity Analysis (assuming an adverse change in market prices of 10 percent):
In Millions -------------------------------------- March 31, 2006 December 31, 2005 -------------- ----------------- Potential REDUCTION in fair value: Gas supply option contracts $ - $ 1 Derivative contracts associated with the MCV Partnership: Long-term gas contracts 26 39 Gas futures, options, and swaps 41 48
Investment Securities Price Risk Sensitivity Analysis (assuming an adverse change in market prices of 10 percent):
In Millions --------------------------------------- March 31, 2006 December 31, 2005 -------------- ----------------- Potential REDUCTION in fair value of available-for-sale equity securities (SERP investments and investments in CMS Energy common stock) $ 5 $ 6
We maintain trust funds, as required by the NRC, for the purpose of funding certain costs of nuclear plant decommissioning. At March 31, 2006 and December 31, 2005, these funds were invested primarily in equity securities, fixed-rate, fixed-income debt securities, and cash and cash equivalents, and are recorded at fair value on our Consolidated Balance Sheets. These investments are exposed to price fluctuations in equity markets and changes in interest rates. Because the accounting for nuclear plant decommissioning recognizes that costs are recovered through our electric rates, fluctuations in equity prices or interest rates do not affect our consolidated earnings or cash flows. For additional details on market risk and derivative activities, see Note 4, Financial and Derivative Instruments. OTHER Other accounting policies important to an understanding of our results of operations and financial condition include: - accounting for long-lived assets and equity method investments, - accounting for the effects of industry regulation, - accounting for pension and OPEB, - accounting for asset retirement obligations, CE-10 Consumers Energy Company - accounting for nuclear decommissioning costs, and - accounting for related party transactions. These accounting policies were disclosed in our 2005 Form 10-K and there have been no material changes. CAPITAL RESOURCES AND LIQUIDITY Factors affecting our liquidity and capital requirements are: - results of operations, - capital expenditures, - energy commodity costs, - contractual obligations, - regulatory decisions, - debt maturities, - credit ratings, - working capital needs, and - collateral requirements. During the summer months, we purchase natural gas and store it for resale primarily during the winter heating season. Although our prudent natural gas purchases are recoverable from our customers, the amount paid for natural gas stored as inventory requires additional liquidity due to the timing of the cost recoveries. We have credit agreements with our commodity suppliers and those agreements contain terms that have resulted in margin calls. Additional margin calls or other credit support may be required if agency ratings are lowered or if market conditions remain unfavorable relative to our obligations to those parties. Our current financial plan includes controlling operating expenses and capital expenditures and evaluating market conditions for financing opportunities. Due to the adverse impact of the MCV Partnership asset impairment charge recorded in 2005, our ability to issue FMB as primary obligations or as collateral for financing is expected to be limited to $298 million through September 30, 2006. After September 30, 2006, our ability to issue FMB in excess of $298 million is based on achieving a two-times FMB interest coverage ratio. We believe the following items will be sufficient to meet our liquidity needs: - our current level of cash and revolving credit facilities, - our ability to access junior secured and unsecured borrowing capacity in the capital markets, and - our anticipated cash flows from operating and investing activities. CASH POSITION, INVESTING, AND FINANCING Our operating, investing, and financing activities meet consolidated cash needs. At March 31, 2006, $508 million consolidated cash was on hand, which includes $55 million of restricted cash and $234 million from entities consolidated pursuant to FASB Interpretation No. 46(R). CE-11 Consumers Energy Company SUMMARY OF CONSOLIDATED STATEMENTS OF CASH FLOWS:
In Millions --------------------- Three Months Ended March 31 2006 2005 - --------------------------- ------ ------ Net cash provided by (used in): Operating activities $ 75 $ 321 Investing activities (29) (152) ------ ------ Net cash provided by operating and investing activities 46 169 Financing activities (9) 178 ------ ------ Net Increase in Cash and Cash Equivalents $ 37 $ 347 ====== ======
OPERATING ACTIVITIES: For the three months ended March 31, 2006, net cash provided by operating activities was $75 million, a decrease of $246 million versus 2005. This decrease was due to the timing of payments for higher priced gas used during the heating season and an income tax payment partially related to an IRS ruling regarding the "simplified service cost" method of tax accounting. INVESTING ACTIVITIES: For the three months ended March 31, 2006, net cash used in investing activities was $29 million, a decrease of $123 million versus 2005. This decrease was due to the release of restricted cash in February 2006, which we used to extinguish long-term debt - related parties. FINANCING ACTIVITIES: For the three months ended March 31, 2006, net cash used in financing activities was $9 million, an increase of $187 million versus 2005. This increase was primarily due to the absence of refinancing activity and the extinguishment of the current portion of long-term debt - related parties. This increase was offset by a decrease in payments of common stock dividends of $78 million. For additional details on long-term debt activity, see Note 3, Financings and Capitalization. OBLIGATIONS AND COMMITMENTS DIVIDEND RESTRICTIONS: For details on dividend restrictions, see Note 3, Financings and Capitalization. OFF-BALANCE SHEET ARRANGEMENTS: We enter into various arrangements in the normal course of business to facilitate commercial transactions with third parties. These arrangements include indemnifications, letters of credit and surety bonds. For details on guarantee arrangements, see Note 2, Contingencies, "Other Contingencies -FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." REVOLVING CREDIT FACILITIES: For details on revolving credit facilities, see Note 3, Financings and Capitalization. SALE OF ACCOUNTS RECEIVABLE: For details on the sale of accounts receivable, see Note 3, Financings and Capitalization. CE-12 Consumers Energy Company OUTLOOK ELECTRIC BUSINESS OUTLOOK GROWTH: Summer 2005 temperatures were higher than historical averages, leading to increased demand from electric customers. In 2006, we project electric deliveries will decline less than one percent from 2005 levels. This short-term outlook assumes a stabilizing economy and normal weather conditions throughout the remainder of the year. Over the next five years, we expect electric deliveries to grow at an average rate of about one and one-half percent per year. However, such growth is dependent on a modestly growing customer base and a stabilizing Michigan economy. This growth rate includes both full-service sales and delivery service to customers who choose to buy generation service from an alternative electric supplier, but excludes transactions with other wholesale market participants and other electric utilities. This growth rate reflects a long-range expected trend of growth. Growth firm year to year may vary from this trend due to customer response to fluctuations in weather conditions and changes in economic conditions, including utilization and expansion or contraction of manufacturing facilities. ELECTRIC RESERVE MARGIN: We are planning for a reserve margin of approximately 11 percent for summer 2006, or supply resources equal to 111 percent of projected firm summer peak load. Of the 2006 supply resources target of 111 percent, we expect to meet approximately 97 percent from our electric generating plants and long-term power purchase contracts, and approximately 14 percent from other contractual arrangements. Through a combination of owned capacity and purchases, we have supply resources in place to cover approximately 110 percent of the projected firm summer peak load for 2006. We have purchased capacity and energy contracts covering partially the estimated reserve margin requirements for 2007 through 2010. As a result, we have recognized an asset of $72 million for unexpired capacity and energy contracts at March 31, 2006. ELECTRIC TRANSMISSION EXPENSES: The METC, which provides electric transmission service to us, increased substantially the transmission rates it charges us in 2006. The increased rates are subject to refund and to reduction based on the outcome of hearings at the FERC scheduled for September 2006. We are attempting to recover these costs through our 2006 PSCR plan case. In December 2005, the MPSC issued an order that temporarily excluded a portion of the increased costs from our 2006 PSCR charge. In April 2006, the MPSC Staff filed briefs in the 2006 PSCR case recommending that the MPSC approve recovery of all filed costs, including those temporarily excluded in the December 2005 order. The PSCR process allows recovery of all reasonable and prudent power supply costs. However, we cannot predict when full recovery of these transmission costs will commence. To the extent that we incur and are unable to collect these increased costs in a timely manner, our cash flows from electric utility operations will be affected negatively. For additional details, see Note 2, Contingencies, "Electric Rate Matters - Power Supply Costs." INDUSTRIAL REVENUE OUTLOOK: Our electric utility customer base includes a mix of residential, commercial, and diversified industrial customers, the largest segment of which is the automotive industry. In November 2005, General Motors Corporation, a large industrial customer of Consumers, announced plans to reduce certain manufacturing operations in Michigan. However, since the targeted operations are outside of our service territory, we do not anticipate a significant impact on electric utility revenue. In March 2006, Delphi Corporation, also a large industrial customer of Consumers, announced plans to sell or close all but one of their manufacturing operations in Michigan as part of their bankruptcy restructuring. Our electric utility operations are not dependent upon a single customer, or even a few customers, and customers in the automotive sector constitute 4 percent of our total electric revenue. In addition, returning industrial customers will benefit our electric utility revenue. However, we cannot predict the impact of these restructuring plans or possible future actions by other industrial customers. CE-13 Consumers Energy Company THE ELECTRIC CAPACITY NEED FORUM: In January 2006, the MPSC Staff issued a report on future electric capacity in the state of Michigan. The report indicated that existing generation resources are adequate in the short term, but could be insufficient to maintain reliability standards by 2009. The report also indicated that new coal-fired baseload generation may be needed by 2011. The MPSC Staff recommended an approval and bid process for new power plants. To address revenue stability risks, the Staff also recommended a special reliability charge a utility would assess on all electric distribution customers. In April 2006, the governor of Michigan issued an executive directive calling for the development of a comprehensive energy plan for the state of Michigan. The directive calls for the Chairman of the MPSC, working in cooperation with representatives from the public and private sectors, to make recommendations on Michigan's energy policy by the end of 2006. We will continue to participate as the MPSC addresses future electric capacity needs. ELECTRIC BUSINESS UNCERTAINTIES Several electric business trends or uncertainties may affect our financial results and condition. These trends or uncertainties have, or we reasonably expect could have, a material impact on revenues or income from continuing electric operations. ELECTRIC ENVIRONMENTAL ESTIMATES: Our operations are subject to environmental laws and regulations. Costs to operate our facilities in compliance with these laws and regulations generally have been recovered in customer rates. Clean Air: Compliance with the federal Clean Air Act and resulting regulations has been, and will continue to be, a significant focus for us. The Nitrogen Oxide State Implementation Plan requires significant reductions in nitrogen oxide emissions. To comply with the regulations, we expect to incur capital expenditures totaling $819 million. As of March 2006, we incurred $616 million in capital expenditures to comply with the federal Clean Air Act and resulting regulations and anticipate that the remaining $203 million of capital expenditures will be made in 2006 through 2011. In addition to modifying coal-fired electric generating plants, our compliance plan includes the use of nitrogen oxide emission allowances until all of the control equipment is operational in 2011. The nitrogen oxide emission allowance annual expense is projected to be $6 million per year, which we expect to recover from our customers through the PSCR process. The allowances and their costs are accounted for as inventory. The allowance inventory is expensed at the rolling average cost as the coal-fired electric generating plants emit nitrogen oxide. In March 2005, the EPA adopted the Clean Air Interstate Rule that requires additional coal-fired electric generating plant emission controls for nitrogen oxides and sulfur dioxide. The rule involves a two-phase program to reduce emissions of nitrogen oxides by 63 percent and sulfur dioxide by 71 percent from 2003 levels by 2015. We plan to meet this rule by year round operations of our selective catalytic control technology units to meet nitrogen oxide targets and installation of flue gas desulfurization scrubbers at an estimated cost of $960 million. Also in March 2005, the EPA issued the Clean Air Mercury Rule, which requires initial reductions of mercury emissions from coal-fired electric generating plants by 2010 and further reductions by 2018. The Clean Air Mercury Rule establishes a cap-and-trade system for mercury emissions that is similar to the system used in the Clean Air Interstate Rule. The industry has not reached a consensus on the technical methods for curtailing mercury emissions. However, we anticipate our capital and operating costs for mercury emissions reductions required by the Clean Air Mercury Rule to be significantly less than what was required for selective catalytic reduction technology used for nitrogen oxide compliance. CE-14 Consumers Energy Company In April 2006, Michigan's governor announced a plan that would result in mercury emissions reductions of 90 percent by 2015. This plan adopts the Federal Clean Air Mercury Rule through its first phase, which ends in 2010. After the year 2010, the mercury emissions reduction standards outlined in the governor's plan become more stringent than those included in the Federal Clean Air Mercury Rule. If implemented as proposed, we anticipate the costs to comply with the governor's plan will exceed Federal Clean Air Mercury Rule compliance costs. We will work with the MDEQ on the details of these rules. Several legislative proposals 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 of these rules and their effect on our operations and financial results. To the extent that greenhouse gas emission reduction rules come into effect, the mandatory emissions reduction requirements could have far-reaching and significant implications for the energy sector. We cannot estimate the potential effect of federal or state level greenhouse gas policy on our future consolidated results of operations, cash flows, or financial position due to the uncertain nature of the policies at this time. However, we stay abreast of greenhouse gas policy developments and will continue to assess and respond to their potential implications on our business operations. Water: In March 2004, the EPA issued rules that govern electric generating plant cooling water intake systems. The rules require significant reduction in fish killed by operating equipment. Some of our facilities will be required to comply with the new rules by 2007. We are performing the required studies to determine the most cost-effective solutions for compliance. For additional details on electric environmental matters, see Note 2, Contingencies, "Electric Contingencies - Electric Environmental Matters." COMPETITION AND REGULATORY RESTRUCTURING: The Customer Choice Act allows all of our electric customers to buy electric generation service from us or from an alternative electric supplier. At March 31, 2006, alternative electric suppliers were providing 348 MW of generation service to ROA customers. This is 4 percent of our total distribution load and represents a decrease of 61 percent compared to March 31, 2005. It is difficult to predict future ROA customer trends. Section 10d(4) Regulatory Assets: In December 2005, the MPSC issued an order that authorized us to recover $333 million in Section 10d(4) costs. Instead of collecting these costs evenly over five years, the order instructed us to collect 10 percent of the regulatory asset total in the first year, 15 percent in the second year, and 25 percent in the third, fourth, and fifth years. In January 2006, we filed a petition for rehearing with the MPSC that disputed the aspect of the order dealing with the timing of our collection of these costs. In April 2006, the MPSC issued an order that denied our petition for rehearing. Through and Out Rates: In December 2004, we began paying a transitional charge pursuant to a FERC order eliminating regional "through and out" rates. Although the transitional charge ended in March 2006, there are hearings scheduled for May 2006 at the FERC to discuss these charges. These hearings could result in refunds or additional transitional charges to us. In April 2006, we filed an agreement with the FERC between the PJM RTO transmission owners and Consumers concerning these transitional charges. If approved by the FERC, the agreement would resolve all issues regarding transitional charges for Consumers and eliminate the potential for refunds or additional transitional charges to Consumers. We cannot predict the outcome of this matter. For additional details and material changes relating to the restructuring of the electric utility industry and electric rate matters, see Note 2, Contingencies, "Electric Restructuring Matters," and "Electric Rate Matters." CE-15 Consumers Energy Company OTHER ELECTRIC BUSINESS UNCERTAINTIES MCV UNDERRECOVERIES: The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990. We hold a 49 percent partnership interest in the MCV Partnership, and a 35 percent lessor interest in the MCV Facility. Under the MCV PPA, variable energy payments to the MCV Partnership are based on the cost of coal burned at our coal plants and our operation and maintenance expenses. However, the MCV Partnership's costs of producing electricity are tied to the cost of natural gas. Natural gas prices have increased substantially in recent years and throughout 2005. In 2005, the MCV Partnership reevaluated the economics of operating the MCV Facility and recorded an impairment charge. If natural gas prices remain at present levels or increase, the operations of the MCV Facility would be adversely affected and could result in the MCV Partnership failing to meet its obligations under the sale and leaseback transactions and other contracts. We are evaluating various alternatives in order to develop a new long-term strategy with respect to the MCV Facility. Further, the cost that we incur under the MCV PPA exceeds the recovery amount allowed by the MPSC. As a result, we estimate cash underrecoveries of capacity and fixed energy payments of $55 million in 2006 and $39 million in 2007. However, Consumers' direct savings from the RCP, after allocating a portion to customers, are used to offset a portion of our capacity and fixed energy underrecoveries expense. After September 15, 2007, we expect to claim relief under the regulatory out provision in the MCV PPA, thereby limiting our capacity and fixed energy payments to the MCV Partnership to the amounts that we collect from our customers. The effect of any such action would be to: - reduce cash flow to the MCV Partnership, which could have an adverse effect on the MCV Partnership's financial performance, and - eliminate our underrecoveries of capacity and fixed energy payments. The MCV Partnership has indicated that it may take issue with our exercise of the regulatory out clause after September 15, 2007. We believe that the clause is valid and fully effective, but cannot assure that it will prevail in the event of a dispute. If we are successful in exercising the regulatory out clause, the MCV Partnership has the right to terminate the MCV PPA. The MPSC's future actions on the capacity and fixed energy payments recoverable from customers subsequent to September 15, 2007 may affect negatively the financial performance of the MCV Partnership. If the MCV Partnership terminates the MCV PPA, we would be required to replace the lost capacity to maintain an adequate electric reserve margin. This could involve entering into a new PPA and / or entering into electric capacity contracts on the open market. We cannot predict our ability to enter into such contracts at a reasonable price. We are also unable to predict regulatory approval of the terms and conditions of such contracts, or that the MPSC would allow full recovery of our incurred costs. For additional details on the MCV Partnership, see Note 2, Contingencies, "Other Electric Contingencies - The Midland Cogeneration Venture." NUCLEAR MATTERS: Big Rock: Decommissioning of the site is nearing completion. Demolition of the last remaining plant structure, the containment building, and removal of remaining underground utilities and temporary office structures is expected to be completed by the summer of 2006. Final radiological surveys will then be completed to ensure that the site meets all requirements for free, unrestricted release in accordance with the NRC approved License Termination Plan (LTP) for the project. We anticipate NRC approval to return approximately 475 acres of the site, including the area formerly occupied by the nuclear plant, to a natural setting for unrestricted use by early 2007. We expect another area of approximately 105 acres encompassing the Big Rock Independent Spent Fuel Storage Installation (ISFSI), where eight CE-16 Consumers Energy Company casks loaded with spent fuel and other high-level radioactive material are stored, to be returned to a natural state within approximately two years from the date the DOE finishes removing the spent fuel from Big Rock also in accordance with the LTP. Palisades: The amount of spent nuclear fuel at Palisades exceeds the plant's temporary onsite wet storage pool capacity. We are using dry casks for temporary onsite dry storage to supplement the wet storage pool capacity. As of March 2006, we have loaded 29 dry casks with spent nuclear fuel. Palisades' current license from the NRC expires in 2011. In March 2005, the NMC, which operates the Palisades plant, applied for a 20-year license renewal for the plant on behalf of Consumers. We expect a decision from the NRC on the license renewal application in 2007. In December 2005, we announced plans to sell the Palisades nuclear plant and enter into a long-term power purchase agreement with the new owner. Subject to review of the terms that are realized through a bidding process, we believe a sale is the best option for our company, as it will reduce risk and improve cash flow while retaining the benefits of the plant for customers. The Palisades sale will use a competitive bid process, providing interested companies certain options to bid on the plant, as well as the related decommissioning liabilities and trust funds assets, and spent nuclear fuel at Palisades and Big Rock. Any sale will be subject to various approvals, including regulatory approvals of a long-term contract for us to purchase power from the plant, and various other contingencies. We expect to complete the sale in 2007. For additional details on nuclear plant decommissioning at Big Rock and Palisades, see Note 2, Contingencies, "Other Electric Contingencies - Nuclear Plant Decommissioning." GAS BUSINESS OUTLOOK GROWTH: In 2006, we project gas deliveries will decline by four percent, on a weather-adjusted basis, from 2005 levels due to increased conservation and overall economic conditions in the State of Michigan. Over the next five years, we expect gas deliveries to be relatively flat. Actual gas deliveries in future periods may be affected by: - fluctuations in weather patterns, - use by independent power producers, - competition in sales and delivery, - changes in gas commodity prices, - Michigan economic conditions, - the price of competing energy sources or fuels, and - gas consumption per customer. GAS BUSINESS UNCERTAINTIES Several gas business trends or uncertainties may affect our future financial results and financial condition. These trends or uncertainties could have a material impact on revenues or income from gas operations. GAS ENVIRONMENTAL ESTIMATES: We expect to incur investigation and remedial action costs at a number of sites, including 23 former manufactured gas plant sites. For additional details, see Note 2, Contingencies, "Gas Contingencies - Gas Environmental Matters." GAS COST RECOVERY: The GCR process is designed to allow us to recover all of our purchased natural gas costs if incurred under reasonable and prudent policies and practices. The MPSC reviews these costs, CE-17 Consumers Energy Company policies, and practices for prudency in annual plan and reconciliation proceedings. For additional details on gas cost recovery, see Note 2, Contingencies, "Gas Rate Matters - Gas Cost Recovery." 2001 GAS DEPRECIATION CASE: In October and December 2004, the MPSC issued Opinions and Orders in our gas depreciation case, which: - reaffirmed the previously-ordered $34 million reduction in our depreciation expense, - required us to undertake a study to determine why our plant removal costs are in excess of other regulated Michigan natural gas utilities, and - required us to file a study report with the MPSC Staff on or before December 31, 2005. We filed the study report with the MPSC Staff on December 29, 2005. We are also required to file our next gas depreciation case within 90 days after the MPSC issuance of a final order in the pending case related to ARO accounting. We cannot predict when the MPSC will issue a final order in the ARO accounting case. If the depreciation case order is issued after the gas general rate case order, we proposed to incorporate its results into the gas general rates using a surcharge mechanism. 2005 GAS RATE CASE: In July 2005, we filed an application with the MPSC seeking a 12 percent authorized return on equity along with a $132 million annual increase in our gas delivery and transportation rates. As part of this filing, we also requested interim rate relief of $75 million. The MPSC Staff and intervenors filed interim rate relief testimony on October 31, 2005. In its testimony, the MPSC Staff recommended granting interim rate relief of $38 million. In February 2006, the MPSC Staff recommended granting final rate relief of $62 million. The MPSC Staff proposed that $17 million of this amount be contributed to a low income energy efficiency fund. The MPSC Staff also recommended reducing our return on common equity to 11.15 percent, from our current 11.4 percent. In March 2006, the MPSC Staff revised its recommended final rate relief to $71 million. As of April 2006, the MPSC has not acted on our interim or final rate relief requests. In April 2006, we revised our request for final rate relief downward to $118 million. OTHER OUTLOOK MCV PARTNERSHIP NEGATIVE EQUITY: Due to the impairment of the MCV Facility and operating losses from mark-to-market adjustments on derivative instruments, the value of the equity held by Consumers and by all of the owners of the MCV Partnership has decreased significantly and is now negative. Since Consumers is one of the general partners of the MCV Partnership, we have recognized a portion of the limited partners' negative equity. As the MCV Partnership recognizes future losses, we will continue to assume a portion of the limited partners' share of those losses, in addition to our proportionate share. LITIGATION AND REGULATORY INVESTIGATION: CMS Energy is the subject of various investigations as a result of round-trip trading transactions by CMS MST, including an investigation by the DOJ. Additionally, CMS Energy and Consumers are named as parties in a class action lawsuit alleging ERISA violations. For additional details regarding this investigation and litigation, see Note 2, Contingencies. PENSION REFORM: Both branches of Congress passed legislation aimed at reforming pension plans. The U.S. Senate passed The Pension Security and Transparency Act in November 2005 and The House of Representatives passed the Pension Protection Act of 2005 in December 2005. At the core of both bills are changes in the calculation of pension plan funding requirements effective for plan years beginning in 2007, with interest rate relief extended until then, and an increase in premiums paid to the Pension Benefit CE-18 Consumers Energy Company Guaranty Corporation (PBGC). The latter was addressed through the broader budget reconciliation bill, which raises the PBGC flat-rate premiums from $19 to $30 per participant per year beginning in 2006. Although the Senate and House bills are similar, they do contain a number of technical differences, including differences in the time period allowed for interest rate and asset smoothing, the interest rate used to calculate lump sum payments, and the criteria used to determine whether a plan is "at-risk," which requires higher contribution levels. The Senate and the House plan to work out the differences between the two bills in a joint conference. The timing, however, of a final pension reform bill is unknown. IMPLEMENTATION OF NEW ACCOUNTING STANDARDS SFAS NO. 123(R) AND SAB NO. 107, SHARE-BASED PAYMENT: SFAS No. 123(R) requires companies to use the fair value of employee stock options and similar awards at the grant date to value the awards. SFAS No. 123(R) was effective for us on January 1, 2006. We elected to adopt the modified prospective method recognition provisions of this Statement instead of retrospective restatement. We adopted the fair value method of accounting for share-based awards effective December 2002. Therefore, SFAS No. 123(R) did not have a significant impact on our results of operations when it became effective. We applied the additional guidance provided by SAB No. 107 upon implementation of SFAS No. 123(R). For additional details, see Note 7, Executive Incentive Compensation. PROPOSED ACCOUNTING STANDARD On March 31, 2006, the FASB released an Exposure Draft of a proposed SFAS entitled "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans." The proposed SFAS would amend SFAS Nos. 87, 88, 106, and 132(R) and is expected to be effective for us on December 31, 2006. The most significant requirement stated in the proposed SFAS is the balance sheet recognition of the underfunded portion of our defined benefit postretirement plans at the date of adoption. We expect that we will be allowed to apply SFAS No. 71 and recognize the underfunded portion as a regulatory asset. If we determine that SFAS No. 71 does not apply, our equity could be reduced significantly. We are in the process of determining the impact of this proposed SFAS on our financial statements. CE-19 CONSUMERS ENERGY COMPANY CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
In Millions Three Months Ended ------------------------- March 31 2006 2005 - -------- -------- -------- OPERATING REVENUE $ 1,782 $ 1,632 OPERATING EXPENSES Fuel for electric generation 172 154 Fuel costs mark-to-market at MCV 156 (209) Purchased and interchange power 110 64 Purchased power - related parties 18 17 Cost of gas sold 816 740 Other operating expenses 215 188 Maintenance 71 52 Depreciation, depletion, and amortization 152 145 General taxes 65 65 -------- -------- 1,775 1,216 -------- -------- OPERATING INCOME 7 416 OTHER INCOME (DEDUCTIONS) Interest and dividends 10 5 Regulatory return on capital expenditures 3 16 Other income 4 4 Other expense (3) (6) -------- -------- 14 19 -------- -------- INTEREST CHARGES Interest on long-term debt 72 72 Interest on long-term debt - related parties 1 7 Other interest 3 2 Capitalized interest (2) (1) -------- -------- 74 80 -------- -------- INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTERESTS (53) 355 MINORITY INTERESTS (OBLIGATIONS), NET (72) 111 -------- -------- INCOME BEFORE INCOME TAXES 19 244 INCOME TAX EXPENSE 9 87 -------- -------- NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 10 $ 157 ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CE-20 CONSUMERS ENERGY COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
In Millions Three Months Ended --------------------- March 31 2006 2005 - -------- ------ ------ CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 10 $ 157 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion, and amortization (includes nuclear decommissioning of $1 per year) 152 145 Deferred income taxes and investment tax credit (51) 63 Fuel costs mark-to-market at MCV 156 (209) Minority interests (obligations), net (72) 111 Regulatory return on capital expenditures (3) (16) Capital lease and other amortization 9 8 Changes in assets and liabilities: Increase in accounts receivable and accrued revenue (238) (325) Decrease in inventories 366 401 Decrease in accounts payable (82) (8) Decrease in accrued expenses (85) (46) Decrease in MCV gas supplier funds on deposit (90) (15) Decrease (increase) in other current and non-current assets (4) 74 Increase (decrease) in other current and non-current liabilities 7 (19) ------ ------ Net cash provided by operating activities 75 321 ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (excludes assets placed under capital lease) (125) (145) Cost to retire property (25) (27) Restricted cash and restriced short-term investments 128 (1) Investments in Electric Restructuring Implementation Plan - (1) Investments in nuclear decommissioning trust funds (17) (1) Proceeds from nuclear decommissioning trust funds 4 7 Proceeds from short-term investments - 145 Purchase of short-term investments - (141) Maturity of MCV restricted investment securities held-to-maturity 28 126 Purchase of MCV restricted investment securities held-to-maturity (26) (126) Other investing 4 12 ------ ------ Net cash used in investing activities (29) (152) ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of long term debt - 550 Retirement of long-term debt (136) (444) Payment of common stock dividends (40) (118) Payment of capital and finance lease obligations (3) (3) Stockholder's contribution, net 200 200 Decrease in notes payable, net (27) - Debt issuance and financing costs (3) (7) ------ ------ Net cash provided by (used in) financing activities (9) 178 ------ ------ Net Increase in Cash and Cash Equivalents 37 347 Cash and Cash Equivalents, Beginning of Period 416 171 ------ ------ Cash and Cash Equivalents, End of Period $ 453 $ 518 ====== ======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CE-21 CONSUMERS ENERGY COMPANY CONSOLIDATED BALANCE SHEETS
In Millions --------------------------- March 31 2006 December 31 (Unaudited) 2005 ----------- ----------- ASSETS PLANT AND PROPERTY (AT COST) Electric $ 8,266 $ 8,204 Gas 3,165 3,151 Other 227 227 --------- --------- 11,658 11,582 Less accumulated depreciation, depletion, and amortization 4,855 4,804 --------- --------- 6,803 6,778 Construction work-in-progress 538 509 --------- --------- 7,341 7,287 --------- --------- INVESTMENTS Stock of affiliates 28 33 Other 4 7 --------- --------- 32 40 --------- --------- CURRENT ASSETS Cash and cash equivalents at cost, which approximates market 453 416 Restricted cash and restricted short-term investments 55 183 Accounts receivable, notes receivable, and accrued revenue, less allowances of $14 in 2006 and $13 in 2005 887 653 Accounts receivable - related parties 8 9 Inventories at average cost Gas in underground storage 702 1,068 Materials and supplies 72 75 Generating plant fuel stock 83 80 Deferred property taxes 164 159 Regulatory assets - postretirement benefits 19 19 Derivative instruments 121 242 Prepayments and other 96 70 --------- --------- 2,660 2,974 --------- --------- NON-CURRENT ASSETS Regulatory assets Securitized costs 549 560 Additional minimum pension 399 399 Postretirement benefits 110 116 Customer Choice Act 213 222 Other 481 484 Nuclear decommissioning trust funds 576 555 Other 582 520 --------- --------- 2,910 2,856 --------- --------- TOTAL ASSETS $ 12,943 $ 13,157 ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CE-22 STOCKHOLDER'S INVESTMENT AND LIABILITIES
In Millions --------------------------- March 31 2006 December 31 (Unaudited) 2005 ----------- ----------- CAPITALIZATION Common stockholder's equity Common stock, authorized 125.0 shares; outstanding 84.1 shares for all periods $ 841 $ 841 Paid-in capital 1,832 1,632 Accumulated other comprehensive income 58 72 Retained earnings since December 31, 1992 203 233 --------- --------- 2,934 2,778 Preferred stock 44 44 Long-term debt 4,297 4,303 Non-current portion of capital leases and finance lease obligations 309 308 --------- --------- 7,584 7,433 --------- --------- MINORITY INTERESTS 264 259 --------- --------- CURRENT LIABILITIES Current portion of long-term debt, capital leases and finance leases 112 112 Current portion of long-term debt - related parties - 129 Notes payable - related parties - 27 Accounts payable 292 372 Accounts payable - related parties 23 25 Accrued interest 66 82 Accrued taxes 322 400 Deferred income taxes 60 55 MCV gas supplier funds on deposit 103 193 Other 190 251 --------- --------- 1,168 1,646 --------- --------- NON-CURRENT LIABILITIES Deferred income taxes 956 1,027 Regulatory liabilities Regulatory liabilities for cost of removal 1,152 1,120 Income taxes, net 464 455 Other regulatory liabilities 231 178 Postretirement benefits 325 308 Asset retirement obligations 496 494 Deferred investment tax credit 65 67 Other 238 170 --------- --------- 3,927 3,819 --------- --------- Commitments and Contingencies (Notes 2, 3, and 4) TOTAL STOCKHOLDER'S INVESTMENT AND LIABILITIES $ 12,943 $ 13,157 ========= =========
CE-23 CONSUMERS ENERGY COMPANY CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY (UNAUDITED)
In Millions Three Months Ended March 31 2006 2005 - -------- --------- --------- COMMON STOCK At beginning and end of period (a) $ 841 $ 841 --------- --------- OTHER PAID-IN CAPITAL At beginning of period 1,632 932 Stockholder's contribution 200 200 --------- --------- At end of period 1,832 1,132 --------- --------- ACCUMULATED OTHER COMPREHENSIVE INCOME Minimum pension liability At beginning and end of period (2) (1) --------- --------- Investments At beginning of period 18 12 Unrealized gain (loss) on investments (b) (2) 3 --------- --------- At end of period 16 15 --------- --------- Derivative instruments At beginning of period 56 20 Unrealized gain (loss) on derivative instruments (b) (10) 16 Reclassification adjustments included in net income (b) (2) (10) --------- --------- At end of period 44 26 --------- --------- Total Accumulated Other Comprehensive Income 58 40 --------- --------- RETAINED EARNINGS At beginning of period 233 608 Net income 10 157 Cash dividends declared - Common Stock (40) (118) --------- --------- At end of period 203 647 --------- --------- TOTAL COMMON STOCKHOLDER'S EQUITY $ 2,934 $ 2,660 ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS. CE-24 (a) Number of shares of common stock outstanding was 84,108,789 for all periods presented. (b) Disclosure of Other Comprehensive Income:
In Millions ------------------- Three Months Ended March 31 2006 2005 - -------- ----- ----- Investments Unrealized gain (loss) on investments, net of tax of $(1) in 2006 and $2 in 2005 $ (2) $ 3 Derivative instruments Unrealized gain (loss) on derivative instruments, net of tax of $(5) in 2006 and $9 in 2005 (10) 16 Reclassification adjustments included in net income, net of tax benefit of $(1) in 2006 and $(6) in 2005 (2) (10) Net income 10 157 ----- ----- Total Comprehensive Income $ (4) $ 166 ===== =====
CE-25 Consumers Energy Company (This page intentionally left blank) CE-26 Consumers Energy Company CONSUMERS ENERGY COMPANY CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) These interim Consolidated Financial Statements have been prepared by Consumers in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. As such, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. Certain prior year amounts have been reclassified to conform to the presentation in the current year. In management's opinion, the unaudited information contained in this report reflects all adjustments of a normal recurring nature necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. The Condensed Notes to Consolidated Financial Statements and the related Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and related Notes contained in the Consumers' Form 10-K for the year ended December 31, 2005. Due to the seasonal nature of Consumers' operations, the results as presented for this interim period are not necessarily indicative of results to be achieved for the fiscal year. 1: CORPORATE STRUCTURE AND ACCOUNTING POLICIES CORPORATE STRUCTURE: Consumers, a subsidiary of CMS Energy, a holding company, is a combination electric and gas utility company serving Michigan's Lower Peninsula. Our customer base includes a mix of residential, commercial, and diversified industrial customers, the largest segment of which is the automotive industry. We manage our business by the nature of services each provides and operate principally in two business segments: electric utility and gas utility. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include Consumers, and all other entities in which we have a controlling financial interest or are the primary beneficiary, in accordance with FASB Interpretation No. 46(R). We use the equity method of accounting for investments in companies and partnerships that are not consolidated, where we have significant influence over operations and financial policies, but are not the primary beneficiary. We eliminate intercompany transactions and balances. USE OF ESTIMATES: We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. We are required to make estimates using assumptions that may affect the reported amounts and disclosures. Actual results could differ from those estimates. We are required to record estimated liabilities in the consolidated financial statements when it is probable that a loss will be incurred in the future as a result of a current event, and when the amount can be reasonably estimated. We have used this accounting principle to record estimated liabilities as discussed in Note 2, Contingencies. REVENUE RECOGNITION POLICY: We recognize revenues from deliveries of electricity and natural gas, and the storage of natural gas when services are provided. Sales taxes are recorded as liabilities and are not included in revenues. CE-27 Consumers Energy Company ACCOUNTING FOR MISO TRANSACTIONS: We account for MISO transactions on a net basis for all of our generating units combined. We record billing adjustments when invoices are received and also record an expense accrual for future adjustments based on historical experience. LONG-LIVED ASSETS AND EQUITY METHOD INVESTMENTS: Our assessment of the recoverability of long-lived assets and equity method investments involves critical accounting estimates. We periodically perform tests of impairment if certain conditions that are other than temporary exist that may indicate the carrying value may not be recoverable. Of our total assets, recorded at $12.943 billion at March 3l, 2006, 57 percent represent long-lived assets and equity method investments that are subject to this type of analysis. OTHER INCOME AND OTHER EXPENSE: The following tables show the components of Other income and Other expense:
In Millions --------------- Three Months Ended March 31 2006 2005 - --------------------------- ---- ---- Other income Electric restructuring return $ 1 $ 1 Return on stranded and security costs 1 1 Gain on stock 1 1 All other 1 1 --- --- Total other income $ 4 $ 4 === ===
In Millions ----------------- Three Months Ended March 31 2006 2005 - --------------------------- ---- ---- Other expense Loss on reacquired debt $ - $ (5) Civic and political expenditures (1) (1) Donations (1) - All other (1) - ---- ---- Total other expense $ (3) $ (6) ==== ====
RECLASSIFICATIONS: Certain prior year amounts have been reclassified for comparative purposes. These reclassifications did not affect consolidated net income for the years presented. 2: CONTINGENCIES SEC AND OTHER INVESTIGATIONS: During the period of May 2000 through January 2002, CMS MST engaged in simultaneous, prearranged commodity trading transactions in which energy commodities were sold and repurchased at the same price. These so called round-trip trades had no impact on previously reported consolidated net income, earnings per share, or cash flows but had the effect of increasing operating revenues and operating expenses by equal amounts. CMS Energy is cooperating with an investigation by the DOJ concerning round-trip trading, which the DOJ commenced in May 2002. CMS Energy is unable to predict the outcome of this matter and what effect, if any, this investigation will have on its business. In March 2004, the SEC approved a cease-and-desist order settling an administrative action against CMS Energy related to round-trip trading. The CE-28 Consumers Energy Company order did not assess a fine and CMS Energy neither admitted nor denied the order's findings. The settlement resolved the SEC investigation involving CMS Energy and CMS MST. Also in March 2004, the SEC filed an action against three former employees related to round-trip trading by CMS MST. One of the individuals has settled with the SEC. CMS Energy is currently advancing legal defense costs for the remaining two individuals, in accordance with existing indemnification policies. Those individuals filed a motion to dismiss the SEC action, which was denied. SECURITIES CLASS ACTION LAWSUITS: Beginning on May 17, 2002, a number of complaints were filed against CMS Energy, Consumers, and certain officers and directors of CMS Energy and its affiliates. The cases were consolidated into a single lawsuit, which generally seeks unspecified damages based on allegations that the defendants violated United States securities laws and regulations by making allegedly false and misleading statements about CMS Energy's business and financial condition, particularly with respect to revenues and expenses recorded in connection with round-trip trading by CMS MST. In January 2005, the court granted a motion to dismiss Consumers and three of the individual defendants, but denied the motions to dismiss CMS Energy and the 13 remaining individual defendants. The court issued an opinion and order dated March 24, 2006, granting in part and denying in part plaintiffs' amended motion for class certification. The court conditionally certified a class consisting of "[a]ll persons who purchased CMS Common Stock during the period of October 25, 2000 through and including May 17, 2002 and who were damaged thereby." Appeals and motions for reconsideration of the court's ruling have been lodged by the parties. CMS Energy and the individual defendants will defend themselves vigorously in this litigation but cannot predict its outcome. ERISA LAWSUITS: CMS Energy is a named defendant, along with Consumers, CMS MST, and certain named and unnamed officers and directors, in two lawsuits, filed in July 2002 in United States District Court for the Eastern District of Michigan, brought as purported class actions on behalf of participants and beneficiaries of the CMS Employees' Savings Plan (the Plan). Plaintiffs 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, as well as other equitable relief and legal fees. On March 1, 2006, CMS Energy and Consumers reached an agreement, subject to court and independent fiduciary approval, to settle the lawsuits. The settlement agreement requires a $28 million cash payment by CMS Energy's primary insurer that will be used to pay Plan participants and beneficiaries for alleged losses, as well as any legal fees and expenses. In addition, CMS Energy agreed to certain other steps regarding administration of the Plan. The court issued an order on March 23, 2006, granting preliminary approval of the settlement and scheduling the Fairness Hearing for June 15, 2006. 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: Compliance with the federal Clean Air Act and resulting regulations has been, and will continue to be, a significant focus for us. The Nitrogen Oxide State Implementation Plan requires significant reductions in nitrogen oxide emissions. To comply with the regulations, we expect to incur capital expenditures totaling $819 million. The key assumptions in the capital expenditure estimate include: - construction commodity prices, especially construction material and labor, - project completion schedules, - cost escalation factor used to estimate future years' costs, and - an AFUDC capitalization rate. CE-29 Consumers Energy Company Our current capital cost estimates include an escalation rate of 2.6 percent and an AFUDC capitalization rate of 8.4 percent. As of March 2006, we incurred $616 million in capital expenditures to comply with the federal Clean Air Act and resulting regulations and anticipate that the remaining $203 million of capital expenditures will be made in 2006 through 2011. These expenditures include installing selective catalytic control reduction technology at four of our coal-fired electric generating plants. In addition to modifying coal-fired electric generating plants, our compliance plan includes the use of nitrogen oxide emission allowances until all of the control equipment is operational in 2011. The nitrogen oxide emission allowance annual expense is projected to be $6 million per year, which we expect to recover from our customers through the PSCR process. The projected annual expense is based on market price forecasts and forecasts of regulatory provisions, known as progressive flow control, that restrict the usage in any given year of allowances banked from previous years. The allowances and their cost are accounted for as inventory. The allowance inventory is expensed at the rolling average cost as the coal-fired electric generating plants emit nitrogen oxide. In March 2005, the EPA adopted the Clean Air Interstate Rule that requires additional coal-fired electric generating plant emission controls for nitrogen oxides and sulfur dioxide. The rule involves a two-phase program to reduce emissions of nitrogen oxides by 63 percent and sulfur dioxide by 71 percent from 2003 levels by 2015. The final rule will require that we run our selective catalytic control reduction technology units year round beginning in 2009 and may require that we purchase additional nitrogen oxide allowances beginning in 2009. The additional nitrogen oxide allowances are estimated to cost $4 million per year for years 2009 through 2011. In addition to the selective catalytic control reduction technology installed to meet the nitrogen oxide standards, our current plan includes installation of flue gas desulfurization scrubbers. The scrubbers are to be installed by 2014 to meet the Phase I reduction requirements of the Clean Air Interstate Rule, at an estimated cost of $960 million. Our capital cost estimates include an escalation rate of 2.6 percent and an AFUDC capitalization rate of 8.4 percent. We currently have a surplus of sulfur dioxide allowances, which were granted by the EPA and are accounted for as inventory. In January 2006, we sold some of our excess sulfur dioxide allowances for $61 million and recognized the proceeds as a regulatory liability. Also in March 2005, the EPA issued the Clean Air Mercury Rule, which requires initial reductions of mercury emissions from coal-fired electric generating plants by 2010 and further reductions by 2018. The Clean Air Mercury Rule establishes a cap-and-trade system for mercury emissions that is similar to the system used in the Clean Air Interstate Rule. The industry has not reached a consensus on the technical methods for curtailing mercury emissions. However, we anticipate our capital and operating costs for mercury emissions reductions required by the Clean Air Mercury Rule to be significantly less than what was required for selective catalytic reduction technology used for nitrogen oxide compliance. In April 2006, Michigan's governor announced a plan that would result in mercury emissions reductions of 90 percent by 2015. This plan adopts the Federal Clean Air Mercury Rule through its first phase, which ends in 2010. After the year 2010, the mercury emissions reduction standards outlined in the governor's plan become more stringent than those included in the Federal Clean Air Mercury Rule. If implemented as proposed, we anticipate the costs to comply with the governor's plan will exceed Federal Clean Air Mercury Rule compliance costs. We will work with the MDEQ on the details of these rules. In August 2005, the MDEQ filed a Motion to Intervene in a court challenge to certain aspects of EPA's Clean Air Mercury Rule, asserting that the rule is inadequate. In October 2005, the EPA announced it would reconsider certain aspects of the Clean Air Mercury Rule. During the reconsideration process, the court challenge to the rule is on hold. We cannot predict the outcome of this proceeding. CE-30 Consumers Energy Company The EPA has alleged that some utilities have incorrectly classified plant modifications as "routine maintenance" rather than seeking permits to modify the plant from the EPA. We have received and responded to information requests from the EPA on this subject. We believe that we have properly interpreted the requirements of "routine maintenance." If our interpretation is found to be incorrect, we may be required to install additional pollution controls at some or all of our coal-fired electric generating plants and potentially pay fines. Additionally, the viability of certain plants remaining in operation could be called into question. Cleanup and Solid Waste: Under the Michigan Natural Resources and Environmental Protection Act, we expect that we will ultimately incur investigation and remedial action costs at a number of sites. We believe that these costs will be recoverable in rates under current ratemaking policies. We are a potentially responsible party at several contaminated sites administered under Superfund. Superfund liability is joint and several, meaning that many other creditworthy parties with substantial assets are potentially responsible with respect to the individual sites. Based on our experience, we estimate that our share of the total liability for the known Superfund sites will be between $2 million and $10 million. At March 31, 2006, we have recorded a liability for the minimum amount of our estimated Superfund liability. In October 1998, during routine maintenance activities, we identified PCB as a component in certain paint, grout, and sealant materials at Ludington. We removed and replaced part of the PCB material. We have proposed a plan to deal with the remaining materials and are awaiting a response from the EPA. MCV Environmental Issue: On July 12, 2004, the MDEQ, Air Control Division, issued the MCV Partnership a Letter of Violation asserting that the MCV Facility violated its Air Use Permit to Install (PTI) by exceeding the carbon monoxide emission limit on the Unit 14 duct burner and failing to maintain certain records in the required format. The MCV Partnership has declared five of the six duct burners in the MCV Facility as unavailable for operational use (which reduces the generation capability of the MCV Facility by approximately 100 MW) and took other corrective action to address the MDEQ's assertions. The one available duct burner was tested in April 2005 and its emissions met permitted levels due to the configuration of that particular unit. The MCV Partnership disagrees with certain of the MDEQ's assertions. The MCV Partnership filed a response in July 2004 to address the Letter of Violation. On December 13, 2004, the MDEQ informed the MCV Partnership that it was pursuing an escalated enforcement action against the MCV Partnership regarding the alleged violations of the MCV Facility's PTI. The MDEQ also stated that the alleged violations are deemed federally significant and, as such, placed the MCV Partnership on the EPA's High Priority Violators List (HPVL). The MDEQ and the MCV Partnership are pursuing voluntary settlement of this matter, which includes establishing a higher carbon monoxide emissions limit on the five duct burners currently unavailable, sufficient to allow the MCV Facility to return those duct burners to service. The settlement would also satisfy state and federal requirements and remove the MCV Partnership from the HPVL. Any such settlement may involve a fine, but at this time, the MDEQ has not stated what, if any, fine they will seek to impose. At this time, we cannot predict the financial impact or outcome of this issue. On July 13, 2004, the MDEQ, Water Division, issued the MCV Facility a Notice Letter asserting the MCV Facility violated its National Pollutant Discharge Elimination System (NPDES) Permit by discharging heated process wastewater into the storm water system, failing to document inspections, and other minor infractions (alleged NPDES violations). In August 2004, the MCV Partnership filed a response to the MDEQ letter covering the remediation for each of the MDEQ's alleged violations. On October 17, 2005, the MDEQ, Water Bureau, issued the MCV Partnership a Compliance Inspection CE-31 Consumers Energy Company report, which listed several minor violations and concerns that needed to be addressed by the MCV Facility. This report was issued in connection with an inspection of the MCV Facility in September 2005, which was conducted for compliance and review of the Storm Water Pollution Prevention Plans (SWPPP). The MCV Partnership submitted its updated SWPPP on December 1, 2005. The MCV Partnership management believes it has resolved all issues associated with the Notice Letter and Compliance Inspection and does not expect any further MDEQ actions on these matters. ALLOCATION OF BILLING COSTS: In February 2006, the MPSC issued an order which determined that we violated the MPSC code of conduct by including a bill insert advertising an unregulated service. The MPSC issued a penalty of $45,000 and stated that any subsidy for the use of our billing system arising from past code of conduct violations will be accounted for in our next electric rate case. We cannot predict the outcome or the impact on any future electric rate case. LITIGATION: In October 2003, a group of eight PURPA qualifying facilities (the plaintiffs), which sell power to us, filed a lawsuit in Ingham County Circuit Court. The lawsuit alleged that we incorrectly calculated the energy charge payments made pursuant to power purchase agreements with qualifying facilities. In February 2004, the Ingham County Circuit Court judge deferred to the primary jurisdiction of the MPSC, dismissing the circuit court case without prejudice. The Michigan Court of Appeals upheld this order on the primary jurisdiction question, but remanded the case back on another issue. In February 2005, the MPSC issued an order in the 2004 PSCR plan case concluding that we have been correctly administering the energy charge calculation methodology. The plaintiffs have appealed the MPSC order to the Michigan Court of Appeals. The plaintiffs also filed suit in the United States Court for the Western District of Michigan, which the judge subsequently dismissed. The plaintiffs have appealed the dismissal to the United States Court of Appeals. We cannot predict the outcome of these appeals. ELECTRIC RESTRUCTURING MATTERS ELECTRIC ROA: The Customer Choice Act allows all of our electric customers to buy electric generation service from us or from an alternative electric supplier. At March 31, 2006, alternative electric suppliers were providing 348 MW of generation service to ROA customers. This is 4 percent of our total distribution load and represents a decrease of 61 percent compared to March 31, 2005. It is difficult to predict future ROA customer trends. STRANDED COSTS: Prior MPSC orders adopted a mechanism pursuant to the Customer Choice Act to provide recovery of Stranded Costs that occur when customers leave our system to purchase electricity from alternative suppliers. In November 2005, we filed an application with the MPSC related to the determination of 2004 Stranded Costs. Applying the Stranded Cost methodology used in prior MPSC orders, we concluded that we experienced zero Stranded Costs in 2004. ELECTRIC RATE MATTERS POWER SUPPLY COSTS: To reduce the risk of high electric prices during peak demand periods and to achieve our reserve margin target, we employ a strategy of purchasing electric capacity and energy contracts for the physical delivery of electricity primarily in the summer months and to a lesser degree in the winter months. Through a combination of owned capacity and purchases, we have supply resources in place to cover approximately 110 percent of the projected firm summer peak load for 2006. We have purchased capacity and energy contracts covering partially the estimated reserve margin requirements for 2007 through 2010. As a result, we have recognized an asset of $72 million for unexpired capacity and energy contracts at March 31, 2006. At April 2006, we expect the total capacity cost of electric capacity and energy contracts for 2006 to be $18 million. CE-32 Consumers Energy Company PSCR: The PSCR process allows recovery of reasonable and prudent power supply costs. Revenues from the PSCR charges are subject to reconciliation after actual costs are reviewed for reasonableness and prudence. In September 2005, we submitted our 2006 PSCR plan filing to the MPSC. In November 2005, we submitted an amended 2006 PSCR plan to the MPSC to include higher estimates for certain METC and coal supply costs. In December 2005, the MPSC issued an order that temporarily excluded these increased costs from our PSCR charge and further reduced the charge by one mill per kWh. We implemented the temporary order in January 2006. If the temporary order remains in effect for the remainder of 2006, it would result in a delay in the recovery of $169 million. In April 2006, the MPSC Staff filed briefs in the 2006 PSCR plan case recommending inclusion of all filed costs in the 2006 PSCR charge, including those temporarily excluded in the December 2005 order. If the MPSC adopts the Staff's recommendation, our underrecovery of PSCR costs in 2006 would be reduced to $67 million. These underrecoveries are due to increased bundled sales and other cost increases beyond those included in the September and November filings. We expect to recover fully all of our PSCR costs. To the extent that we incur and are unable to collect these costs in a timely manner, our cash flows from electric utility operations are affected negatively. In March 2006, we submitted our 2005 PSCR reconciliation filing to the MPSC. We calculated an underrecovery of $33 million for commercial and industrial customers, which we expect to recover fully. We cannot predict the outcome of these PSCR proceedings. OTHER ELECTRIC CONTINGENCIES THE MIDLAND COGENERATION VENTURE: The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990. We hold a 49 percent partnership interest in the MCV Partnership, and a 35 percent lessor interest in the MCV Facility. In 2004, we consolidated the MCV Partnership and the FMLP into our consolidated financial statements in accordance with FASB Interpretation No. 46(R). Under the MCV PPA, variable energy payments to the MCV Partnership are based on the cost of coal burned at our coal plants and our operation and maintenance expenses. However, the MCV Partnership's costs of producing electricity are tied to the cost of natural gas. Natural gas prices have increased substantially in recent years and throughout 2005. In 2005, the MCV Partnership reevaluated the economics of operating the MCV Facility and recorded an impairment charge. If natural gas prices remain at present levels or increase, the operations of the MCV Facility would be adversely affected and could result in the MCV Partnership failing to meet its obligations under the sale and leaseback transactions and other contracts. Due to the impairment of the MCV Facility and subsequent losses, the value of the equity held by all of the owners of the MCV Partnership has decreased significantly and is now negative. Since we are one of the general partners of the MCV Partnership, we have recognized a portion of the limited partners' negative equity. At March 31, 2006, the negative minority interest for the other general partners' share, including their portion of the limited partners' negative equity, is $96 million and is included in Other Non-current Assets on our Consolidated Balance Sheets. We are evaluating various alternatives in order to develop a new long-term strategy with respect to the MCV Facility. Further, the cost that we incur under the MCV PPA exceeds the recovery amount allowed by the MPSC. We expense all cash underrecoveries directly to income. We estimate underrecoveries of $55 million in 2006 and $39 million in 2007. Of the 2006 estimate, we expensed $14 million during the three months ended March 31, 2006. However, Consumers' direct savings from the RCP, after allocating a portion to customers, are used to offset our capacity and fixed energy underrecoveries expense. After September 15, 2007, we expect to claim relief under the regulatory out provision in the MCV PPA, thereby limiting our capacity and fixed energy payments to the MCV Partnership to the amounts that we collect from our customers. The MCV Partnership has indicated that it may take issue with our exercise CE-33 Consumers Energy Company of the regulatory out clause after September 15, 2007. We believe that the clause is valid and fully effective, but cannot assure that it will prevail in the event of a dispute. If we are successful in exercising the regulatory out clause, the MCV Partnership has the right to terminate the MCV PPA. The MPSC's future actions on the capacity and fixed energy payments recoverable from customers subsequent to September 15, 2007 may affect negatively the financial performance of the MCV Partnership. In January 2005, the MPSC issued an order approving the RCP, with modifications. The RCP allows us to recover the same amount of capacity and fixed energy charges from customers as approved in prior MPSC orders. However, we are able to dispatch the MCV Facility on the basis of natural gas market prices, which reduces the MCV Facility's annual production of electricity and, as a result, reduces the MCV Facility's consumption of natural gas by an estimated 30 to 40 bcf annually. This decrease in the quantity of high-priced natural gas consumed by the MCV Facility benefits our ownership interest in the MCV Partnership. In January 2005, we implemented the RCP. The underlying agreement for the RCP between Consumers and the MCV Partnership extends through the term of the MCV PPA. However, either party may terminate that agreement under certain conditions. In February 2005, a group of intervenors in the RCP case filed for rehearing of the MPSC order approving the RCP. The Attorney General also filed an appeal with the Michigan Court of Appeals. We cannot predict the outcome of these matters. MCV PARTNERSHIP PROPERTY TAXES: In January 2004, the Michigan Tax Tribunal issued its decision in the MCV Partnership's tax appeal against the City of Midland for tax years 1997 through 2000. The City of Midland appealed the decision to the Michigan Court of Appeals, and the MCV Partnership filed a cross-appeal at the Michigan Court of Appeals. The MCV Partnership also has a pending case with the Michigan Tax Tribunal for tax years 2001 through 2005. The MCV Partnership estimates that the 1997 through 2005 tax year cases will result in a refund to the MCV Partnership of $87 million, inclusive of interest, if the decision of the Michigan Tax Tribunal is upheld. In February 2006, the Michigan Court of Appeals largely affirmed the Michigan Tax Tribunal decision, but remanded the case back to the Michigan Tax Tribunal to clarify certain aspects of the Tax Tribunal decision. The remanded proceedings may result in the determination of a greater refund to the MCV Partnership. In April 2006, the City of Midland filed an application for Leave to Appeal with the Michigan Supreme Court. The MCV Partnership filed a response in opposition to that application. The MCV Partnership cannot predict the outcome of these proceedings; therefore, this anticipated refund has not been recognized in earnings. NUCLEAR PLANT DECOMMISSIONING: The MPSC and the FERC regulate the recovery of costs to decommission, or remove from service, our Big Rock and Palisades nuclear plants. Decommissioning funding practices approved by the MPSC require us to file a report on the adequacy of funds for decommissioning at three-year intervals. We prepared and filed updated cost estimates for Big Rock and Palisades in March 2004. Excluding additional costs for spent nuclear fuel storage, due to the DOE's failure to accept this spent nuclear fuel on schedule, these reports show a decommissioning cost of $361 million for Big Rock and $868 million for Palisades. Since Big Rock is currently in the process of decommissioning, this estimated cost includes historical expenditures in nominal dollars and future costs in 2003 dollars, with all Palisades costs given in 2003 dollars. Recently updated cost projections for Big Rock indicate an anticipated decommissioning cost of $390 million as of March 2006. Big Rock: In December 2000, funding of the Big Rock trust fund stopped because the MPSC-authorized decommissioning surcharge collection period expired. In March 2006, we contributed $16 million to the trust fund from our corporate funds. Excluding the additional nuclear fuel storage costs due to the DOE's failure to accept spent fuel on schedule, we are currently projecting that the level of funds CE-34 Consumers Energy Company provided by the trust for Big Rock will fall short of the amount needed to complete the decommissioning by $36 million. At this time, we plan to provide this additional amount from our corporate funds, and, subsequent to the completion in 2007 of radiological decommissioning work, seek recovery of such expenditures, in addition to the amount we added to the fund, from some alternative source. We cannot predict the outcome of these efforts. Palisades: Excluding additional nuclear fuel storage costs due to the DOE's failure to accept spent fuel on schedule, we concluded, based on the cost estimates filed in March 2004, that the existing Palisades' surcharge of $6 million needed to be increased to $25 million annually, beginning January 2006. A settlement agreement was approved by the MPSC, providing for the continuation of the existing $6 million annual decommissioning surcharge through 2011, our current license expiration date, and for the next periodic review to be filed in March 2007. Amounts collected from electric retail customers and deposited in trusts, including trust earnings, are credited to a regulatory liability. In March 2005, the NMC, which operates the Palisades plant, applied for a 20-year license renewal for the plant on behalf of Consumers. We expect a decision from the NRC on the license renewal application in 2007. At this time, we cannot determine what impact this will have on decommissioning costs or the adequacy of funding. In December 2005, we announced plans to sell Palisades and have begun pursuing this asset divestiture. As a sale is not probable to occur until a firm purchase commitment is entered into with a potential buyer, we have not classified the Palisades assets as held for sale on our Consolidated Balance Sheets. NUCLEAR MATTERS: Nuclear Fuel Cost: We amortize nuclear fuel cost to fuel expense based on the quantity of heat produced for electric generation. For nuclear fuel used after April 6, 1983, we charge certain disposal costs to nuclear fuel expense, recover these costs through electric rates, and remit them to the DOE quarterly. We elected to defer payment for disposal of spent nuclear fuel burned before April 7, 1983. At March 31, 2006, our DOE liability is $147 million. This amount includes interest, which is payable upon the first delivery of spent nuclear fuel to the DOE. The amount of this liability, excluding a portion of interest, was recovered through electric rates. DOE Litigation: In 1997, a U.S. Court of Appeals decision confirmed that the DOE was to begin accepting deliveries of spent nuclear fuel for disposal by January 1998. Subsequent U.S. Court of Appeals litigation, in which we and other utilities participated, has not been successful in producing more specific relief for the DOE's failure to accept the spent nuclear fuel. There are two court decisions that support the right of utilities to pursue damage claims in the United States Court of Claims against the DOE for failure to take delivery of spent nuclear fuel. Over 60 utilities have initiated litigation in the United States Court of Claims. We filed our complaint in December 2002. If our litigation against the DOE is successful, we plan to use any recoveries to pay the cost of spent nuclear fuel storage until the DOE takes possession as required by law. We can make no assurance that the litigation against the DOE will be successful. In 2002, the site at Yucca Mountain, Nevada was designated for the development of a repository for the disposal of high-level radioactive waste and spent nuclear fuel. We expect that the DOE, in due course, will submit a final license application to the NRC for the repository. The application and review process is estimated to take several years. Insurance: We maintain nuclear insurance coverage on our nuclear plants. At Palisades, we maintain nuclear property insurance from NEIL totaling $2.750 billion and insurance that would partially cover the cost of replacement power during certain prolonged accidental outages. Because NEIL is a mutual CE-35 Consumers Energy Company insurance company, we could be subject to assessments of up to $28 million in any policy year if insured losses in excess of NEIL's maximum policyholders surplus occur at our, or any other member's, nuclear facility. NEIL's policies include coverage for acts of terrorism. At Palisades, we maintain nuclear liability insurance for third-party bodily injury and off-site property damage resulting from a nuclear energy hazard for up to approximately $10.761 billion, the maximum insurance liability limits established by the Price-Anderson Act. Part of the Price-Anderson Act's financial protection is a mandatory industry-wide program under which owners of nuclear generating facilities could be assessed if a nuclear incident occurs at any nuclear generating facility. The maximum assessment against us could be $101 million per occurrence, limited to maximum annual installment payments of $15 million. We also maintain insurance under a program that covers tort claims for bodily injury to nuclear workers caused by nuclear hazards. The policy contains a $300 million nuclear industry aggregate limit. Under a previous insurance program providing coverage for claims brought by nuclear workers, we remain responsible for a maximum assessment of up to $6 million. This requirement will end December 31, 2007. Big Rock remains insured for nuclear liability 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. GAS CONTINGENCIES GAS ENVIRONMENTAL MATTERS: We expect to incur investigation and remediation costs at a number of sites under the Michigan Natural Resources and Environmental Protection Act, a Michigan statute that covers environmental activities including remediation. These sites include 23 former manufactured gas plant facilities. We operated the facilities on these sites for some part of their operating lives. For some of these sites, we have no current ownership or may own only a portion of the original site. In 2005, we estimated our remaining costs to be between $29 million and $71 million, based on 2005 discounted costs, using a discount rate of three percent. The discount rate represents a 10-year average of U.S. Treasury bond rates reduced for increases in the consumer price index. We expect to fund most of these costs through proceeds derived from a settlement with insurers and MPSC-approved rates. At March 31, 2006, we have a liability of $28 million, net of $54 million of expenditures incurred to date, and a regulatory asset of $60 million. Any significant change in assumptions, such as an increase in the number of sites, different remediation techniques, nature and extent of contamination, and legal and regulatory requirements, could affect our estimate of remedial action costs. GAS RATE MATTERS GAS COST RECOVERY: The GCR process is designed to allow us to recover all of our purchased natural gas costs if incurred under reasonable and prudent policies and practices. The MPSC reviews these costs, policies, and practices for prudency in annual plan and reconciliation proceedings. GCR reconciliation for year 2004-2005: In March 2006, a settlement was reached and submitted to the MPSC for approval for our 2004-2005 GCR year reconciliation. The settlement is for a $2 million net overrecovery for the GCR year; it includes interest through March 2005 and refunds that we received from our suppliers that are required to be refunded to our customers. In April 2006, the MPSC approved the settlement; the settlement amount will be rolled into the 2005-2006 GCR year. CE-36 Consumers Energy Company GCR plan for year 2005-2006: In November 2005, the MPSC issued an order for our 2005-2006 GCR Plan year, which resulted in approval of a settlement agreement and established a fixed price cap of $10.10 for the December 2005 through March 2006 billing period. We were able to maintain our billing GCR factor below the authorized level for that period. The order was appealed to the Michigan Court of Appeals by one intervenor. No action has been taken by the Court of Appeals on the merits of the appeal and we are unable to predict the outcome. GCR plan for year 2006-2007: In December 2005, we filed an application with the MPSC seeking approval of a GCR plan for the 12-month period of April 2006 through March 2007. Our request proposed using a GCR factor consisting of: - a base GCR ceiling factor of $11.10 per mcf, plus - a quarterly GCR ceiling price adjustment contingent upon future events. Our GCR factor for the billing month of May 2006 is $9.07 per mcf. 2001 GAS DEPRECIATION CASE: In October and December 2004, the MPSC issued Opinions and Orders in our gas depreciation case, which: - reaffirmed the previously-ordered $34 million reduction in our depreciation expense, - required us to undertake a study to determine why our plant removal costs are in excess of other regulated Michigan natural gas utilities, and - required us to file a study report with the MPSC Staff on or before December 31, 2005. We filed the study report with the MPSC Staff on December 29, 2005. We are also required to file our next gas depreciation case within 90 days after the MPSC issuance of a final order in the pending case related to ARO accounting. We cannot predict when the MPSC will issue a final order in the ARO accounting case. If the depreciation case order is issued after the gas general rate case order, we proposed to incorporate its results into the gas general rates using a surcharge mechanism. 2005 GAS RATE CASE: In July 2005, we filed an application with the MPSC seeking a 12 percent authorized return on equity along with a $132 million annual increase in our gas delivery and transportation rates. As part of this filing, we also requested interim rate relief of $75 million. The MPSC Staff and intervenors filed interim rate relief testimony on October 31, 2005. In its testimony, the MPSC Staff recommended granting interim rate relief of $38 million. In February 2006, the MPSC Staff recommended granting final rate relief of $62 million. The MPSC Staff proposed that $17 million of this amount be contributed to a low income energy efficiency fund. The MPSC Staff also recommended reducing our return on common equity to 11.15 percent, from our current 11.4 percent. In March 2006, the MPSC Staff revised its recommended final rate relief to $71 million. As of April 2006, the MPSC has not acted on our interim or final rate relief requests. In April 2006, we revised our request for final rate relief downward to $118 million. CE-37 Consumers Energy Company OTHER CONTINGENCIES IRS RULING AND AUDIT: In August 2005, the IRS issued Revenue Ruling 2005-53 and regulations to provide guidance with respect to the use of the "simplified service cost" method of tax accounting. We use this tax accounting method, generally allowed by the IRS under section 263A of the Internal Revenue Code, with respect to the allocation of certain corporate overheads to the tax basis of self-constructed utility assets. Under the IRS guidance, significant issues with respect to the application of this method remain unresolved and subject to dispute. However, the effect of the IRS's position may be to require Consumers either (1) to repay all or a portion of previously received tax benefits, or (2) to add back to taxable income, half in each of 2005 and 2006, all or a portion of previously deducted overheads. The IRS is currently auditing Consumers and recently notified us that it intends to propose an adjustment to 2001 taxable income disallowing our simplified service cost deduction. The impact of this matter on future earnings, cash flows, or our present NOL carryforwards remains uncertain, but could be material. Consumers cannot predict the outcome of this matter. OTHER: In addition to the matters disclosed within this Note, we are party to certain lawsuits and administrative proceedings before various courts and governmental agencies arising from the ordinary course of business. These lawsuits and proceedings may involve personal injury, property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing, and other matters. We have accrued estimated losses for certain contingencies discussed within this Note. Resolution of these contingencies is not expected to have a material adverse impact on our financial position, liquidity, or results of operations. FASB INTERPRETATION NO. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS: The Interpretation requires the guarantor, upon issuance of a guarantee, to recognize a liability for the fair value of the obligation it undertakes in issuing the guarantee. The following table describes our guarantees at March 31, 2006:
In Millions ----------------------------------------------------------- Issue Expiration Maximum Carrying Guarantee Description Date Date Obligation Amount - --------------------- ------- ---------- ---------- -------- Standby letters of credit Various Various $ 36 $ - Surety bonds Various Indefinite 1 - Guarantee Jan 1987 Mar 2015 85 - Nuclear insurance retrospective premiums Various Indefinite 135 -
CE-38 Consumers Energy Company The following table provides additional information regarding our guarantees:
Guarantee Description How Guarantee Arose Events That Would Require Performance - --------------------- ------------------- ------------------------------------- Standby letters of credit Normal operations of coal power plants Noncompliance with environmental regulations and inadequate response to demands for corrective action Natural gas transportation Nonperformance Self-insurance requirement Nonperformance Surety bonds Normal operating activity, permits and Nonperformance licenses Guarantee Agreement to provide power and steam to MCV Partnership's nonperformance or Dow non-payment under a related contract Nuclear insurance retrospective premiums Normal operations of nuclear plants Call by NEIL and Price-Anderson Act for nuclear incident
At March 31, 2006, none of our guarantees contained provisions allowing us to recover, from third parties, any amount paid under the guarantees. We enter into various agreements containing indemnification provisions in connection with a variety of transactions. While we are unable to estimate the maximum potential obligation related to these indemnities, we consider the likelihood that we would be required to perform or incur significant losses related to these indemnities and the guarantees listed in the preceding tables to be remote. 3: FINANCINGS AND CAPITALIZATION Long-term debt is summarized as follows:
In Millions ------------------------------------------ March 31, 2006 December 31, 2005 -------------- ----------------- First mortgage bonds $ 3,175 $ 3,175 Senior notes and other 853 852 Securitization bonds 362 369 ---------- ---------- Principal amounts outstanding 4,390 4,396 Current amounts (85) (85) Net unamortized discount (8) (8) ---------- ---------- Total Long-term debt $ 4,297 $ 4,303 ========== ==========
DEBT RETIREMENTS: The following is a summary of significant long-term debt retirements during the three months ended March 31, 2006:
Principal Interest Issue/Retirement (in millions) Rate (%) Date Maturity Date ------------- -------- ---------------- ------------- Long-term debt - related parties $ 129 9.00 February 2006 June 2031
CE-39 Consumers Energy Company REVOLVING CREDIT FACILITIES: The following secured revolving credit facilities with banks are available at March 31, 2006:
In Millions Outstanding ----------- Amount of Amount Letters-of- Amount Company Expiration Date Facility Borrowed Credit Available ------- --------------- --------- -------- ------------ ----------- Consumers March 30, 2007 $ 300 $ - $ - $ 300 Consumers May 18, 2010 500 - 36 464 MCV Partnership August 26, 2006 50 - 2 48
In March 2006, we entered into a short-term secured revolving credit agreement with banks. This facility provides $300 million of funds for working capital and other general corporate purposes. DIVIDEND RESTRICTIONS: Under the provisions of our articles of incorporation, at March 31, 2006, we had $149 million of unrestricted retained earnings available to pay common stock dividends. Covenants in our debt facilities cap common stock dividend payments at $300 million in a calendar year. For the three months ended March 31, 2006, we paid $40 million in common stock dividends to CMS Energy. Also, the provisions of the Federal Power Act and the Natural Gas Act effectively restrict dividends to the amount of our retained earnings. CAPITAL AND FINANCE LEASE OBLIGATIONS: Our capital leases are comprised mainly of leased service vehicles, power purchase agreements and office furniture. At March 31, 2006, capital lease obligations totaled $57 million. In order to obtain permanent financing for the MCV Facility, the MCV Partnership entered into a sale and lease back agreement with a lessor group, which includes the FMLP, for substantially all of the MCV Partnership's fixed assets. In accordance with SFAS No. 98, the MCV Partnership accounted for the transaction as a financing arrangement. At March 31, 2006, finance lease obligations totaled $279 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 sell certain accounts receivable to a wholly owned, consolidated, bankruptcy remote special purpose entity. In turn, the special purpose entity may sell an undivided interest in up to $325 million of the receivables. The special purpose entity sold no receivables at March 31, 2006 and $325 million of receivables at December 31, 2005. We continue to service the receivables sold to the special purpose entity. The purchaser of the receivables has no recourse against our other assets for failure of a debtor to pay when due and no right to any receivables not sold. We have neither recorded a gain or loss on the receivables sold nor retained interest in the receivables sold. Certain cash flows under our accounts receivable sales program are shown in the following table:
In Millions ---------------------- Three months ended March 31 2006 2005 - --------------------------- ------- ------- Net cash flow as a result of accounts receivable financing $ (325) $ (304) Collections from customers $1,817 $ 1,592
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. CE-40 Consumers Energy Company The cost and fair value of our long-term financial instruments are as follows:
In Millions -------------------------------------------------------------------------------- March 31, 2006 December 31, 2005 ------------------------------------- ------------------------------------- Fair Unrealized Fair Unrealized Cost Value Gain (Loss) Cost Value Gain (Loss) ------ ------ ----------- ------ ------ ----------- Long-term debt, including current amounts $4,382 $4,304 $ 78 $4,388 $4,393 $ (5) Long-term debt - related parties, including current amounts - - - 129 131 (2) Available-for-sale securities: Common stock of CMS Energy 10 29 19 10 33 23 SERP: Equity securities 16 23 7 16 22 6 Debt securities 8 7 (1) 8 8 - Nuclear decommissioning investments: Equity securities 136 261 125 134 252 118 Debt securities 301 301 - 287 291 4
DERIVATIVE INSTRUMENTS: We are exposed to market risks including, but not limited to, changes in commodity prices, interest rates, and equity security prices. We may use various contracts to manage these risks, including options, futures, swaps, and forward contracts. We enter into these risk management contracts using established policies and procedures, under the direction of both: - an executive oversight committee consisting of senior management representatives, and - a risk committee consisting of business unit managers. Our intention is that any increases or decreases in the value of these contracts will be offset by an opposite change in the value of the item at risk. We enter into all of these contracts for purposes other than trading. The contracts we use to manage market risks may qualify as derivative instruments that are subject to derivative and hedge accounting under SFAS No. 133. If a contract is a derivative, it is recorded on the balance sheet at its fair value. We then adjust the resulting asset or liability each quarter to reflect any change in the market value of the contract, a practice known as marking the contract to market. If a derivative qualifies for cash flow hedge accounting treatment, the changes in fair value (gains or losses) are reported in accumulated other comprehensive income; otherwise, the changes are reported in earnings. For a derivative instrument to qualify for hedge accounting: - the relationship between the derivative instrument and the item being hedged must be formally documented at inception, - the derivative instrument must be highly effective in offsetting the hedged item's cash flows or changes in fair value, and - if hedging a forecasted transaction, the forecasted transaction must be probable. If a derivative qualifies for cash flow hedge accounting treatment and gains or losses are recorded in accumulated other comprehensive income, those gains or losses will be reclassified into earnings in the same period or periods the hedged forecasted transaction affects earnings. If a cash flow hedge is CE-41 Consumers Energy Company terminated early because it is determined that the forecasted transaction will not occur, any gain or loss recorded in accumulated other comprehensive income at that date is recognized immediately in earnings. If a cash flow hedge is terminated early for other economic reasons, any gain or loss as of the termination date is deferred and then reclassified to earnings when the forecasted transaction affects earnings. The ineffective portion, if any, of all hedges is recognized in earnings. To determine the fair value of our derivatives, we use information from external sources (i.e., quoted market prices and third-party valuations), if available. For certain contracts, this information is not available and we use mathematical valuation models to value our derivatives. These models require various inputs and assumptions, including commodity market prices and volatilities, as well as interest rates and contract maturity dates. The cash returns we actually realize on these contracts may vary, either positively or negatively, from the results that we estimate using these models. As part of valuing our derivatives at market, we maintain reserves, if necessary, for credit risks arising from the financial condition of counterparties. The majority of our commodity purchase and sale contracts are not subject to derivative accounting under SFAS No. 133 because: - they do not have a notional amount (that is, a number of units specified in a derivative instrument, such as MW of electricity or bcf of natural gas), - they qualify for the normal purchases and sales exception, or - there is not an active market for the commodity. Our coal purchase contracts are not derivatives because there is not an active market for the coal we purchase. Similarly, our electric capacity and energy contracts are not derivatives due to the lack of an active energy market in Michigan. If active markets for these commodities develop in the future, some of these contracts may qualify as derivatives. For our coal purchase contracts, the resulting mark-to-market impact on earnings could be material. For our electric capacity and energy contracts, we believe that we would be able to apply the normal purchases and sales exception, and, therefore, would not be required to mark these contracts to market. In 2005, the MISO began operating the Midwest Energy Market. As a result, the MISO now centrally dispatches electricity and transmission service throughout much of the Midwest and provides day-ahead and real-time energy market information. At this time, we believe that the establishment of this market does not represent the development of an active energy market in Michigan, as defined by SFAS No. 133. However, as the Midwest Energy Market matures, we will continue to monitor its activity level and evaluate whether or not an active energy market may exist in Michigan. CE-42 Derivative accounting is required for certain contracts used to limit our exposure to commodity price risk. The following table summarizes our derivative instruments:
In Millions ------------------------------------------------------------------------- March 31, 2006 December 31, 2005 -------------------------------- ------------------------------- Fair Unrealized Fair Unrealized Derivative Instruments Cost Value Gain Cost Value Gain (Loss) - ---------------------- ---- ----- ---- ---- ----- ----------- Gas supply option contracts $- $ - $ - $1 $ (1) $ (2) FTRs - - - - 1 1 Derivative contracts associated with the MCV Partnership: Long-term gas contracts (a) - 93 93 - 205 205 Gas futures, options, and swaps (a) - 144 144 - 223 223
(a) The fair value of the MCV Partnership's long-term gas contracts and gas futures, options, and swaps has decreased significantly from December 31, 2005 due to a decrease in natural gas prices since that time. We record the fair value of our derivative contracts in Derivative instruments, Other assets, or Other liabilities on our Consolidated Balance Sheets. GAS SUPPLY OPTION CONTRACTS: Our gas utility business uses fixed-priced weather-based gas supply call options and fixed-priced gas supply call and put options to meet our regulatory obligation to provide gas to our customers at a reasonable and prudent cost. As part of the GCR process, the mark-to-market gains and losses associated with these options are reported directly in earnings as part of Other income, and then immediately reversed out of earnings and recorded on the balance sheet as a regulatory asset or liability. FTRs: With the establishment of the Midwest Energy Market, FTRs were established. FTRs are financial instruments that manage price risk related to electricity transmission congestion. An FTR entitles its holder to receive compensation (or, conversely, to remit payment) for congestion-related transmission charges. FTRs are marked-to-market each quarter, with changes in fair value reported to earnings as part of Other income. DERIVATIVE CONTRACTS ASSOCIATED WITH THE MCV PARTNERSHIP: Long-term gas contracts: The MCV Partnership uses long-term gas contracts to purchase and manage the cost of the natural gas it needs to generate electricity and steam. The MCV Partnership believes that certain of these contracts qualify as normal purchases under SFAS No. 133. Accordingly, we have not recognized these contracts at fair value on our Consolidated Balance Sheets at March 31, 2006. The MCV Partnership also holds certain long-term gas contracts that do not qualify as normal purchases because these contracts contain volume optionality. In addition, as a result of implementing the RCP in 2005, a significant portion of long-term gas contracts no longer qualify as normal purchases, because the gas will not be used to generate electricity or steam. Accordingly, all of these contracts are accounted for as derivatives, with changes in fair value recorded in earnings each quarter. For the three months ended March 31, 2006, we recorded a $111 million loss, before considering tax effects and minority interest, associated with the decrease in fair value of these long-term gas contracts. This loss is included in the total Fuel costs mark-to-market at MCV on our Consolidated Statements of Income. Because of the volatility of the natural gas market, the MCV Partnership expects future earnings volatility on these contracts, since gains and losses will be recorded each quarter. CE-43 Consumers Energy Company We have recorded derivative assets totaling $93 million associated with the fair value of long-term gas contracts on our Consolidated Balance Sheets at March 31, 2006. We expect almost all of these assets, which represent cumulative net mark-to-market gains, to reverse as losses through earnings during 2006 and 2007 as the gas is purchased, with the remainder reversing between 2008 and 2011. As the MCV Partnership recognizes future losses from the reversal of these derivative assets, we will continue to assume a portion of the limited partners' share of those losses, in addition to our proportionate share. For further details on the RCP, see Note 2, Contingencies, "Other Electric Contingencies - The Midland Cogeneration Venture." Gas Futures, Options, and Swaps: The MCV Partnership enters into natural gas futures, options, and over-the-counter swap transactions in order to hedge against unfavorable changes in the market price of natural gas. The MCV Partnership uses these financial instruments to: - ensure an adequate supply of natural gas for the projected generation and sales of electricity and steam, and - manage price risk by fixing the price to be paid for natural gas on some of its long-term gas contracts. At March 31, 2006, the MCV Partnership held natural gas futures, options, and swaps. We have recorded derivative assets totaling $144 million associated with the fair value of these contracts on our Consolidated Balance Sheets at March 31, 2006. Certain of these contracts qualify for cash flow hedge accounting and we record our proportionate share of their mark-to-market gains and losses in Accumulated other comprehensive income. The remaining contracts are not cash flow hedges and their mark-to-market gains and losses are recorded to earnings. Those contracts that qualify as cash flow hedges represent $137 million of the total $144 million of futures, options, and swaps held. We have recorded a cumulative net gain of $44 million, net of tax and minority interest, in Accumulated other comprehensive income at March 31, 2006, representing our proportionate share of the cash flow hedges held by the MCV Partnership. Of this balance, we expect to reclassify $16 million, net of tax and minority interest, as an increase to earnings during the next 12 months as the contracts settle, offsetting the costs of gas purchases, with the remainder to be realized through 2009. There was no ineffectiveness associated with any of these cash flow hedges. The remaining futures, options, and swap contracts, representing $7 million of the total $144 million, do not qualify as cash flow hedges. Prior to the implementation of the RCP, the futures and swap contracts were accounted for as cash flow hedges. Since the RCP was implemented in 2005, these instruments no longer qualify for cash flow hedge accounting and we record any changes in their fair value in earnings each quarter. For the three months ended March 31, 2006, we recorded a $45 million loss, before considering tax effects and minority interest, associated with the decrease in fair value of these instruments. This loss is included in the total Fuel costs mark-to-market at MCV on our Consolidated Statements of Income. Because of the volatility of the natural gas market, the MCV Partnership expects future earnings volatility on these contracts, since gains and losses will be recorded each quarter. We expect almost all of these futures, options, and swap contracts to be realized during 2006 as the contracts settle, with the remainder to be realized during 2007. For further details on the RCP, see Note 2, Contingencies, "Other Electric Contingencies - The Midland Cogeneration Venture." CREDIT RISK: Our swaps and forward contracts contain credit risk, which is the risk that counterparties will fail to perform their contractual obligations. We reduce this risk through established credit policies. For each counterparty, we assess credit quality by using credit ratings, financial condition, and other CE-44 Consumers Energy Company available information. We then establish a credit limit for each counterparty based upon our evaluation of credit quality. We monitor the degree to which we are exposed to potential loss under each contract and take remedial action, if necessary. The MCV Partnership enters into contracts primarily with companies in the electric and gas industry. This industry concentration may have an impact on our exposure to credit risk, either positively or negatively, based on how these counterparties are affected by similar changes in economic, weather, or other conditions. The MCV Partnership typically uses industry-standard agreements that allow for netting positive and negative exposures associated with the same counterparty, thereby reducing exposure. These contracts also typically provide for the parties to demand adequate assurance of future performance when there are reasonable grounds for doing so. The following table illustrates our exposure to potential losses at March 31, 2006, if each counterparty within this industry concentration failed to perform its contractual obligations. This table includes contracts accounted for as financial instruments. It does not include trade accounts receivable, derivative contracts that qualify for the normal purchases and sales exception under SFAS No. 133, or other contracts that are not accounted for as derivatives.
In Millions ---------------------------------------------------------------------------------------------- Net Exposure Net Exposure Exposure from Investment from Investment Before Collateral Net Grade Grade Collateral (a) Held (b) Exposure Companies (c) Companies (%) -------------- -------- -------- ------------- ------------- MCV Partnership $224 $104 $120 $102 85
(a) Exposure is reflected net of payables or derivative liabilities if netting arrangements exist. (b) Collateral held includes cash and letters of credit received from counterparties. (c) Approximately half of the remaining balance of our net exposure was from independent natural gas producers/suppliers that do not have published credit ratings. Based on our credit policies and our current exposures, we do not expect a material adverse effect on our financial position or future earnings as a result of counterparty nonperformance. 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 between July 1, 2003 and August 31, 2005, - a DCCP for employees hired on or after September 1, 2005, - benefits to certain management employees under SERP, - a defined contribution 401(k) Savings Plan, - benefits to a select group of management under the EISP, and - health care and life insurance benefits under OPEB. Pension Plan: The Pension Plan includes funds for most of our current employees, our non-utility affiliates, and Panhandle, a former affiliate. The Pension Plan's assets are not distinguishable by CE-45 Consumers Energy Company company. Effective January 11, 2006, the MPSC electric rate order authorized us to include $33 million of electric pension expense in our electric rates. Due to the volatility of these particular costs, the order also established a pension equalization mechanism to track actual costs. If actual pension expenses are greater than the $33 million included in electric rates, the difference will be recognized as a regulatory asset for future recovery from customers. If actual pension expenses are less than the $33 million included in electric rates, the difference will be recognized as a regulatory liability, and refunded to our customers. The difference between pension expense allowed in our electric rates and pension expense under SFAS No. 87, resulted in a $3 million net reduction in pension expense and establishment of a corresponding regulatory asset for the three months ending March 31, 2006. Effective January 11, 2006, the MPSC electric rate order authorized us to include $28 million of electric OPEB expense in our electric rates. Due to the volatility of these particular costs, the order also established an OPEB equalization mechanism to track actual costs. If actual OPEB expenses are greater than the $28 million included in electric rates, the difference will be recognized as a regulatory asset for future recovery from our customers. If actual OPEB expenses are less than the $28 million included in electric rates, the difference will be recognized as a regulatory liability, and refunded to our customers. The difference between OPEB expense allowed in our electric rates and OPEB expense under SFAS No. 106, resulted in less than $1 million net reduction in OPEB expense and establishment of a corresponding regulatory asset for the three months ending March 31, 2006. Costs: The following table recaps the costs incurred in our retirement benefits plans:
In Millions -------------------------------------------- Pension OPEB ----------------- ------------------ Three Months Ended March 31 2006 2005 2006 2005 - --------------------------- ----- ----- ----- ----- Service cost $12 $ 9 $ 6 $ 5 Interest expense 19 18 16 15 Expected return on plan assets (20) (23) (14) (13) Amortization of: Net loss 10 7 5 5 Prior service cost 2 1 (3) (2) --- --- --- --- Net periodic cost 23 12 10 10 Regulatory adjustment (3) - - - --- --- --- --- Net periodic cost after regulatory adjustment $20 $12 $10 $10 === === === ===
SERP: On April 1, 2006, we implemented a Defined Contribution Supplemental Executive Retirement Plan (DC SERP) and froze further new participation in the defined benefit SERP. The DC SERP plan provides promoted and newly hired participants benefits ranging from five to 15 percent of total compensation. The DC SERP plan requires a minimum of five years of participation before vesting; our contributions to the plan, if any, will be placed in a grantor trust. The MCV Partnership sponsors defined cost postretirement health care plans that cover all full-time employees, except key management. Participants in the postretirement health care plans become eligible for the benefits if they retire on or after the attainment of age 65 or upon a qualified disability retirement, or if they have 10 or more years of service and retire at age 55 or older. The MCV Partnership's net periodic postretirement health care cost for the three months ended March 31, 2006 and 2005 was less than $1 million. CE-46 Consumers Energy Company 6: ASSET RETIREMENT OBLIGATIONS SFAS NO. 143: This standard requires companies to record the fair value of the cost to remove assets at the end of their useful life, if there is a legal obligation to remove them. We have legal obligations to remove some of our assets, including our nuclear plants, at the end of their useful lives. The fair value of ARO liabilities has been calculated using an expected present value technique. This technique reflects assumptions such as costs, inflation, and profit margin that third parties would consider to assume the settlement of the obligation. Fair value, to the extent possible, should include a market risk premium for unforeseeable circumstances. No market risk premium was included in our ARO fair value estimate since a reasonable estimate could not be made. If a five percent market risk premium were assumed, our ARO liability would increase by $25 million. If a reasonable estimate of fair value cannot be made in the period in which the ARO is incurred, such as for assets with indeterminate lives, the liability is to be recognized when a reasonable estimate of fair value can be made. Generally, gas transmission and electric and gas distribution assets have indeterminate lives. Retirement cash flows cannot be determined and there is a low probability of a retirement date. Therefore, no liability has been recorded for these assets or associated obligations related to potential future abandonment. Also, no liability has been recorded for assets that have insignificant cumulative disposal costs, such as substation batteries. The measurement of the ARO liabilities for Palisades and Big Rock include use of decommissioning studies that largely utilize third-party cost estimates. FASB INTERPRETATION NO. 47, ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT OBLIGATIONS: This Interpretation clarified the term "conditional asset retirement obligation" as used in SFAS No. 143. The term refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event. We determined that abatement of asbestos included in our plant investments qualify as a conditional ARO, as defined by FASB Interpretation No. 47. The following tables describe our assets that have legal obligations to be removed at the end of their useful life:
March 31, 2006 In Millions - --------------------------------------------------------------------------------------------------------------------------- In Service Trust ARO Description Date Long Lived Assets Fund - --------------- ---- ----------------- ---- Palisades - decommission plant site 1972 Palisades nuclear plant $554 Big Rock - decommission plant site 1962 Big Rock nuclear plant 22 JHCampbell intake/discharge water line 1980 Plant intake/discharge water line - Closure of coal ash disposal areas Various Generating plants coal ash areas - Closure of wells at gas storage fields Various Gas storage fields - Indoor gas services equipment relocations Various Gas meters located inside structures - Asbestos abatement 1973 Electric and gas utility plant -
CE-47 Consumers Energy Company
In Millions ------------------------------------------------------------------------------------------ ARO ARO Liability Cash flow Liability ARO Description 12/31/05 Incurred Settled Accretion Revisions 3/31/06 - --------------- -------- -------- ------- --------- --------- ------- Palisades - decommission $375 $ - $- $6 $ - $381 Big Rock - decommission 27 - (4) 1 - 24 JHCampbell intake line - - - - - - Coal ash disposal areas 54 - - 1 - 55 Wells at gas storage fields 1 - - - - 1 Indoor gas services relocations 1 - - - - 1 Asbestos abatement 36 - (2) - - 34 ---- --- --- -- --- ---- Total $494 $ - $(6) $8 $ - $496 ==== === === == === ====
In October 2004, the MPSC initiated a generic proceeding to review SFAS No. 143, FERC Order No. 631, Accounting, Financial Reporting, and Rate Filing Requirements for Asset Retirement Obligations, and related accounting and ratemaking issues for MPSC-jurisdictional electric and gas utilities. On December 5, 2005, the ALJ issued a proposal for decision recommending that the MPSC dismiss the proceeding. In March 2006, the MPSC remanded the case to the ALJ for findings and recommendations. We consider the proceeding a clarification of accounting and reporting issues that relate to all Michigan utilities. We cannot predict the outcome of the proceeding. 7: EXECUTIVE INCENTIVE COMPENSATION We provide a Performance Incentive Stock Plan (the Plan) to key employees and non-employee directors based on their contributions to the successful management of the company. The Plan has a five-year term, expiring in May 2009. All grants awarded under the Plan for the three months ended March 31, 2006 and in 2005 were in the form of restricted stock. Restricted stock awards are outstanding shares to which the recipient has full voting and dividend rights and vest 100 percent after three years of continued employment. Restricted stock awards granted to officers in 2005 and 2004 are also subject to the achievement of specified levels of total shareholder return, including a comparison to a peer group of companies. All restricted stock awards are subject to forfeiture if employment terminates before vesting. However, restricted shares may continue to vest upon retirement or disability and vest fully if control of CMS Energy changes, as defined by the Plan. The Plan also allows for the following types of awards: - stock options, - stock appreciation rights, - phantom shares, and - performance units. For the three months ended March 31, 2006 and in 2005, we did not grant any of these types of awards. Select participants may elect to receive all or a portion of their incentive payments under the Officer's Incentive Compensation Plan in the form of cash, shares of restricted common stock, shares of restricted stock units, or any combination of these. These participants may also receive awards of additional restricted common stock or restricted stock units, provided the total value of these additional grants does CE-48 Consumers Energy Company not exceed $2.5 million for any fiscal year. Shares awarded or subject to stock options, phantom shares, and performance units may not exceed 6 million shares from June 2004 through May 2009, nor may such awards to any participant exceed 250,000 shares in any fiscal year. We may issue awards of up to 4,943,630 shares of common stock under the Plan at March 31, 2006. Shares for which payment or exercise is in cash, as well as shares or stock options that are forfeited, may be awarded or granted again under the Plan. SFAS NO. 123(R) AND SAB NO. 107, SHARE-BASED PAYMENT: SFAS No. 123(R) was effective for us on January 1, 2006. SFAS No. 123(R) requires companies to use the fair value of employee stock options and similar awards at the grant date to value the awards. Companies must expense this value over the required service period of the awards. As a result, future compensation costs for share-based awards with accelerated service provisions upon retirement will need to be fully expensed by the period in which the employee becomes eligible to retire. At January 1, 2006, unrecognized compensation cost for such share-based awards held by retirement-eligible employees was not material. We elected to adopt the modified prospective method recognition provisions of this Statement instead of retrospective restatement. The modified prospective method applies the recognition provisions to all awards granted or modified after the adoption date of this Statement. We adopted the fair value method of accounting for share-based awards effective December 2002. Therefore, SFAS No. 123(R) did not have a significant impact on our results of operations when it became effective. The SEC issued SAB No. 107 to express the views of the staff regarding the interaction between SFAS No. 123(R) and certain SEC rules and regulations. Also, the SEC issued SAB No. 107 to provide the staff's views regarding the valuation of share-based payments, including assumptions such as expected volatility and expected term. We applied the additional guidance provided by SAB No. 107 upon implementation of SFAS No. 123(R) with no impact on our consolidated results of operations. The following table summarizes restricted stock activity under the Plan:
Weighted- Average Grant Restricted Stock Number of Shares Date Fair Value - ---------------- ---------------- --------------- Nonvested at December 31, 2005 1,141,316 $10.84 Granted 2,000 $13.38 Vested (a) - - Forfeited - - --------- ------ Nonvested at March 31, 2006 1,143,316 $10.84 ========= ======
(a) No shares vested during the three months ended March 31, 2006 and 2005. We calculate the fair value of restricted shares granted based on the price of our common stock on the grant date and expense the fair value over the required service period. Total compensation cost recognized in income related to restricted stock was $1 million for the three months ended March 31, 2006 and 2005. The total related income tax benefit recognized in income was less than $1 million for the three months ended March 31, 2006 and 2005. At March 31, 2006, there was $8 million of total unrecognized compensation cost related to restricted stock. We expect to recognize this cost over a weighted-average period of 2.1 years. CE-49 Consumers Energy Company The following table summarizes stock option activity under the Plan:
Weighted- Options Weighted- Average Aggregate Outstanding, Average Remaining Intrinsic Fully Vested, Exercise Contractual Value Stock Options and Exercisable Price Term (In Millions) - ------------- --------------- --------- ----------- ------------- Outstanding at December 31, 2005 1,714,787 $18.13 5.9 years $ (6) Granted - - Exercised (14,000) $6.35 Cancelled or Expired - - --------- ------ --------- ---- Outstanding at March 31, 2006 1,700,787 $18.22 5.6 years $ (9) ========= ====== ========= ====
Stock options give the holder the right to purchase common stock at a price equal to the fair value of our common stock on the grant date. Stock options are exercisable upon grant, and expire up to 10 years and one month from the grant date. We issue new shares when participants exercise stock options. For the three months ended March 31, 2006, the total intrinsic value of stock options exercised was less than $1 million. Cash received from exercise of these stock options was less than $1 million. Since we utilized tax loss carryforwards, we were not able to realize the excess tax benefits upon exercise of stock options. Therefore, we did not recognize the related excess tax benefits in equity. No stock options were exercised for the three months ended March 31, 2005. 8: REPORTABLE SEGMENTS Our reportable segments are strategic business units organized and managed by the nature of the products and services each provides. We evaluate performance based upon the net income of each segment. We operate principally in two segments: electric utility and gas utility. The following table shows our financial information by reportable segment:
In Millions ----------------------- Three Months Ended March 31 2006 2005 - --------------------------- ---- ---- Operating revenue Electric $729 $628 Gas 1,041 992 Other 12 12 ------- ------- Total Operating Revenue $ 1,782 $ 1,632 ======= ======= Net income available to common stockholder Electric $ 29 $33 Gas 37 58 Other (56) 66 ------- ------- Total Net Income Available to Common Stockholder $ 10 $ 157 ======= =======
CE-50 Consumers Energy Company
In Millions ---------------------------------------- March 31, 2006 December 31, 2005 -------------- ----------------- Assets Electric (a) $ 7,864 $ 7,743 Gas (a) 3,193 3,600 Other 1,886 1,814 -------- -------- Total Assets $ 12,943 $ 13,157 ======== ========
(a) Amounts include a portion of our other common assets attributable to both the electric and gas utility businesses. CE-51 Consumers Energy Company This page intentionally left blank CE-52 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK CMS ENERGY Quantitative and Qualitative Disclosures about Market Risk is contained in PART I: CMS Energy Corporation's Management's Discussion and Analysis, which is incorporated by reference herein. CONSUMERS Quantitative and Qualitative Disclosures about Market Risk is contained in PART I: Consumers Energy Company's Management's Discussion and Analysis, which is incorporated by reference herein. ITEM 4. CONTROLS AND PROCEDURES CMS ENERGY Disclosure Controls and Procedures: CMS Energy's management, with the participation of its CEO and CFO, has evaluated the effectiveness of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, CMS Energy's CEO and CFO have concluded that, due to the fact that the material weakness in CMS Energy's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) identified in its 2005 Form 10-K, has not been tested to confirm evidence of remediation, its disclosure controls and procedures were not effective at March 31, 2006. Management continues to validate the remedial actions it has taken to correct the income tax-related material weakness identified in CMS Energy's 2005 Form 10-K. Management believes it has implemented the necessary processes and procedures to overcome the material weakness relating to income taxes; however, these processes and procedures, and correlating controls, have not been in place for an adequate period of time to conclude that the material weakness has been remediated at March 31, 2006. Management will continue to monitor and test the continuous effectiveness of these controls and procedures and make appropriate modifications, as necessary. Management believes that the consolidated financial statements included in this Form 10-Q fairly present, in all material respects, CMS Energy's financial condition, results of operations and cash flows for the periods presented. Internal Control Over Financial Reporting: Except as otherwise discussed herein, there have not been any changes in CMS Energy's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting. CONSUMERS Disclosure Controls and Procedures: Consumers' management, with the participation of its CEO and CFO, has evaluated the effectiveness of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, Consumers' CEO and CFO have concluded that, as of the end of such period, its disclosure controls and procedures are effective. CO-1 Internal Control Over Financial Reporting: There have not been any changes in Consumers' internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The discussion below is limited to an update of developments that have occurred in various judicial and administrative proceedings, many of which are more fully described in CMS Energy's and Consumers' Forms 10-K for the year ended December 31, 2005. Reference is also made to the Condensed Notes to Consolidated Financial Statements, in particular, Note 2, Contingencies, for CMS Energy and Note 2, Contingencies, for Consumers, included herein for additional information regarding various pending administrative and judicial proceedings involving rate, operating, regulatory and environmental matters. CMS ENERGY SEC REQUEST On August 5, 2004, CMS Energy received a request from the SEC that CMS Energy voluntarily produce documents and data relating to the SEC's inquiry into payments made to the officials or relatives of officials of the government of Equatorial Guinea. On August 17, 2004, CMS Energy submitted its response, advising the SEC of the information and documentation it had available. On March 8, 2005, CMS Energy received a request from the SEC that CMS Energy voluntarily produce certain of such documents. CMS Energy has provided responsive documents to the SEC and will continue to provide such documents as it reviews its electronic records in further response to the SEC's request. The SEC subsequently issued a formal order of private investigation on this matter on August 1, 2005. CMS Energy and several other companies who have conducted business in Equatorial Guinea received subpoenas from the SEC to provide documents regarding payments made to officials or relatives of officials of the government of Equatorial Guinea. CMS Energy is cooperating and has been and will continue to produce documents responsive to the subpoena. GAS INDEX PRICE REPORTING LITIGATION On February 28, 2006, CMS MST and CMS Field Services (which was sold to Cantera Natural Gas, LLC and for which CMS Energy has indemnification obligations) reached an agreement, subject to court approval, to settle a consolidated class action lawsuit filed in the United States District Court for the Southern District of New York. Cornerstone Propane Partners, L.P. filed the original complaint in August 2003 as a putative class action and it was later consolidated with two similar complaints filed by other plaintiffs. The amended consolidated complaint, filed in January 2004, alleged that false natural gas price reporting by the defendants manipulated the prices of NYMEX natural gas futures and options. The complaint contained two counts under the Commodity Exchange Act, one for manipulation and one for aiding and abetting violations. The settlement agreement among the plaintiffs, CMS MST and CMS Field Services requires a $6.975 million cash payment that CMS MST is responsible to pay. The payment was made into a settlement fund that will be used to pay the class members as well as any legal fees awarded to plaintiffs' attorneys. CMS Energy established a reserve for this amount in the fourth quarter of 2005. In a similar but unrelated matter, Texas-Ohio Energy, Inc. filed a putative class action lawsuit in the United States District Court for the Eastern District of California in November 2003 against a number of CO-2 energy companies engaged in the sale of natural gas in the United States (including CMS Energy). The complaint alleged defendants entered into a price-fixing scheme by engaging in activities to manipulate the price of natural gas in California. The complaint alleged violations of the federal Sherman Act, the California Cartwright Act, and the California Business and Professions Code relating to unlawful, unfair and deceptive business practices. The complaint sought both actual and exemplary damages for alleged overcharges, attorneys fees and injunctive relief regulating defendants' future conduct relating to pricing and price reporting. In April 2004, a Nevada Multidistrict Litigation (MDL) Panel ordered the transfer of the Texas-Ohio case to a pending MDL matter in the Nevada federal district court that at the time involved seven complaints originally filed in various state courts in California. These complaints make allegations similar to those in the Texas-Ohio case regarding price reporting, although none contain a federal Sherman Act claim. In November 2004, those seven complaints, as well as a number of others that were originally filed in various state courts in California and subsequently transferred to the MDL proceeding, were remanded back to California state court. The Texas-Ohio case remained in Nevada federal district court, and defendants, with CMS Energy joining, filed a motion to dismiss. The court issued an order granting the motion to dismiss on April 8, 2005 and entered a judgment in favor of the defendants on April 11, 2005. Texas-Ohio has appealed the dismissal to the Ninth Circuit Court of Appeals. Three federal putative class actions, Fairhaven Power Company v. Encana Corp. et al., Utility Savings & Refund Services LLP v. Reliant Energy Resources Inc. et al., and Abelman Art Glass v. Encana Corp. et al., all of which make allegations similar to those in the Texas-Ohio case regarding price manipulation and seek similar relief, were originally filed in the United States District Court for the Eastern District of California in September 2004, November 2004 and December 2004, respectively. The Fairhaven and Abelman Art Glass cases also include claims for unjust enrichment and a constructive trust. The three complaints were filed against CMS Energy and many of the other defendants named in the Texas-Ohio case. In addition, the Utility Savings case names CMS MST and Cantera Resources Inc. (Cantera Resources Inc. is the parent of Cantera Natural Gas, LLC. and CMS Energy is required to indemnify Cantera Natural Gas, LLC and Cantera Resources Inc. with respect to these actions.) The Fairhaven, Utility Savings and Abelman Art Glass cases have been transferred to the MDL proceeding, where the Texas-Ohio case was pending. Pursuant to stipulation by the parties and court order, defendants were not required to respond to the Fairhaven, Utility Savings and Abelman Art Glass complaints until the court ruled on defendants' motion to dismiss in the Texas-Ohio case. Plaintiffs subsequently filed a consolidated class action complaint alleging violations of federal and California antitrust laws. Defendants filed a motion to dismiss, arguing that the consolidated complaint should be dismissed for the same reasons as the Texas-Ohio case. The court issued an order granting the motion to dismiss on December 19, 2005 and entered judgment in favor of defendants on December 23, 2005. Plaintiffs have appealed the dismissal to the Ninth Circuit Court of Appeals. Commencing in or about February 2004, 15 state law complaints containing allegations similar to those made in the Texas-Ohio case, but generally limited to the California Cartwright Act and unjust enrichment, were filed in various California state courts against many of the same defendants named in the federal price manipulation cases discussed above. In addition to CMS Energy, CMS MST is named in all of the 15 state law complaints. Cantera Gas Company and Cantera Natural Gas, LLC (erroneously sued as Cantera Natural Gas, Inc.) are named in all but one complaint. In February 2005, these 15 separate actions, as well as nine other similar actions that were filed in California state court but do not name CMS Energy or any of its former or current subsidiaries, were ordered coordinated with pending coordinated proceedings in the San Diego Superior Court. The 24 state court complaints involving price reporting were coordinated as Natural Gas Antitrust Cases V. Plaintiffs in Natural Gas Antitrust Cases V were ordered to file a consolidated complaint, but a consolidated CO-3 complaint was filed only for the two putative class action lawsuits. On April 8, 2005, defendants filed a demurrer to the master class action complaint and the individual complaints and on May 13, 2005, plaintiffs filed a memorandum of points and authorities in opposition to defendants' federal preemption demurrer and motion to strike. Pursuant to a ruling dated June 29, 2005, the demurrer was overruled and the motion to strike was denied. Samuel D. Leggett, et al v. Duke Energy Corporation, et al, a class action complaint brought on behalf of retail and business purchasers of natural gas in Tennessee, was filed in the Chancery Court of Fayette County, Tennessee in January 2005. The complaint contains claims for violations of the Tennessee Trade Practices Act based upon allegations of false reporting of price information by defendants to publications that compile and publish indices of natural gas prices for various natural gas hubs. The complaint seeks statutory full consideration damages and attorneys fees and injunctive relief regulating defendants' future conduct. The defendants include CMS Energy, CMS MST and CMS Field Services. On March 7, 2005, defendants removed the case to the United States District Court for the Western District of Tennessee, Western Division, and they filed a motion on May 20, 2005 to transfer the case to the MDL proceeding in Nevada. On April 6, 2005, plaintiffs filed a motion to remand the case back to the Chancery Court in Tennessee. On August 10, 2005, certain defendants, including CMS MST, filed a motion to dismiss and CMS Energy and CMS Field Services filed a motion to dismiss for lack of personal jurisdiction. Plaintiffs have opposed the motions to dismiss. An order transferring the case to the MDL proceeding was issued on or about August 11, 2005, and the motions to dismiss remain pending. On November 20, 2005, CMS MST was served with a summons and complaint which named CMS Energy, CMS MST and CMS Field Services as defendants in a new putative class action filed in Kansas state court, Learjet, Inc., et al. v. Oneok, Inc., et al. Similar to the other actions that have been filed, the complaint alleges that during the putative class period, January 1, 2000 through October 31, 2002, defendants engaged in a scheme to violate the Kansas Restraint of Trade Act by knowingly reporting false or inaccurate information to the publications, thereby affecting the market price of natural gas. Plaintiffs, who allege they purchased natural gas from defendants and other for their facilities, are seeking statutory full consideration damages consisting of the full consideration paid by plaintiffs for natural gas. On December 7, 2005, the case was removed to the United States District Court for the District of Kansas and later that month a motion was filed to transfer the case to the MDL proceeding. On January 6, 2006, plaintiffs filed a motion to remand the case to Kansas state court. On January 23, 2006, a conditional transfer order transferring the case to the MDL proceeding was issued. On February 7, 2006, plaintiffs filed an opposition to the conditional transfer order. CMS Energy and the other CMS defendants will defend themselves vigorously against these matters but cannot predict their outcome. CMS ENERGY AND CONSUMERS SECURITIES CLASS ACTION LAWSUITS Beginning on May 17, 2002, a number of complaints were filed against CMS Energy, Consumers, and certain officers and directors of CMS Energy and its affiliates. The cases were consolidated into a single lawsuit, which generally seeks unspecified damages based on allegations that the defendants violated United States securities laws and regulations by making allegedly false and misleading statements about CMS Energy's business and financial condition, particularly with respect to revenues and expenses recorded in connection with round-trip trading by CMS MST. In January 2005, the court granted a motion to dismiss Consumers and three of the individual defendants, but denied the motions to dismiss CMS Energy and the 13 remaining individual defendants. The court issued an opinion and order dated March 24, 2006, granting in part and denying in part plaintiffs' amended motion for class certification. CO-4 The court conditionally certified a class consisting of "[a]ll persons who purchased CMS Common Stock during the period of October 25, 2000 through and including May 17, 2002 and who were damaged thereby." Appeals and motions for reconsideration of the court's ruling have been lodged by the parties. CMS Energy and the individual defendants will defend themselves vigorously in this litigation but cannot predict its outcome. ERISA LAWSUITS CMS Energy is a named defendant, along with Consumers, CMS MST, and certain named and unnamed officers and directors, in two lawsuits, filed in July 2002 in United States District Court for the Eastern District of Michigan, brought as purported class actions on behalf of participants and beneficiaries of the CMS Employees' Savings Plan (the Plan). Plaintiffs 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, as well as other equitable relief and legal fees. On March 1, 2006, CMS Energy and Consumers reached an agreement, subject to court and independent fiduciary approval, to settle the lawsuits. The settlement agreement requires a $28 million cash payment by CMS Energy's primary insurer that will be used to pay Plan participants and beneficiaries for alleged losses, as well as any legal fees and expenses. In addition, CMS Energy agreed to certain other steps regarding administration of the Plan. The court issued an order on March 23, 2006, granting preliminary approval of the settlement and scheduling the Fairness Hearing for June 15, 2006. ENVIRONMENTAL MATTERS CMS Energy, Consumers and their subsidiaries and affiliates are subject to various federal, state and local laws and regulations relating to the environment. Several of these companies have been named parties to various actions involving environmental issues. Based on their present knowledge and subject to future legal and factual developments, CMS Energy and Consumers believe that it is unlikely that these actions, individually or in total, will have a material adverse effect on their financial condition. See CMS Energy's and Consumers' MANAGEMENT'S DISCUSSION AND ANALYSIS and CMS Energy's and Consumers' CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. ITEM 1A. RISK FACTORS Other than discussed below, there have been no material changes to the Risk Factors as previously disclosed in CMS Energy's and Consumers' Forms 10-K for the year ended December 31, 2005. RISKS RELATED TO CMS ENERGY CMS ENERGY'S NATURAL GAS PIPELINE AND ELECTRIC GENERATION PROJECT LOCATED IN ARGENTINA AND CHILE MAY BE NEGATIVELY IMPACTED BY ARGENTINE GOVERNMENTAL RESTRICTIONS PLACED ON NATURAL GAS EXPORTS TO CHILE. On March 24, 2004, the Argentine government authorized the restriction of exports of natural gas to Chile, giving priority to domestic demand in Argentina. This restriction could have a detrimental effect on GasAtacama's earnings since GasAtacama's gas-fired electric generating plant is located in Chile and uses Argentine gas for fuel. From April through December, 2004, Bolivia agreed to export 4 million cubic meters of gas per day to Argentina, which allowed Argentina to minimize its curtailments to Chile. Argentina and Bolivia extended the term of that agreement through December 31, 2006. With the Bolivian gas supply, Argentina relaxed its export restrictions to GasAtacama, currently allowing GasAtacama to receive approximately 50 percent of its contracted gas quantities at its electric generating CO-5 plant. On May 1, 2006, the Bolivian government announced its intention to nationalize the natural gas industry. At this point in time, it is not possible to predict the outcome of these events and their effect on the earnings of GasAtacama. At March 31, 2006, the value of our investment in GasAtacama was $378 million. RISKS RELATED TO CMS ENERGY AND CONSUMERS CMS ENERGY AND CONSUMERS MAY BE NEGATIVELY IMPACTED BY THE RESULTS OF AN EMPLOYEE BENEFIT PLAN LAWSUIT. 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 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. On March 1, 2006, CMS Energy and Consumers reached an agreement, subject to court and independent fiduciary approval, to settle the consolidated lawsuits. The settlement agreement among the plaintiffs and the defendants requires a $28 million cash payment that will be paid by CMS Energy's primary insurer and will be used to pay Plan participants and beneficiaries for alleged losses, as well as any legal fees and expenses awarded to plaintiffs' attorneys. In addition, CMS Energy agreed to enhance fiduciary education and training, improve discussion of investment diversification with Plan participants and not prevent, for a period of four years, Plan participants from selling CMS Energy Common Stock held in the Plan. The court issued an order on March 23, 2006, granting preliminary approval of the settlement and scheduling the Fairness Hearing for June 15, 2006. CMS ENERGY AND CONSUMERS COULD INCUR SIGNIFICANT CAPITAL EXPENDITURES TO COMPLY WITH ENVIRONMENTAL STANDARDS AND FACE DIFFICULTY IN RECOVERING THESE COSTS ON A CURRENT BASIS. CMS Energy, Consumers, and their subsidiaries are subject to costly and increasingly stringent environmental regulations. They expect that the cost of future environmental compliance, especially compliance with clean air and water laws, will be significant. In March 2005, the EPA issued the Clean Air Mercury Rule, which requires initial reductions of mercury emissions from coal-fired electric generating plants by 2010 and further reductions by 2018. The Clean Air Mercury Rule establishes a cap-and-trade system for mercury emissions that is similar to the system used in the Clean Air Interstate Rule. The industry has not reached a consensus on the technical methods for curtailing mercury emissions. However, Consumers anticipates its capital and operating costs for mercury emissions reductions required by the Clean Air Mercury Rule to be significantly less than what was required for selective catalytic reduction technology used for nitrogen oxide compliance. In April 2006, Michigan's governor announced a plan that would result in mercury emissions reductions of 90 percent by 2015. This plan adopts the Federal Clean Air Mercury Rule through its first phase, which ends in 2010. After the year 2010, the mercury emissions reduction standards outlined in the governor's plan become more stringent than those included in the Federal Clean Air Mercury Rule. If implemented as proposed, Consumers anticipates its costs to comply with the governor's plan will exceed Federal Clean Air Mercury Rule compliance costs. Consumers will work with the MDEQ on the details of these rules. CO-6 These and other required environmental expenditures, if not recovered from customers in Consumers' rates, may require CMS Energy and/or Consumers to seek significant additional financing to fund these expenditures and could strain their cash resources. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION A shareholder who wishes to submit a proposal for consideration at the CMS Energy 2007 Annual Meeting pursuant to the applicable rules of the SEC must send the proposal to reach CMS Energy's Corporate Secretary on or before December 15, 2006. In any event if CMS Energy has not received written notice of any matter to be proposed at that meeting by February 28, 2007, the holders of proxies may use their discretionary voting authority on such matter. The proposals should be addressed to: Corporate Secretary, CMS Energy Corporation, One Energy Plaza, Jackson, MI 49201. ITEM 6. EXHIBITS (10)(a) $300 million Credit Agreement dated as of March 31, 2006 among Consumers, the Banks, the Administrative Agent, the Syndication Agent, the Co-Documentation Agents, and the Co-Managing Agents, all as defined therein (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 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: May 3, 2006 By: /s/ Thomas J. Webb ---------------------------- Thomas J. Webb Executive Vice President and Chief Financial Officer CONSUMERS ENERGY COMPANY (Registrant) Dated: May 3, 2006 By: /s/ Thomas J. Webb ---------------------------- Thomas J. Webb Executive Vice President and Chief Financial Officer CO-8 EXHIBIT INDEX EX. NO. DESCRIPTION - ------- ----------- (10)(a) $300 million Credit Agreement dated as of March 31, 2006 among C onsumers, the Banks, the Administrative Agent, the Syndication Agent, the Co-Documentation Agents, and the Co-Managing Agents, all as defined therein (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 k04805exv10wxay.txt CREDIT AGREEMENT DATED AS OF MARCH 31, 2006 EXHIBIT 10(a) ================================================================================ CREDIT AGREEMENT DATED AS OF MARCH 31, 2006 AMONG CONSUMERS ENERGY COMPANY, AS THE BORROWER, THE FINANCIAL INSTITUTIONS NAMED HEREIN, AS THE BANKS, BARCLAYS BANK PLC, AS ADMINISTRATIVE AGENT, UNION BANK OF CALIFORNIA, N.A., AS SYNDICATION AGENT, BNP PARIBAS, DEUTSCHE BANK TRUST COMPANY AMERICAS AND WACHOVIA BANK, NATIONAL ASSOCIATION, AS CO-DOCUMENTATION AGENTS, AND CITIBANK, N.A., J.P. MORGAN CHASE BANK, N.A., MERRILL LYNCH BANK USA AND THE BANK OF NOVA SCOTIA, AS CO-MANAGING AGENTS, BARCLAYS CAPITAL AND UNION BANK OF CALIFORNIA, N.A. CO-LEAD ARRANGERS AND JOINT BOOK RUNNERS ================================================================================ TABLE OF CONTENTS
PAGE ARTICLE I DEFINITIONS.......................................................................................... 1 1.1 Definitions............................................................................................ 1 1.2 Interpretation......................................................................................... 11 1.3 Accounting Terms....................................................................................... 11 ARTICLE II THE ADVANCES......................................................................................... 12 2.1 Commitment............................................................................................. 12 2.2 Repayment.............................................................................................. 12 2.3 Ratable Loans.......................................................................................... 12 2.4 Types of Advances...................................................................................... 12 2.5 Fees and Changes in Commitments........................................................................ 12 2.6 Minimum Amount of Advances............................................................................. 14 2.7 Optional Principal Payments............................................................................ 14 2.8 Method of Selecting Types and Interest Periods for New Advances........................................ 14 2.9 Conversion and Continuation of Outstanding Advances.................................................... 15 2.10 Interest Rates, Interest Payment Dates................................................................. 15 2.11 Rate after Maturity.................................................................................... 16 2.12 Method of Payment...................................................................................... 16 2.13 Bonds; Record-keeping; Telephonic Notices.............................................................. 16 2.14 Lending Installations.................................................................................. 17 2.15 Non-Receipt of Funds by the Agent...................................................................... 17 ARTICLE III SECURITY........................................................................................... 17 3.1 Mortgage and Security Agreement........................................................................ 17 3.2 First Mortgage Bonds................................................................................... 18 3.3 Release of Collateral.................................................................................. 18 ARTICLE IV CHANGE IN CIRCUMSTANCES............................................................................. 18 4.1 Yield Protection....................................................................................... 18 4.2 Replacement Bank....................................................................................... 19 4.3 Availability of Eurodollar Rate Loans.................................................................. 20 4.4 Funding Indemnification................................................................................ 20
-i- TABLE OF CONTENTS (continued)
PAGE 4.5 Taxes.................................................................................................. 20 4.6 Bank Certificates, Survival of Indemnity............................................................... 22 ARTICLE V REPRESENTATIONS AND WARRANTIES...................................................................... 22 5.1 Incorporation and Good Standing........................................................................ 23 5.2 Corporate Power and Authority: No Conflicts............................................................ 23 5.3 Governmental Approvals................................................................................. 23 5.4 Legally Enforceable Agreements......................................................................... 23 5.5 Financial Statements................................................................................... 23 5.6 Litigation............................................................................................. 23 5.7 Margin Stock........................................................................................... 24 5.8 ERISA.................................................................................................. 24 5.9 Insurance.............................................................................................. 24 5.10 Taxes.................................................................................................. 24 5.11 Investment Company Act................................................................................. 24 5.12 Bonds.................................................................................................. 24 5.13 Disclosure............................................................................................. 24 5.14 OFAC................................................................................................... 24 ARTICLE VI AFFIRMATIVE COVENANTS............................................................................... 24 6.1 Payment of Taxes, Etc.................................................................................. 24 6.2 Maintenance of Insurance............................................................................... 25 6.3 Preservation of Corporate Existence, Etc............................................................... 25 6.4 Compliance with Laws, Etc.............................................................................. 25 6.5 Visitation Rights...................................................................................... 25 6.6 Keeping of Books....................................................................................... 25 6.7 Reporting Requirements................................................................................. 25 6.8 Use of Proceeds........................................................................................ 27 6.9 Maintenance of Properties, Etc......................................................................... 27 6.10 Bonds.................................................................................................. 27 ARTICLE VII NEGATIVE COVENANTS................................................................................. 27
-ii- TABLE OF CONTENTS (continued)
PAGE 7.1 Liens.................................................................................................. 28 7.2 Sale of Assets......................................................................................... 29 7.3 Mergers, Etc........................................................................................... 29 7.4 Compliance with ERISA.................................................................................. 29 7.5 Change in Nature of Business........................................................................... 30 7.6 Restricted Payments.................................................................................... 30 7.7 Off-Balance Sheet Liabilities.......................................................................... 30 7.8 Transactions with Affiliates........................................................................... 30 ARTICLE VIII FINANCIAL COVENANTS.............................................................................. 30 8.1 Debt to Capital Ratio.................................................................................. 30 8.2 Interest Coverage Ratio................................................................................ 30 ARTICLE IX EVENTS OF DEFAULT.................................................................................. 30 9.1 Events of Default...................................................................................... 30 9.2 Remedies............................................................................................... 32 ARTICLE X WAIVERS, AMENDMENTS AND REMEDIES.................................................................... 32 10.1 Amendments............................................................................................. 32 10.2 Preservation of Rights................................................................................. 33 ARTICLE XI CONDITIONS PRECEDENT............................................................................... 33 11.1 Initial Advance Prior to the FMB Issue Date............................................................ 33 11.2 Initial Advance After the FMB Issue Date............................................................... 34 11.3 Each Advance........................................................................................... 35 ARTICLE XII GENERAL PROVISIONS................................................................................. 35 12.1 Successors and Assigns................................................................................. 35 12.2 Survival of Representations............................................................................ 37 12.3 Governmental Regulation................................................................................ 37 12.4 Taxes.................................................................................................. 37 12.5 Choice of Law.......................................................................................... 37 12.6 Headings............................................................................................... 37 12.7 Entire Agreement....................................................................................... 37
-iii- TABLE OF CONTENTS (continued)
PAGE 12.8 Expenses; Indemnification.............................................................................. 37 12.9 Severability of Provisions............................................................................. 38 12.10 Setoff................................................................................................. 38 12.11 Ratable Payments....................................................................................... 38 12.12 Nonliability........................................................................................... 39 12.13 Other Agents........................................................................................... 39 12.14 USA Patriot Act........................................................................................ 39 12.15 Platform............................................................................................... 39 ARTICLE XIII THE AGENT........................................................................................ 41 13.1 Appointment............................................................................................ 41 13.2 Powers................................................................................................. 41 13.3 General Immunity....................................................................................... 41 13.4 No Responsibility for Loans, Recitals, Etc............................................................. 41 13.5 Action on Instructions of Banks........................................................................ 41 13.6 Employment of Agents and Counsel....................................................................... 42 13.7 Reliance on Documents; Counsel......................................................................... 42 13.8 Agent's Reimbursement and Indemnification.............................................................. 42 13.9 Rights as a Bank....................................................................................... 42 13.10 Bank Credit Decision................................................................................... 43 13.11 Successor Agent........................................................................................ 43 13.12 Agent and Arranger Fees................................................................................ 44 ARTICLE XIV NOTICES........................................................................................... 44 14.1 Giving Notice.......................................................................................... 44 14.2 Change of Address...................................................................................... 44 ARTICLE XV COUNTERPARTS........................................................................................ 44 ARTICLE XVI RELEASE OF BONDS................................................................................... 44
-iv- TABLE OF CONTENTS SCHEDULES Schedule 1 Pricing Schedule Schedule 2 Commitment Schedule Schedule 3 Notice Information EXHIBITS Exhibit A Form of Supplemental Indenture Exhibit B-1 Required Opinions from General Counsel or Assistant General Counsel (Section 11.1) Exhibit B-2 Required Opinion from Miller, Canfield, Paddock and Stone, P.L.C. (Section 11.1) Exhibit B-3 Required Opinions from General Counsel or Assistant General Counsel (Section 11.2) Exhibit B-4 Required Opinion from Miller, Canfield, Paddock and Stone, P.L.C. (Section 11.2) Exhibit C Form of Compliance Certificate Exhibit D Form of Assignment and Assumption Agreement Exhibit E Terms of Subordination (Junior Subordinated Debt) Exhibit F Terms of Subordination (Guaranty of Hybrid Preferred Securities) Exhibit G Form of Bond Delivery Agreement Exhibit H Form of Increase Request Exhibit I Form of Mortgage and Security Agreement
-v- CREDIT AGREEMENT This Credit Agreement, dated as of March 31, 2006, is among Consumers Energy Company, a Michigan corporation (the "Company"), the financial institutions listed on the signature pages hereof (together with their respective successors and assigns, the "Banks") and Barclays Bank PLC, as Agent. WITNESSETH: WHEREAS, the Company has requested, and the Banks have agreed to enter into, a credit facility in an aggregate amount of $300,000,000 (subject to increase as provided herein); NOW THEREFORE, the parties hereto agree as follows: ARTICLE I DEFINITIONS 1.1 Definitions. As used in this Agreement: "Accounting Changes" - see Section 1.3. "Administrative Questionnaire" means an administrative questionnaire, substantially in the form supplied by the Agent, completed by a Bank and furnished to the Agent in connection with this Agreement. "Advance" means a group of Loans made by the Banks hereunder of the same Type, made, converted or continued on the same day and, in the case of Eurodollar Rate Loans, having the same Interest Period. "Affiliate" means, with respect to any Person, any other Person directly or indirectly controlling (including all directors and officers of such Person), controlled by, or under direct or indirect common control with such Person. A Person shall be deemed to control another entity if such Person possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of such entity, whether through the ownership of voting securities, by contract or otherwise. "Agent" means Barclays Bank PLC in its capacity as administrative agent for the Banks pursuant to Article XIII, and not in its individual capacity as a Bank, and any successor Agent appointed pursuant to Article XIII. "Aggregate Commitment" means the aggregate amount of the Commitments of all Banks. "Aggregate Outstandings" means, at any time, the aggregate principal amount of all outstanding Advances. "Agreement" means this Credit Agreement, as amended from time to time. "Alternate Base Rate" means, for any day, a rate per annum equal to the higher of (i) the Prime Rate for such day and (ii) the sum of the Federal Funds Effective Rate for such day plus 1/2% per annum. "Applicable Margin" means, with respect to Advances of any Type at any time, the percentage rate per annum which is applicable at such time with respect to Advances of such Type as set forth in Schedule 1. "Arranger" means each of Barclays Capital and Union Bank of California, N.A. in its capacity as Co-Lead Arranger and Joint Book Runner for the credit facility created hereby. "Assignment Agreement" - see Section 12.1(e). "Banks" - see the preamble. "Barclays" means Barclays Bank PLC, in its individual capacity, and its successors and assigns. "Base Eurodollar Rate" means, with respect to a Eurodollar Advance for the relevant Interest Period, the per annum interest rate determined by the offered rate per annum at which deposits in U.S. dollars, for a period equal or comparable to such Interest Period, appears on page 3750 (or any successor page) of the Dow Jones Market Service as of 11:00 a.m. (London time) two Business Days prior to the first day of such Interest Period, or in the event such offered rate is not available from the Dow Jones Market Service page, the rate offered on deposits in U.S. dollars, for a period equal or comparable to such Interest Period, by Barclays' London Office to prime banks in the London interbank market at approximately 11:00 a.m. (London time), two Business Days prior to the first day of such Interest Period, and in an amount substantially equal to the amount of Barclays' relevant Eurodollar Rate Loan for such Interest Period. "Bond Delivery Agreement" means a bond delivery agreement whereby the Agent (x) acknowledges delivery of the Bonds and (y) agrees to hold the Bonds for the benefit of the Banks and to distribute all payments made by the Company on account thereof to the Banks, substantially in the form of Exhibit G. "Bonds" means a series of interest-bearing First Mortgage Bonds created under a Supplemental Indenture issued in favor of, and in form and substance satisfactory to, the Agent. "Borrowing Date" means a date on which an Advance is made hereunder. "Borrowing Notice" - see Section 2.8. "Business Day" means (i) with respect to any borrowing, payment or rate selection of Eurodollar Advances, a day (other than a Saturday or Sunday) on which banks generally are open in New York, New York for the conduct of substantially all of their commercial lending activities, interbank wire transfers can be made on the Fedwire system and dealings in United States dollars are carried on in the London interbank market and (ii) for all other purposes, a day 2 (other than a Saturday or Sunday) on which banks generally are open in New York, New York for the conduct of substantially all of their commercial lending activities and interbank wire transfers can be made on the Fedwire system. "Capital Lease" means any lease which has been or would be capitalized on the books of the lessee in accordance with GAAP. "CMS" means CMS Energy Corporation, a Michigan corporation. "Code" means the Internal Revenue Code of 1986, as amended from time to time. "Commitment" means, for each Bank, the obligation of such Bank to make Loans to the Company in an aggregate amount not exceeding the amount set forth on Schedule 2 or as set forth in any Assignment Agreement that has become effective pursuant to Section 12.1, as such amount may be modified from time to time. "Commitment Fee" - see Section 2.5. "Commitment Fee Rate" means, at any time, the percentage rate per annum at which Commitment Fees are accruing on the Unused Commitment as set forth in Schedule 1. "Company" - see the preamble. "Consolidated EBIT" means, for any period, Consolidated Net Income for such period plus (i) to the extent deducted from revenues in determining such Consolidated Net Income (without duplication), (a) Consolidated Interest Expense plus interest and dividends on Hybrid Preferred Securities and on securities of the type described in clause (iv) of the definition of Total Consolidated Debt (but only, in the case of securities of the type described in such clause (iv), to the extent such securities have been deemed to be equity), (b) expense for taxes paid or accrued, (c) non-cash write-offs and write-downs contained in the Company's Consolidated Net Income, including write-offs or write-downs related to the sale of assets, impairment of assets and loss on contracts, and (d) non-cash losses on mark-to-market valuation of contracts minus (ii) to the extent included in such Consolidated Net Income, extraordinary gains realized other than in the ordinary course of business and non-cash gains on mark-to-market valuation of contracts, all calculated for the Company and its Subsidiaries on a consolidated basis in accordance with GAAP. "Consolidated Interest Expense" means, with respect to any period, an amount equal to interest expense on Debt, including payments in the nature of interest under Capital Leases but excluding (a) interest and dividends paid on Hybrid Preferred Securities and on securities of the type described in clause (iv) of the definition of Total Consolidated Debt (but only, in the case of securities of the type described in such clause (iv), to the extent such securities have been deemed to be equity), all calculated for the Company and its Subsidiaries on a consolidated basis in accordance with GAAP (except as otherwise provided above). "Consolidated Net Income" means, for any period, the net income (or loss) of the Company and its Subsidiaries calculated on a consolidated basis for such period. 3 "Consolidated Subsidiary" means any Subsidiary the accounts of which are or are required to be consolidated with the accounts of the Company in accordance with GAAP. "Credit Documents" means this Agreement, any promissory note issued pursuant to Section 2.13, prior to the FMB Issue Date, the Mortgage and Security Agreement, and on and after the FMB Issue Date, the Supplemental Indenture and the Bonds. "Debt" means, with respect to any Person, and without duplication, (a) all indebtedness of such Person for borrowed money, (b) all indebtedness of such Person for the deferred purchase price of property or services (other than trade accounts payable arising in the ordinary course of business which are not overdue), (c) all liabilities arising from any accumulated funding deficiency (as defined in Section 412(a) of the Code) for a Plan, (d) all liabilities arising in connection with any withdrawal liability under ERISA to any Multiemployer Plan, (e) all obligations of such Person arising under acceptance facilities, (f) all obligations of such Person as lessee under Capital Leases, (g) all obligations of such Person arising under any interest rate swap, "cap", "collar" or other hedging agreement; provided that for purposes of the calculation of Debt for this clause (g) only, the actual amount of Debt of such Person shall be determined on a net basis to the extent such agreements permit such amounts to be calculated on a net basis, and (h) all guaranties, endorsements (other than for collection in the ordinary course of business) and other contingent obligations of such Person to assure a creditor against loss (whether by the purchase of goods or services, the provision of funds for payment, the supply of funds to invest in any Person or otherwise) in respect of indebtedness or obligations of any other Person of the kinds referred to in clauses (a) through (g) above. "Default" means an event which but for the giving of notice or lapse of time, or both, would constitute an Event of Default. "Designated Officer" means the Chief Financial Officer, the Treasurer, an Assistant Treasurer, any Vice President in charge of financial or accounting matters or the principal accounting officer of the Company. "Effective Date" means March 31, 2006. "Environmental Laws" means all laws, rules, regulations, codes, ordinances, orders, decrees, judgments, injunctions, notices or binding agreements issued, promulgated or entered into by any governmental agency or authority relating in any way to the environment, preservation or reclamation of natural resources, the management, release or threatened release of any Hazardous Substance or to health and safety matters. "Environmental Liability" means any liability, contingent or otherwise (including any liability for damages, costs of environmental remediation, fines, penalties or indemnities), directly or indirectly resulting from or based upon (a) violation of any Environmental Law, (b) the generation, use, handling, transportation, storage, treatment or disposal of any Hazardous Substance, (c) exposure to any Hazardous Substance, (d) the release or threatened release of any Hazardous Substance into the environment or (e) any contract, agreement or other consensual 4 arrangement pursuant to which liability is assumed or imposed with respect to any of the foregoing. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time. "ERISA Affiliate" means any corporation or trade or business which is a member of the same controlled group of corporations (within the meaning of Section 414(b) of the Code) as the Company or is under common control (within the meaning of Section 414(c) of the Code) with the Company. "Eurodollar Advance" means an Advance consisting of Eurodollar Rate Loans. "Eurodollar Rate" means, with respect to a Eurodollar Advance for the relevant Interest Period, an interest rate per annum equal to the sum of (i) the quotient obtained by dividing (a) the Base Eurodollar Rate applicable to such Interest Period by (b) one minus the Reserve Requirement (expressed as a decimal) applicable to such Interest Period, plus (ii) the Applicable Margin. "Eurodollar Rate Loan" means a Loan which bears interest by reference to the Eurodollar Rate. "Event of Default" means an event described in Article IX. "Excluded Taxes" means, in the case of each Bank or applicable Lending Installation and the Agent, taxes imposed on its overall net income, and franchise taxes imposed on it, by (i) the jurisdiction under the laws of which such Bank or the Agent is incorporated or organized or (ii) the jurisdiction in which the Agent's or such Bank's principal executive office or such Bank's applicable Lending Installation is located. "Federal Funds Effective Rate" means, for any day, an interest rate per annum equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers on such day, as published for such day (or, if such day is not a Business Day, for the immediately preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations at approximately 11:00 a.m. (New York time) on such day on such transactions received by the Agent from three Federal funds brokers of recognized standing selected by the Agent in its sole discretion. "Final Maturity Date" - see Section 2.2. "First Mortgage Bonds" means bonds issued by the Company pursuant to the Indenture. "Floating Rate" means a rate per annum equal to (i) the Alternate Base Rate plus (ii) the Applicable Margin, changing when and as the Alternate Base Rate or the Applicable Margin changes. 5 "Floating Rate Advance" means an Advance consisting of Floating Rate Loans. "Floating Rate Loan" means a Loan which bears interest at the Floating Rate. "FMB Issue Date" - see Section 3.2. "FMB Release Date" means the date on which the Bonds are released pursuant to Article XVI. "FRB" means the Board of Governors of the Federal Reserve System or any successor thereto. "GAAP" means generally accepted accounting principles in the United States of America as in effect on the date hereof, applied on a basis consistent with those used in the preparation of the financial statements referred to in Section 5.5 (except, for purposes of the financial statements required to be delivered pursuant to Sections 6.7(b) and (c), for changes concurred in by the Company's independent public accountants). "Hazardous Substance" means any waste, substance or material identified as hazardous, dangerous or toxic by any office, agency, department, commission, board, bureau or instrumentality of the United States or of the State or locality in which the same is located having or exercising jurisdiction over such waste, substance or material. "Hybrid Preferred Securities" means any preferred securities issued by a Hybrid Preferred Securities Subsidiary, where such preferred securities have the following characteristics: (i) such Hybrid Preferred Securities Subsidiary lends substantially all of the proceeds from the issuance of such preferred securities to the Company or a wholly-owned direct or indirect Subsidiary of the Company in exchange for Junior Subordinated Debt issued by the Company or such wholly-owned direct or indirect Subsidiary, respectively; (ii) such preferred securities contain terms providing for the deferral of interest payments corresponding to provisions providing for the deferral of interest payments on such Junior Subordinated Debt; and (iii) the Company or a wholly-owned direct or indirect Subsidiary of the Company (as the case may be) makes periodic interest payments on such Junior Subordinated Debt, which interest payments are in turn used by the Hybrid Preferred Securities Subsidiary to make corresponding payments to the holders of the preferred securities. "Hybrid Preferred Securities Subsidiary" means any Delaware business trust (or similar entity) (i) all of the common equity interest of which is owned (either directly or indirectly through one or more wholly-owned Subsidiaries of the Company) at all times by the Company or a wholly-owned direct or indirect Subsidiary of the Company, (ii) that has been formed for the 6 purpose of issuing Hybrid Preferred Securities and (iii) substantially all of the assets of which consist at all times solely of Junior Subordinated Debt issued by the Company or a wholly-owned direct or indirect Subsidiary of the Company (as the case may be) and payments made from time to time on such Junior Subordinated Debt. "Indenture" means the Indenture, dated as of September 1, 1945, as supplemented and amended from time to time, from the Company to the Indenture Trustee. "Indenture Trustee" means JPMorgan Chase Bank, N.A., as trustee, and its successors, under the Indenture. "Interest Period" means, with respect to a Eurodollar Advance, a period of one, two, three or six months, or such shorter period agreed to by the Company and the Banks, commencing on a Business Day selected by the Company pursuant to this Agreement. Such Interest Period shall end on the day which corresponds numerically to such date one, two, three or six months thereafter (or such shorter period agreed to by the Company and the Banks); provided that if there is no such numerically corresponding day in such next, second, third or sixth succeeding month (or such shorter period, as applicable), such Interest Period shall end on the last Business Day of such next, second, third or sixth succeeding month (or such shorter period, as applicable). If an Interest Period would otherwise end on a day which is not a Business Day, such Interest Period shall end on the next succeeding Business Day; provided that if said next succeeding Business Day falls in a new calendar month, such Interest Period shall end on the immediately preceding Business Day. The Company may not select any Interest Period that ends after the scheduled Revolving Termination Date (or, if the Company exercises the Term Out Option, the Final Maturity Date). "Junior Subordinated Debt" means any unsecured Debt of the Company or a Subsidiary of the Company that is (i) issued in exchange for the proceeds of Hybrid Preferred Securities and (ii) subordinated to the rights of the Banks hereunder and under the other Credit Documents pursuant to terms of subordination substantially similar to those set forth in Exhibit E, or pursuant to other terms and conditions satisfactory to the Majority Banks. "Lending Installation" means any office, branch, subsidiary or affiliate of a Bank. "Lien" means any lien (statutory or otherwise), security interest, mortgage, deed of trust, priority, pledge, charge, conditional sale, title retention agreement, financing lease or other encumbrance or similar right of others, or any agreement to give any of the foregoing. "Loan" - see Section 2.1. "Majority Banks" means, as of any date of determination, Banks in the aggregate having more than 50% of the Aggregate Commitment as of such date or, if the Aggregate Commitment has been terminated, Banks in the aggregate holding more than 50% of the aggregate unpaid principal amount of the Aggregate Outstandings as of such date. "Material Adverse Change" means any event, development or circumstance that has had or could reasonably be expected to have a material adverse effect on (a) the financial condition 7 or results of operations of the Company and its Consolidated Subsidiaries, taken as a whole, (b) the Company's ability to perform its obligations under any Credit Document or (c) the validity or enforceability of any Credit Document or the rights or remedies of the Agent or the Banks thereunder. "Moody's" means Moody's Investors Service, Inc. or any successor thereto. "Mortgage and Security Agreement" means a Mortgage and Security Agreement substantially in the form of Exhibit I between the Company and the Agent. "Multiemployer Plan" means a "multiemployer plan" as defined in Section 4001(a)(3) of ERISA. "Net Proceeds" means, with respect to any sale or issuance of securities or incurrence of Debt by any Person, the excess of (i) the gross cash proceeds received by or on behalf of such Person in respect of such sale, issuance or incurrence (as the case may be) over (ii) customary underwriting commissions, auditing and legal fees, printing costs, rating agency fees and other customary and reasonable fees and expenses incurred by such Person in connection therewith. "Net Worth" means, with respect to any Person, the excess of such Person's total assets over its total liabilities, total assets and total liabilities each to be determined in accordance with GAAP consistently applied, excluding from the determination of total assets (i) goodwill, organizational expenses, research and development expenses, trademarks, trade names, copyrights, patents, patent applications, licenses and rights in any thereof, and other similar intangibles, (ii) cash held in a sinking or other analogous fund established for the purpose of redemption, retirement or prepayment of capital stock or Debt, and (iii) any item not included in clause (i) or (ii) above, that is treated as an intangible asset in conformity with GAAP. "Obligations" means all unpaid principal of and accrued and unpaid interest on the Loans, all accrued and unpaid fees and all other obligations of the Company to any Bank or the Agent arising under the Credit Documents. "Off-Balance Sheet Liability" of a Person means (i) any repurchase obligation or liability of such Person with respect to accounts or notes receivable sold by such Person, (ii) any liability under any sale and leaseback transaction which is not a Capital Lease, (iii) any liability under any so-called "synthetic lease" transaction entered into by such Person, or (iv) any obligation arising with respect to any other transaction which is the functional equivalent of or takes the place of borrowing but which does not constitute a liability on the balance sheet of such Person, but excluding from this clause (iv) Operating Leases. "Operating Lease" of a Person means any lease of Property (other than a Capital Lease) by such Person as lessee. "Other Taxes" - see Section 4.5(b). 8 "Payment Date" means the second Business Day of each calendar quarter occurring after the Effective Date; provided that, solely for purposes of payments of the Commitment Fee pursuant to Section 2.5, the first Payment Date shall be July 5, 2006. "PBGC" means the Pension Benefit Guaranty Corporation and any entity succeeding to any or all of its functions under ERISA. "Person" means an individual, partnership, corporation, limited liability company, business trust, joint stock company, trust, unincorporated association, joint venture, governmental authority or other entity of whatever nature. "Plan" means any employee benefit plan (other than a Multiemployer Plan) maintained for employees of the Company or any ERISA Affiliate and covered by Title IV of ERISA. "Plan Termination Event" means (a) a Reportable Event described in Section 4043 of ERISA and the regulations issued thereunder (other than a Reportable Event not subject to the provision for 30-day notice to the PBGC under such regulations), (b) the withdrawal of the Company or any ERISA Affiliate from a Plan during a plan year in which it was a "substantial employer" as defined in Section 4001(a)(2) of ERISA, (c) the filing of a notice of intent to terminate a Plan or the treatment of a Plan amendment as a termination under Section 4041 of ERISA, or (d) the institution of proceedings to terminate a Plan by the PBGC or to appoint a trustee to administer any Plan. "Prime Rate" means a rate per annum equal to the prime rate of interest announced from time to time by Barclays or its parent (which is not necessarily the lowest rate charged to any customer), changing when and as said prime rate changes. "Property" of a Person means any and all property, whether real, personal, tangible, intangible, or mixed, of such Person, or other assets owned, leased or operated by such Person. "Pro Rata Share" means, with respect to a Bank, a portion equal to a fraction the numerator of which is such Bank's Commitment and the denominator of which is the Aggregate Commitment. "Regulation D" means Regulation D of the FRB from time to time in effect and shall include any successor or other regulation or official interpretation of the FRB relating to reserve requirements applicable to member banks of the Federal Reserve System. "Regulation U" means Regulation U of the FRB from time to time in effect and shall include any successor or other regulation or official interpretation of the FRB relating to the extension of credit by banks, non-banks and non-broker-dealers for the purpose of purchasing or carrying margin stocks. "Reportable Event" has the meaning assigned to that term in Title IV of ERISA. 9 "Reserve Requirement" means, with respect to an Interest Period, the maximum aggregate reserve requirement (including all basic, supplemental, marginal and other reserves) which is imposed under Regulation D on Eurocurrency liabilities. "Revolving Termination Date" means the earlier of (i) March 30, 2007 and (ii) the date on which the Commitments are terminated. "S&P" means Standard and Poor's Rating Services, a division of The McGraw Hill Companies, Inc., or any successor thereto. "SEC" means the Securities and Exchange Commission or any governmental authority which may be substituted therefor. "Securitized Bonds" means nonrecourse bonds or similar asset-backed securities issued by a special-purpose Subsidiary of the Company which are payable solely from specialized charges authorized by the utility commission of the relevant state in connection with the recovery of (x) stranded regulatory costs, (y) stranded clean air and pension costs and (z) other "Qualified Costs" (as defined in M.C.L. ss.460.10h(g)) authorized to be securitized by the Michigan Public Service Commission. "Senior Debt" means the First Mortgage Bonds. "Single Employer Plan" means a Plan maintained by the Company or any ERISA Affiliate for employees of the Company or any ERISA Affiliate. "Subsidiary" means, as to any Person, any corporation or other entity of which at least a majority of the securities or other ownership interests having ordinary voting power (absolutely or contingently) for the election of directors or other Persons performing similar functions are at the time owned directly or indirectly by such Person. "Supplemental Indenture" means a supplemental indenture substantially in the form of Exhibit A. "Taxes" means any and all present or future taxes, duties, levies, imposts, deductions, charges or withholdings, and any and all liabilities with respect to the foregoing, but excluding Excluded Taxes and Other Taxes. "Term Out Option" - see Section 2.2. "Total Consolidated Capitalization" means, at any date of determination, without duplication, the sum of (a) Total Consolidated Debt plus all amounts excluded from Total Consolidated Debt pursuant to clauses (ii), (iii) and (iv) of the proviso to the definition of such term (but only, in the case of securities of the type described in such clause (iv), to the extent such securities have been deemed to be equity), (b) equity of the common stockholders of the Company, (c) equity of the preference stockholders of the Company and (d) equity of the preferred stockholders of the Company, in each case determined at such date. 10 "Total Consolidated Debt" means, at any date of determination, the aggregate Debt of the Company and its Consolidated Subsidiaries; provided that Total Consolidated Debt shall exclude (i) the principal amount of any Securitized Bonds, (ii) any Junior Subordinated Debt owned by any Hybrid Preferred Securities Subsidiary, (iii) any guaranty by the Company of payments with respect to any Hybrid Preferred Securities, provided that such guaranty is subordinated to the rights of the Banks hereunder and under the other Credit Documents pursuant to terms of subordination substantially similar to those set forth in Exhibit F, or pursuant to other terms and conditions satisfactory to the Majority Banks, (iv) such percentage of the Net Proceeds from any issuance of hybrid debt/equity securities (other than Junior Subordinated Debt and Hybrid Preferred Securities) by the Company or any Consolidated Subsidiary as shall be agreed to be deemed equity by the Agent and the Company prior to the issuance thereof (which determination shall be based on, among other things, the treatment (if any) given to such securities by the applicable rating agencies). "Type" - see Section 2.4. "Unused Commitment" means, at any time, the Aggregate Commitment then in effect minus the Aggregate Outstandings at such time. "USA Patriot Act" means the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, Pub. L. No. 107-56, 115 Stat. 272 (2001), as amended. 1.2 Interpretation. (a) The foregoing definitions shall be equally applicable to both the singular and plural forms of the defined terms. (b) The words "include," "includes" and "including" shall be deemed to be followed by the phrase "without limitation." (c) Unless otherwise specified, each reference to an Article, Section, Exhibit and Schedule means an Article or Section of or an Exhibit or Schedule to this Agreement. 1.3 Accounting Terms. All accounting terms not specifically defined herein shall be construed in accordance with GAAP; provided that the financial covenants set forth in Sections 8.1 and 8.2 shall be calculated exclusive of all Debt of any Affiliate of the Company (including Midland Cogeneration Venture Limited Partnership and First Midland Limited Partnership) that (a) is (i) consolidated on the financial statements of the Company solely as a result of the effect and application of Financial Accounting Standards Board No. 46 and of Accounting Research Bulletin No. 51, Consolidated Financial Statements, as modified by Statement of Financial Accounting Standards No. 94, and (ii) non-recourse to the Company or any of its Affiliates (other than the primary obligor of such Debt and any of its Subsidiaries); or (b) is re-categorized as such from certain lease obligations pursuant to Emerging Issues Task Force ("EITF") Issue 01-8, any subsequent EITF Issue or recommendation or other interpretation, bulletin or other similar document by the Financial Accounting Standards Board on or related to such 11 re-categorization. If any changes in generally accepted accounting principles are hereafter required or permitted and are adopted by the Company or any of its Subsidiaries, or the Company or any of its Subsidiaries shall change its application of generally accepted accounting principles with respect to any Off-Balance Sheet Liabilities, including the application of Financial Accounting Standards Board Interpretation Nos. 45 and 46 and Financial Accounting Standards Board Statement No. 150, in each case with the agreement of its independent certified public accountants, and such changes result in a change in the method of calculation of any of the financial covenants, tests, restrictions or standards herein or in the related definitions or terms used therein ("Accounting Changes"), the parties hereto agree, at the Company's request, to enter into negotiations, in good faith, in order to amend such provisions in a credit neutral manner so as to reflect equitably such changes with the desired result that the criteria for evaluating the Company's and its Subsidiaries' financial condition shall be the same after such changes as if such changes had not been made; provided that, until such provisions are amended in a manner reasonably satisfactory to the Majority Banks, no Accounting Change shall be given effect in such calculations. In the event such amendment is entered into, all references in this Agreement to GAAP shall mean generally accepted accounting principles as of the date of such amendment. ARTICLE II THE ADVANCES 2.1 Commitment. From and including the Effective Date and prior to the Revolving Termination Date, each Bank severally agrees, on the terms and conditions set forth in this Agreement, to make loans to the Company from time to time (the "Loans"); provided that, after giving effect to the making of each such Loan, the principal amount of such Bank's Loans shall not exceed its Commitment. In no event may the Aggregate Outstandings exceed the Aggregate Commitment. Subject to the terms and conditions of this Agreement, the Company may borrow, repay and reborrow at any time prior to the Revolving Termination Date. The Commitments shall expire on the Revolving Termination Date. 2.2 Repayment. All outstanding Loans and all other unpaid obligations of the Company hereunder shall be paid in full on the Revolving Termination Date; provided that if (a) not less than ten Business Days prior to such date, the Company submits a notice in writing to the Agent (which shall promptly notify each Bank thereof) that it wishes to exercise its option pursuant to this Section 2.2 (the "Term Out Option"), (b) the Company certifies on the Revolving Termination Date that the representations and warranties contained in Article V are true and correct in all material respects as of the Revolving Termination Date and (c) no Default or Event of Default exists on the Revolving Termination Date, then all outstanding Loans and all other unpaid obligations of the Company hereunder shall be paid in full on the first anniversary of the Revolving Termination Date (the "Final Maturity Date"). 2.3 Ratable Loans. Each Advance shall consist of Loans made by the several Banks ratably according to their Pro Rata Shares. 12 2.4 Types of Advances. The Advances may be Floating Rate Advances or Eurodollar Advances (each a "Type" of Advance), or a combination thereof, as selected by the Company in accordance with Sections 2.8 and 2.9. 2.5 Fees and Changes in Commitments. (a) The Company agrees to pay to the Agent for the account of each Bank according to its Pro Rata Share a commitment fee (the "Commitment Fee") at the Commitment Fee Rate on the daily Unused Commitment from the Effective Date to but not including the date on which this Agreement is terminated in full and all of the Obligations hereunder have been paid in full. The fees payable pursuant to this clause (a) shall be payable quarterly in arrears on each Payment Date (for the quarter then most recently ended) and on the Revolving Termination Date or, if the Company exercises the Term Out Option, the Final Maturity Date (for the period then ended for which such fee has not previously been paid) and shall be calculated for actual days elapsed on the basis of a 360 day year. (b) The Company may permanently reduce the Aggregate Commitment in whole, or in part ratably among the Banks in the minimum amount of $10,000,000 (and in multiples of $1,000,000 if in excess thereof), upon at least five Business Days' written notice to the Agent, which notice shall specify the amount of any such reduction; provided that the Aggregate Commitment may not be reduced below the Aggregate Outstandings. All accrued Commitment Fees shall be payable on the effective date of any termination of the obligation of the Banks to make Advances hereunder. Upon any permanent reduction in the Aggregate Commitment pursuant to the terms of this Section 2.5(b) after the FMB Issue Date, the Agent shall, upon request of the Company, promptly surrender to or upon the order of the Company one or more Bonds specified by the Company; provided that the Company remains in compliance with Section 6.10. (c) The Company may, from time to time, by means of a letter delivered to the Agent substantially in the form of Exhibit H, request that the Aggregate Commitment be increased by up to $200,000,000 (in the aggregate during the term of this Agreement) by (i) increasing the Commitment of one or more Banks which have agreed to such increase in writing pursuant to the procedures described below (it being understood that no Bank has any obligation to agree to such increase) and/or (ii) adding one or more commercial banks or other Persons as a party hereto (each an "Additional Bank") with a Commitment in an amount agreed to by any such Additional Bank; provided that no Additional Bank shall be added as a party hereto without the written consent of the Agent (which consent shall not be unreasonably withheld) or if a Default or an Event of Default exists. Any increase in the Aggregate Commitment pursuant to this clause (c) shall be effective three Business Days (or such other reasonable period of time as may be specified by the Agent) after the date on which the Agent has received (A) the applicable increase letter in the form of Annex 1 to Exhibit H (in the case of an increase in the Commitment of an existing Bank) or assumption letter in the form of Annex 2 to Exhibit H (in the case of the addition of a commercial bank or other Person as a new Bank), in each case signed by all applicable parties; and (b) if the requested increase is to occur after the FMB Issue Date and before the FMB Release Date and, after giving effect to such increase, the Aggregate Commitment would exceed the face amount of all Bonds, additional Bonds in an amount not less 13 than such excess together with such certificates, opinions of counsel and other documents as the Agent may reasonably request in connection with the issuance and delivery of such Bonds. The Agent shall promptly notify the Company and the Banks of any increase in the amount of the Aggregate Commitment pursuant to this clause (c) and of the Pro Rata Share of each Bank after giving effect thereto. The parties hereto agree that, notwithstanding any other provision of this Agreement, the Agent, the Company, each Additional Bank and each increasing Bank, as applicable, may make arrangements satisfactory to such parties to cause an Additional Bank or an increasing Bank to temporarily hold risk participations in the outstanding Loans of the other Banks (rather than fund its Percentage of all outstanding Loans concurrently with the applicable increase) with a view toward minimizing breakage costs and transfers of funds in connection with any increase in the Aggregate Commitment. The Company acknowledges that if, as a result of an increase in the Aggregate Commitment that is not pro rata among the existing Banks, any Eurodollar Rate Loan is prepaid or converted (in whole or in part) on a day other than the last day of an Interest Period therefor, then such prepayment or conversion shall be subject to the provisions of Section 4.4. 2.6 Minimum Amount of Advances. Each Advance shall be in the minimum amount of $10,000,000 (and in integral multiples of $1,000,000 if in excess thereof); provided that any Floating Rate Advance may be in the amount of the unused Aggregate Commitment (rounded down, if necessary, to an integral multiple of $1,000,000). 2.7 Optional Principal Payments. The Company may from time to time prepay, without penalty or premium, all outstanding Floating Rate Advances or, in a minimum aggregate amount of $10,000,000 or a higher integral multiple of $1,000,000, any portion of the outstanding Floating Rate Advances upon one Business Day's prior notice to the Agent. The Company may from time to time pay, subject to the payment of any funding indemnification amounts required by Section 4.4 but without penalty or premium, all outstanding Eurodollar Advances or, in a minimum aggregate amount of $10,000,000 or a higher integral multiple of $1,000,000, any portion of any outstanding Eurodollar Advance upon three Business Days' prior notice to the Agent; provided that if after giving effect to any such prepayment the principal amount of any Eurodollar Advance is less than $10,000,000, such Eurodollar Advance shall automatically convert into a Floating Rate Advance. 2.8 Method of Selecting Types and Interest Periods for New Advances. The Company shall select the Type of Advance and, in the case of each Eurodollar Advance, the Interest Period applicable thereto from time to time. The Company shall give the Agent irrevocable notice (a "Borrowing Notice") not later than 12:00 noon (New York time) on the Borrowing Date of each Floating Rate Advance and not later than 12:00 noon (New York time) three Business Days before the Borrowing Date for each Eurodollar Advance, specifying: (i) the Borrowing Date, which shall be a Business Day; (ii) the aggregate amount of such Advance; (iii) the Type of Advance selected; and 14 (iv) in the case of each Eurodollar Advance, the initial Interest Period applicable thereto. Promptly after receipt thereof, the Agent will notify each Bank of the contents of each Borrowing Notice. Not later than 2:00 p.m. (New York time) on each Borrowing Date, each Bank shall make available its Loan in funds immediately available in New York to the Agent at its address specified pursuant to Section 14. To the extent funds are received from the Banks, the Agent will make such funds available to the Company at the Agent's aforesaid address. No Bank's obligation to make any Loan shall be affected by any other Bank's failure to make any Loan. 2.9 Conversion and Continuation of Outstanding Advances. Floating Rate Advances shall continue as Floating Rate Advances unless and until such Floating Rate Advances are converted into Eurodollar Advances pursuant to this Section 2.9 or are repaid in accordance with Section 2.2 or 2.7. Each Eurodollar Advance shall continue as a Eurodollar Advance until the end of the then applicable Interest Period therefor, at which time such Eurodollar Advance shall be automatically converted into a Floating Rate Advance unless (x) such Eurodollar Advance is or was repaid in accordance with Section 2.2 or 2.7 or (y) the Company shall have given the Agent a Conversion/Continuation Notice (as defined below) requesting that, at the end of such Interest Period, such Eurodollar Advance continue as a Eurodollar Advance for the same or another Interest Period. Subject to the terms of Section 2.6, the Company may elect from time to time to convert all or any part of a Floating Rate Advance into a Eurodollar Advance. The Company shall give the Agent irrevocable notice (a "Conversion/Continuation Notice") of each conversion of a Floating Rate Advance into a Eurodollar Advance or continuation of a Eurodollar Advance not later than 12:00 noon (New York time) at least three Business Days prior to the date of the requested conversion or continuation, specifying: (i) the requested date, which shall be a Business Day, of such conversion or continuation; (ii) the aggregate amount and Type of the Advance which is to be converted or continued; and (iii) the amount of the Advance which is to be converted into or continued as a Eurodollar Advance and the duration of the Interest Period applicable thereto; provided that no Advance may be continued as, or converted into, a Eurodollar Advance if (x) such continuation or conversion would violate any provision of this Agreement or (y) a Default or Event of Default exists. 2.10 Interest Rates, Interest Payment Dates. (a) Subject to Section 2.11, each Advance shall bear interest as follows: (i) at any time such Advance is a Floating Rate Advance, at a rate per annum equal to the Floating Rate from time to time in effect; and 15 (ii) at any time such Advance is a Eurodollar Advance, at a rate per annum equal to the Eurodollar Rate for each applicable Interest Period. Changes in the rate of interest on that portion or any Advance maintained as a Floating Rate Advance will take effect simultaneously with each change in the Floating Rate. (b) Interest accrued on each Floating Rate Advance shall be payable on each Payment Date and on the Revolving Termination Date (or, if the Company exercises the Term Out Option, on the Final Maturity Date). Interest accrued on each Eurodollar Advance shall be payable on the last day of its applicable Interest Period, on any date on which such Eurodollar Advance is prepaid and on the Revolving Termination Date (or, if the Company exercises the Term Out Option, on the Final Maturity Date). Interest accrued on each Eurodollar Advance having an Interest Period longer than three months shall also be payable on the last day of each three-month interval during such Interest Period. Interest on Eurodollar Advances and interest on Floating Rate Advances based on the Federal Funds Effective Rate shall be calculated for actual days elapsed on the basis of a 360-day year. Interest on Floating Rate Advances based on the Prime Rate shall be calculated for actual days elapsed on the basis of a 365- or 366-day year, as appropriate. Interest on each Advance shall accrue from and including the date such Advance is made to but excluding the date payment thereof is received in accordance with Section 2.12. If any payment of principal of or interest on an Advance shall become due on a day which is not a Business Day, such payment shall be made on the next succeeding Business Day (unless, in the case of a Eurodollar Advance, such next succeeding Business Day falls in a new calendar month, in which case such payment shall be due on the immediately preceding Business Day) and, in the case of a principal payment, such extension of time shall be included in computing interest in connection with such payment. 2.11 Rate after Maturity. Any Advance not paid by the Company at maturity, whether by acceleration or otherwise, shall bear interest until paid in full at a rate per annum equal to the higher of (i) the rate otherwise applicable thereto plus 1% or (ii) the Floating Rate plus 1%. 2.12 Method of Payment. All payments of principal, interest and fees hereunder shall be made in immediately available funds to the Agent at its address specified on Schedule 3 (or at any other Lending Installation of the Agent specified in writing by the Agent to the Company) not later than 1:00 p.m. (New York time) on the date when due and shall be applied ratably by the Agent among the Banks. Funds received after such time shall be deemed received on the following Business Day unless the Agent shall have received from, or on behalf of, the Company a Federal Reserve reference number with respect to such payment before 4:00 p.m. (New York time) on the date of such payment. Each payment delivered to the Agent for the account of any Bank shall be delivered promptly by the Agent in the same type of funds received by the Agent to such Bank at the address specified for such Bank in its Administrative Questionnaire or at any Lending Installation specified in a notice received by the Agent from such Bank. The Agent is hereby authorized to charge the account of the Company maintained with Barclays, if any, for each payment of principal, interest and fees as such payment becomes due hereunder. 2.13 Bonds; Record-keeping; Telephonic Notices. 16 (a) Beginning on the FMB Issue Date and continuing thereafter until the FMB Release Date, the obligation of the Company to repay the Obligations shall be evidenced by one or more Bonds. After the FMB Release Date, the Company shall, at the request of any Bank deliver to such Bank a promissory note in form and substance reasonably satisfactory to the Company, the Agent and such Bank. (b) Each Bank shall maintain in accordance with its usual practice an account or accounts evidencing the indebtedness of the Company to such Bank resulting from each Loan made by such Bank from time to time, including the amounts of principal and interest payable and paid to such Bank from time to time hereunder. (c) The Agent shall also maintain accounts in which it will record (i) the amount of each Loan made hereunder, the Type thereof and, if applicable, the Interest Period with respect thereto, (ii) the amount of any principal or interest due and payable or to become due and payable from the Company to each Bank hereunder, and (iii) the amount of any sum received by the Agent hereunder from the Company and each Bank's share thereof. (d) The entries maintained in the accounts maintained pursuant to clauses (b) and (c) above shall be prima facie evidence of the existence and amounts of the Obligations therein recorded; provided that the failure of the Agent or any Bank to maintain such accounts or any error therein shall not in any manner affect the obligation of the Company to repay the Obligations in accordance with their terms. (e) The Company hereby authorizes the Banks and the Agent to make Advances based on telephonic notices made by any person or persons the Agent or any Bank in good faith believes to be acting on behalf of the Company. The Company agrees to deliver promptly to the Agent a written confirmation of each telephonic notice signed by a Designated Officer. If the written confirmation differs in any material respect from the action taken by the Agent and the Banks, the records of the Agent and the Banks shall govern absent manifest error. 2.14 Lending Installations. Subject to the provisions of Section 4.6, each Bank may book its Loans at any Lending Installation selected by such Bank and may change its Lending Installation from time to time. All terms of this Agreement shall apply to any such Lending Installation and the Loans shall be deemed held by the applicable Bank for the benefit of such Lending Installation. Each Bank may, by written or facsimile notice to the Company, designate a Lending Installation through which Loans will be made by it and for whose account payments on the Loans are to be made. 2.15 Non-Receipt of Funds by the Agent. Unless a Bank or the Company, as the case may be, notifies the Agent prior to the date on which it is scheduled to make payment to the Agent of (i) in the case of a Bank, the proceeds of a Loan or (ii) in the case of the Company, a payment of principal, interest or fees to the Agent for the account of the Banks, that it does not intend to make such payment, the Agent may assume that such payment has been made. The Agent may, but shall not be obligated to, make the amount of such payment available to the intended recipient in reliance upon such assumption. If such Bank or the Company, as the case may be, has not in fact made such payment to the Agent, the recipient of such payment shall, on 17 demand by the Agent, repay to the Agent the amount so made available together with interest thereon in respect of each day during the period commencing on the date such amount was so made available by the Agent until the date the Agent recovers such amount at a rate per annum equal to (i) in the case of payment by a Bank, the Federal Funds Rate for such day or (ii) in the case of payment by the Company, the interest rate applicable to the relevant Loan. ARTICLE III SECURITY 3.1 Mortgage and Security Agreement. Prior to the FMB Issue Date, the Obligations shall be secured, pursuant to the Mortgage and Security Agreement, by a second lien on the collateral securing the Company's First Mortgage Bonds (excluding (a) surplus land at the Company's Ludington pumped storage plant and (b) the Palisades nuclear power plant property that the Company proposes to sell that also includes a parcel of land located at the Company's Big Rock Point site where spent nuclear fuel is stored (the "Palisades Property"); provided that if the Company determines that it will not proceed with the sale of all or substantially all of the Palisades Property, or the Company has not entered into a contract for the sale of such property by December 31, 2006, then the Company will promptly grant a second lien on such property to secure the Obligations). 3.2 First Mortgage Bonds. Within 60 days after the date on which the Company has capacity (in addition to the $300,000,000 of capacity existing on the date hereof) to issue First Mortgage Bonds under the Indenture in an amount at least equal to the Aggregate Commitment, the Company shall issue First Mortgage Bonds to the Agent pursuant to the Bond Delivery Agreement and a Supplemental Indenture (the date of such issuance, the "FMB Issue Date"). Upon the issuance of such First Mortgage Bonds, the Agent shall release the second lien securing the Obligations referred to in Section 3.1. 3.3 Release of Collateral. So long as the Obligations are secured by the second lien referred to in Section 3.1, upon the request of the Company, the Agent will promptly execute a release of such lien on any collateral that has been contracted to be sold or otherwise disposed of by the Company if the Indenture Trustee has released the lien on such property securing the First Mortgage Bonds; provided that if an Acceleration (as defined in the Mortgage and Security Agreement) has occurred, the Agent shall not be obligated to release such lien unless it has received satisfactory evidence that the net proceeds of such disposition will be applied to repay (a) First Mortgage Bonds, (b) the Obligations or (c) ratably to the Obligations and to Debt of the type referred to in the proviso to Section 7.1(p). Any such request shall be accompanied by a signed copy of the release by the Indenture Trustee and a form of release in recordable form for the Agent to execute. Upon receipt of such documents, subject to the proviso to the first sentence of this Section 3.3, the Agent shall forthwith execute such form of release without any further documentation being required. ARTICLE IV CHANGE IN CIRCUMSTANCES 4.1 Yield Protection. 18 (a) If any change in law or any governmental rule, regulation, policy, guideline or directive (whether or not having the force of law), or any interpretation thereof by any agency or authority having jurisdiction over any Bank, (i) subjects any Bank or any applicable Lending Installation to any increased tax, duty, charge or withholding on or from payments due from the Company (excluding taxation measured by or attributable to the overall net income of such Bank or such applicable Lending Installation, whether overall or in any geographic area), or changes the rate of taxation of payments to any Bank in respect of its Loans or other amounts due it hereunder, or (ii) imposes or increases or deems applicable any reserve, assessment, insurance charge, special deposit or similar requirement against assets of, deposits with or for the account of, or credit extended by any Bank or any applicable Lending Installation (including any reserve costs under Regulation D with respect to Eurocurrency liabilities (as defined in Regulation D)), or (iii) imposes any other condition the result of which is to increase the cost to any Bank or any applicable Lending Installation of making, funding or maintaining Loans, or reduces any amount receivable by any Bank or any applicable Lending Installation in connection with Loans or requires any Bank or any applicable Lending Installation to make any payment calculated by reference to its Loans or interest received by it, by an amount deemed material by such Bank, or (iv) affects the amount of capital required or expected to be maintained by any Bank or any applicable Lending Installation or any corporation controlling any Bank and such Bank determines the amount of capital required is increased by or based upon the existence of this Agreement or its obligation to make Loans hereunder or of commitments of this type, then, upon presentation by such Bank to the Company of a certificate (as referred to in the immediately succeeding sentence of this Section 4.1) setting forth the basis for such determination and the additional amounts reasonably determined by such Bank for the period of up to 90 days prior to the date on which such certificate is delivered to the Company and the Agent, to be sufficient to compensate such Bank in light of such circumstances, the Company shall within 30 days of such delivery of such certificate pay to the Agent for the account of such Bank the specified amounts set forth on such certificate. The affected Bank shall deliver to the Company and the Agent a certificate setting forth the basis of the claim and specifying in reasonable detail the calculation of such increased expense, which certificate shall be prima facie evidence as to such increase and such amounts. An affected Bank may deliver more than one certificate to the Company during the term of this Agreement. In making the determinations contemplated by the above-referenced certificate, any Bank may make such reasonable estimates, assumptions, allocations and the like that such Bank in good faith determines to be appropriate, and such Bank's selection thereof in accordance with this Section 4.1 shall be conclusive and binding on the Company, absent manifest error. 19 (b) No Bank shall be entitled to demand compensation or be compensated hereunder to the extent that such compensation relates to any period of time more than 90 days prior to the date upon which such Bank first notified the Company of the occurrence of the event entitling such Bank to such compensation (unless, and to the extent, that any such compensation so demanded shall relate to the retroactive application of any event so notified to the Company). 4.2 Replacement Bank. (a) If any Bank shall make a demand for payment under Section 4.1, then within 30 days after such demand, the Company may, with the approval of the Agent (which approval shall not be unreasonably withheld) and provided that no Default or Event of Default shall then have occurred and be continuing, demand that such Bank assign to one or more financial institutions designated by the Company and approved by the Agent all (but not less than all) of such Bank's Commitment and Loans within the period ending on the later of such 30th day and the last day of the longest of the then current Interest Periods. Any such assignment shall be consummated on terms satisfactory to the assigning Bank; provided that such Bank's consent to such assignment shall not be unreasonably withheld. (b) If the Company shall elect to replace a Bank pursuant to clause (a) above, the Company shall prepay the outstanding Loans of such Bank, and the financial institution or institutions selected by the Company shall replace such Bank as a Bank hereunder pursuant to an instrument satisfactory to the Company, the Agent and the Bank being replaced by making Loans to the Company in the amount of the outstanding Loans of such assigning Bank and assuming all the same rights and responsibilities hereunder as such assigning Bank and having the same Commitment as such assigning Bank. 4.3 Availability of Eurodollar Rate Loans. If (a) any Bank determines that maintenance of a Eurodollar Rate Loan at a suitable Lending Installation would violate any applicable law, rule, regulation or directive, whether or not having the force of law, or (b) the Majority Banks determine that (i) deposits of a type and maturity appropriate to match fund Eurodollar Rate Loans are not available or (ii) the Base Eurodollar Rate does not accurately reflect the cost of making or maintaining a Eurodollar Rate Loan, then the Agent shall suspend the availability of Eurodollar Rate Loans and, in the case of clause (a), require any outstanding Eurodollar Rate Loans to be converted to Floating Rate Loans on such date as is required by the applicable law, rule, regulation or directive. 4.4 Funding Indemnification. If any payment of a Eurodollar Rate Loan occurs on a date which is not the last day of an applicable Interest Period, whether because of prepayment or otherwise, or a Eurodollar Rate Loan is not made on the date specified by the Company for any reason other than default by the Banks, the Company will indemnify each Bank for any loss or cost (but not lost profits) incurred by it resulting therefrom, including any loss or cost in liquidating or employing deposits acquired to fund or maintain such Eurodollar Rate Loan; 20 provided that the Company shall not be liable for any of the foregoing to the extent they arise because of acceleration by any Bank. 4.5 Taxes. (a) All payments by the Company to or for the account of any Bank or the Agent hereunder or under any Bond shall be made free and clear of and without deduction for any and all Taxes. If the Company shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder to any Bank or the Agent, (i) the sum payable shall be increased as necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section 4.5) such Bank or the Agent (as the case may be) receives an amount equal to the sum it would have received had no such deductions been made, (ii) the Company shall make such deductions, (iii) the Company shall pay the full amount deducted to the relevant authority in accordance with applicable law and (iv) the Company shall furnish to the Agent the original copy of a receipt evidencing payment thereof within 30 days after such payment is made. (b) In addition, the Company hereby agrees to pay any present or future stamp or documentary taxes and any other excise or property taxes, charges or similar levies which arise from any payment made hereunder or under any Bond or from the execution or delivery of, or otherwise with respect to, this Agreement or any Bond ("Other Taxes"). (c) The Company hereby agrees to indemnify the Agent and each Bank for the full amount of Taxes or Other Taxes (including any Taxes or Other Taxes imposed on amounts payable under this Section 4.5) paid by the Agent or such Bank and any liability (including penalties, interest and expenses) arising therefrom or with respect thereto. Payments due under this indemnification shall be made within 30 days of the date the Agent or such Bank makes demand therefor pursuant to Section 4.6. (d) Each Bank that is not incorporated under the laws of the United States of America or a state thereof (each a "Non-U.S. Bank") agrees that it will, not more than ten Business Days after the date hereof, or, if later, not more than ten Business Days after becoming a Bank hereunder, (i) deliver to each of the Company and the Agent two duly completed copies of United States Internal Revenue Service Form W-8BEN or W-8ECI, certifying in either case that such Bank is entitled to receive payments under this Agreement without deduction or withholding of any United States federal income taxes, and (ii) deliver to each of the Company and the Agent a United States Internal Revenue Form W-8 or W-9, as the case may be, and certify that it is entitled to an exemption from United States backup withholding tax. Each Non-U.S. Bank further undertakes to deliver to each of the Company and the Agent (x) renewals or additional copies of such form (or any successor form) on or before the date that such form expires or becomes obsolete, and (y) after the occurrence of any event requiring a change in the most recent forms so delivered by it, such additional forms or amendments thereto as may be reasonably requested by the Company or the Agent. All forms or amendments described in the preceding sentence shall certify that such Bank is entitled to receive payments under this Agreement without deduction or withholding of any United States federal income taxes, unless an event (including any change in treaty, law or regulation) has occurred prior to the date on 21 which any such delivery would otherwise be required which renders all such forms inapplicable or which would prevent such Bank from duly completing and delivering any such form or amendment with respect to it and such Bank advises the Company and the Agent that it is not capable of receiving payments without any deduction or withholding of United States federal income tax. (e) For any period during which a Non-U.S. Bank has failed to provide the Company with an appropriate form pursuant to clause (d), above (unless such failure is due to a change in treaty, law or regulation, or any change in the interpretation or administration thereof by any governmental authority, occurring subsequent to the date on which a form originally was required to be provided), such Non-U.S. Bank shall not be entitled to indemnification under this Section 4.5 with respect to Taxes imposed by the United States; provided that, should a Non-U.S. Bank which is otherwise exempt from or subject to a reduced rate of withholding tax become subject to Taxes because of its failure to deliver a form required under clause (d) above, the Company shall take such steps as such Non-U.S. Bank shall reasonably request to assist such Non-U.S. Bank to recover such Taxes. (f) Any Bank that is entitled to an exemption from or reduction of withholding tax with respect to payments under this Agreement or any Bond pursuant to the law of any relevant jurisdiction or any treaty shall deliver to the Company (with a copy to the Agent), at the time or times prescribed by applicable law, such properly completed and executed documentation prescribed by applicable law as will permit such payments to be made without withholding or at a reduced rate. (g) If the U.S. Internal Revenue Service or any other governmental authority of the United States or any other country or any political subdivision thereof asserts a claim that the Agent did not properly withhold tax from amounts paid to or for the account of any Bank (because the appropriate form was not delivered or properly completed, because such Bank failed to notify the Agent of a change in circumstances which rendered its exemption from withholding ineffective, or for any other reason), such Bank shall indemnify the Agent fully for all amounts paid, directly or indirectly, by the Agent as tax, withholding therefor, or otherwise, including penalties and interest, and including taxes imposed by any jurisdiction on amounts payable to the Agent under this clause (g), together with all costs and expenses related thereto (including attorneys fees and time charges of attorneys for the Agent, which attorneys may be employees of the Agent). The obligations of the Banks under this clause (g) shall survive the payment of the Obligations and termination of this Agreement. 4.6 Bank Certificates, Survival of Indemnity. To the extent reasonably possible, each Bank shall designate an alternate Lending Installation with respect to Eurodollar Rate Loans to reduce any liability of the Company to such Bank under Section 4.1 or to avoid the unavailability of Eurodollar Rate Loan under Section 4.3, so long as such designation is not disadvantageous to such Bank. A certificate of such Bank as to the amount due under Section 4.1, 4.4 or 4.5 shall be final, conclusive and binding on the Company in the absence of manifest error. Determination of amounts payable under such Sections in connection with a Eurodollar Rate Loan shall be calculated as though each Bank funded each Eurodollar Rate Loan through the purchase of a deposit of the type and maturity corresponding to the deposit used as a reference in determining 22 the Base Eurodollar Rate applicable to such Loan whether in fact that is the case or not. Unless otherwise provided herein, the amount specified in any certificate shall be payable on demand after receipt by the Company of such certificate. The obligations of the Company under Sections 4.1, 4.4 and 4.5 shall survive payment of the Obligations and termination of this Agreement; provided that no Bank shall be entitled to compensation to the extent that such compensation relates to any period of time more than 90 days after the termination of this Agreement. ARTICLE V REPRESENTATIONS AND WARRANTIES The Company hereby represents and warrants that: 5.1 Incorporation and Good Standing. The Company is duly incorporated, validly existing and in good standing under the laws of the State of Michigan. 5.2 Corporate Power and Authority: No Conflicts. The execution, delivery and performance by the Company of the Credit Documents are within the Company's corporate powers, have been duly authorized by all necessary corporate action and do not (i) violate the Company's charter, bylaws or any applicable law, or (ii) breach or result in an event of default under any indenture or material agreement, and do not result in or require the creation of any Lien upon or with respect to any of its properties (except the Lien of the Indenture securing the Bonds). 5.3 Governmental Approvals. No authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required for the due execution, delivery and performance by the Company of any Credit Document, except for the authorization to issue, sell or guarantee secured and/or unsecured short-term debt granted by the Federal Energy Regulatory Commission, which authorization has been obtained and is in full force and effect. 5.4 Legally Enforceable Agreements. Each Credit Document constitutes a legal, valid and binding obligation of the Company, enforceable in accordance with its terms, subject to (a) the effect of applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and (b) the application of general principles of equity (regardless of whether considered in a proceeding in equity or at law). 5.5 Financial Statements. The audited balance sheet of the Company and its Consolidated Subsidiaries as at December 31, 2005, and the related statements of income and cash flows of the Company and its Consolidated Subsidiaries for the fiscal year then ended, as set forth in the Company's Annual Report on Form 10-K (copies of which have been furnished to each Bank), fairly present the financial condition of the Company and its Consolidated Subsidiaries as at such dates and the results of operations of the Company and its Consolidated Subsidiaries for the periods ended on such dates, all in accordance with GAAP, and since December 31, 2005, there has been no Material Adverse Change. 23 5.6 Litigation. Except (i) to the extent described in the Company's Annual Report on Form 10-K for the year ended December 31, 2005 and Current Report on Form 8-K filed by the Company on March 1, 2006, in each case as filed with the SEC, and (ii) such other similar actions, suits and proceedings predicated on the occurrence of the same events giving rise to any actions, suits and proceedings described in the Reports referred to in the foregoing clause (i) (all matters described in clauses (i) and (ii) above, the "Disclosed Matters"), there is no pending or threatened action, suit, investigation or proceeding against the Company or any of its Consolidated Subsidiaries before any court, governmental agency or arbitrator, which, if adversely determined, might reasonably be expected to result in a Material Adverse Change. As of the Effective Date, (a) there is no litigation challenging the validity or the enforceability of any of the Credit Documents and (b) there have been no adverse developments with respect to the Disclosed Matters that have resulted, or could reasonably be expected to result, in a Material Adverse Change. 5.7 Margin Stock. The Company is not engaged in the business of extending credit for the purpose of buying or carrying margin stock (within the meaning of Regulation U), and no proceeds of any Loan will be used to buy or carry any margin stock or to extend credit to others for the purpose of buying or carrying any margin stock. 5.8 ERISA. No Plan Termination Event has occurred or is reasonably expected to occur with respect to any Plan. Neither the Company nor any ERISA Affiliate is an employer under or has any liability with respect to a Multiemployer Plan. 5.9 Insurance. All insurance required by Section 6.2 is in full force and effect. 5.10 Taxes. The Company and its Subsidiaries have filed all tax returns (Federal, state and local) required to be filed and paid all taxes shown thereon to be due, including interest and penalties, or, to the extent the Company or any of its Subsidiaries is contesting in good faith an assertion of liability based on such returns, has provided adequate reserves for payment thereof in accordance with GAAP. 5.11 Investment Company Act. The Company is not an investment company (within the meaning of the Investment Company Act of 1940, as amended). 5.12 Bonds. On and after the FMB Issue Date, the issuance to the Agent of Bonds as evidence of the Obligations (i) will not violate any provision of the Indenture or any other agreement or instrument, or any law or regulation, or judicial or regulatory order, judgment or decree, to which the Company or any of its Subsidiaries is a party or by which any of the foregoing is bound and (ii) will, prior to the FMB Release Date, provide the Banks, as beneficial holders of the Bonds through the Agent, the benefit of the Lien of the Indenture equally and ratably with the holders of other First Mortgage Bonds. 5.13 Disclosure. The Company has not withheld any fact from the Agent or the Banks in regard to the occurrence of a Material Adverse Change; and all financial information delivered by the Company to the Agent and the Banks on and after the date of this Agreement is true and correct in all material respects as at the dates and for the periods indicated therein. 24 5.14 OFAC. Neither the Company nor any Subsidiary or Affiliate of the Company is named on the United States Department of the Treasury's Specially Designated Nationals or Blocked Persons list available through http://www.treas.gov/offices/eotffc/ofac/sdn/t11sdn.pdf or as otherwise published from time. ARTICLE VI AFFIRMATIVE COVENANTS So long as any Obligations shall remain unpaid or any Bank shall have any Commitment under this Agreement, the Company shall: 6.1 Payment of Taxes, Etc. Pay and discharge, before the same shall become delinquent, (a) all taxes, assessments and governmental charges or levies imposed upon it or upon its property, and (b) all lawful claims which, if unpaid, might by law become a Lien upon its property; provided that the Company shall not be required to pay or discharge any such tax, assessment, charge or claim (i) which is being contested by it in good faith and by proper procedures or (ii) the non-payment of which will not result in a Material Adverse Change. 6.2 Maintenance of Insurance. Maintain insurance in such amounts and covering such risks with respect to its business and properties as is usually carried by companies engaged in similar businesses and owning similar properties, either with reputable insurance companies or, in whole or in part, by establishing reserves or one or more insurance funds, either alone or with other corporations or associations. 6.3 Preservation of Corporate Existence, Etc. Preserve and maintain its corporate existence, rights and franchises, and qualify and remain qualified as a foreign corporation in each jurisdiction in which such qualification is necessary in view of its business and operations or the ownership of its properties; provided that the Company shall not be required to preserve any such right or franchise or to remain so qualified unless the failure to do so would reasonably be expected to result in a Material Adverse Change. 6.4 Compliance with Laws, Etc. Comply with the requirements of all applicable laws, rules, regulations and orders of any governmental authority, the non-compliance with which would reasonably be expected to result in a Material Adverse Change. 6.5 Visitation Rights. Subject to any necessary approval from the Nuclear Regulatory Commission, at any reasonable time and from time to time, permit the Agent, any of the Banks or any agents or representatives thereof to examine and make copies of and abstracts from its records and books of account, visit its properties and discuss its affairs, finances and accounts with any of its officers. 6.6 Keeping of Books. Keep, and cause each Consolidated Subsidiary to keep, adequate records and books of account, in which full and correct entries shall be made of all of its financial transactions and its assets and business so as to permit the Company and its Consolidated Subsidiaries to present financial statements in accordance with GAAP. 25 6.7 Reporting Requirements. Furnish to the Agent, with sufficient copies for each of the Banks: (a) as soon as practicable and in any event within five Business Days after becoming aware of the occurrence of any Default or Event of Default, a statement of a Designated Officer as to the nature thereof, and as soon as practicable and in any event within five Business Days thereafter, a statement of a Designated Officer as to the action which the Company has taken, is taking or proposes to take with respect thereto; (b) as soon as available and in any event within 60 days after the end of each of the first three quarters of each fiscal year of the Company, a consolidated balance sheet of the Company and its Consolidated Subsidiaries as at the end of such quarter, and the related consolidated statements of income, cash flows and common stockholder's equity of the Company and its Consolidated Subsidiaries as at the end of and for the period commencing at the end of the previous fiscal year and ending with the end of such quarter, setting forth in each case in comparative form the corresponding figures for the corresponding date or period of the preceding fiscal year, or statements providing substantially similar information (which requirement shall be deemed satisfied by the delivery of the Company's quarterly report on Form 10-Q for such quarter), all in reasonable detail and duly certified (subject to the absence of footnotes and to year-end audit adjustments) by a Designated Officer as having been prepared in accordance with GAAP, together with (i) a certificate of a Designated Officer (which certificate shall also accompany the financial statements delivered pursuant to clause (c) below) stating that such officer has no knowledge (having made due inquiry with respect thereto) that a Default or Event of Default has occurred and is continuing, or, if a Default or Event of Default has occurred and is continuing, a statement as to the nature thereof and the actions which the Company has taken, is taking or proposes to take with respect thereto, and (ii) a certificate of a Designated Officer, in substantially the form of Exhibit C hereto, setting forth the Company's computation of the financial ratios specified in Sections 8.1 and 8.2 as of the end of the immediately preceding fiscal quarter or year, as the case may be, of the Company; (c) as soon as available and in any event within 120 days after the end of each fiscal year of the Company, a copy of the Company's Annual Report on Form 10-K (or any successor form) for such year, including therein the consolidated balance sheet of the Company and its Consolidated Subsidiaries as at the end of such year and the consolidated statements of income, cash flows and common stockholder's equity of the Company and its Consolidated Subsidiaries as at the end of and for such year, or statements providing substantially similar information, in each case certified by independent public accountants of recognized national standing selected by the Company (and not objected to by the Majority Banks), together with a certificate of such accounting firm addressed to the Banks stating that, in the course of its examination of the consolidated financial statements of the Company and its Consolidated Subsidiaries, which examination was conducted by such accounting firm in accordance with GAAP, (1) such accounting firm has obtained no knowledge that an Event of Default, insofar as such Event of Default related to accounting or financial matters, has occurred and is continuing, or if, in the opinion of such accounting firm, such an Event of Default has occurred and is continuing, a statement as to the nature thereof, and (2) such accounting firm has examined a certificate prepared by the Company setting forth the computations made by the Company in determining, 26 as of the end of such fiscal year, the ratios specified in Sections 8.1 and 8.2, which certificate shall be attached to the certificate of such accounting firm, and such accounting firm confirms that such computations accurately reflect such ratios; (d) promptly after the sending or filing thereof, copies of all proxy statements which the Company sends to its stockholders, copies of all regular, periodic and special reports (other than those which relate solely to employee benefit plans) which the Company files with the SEC and notice of the sending or filing of (and, upon the request of the Agent or any Bank, a copy of) any final prospectus filed with the SEC; (e) as soon as possible and in any event (i) within 30 days after the Company or any ERISA Affiliate knows or has reason to know that any Plan Termination Event described in clause (a) of the definition of Plan Termination Event with respect to any Plan has occurred and (ii) within ten days after the Company or any ERISA Affiliate knows or has reason to know that any other Plan Termination Event with respect to any Plan has occurred, a statement of the Chief Financial Officer of the Company describing such Plan Termination Event and the action, if any, which the Company or such ERISA Affiliate, as the case may be, proposes to take with respect thereto; (f) promptly upon becoming aware thereof, notice of any upgrading or downgrading of the rating of the Senior Debt by Moody's or S & P; (g) as soon as possible and in any event within five days after the occurrence of any default under any agreement to which the Company or any of its Subsidiaries is a party, which default would reasonably be expected to result in a Material Adverse Change, and which is continuing on the date of such certificate, a certificate of the president or chief financial officer of the Company setting forth the details of such default and the action which the Company or any such Subsidiary proposes to take with respect thereto; and (h) promptly, such other information respecting the business, properties or financial condition of the Company as the Agent or any Bank through the Agent may from time to time reasonably request. 6.8 Use of Proceeds. The Company will use the proceeds of the Loans for general corporate purposes and working capital. The Company will not, nor will it permit any Subsidiary to, use any of the proceeds of the Loans to purchase or carry any "margin stock" (as defined in Regulation U). 6.9 Maintenance of Properties, Etc. The Company shall, and shall cause each of its Subsidiaries to, maintain in all material respects all of its respective owned and leased Property in good and safe condition and repair to the same degree as other companies engaged in similar businesses and owning similar properties, and not permit, commit or suffer any waste or abandonment of any such Property, and from time to time make or cause to be made all material repairs, renewals and replacements thereof, including any capital improvements which may be required; provided that such Property may be altered or renovated in the ordinary course of the Company's or its Subsidiaries' business; and provided, further, that the foregoing shall not 27 restrict the sale of any asset of the Company or any Subsidiary to the extent not prohibited by Section 7.2. 6.10 Bonds. Beginning on the FMB Issue Date and continuing until the earlier of (i) the FMB Release Date and (ii) the date on which the Commitments have terminated and all Obligations have been paid in full, cause the face amount of all Bonds to at all times be equal to or greater than the greater of (a) the Aggregate Commitment and (b) the Aggregate Outstandings. ARTICLE VII NEGATIVE COVENANTS So long as any Obligations shall remain unpaid or any Bank shall have any Commitment under this Agreement, the Company shall not: 7.1 Liens. Create, incur, assume or suffer to exist any Lien upon or with respect to any of its properties, now owned or hereafter acquired, except: (a) Liens created pursuant to the Indenture securing First Mortgage Bonds; provided that the aggregate amount of First Mortgage Bonds issued after the Effective Date and prior to the FMB Issue Date shall not exceed $300,000,000; (b) Liens securing pollution control bonds, or bonds issued to refund or refinance pollution control bonds (including Liens securing obligations (contingent or otherwise) of the Company under letter of credit agreements or other reimbursement or similar credit enhancement agreements with respect to pollution control bonds); provided that the aggregate face amount of any such bonds so issued shall not exceed the aggregate face amount of such pollution control bonds, as the case may be, so refunded or refinanced; (c) Liens in (and only in) assets acquired to secure Debt incurred to finance the acquisition of such assets; (d) Statutory and common law banker's Liens on bank deposits; (e) Liens in respect of accounts receivable sold, transferred or assigned by the Company; (f) Liens for taxes, assessments or other governmental charges or levies not at the time delinquent or thereafter payable without penalty or being contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books; (g) Liens of carriers, warehousemen, mechanics, materialmen and landlords incurred in the ordinary course of business for sums not overdue or being contested in good faith by appropriate proceedings and for which adequate reserves shall have been set aside on its books; (h) Liens incurred in the ordinary course of business in connection with workers' compensation, unemployment insurance or other forms of governmental insurance or benefits, or 28 to secure performance of tenders, statutory obligations, leases and contracts (other than for borrowed money) entered into in the ordinary course of business or to secure obligations on surety or appeal bonds; (i) Judgment Liens in existence less than 30 days after the entry thereof or with respect to which execution has been stayed or the payment of which is covered (subject to a customary deductible) by insurance; (j) Zoning restrictions, easements, licenses, covenants, reservations, utility company rights, restrictions on the use of real property or minor irregularities of title incident thereto which do not in the aggregate materially detract from the value of the property or assets of the Company or materially impair the operation of its business; (k) Liens arising in connection with the financing of the Company's fuel resources, including nuclear fuel; (l) Liens arising pursuant to M.C.L. 324.20138; provided that the aggregate amount of all obligations secured by such Liens (excluding any such Liens of which the Company has no knowledge or which are permitted by clause (f) above) shall not exceed $20,000,000; (m) Liens arising in connection with Securitized Bonds; (n) Liens on natural gas, oil and mineral, or on stock in trade, material or supplies manufactured or acquired for the purpose of sale and or resale in the usual course of business or consumable in the operation of any of the properties of the Company; provided that such Liens secure obligations not exceeding $500,000,000 in aggregate principal amount; (o) Liens securing the Obligations; (p) Other Liens securing Debt in an aggregate amount not in excess of the lesser of (i) $200,000,000 and (ii) the remainder of $500,000,000 less the Aggregate Commitment; provided that such Debt (i) has no scheduled amortization prior to the 91st day after the scheduled Revolving Termination Date (or, if the Company exercises the Term Out Option, the Final Maturity Date), (ii) has no borrowing conditions, mandatory prepayments, covenants or defaults that are more restrictive than the provisions of this Agreement, (iii) is not entitled to receive First Mortgage Bonds prior to the FMB Issue Date and (iv) prior to the FMB Issue Date, has no collateral other than, if applicable, the collateral described in the Mortgage and Security Agreement and the Lien thereon shared with the Banks on a pro rata basis. 7.2 Sale of Assets. During the period from the Effective Date through the Revolving Termination Date or, if the Company exercises the Term Out Option, the Final Maturity Date, sell, lease, assign, transfer or otherwise dispose of 25% or more of its assets calculated with reference to total assets as reflected on the Company's consolidated balance sheet as at December 31, 2005. 7.3 Mergers, Etc. Merge with or into or consolidate with or into any other Person, except that the Company may merge with any other Person; provided that, in each case, 29 immediately after giving effect thereto, (a) no event shall occur and be continuing which constitutes a Default or Event of Default, (b) the Company is the surviving corporation, (c) the Company shall not be liable with respect to any Debt or allow its Property to be subject to any Lien which it could not become liable with respect to or allow its Property to become subject to under this Agreement on the date of such transaction and (d) the Company's Net Worth shall be equal to or greater than its Net Worth immediately prior to such merger. 7.4 Compliance with ERISA. Permit to exist any occurrence of any Reportable Event, or any other event or condition which presents a material (in the reasonable opinion of the Majority Banks) risk of a termination by the PBGC of any Plan, which termination will result in any material (in the reasonable opinion of the Majority Banks) liability of the Company or such ERISA Affiliate to the PBGC. 7.5 Change in Nature of Business. Make any material change in the nature of its business as carried on as of the date hereof. 7.6 Restricted Payments. (a) Declare or pay any dividends or make any other distributions on its capital stock (other than dividends payable solely in such capital stock) or redeem any such capital stock; (b) purchase or otherwise acquire or retire, or permit any Subsidiary to purchase or otherwise acquire or retire, any of the Company's capital stock or (c) make, or permit any Subsidiary to make, any loans or advances to CMS or any Subsidiary thereof (other than the Company or any Subsidiary thereof); provided that, so long as no Default or Event of Default exists or would result therefrom, the Company may pay dividends in an aggregate amount not to exceed $300,000,000 during any calendar year. 7.7 Off-Balance Sheet Liabilities. Create, incur, assume or suffer to exist, or permit any Subsidiary to create, incur, assume or suffer to exist, Off-Balance Sheet Liabilities (exclusive of obligations arising in connection with the Purchase Agreement among the Company, Consumers Receivables Funding II, LLC, Falcon Asset Securitization Corporation and JPMorgan Chase Bank, N.A., dated as of May 22, 2003, as amended, restated or otherwise modified from time to time and any similar agreement entered into in replacement thereof) in the aggregate in excess of $250,000,000 at any time. 7.8 Transactions with Affiliates. Enter into, or permit any Subsidiary to enter into, any transaction with any of its Affiliates (other than the Company or any Subsidiary) unless such transaction is on terms no less favorable to the Company or such Subsidiary than if the transaction had been negotiated in good faith on an arm's-length basis with a non-Affiliate; provided that any transaction permitted under Section 7.6 shall be permitted hereunder. ARTICLE VIII FINANCIAL COVENANTS So long as any of the Obligations shall remain unpaid or any Bank shall have any Commitment under this Agreement, the Company shall: 30 8.1 Debt to Capital Ratio. At all times, maintain a ratio of Total Consolidated Debt to Total Consolidated Capitalization of not greater than 0.70 to 1.0. 8.2 Interest Coverage Ratio. Not permit the ratio, determined as of the end of each of its fiscal quarters for the then most-recently ended four fiscal quarters, of (i) Consolidated EBIT to (ii) Consolidated Interest Expense to be less than 2.0 to 1.0. ARTICLE IX EVENTS OF DEFAULT 9.1 Events of Default. The occurrence of any of the following events shall constitute an "Event of Default": (a) The Company shall fail to pay (i) any principal of any Advance when due and payable, or (ii) any interest on any Advance or any fee or other Obligation payable hereunder within five days after such interest or fee or other Obligation becomes due and payable; (b) Any representation or warranty made by the Company (or any of its officers) in this Agreement or any other Credit Document or in any certificate, document, report, financial or other written statement furnished at any time pursuant to any Credit Document shall prove to have been incorrect in any material respect on or as of the date made or deemed made; (c) The Company shall fail to perform or observe any term, covenant or agreement contained in Section 6.10, Article VII or Article VIII; or the Company shall fail to perform or observe any other term, covenant or agreement on its part to be performed or observed in this Agreement or in any other Credit Document and such failure shall continue for 30 consecutive days after the earlier of (i) a Designated Officer obtaining knowledge of such breach and (ii) written notice thereof by means of facsimile, regular mail or written notice delivered in person (or telephonic notice thereof confirmed in writing) having been given to the Company by the Agent or the Majority Banks; (d) The Company shall: (i) fail to pay any Debt (other than the payment obligations described in clause (a) above) in excess of $50,000,000, or any interest or premium thereon, when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) and such failure shall continue after the applicable grace period, if any, specified in the instrument or agreement relating to such Debt; or (ii) fail to perform or observe any term, covenant or condition on its part to be performed or observed under any agreement or instrument relating to any such Debt, when required to be performed or observed, if the effect of such failure to perform or observe is to accelerate, or to permit the acceleration of, the maturity of such Debt, unless the obligee under or holder of such Debt shall have waived in writing such circumstance, or such circumstance has been cured, so that such circumstance is no longer continuing; or (iii) any such Debt shall be declared to be due and payable, or required to be prepaid (other than by a regularly scheduled required prepayment), in each case in accordance with the terms of such agreement or instrument, prior to the stated maturity thereof; or (iv) generally not, or shall admit in writing its inability to, pay its debts as such debts become due; 31 (e) The Company: (i) shall make an assignment for the benefit of creditors, or petition or apply to any tribunal for the appointment of a custodian, receiver or trustee for it or a substantial part of its assets; or (ii) shall commence any proceeding under any bankruptcy, reorganization, arrangement, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction, whether now or hereafter in effect; or (iii) shall have had any such petition or application filed or any such proceeding shall have been commenced, against it, in which an adjudication or appointment is made or order for relief is entered, or which petition, application or proceeding remains undismissed for a period of 30 consecutive days or more; or (iv) by any act or omission shall indicate its consent to, approval of or acquiescence in any such petition, application or proceeding or order for relief or the appointment of a custodian, receiver or trustee for all or any substantial part of its property; or (v) shall suffer any such custodianship, receivership or trusteeship to continue undischarged for a period of 30 days or more; or (vi) shall take any corporate action to authorize any of the actions set forth above in this clause (e); (f) One or more judgments, decrees or orders for the payment of money in excess of $50,000,000 in the aggregate shall be rendered against the Company and either (i) enforcement proceedings shall have been commenced by any creditor upon any such judgment or order or (ii) there shall be any period of more than 30 consecutive days during which a stay of enforcement of such judgment or order, by reason of a pending appeal or otherwise, shall not be in effect; (g) Any Plan Termination Event with respect to a Plan shall have occurred, and 30 days after notice thereof shall have been given to the Company by the Agent, (i) such Plan Termination Event (if correctable) shall not have been corrected and (ii) the then present value of such Plan's vested benefits exceeds the then current value of the assets accumulated in such Plan by more than the amount of $25,000,000 (or in the case of a Plan Termination Event involving the withdrawal of a "substantial employer" (as defined in Section 4001(A)(2) of ERISA), the withdrawing employer's proportionate share of such excess shall exceed such amount). (h) Prior to the FMB Issue Date, the Mortgage and Security Agreement shall cease to be in full force and effect or the Company shall deny that it has any liability or obligation under the Mortgage and Security Agreement. (i) On and after the FMB Issue Date but prior to the FMB Release Date, (i) any Bond shall cease to be in full force and effect (except for Bonds surrendered by the Agent pursuant to Section 2.5(b); or (ii) the Company shall deny that it has any liability or obligation under any Bond or purport to revoke, terminate, rescind or redeem any Bond (other than in accordance with the terms of the Bonds and the Indenture). 9.2 Remedies. (a) If any Event of Default shall occur and be continuing, the Agent shall upon the request, or may with the consent, of the Majority Banks, by notice to the Company, (i) declare the Commitments to be terminated or suspended, whereupon the same shall forthwith terminate, and/or (ii) declare the Obligations to be forthwith due and payable, whereupon all Loans and all other Obligations shall become and be forthwith due and payable; provided that in the case of an Event of Default referred to in Section 9.1(e), the Commitments shall automatically terminate 32 and the Obligations shall automatically become due and payable without notice, presentment, demand, protest or other formalities of any kind, all of which are hereby expressly waived by the Company. ARTICLE X WAIVERS, AMENDMENTS AND REMEDIES 10.1 Amendments. Subject to the provisions of this Article X, the Majority Banks (or the Agent with the consent in writing of the Majority Banks) and the Company may enter into written agreements supplemental hereto for the purpose of adding or modifying any provisions to the Credit Documents or changing in any manner the rights of the Banks or the Company hereunder or waiving any Event of Default hereunder; provided that no such supplemental agreement shall, without the consent of all of the Banks: (a) Extend the maturity of any Loan or reduce the principal amount thereof, or reduce the rate or extend the time of payment of interest thereon or fees thereon. (b) Modify the percentage specified in the definition of Majority Banks. (c) Extend the Revolving Termination Date or the Final Maturity Date or increase the amount of the Commitment of any Bank hereunder or permit the Company to assign its rights under this Agreement. (d) Amend Section 6.10, this Section 10.1 or Section 12.11. (e) Make any change in an express right in this Agreement of a single Bank to give its consent, make a request or give a notice. (f) (i) Prior to the FMB Issue Date, release all or substantially all of the collateral described in the Mortgage and Security Agreement or (ii) on or after the FMB Issue Date, authorize the Agent to vote in favor of the release of all or substantially all of the collateral securing the Bonds. No amendment of any provision of this Agreement relating to the Agent shall be effective without the written consent of the Agent. 10.2 Preservation of Rights. No delay or omission of the Banks or the Agent to exercise any right under the Credit Documents shall impair such right or be construed to be a waiver of any Default or Event of Default or an acquiescence therein, and the making of an Advance notwithstanding the existence of a Default or Event of Default or the inability of the Company to satisfy the conditions precedent to such Advance shall not constitute any waiver or acquiescence. Any single or partial exercise of any such right shall not preclude other or further exercise thereof or the exercise of any other right, and no waiver, amendment or other variation of the terms, conditions or provisions of the Credit Documents whatsoever shall be valid unless in writing signed by the Banks required pursuant to Section 10.1, and then only to the extent in such writing specifically set forth. All remedies contained in the Credit Documents or by law 33 afforded shall be cumulative and all shall be available to the Agent and the Banks until the Obligations have been paid in full. ARTICLE XI CONDITIONS PRECEDENT 11.1 Initial Advance Prior to the FMB Issue Date. The Banks shall not be required to make the initial Advance prior to the FMB Issue Date hereunder unless the Company has furnished to the Agent with sufficient copies for the Banks: (a) Counterparts of this Agreement executed by the Company and the Banks. (b) Copies of the Restated Articles of Incorporation of the Company, together with all amendments, certified by the Secretary or an Assistant Secretary of the Company, and a certificate of good standing, certified by the appropriate governmental officer in its jurisdiction of incorporation. (c) Copies, certified by the Secretary or an Assistant Secretary of the Company, of its bylaws and of its Board of Directors' resolutions (and resolutions of other bodies, if any are deemed necessary by counsel for any Bank) authorizing the execution of the Credit Documents. (d) An incumbency certificate, executed by the Secretary or an Assistant Secretary of the Company, which shall identify by name and title and bear the original or facsimile signature of the officers of the Company authorized to sign the Credit Documents and the officers or other employees authorized to make borrowings hereunder, upon which certificate the Banks shall be entitled to rely until informed of any change in writing by the Company. (e) A certificate, signed by a Designated Officer of the Company, stating that on the date hereof no Default or Event of Default has occurred and is continuing. (f) Counterparts of the Mortgage and Security Agreement executed by the Company and the Agent. (g) Favorable opinions of: (i) the General Counsel or an Assistant General Counsel of the Company or CMS, as to the matters set forth in Exhibit B-1 and as to such other matters as the Agent may reasonably request; and (ii) Miller, Canfield, Paddock and Stone, P.L.C., as to the matters set forth in Exhibit B-2 and as to such other matters as the Agent may reasonably request. Such opinions shall be addressed to the Agent and the Banks and shall be satisfactory in form and substance to the Agent. (h) Evidence, in form and substance satisfactory to the Agent, that the Company has obtained all governmental approvals, if any, necessary for it to enter into the Credit Documents. (i) Such other documents as any Bank or its counsel may have reasonably requested. It shall be a further condition precedent to the making of the initial Advance hereunder that the Company shall have paid (i) to the Agent for the account of the Banks the fees required to be 34 paid on the Effective Date and (ii) to the Agent and each Arranger the fees required to be paid to them pursuant to any fee letter. 11.2 Initial Advance After the FMB Issue Date. The Banks shall not be required to make the initial Advance on or after the FMB Issue Date hereunder unless the Company has furnished to the Agent with sufficient copies for the Banks: (a) The First Mortgage Bonds referred to in Section 3.2. (b) Favorable opinions of: (i) the General Counsel or an Assistant General Counsel of the Company or CMS, as to the matters set forth in Exhibit B-3 and as to such other matters as the Agent may reasonably request; and (ii) Miller, Canfield, Paddock and Stone, P.L.C., as to the matters set forth in Exhibit B-4 and as to such other matters as the Agent may reasonably request. Such opinions shall be addressed to the Agent and the Banks and shall be satisfactory in form and substance to the Agent. (c) If no Advances were made prior to the FMB Issue Date, each of the documents specified in the Section 11.1(a), (b), (c), (d) and (h) (to the extent not previously delivered). (d) Such other documents as any Bank or its counsel may have reasonably requested. 11.3 Each Advance. The Banks shall not be required to make any Advance if on the applicable Borrowing Date, (i) any Default or Event of Default exists, (ii) any representation or warranty contained in Article V is not true and correct as of such Borrowing Date, (iii) after the FMB Issue Date but prior to the FMB Release Date, after giving effect to such Advance the Aggregate Outstandings would exceed the face amount of all Bonds or (iv) all legal matters incident to the making of such Advance are not satisfactory to the Banks and their counsel; provided that, on any date following the Effective Date on which the ratings of the Senior Debt from Moody's and S&P are Baa2 or higher and BBB or higher, respectively, the Company shall not be required to make the representation and warranty (x) regarding no Material Adverse Change set forth in Section 5.5 or (y) set forth in the first sentence of Section 5.6. Each Borrowing Notice shall constitute a representation and warranty by the Company that the conditions contained in clauses (i), (ii) and (iii) above will be satisfied on the relevant Borrowing Date. For the avoidance of doubt, the conversion or continuation of an Advance shall not be considered the making of a Advance. ARTICLE XII GENERAL PROVISIONS 12.1 Successors and Assigns. (a) The terms and provisions of the Credit Documents shall be binding upon and inure to the benefit of the Company and the Banks and their respective successors and assigns, except that the Company shall not have the right to assign its rights under the Credit Documents. Any Bank may sell participations in all or a portion of its rights and obligations under this Agreement pursuant to clause (b) below and any Bank may assign all or any part of its rights and obligations under this Agreement pursuant to clause (c) below. 35 (b) Any Bank may sell participations to one or more banks or other entities (each a "Participant") in all or a portion of its rights and obligations under this Agreement (including all or a portion of its Commitment and its Loans); provided that (i) such Bank's obligations under this Agreement (including its Commitment to the Company hereunder) shall remain unchanged, (ii) such Bank shall remain solely responsible to the other parties hereto for the performance of such obligations, (iii) such Bank shall remain the holder of its Loans for all purposes of this Agreement and (iv) the Company shall continue to deal solely and directly with such Bank in connection with such Bank's rights and obligations under this Agreement. Each Bank shall retain the sole right to approve, without the consent of any Participant, any amendment, modification or waiver of any provision of the Credit Documents other than any amendment, modification or waiver with respect to any Loan or Commitment in which such Participant has an interest which would require consent of all of the Banks pursuant to the terms of Section 10.1 or of any other Credit Document. The Company agrees that each Participant shall be deemed to have the right of setoff provided in Section 12.10 in respect of its participating interest in amounts owing under the Credit Documents to the same extent as if the amount of its participating interest were owing directly to it as a Bank under the Credit Documents; provided that each Bank shall retain the right of setoff provided in Section 12.10 with respect to the amount of participating interests sold to each Participant. The Banks agree to share with each Participant, and each Participant, by exercising the right of setoff provided in Section 12.10, agrees to share with each Bank, any amount received pursuant to the exercise of its right of setoff, such amounts to be shared in accordance with Section 12.10 as if each Participant were a Bank. The Company further agrees that each Participant shall be entitled to the benefits of Sections 4.1, 4.3, 4.4 and 4.5 to the same extent as if it were a Bank and had acquired its interest by assignment pursuant to Section 12.1(c); provided that (i) a Participant shall not be entitled to receive any greater payment under Section 4.1, 4.3, 4.4 or 4.5 than the Bank that sold the participating interest to such Participant would have received had it retained such interest for its own account, unless the sale of such interest to such Participant is made with the prior written consent of the Company, and (ii) any Participant not incorporated under the laws of the United States of America or any State thereof agrees to comply with the provisions of Section 4.5 to the same extent as if it were a Bank. (c) Any Bank may, in the ordinary course of its business and in accordance with applicable law, at any time assign to one or more financial institutions or other Persons all or any part of its rights and obligations under this Agreement; provided that (i) unless such assignment is to another Bank, an affiliate of such assigning Bank or any direct or indirect contractual counterparty in any swap agreement relating to the Loans to the extent required in connection with the settlement of such Bank's obligations pursuant thereto, such Bank has received the Agent's and, so long as no Event of Default exists, the Company's prior written consent to such assignment, which consent shall not be unreasonably withheld or delayed, and (ii) the minimum principal amount of any such assignment (other than assignments to a Federal Reserve Bank, to another Bank, to an affiliate of such assigning Bank or to any direct or indirect contractual counterparty in any swap agreement relating to the Loans to the extent required in connection with the settlement of such Bank's obligations pursuant thereto) shall be $5,000,000 (or such lesser amount consented to by the Agent and, so long as no Event of Default shall be continuing, the Company), which consents shall not be unreasonably withheld or delayed; provided that after 36 giving effect to such assignment the assigning Bank shall have a Commitment of not less than $5,000,000 (unless otherwise consented to by the Agent and, so long as no Event of Default shall be continuing, the Company). Notwithstanding the foregoing sentence, (x) any Bank may at any time, without the consent of the Company or the Agent, assign all or any portion of its rights under this Agreement to a Federal Reserve Bank; provided that no such assignment shall release the transferor Bank from its obligations hereunder; and (y) no assignment by a Bank shall release such Bank from its obligations hereunder unless (I) the Agent and, so long as no Event of Default exists, the Company have approved such assignment or (II) the creditworthiness of such affiliate (as determined in accordance with customary standards of the banking industry) is no less than that of the assigning Bank. (d) Any Bank may, in connection with any sale or participation or proposed sale or participation pursuant to this Section 12.1, disclose to the purchaser or participant or proposed purchaser or participant any information relating to the Company furnished to such Bank by or on behalf of the Company; provided that prior to any such disclosure of non-public information, the purchaser or participant or proposed purchaser or participant (which purchaser or participant is not an affiliate of a Bank) shall agree to preserve the confidentiality of any confidential information (except any such disclosure as may be required by law or regulatory process) relating to the Company received by it from such Bank. (e) Assignments under this Section 12.1 shall be made pursuant to an agreement (an "Assignment Agreement") substantially in the form of Exhibit D hereto or in such other form as may be agreed to by the parties thereto and shall not be effective until a $3,500 fee has been paid to the Agent by the assignee, which fee shall cover the cost of processing such assignment; provided that such fee shall not be incurred in the event of an assignment by any Bank of all or a portion of its rights under this Agreement to (i) a Federal Reserve Bank or (ii) a Bank or an affiliate of the assigning Bank or (iii) to any direct or indirect contractual counterparties in swap agreements relating to the Loans to the extent required in connection with the settlement of any Bank's obligations pursuant thereto. 12.2 Survival of Representations. All representations and warranties of the Company contained in this Agreement shall survive the making of the Advances herein contemplated. 12.3 Governmental Regulation. Anything contained in this Agreement to the contrary notwithstanding, no Bank shall be obligated to extend credit to the Company in violation of any limitation or prohibition provided by any applicable statute or regulation. 12.4 Taxes. Any taxes (excluding income taxes) payable or ruled payable by any Federal or State authority in respect of the execution of the Credit Documents shall be paid by the Company, together with interest and penalties, if any. 12.5 Choice of Law. THE CREDIT DOCUMENTS SHALL BE CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (INCLUDING SECTION 5-1401 OF THE GENERAL OBLIGATIONS LAW OF NEW YORK, BUT OTHERWISE WITHOUT REGARD TO THE LAW OF CONFLICTS) OF THE STATE OF NEW YORK, BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS. THE COMPANY 37 HEREBY IRREVOCABLY SUBMITS TO THE NON-EXCLUSIVE JURISDICTION OF ANY UNITED STATES FEDERAL OR NEW YORK STATE COURT SITTING IN NEW YORK, NEW YORK IN ANY ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO ANY CREDIT DOCUMENT AND THE COMPANY HEREBY IRREVOCABLY AGREES THAT ALL CLAIMS IN RESPECT OF ANY SUCH ACTION OR PROCEEDING MAY BE HEARD AND DETERMINED IN ANY SUCH COURT. THE COMPANY HEREBY WAIVES ANY RIGHT TO A JURY TRIAL IN ANY ACTION OR ARISING HEREUNDER OR UNDER ANY CREDIT DOCUMENT. 12.6 Headings. Section headings in the Credit Documents are for convenience of reference only, and shall not govern the interpretation of any of the provisions of the Credit Documents. 12.7 Entire Agreement. The Credit Documents embody the entire agreement and understanding between the Company, the Agent and the Banks and supersede all prior agreements and understandings between the Company, the Agent and the Banks relating to the subject matter thereof (other than those contained in the any fee letter, which shall survive and remain in full force and effect during the term of this Agreement). 12.8 Expenses; Indemnification. The Company shall reimburse the Agent and each Arranger for (a) any reasonable costs, internal charges and out-of-pocket expenses (including reasonable attorneys' fees and time charges of attorneys for the Agent) paid or incurred by the Agent or such Arranger in connection with the preparation, review, execution, delivery, syndication, distribution (including via the internet), amendment and modification of the Credit Documents and (b) any reasonable costs, internal charges and out-of-pocket expenses (including reasonable attorneys' fees and time charges of attorneys for the Agent) paid or incurred by the Agent or such Arranger on its own behalf or on behalf of any Bank and, on or after the date upon which an Event of Default specified in Section 9.1(a) or 9.1(e) has occurred and is continuing, each Bank, in connection with the collection and enforcement of the Credit Documents. The Company further agrees to indemnify the Agent, each Arranger, each Bank and their respective Affiliates, and the directors, officers, employees and agents of the foregoing (all of the foregoing, the "Indemnified Persons), against all losses, claims, damages, penalties, judgments, liabilities and reasonable expenses (including all reasonable expenses of litigation or preparation therefor whether or not an Indemnified Person is a party thereto) which any of them may pay or incur arising out of or relating to this Agreement, the other Credit Documents, the transactions contemplated hereby, the direct or indirect application or proposed application of the proceeds of any Advance hereunder, any actual or alleged presence or release of any Hazardous Substance on or from any property owned or operated by the Company or any Subsidiary or any Environmental Liability related in any way to the Company or any Subsidiary; provided that the Company shall not be liable to any Indemnified Person for any of the foregoing to the extent they arise from the gross negligence or willful misconduct of such Indemnified Person. Without limiting the foregoing, the Company shall pay any civil penalty or fine assessed by the Office of Foreign Assets Control against any Indemnified Person, and all reasonable costs and expenses (including reasonable fees and expenses of counsel to such Indemnified Person) incurred in connection with defense thereof, as a result of any breach or inaccuracy of the representation 38 made in Section 5.14. The obligations of the Company under this Section shall survive the termination of this Agreement. 12.9 Severability of Provisions. Any provision in any Credit Document that is held to be inoperative, unenforceable or invalid in any jurisdiction shall, as to that jurisdiction, be inoperative, unenforceable or invalid without affecting the remaining provisions in that jurisdiction or the operation, enforceability or validity of that provision in any other jurisdiction, and to this end the provisions of all Credit Documents are declared to be severable. 12.10 Setoff. In addition to, and without limitation of, any rights of the Banks under applicable law, if the Company becomes insolvent, however evidenced, or any Default or Event of Default occurs, any indebtedness from any Bank or any of its Affiliates to the Company (including all account balances, whether provisional or final and whether or not collected or available) may be offset and applied toward the payment of the Obligations owing to such Bank or such Affiliate, whether or not the Obligations, or any part hereof, shall then be due. The Company agrees that any purchaser or participant under Section 12.1 may, to the fullest extent permitted by law, exercise all its rights of payment with respect to such purchase or participation as if it were the direct creditor of the Company in the amount of such purchase or participation. 12.11 Ratable Payments. If any Bank, whether by setoff or otherwise, has payment made to it upon its Loans in a greater proportion than that received by any other Bank, such Bank agrees, promptly upon demand, to purchase a portion of the Loans held by the other Banks so that after such purchase each Bank will hold its Pro Rata Share of all outstanding Loans. If any Bank, whether in connection with setoff or amounts which might be subject to setoff or otherwise, receives collateral or other protection for its Obligations or such amounts which may be subject to setoff, such Bank agrees, promptly upon demand, to take such action necessary such that all Banks share in the benefits of such collateral ratably in proportion to their respective Pro Rata Share of the Total Outstandings. In case any such payment is disturbed by legal process, or otherwise, appropriate further adjustments shall be made. 12.12 Nonliability. The relationship between the Company, on the one hand, and the Banks, the Arrangers and the Agent, on the other hand, shall be solely that of borrower and lender. None of the Agent, either Arranger or any Bank shall have any fiduciary responsibilities to the Company. None of the Agent, either Arranger or any Bank undertakes any responsibility to the Company to review or inform the Company of any matter in connection with any phase of the Company's business or operations. The Company shall rely entirely upon its own judgment with respect to its business, and any review, inspection, supervision or information supplied to the Company by the Banks is for the protection of the Banks and neither the Company nor any third party is entitled to rely thereon. The Company agrees that none of the Agent, either Arranger or any Bank shall have liability to the Company (whether sounding in tort, contract or otherwise) for losses suffered by the Company in connection with, arising out of, or in any way related to, the transactions contemplated and the relationship established by the Credit Documents, or any act, omission or event occurring in connection therewith, unless it is determined in a final non-appealable judgment by a court of competent jurisdiction that such losses resulted from the gross negligence or willful misconduct of the party from which recovery is sought. None of the Agent, either Arranger or any Bank shall have any liability with respect 39 to, and the Company hereby waives, releases and agrees not to sue for, any special, indirect, consequential or punitive damages suffered by the Company in connection with, arising out of, or in any way related to the Credit Documents or the transactions contemplated thereby. 12.13 Other Agents. The Banks identified on the signature pages of this Agreement or otherwise herein, or in any amendment hereof or other document related hereto, as being the "Syndication Agent", a "Co-Documentation Agent" or a "Co-Managing Agent" (the "Other Agents") shall have no rights, powers, obligations, liabilities, responsibilities or duties under this Agreement other than those applicable to all Banks as such. Without limiting the foregoing, the Other Agents shall not have or be deemed to have any fiduciary relationship with any Bank. Each Bank acknowledges that it has not relied, and will not rely, on the Other Agents in deciding to enter into this Agreement or in taking or refraining from taking any action hereunder or pursuant hereto. 12.14 USA Patriot Act. Each Bank hereby notifies the Company that pursuant to requirements of the USA Patriot Act, such Bank is required to obtain, verify and record information that identifies the Company, which information includes the name and address of the Company and other information that will allow such Bank to identify the Company in accordance with the USA Patriot Act. 12.15 Platform. (a) The Company shall use its commercially reasonable best efforts to transmit to the Agent all information, documents and other materials that it is obligated to furnish to the Agent pursuant to this Agreement and the other Credit Documents, including all notices, requests, financial statements, financial and other reports, certificates and other information materials, but excluding (i) any Borrowing Notice, Conversion/Continuation Notice or notice of prepayment, (ii) any notice of a Default or an Event of Default or (iii) any communication that is required to be delivered to satisfy any condition precedent to the effectiveness of this Agreement and/or any Advance hereunder (all such non-excluded communications, collectively, "Communications"), in an electronic/soft medium in a format reasonably acceptable to the Agent to such e-mail address as designated by the Agent from time to time. In addition, the Company shall continue to provide Communications to the Agent or any Bank in the manner specified in this Agreement but only to the extent requested by the Agent or such Bank. Each Bank and the Company further agrees that the Agent may make Communications available to the Banks by posting Communications on IntraLinks or a substantially similar electronic transmission system (the "Platform"); provided, that upon written notice to the Agent and the Company, any Bank (such bank, a "Declining Bank") may decline to receive Communications via the Platform and shall direct the Company to provide, and the Company shall so provide, such Communications to such Declining Bank by delivery to such Declining Bank's address in accordance with Section 14.1. Subject to the conditions set forth in the proviso in the immediately preceding sentence, nothing in this Section 12.15 shall prejudice the right of the Agent to make Communications available to the Banks in any other manner specified herein. (b) Each Bank (other than a Declining Bank) agrees that e-mail notice to it (at the address provided pursuant to the next sentence and deemed delivered as provided in clause (c) 40 below) specifying that a Communication has been posted to the Platform shall constitute effective delivery of such Communication to such Bank for purposes of this Agreement. Each Bank (other than a Declining Bank) agrees (i) to notify the Agent in writing (including by electronic communication) from time to time to ensure that the Agent has on record an effective e-mail address for such Bank to which the foregoing notice may be sent by electronic transmission and (ii) that the foregoing notice may be sent to such e-mail address. (c) Each party hereto (other than a Declining Bank) agrees that any electronic Communication referred to in this Section 12.15 shall be deemed delivered upon the posting of a record of such Communication as "sent" in the e-mail system of the sending party or, in the case of any such Communication to the Agent, upon the posting of a record of such Communication as "received" in the e-mail system of the Agent, provided that if such Communication is not so received by a Person during the normal business hours of such Person, such Communication shall be deemed delivered at the opening of business on the next business day for such Person. (d) Each party hereto acknowledges that the distribution of material through an electronic medium is not necessarily secure and there are confidentiality and other risks associated with such distribution. (e) EACH PARTY HERETO FURTHER ACKNOWLEDGES AND AGREES THAT: (i) NONE OF THE AGENT OR ITS AFFILIATES OR ANY OF THEIR RESPECTIVE OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, ADVISORS OR REPRESENTATIVES (COLLECTIVELY, THE "AGENT PARTIES") WARRANTS THE ADEQUACY OF THE PLATFORM OR THE ACCURACY OR COMPLETENESS OF ANY COMMUNICATION, AND EACH AGENT PARTY EXPRESSLY DISCLAIMS LIABILITY FOR ERRORS OR OMISSIONS IN ANY COMMUNICATION; AND (ii) NO WARRANTY OF ANY KIND, EXPRESS, IMPLIED OR STATUTORY, INCLUDING ANY WARRANTY OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, NON-INFRINGEMENT OF THIRD PARTY RIGHTS OR FREEDOM FROM VIRUSES OR OTHER CODE DEFECTS, IS MADE BY ANY AGENT PARTY IN CONNECTION WITH ANY COMMUNICATION OR THE PLATFORM. (f) This Section 12.15 shall terminate on the date that no Agent Party is the Agent under this Agreement. ARTICLE XIII THE AGENT 13.1 Appointment. Barclays Bank PLC is hereby appointed Agent hereunder, and each of the Banks irrevocably authorizes the Agent to act as the contractual representative on behalf of such Bank. The Agent agrees to act as such upon the express conditions contained in 41 this Article XIII. The Agent shall not have a fiduciary relationship in respect of any Bank by reason of this Agreement. 13.2 Powers. The Agent shall have and may exercise such powers hereunder as are specifically delegated to the Agent by the terms hereof, together with such powers as are reasonably incidental thereto. The Agent shall not have any implied duties to the Banks or any obligation to the Banks to take any action hereunder except any action specifically provided by this Agreement to be taken by the Agent. 13.3 General Immunity. Neither the Agent nor any of its directors, officers, agents or employees shall be liable to the Banks or any Bank for any action taken or omitted to be taken by it or them hereunder or in connection herewith except for its or their own gross negligence or willful misconduct. 13.4 No Responsibility for Loans, Recitals, Etc. The Agent shall not be responsible to the Banks for any recitals, reports, statements, warranties or representations herein or in any Credit Document or be bound to ascertain or inquire as to the performance or observance of any of the terms of this Agreement. 13.5 Action on Instructions of Banks. The Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder and under any other Credit Document in accordance with written instructions signed by the Majority Banks (or all of the Banks if required by Section 10.1), and such instructions and any action taken or failure to act pursuant thereto shall be binding on all of the Banks. The Banks hereby acknowledge that the Agent shall be under no duty to take any discretionary action permitted to be taken by it pursuant to the provisions of this Agreement or any other Credit Document unless it shall be requested in writing to do so by the Majority Banks. The Agent shall be fully justified in failing or refusing to take any action hereunder and under any other Credit Document unless it shall first be indemnified to its satisfaction by the Banks pro rata against any and all liability, cost and expense that it may incur by reason of taking or continuing to take any such action. 13.6 Employment of Agents and Counsel. The Agent may execute any of its duties as Agent hereunder by or through employees, agents and attorneys-in-fact and shall not be answerable to the Banks, except as to money or securities received by it or its authorized agents, for the default or misconduct of any such agents or attorneys-in-fact selected by it with reasonable care. The Agent shall be entitled to advice of counsel concerning all matters pertaining to the agency hereby created and its duties hereunder. 13.7 Reliance on Documents; Counsel. The Agent shall be entitled to rely upon any notice, consent, certificate, affidavit, letter, telegram, statement, paper or document believed by it to be genuine and correct and to have been signed or sent by the proper person or persons, and, in respect to legal matters, upon the opinion of counsel selected by the Agent, which counsel may be employees of the Agent. 13.8 Agent's Reimbursement and Indemnification. The Banks agree to reimburse and indemnify the Agent ratably in accordance with their respective Pro Rata Shares (i) for any 42 amounts not reimbursed by the Company for which the Agent is entitled to reimbursement by the Company under the Credit Documents, (ii) for any other expenses reasonably incurred by the Agent on behalf of the Banks, in connection with the preparation, execution, delivery, administration and enforcement of the Credit Documents, and for which the Agent is not entitled to reimbursement by the Company under the Credit Documents, and (iii) for any liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind and nature whatsoever which may be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of this Agreement or any other document delivered in connection with this Agreement or the transactions contemplated hereby or the enforcement of any of the terms hereof or of any such other documents, and for which the Agent is not entitled to reimbursement by the Company under the Credit Documents; provided that no Bank shall be liable for any of the foregoing to the extent they arise from the gross negligence or willful misconduct of the Agent. 13.9 Rights as a Bank. With respect to its Commitment and any Advance made by it, the Agent shall have the same rights and powers hereunder as any Bank and may exercise the same as though it were not the Agent, and the term "Bank" or "Banks" shall, unless the context otherwise indicates, include Barclays in its individual capacity. The Agent may accept deposits from, lend money to, and generally engage in any kind of banking or trust business with the Company or any Subsidiary as if it were not the Agent. 13.10 Bank Credit Decision. (a) Each Bank acknowledges that it has, independently and without reliance upon the Agent or any other Bank and based on the financial statements prepared by the Company and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Bank also acknowledges that it will, independently and without reliance upon the Agent or any other Bank and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement. (b) Without limiting clause (a) above, each Bank acknowledges and agrees that neither such Bank nor any of its Affiliates, participants or assignees may rely on the Agent to carry out such Bank's or other Person's customer identification program, or other obligations required or imposed under or pursuant to the USA Patriot Act or the regulations thereunder, including the regulations contained in 31 C.F.R. 103.121 (as amended or replaced, the "CIP Regulations"), or any other applicable law, rule, regulation or order of any governmental authority, including any program involving any of the following items relating to or in connection with the Company or any of its Subsidiaries or Affiliates or agents, the Credit Documents or the transactions contemplated hereby: (i) any identity verification procedure; (ii) any recordkeeping; (iii) any comparison with a government list; (iv) any customer notice or (v) any other procedure required under the CIP Regulations or such other law, rule, regulation or order. (c) Within 10 days after the date of this Agreement and at such other times as are required under the USA Patriot Act, each Bank and each assignee and participant that is not incorporated under the laws of the United States of America or a state thereof (and is not excepted from the certification requirement contained in Section 313 of the USA Patriot Act and 43 the applicable regulations because it is both (i) an affiliate of a depository institution or foreign bank that maintains a physical presence in the United States or foreign country and (ii) subject to supervision by a banking authority regulating such affiliated depository institution or foreign bank) shall deliver to the Agent a certification, or, if applicable, recertification, certifying that such Bank is not a "shell" and certifying as to other matters as required by Section 313 of the USA Patriot Act and the applicable regulations. 13.11 Successor Agent. The Agent may resign at any time by giving written notice thereof to the Banks and the Company, and the Agent may be removed at any time with or without cause by written notice received by the Agent from the Majority Banks. Upon any such resignation or removal, the Majority Banks shall have the right to appoint, on behalf of the Banks, a successor Agent. If no successor Agent shall have been so appointed by the Majority Banks and shall have accepted such appointment within thirty days after the retiring Agent's giving notice of resignation, then the retiring Agent may appoint, on behalf of the Banks, a successor Agent. Such successor Agent shall be a commercial bank having capital and retained earnings of at least $500,000,000. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent, and the retiring Agent shall be discharged from its duties and obligations hereunder. After any retiring Agent's resignation hereunder as Agent, the provisions of this Article XIII shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as the Agent hereunder. 13.12 Agent and Arranger Fees. The Company agrees to pay to the Agent and the Arrangers, for their respective accounts, such fees as may be agreed to between or among any of such parties from time to time. ARTICLE XIV NOTICES 14.1 Giving Notice. Except as otherwise permitted by Section 2.13 with respect to borrowing notices, all notices, requests and other communications to any party hereunder shall be in writing (including electronic transmission, facsimile transmission or similar writing) and shall be given to such party: (x) in the case of the Company, the Agent, at its address or facsimile number set forth on Schedule 3, (y) in the case of any Bank, at its address or facsimile number set forth in its Administrative Questionnaire or (z) in the case of any party, at such other address or facsimile number as such party may hereafter specify for the purpose by notice to the Agent and the Company in accordance with the provisions of this Section 14.1. Each such notice, request or other communication shall be effective (i) if given by facsimile transmission, when transmitted to the facsimile number specified in this Section and confirmation of receipt is received, (ii) if given by mail, 72 hours after such communication is deposited in the mails with first class postage prepaid, addressed as aforesaid, or (iii) if given by any other means, when delivered (or, in the case of electronic transmission, received) at the address specified in this Section; provided that notices to the Agent under Article II shall not be effective until received. 44 14.2 Change of Address. The Company, the Agent and any Bank may each change the address for service of notice upon it by a notice in writing to the other parties hereto. ARTICLE XV COUNTERPARTS This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one agreement, and any of the parties hereto may execute this Agreement by signing any such counterpart. This Agreement shall be effective when it has been executed by the Company, the Agent and the Banks and each party has notified the Agent by facsimile or telephone that it has taken such action. ARTICLE XVI RELEASE OF BONDS The Agent will release the Bonds without any further action or consent by the Banks, and deliver, at the Company's expense, such documents to the Company or the trustee under the Indenture as the Company may reasonably require to evidence such release, upon written request by the Company accompanied by a certificate of a Designated Officer certifying that (a) no Default or Event of Default exists prior to or after giving effect to such release and (b) the then current ratings for the Company's senior unsecured long-term debt (without third-party credit enhancement) are Baa2 or higher in the case of Moody's and BBB or higher in the case of S&P. [REMAINDER OF PAGE LEFT INTENTIONALLY BLANK] 45 IN WITNESS WHEREOF, the Company, the Banks and the Agent have executed this Agreement as of the date first above written. CONSUMERS ENERGY COMPANY By: /s/ Laura L. Mountcastle ---------------------------------- Name: Laura L. Mountcastle Title: Vice President and Treasurer Credit Agreement BARCLAYS BANK PLC, as Administrative Agent and as a Bank By: /s/ Sydney G. Dennis ---------------------------------- Name: Sydney G. Dennis Title: Director Credit Agreement UNION BANK OF CALIFORNIA, N.A., as Syndication Agent and as a Bank By: /s/ Robert J. Olson ---------------------------------- Name: Robert J. Olson Title: Senior Vice President Credit Agreement BNP PARIBAS By: /s/ Francis J. Delaney ---------------------------------- Name: Francis J. Delaney Title: Managing Director By: /s/ Timothy F. Vincent ---------------------------------- Name: Timothy F. Vincent Title: Director Credit Agreement DEUTSCHE BANK TRUST COMPANY AMERICAS By: /s/ Marcus M. Tarkington ---------------------------------- Name: Marcus M. Tarkington Title: Director By: /s/ Evelyn Thierry ---------------------------------- Name: Evelyn Thierry Title: Vice President Credit Agreement WACHOVIA BANK, NATIONAL ASSOCIATION By: /s/ Lawrence N. Gross ---------------------------------- Name: Lawrence N. Gross Title: Assistant Vice President Credit Agreement CITIBANK, N.A. By: /s/ Richard Evans ---------------------------------- Name: Richard Evans Title: Vice President Credit Agreement JPMORGAN CHASE BANK, N.A. By: /s/ Michael J. DeForge ---------------------------------- Name: Michael J. DeForge Title: Vice President Credit Agreement MERRILL LYNCH BANK USA By: /s/ Louis Alder ---------------------------------- Name: Louis Alder Title: Director Credit Agreement THE BANK OF NOVA SCOTIA By: /s/ Thane Rattew ---------------------------------- Name: Thane Rattew Title: Managing Director Credit Agreement UBS LOAN FINANCE LLC By: /s/ Richard L. Tavrow ---------------------------------- Name: Richard L. Tavrow Title: Director By: /s/ Irja R. Otsa ---------------------------------- Name: Irja R. Otsa Title: Associate Director Credit Agreement COMERICA BANK By: /s/ Blake W. Arnett ---------------------------------- Name: Blake W. Arnett Title: Assistant Vice President Credit Agreement FIFTH THIRD BANK By: /s/ Randal Wolffis ---------------------------------- Name: Randal Wolffis Title: Vice President Credit Agreement LASALLE BANK MIDWEST NATIONAL ASSOCIATION By: /s/ David J. Lochner ---------------------------------- Name: David J. Lochner Title: Senior Vice President Credit Agreement SUNTRUST BANK By: /s/ Kelley Brandenburg ---------------------------------- Name: Kelley Brandenburg Title: Vice President Credit Agreement WELLS FARGO BANK, NATIONAL ASSOCIATION By: /s/ Steven Buehler ---------------------------------- Name: Steven Buehler Title: Vice President By: /s/ Peter Martinets ---------------------------------- Name: Peter Martinets Title: Vice President Credit Agreement HUNTINGTON NATIONAL BANK By: /s/ Patrick T. Barbour ---------------------------------- Name: Patrick T. Barbour Title: Vice President Credit Agreement THE NORINCHUKIN BANK By: /s/ Masanori Shoji ---------------------------------- Name: Masanori Shoji Title: Joint General Manager Credit Agreement EXHIBIT A [FORM OF SUPPLEMENTAL INDENTURE] ONE HUNDRED [_________] SUPPLEMENTAL INDENTURE PROVIDING AMONG OTHER THINGS FOR FIRST MORTGAGE BONDS, [200[ ]-[ ]] COLLATERAL SERIES (INTEREST BEARING) -------------- DATED AS OF [ ], 200[ ] -------------- CONSUMERS ENERGY COMPANY TO JPMORGAN CHASE BANK, N.A., TRUSTEE Counterpart ____ of 80 THIS ONE HUNDRED [_________]SUPPLEMENTAL INDENTURE, dated as of [ ], 200_ (herein sometimes referred to as "this Supplemental Indenture"), made and entered into by and between CONSUMERS ENERGY COMPANY, a corporation organized and existing under the laws of the State of Michigan, with its principal executive office and place of business at One Energy Plaza, in Jackson, Jackson County, Michigan 49201, formerly known as Consumers Power Company (hereinafter sometimes referred to as the "Company"), and JPMORGAN CHASE BANK, N.A., a national banking association organized under the laws of the United States of America, with its corporate trust offices at 4 New York Plaza, in the Borough of Manhattan, The City of New York, New York 10004 (hereinafter sometimes referred to as the "Trustee"), as Trustee under the Indenture dated as of September 1, 1945 between Consumers Power Company, a Maine corporation (hereinafter sometimes referred to as the "Maine corporation"), and City Bank Farmers Trust Company (Citibank, N.A., successor, hereinafter sometimes referred to as the "Predecessor Trustee"), securing bonds issued and to be issued as provided therein (hereinafter sometimes referred to as the "Indenture"), WHEREAS at the close of business on January 30, 1959, City Bank Farmers Trust Company was converted into a national banking association under the title "First National City Trust Company"; and WHEREAS at the close of business on January 15, 1963, First National City Trust Company was merged into First National City Bank; and WHEREAS at the close of business on October 31, 1968, First National City Bank was merged into The City Bank of New York, National Association, the name of which was thereupon changed to First National City Bank; and WHEREAS effective March 1, 1976, the name of First National City Bank was changed to Citibank, N.A.; and WHEREAS effective July 16, 1984, Manufacturers Hanover Trust Company succeeded Citibank, N.A. as Trustee under the Indenture; and WHEREAS effective June 19, 1992, Chemical Bank succeeded by merger to Manufacturers Hanover Trust Company as Trustee under the Indenture; and WHEREAS effective July 15, 1996, The Chase Manhattan Bank (National Association), merged with and into Chemical Bank which thereafter was renamed The Chase Manhattan Bank; and WHEREAS effective November 11, 2001, The Chase Manhattan Bank merged with Morgan Guaranty Trust Company of New York and the surviving corporation was renamed JPMorgan Chase Bank; and WHEREAS, effective November 13, 2004, the name of JPMorgan Chase Bank was changed to JPMorgan Chase Bank, N.A.; and WHEREAS the Indenture was executed and delivered for the purpose of securing such bonds as may from time to time be issued under and in accordance with the terms of the Indenture, the aggregate principal amount of bonds to be secured thereby being limited to $5,000,000,000 at any one time outstanding (except as provided in Section 2.01 of the Indenture), and the Indenture describes and sets forth the property conveyed thereby and is filed in the Office of the Secretary of State of the State of Michigan and is of record in the Office of the Register of Deeds of each county in the State of Michigan in which this Supplemental Indenture is to be recorded; and WHEREAS the Indenture has been supplemented and amended by various indentures supplemental thereto, each of which is filed in the Office of the Secretary of State of the State of Michigan and is of record in the Office of the Register of Deeds of each county in the State of Michigan in which this Supplemental Indenture is to be recorded; and WHEREAS the Company and the Maine corporation entered into an Agreement of Merger and Consolidation, dated as of February 14, 1968, which provided for the Maine corporation to merge into the Company; and WHEREAS the effective date of such Agreement of Merger and Consolidation was June 6, 1968, upon which date the Maine corporation was merged into the Company and the name of the Company was changed from "Consumers Power Company of Michigan" to "Consumers Power Company"; and WHEREAS the Company and the Predecessor Trustee entered into a Sixteenth Supplemental Indenture, dated as of June 4, 1968, which provided, among other things, for the assumption of the Indenture by the Company; and WHEREAS said Sixteenth Supplemental Indenture became effective on the effective date of such Agreement of Merger and Consolidation; and WHEREAS the Company has succeeded to and has been substituted for the Maine corporation under the Indenture with the same effect as if it had been named therein as the mortgagor corporation; and WHEREAS effective March 11, 1997, the name of Consumers Power Company was changed to Consumers Energy Company; and WHEREAS, the Company has entered into a Credit Agreement dated as of March 31, 2006 (as amended or otherwise modified from time to time, the "Credit Agreement") with various financial institutions and Barclays Bank PLC, as administrative agent (in such capacity, the "Agent") for the Banks (as defined in the Credit Agreement), providing for the making of certain financial accommodations thereunder, and pursuant to such Credit Agreement the Company has agreed to issue to the Agent, as evidence of and security for the Obligations (as defined in the Credit Agreement), a new series of bonds under the Indenture; and WHEREAS, for such purposes the Company desires to issue a new series of bonds, to be designated First Mortgage Bonds, [200[ ]-[ ]] Collateral Series (Interest Bearing), each of which A-2 bonds shall also bear the descriptive title "First Mortgage Bond" (hereinafter provided for and hereinafter sometimes referred to as the "[200[ ]-[ ]] Collateral Bonds"), the bonds of which series are to be issued as registered bonds without coupons and are to bear interest at the rate per annum specified herein and are to mature on the Revolving Termination Date (as defined in the Credit Agreement) or, if the Company exercises the Term Out Option (as defined in the Credit Agreement), the Final Maturity Date (as defined in the Credit Agreement); and WHEREAS, each of the registered bonds without coupons of the [200[ ]-[ ]] Collateral Bonds and the Trustee's Authentication Certificate thereon are to be substantially in the following form, to wit: A-3 [FORM OF REGISTERED BOND OF THE [200[ ]-[ ]] COLLATERAL BONDS] [FACE] CONSUMERS ENERGY COMPANY FIRST MORTGAGE BOND [200[ ]-[ ]] COLLATERAL SERIES (INTEREST BEARING) No. 1 $________________ CONSUMERS ENERGY COMPANY, a Michigan corporation (hereinafter called the "Company"), for value received, hereby promises to pay to Barclays Bank PLC, as administrative agent (in such capacity, the "Agent") for the Banks under and as defined in the Credit Agreement dated as of March 31, 2006 among the Company, the Banks and the Agent (as amended or otherwise modified from time to time, the "Credit Agreement"), or registered assigns, the principal sum of __________________ Million Dollars ($__________) or such lesser principal amount as shall be equal to the aggregate principal amount of the Loans (as defined in the Credit Agreement) included in the Obligations (as defined in the Credit Agreement) outstanding on the Revolving Termination Date (as defined in the Credit Agreement) or, if the Company exercises the Term Out Option (as defined in the Credit Agreement), the Final Maturity Date (as defined in the Credit Agreement) (the "Maturity Date"), but not in excess, however, of the principal amount of this bond, and to pay interest thereon at the Interest Rate (as defined below) until the principal hereof is paid or duly made available for payment on the Maturity Date, or, in the event of redemption of this bond, until the redemption date, or, in the event of default in the payment of the principal hereof, until the Company's obligations with respect to the payment of such principal shall be discharged as provided in the Indenture (as defined on the reverse hereof). Interest on this bond shall be payable on each Interest Payment Date (as defined below), commencing on the first Interest Payment Date next succeeding March 31, 2006. If the Maturity Date falls on a day which is not a Business Day, as defined below, principal and any interest and/or fees payable with respect to the Maturity Date will be paid on the immediately preceding Business Day. The interest payable, and punctually paid or duly provided for, on any Interest Payment Date will, subject to certain exceptions, be paid to the person in whose name this bond (or one or more predecessor bonds) is registered at the close of business on the Record Date (as defined below); provided, however, that interest payable on the Maturity Date will be payable to the person to whom the principal hereof shall be payable. Should the Company default in the payment of interest ("Defaulted Interest"), the Defaulted Interest shall be paid to the person in whose name this bond (or one or more predecessor bonds) is registered on a subsequent record date fixed by the Company, which subsequent record date shall be fifteen (15) days prior to the payment of such Defaulted Interest. As used herein, (A) "Business Day" shall mean any day, other than a Saturday or Sunday, on which banks generally are open in New York, New York for the conduct of substantially all of A-4 their commercial lending activities and on which interbank wire transfers can be made on the Fedwire system; (B) "Interest Payment Date" shall mean each date on which Obligations constituting interest and/or fees are due and payable from time to time pursuant to the Credit Agreement; (C) "Interest Rate" shall mean a rate of interest per annum, adjusted as necessary, to result in an interest payment equal to the aggregate amount of Obligations constituting interest and fees due under the Credit Agreement on the applicable Interest Payment Date; and (D) "Record Date" with respect to any Interest Payment Date shall mean the day (whether or not a Business Day) immediately next preceding such Interest Payment Date. Payment of the principal of and interest on this bond will be made in immediately available funds at the office or agency of the Company maintained for that purpose in the City of Jackson, Michigan, in such coin or currency of the United States of America as at the time of payment is legal tender for payment of public and private debts. The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not be valid or become obligatory for any purpose unless and until it shall have been authenticated by the execution by the Trustee or its successor in trust under the Indenture of the certificate hereon. A-5 IN WITNESS WHEREOF, Consumers Energy Company has caused this bond to be executed in its name by its Chairman of the Board, its President or one of its Vice Presidents by his or her signature or a facsimile thereof, and its corporate seal or a facsimile thereof to be affixed hereto or imprinted hereon and attested by its Secretary or one of its Assistant Secretaries by his or her signature or a facsimile thereof. CONSUMERS ENERGY COMPANY Dated: By ________________________________ Printed __________________________ Title _____________________________ Attest: ___________________ TRUSTEE'S AUTHENTICATION CERTIFICATE This is one of the bonds, of the series designated therein, described in the within-mentioned Indenture. JPMORGAN CHASE BANK, N.A., Trustee By __________________________________ Authorized Officer A-6 [REVERSE] CONSUMERS ENERGY COMPANY FIRST MORTGAGE BOND [200[ ]-[ ]] COLLATERAL SERIES (INTEREST BEARING) This bond is one of the bonds of a series designated as First Mortgage Bonds, [200[ ]-[ ]] Collateral Series (Interest Bearing) (sometimes herein referred to as the "[200[ ]-[ ]] Collateral Bonds") issued under and in accordance with and secured by an Indenture dated as of September 1, 1945, given by the Company (or its predecessor, Consumers Power Company, a Maine corporation) to City Bank Farmers Trust Company (JPMorgan Chase Bank, N.A., successor) (hereinafter sometimes referred to as the "Trustee"), together with indentures supplemental thereto, heretofore or hereafter executed, to which indenture and indentures supplemental thereto (hereinafter referred to collectively as the "Indenture") reference is hereby made for a description of the property mortgaged and pledged, the nature and extent of the security and the rights, duties and immunities thereunder of the Trustee and the rights of the holders of said bonds and of the Trustee and of the Company in respect of such security, and the limitations on such rights. By the terms of the Indenture, the bonds to be secured thereby are issuable in series which may vary as to date, amount, date of maturity, rate of interest and in other respects as provided in the Indenture. The [200[ ]-[ ]] Collateral Bonds are to be issued and delivered to the Agent in order to evidence and secure the obligation of the Company under the Credit Agreement to make payments to the Banks under the Credit Agreement and to provide the Banks the benefit of the lien of the Indenture with respect to the [200[ ]-[ ]] Collateral Bonds. The obligation of the Company to make payments with respect to the principal of [200[ ]-[ ]] Collateral Bonds shall be fully or partially, as the case may be, satisfied and discharged to the extent that, at the time that any such payment shall be due, the then due principal of the Loans included in the Obligations shall have been fully or partially paid. Satisfaction of any obligation to the extent that payment is made with respect to the Loans means that if any payment is made on the principal of the Loans, a corresponding payment obligation with respect to the principal of the [200[ ]-[ ]] Collateral Bonds shall be deemed discharged in the same amount as the payment with respect to the Loans discharges the outstanding obligation with respect to such Loans. No such payment of principal shall reduce the principal amount of the [200[ ]- [ ]] Collateral Bonds. The obligation of the Company to make payments with respect to the interest on [200[ ]-[ ]] Collateral Bonds shall be fully or partially, as the case may be, satisfied and discharged to the extent that, at the time that any such payment shall be due, the then due interest and/or fees under the Credit Agreement shall have been fully or partially paid. Satisfaction of any obligation to the extent that payment is made with respect to the interest and/or fees under the Credit Agreement means that if any payment is made on the interest and/or fees under the Credit Agreement, a corresponding payment obligation with respect to the interest on the [200[ ]-[ ]] Collateral Bonds shall be deemed discharged in the same amount as the payment with respect to the Loans discharges the outstanding obligation with respect to such Loans. A-7 The Trustee may at any time and all times conclusively assume that the obligation of the Company to make payments with respect to the principal of and interest on this bond, so far as such payments at the time have become due, has been fully satisfied and discharged unless and until the Trustee shall have received a written notice from the Agent stating (i) that timely payment of principal and interest on the [200[ ]-[ ]] Collateral Bonds has not been made, (ii) that the Company is in arrears as to the payments required to be made by it to the Agent in connection with the Obligations pursuant to the Credit Agreement, and (iii) the amount of the arrearage. If an Event of Default (as defined in the Credit Agreement) with respect to the payment of the principal of the Loans shall have occurred, it shall be deemed to be a default for purposes of Section 11.01 of the Indenture in the payment of the principal of the [200[ ]-[ ]] Collateral Bonds equal to the amount of such unpaid principal (but in no event in excess of the principal amount of the [200[ ]-[ ]] Collateral Bonds). If an Event of Default (as defined in the Credit Agreement) with respect to the payment of interest on the Loans or any fees shall have occurred, it shall be deemed to be a default for purposes of Section 11.01 of the Indenture in the payment of the interest on the [200[ ]- [ ]] Collateral Bonds equal to the amount of such unpaid interest or fees. This bond is not redeemable except upon written demand of the Agent following the occurrence of an Event of Default under the Credit Agreement and the acceleration of the Obligations, as provided in Section 9.2 of the Credit Agreement. This bond is not redeemable by the operation of the improvement fund or the maintenance and replacement provisions of the Indenture or with the proceeds of released property. In case of certain defaults as specified in the Indenture, the principal of this bond may be declared or may become due and payable on the conditions, at the time, in the manner and with the effect provided in the Indenture. The holders of certain specified percentages of the bonds at the time outstanding, including in certain cases specified percentages of bonds of particular series, may in certain cases, to the extent and as provided in the Indenture, waive certain defaults thereunder and the consequences of such defaults. The Indenture contains provisions permitting the Company and the Trustee, with the consent of the holders of not less than seventy-five per centum in principal amount of the bonds (exclusive of bonds disqualified by reason of the Company's interest therein) at the time outstanding, including, if more than one series of bonds shall be at the time outstanding, not less than sixty per centum in principal amount of each series affected, to effect, by an indenture supplemental to the Indenture, modifications or alterations of the Indenture and of the rights and obligations of the Company and the rights of the holders of the bonds and coupons; provided, however, that no such modification or alteration shall be made without the written approval or consent of the holder hereof which will (a) extend the maturity of this bond or reduce the rate or extend the time of payment of interest hereon or reduce the amount of the principal hereof, or (b) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of the Indenture, or (c) reduce the percentage of the principal amount of the bonds the holders of which are required to approve any such supplemental indenture. A-8 The Company reserves the right, without any consent, vote or other action by holders of the [200[ ]-[ ]] Collateral Bonds or any other series created after the Sixty-eighth Supplemental Indenture, to amend the Indenture to reduce the percentage of the principal amount of bonds the holders of which are required to approve any supplemental indenture (other than any supplemental indenture which is subject to the proviso contained in the immediately preceding sentence) (a) from not less than seventy-five per centum (including sixty per centum of each series affected) to not less than a majority in principal amount of the bonds at the time outstanding or (b) in case fewer than all series are affected, not less than a majority in principal amount of the bonds of all affected series, voting together. No recourse shall be had for the payment of the principal of or interest on this bond, or for any claim based hereon, or otherwise in respect hereof or of the Indenture, to or against any incorporator, stockholder, director or officer, past, present or future, as such, of the Company, or of any predecessor or successor company, either directly or through the Company, or such predecessor or successor company, or otherwise, under any constitution or statute or rule of law, or by the enforcement of any assessment or penalty, or otherwise, all such liability of incorporators, stockholders, directors and officers, as such, being waived and released by the holder and owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Indenture. This bond shall be exchangeable for other registered bonds of the same series, in the manner and upon the conditions prescribed in the Indenture, upon the surrender of such bonds at the Investor Services Department of the Company, as transfer agent. However, notwithstanding the provisions of Section 2.05 of the Indenture, no charge shall be made upon any registration of transfer or exchange of bonds of said series other than for any tax or taxes or other governmental charge required to be paid by the Company. The Agent shall surrender this bond to the Trustee when all of the principal of and interest on the Loans arising under the Credit Agreement, and all of the fees payable pursuant to the Credit Agreement with respect to the Obligations shall have been duly paid, and the Credit Agreement shall have been terminated. [END OF FORM OF REGISTERED BOND OF THE [200[ ]-[ ]] COLLATERAL BONDS] - - - - - - - - - - - A-9 AND WHEREAS all acts and things necessary to make the [200[ ]-[ ]] Collateral Bonds (the "Collateral Bonds"), when duly executed by the Company and authenticated by the Trustee or its agent and issued as prescribed in the Indenture, as heretofore supplemented and amended, and this Supplemental Indenture provided, the valid, binding and legal obligations of the Company, and to constitute the Indenture, as supplemented and amended as aforesaid, as well as by this Supplemental Indenture, a valid, binding and legal instrument for the security thereof, have been done and performed, and the creation, execution and delivery of this Supplemental Indenture and the creation, execution and issuance of bonds subject to the terms hereof and of the Indenture, as so supplemented and amended, have in all respects been duly authorized; NOW, THEREFORE, in consideration of the premises, of the acceptance and purchase by the holders thereof of the bonds issued and to be issued under the Indenture, as supplemented and amended as above set forth, and of the sum of One Dollar duly paid by the Trustee to the Company, and of other good and valuable considerations, the receipt whereof is hereby acknowledged, and for the purpose of securing the due and punctual payment of the principal of and premium, if any, and interest on all bonds now outstanding under the Indenture and the $__________ principal amount of the Collateral Bonds and all other bonds which shall be issued under the Indenture, as supplemented and amended from time to time, and for the purpose of securing the faithful performance and observance of all covenants and conditions therein, and in any indenture supplemental thereto, set forth, the Company has given, granted, bargained, sold, released, transferred, assigned, hypothecated, pledged, mortgaged, confirmed, set over, warranted, alienated and conveyed and by these presents does give, grant, bargain, sell, release, transfer, assign, hypothecate, pledge, mortgage, confirm, set over, warrant, alien and convey unto JPMorgan Chase Bank, N.A., as Trustee, as provided in the Indenture, and its successor or successors in the trust thereby and hereby created and to its or their assigns forever, all the right, title and interest of the Company in and to all the property, described in Section 11 hereof, together (subject to the provisions of Article X of the Indenture) with the tolls, rents, revenues, issues, earnings, income, products and profits thereof, excepting, however, the property, interests and rights specifically excepted from the lien of the Indenture as set forth in the Indenture. TOGETHER WITH all and singular the tenements, hereditaments and appurtenances belonging or in any wise appertaining to the premises, property, franchises and rights, or any thereof, referred to in the foregoing granting clause, with the reversion and reversions, remainder and remainders and (subject to the provisions of Article X of the Indenture) the tolls, rents, revenues, issues, earnings, income, products and profits thereof, and all the estate, right, title and interest and claim whatsoever, at law as well as in equity, which the Company now has or may hereafter acquire in and to the aforesaid premises, property, franchises and rights and every part and parcel thereof. SUBJECT, HOWEVER, with respect to such premises, property, franchises and rights, to excepted encumbrances as said term is defined in Section 1.02 of the Indenture, and subject also to all defects and limitations of title and to all encumbrances existing at the time of acquisition. TO HAVE AND TO HOLD all said premises, property, franchises and rights hereby conveyed, assigned, pledged or mortgaged, or intended so to be, unto the Trustee, its successor or successors in trust and their assigns forever; A-10 BUT IN TRUST, NEVERTHELESS, with power of sale for the equal and proportionate benefit and security of the holders of all bonds now or hereafter authenticated and delivered under and secured by the Indenture and interest coupons appurtenant thereto, pursuant to the provisions of the Indenture and of any supplemental indenture, and for the enforcement of the payment of said bonds and coupons when payable and the performance of and compliance with the covenants and conditions of the Indenture and of any supplemental indenture, without any preference, distinction or priority as to lien or otherwise of any bond or bonds over others by reason of the difference in time of the actual authentication, delivery, issue, sale or negotiation thereof or for any other reason whatsoever, except as otherwise expressly provided in the Indenture; and so that each and every bond now or hereafter authenticated and delivered thereunder shall have the same lien, and so that the principal of and premium, if any, and interest on every such bond shall, subject to the terms thereof, be equally and proportionately secured, as if it had been made, executed, authenticated, delivered, sold and negotiated simultaneously with the execution and delivery thereof. AND IT IS EXPRESSLY DECLARED by the Company that all bonds authenticated and delivered under and secured by the Indenture, as supplemented and amended as above set forth, are to be issued, authenticated and delivered, and all said premises, property, franchises and rights hereby and by the Indenture and indentures supplemental thereto conveyed, assigned, pledged or mortgaged, or intended so to be, are to be dealt with and disposed of under, upon and subject to the terms, conditions, stipulations, covenants, agreements, trusts, uses and purposes expressed in the Indenture, as supplemented and amended as above set forth, and the parties hereto mutually agree as follows: SECTION 1. There is hereby created a series of bonds (the "[200[ ]-[ ]] Collateral Bonds") designated as hereinabove provided, which shall also bear the descriptive title "First Mortgage Bond", and the forms thereof shall be substantially as hereinbefore set forth (collectively, the "Sample Bond"). The [200[ ]-[ ]] Collateral Bonds shall be issued in the aggregate principal amount of $__________, shall mature on the Revolving Termination Date (as defined in the Credit Agreement) or, if the Company exercises the Term Out Option (as defined in the Credit Agreement), the Final Maturity Date (as defined in the Credit Agreement) and shall be issued only as registered bonds without coupons in denominations of $1,000 and any multiple thereof. The serial numbers of the Collateral Bonds shall be such as may be approved by any officer of the Company, the execution thereof by any such officer either manually or by facsimile signature to be conclusive evidence of such approval. The Collateral Bonds are to be issued to and registered in the name of the Agent under the Credit Agreement (as defined in the Sample Bonds) to evidence and secure any and all Obligations (as defined in the Credit Agreement) of the Company under the Credit Agreement. The [200[ ]-[ ]] Collateral Bonds shall bear interest as set forth in the Sample Bond. The principal of and the interest on said bonds shall be payable as set forth in the Sample Bond. The obligation of the Company to make payments with respect to the principal of [200[ ]-[ ]] Collateral Bonds shall be fully or partially, as the case may be, satisfied and discharged to the extent that, at the time that any such payment shall be due, the then due principal of the Loans included in the Obligations shall have been fully or partially paid. Satisfaction of any A-11 obligation to the extent that payment is made with respect to the Loans means that if any payment is made on the principal of the Loans, a corresponding payment obligation with respect to the principal of the [200[ ]-[ ]] Collateral Bonds shall be deemed discharged in the same amount as the payment with respect to the Loans discharges the outstanding obligation with respect to such Loans. No such payment of principal shall reduce the principal amount of the [200[ ]- [ ]] Collateral Bonds. The obligation of the Company to make payments with respect to interest on [200[ ]-[ ]] Collateral Bonds shall be fully or partially, as the case may be, satisfied and discharged to the extent that, at the time that any such payment shall be due, the then due interest and/or fees under the Credit Agreement shall have been fully or partially paid. Satisfaction of any obligation to the extent that payment is made with respect to the interest and/or fees under the Credit Agreement means that if any payment is made on the interest and/or fees under the Credit Agreement, a corresponding payment obligation with respect to the interest on the [200[ ]-[ ]] Collateral Bonds shall be deemed discharged in the same amount as the payment with respect to the interest and/or fees discharges the outstanding obligation with respect to such interest and/or fees. The Trustee may at any time and all times conclusively assume that the obligation of the Company to make payments with respect to the principal of and interest on the Collateral Bonds, so far as such payments at the time have become due, has been fully satisfied and discharged unless and until the Trustee shall have received a written notice from the Agent stating (i) that timely payment of principal and interest on the [200[ ]-[ ]] Collateral Bonds has not been made, (ii) that the Company is in arrears as to the payments required to be made by it to the Agent pursuant to the Credit Agreement, and (iii) the amount of the arrearage. The Collateral Bonds shall be exchangeable for other registered bonds of the same series, in the manner and upon the conditions prescribed in the Indenture, upon the surrender of such bonds at the Investor Services Department of the Company, as transfer agent. However, notwithstanding the provisions of Section 2.05 of the Indenture, no charge shall be made upon any registration of transfer or exchange of bonds of said series other than for any tax or taxes or other governmental charge required to be paid by the Company. SECTION 2. The Collateral Bonds are not redeemable by the operation of the maintenance and replacement provisions of this Indenture or with the proceeds of released property. SECTION 3. Upon the occurrence of an Event of Default under the Credit Agreement and the acceleration of the Obligations, the Collateral Bonds shall be redeemable in whole upon receipt by the Trustee of a written demand from the Agent stating that there has occurred under the Credit Agreement both an Event of Default and a declaration of acceleration of the Obligations and demanding redemption of the Collateral Bonds (including a description of the amount of principal, interest and fees which comprise such Obligations). The Company waives any right it may have to prior notice of such redemption under the Indenture. Upon surrender of the Collateral Bonds by the Agent to the Trustee, the Collateral Bonds shall be redeemed at a redemption price equal to the aggregate amount of the Obligations. A-12 SECTION 4. The Company reserves the right, without any consent, vote or other action by the holder of the Collateral Bonds or of any subsequent series of bonds issued under the Indenture, to make such amendments to the Indenture, as supplemented, as shall be necessary in order to amend Section 17.02 to read as follows: SECTION 17.02. With the consent of the holders of not less than a majority in principal amount of the bonds at the time outstanding or their attorneys-in-fact duly authorized, or, if fewer than all series are affected, not less than a majority in principal amount of the bonds at the time outstanding of each series the rights of the holders of which are affected, voting together, the Company, when authorized by a resolution, and the Trustee may from time to time and at any time enter into an indenture or indentures supplemental hereto for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Indenture or of any supplemental indenture or modifying the rights and obligations of the Company and the rights of the holders of any of the bonds and coupons; provided, however, that no such supplemental indenture shall (1) extend the maturity of any of the bonds or reduce the rate or extend the time of payment of interest thereon, or reduce the amount of the principal thereof, or reduce any premium payable on the redemption thereof, without the consent of the holder of each bond so affected, or (2) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of this Indenture, without the consent of the holders of all the bonds then outstanding, or (3) reduce the aforesaid percentage of the principal amount of bonds the holders of which are required to approve any such supplemental indenture, without the consent of the holders of all the bonds then outstanding. For the purposes of this Section, bonds shall be deemed to be affected by a supplemental indenture if such supplemental indenture adversely affects or diminishes the rights of holders thereof against the Company or against its property. The Trustee may in its discretion determine whether or not, in accordance with the foregoing, bonds of any particular series would be affected by any supplemental indenture and any such determination shall be conclusive upon the holders of bonds of such series and all other series. Subject to the provisions of Sections 16.02 and 16.03 hereof, the Trustee shall not be liable for any determination made in good faith in connection herewith. Upon the written request of the Company, accompanied by a resolution authorizing the execution of any such supplemental indenture, and upon the filing with the Trustee of evidence of the consent of bondholders as aforesaid (the instrument or instruments evidencing such consent to be dated within one year of such request), the Trustee shall join with the Company in the execution of such supplemental indenture unless such supplemental indenture affects the Trustee's own rights, duties or immunities under this Indenture or otherwise, in which case the Trustee A-13 may in its discretion but shall not be obligated to enter into such supplemental indenture. It shall not be necessary for the consent of the bondholders under this Section to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such consent shall approve the substance thereof. The Company and the Trustee, if they so elect, and either before or after such consent has been obtained, may require the holder of any bond consenting to the execution of any such supplemental indenture to submit his bond to the Trustee or to ask such bank, banker or trust company as may be designated by the Trustee for the purpose, for the notation thereon of the fact that the holder of such bond has consented to the execution of such supplemental indenture, and in such case such notation, in form satisfactory to the Trustee, shall be made upon all bonds so submitted, and such bonds bearing such notation shall forthwith be returned to the persons entitled thereto. Prior to the execution by the Company and the Trustee of any supplemental indenture pursuant to the provisions of this Section, the Company shall publish a notice, setting forth in general terms the substance of such supplemental indenture, at least once in one daily newspaper of general circulation in each city in which the principal of any of the bonds shall be payable, or, if all bonds outstanding shall be registered bonds without coupons or coupon bonds registered as to principal, such notice shall be sufficiently given if mailed, first class, postage prepaid, and registered if the Company so elects, to each registered holder of bonds at the last address of such holder appearing on the registry books, such publication or mailing, as the case may be, to be made not less than thirty days prior to such execution. Any failure of the Company to give such notice, or any defect therein, shall not, however, in any way impair or affect the validity of any such supplemental indenture. SECTION 5. As supplemented and amended as above set forth, the Indenture is in all respects ratified and confirmed, and the Indenture and all indentures supplemental thereto shall be read, taken and construed as one and the same instrument. SECTION 6. Nothing contained in this Supplemental Indenture shall, or shall be construed to, confer upon any person other than a holder of bonds issued under the Indenture, as supplemented and amended as above set forth, the Company, the Trustee and the Agent, for the benefit of the Banks (as defined in the Credit Agreement), any right or interest to avail himself of any benefit under any provision of the Indenture, as so supplemented and amended. SECTION 7. The Trustee assumes no responsibility for or in respect of the validity or sufficiency of this Supplemental Indenture or of the Indenture as hereby supplemented or the due A-14 execution hereof by the Company or for or in respect of the recitals and statements contained herein (other than those contained in the sixth, seventh and eighth recitals hereof), all of which recitals and statements are made solely by the Company. SECTION 8. This Supplemental Indenture may be simultaneously executed in several counterparts and all such counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. SECTION 9. In the event the date of any notice required or permitted hereunder shall not be a Business Day, then (notwithstanding any other provision of the Indenture or of any supplemental indenture thereto) such notice need not be made on such date, but may be made on the next succeeding Business Day with the same force and effect as if made on the date fixed for such notice. "Business Day" means, with respect to this Section 9, any day, other than a Saturday or Sunday, on which banks generally are open in New York, New York for the conduct of substantially all of their commercial lending activities and on which interbank wire transfers can be made on the Fedwire system. SECTION 10. This Supplemental Indenture and the Collateral Bonds shall be governed by and deemed to be a contract under, and construed in accordance with, the laws of the State of Michigan, and for all purposes shall be construed in accordance with the laws of such state, except as may otherwise be required by mandatory provisions of law. SECTION 11. Detailed Description of Property Mortgaged: I. ELECTRIC GENERATING PLANTS AND DAMS All the electric generating plants and stations of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, including all powerhouses, buildings, reservoirs, dams, pipelines, flumes, structures and works and the land on which the same are situated and all water rights and all other lands and easements, rights of way, permits, privileges, towers, poles, wires, machinery, equipment, appliances, appurtenances and supplies and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such plants and stations or any of them, or adjacent thereto. II. ELECTRIC TRANSMISSION LINES All the electric transmission lines of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, including towers, poles, pole lines, wires, switches, switch racks, switchboards, insulators and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such transmission lines or any of them or adjacent thereto; together with all real A-15 property, rights of way, easements, permits, privileges, franchises and rights for or relating to the construction, maintenance or operation thereof, through, over, under or upon any private property or any public streets or highways, within as well as without the corporate limits of any municipal corporation. Also all the real property, rights of way, easements, permits, privileges and rights for or relating to the construction, maintenance or operation of certain transmission lines, the land and rights for which are owned by the Company, which are either not built or now being constructed. III. ELECTRIC DISTRIBUTION SYSTEMS All the electric distribution systems of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, including substations, transformers, switchboards, towers, poles, wires, insulators, subways, trenches, conduits, manholes, cables, meters and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such distribution systems or any of them or adjacent thereto; together with all real property, rights of way, easements, permits, privileges, franchises, grants and rights, for or relating to the construction, maintenance or operation thereof, through, over, under or upon any private property or any public streets or highways within as well as without the corporate limits of any municipal corporation. IV. ELECTRIC SUBSTATIONS, SWITCHING STATIONS AND SITES All the substations, switching stations and sites of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, for transforming, regulating, converting or distributing or otherwise controlling electric current at any of its plants and elsewhere, together with all buildings, transformers, wires, insulators and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with any of such substations and switching stations, or adjacent thereto, with sites to be used for such purposes. V. GAS COMPRESSOR STATIONS, GAS PROCESSING PLANTS, DESULPHURIZATION STATIONS, METERING STATIONS, ODORIZING STATIONS, REGULATORS AND SITES All the compressor stations, processing plants, desulphurization stations, metering stations, odorizing stations, regulators and sites of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, for compressing, processing, desulphurizing, metering, odorizing and regulating manufactured or natural gas at any of its plants and A-16 elsewhere, together with all buildings, meters and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with any of such purposes, with sites to be used for such purposes. VI. GAS STORAGE FIELDS The natural gas rights and interests of the Company, including wells and well lines (but not including natural gas, oil and minerals), the gas gathering system, the underground gas storage rights, the underground gas storage wells and injection and withdrawal system used in connection therewith, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture: In the Overisel Gas Storage Field, located in the Township of Overisel, Allegan County, and in the Township of Zeeland, Ottawa County, Michigan; in the Northville Gas Storage Field located in the Township of Salem, Washtenaw County, Township of Lyon, Oakland County, and the Townships of Northville and Plymouth and City of Plymouth, Wayne County, Michigan; in the Salem Gas Storage Field, located in the Township of Salem, Allegan County, and in the Township of Jamestown, Ottawa County, Michigan; in the Ray Gas Storage Field, located in the Townships of Ray and Armada, Macomb County, Michigan; in the Lenox Gas Storage Field, located in the Townships of Lenox and Chesterfield, Macomb County, Michigan; in the Ira Gas Storage Field, located in the Township of Ira, St. Clair County, Michigan; in the Puttygut Gas Storage Field, located in the Township of Casco, St. Clair County, Michigan; in the Four Corners Gas Storage Field, located in the Townships of Casco, China, Cottrellville and Ira, St. Clair County, Michigan; in the Swan Creek Gas Storage Field, located in the Township of Casco and Ira, St. Clair County, Michigan; and in the Hessen Gas Storage Field, located in the Townships of Casco and Columbus, St. Clair, Michigan. VII. GAS TRANSMISSION LINES All the gas transmission lines of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, including gas mains, pipes, pipelines, gates, valves, meters and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such transmission lines or any of them or adjacent thereto; together with all real property, right of way, easements, permits, privileges, franchises and rights for or relating to the construction, maintenance or operation thereof, through, over, under or upon any private property or any public streets or highways, within as well as without the corporate limits of any municipal corporation. A-17 VIII. GAS DISTRIBUTION SYSTEMS All the gas distribution systems of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, including tunnels, conduits, gas mains and pipes, service pipes, fittings, gates, valves, connections, meters and other appliances and equipment, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such distribution systems or any of them or adjacent thereto; together with all real property, rights of way, easements, permits, privileges, franchises, grants and rights, for or relating to the construction, maintenance or operation thereof, through, over, under or upon any private property or any public streets or highways within as well as without the corporate limits of any municipal corporation. IX. OFFICE BUILDINGS, SERVICE BUILDINGS, GARAGES, ETC. All office, garage, service and other buildings of the Company, wherever located, in the State of Michigan, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, together with the land on which the same are situated and all easements, rights of way and appurtenances to said lands, together with all furniture and fixtures located in said buildings. X. TELEPHONE PROPERTIES AND RADIO COMMUNICATION EQUIPMENT All telephone lines, switchboards, systems and equipment of the Company, constructed or otherwise acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture, used or available for use in the operation of its properties, and all other property, real or personal, forming a part of or appertaining to or used, occupied or enjoyed in connection with such telephone properties or any of them or adjacent thereto; together with all real estate, rights of way, easements, permits, privileges, franchises, property, devices or rights related to the dispatch, transmission, reception or reproduction of messages, communications, intelligence, signals, light, vision or sound by electricity, wire or otherwise, including all telephone equipment installed in buildings used as general and regional offices, substations and generating stations and all telephone lines erected on towers and poles; and all radio communication equipment of the Company, together with all property, real or personal (except any in the Indenture expressly excepted), fixed stations, towers, auxiliary radio buildings and equipment, and all appurtenances used in connection therewith, wherever located, in the State of Michigan. XI. A-18 OTHER REAL PROPERTY All other real property of the Company and all interests therein, of every nature and description (except any in the Indenture expressly excepted) wherever located, in the State of Michigan, acquired by it and not heretofore described in the Indenture or any supplement thereto and not heretofore released from the lien of the Indenture. Such real property includes but is not limited to the following described property, such property is subject to any interests that were excepted or reserved in the conveyance to the Company: ALCONA COUNTY Certain land in Caledonia Township, Alcona County, Michigan described as: The East 330 feet of the South 660 feet of the SW 1/4 of the SW 1/4 of Section 8, T28N, R8E, except the West 264 feet of the South 330 feet thereof; said land being more particularly described as follows: To find the place of beginning of this description, commence at the Southwest corner of said section, run thence East along the South line of said section 1243 feet to the place of beginning of this description, thence continuing East along said South line of said section 66 feet to the West 1/8 line of said section, thence N 02 degrees 09' 30" E along the said West 1/8 line of said section 660 feet, thence West 330 feet, thence S 02 degrees 09' 30" W, 330 feet, thence East 264 feet, thence S 02 degrees 09' 30" W, 330 feet to the place of beginning. ALLEGAN COUNTY Certain land in Lee Township, Allegan County, Michigan described as: The NE 1/4 of the NW 1/4 of Section 16, T1N, R15W. ALPENA COUNTY Certain land in Wilson and Green Townships, Alpena County, Michigan described as: All that part of the S'ly 1/2 of the former Boyne City-Gaylord and Alpena Railroad right of way, being the Southerly 50 feet of a 100 foot strip of land formerly occupied by said Railroad, running from the East line of Section 31, T31N, R7E, Southwesterly across said Section 31 and Sections 5 and 6 of T30N, R7E and Sections 10, 11 and the E 1/2 of Section 9, except the West 1646 feet thereof, all in T30N, R6E. ANTRIM COUNTY Certain land in Mancelona Township, Antrim County, Michigan described as: A-19 The S 1/2 of the NE 1/4 of Section 33, T29N, R6W, excepting therefrom all mineral, coal, oil and gas and such other rights as were reserved unto the State of Michigan in that certain deed running from the State of Michigan to August W. Schack and Emma H. Schack, his wife, dated April 15, 1946 and recorded May 20, 1946 in Liber 97 of Deeds on page 682 of Antrim County Records. ARENAC COUNTY Certain land in Standish Township, Arenac County, Michigan described as: A parcel of land in the SW 1/4 of the NW 1/4 of Section 12, T18N, R4E, described as follows: To find the place of beginning of said parcel of land, commence at the Northwest corner of Section 12, T18N, R4E; run thence South along the West line of said section, said West line of said section being also the center line of East City Limits Road 2642.15 feet to the W 1/4 post of said section and the place of beginning of said parcel of land; running thence N 88 degrees 26' 00" E along the East and West 1/4 line of said section, 660.0 feet; thence North parallel with the West line of said section, 310.0 feet; thence S 88 degrees 26' 00" W, 330.0 feet; thence South parallel with the West line of said section, 260.0 feet; thence S 88 degrees 26' 00" W, 330.0 feet to the West line of said section and the center line of East City Limits Road; thence South along the said West line of said section, 50.0 feet to the place of beginning. BARRY COUNTY Certain land in Johnstown Township, Barry County, Michigan described as: A strip of land 311 feet in width across the SW 1/4 of the NE 1/4 of Section 31, T1N, R8W, described as follows: To find the place of beginning of this description, commence at the E -1/4 post of said section; run thence N 00 degrees 55' 00" E along the East line of said section, 555.84 feet; thence N 59 degrees 36' 20" W, 1375.64 feet; thence N 88 degrees 30' 00" W, 130 feet to a point on the East 1/8 line of said section and the place of beginning of this description; thence continuing N 88 degrees 30' 00" W, 1327.46 feet to the North and South 1/4 line of said section; thence S 00 degrees 39'35" W along said North and South 1/4 line of said section, 311.03 feet to a point, which said point is 952.72 feet distant N'ly from the East and West 1/4 line of said section as measured along said North and South 1/4 line of said section; thence S 88 degrees 30' 00" E, 1326.76 feet to the East 1/8 line of said section; thence N 00 degrees 47' 20" E along said East 1/8 line of said section, 311.02 feet to the place of beginning. A-20 BAY COUNTY Certain land in Frankenlust Township, Bay County, Michigan described as: The South 250 feet of the N 1/2 of the W 1/2 of the W 1/2 of the SE 1/4 of Section 9, T13N, R4E. BENZIE COUNTY Certain land in Benzonia Township, Benzie County, Michigan described as: A parcel of land in the Northeast 1/4 of Section 7, Township 26 North, Range 14 West, described as beginning at a point on the East line of said Section 7, said point being 320 feet North measured along the East line of said section from the East 1/4 post; running thence West 165 feet; thence North parallel with the East line of said section 165 feet; thence East 165 feet to the East line of said section; thence South 165 feet to the place of beginning. BRANCH COUNTY Certain land in Girard Township, Branch County, Michigan described as: A parcel of land in the NE 1/4 of Section 23 T5S, R6W, described as beginning at a point on the North and South quarter line of said section at a point 1278.27 feet distant South of the North quarter post of said section, said distance being measured along the North and South quarter line of said section, running thence S89 degrees21'E 250 feet, thence North along a line parallel with the said North and South quarter line of said section 200 feet, thence N89 degrees21'W 250 feet to the North and South quarter line of said section, thence South along said North and South quarter line of said section 200 feet to the place of beginning. CALHOUN COUNTY Certain land in Convis Township, Calhoun County, Michigan described as: A parcel of land in the SE 1/4 of the SE 1/4 of Section 32, T1S, R6W, described as follows: To find the place of beginning of this description, commence at the Southeast corner of said section; run thence North along the East line of said section 1034.32 feet to the place of beginning of this description; running thence N 89 degrees 39' 52" W, 333.0 feet; thence North 290.0 feet to the South 1/8 line of said section; thence S 89 degrees 39' 52" E along said South 1/8 line of said section 333.0 feet to the East line of said section; thence South along said East line of said section 290.0 feet to the place of beginning. (Bearings are A-21 based on the East line of Section 32, T1S, R6W, from the Southeast corner of said section to the Northeast corner of said section assumed as North.) CASS COUNTY Certain easement rights located across land in Marcellus Township, Cass County, Michigan described as: The East 6 rods of the SW 1/4 of the SE 1/4 of Section 4, T5S, R13W. CHARLEVOIX COUNTY Certain land in South Arm Township, Charlevoix County, Michigan described as: A parcel of land in the SW 1/4 of Section 29, T32N, R7W, described as follows: Beginning at the Southwest corner of said section and running thence North along the West line of said section 788.25 feet to a point which is 528 feet distant South of the South 1/8 line of said section as measured along the said West line of said section; thence N 89 degrees 30' 19" E, parallel with said South 1/8 line of said section 442.1 feet; thence South 788.15 feet to the South line of said section; thence S 89 degrees 29' 30" W, along said South line of said section 442.1 feet to the place of beginning. CHEBOYGAN COUNTY Certain land in Inverness Township, Cheboygan County, Michigan described as: A parcel of land in the SW frl 1/4 of Section 31, T37N, R2W, described as beginning at the Northwest corner of the SW frl 1/4, running thence East on the East and West quarter line of said Section, 40 rods, thence South parallel to the West line of said Section 40 rods, thence West 40 rods to the West line of said Section, thence North 40 rods to the place of beginning. CLARE COUNTY Certain land in Frost Township, Clare County, Michigan described as: The East 150 feet of the North 225 feet of the NW 1/4 of the NW 1/4 of Section 15, T20N, R4W. CLINTON COUNTY Certain land in Watertown Township, Clinton County, Michigan described as: A-22 The NE 1/4 of the NE 1/4 of the SE 1/4 of Section 22, and the North 165 feet of the NW 1/4 of the NE 1/4 of the SE 1/4 of Section 22, T5N, R3W. CRAWFORD COUNTY Certain land in Lovells Township, Crawford County, Michigan described as: A parcel of land in Section 1, T28N, R1W, described as: Commencing at NW corner said section; thence South 89 degrees53'30" East along North section line 105.78 feet to point of beginning; thence South 89 degrees53'30" East along North section line 649.64 feet; thence South 55 degrees 42'30" East 340.24 feet; thence South 55 degrees 44' 37"" East 5,061.81 feet to the East section line; thence South 00 degrees 00' 08"" West along East section line 441.59 feet; thence North 55 degrees 44' 37" West 5,310.48 feet; thence North 55 degrees 42'30" West 877.76 feet to point of beginning. EATON COUNTY Certain land in Eaton Township, Eaton County, Michigan described as: A parcel of land in the SW 1/4 of Section 6, T2N, R4W, described as follows: To find the place of beginning of this description commence at the Southwest corner of said section; run thence N 89 degrees 51' 30" E along the South line of said section 400 feet to the place of beginning of this description; thence continuing N 89 degrees 51' 30" E, 500 feet; thence N 00 degrees 50' 00" W, 600 feet; thence S 89 degrees 51' 30" W parallel with the South line of said section 500 feet; thence S 00 degrees 50' 00" E, 600 feet to the place of beginning. EMMET COUNTY Certain land in Wawatam Township, Emmet County, Michigan described as: The West 1/2 of the Northeast 1/4 of the Northeast 1/4 of Section 23, T39N, R4W. GENESEE COUNTY Certain land in Argentine Township, Genesee County, Michigan described as: A parcel of land of part of the SW 1/4 of Section 8, T5N, R5E, being more particularly described as follows: Beginning at a point of the West line of Duffield Road, 100 feet wide, (as now established) distant 829.46 feet measured N01 A-23 degrees42'56"W and 50 feet measured S88 degrees14'04"W from the South quarter corner, Section 8, T5N, R5E; thence S88 degrees14'04"W a distance of 550 feet; thence N01 degrees42'56"W a distance of 500 feet to a point on the North line of the South half of the Southwest quarter of said Section 8; thence N88 degrees14'04"E along the North line of South half of the Southwest quarter of said Section 8 a distance 550 feet to a point on the West line of Duffield Road, 100 feet wide (as now established); thence S01 degrees42'56"E along the West line of said Duffield Road a distance of 500 feet to the point of beginning. GLADWIN COUNTY Certain land in Secord Township, Gladwin County, Michigan described as: The East 400 feet of the South 450 feet of Section 2, T19N, R1E. GRAND TRAVERSE COUNTY Certain land in Mayfield Township, Grand Traverse County, Michigan described as: A parcel of land in the Northwest 1/4 of Section 3, T25N, R11W, described as follows: Commencing at the Northwest corner of said section, running thence S 89 degrees19'15" E along the North line of said section and the center line of Clouss Road 225 feet, thence South 400 feet, thence N 89 degrees19'15" W 225 feet to the West line of said section and the center line of Hannah Road, thence North along the West line of said section and the center line of Hannah Road 400 feet to the place of beginning for this description. GRATIOT COUNTY Certain land in Fulton Township, Gratiot County, Michigan described as: A parcel of land in the NE 1/4 of Section 7, Township 9 North, Range 3 West, described as beginning at a point on the North line of George Street in the Village of Middleton, which is 542 feet East of the North and South one-quarter (1/4) line of said Section 7; thence North 100 feet; thence East 100 feet; thence South 100 feet to the North line of George Street; thence West along the North line of George Street 100 feet to place of beginning. HILLSDALE COUNTY Certain land in Litchfield Village, Hillsdale County, Michigan described as: Lot 238 of Assessors Plat of the Village of Litchfield. A-24 HURON COUNTY Certain easement rights located across land in Sebewaing Township, Huron County, Michigan described as: The North 1/2 of the Northwest 1/4 of Section 15, T15N, R9E. INGHAM COUNTY Certain land in Vevay Township, Ingham County, Michigan described as: A parcel of land 660 feet wide in the Southwest 1/4 of Section 7 lying South of the centerline of Sitts Road as extended to the North-South 1/4 line of said Section 7, T2N, R1W, more particularly described as follows: Commence at the Southwest corner of said Section 7, thence North along the West line of said Section 2502.71 feet to the centerline of Sitts Road; thence South 89 degrees54'45" East along said centerline 2282.38 feet to the place of beginning of this description; thence continuing South 89 degrees54'45" East along said centerline and said centerline extended 660.00 feet to the North-South 1/4 line of said section; thence South 00 degrees07'20" West 1461.71 feet; thence North 89 degrees34'58" West 660.00 feet; thence North 00 degrees07'20" East 1457.91 feet to the centerline of Sitts Road and the place of beginning. IONIA COUNTY Certain land in Sebewa Township, Ionia County, Michigan described as: A strip of land 280 feet wide across that part of the SW 1/4 of the NE 1/4 of Section 15, T5N, R6W, described as follows: To find the place of beginning of this description commence at the E 1/4 corner of said section; run thence N 00 degrees 05' 38" W along the East line of said section, 1218.43 feet; thence S 67 degrees 18' 24" W, 1424.45 feet to the East 1/8 line of said section and the place of beginning of this description; thence continuing S 67 degrees 18' 24" W, 1426.28 feet to the North and South 1/4 line of said section at a point which said point is 105.82 feet distant N'ly of the center of said section as measured along said North and South 1/4 line of said section; thence N 00 degrees 04' 47" E along said North and South 1/4 line of said section, 303.67 feet; thence N 67 degrees 18' 24" E, 1425.78 feet to the East 1/8 line of said section; thence S 00 degrees 00' 26" E along said East 1/8 line of said section, 303.48 feet to the place of beginning. (Bearings are based on the East line of Section 15, T5N, R6W, from the E 1/4 corner of said section to the Northeast corner of said section assumed as N 00 degrees 05' 38" W.) A-25 IOSCO COUNTY Certain land in Alabaster Township, Iosco County, Michigan described as: A parcel of land in the NW 1/4 of Section 34, T21N, R7E, described as follows: To find the place of beginning of this description commence at the N 1/4 post of said section; run thence South along the North and South 1/4 line of said section, 1354.40 feet to the place of beginning of this description; thence continuing South along the said North and South 1/4 line of said section, 165.00 feet to a point on the said North and South 1/4 line of said section which said point is 1089.00 feet distant North of the center of said section; thence West 440.00 feet; thence North 165.00 feet; thence East 440.00 feet to the said North and South 1/4 line of said section and the place of beginning. ISABELLA COUNTY Certain land in Chippewa Township, Isabella County, Michigan described as: The North 8 rods of the NE 1/4 of the SE 1/4 of Section 29, T14N, R3W. JACKSON COUNTY Certain land in Waterloo Township, Jackson County, Michigan described as: A parcel of land in the North fractional part of the N fractional 1/2 of Section 2, T1S, R2E, described as follows: To find the place of beginning of this description commence at the E 1/4 post of said section; run thence N 01 degrees 03' 40" E along the East line of said section 1335.45 feet to the North 1/8 line of said section and the place of beginning of this description; thence N 89 degrees 32' 00" W, 2677.7 feet to the North and South 1/4 line of said section; thence S 00 degrees 59' 25" W along the North and South 1/4 line of said section 22.38 feet to the North 1/8 line of said section; thence S 89 degrees 59' 10" W along the North 1/8 line of said section 2339.4 feet to the center line of State Trunkline Highway M-52; thence N 53 degrees 46' 00" W along the center line of said State Trunkline Highway 414.22 feet to the West line of said section; thence N 00 degrees 55' 10" E along the West line of said section 74.35 feet; thence S 89 degrees 32' 00" E, 5356.02 feet to the East line of said section; thence S 01 degrees 03' 40" W along the East line of said section 250 feet to the place of beginning. A-26 KALAMAZOO COUNTY Certain land in Alamo Township, Kalamazoo County, Michigan described as: The South 350 feet of the NW 1/4 of the NW 1/4 of Section 16, T1S, R12W, being more particularly described as follows: To find the place of beginning of this description, commence at the Northwest corner of said section; run thence S 00 degrees 36' 55" W along the West line of said section 971.02 feet to the place of beginning of this description; thence continuing S 00 degrees 36' 55" W along said West line of said section 350.18 feet to the North 1/8 line of said section; thence S 87 degrees 33' 40" E along the said North 1/8 line of said section 1325.1 feet to the West 1/8 line of said section; thence N 00 degrees 38' 25" E along the said West 1/8 line of said section 350.17 feet; thence N 87 degrees 33' 40" W, 1325.25 feet to the place of beginning. KALKASKA COUNTY Certain land in Kalkaska Township, Kalkaska County, Michigan described as: The NW 1/4 of the SW 1/4 of Section 4, T27N, R7W, excepting therefrom all mineral, coal, oil and gas and such other rights as were reserved unto the State of Michigan in that certain deed running from the Department of Conservation for the State of Michigan to George Welker and Mary Welker, his wife, dated October 9, 1934 and recorded December 28, 1934 in Liber 39 on page 291 of Kalkaska County Records, and subject to easement for pipeline purposes as granted to Michigan Consolidated Gas Company by first party herein on April 4, 1963 and recorded June 21, 1963 in Liber 91 on page 631 of Kalkaska County Records. KENT COUNTY Certain land in Caledonia Township, Kent County, Michigan described as: A parcel of land in the Northwest fractional 1/4 of Section 15, T5N, R10W, described as follows: To find the place of beginning of this description commence at the North 1/4 corner of said section, run thence S 0 degrees 59' 26" E along the North and South 1/4 line of said section 2046.25 feet to the place of beginning of this description, thence continuing S 0 degrees 59' 26" E along said North and South 1/4 line of said section 332.88 feet, thence S 88 degrees 58' 30" W 2510.90 feet to a point herein designated "Point A" on the East bank of the Thornapple River, thence continuing S 88 degrees 53' 30" W to the center thread of the Thornapple River, thence NW'ly along the center thread of said Thornapple River to a point which said point is S 88 degrees 58' 30" W of a point on the East bank of the Thornapple River herein designated "Point A-27 B", said "Point B" being N 23 degrees 41' 35" W 360.75 feet from said above-described "Point A", thence N 88 degrees 58' 30" E to said "Point B", thence continuing N 88 degrees 58' 30" E 2650.13 feet to the place of beginning. (Bearings are based on the East line of Section 15, T5N, R10W between the East 1/4 corner of said section and the Northeast corner of said section assumed as N 0 degrees 59' 55" W.) LAKE COUNTY Certain land in Pinora and Cherry Valley Townships, Lake County, Michigan described as: A strip of land 50 feet wide East and West along and adjoining the West line of highway on the East side of the North 1/2 of Section 13 T18N, R12W. Also a strip of land 100 feet wide East and West along and adjoining the East line of the highway on the West side of following described land: The South 1/2 of NW 1/4, and the South 1/2 of the NW 1/4 of the SW 1/4, all in Section 6, T18N, R11W. LAPEER COUNTY Certain land in Hadley Township, Lapeer County, Michigan described as: The South 825 feet of the W 1/2 of the SW 1/4 of Section 24, T6N, R9E, except the West 1064 feet thereof. LEELANAU COUNTY Certain land in Cleveland Township, Leelanau County, Michigan described as: The North 200 feet of the West 180 feet of the SW 1/4 of the SE 1/4 of Section 35, T29N, R13W. LENAWEE COUNTY Certain land in Madison Township, Lenawee County, Michigan described as: A strip of land 165 feet wide off the West side of the following described premises: The E 1/2 of the SE 1/4 of Section 12. The E 1/2 of the NE 1/4 and the NE 1/4 of the SE 1/4 of Section 13, being all in T7S, R3E, excepting therefrom a parcel of land in the E 1/2 of the SE 1/4 of Section 12, T7S, R3E, beginning at the Northwest corner of said E 1/2 of the SE 1/4 of Section 12, running thence East 4 rods, thence South 6 rods, thence West 4 rods, thence North 6 rods to the place of beginning. A-28 LIVINGSTON COUNTY Certain land in Cohoctah Township, Livingston County, Michigan described as: Parcel 1 The East 390 feet of the East 50 rods of the SW 1/4 of Section 30, T4N, R4E. Parcel 2 A parcel of land in the NW 1/4 of Section 31, T4N, R4E, described as follows: To find the place of beginning of this description commence at the N 1/4 post of said section; run thence N 89 degrees 13' 06" W along the North line of said section, 330 feet to the place of beginning of this description; running thence S 00 degrees 52' 49" W, 2167.87 feet; thence N 88 degrees 59' 49" W, 60 feet; thence N 00 degrees 52' 49" E, 2167.66 feet to the North line of said section; thence S 89 degrees 13' 06" E along said North line of said section, 60 feet to the place of beginning. MACOMB COUNTY Certain land in Macomb Township, Macomb County, Michigan described as: A parcel of land commencing on the West line of the E 1/2 of the NW 1/4 of fractional Section 6, 20 chains South of the NW corner of said E 1/2 of the NW 1/4 of Section 6; thence South on said West line and the East line of A. Henry Kotner's Hayes Road Subdivision #15, according to the recorded plat thereof, as recorded in Liber 24 of Plats, on page 7, 24.36 chains to the East and West 1/4 line of said Section 6; thence East on said East and West 1/4 line 8.93 chains; thence North parallel with the said West line of the E 1/2 of the NW 1/4 of Section 6, 24.36 chains; thence West 8.93 chains to the place of beginning, all in T3N, R13E. MANISTEE COUNTY Certain land in Manistee Township, Manistee County, Michigan described as: A parcel of land in the SW 1/4 of Section 20, T22N, R16W, described as follows: To find the place of beginning of this description, commence at the Southwest corner of said section; run thence East along the South line of said section 832.2 feet to the place of beginning of this description; thence continuing East along said South line of said section 132 feet; thence North 198 feet; thence West 132 feet; thence South 198 feet to the place of beginning, excepting therefrom the South 2 rods thereof which was conveyed to Manistee Township for highway purposes A-29 by a Quitclaim Deed dated June 13, 1919 and recorded July 11, 1919 in Liber 88 of Deeds on page 638 of Manistee County Records. MASON COUNTY Certain land in Riverton Township, Mason County, Michigan described as: Parcel 1 The South 10 acres of the West 20 acres of the S 1/2 of the NE 1/4 of Section 22, T17N, R17W. Parcel 2 A parcel of land containing 4 acres of the West side of highway, said parcel of land being described as commencing 16 rods South of the Northwest corner of the NW 1/4 of the SW -1/4 of Section 22, T17N, R17W, running thence South 64 rods, thence NE'ly and N'ly and NW'ly along the W'ly line of said highway to the place of beginning, together with any and all right, title, and interest of Howard C. Wicklund and Katherine E. Wicklund in and to that portion of the hereinbefore mentioned highway lying adjacent to the E'ly line of said above described land. MECOSTA COUNTY Certain land in Wheatland Township, Mecosta County, Michigan described as: A parcel of land in the SW 1/4 of the SW 1/4 of Section 16, T14N, R7W, described as beginning at the Southwest corner of said section; thence East along the South line of Section 133 feet; thence North parallel to the West section line 133 feet; thence West 133 feet to the West line of said Section; thence South 133 feet to the place of beginning. MIDLAND COUNTY Certain land in Ingersoll Township, Midland County, Michigan described as: The West 200 feet of the W 1/2 of the NE 1/4 of Section 4, T13N, R2E. MISSAUKEE COUNTY Certain land in Norwich Township, Missaukee County, Michigan described as: A parcel of land in the NW 1/4 of the NW 1/4 of Section 16, T24N, R6W, described as follows: Commencing at the Northwest corner of said section, running thence N 89 degrees 01' 45" E along the North A-30 line of said section 233.00 feet; thence South 233.00 feet; thence S 89 degrees 01' 45" W, 233.00 feet to the West line of said section; thence North along said West line of said section 233.00 feet to the place of beginning. (Bearings are based on the West line of Section 16, T24N, R6W, between the Southwest and Northwest corners of said section assumed as North.) MONROE COUNTY Certain land in Whiteford Township, Monroe County, Michigan described as: A parcel of land in the SW1/4 of Section 20, T8S, R6E, described as follows: To find the place of beginning of this description commence at the S 1/4 post of said section; run thence West along the South line of said section 1269.89 feet to the place of beginning of this description; thence continuing West along said South line of said section 100 feet; thence N 00 degrees 50' 35" E, 250 feet; thence East 100 feet; thence S 00 degrees 50' 35" W parallel with and 16.5 feet distant W'ly of as measured perpendicular to the West 1/8 line of said section, as occupied, a distance of 250 feet to the place of beginning. MONTCALM COUNTY Certain land in Crystal Township, Montcalm County, Michigan described as: The N 1/2 of the S 1/2 of the SE 1/4 of Section 35, T10N, R5W. MONTMORENCY COUNTY Certain land in the Village of Hillman, Montmorency County, Michigan described as: Lot 14 of Hillman Industrial Park, being a subdivision in the South 1/2 of the Northwest 1/4 of Section 24, T31N, R4E, according to the plat thereof recorded in Liber 4 of Plats on Pages 32-34, Montmorency County Records. MUSKEGON COUNTY Certain land in Casnovia Township, Muskegon County, Michigan described as: The West 433 feet of the North 180 feet of the South 425 feet of the SW 1/4 of Section 3, T10N, R13W. NEWAYGO COUNTY Certain land in Ashland Township, Newaygo County, Michigan described as: The West 250 feet of the NE 1/4 of Section 23, T11N, R13W. A-31 OAKLAND COUNTY Certain land in Wixcom City, Oakland County, Michigan described as: The E 75 feet of the N 160 feet of the N 330 feet of the W 526.84 feet of the NW 1/4 of the NW 1/4 of Section 8, T1N, R8E, more particularly described as follows: Commence at the NW corner of said Section 8, thence N 87 degrees 14' 29" E along the North line of said Section 8 a distance of 451.84 feet to the place of beginning for this description; thence continuing N 87 degrees 14' 29" E along said North section line a distance of 75.0 feet to the East line of the West 526.84 feet of the NW 1/4 of the NW 1/4 of said Section 8; thence S 02 degrees 37' 09" E along said East line a distance of 160.0 feet; thence S 87 degrees 14' 29" W a distance of 75.0 feet; thence N 02 degrees 37' 09" W a distance of 160.0 feet to the place of beginning. OCEANA COUNTY Certain land in Crystal Township, Oceana County, Michigan described as: The East 290 feet of the SE 1/4 of the NW 1/4 and the East 290 feet of the NE 1/4 of the SW 1/4, all in Section 20, T16N, R16W. OGEMAW COUNTY Certain land in West Branch Township, Ogemaw County, Michigan described as: The South 660 feet of the East 660 feet of the NE 1/4 of the NE 1/4 of Section 33, T22N, R2E. OSCEOLA COUNTY Certain land in Hersey Township, Osceola County, Michigan described as: A parcel of land in the North 1/2 of the Northeast 1/4 of Section 13, T17N, R9W, described as commencing at the Northeast corner of said Section; thence West along the North Section line 999 feet to the point of beginning of this description; thence S 01 degrees 54' 20" E 1327.12 feet to the North 1/8 line; thence S 89 degrees 17' 05" W along the North 1/8 line 330.89 feet; thence N 01 degrees 54' 20" W 1331.26 feet to the North Section line; thence East along the North Section line 331 feet to the point of beginning. OSCODA COUNTY Certain land in Comins Township, Oscoda County, Michigan described as: A-32 The East 400 feet of the South 580 feet of the W 1/2 of the SW 1/4 of Section 15, T27N, R3E. OTSEGO COUNTY Certain land in Corwith Township, Otsego County, Michigan described as: Part of the NW 1/4 of the NE 1/4 of Section 28, T32N, R3W, described as: Beginning at the N 1/4 corner of said section; running thence S 89 degrees 04' 06" E along the North line of said section, 330.00 feet; thence S 00 degrees 28' 43" E, 400.00 feet; thence N 89 degrees 04' 06" W, 330.00 feet to the North and South 1/4 line of said section; thence N 00 degrees 28' 43" W along the said North and South 1/4 line of said section, 400.00 feet to the point of beginning; subject to the use of the N'ly 33.00 feet thereof for highway purposes. OTTAWA COUNTY Certain land in Robinson Township, Ottawa County, Michigan described as: The North 660 feet of the West 660 feet of the NE 1/4 of the NW 1/4 of Section 26, T7N, R15W. PRESQUE ISLE COUNTY Certain land in Belknap and Pulawski Townships, Presque Isle County, Michigan described as: Part of the South half of the Northeast quarter, Section 24, T34N, R5E, and part of the Northwest quarter, Section 19, T34N, R6E, more fully described as: Commencing at the East -1/4 corner of said Section 24; thence N 00 degrees15'47" E, 507.42 feet, along the East line of said Section 24 to the point of beginning; thence S 88 degrees15'36" W, 400.00 feet, parallel with the North 1/8 line of said Section 24; thence N 00 degrees15'47" E, 800.00 feet, parallel with said East line of Section 24; thence N 88 degrees15'36"E, 800.00 feet, along said North 1/8 line of Section 24 and said line extended; thence S 00 degrees15'47" W, 800.00 feet, parallel with said East line of Section 24; thence S 88 degrees15'36" W, 400.00 feet, parallel with said North 1/8 line of Section 24 to the point of beginning. Together with a 33 foot easement along the West 33 feet of the Northwest quarter lying North of the North 1/8 line of Section 24, Belknap Township, extended, in Section 19, T34N, R6E. A-33 ROSCOMMON COUNTY Certain land in Gerrish Township, Roscommon County, Michigan described as: A parcel of land in the NW 1/4 of Section 19, T24N, R3W, described as follows: To find the place of beginning of this description commence at the Northwest corner of said section, run thence East along the North line of said section 1,163.2 feet to the place of beginning of this description (said point also being the place of intersection of the West 1/8 line of said section with the North line of said section), thence S 01 degrees 01' E along said West 1/8 line 132 feet, thence West parallel with the North line of said section 132 feet, thence N 01 degrees 01' W parallel with said West 1/8 line of said section 132 feet to the North line of said section, thence East along the North line of said section 132 feet to the place of beginning. SAGINAW COUNTY Certain land in Chapin Township, Saginaw County, Michigan described as: A parcel of land in the SW 1/4 of Section 13, T9N, R1E, described as follows: To find the place of beginning of this description commence at the Southwest corner of said section; run thence North along the West line of said section 1581.4 feet to the place of beginning of this description; thence continuing North along said West line of said section 230 feet to the center line of a creek; thence S 70 degrees 07' 00" E along said center line of said creek 196.78 feet; thence South 163.13 feet; thence West 185 feet to the West line of said section and the place of beginning. SANILAC COUNTY Certain easement rights located across land in Minden Township, Sanilac County, Michigan described as: The Southeast 1/4 of the Southeast 1/4 of Section 1, T14N, R14E, excepting therefrom the South 83 feet of the East 83 feet thereof. SHIAWASSEE COUNTY Certain land in Burns Township, Shiawassee County, Michigan described as: The South 330 feet of the E 1/2 of the NE 1/4 of Section 36, T5N, R4E. ST. CLAIR COUNTY Certain land in Ira Township, St. Clair County, Michigan described as: A-34 The N 1/2 of the NW 1/4 of the NE 1/4 of Section 6, T3N, R15E. ST. JOSEPH COUNTY Certain land in Mendon Township, St. Joseph County, Michigan described as: The North 660 feet of the West 660 feet of the NW 1/4 of SW 1/4, Section 35, T5S, R10W. TUSCOLA COUNTY Certain land in Millington Township, Tuscola County, Michigan described as: A strip of land 280 feet wide across the East 96 rods of the South 20 rods of the N 1/2 of the SE 1/4 of Section 34, T10N, R8E, more particularly described as commencing at the Northeast corner of Section 3, T9N, R8E, thence S 89 degrees 55' 35" W along the South line of said Section 34 a distance of 329.65 feet, thence N 18 degrees 11' 50" W a distance of 1398.67 feet to the South 1/8 line of said Section 34 and the place of beginning for this description; thence continuing N 18 degrees 11' 50" W a distance of 349.91 feet; thence N 89 degrees 57' 01" W a distance of 294.80 feet; thence S 18 degrees 11' 50" E a distance of 350.04 feet to the South 1/8 line of said Section 34; thence S 89 degrees 58' 29" E along the South 1/8 line of said section a distance of 294.76 feet to the place of beginning. VAN BUREN COUNTY Certain land in Covert Township, Van Buren County, Michigan described as: All that part of the West 20 acres of the N 1/2 of the NE fractional 1/4 of Section 1, T2S, R17W, except the West 17 rods of the North 80 rods, being more particularly described as follows: To find the place of beginning of this description commence at the N 1/4 post of said section; run thence N 89 degrees 29' 20" E along the North line of said section 280.5 feet to the place of beginning of this description; thence continuing N 89 degrees 29' 20" E along said North line of said section 288.29 feet; thence S 00 degrees 44' 00" E, 1531.92 feet; thence S 89 degrees 33' 30" W, 568.79 feet to the North and South 1/4 line of said section; thence N 00 degrees 44' 00" W along said North and South 1/4 line of said section 211.4 feet; thence N 89 degrees 29' 20" E, 280.5 feet; thence N 00 degrees 44' 00" W, 1320 feet to the North line of said section and the place of beginning. WASHTENAW COUNTY Certain land in Manchester Township, Washtenaw County, Michigan described as: A-35 A parcel of land in the NE 1/4 of the NW 1/4 of Section 1, T4S, R3E, described as follows: To find the place of beginning of this description commence at the Northwest corner of said section; run thence East along the North line of said section 1355.07 feet to the West 1/8 line of said section; thence S 00 degrees 22' 20" E along said West 1/8 line of said section 927.66 feet to the place of beginning of this description; thence continuing S 00 degrees 22' 20" E along said West 1/8 line of said section 660 feet to the North 1/8 line of said section; thence N 86 degrees 36' 57" E along said North 1/8 line of said section 660.91 feet; thence N 00 degrees22' 20" W, 660 feet; thence S 86 degrees 36' 57" W, 660.91 feet to the place of beginning. WAYNE COUNTY Certain land in Livonia City, Wayne County, Michigan described as: Commencing at the Southeast corner of Section 6, T1S, R9E; thence North along the East line of Section 6 a distance of 253 feet to the point of beginning; thence continuing North along the East line of Section 6 a distance of 50 feet; thence Westerly parallel to the South line of Section 6, a distance of 215 feet; thence Southerly parallel to the East line of Section 6 a distance of 50 feet; thence easterly parallel with the South line of Section 6 a distance of 215 feet to the point of beginning. WEXFORD COUNTY Certain land in Selma Township, Wexford County, Michigan described as: A parcel of land in the NW 1/4 of Section 7, T22N, R10W, described as beginning on the North line of said section at a point 200 feet East of the West line of said section, running thence East along said North section line 450 feet, thence South parallel with said West section line 350 feet, thence West parallel with said North section line 450 feet, thence North parallel with said West section line 350 feet to the place of beginning. SECTION 12. The Company is a transmitting utility under Section 9501(2) of the Michigan Uniform Commercial Code (M.C.L. 440.9501(2)) as defined in M.C.L. 440.9102(1)(aaaa). IN WITNESS WHEREOF, said Consumers Energy Company has caused this Supplemental Indenture to be executed in its corporate name by its Chairman of the Board, President, a Vice President or its Treasurer and its corporate seal to be hereunto affixed and to be attested by its Secretary or an Assistant Secretary, and said JPMorgan Chase Bank, N.A., as Trustee as aforesaid, to evidence its acceptance hereof, has caused this Supplemental Indenture to be executed in its corporate name by a Vice President and its corporate seal to be hereunto affixed and to be attested by a Trust Officer, in several counterparts, all as of the day and year first above written. A-36 CONSUMERS ENERGY COMPANY (SEAL) By ____________________________________ Name __________________________________ Attest: Title _________________________________ _____________________________ Joyce H. Norkey Assistant Secretary Signed, sealed and delivered by CONSUMERS ENERGY COMPANY in the presence of _____________________________ Kimberly C. Wilson _____________________________ Sammie B. Dalton STATE OF MICHIGAN ) ss. COUNTY OF JACKSON ) The foregoing instrument was acknowledged before me this ____ day of _______, 200_, by __________________________________, ________________________ of CONSUMERS ENERGY COMPANY, a Michigan corporation, on behalf of the corporation. _______________________________________ Margaret Hillman, Notary Public [SEAL] Jackson County, Michigan My Commission Expires: ________________ S-1 JPMORGAN CHASE BANK, N.A., AS TRUSTEE (SEAL) By ____________________________________ L. O'Brien Attest: Vice President _____________________________ Trust Officer Signed, sealed and delivered by JPMORGAN CHASE BANK, N.A. in the presence of _____________________________ _____________________________ STATE OF NEW YORK ) ss. COUNTY OF NEW YORK ) The foregoing instrument was acknowledged before me this ____ day of ______, 200_, by L. O'Brien, a Vice President of JPMORGAN CHASE BANK, N.A., a national banking association, on behalf of the bank, as trustee. ___________________________________ Notary Public [Seal] New York County, New York My Commission Expires: Prepared by: When recorded, return to: Kimberly C. Wilson Consumers Energy Company One Energy Plaza Business Services Real Estate Dept. Jackson, MI 49201 Attn: Nancy Fisher EP7-439 One Energy Plaza Jackson, MI 49201 S-2 EXHIBIT B-1 REQUIRED OPINIONS FROM GENERAL COUNSEL OR ASSISTANT GENERAL COUNSEL OF THE COMPANY OR CMS 1. The Company is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Michigan. 2. The execution and delivery of the Credit Documents by the Company and the performance by the Company of the Obligations have been duly authorized by all necessary corporate action and proceedings on the part of the Company and will not: (a) contravene the Company's Restated Articles of Incorporation, as amended, or bylaws; (b) contravene any law or any contractual restriction imposed by any indenture or any other agreement or instrument evidencing or governing indebtedness for borrowed money of the Company (including but not limited to the Company Indentures (as defined below)); (c) result in or require the creation of any Lien upon or with respect to any of the Company's properties except (i) the lien of the Mortgage and Security Agreement and (ii) after the FMB Issue Date, the lien of the Indenture securing the Bonds; or (d) conflict with judicial orders or regulatory orders applicable to the Company. As used in this paragraph 2, "Company Indentures" means, collectively, (i) the Indenture (as defined in the Credit Agreement), (ii) the Indenture dated as of January 1, 1996, as supplemented and amended from time to time, between the Company (formerly known as Consumers Power Company) and The Bank of New York, as Trustee, and (iii) the Indenture dated as of February 1, 1998, as supplemented and amended from time to time, between the Company and JPMorgan Chase Bank (formerly known as The Chase Manhattan Bank), as Trustee. 3. The Credit Documents have been duly executed and delivered by the Company. 4. To the best of my knowledge, there is no pending or threatened action or proceeding against the Company or any of its Consolidated Subsidiaries before any court, governmental agency or arbitrator (except (i) to the extent described in the Company's annual report on Form 10-K for the year ended December 31, 2005 and Current Report on Form 8-K filed by the Company on March 1, 2006, in each case as filed with the SEC, and (ii) such other similar actions, suits and proceedings predicated on the occurrence of the same events giving rise to any actions, suits and proceedings described in the reports referred to in clause (i) of this paragraph 4) which might reasonably be expected to materially adversely affect the financial condition or B-1-1 results of operations of the Company and its Consolidated Subsidiaries, taken as a whole, or that would materially adversely affect the Company's ability to perform its obligations under any Credit Document. To the best of my knowledge, there is no litigation challenging the validity or the enforceability of any of the Credit Documents. 5. No authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required for the due execution, delivery and performance by the Company of any Credit Document, except for the authorization to issue, sell or guarantee secured and/or unsecured short-term debt granted by the Federal Energy Regulatory Commission (hereinafter the "FERC") in Docket No. ES04-31-000 (hereinafter the "FERC Order"). The FERC Order is in full force and effect as of the date hereof. 6. The Company is not an "investment company" or a company "controlled" by an "investment company" as such terms are defined in the Investment Company Act of 1940, as amended. 7. In a properly presented case, a Michigan court or a federal court applying Michigan choice of law rules should give effect to the choice of law provisions of the Agreement and should hold that the Agreement is to be governed by the laws of the State of New York rather than the laws of the State of Michigan, except in the case of those provisions set forth in the Agreement the enforcement of which would contravene a fundamental policy of the State of Michigan. In the course of our review of the Agreement, nothing has come to my attention to indicate that any of such provisions would do so. Notwithstanding the foregoing, even if a Michigan court or a federal court holds that the Agreement is to be governed by the laws of the State of Michigan, the Agreement constitutes a legal, valid and binding obligation of the Company, enforceable under Michigan law (including usury provisions) against the Company in accordance with its terms, subject to (a) the effect of applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and (b) the application of general principles of equity (regardless of whether considered in a proceeding in equity or at law). B-1-2 EXHIBIT B-2 REQUIRED OPINION FROM MILLER, CANFIELD, PADDOCK AND STONE, P.L.C. 1. The execution and delivery of the Mortgage and Security Agreement by the Company and the performance by the Company of its obligations thereunder will not conflict with the provisions of the Indenture (as defined in the Credit Agreement). 2. The Mortgage and Security Agreement is effective to create a valid and perfected second lien on the collateral described therein. B-2-1 EXHIBIT B-3 REQUIRED OPINIONS FROM GENERAL COUNSEL OR ASSISTANT GENERAL COUNSEL OF THE COMPANY OR CMS 1. The Bonds, assuming due authentication in accordance with the terms of the Indenture, are in due and proper form and, when delivered to the Agent pursuant to the Bond Delivery Agreement, will evidence and secure the Obligations owing under the Agreement and will be valid and enforceable obligations of the Company in accordance with their terms, secured by the lien of the Indenture on an equal and ratable basis with all other bonds issued thereunder and otherwise entitled to the benefits provided by the Indenture. 2. The Indenture has been qualified under the Trust Indenture Act of 1939, as amended, and the execution and delivery of the Supplemental Indenture will not cause the Indenture to not be so qualified. B-3-1 EXHIBIT B-4 REQUIRED OPINION FROM MILLER, CANFIELD, PADDOCK AND STONE, P.L.C. 1. The Bonds, assuming due authentication in accordance with the terms of the Indenture, are in due and proper form and, when delivered to the Agent pursuant to the Bond Delivery Agreement, will evidence and secure the Obligations owing under the Agreement and will be valid and enforceable obligations of the Company in accordance with their terms, secured by the lien of the Indenture on an equal and ratable basis with all other bonds issued thereunder and otherwise entitled to the benefits provided by the Indenture. B-4-1 EXHIBIT C FORM OF COMPLIANCE CERTIFICATE I, _________________, ______________ of Consumers Energy Company, a Michigan corporation (the "Company"), DO HEREBY CERTIFY in connection with the Credit Agreement dated as of March 31, 2006 (the "Credit Agreement"; the terms defined therein being used herein as so defined) among the Company, various financial institutions and Barclays Bank PLC, as Agent, that: I. Section 8.1 of the Credit Agreement provides that the Company shall: "At all times, maintain a ratio of Total Consolidated Debt to Total Consolidated Capitalization of not greater than 0.70 to 1.0." The following calculations are made in accordance with the definitions of Total Consolidated Debt and Total Consolidated Capitalization in the Credit Agreement and are correct and accurate as of _____________, ___: A. Total Consolidated Debt (a) Indebtedness for borrowed money $ plus (b) Indebtedness for deferred purchase price of property/services plus (c) Liabilities for accumulated funding deficiencies plus (d) Liabilities in connection with withdrawal liability under ERISA plus (e) Obligations under acceptance facilities plus (f) Obligations under Capital Leases plus (g) Obligations under interest rate swap, "cap", "collar" or other hedging agreement plus (h) Guaranties, endorsements and other contingent obligations minus (i) Principal amount of any Securitized Bonds minus (j) Junior Subordinated Debt owned by any Hybrid Preferred Securities Subsidiary minus (k) Subordinated guaranties by the Company of payments with respect to Hybrid Preferred Securities C-1 minus (l) Agreed upon percentage of Net Proceeds from issuance of hybrid debt/equity securities (other than Junior Subordinated Debt and Hybrid Preferred Securities) TOTAL $ B. Total Consolidated Capitalization: (a) Total Consolidated Debt $ plus (b) The sum of Items A(j) through A(l) above plus (c) Equity of common stockholders plus (d) Equity of preference stockholders ____________ plus (e) Equity of preferred stockholders ____________ TOTAL $ C. Debt to Capital Ratio _____ to 1.00 (total of A divided by total of B) II. Section 8.2 of the Credit Agreement provides that the Company shall: "Not permit the ratio, determined as of the end of each of its fiscal quarters for the then most-recently ended four fiscal quarters, of (i) Consolidated EBIT to (ii) cash Consolidated Interest Expense to be less than 2.0 to 1.0" The following calculations are made in accordance with the definitions of Consolidated EBIT and Consolidated Interest Expense in the Credit Agreement and are correct and accurate as of _____________, ___: A. Consolidated EBIT (a) Consolidated Net Income $ plus (b) Consolidated Interest Expense $ plus (c) Interest and dividends on Hybrid Preferred Securities and on securities of the type described in Item A(l) above (but only to the extent securities of the type described in Item A(l) are deemed equity) C-2 plus (d) Expense for taxes paid or accrued $ plus (e) Non-cash write-offs and write-downs contained in the $ Company's Consolidated Net Income, including write-offs or write-downs related to the sale of assets, impairment of assets and loss on contracts plus (f) Non-cash losses on mark-to-market valuation of contracts minus (g) Extraordinary gains realized other than in the $ ordinary course of business minus (h) Non-cash gains on mark-to-market valuation of contracts TOTAL $ B. Consolidated Interest Expense $ C. Interest Coverage Ratio _____ to 1.00 (total of A divided by total of B) IN WITNESS WHEREOF, I have signed this Certificate this ___ day of _________, ___. C-3 EXHIBIT D ASSIGNMENT AND ASSUMPTION AGREEMENT This Assignment and Assumption (the "Assignment and Assumption") is dated as of the Effective Date set forth below and is entered into by and between [Insert name of Assignor] (the "Assignor") and [Insert name of Assignee] (the "Assignee"). Capitalized terms used but not defined herein shall have the meanings given to them in the Credit Agreement identified below (as amended, the "Credit Agreement"), receipt of a copy of which is hereby acknowledged by the Assignee. The Terms and Conditions set forth in Annex 1 attached hereto are hereby agreed to and incorporated herein by reference and made a part of this Assignment and Assumption as if set forth herein in full. For an agreed consideration, the Assignor hereby irrevocably sells and assigns to the Assignee, and the Assignee hereby irrevocably purchases and assumes from the Assignor, subject to and in accordance with the Standard Terms and Conditions and the Credit Agreement, as of the Effective Date inserted by the Agent as contemplated below, the interest in and to all of the Assignor's rights and obligations in its capacity as a Bank under the Credit Agreement and any other documents or instruments delivered pursuant thereto that represents the amount and percentage interest identified below of all of the Assignor's outstanding rights and obligations under the respective facilities identified below (including any letters of credit, guaranties and swingline loans included in such facilities and, to the extent permitted to be assigned under applicable law, all claims (including contract claims, tort claims, malpractice claims, statutory claims and all other claims at law or in equity), suits, causes of action and any other right of the Assignor against any Person whether known or unknown arising under or in connection with the Credit Agreement, any other documents or instruments delivered pursuant thereto or the loan transactions governed thereby) (the "Assigned Interest"). Such sale and assignment is without recourse to the Assignor and, except as expressly provided in this Assignment and Assumption, without representation or warranty by the Assignor. 1. Assignor: _________________________________________________ 2. Assignee: _________________________________________________[and is an affiliate of Assignor] 3. Borrower: Consumers Energy Company 4. Agent: Barclays Bank PLC, as the Agent under the Credit Agreement. 5. Credit Agreement: The Credit Agreement dated as of March 31, 2006 among Consumers Energy Company, the Banks party thereto, and Barclays Bank PLC, as Agent. D-1 6. Assigned Interest:
Aggregate Commitment / Amount of Commitment / Percentage Assigned of Outstanding Loans of Outstanding Loans Commitment / Outstanding Facility Assigned all Banks* Assigned* Loans(1) - ----------------- ---------------------- ------------------------ --------------------------- ____________ $ $ _______% ____________ $ $ _______% ____________ $ $ _______%
7. Trade Date: ____________________________________ (2) Effective Date: ____________________, 20__ TO BE INSERTED BY AGENT AND WHICH SHALL BE THE EFFECTIVE DATE OF RECORDATION OF TRANSFER BY THE AGENT.] - -------------- * Amount to be adjusted by the counterparties to take into account any payments or prepayments made between the Trade Date and the Effective Date. (1) Set forth, to at least 9 decimals, as a percentage of the Commitment/Loans of all Banks thereunder. (2) Insert if satisfaction of minimum amounts is to be determined as of the Trade Date. D-2 The terms set forth in this Assignment and Assumption are hereby agreed to: ASSIGNOR [NAME OF ASSIGNOR] By: __________________________________ Title: ASSIGNEE [NAME OF ASSIGNEE] By: _______________________________________ Title: [Consented to and](3) Accepted: Barclays Bank PLC, as Agent By: ________________________________ Title: [Consented to:](4) [NAME OF RELEVANT PARTY] By: ________________________________ Title: - ----------------- (3) To be added only if the consent of the Agent is required by the terms of the Credit Agreement. (4) To be added only if the consent of the Company and/or other parties (e.g. LC Issuer) is required by the terms of the Credit Agreement. D-3 ANNEX 1 TERMS AND CONDITIONS FOR ASSIGNMENT AND ASSUMPTION 1. Representations and Warranties. 1.1 Assignor. The Assignor represents and warrants that (i) it is the legal and beneficial owner of the Assigned Interest, (ii) the Assigned Interest is free and clear of any lien, encumbrance or other adverse claim and (iii) it has full power and authority, and has taken all action necessary, to execute and deliver this Assignment and Assumption and to consummate the transactions contemplated hereby. Neither the Assignor nor any of its officers, directors, employees, agents or attorneys shall be responsible for (i) any statements, warranties or representations made in or in connection with the Credit Agreement or any other Credit Document, (ii) the execution, legality, validity, enforceability, genuineness, sufficiency, perfection, priority, collectibility, or value of the Credit Documents or any collateral thereunder, (iii) the financial condition of the Company, any of its Subsidiaries or Affiliates or any other Person obligated in respect of any Credit Document, (iv) the performance or observance by the Company, any of its Subsidiaries or Affiliates or any other Person of any of their respective obligations under any Credit Document, (v) inspecting any of the property, books or records of the Company, or any guarantor, or (vi) any mistake, error of judgment, or action taken or omitted to be taken in connection with the Advances or the Credit Documents. 1.2. Assignee. The Assignee (a) represents and warrants that (i) it has full power and authority, and has taken all action necessary, to execute and deliver this Assignment and Assumption and to consummate the transactions contemplated hereby and to become a Bank under the Credit Agreement, (ii) from and after the Effective Date, it shall be bound by the provisions of the Credit Agreement as a Bank thereunder and, to the extent of the Assigned Interest, shall have the obligations of a Bank thereunder, (iii) agrees that its payment instructions and notice instructions are as set forth in Schedule 1 to this Assignment and Assumption, (iv) confirms that none of the funds, monies, assets or other consideration being used to make the purchase and assumption hereunder are "plan assets" as defined under ERISA and that its rights, benefits and interests in and under the Credit Documents will not be "plan assets" under ERISA, (v) agrees to indemnify and hold the Assignor harmless against all losses, costs and expenses (including reasonable attorneys' fees) and liabilities incurred by the Assignor in connection with or arising in any manner from the Assignee's non-performance of the obligations assumed under this Assignment and Assumption, (vi) it has received a copy of the Credit Agreement, together with copies of financial statements and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into this Assignment and Assumption and to purchase the Assigned Interest on the basis of which it has made such analysis and decision independently and without reliance on the Agent or any other Bank, and (vii) attached as Schedule 1 to this Assignment and Assumption is any documentation required to be delivered by the Assignee with respect to its tax status pursuant to the terms of the Credit Agreement, duly completed and executed by the Assignee and (b) agrees that (i) it will, independently and without reliance on the Agent, the Assignor or any other Bank, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Credit Documents, and (ii) it will Annex 1 perform in accordance with their terms all of the obligations which by the terms of the Credit Documents are required to be performed by it as a Bank. 2. Payments. The Assignee shall pay the Assignor, on the Effective Date, the amount agreed to by the Assignor and the Assignee. From and after the Effective Date, the Agent shall make all payments in respect of the Assigned Interest (including payments of principal, interest, fees and other amounts) to the Assignor for amounts which have accrued to but excluding the Effective Date and to the Assignee for amounts which have accrued from and after the Effective Date. 3. General Provisions. This Assignment and Assumption shall be binding upon, and inure to the benefit of, the parties hereto and their respective successors and assigns. This Assignment and Assumption may be executed in any number of counterparts, which together shall constitute one instrument. Delivery of an executed counterpart of a signature page of this Assignment and Assumption by telecopy shall be effective as delivery of a manually executed counterpart of this Assignment and Assumption. This Assignment and Assumption shall be governed by, and construed in accordance with, the law of the State of New York. Annex 1 ADMINISTRATIVE QUESTIONNAIRE (Schedule to be supplied by Closing Unit or Trading Documentation Unit) US AND NON-US TAX INFORMATION REPORTING REQUIREMENTS (Schedule to be supplied by Closing Unit or Trading Documentation Unit) EXHIBIT E TERMS OF SUBORDINATION [JUNIOR SUBORDINATED DEBT] ARTICLE ____ SUBORDINATION Section 1. Applicability of Article; Securities Subordinated to Senior Indebtedness. (a) This Article ____ shall apply only to the Securities of any series which, pursuant to Section ___, are expressly made subject to this Article. Such Securities are referred to in this Article ____ as "Subordinated Securities." (b) The Issuer covenants and agrees, and each Holder of Subordinated Securities by his acceptance thereof likewise covenants and agrees, that the indebtedness represented by the Subordinated Securities and the payment of the principal and interest, if any, on the Subordinated Securities is subordinated and subject in right, to the extent and in the manner provided in this Article, to the prior payment in full of all Senior Indebtedness. "Senior Indebtedness" means the principal of and premium, if any, and interest on the following, whether outstanding on the date hereof or thereafter incurred, created or assumed: (i) indebtedness of the Issuer for money borrowed by the Issuer (including purchase money obligations) or evidenced by debentures (other than the Subordinated Securities), notes, bankers' acceptances or other corporate debt securities, or similar instruments issued by the Issuer; (ii) all capital lease obligations of the Issuer; (iii) all obligations of the Issuer issued or assumed as the deferred purchase price of property, all conditional sale obligations of the Issuer and all obligations of the Issuer under any title retention agreement (but excluding trade accounts payable arising in the ordinary course of business); (iv) obligations with respect to letters of credit; (v) all indebtedness of others of the type referred to in the preceding clauses (i) through (iv) assumed by or guaranteed in any manner by the Issuer or in effect guaranteed by the Issuer; (vi) all obligations of the type referred to in clauses (i) through (v) above of other persons secured by any lien on any property or asset of the Issuer (whether or not such obligation is assumed by the Issuer), except for (1) any such indebtedness that is by its terms subordinated to or pari passu with the Subordinated Notes, as the case may be, including all other debt securities and guaranties in respect of those debt securities, issued to any other trusts, partnerships or other entities affiliated with the Issuer which act as a financing vehicle of the Issuer in connection with the issuance of preferred securities by such entity or other securities which rank pari passu with, or junior to, the Preferred Securities, and (2) any indebtedness between or among the Issuer and its affiliates; and/or (vii) renewals, extensions or refundings of any of the indebtedness referred to in the preceding clauses unless, in the case of any particular indebtedness, renewal, extension or refunding, under the express provisions of the instrument creating or evidencing the same or the assumption or guarantee of the same, or pursuant to which the same is outstanding, such E-1 indebtedness or such renewal, extension or refunding thereof is not superior in right of payment to the Subordinated Securities. This Article shall constitute a continuing obligation to all Persons who, in reliance upon such provisions become holders of, or continue to hold, Senior Indebtedness, and such provisions are made for the benefit of the holders of Senior Indebtedness, and such holders are made obligees hereunder and they and/or each of them may enforce such provisions. Section 2. Issuer Not to Make Payments with Respect to Subordinated Securities in Certain Circumstances. (a) Upon the maturity of any Senior Indebtedness by lapse of time, acceleration or otherwise, all principal thereof and premium and interest thereon shall first be paid in full, or such payment duly provided for in cash in a manner satisfactory to the holders of such Senior Indebtedness, before any payment is made on account of the principal of, or interest on, Subordinated Securities or to acquire any Subordinated Securities or on account of any sinking fund provisions of any Subordinated Securities (except payments made in capital stock of the Issuer or in warrants, rights or options to purchase or acquire capital stock of the Issuer, sinking fund payments made in Subordinated Securities acquired by the Issuer before the maturity of such Senior Indebtedness, and payments made through the exchange of other debt obligations of the Issuer for such Subordinated Securities in accordance with the terms of such Subordinated Securities, provided that such debt obligations are subordinated to Senior Indebtedness at least to the extent that the Subordinated Securities for which they are exchanged are so subordinated pursuant to this Article ____). (b) Upon the happening and during the continuation of any default in payment of the principal of, or interest on, any Senior Indebtedness when the same becomes due and payable or in the event any judicial proceeding shall be pending with respect to any such default, then, unless and until such default shall have been cured or waived or shall have ceased to exist, no payment shall be made by the Issuer with respect to the principal of, or interest on, Subordinated Securities or to acquire any Subordinated Securities or on account of any sinking fund provisions of Subordinated Securities (except payments made in capital stock of the Issuer or in warrants, rights, or options to purchase or acquire capital stock of the Issuer, sinking fund payments made in Subordinated Securities acquired by the Issuer before such default and notice thereof, and payments made through the exchange of other debt obligations of the Issuer for such Subordinated Securities in accordance with the terms of such Subordinated Securities, provided that such debt obligations are subordinated to Senior Indebtedness at least to the extent that the Subordinated Securities for which they are exchanged are so subordinated pursuant to this Article ____). (c) In the event that, notwithstanding the provisions of this Section ___.2, the Issuer shall make any payment to the Trustee on account of the principal of or interest on Subordinated Securities, or on account of any sinking fund provisions of such Securities, after the maturity of any Senior Indebtedness as described in Section ___.2(a) above or after the happening of a default in payment of the principal of or interest on any Senior Indebtedness as described in Section ___.2(b) above, then, unless and until all Senior Indebtedness which shall have matured, E-2 and all premium and interest thereon, shall have been paid in full (or the declaration of acceleration thereof shall have been rescinded or annulled), or such default shall have been cured or waived or shall have ceased to exist, such payment (subject to the provisions of Sections ___.6 and ___.7) shall be held by the Trustee, in trust for the benefit of, and shall be paid forthwith over and delivered to, the holders of such Senior Indebtedness (pro rata as to each of such holders on the basis of the respective amounts of Senior Indebtedness held by them) or their representative or the trustee under the indenture or other agreement (if any) pursuant to which such Senior Indebtedness may have been issued, as their respective interests may appear, for application to the payment of all such Senior Indebtedness remaining unpaid to the extent necessary to pay the same in full in accordance with its terms, after giving effect to any concurrent payment or distribution to or for the holders of Senior Indebtedness. The Issuer shall give prompt written notice to the Trustee of any default in the payment of principal of or interest on any Senior Indebtedness. Section 3. Subordinated Securities Subordinated to Prior Payment of All Senior Indebtedness on Dissolution, Liquidation or Reorganization of Issuer. Upon any distribution of assets of the Issuer in any dissolution, winding up, liquidation or reorganization of the Issuer (whether voluntary or involuntary, in bankruptcy, insolvency or receivership proceedings or upon an assignment for the benefit of creditors or otherwise): (a) the holders of all Senior Indebtedness shall first be entitled to receive payments in full of the principal thereof and premium and interest due thereon, or provision shall be made for such payment, before the Holders of Subordinated Securities are entitled to receive any payment on account of the principal of or interest on such Securities; (b) any payment or distribution of assets of the Issuer of any kind or character, whether in cash, property or securities (other than securities of the Issuer as reorganized or readjusted or securities of the Issuer or any other corporation provided for by a plan of reorganization or readjustment the payment of which is subordinate, at least to the extent provided in this Article ____ with respect to Subordinated Securities, to the payment in full without diminution or modification by such plan of all Senior Indebtedness), to which the Holders of Subordinated Securities or the Trustee on behalf of the Holders of Subordinated Securities would be entitled except for the provisions of this Article ____ shall be paid or delivered by the liquidating trustee or agent or other person making such payment or distribution directly to the holders of Senior Indebtedness or their representative, or to the trustee under any indenture under which Senior Indebtedness may have been issued (pro rata as to each such holder, representative or trustee on the basis of the respective amounts of unpaid Senior Indebtedness held or represented by each), to the extent necessary to make payment in full of all Senior Indebtedness remaining unpaid, after giving effect to any concurrent payment or distribution or provision thereof to the holders of such Senior Indebtedness; and (c) in the event that notwithstanding the foregoing provisions of this Section ___.3, any payment or distribution of assets of the Issuer of any kind or character, whether in cash, property or securities (other than securities of the Issuer as reorganized or readjusted or securities of the Issuer or any other corporation provided for by a plan of reorganization or readjustment the payment of which is subordinate, at least to the extent provided in this Article ____ with E-3 respect to Subordinated Securities, to the payment in full without diminution or modification by such plan of all Senior Indebtedness), shall be received by the Trustee or the Holders of the Subordinated Securities on account of principal of or interest on the Subordinated Securities before all Senior Indebtedness is paid in full, or effective provision made for its payment, such payment or distribution (subject to the provisions of Section ___.6 and ___.7) shall be received and held in trust for and shall be paid over to the holders of the Senior Indebtedness remaining unpaid or unprovided for or their representative, or to the trustee under any indenture under which such Senior Indebtedness may have been issued (pro rata as provided in clause (b) above), for application to the payment of such Senior Indebtedness until all such Senior Indebtedness shall have been paid in full, after giving effect to any concurrent payment or distribution or provision therefor to the holders of such Senior Indebtedness. The Issuer shall give prompt written notice to the Trustee of any dissolution, winding up, liquidation or reorganization of the Issuer. The consolidation of the Issuer with, or the merger of the Issuer into, another corporation or the liquidation or dissolution of the Issuer following the conveyance or transfer of its property as an entirety, or substantially as an entirety, to another corporation upon the terms and conditions provided for in Article ____ hereof shall not be deemed a dissolution, winding up, liquidation or reorganization for the purposes of this Section ___.3 if such other corporation shall, as a part of such consolidation, merger, conveyance or transfer, comply with the conditions stated such in Article ____. Section 4. Holders of Subordinated Securities to be Subrogated to Right of Holders of Senior Indebtedness. Subject to the payment in full of all Senior Indebtedness, the Holders of Subordinated Securities shall be subrogated to the rights of the holders of Senior Indebtedness to receive payments or distributions of assets of the Issuer applicable to the Senior Indebtedness until all amounts owing on Subordinated Securities shall be paid in full, and for the purposes of such subrogation no payments or distributions to the holders of the Senior Indebtedness by or on behalf of the Issuer or by or on behalf of the Holders of Subordinated Securities by virtue of this Article ____ which otherwise would have been made to the Holders of Subordinated Securities shall, as between the Issuer, its creditors other than holders of Senior Indebtedness and the Holders of Subordinated Securities, be deemed to be payment by the Issuer to or on account of the Senior Indebtedness, it being understood that the provisions of this Article ____ are and are intended solely for the purpose of defining the relative rights of the Holders of the Subordinated Securities, on the one hand, and the holders of the Senior Indebtedness, on the other hand. Section 5. Obligation of the Issuer Unconditional. Nothing contained in this Article ____ or elsewhere in this Indenture or in any Subordinated Security is intended to or shall impair, as among the Issuer, its creditors other than holders of Senior Indebtedness and the Holders of Subordinated Securities, the obligation of the Issuer, which is absolute and unconditional, to pay to the Holders of Subordinated Securities the principal of, and interest on, Subordinated Securities as and when the same shall become due and payable in accordance with their terms, or is intended to or shall affect the relative rights of the Holders of Subordinated Securities and creditors of the Issuer other than the holders of the Senior Indebtedness, nor shall anything herein or therein prevent the Trustee or the Holder of any Subordinated Security from E-4 exercising all remedies otherwise permitted by applicable law upon default under this Indenture, subject to the rights, if any, under this Article ____ of the holders of Senior Indebtedness in respect of cash, property or securities of the Issuer received upon the exercise of any such remedy. Upon any payment or distribution of assets of the Issuer referred to in this Article ____, the Trustee and Holders of Subordinated Securities shall be entitled to rely upon any order or decree made by any court of competent jurisdiction in which such dissolution, winding up, liquidation or reorganization proceedings are pending, or, subject to the provisions of Section ___ and ___, a certificate of the receiver, trustee in bankruptcy, liquidating trustee or agent or other Person making such payment or distribution to the Trustee or the Holders of Subordinated Securities, for the purposes of ascertaining the Persons entitled to participate in such distribution, the holders of the Senior Indebtedness and other indebtedness of the Issuer, the amount thereof or payable thereon, the amount or amounts paid or distributed thereon and all other facts pertinent thereto or to this Article ____. Nothing contained in this Article ____ or elsewhere in this Indenture or in any Subordinated Security is intended to or shall affect the obligation of the Issuer to make, or prevent the Issuer from making, at any time except during the pendency of any dissolution, winding up, liquidation or reorganization proceeding, and, except as provided in subsections (a) and (b) of Section ___.2, payments at any time of the principal of, or interest on, Subordinated Securities. Section 6. Trustee Entitled to Assume Payments Not Prohibited in Absence of Notice. The Issuer shall give prompt written notice to the Trustee of any fact known to the Issuer which would prohibit the making of any payment or distribution to or by the Trustee in respect of the Subordinated Securities. Notwithstanding the provisions of this Article ____ or any provision of this Indenture, the Trustee shall not at any time be charged with knowledge of the existence of any facts which would prohibit the making of any payment or distribution to or by the Trustee, unless at least two Business Days prior to the making of any such payment, the Trustee shall have received written notice thereof from the Issuer or from one or more holders of Senior Indebtedness or from any representative thereof or from any trustee therefor, together with proof satisfactory to the Trustee of such holding of Senior Indebtedness or of the authority of such representative or trustee; and, prior to the receipt of any such written notice, the Trustee, subject to the provisions of Sections ___ and ___, shall be entitled to assume conclusively that no such facts exist. The Trustee shall be entitled to rely on the delivery to it of a written notice by a Person representing himself to be a holder of Senior Indebtedness (or a representative or trustee on behalf of the holder) to establish that such notice has been given by a holder of Senior Indebtedness (or a representative of or trustee on behalf of any such holder). In the event that the Trustee determines, in good faith, that further evidence is required with respect to the right of any Person as a holder of Senior Indebtedness to participate in any payments or distribution pursuant of this Article ____, the Trustee may request such Person to furnish evidence to the reasonable satisfaction of the Trustee as to the amount of Senior Indebtedness held by such Person, as to the extent to which such Person is entitled to participate in such payment or distribution, and as to other facts pertinent to the rights of such Person under this Article ____, and if such evidence is not furnished, the Trustee may defer any payment to such Person pending judicial determination as to the right of such Person to receive such payment. The Trustee, however, shall not be deemed to owe any fiduciary duty to the holders of Senior Indebtedness E-5 and nothing in this Article ____ shall apply to claims of, or payments to, the Trustee under or pursuant to Section ___. Section 7. Application by Trustee of Monies or Government Obligations Deposited with It. Money or Government Obligations deposited in trust with the Trustee pursuant to and in accordance with Section ____ shall be for the sole benefit of Securityholders and, to the extent allocated for the payment of Subordinated Securities, shall not be subject to the subordination provisions of this Article ____, if the same are deposited in trust prior to the happening of any event specified in Section ___.2. Otherwise, any deposit of monies or Government Obligations by the Issuer with the Trustee or any paying agent (whether or not in trust) for the payment of the principal of, or interest on, any Subordinated Securities shall be subject to the provisions of Section ___.1, ___.2 and ___.3 except that, if prior to the date on which by the terms of this Indenture any such monies may become payable for any purposes (including, without limitation, the payment of the principal of, or the interest, if any, on any Subordinated Security) the Trustee shall not have received with respect to such monies the notice provided for in Section ___.6, then the Trustee or the paying agent shall have full power and authority to receive such monies and Government Obligations and to apply the same to the purpose for which they were received, and shall not be affected by any notice to the contrary which may be received by it on or after such date. This Section ___.7 shall be construed solely for the benefit of the Trustee and paying agent and, as to the first sentence hereof, the Securityholders, and shall not otherwise effect the rights of holders of Senior Indebtedness. Section 8. Subordination Rights Not Impaired by Acts or Omissions of Issuer or Holders of Senior Indebtedness. No rights of any present or future holders of any Senior Indebtedness to enforce subordination as provided herein shall at any time in any way be prejudiced or impaired by any act or failure to act on the part of the Issuer or by any act or failure to act, in good faith, by any such holders or by any noncompliance by the Issuer with the terms of this Indenture, regardless of any knowledge thereof which any such holder may have or be otherwise charged with. Without in any way limiting the generality of the foregoing paragraph, the holders of Senior Indebtedness of the Issuer may, at any time and from time to time, without the consent of or notice to the Trustee or the Holders of the Subordinated Securities, without incurring responsibility to the Holders of the Subordinated Securities and without impairing or releasing the subordination provided in this Article ____ or the obligations hereunder of the Holders of the Subordinated Securities to the holders of such Senior Indebtedness, do any one or more of the following: (i) change the manner, place or terms of payment or extend the time of payment of, or renew or alter, such Senior Indebtedness, or otherwise amend or supplement in any manner such Senior Indebtedness or any instrument evidencing the same or any agreement under which such Senior Indebtedness is outstanding; (ii) sell, exchange, release or otherwise deal with any property pledged, mortgaged or otherwise securing such Senior Indebtedness; (iii) release any Person liable in any manner for the collection for such Senior Indebtedness; and (iv) exercise or refrain from exercising any rights against the Issuer, as the case may be, and any other Person. Section 9. Securityholders Authorize Trustee to Effectuate Subordination of Securities. Each Holder of Subordinated Securities by his acceptance thereof authorizes and expressly E-6 directs the Trustee on his behalf to take such action as may be necessary or appropriate to effectuate the subordination provided in this Article ____ and appoints the Trustee his attorney-in-fact for such purpose, including in the event of any dissolution, winding up, liquidation or reorganization of the Issuer (whether in bankruptcy, insolvency or receivership proceedings or upon an assignment for the benefit of creditors or otherwise) the immediate filing of a claim for the unpaid balance of his Subordinated Securities in the form required in said proceedings and causing said claim to be approved. If the Trustee does not file a proper claim or proof of debt in the form required in such proceeding prior to 30 days before the expiration of the time to file such claim or claims, then the holders of Senior Indebtedness have the right to file and are hereby authorized to file an appropriate claim for and on behalf of the Holders of said Securities. Section 10. Right of Trustee to Hold Senior Indebtedness. The Trustee in its individual capacity shall be entitled to all of the rights set forth in this Article ____ in respect of any Senior Indebtedness at any time held by it to the same extent as any other holder of Senior Indebtedness, and nothing in this Indenture shall be construed to deprive the Trustee of any of its rights as such holder. With respect to the holders of Senior Indebtedness of the Issuer, the Trustee undertakes to perform or to observe only such of its covenants and obligations as are specifically set forth in this Article ____, and no implied covenants or obligations with respect to the holders of such Senior Indebtedness shall be read into this Indenture against the Trustee. The Trustee shall not be deemed to owe any fiduciary duty to the holders of such Senior Indebtedness and, subject to the provisions of Sections ___.2 and ___.3, the Trustee shall not be liable to any holder of such Senior Indebtedness if it shall pay over or deliver to Holders of Subordinated Securities, the Issuer or any other Person money or assets to which any holder of such Senior Indebtedness shall be entitled by virtue of this Article ____ or otherwise. Section 11. Article ____ Not to Prevent Events of Defaults. The failure to make a payment on account of principal or interest by reason of any provision in this Article ____ shall not be construed as preventing the occurrence of an Event of Default under Section ____. E-7 EXHIBIT F TERMS OF SUBORDINATION [Guaranty of Hybrid Preferred Securities] SECTION ___. This Guarantee will constitute an unsecured obligation of the Guarantor and will rank subordinate and junior in right of payment to all other liabilities of the Guarantor and pari passu with any guarantee now or hereafter entered into by the Guarantor in respect of the securities representing common beneficial interests in the assets of the Issuer or of any preferred or preference stock of any affiliate of the Guarantor. F-1 EXHIBIT G FORM OF BOND DELIVERY AGREEMENT BOND DELIVERY AGREEMENT CONSUMERS ENERGY COMPANY TO BARCLAYS BANK PLC, AS AGENT Dated as of March 31, 2006 --------------- Relating to First Mortgage Bonds, [200[ ]-[ ]] Collateral Series (Interest Bearing) --------------- G-1 THIS BOND DELIVERY AGREEMENT (this "Agreement"), dated as of [ ], 2006, is between Consumers Energy Company (the "Company"), and Barclays Bank PLC, as administrative agent (the "Agent") under the Credit Agreement (as amended, supplemented or otherwise modified from time to time, the "Credit Agreement") dated as of March 31, 2006 among the Company, the financial institutions parties thereto (the "Banks"), and the Agent. Capitalized terms used but not otherwise defined herein have the respective meanings assigned to such terms in the Credit Agreement. Whereas, the Company has entered into the Credit Agreement and may from time to time make borrowings thereunder in accordance with the provisions thereof; Whereas, the Company has established its First Mortgage Bonds, [200[ ]- [ ]] Collateral Series (Interest Bearing) in the aggregate principal amount of $__________ (the "Bonds"), to be issued under and in accordance with the One Hundred [_____________] Supplemental Indenture dated as of [ ], 2006 (the "Supplemental Indenture") to the Indenture of the Company to JPMorgan Chase Bank (formerly known as The Chase Manhattan Bank) dated as of September 1, 1945 (as amended and supplemented, the "Indenture"); and Whereas, the Company proposes to issue and deliver to the Agent, for the benefit of the Banks, the Bonds in order to provide the Bonds as evidence of (and the benefit of the lien of the Indenture with respect to the Bonds for) the Obligations of the Company arising under the Credit Agreement. Now, therefore, in consideration of the premises and for other good and valuable consideration (the receipt and sufficiency of which are hereby acknowledged), the Company and the Agent hereby agree as follows: ARTICLE I THE BONDS Section 1.1 Delivery of Bonds. In order to provide the Bonds as evidence of (and through the Bonds the benefit of the Lien of the Indenture for) the Obligations of the Company under the Credit Agreement as aforesaid, the Company hereby delivers to the Agent the Bonds in the aggregate principal amount of $__________, maturing on the earlier of (a) __________ or such later date as may be fixed as the Revolving Termination Date (as defined in the Credit Agreement) or, if the Company exercises the Term Out Option (as defined in the Credit Agreement), the Final Maturity Date (as defined in the Credit Agreement) under the Credit Agreement and (b) the "FMB Release Date" (as defined in the Credit Agreement) and bearing interest as provided in the Supplemental Indenture. The obligation of the Company to pay the principal of and interest on the Bonds shall be deemed to have been satisfied and discharged in full or in part, as the case may be, to the extent of payment by the Company of the Obligations, all as set forth in the Bonds and in Section 1 of the Supplemental Indenture. G-2 The Bonds are registered in the name of the Agent and shall be owned and held by the Agent, subject to the provisions of this Agreement, for the benefit of the Banks, and the Company shall have no interest therein. The Agent shall be entitled to exercise all rights of bondholders under the Indenture with respect to the Bonds. The Agent hereby acknowledges receipt of the Bonds. Section 1.2 Payments on the Bonds. Any payments received by the Agent on account of the principal of or interest on the Bonds shall be deemed to be and treated in all respects as payments of the Obligations, and such payments shall be distributed by the Agent to the Banks in accordance with the provisions of the Credit Agreement applicable to payments received by the Agent in respect of the Obligations (and the Company hereby consents to such distributions). ARTICLE II NO TRANSFER OF BONDS; SURRENDER OF BONDS Section 2.1 No Transfer of the Bonds. The Agent shall not sell, assign or otherwise transfer any Bonds delivered to it under this Agreement except to a successor administrative agent under the Credit Agreement. The Company may take such actions as it shall deem necessary, desirable or appropriate to effect compliance with such restrictions on transfer, including the issuance of stop-transfer instructions to the trustee under the Indenture or any other transfer agent thereunder. Section 2.2 Surrender of Bonds. (a) The Agent shall forthwith surrender to or upon the order of the Company all Bonds held by it at the first time at which the Commitments shall have been terminated and all Obligations shall have been paid in full. (b) Upon any permanent reduction in the Aggregate Commitment pursuant to the terms of the Credit Agreement, the Agent shall forthwith surrender to or upon the order of the Company Bonds in an aggregate principal amount equal to the excess of the aggregate principal amount of Bonds held by the Agent over the Aggregate Commitment. ARTICLE III GOVERNING LAW This Agreement shall construed in accordance with and governed by the internal laws (without regard to the conflict of laws provisions) of the State of New York, but giving effect to Federal laws applicable to national banks. [SIGNATURE PAGE FOLLOWS] G-3 IN WITNESS WHEREOF, the Company and the Agent have caused this Agreement to be executed and delivered as of the date first above written. CONSUMERS ENERGY COMPANY ___________________________________________ Name: Title: Barclays Bank PLC, as Agent ___________________________________________ Name: Title: G-4 EXHIBIT H FORM OF INCREASE REQUEST _________________________, 20___ Barclays Bank PLC, as Agent under the Credit Agreement referred to below Ladies/Gentlemen: Please refer to the Credit Agreement dated as of March 31, 2006 among Consumers Energy Company (the "Company"), various financial institutions and Barclays Bank PLC, as Agent (as amended, modified, extended or restated from time to time, the "Credit Agreement"). Capitalized terms used but not defined herein have the respective meanings set forth in the Credit Agreement. In accordance with Section 2.5(c) of the Credit Agreement, the Company hereby requests an increase in the Aggregate Commitment from $__________ to $__________. Such increase shall be made by [increasing the Commitment of ____________ from $________ to $________] [adding _____________ as a Bank under the Credit Agreement with a Commitment of $____________] as set forth in the letter attached hereto. Such increase shall be effective three Business Days after the date that the Agent accepts the letter attached hereto or such other date as is agreed among the Company, the Agent and the [increasing] [new] Bank. Very truly yours, CONSUMERS ENERGY COMPANY By: _________________________________ Name: _______________________________ Title: ______________________________ H-1 ANNEX I TO EXHIBIT H [Date] Barclays Bank PLC, as Agent under the Credit Agreement referred to below Ladies/Gentlemen: Please refer to the letter dated __________, 20__ from Consumers Energy Company (the "Company") requesting an increase in the Aggregate Commitment from $__________ to $__________ pursuant to Section 2.5(c) of the Credit Agreement dated as of March 31, 2006 among the Company, various financial institutions and Barclays Bank PLC, as Agent (as amended, modified, extended or restated from time to time, the "Credit Agreement"). Capitalized terms used but not defined herein have the respective meanings set forth in the Credit Agreement. The undersigned hereby confirms that it has agreed to increase its Commitment under the Credit Agreement from $__________ to $__________ effective on the date which is three Business Days after the acceptance hereof by the Agent or on such other date as may be agreed among the Company, the Agent and the undersigned. Very truly yours, [NAME OF INCREASING BANK] By: __________________________ Title: ______________________ Accepted as of __________, _____ Barclays Bank PLC, as Agent By: ________________________________ Name: _____________________________ Title: _____________________________ H-2 ANNEX II TO EXHIBIT H [Date] Barclays Bank PLC, as Agent under the Credit Agreement referred to below Ladies/Gentlemen: Please refer to the letter dated __________, 20___ from Consumers Energy Company (the "Company") requesting an increase in the Aggregate Commitment from $__________ to $__________ pursuant to Section 2.5(c) of the Credit Agreement dated as of March 31, 2006 among the Company, various financial institutions and Barclays Bank PLC, as Agent (as amended, modified, extended or restated from time to time, the "Credit Agreement"). Capitalized terms used but not defined herein have the respective meanings set forth in the Credit Agreement. The undersigned hereby confirms that it has agreed to become a Bank under the Credit Agreement with a Commitment of $__________ effective on the date which is three Business Days after the acceptance hereof, and consent hereto, by the Agent or on such other date as may be agreed among the Company, the Agent and the undersigned. The undersigned (a) acknowledges that it has received a copy of the Credit Agreement and the Schedules and Exhibits thereto, together with copies of the most recent financial statements delivered by the Company pursuant to the Credit Agreement, and such other documents and information as it has deemed appropriate to make its own credit and legal analysis and decision to become a Bank under the Credit Agreement; and (b) agrees that it will, independently and without reliance upon the Agent or any other Bank and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit and legal decisions in taking or not taking action under the Credit Agreement. The undersigned represents and warrants that (i) it is duly organized and existing and it has full power and authority to take, and has taken, all action necessary to execute and deliver this letter and to become a Bank under the Credit Agreement; and (ii) no notices to, or consents, authorizations or approvals of, any Person are required (other than any already given or obtained) for its due execution and delivery of this letter and the performance of its obligations as a Bank under the Credit Agreement. The undersigned agrees to execute and deliver such other instruments, and take such other actions, as the Agent may reasonably request in connection with the transactions contemplated by this letter. H-3 The following administrative details apply to the undersigned: (A) Notice Address: Legal name: __________________________ Address: _______________________________ _________________________________ _________________________________ Attention: _____________________________ Telephone: (___) _______________________ Facsimile: (___) ______________________ (B) Payment Instructions: Account No.: ___________________________ At: __________________________________ _________________________________ _________________________________ Reference: ___________________________ Attention: ___________________________ The undersigned acknowledges and agrees that, on the date on which the undersigned becomes a Bank under the Credit Agreement as set forth in the second paragraph hereof, the undersigned will be bound by the terms of the Credit Agreement as fully and to the same extent as if the undersigned were an original Bank under the Credit Agreement. Very truly yours, [NAME OF NEW BANK] By: ______________________________ Title: ___________________________ Accepted and consented to as of ______________, 20___ Barclays Bank PLC, as Agent By: _____________________________ Name: ___________________________ Title: __________________________ H-4 EXHIBIT I FORM OF MORTGAGE AND SECURITY AGREEMENT [TO BE ATTACHED] I-1 SCHEDULE 1 PRICING SCHEDULE
Greater than or equal to BBB+ from S&P or greater Equal to BBB Equal to BBB- Equal to BB+ Equal to BB Lower than BB than or equal from S&P or from S&P or from S&P or from S&P or from S&P or to Baa1 from equal to Baa2 equal to Baa3 equal to Ba1 equal to Ba2 lower thanBa2 Ratings (1) Moody's from Moody's from Moody's from Moody's from Moody's from Moody's - ----------------- -------------- ------------- --------------- --------------- ------------ --------------- Commitment Fee 10.0 bp 12.50 bp 15.0 bp 17.5 bp 20.0 bp 32.50 bp Applicable Margin 50.0 bp 60.0 bp 87.5 bp 112.5 bp 125.0 bp 250.0 bp Eurodollar Loans Applicable Margin ABR Loans 0.0 bp 0.0 bp 0.0 bp 12.5 bp 25.0 bp 150.0 bp
(1) Pricing shall be based on (a) prior to the FMB Release Date, the S&P rating or the Moody's rating (whichever is higher) that is immediately below such rating agency's rating for the Company's First Mortgage Bonds, provided that if the Agent has received First Mortgage Bonds to secure the full amount of the Obligations, pricing shall be based on the S&P rating or the Moody's rating (whichever is higher) for the Company's First Mortgage Bonds; and (b) on and after the FMB Release Date, the S&P rating or the Moody's rating (whichever is higher) for the Company's senior unsecured long-term debt (without third-party credit enhancement) or, if there is no such rating, the rating that is immediately below such rating agency's rating for the Company's First Mortgage Bonds. If the Company exercises the Term Out Option, then during the term period the Applicable Margin for Eurodollar Loans shall increase by 25 bp at all rating levels and the Applicable Margin for ABR Loans shall increase by 12.5 bp at the BBB-/Baa3 level and by 25 bp at each of the lowest three levels. 1-1 SCHEDULE 2 COMMITMENT SCHEDULE
BANK COMMITMENT - ---- ---------- Barclays Bank PLC $ 21,000,000 Union Bank of California, N.A. $ 21,000,000 BNP Paribas $ 19,000,000 Deutsche Bank Trust Company Americas $ 19,000,000 Wachovia Bank $ 19,000,000 Citibank, N.A. $ 19,000,000 JPMorgan Chase Bank, N.A. $ 19,000,000 Merrill Lynch $ 19,000,000 The Bank of Nova Scotia $ 19,000,000 UBS $ 17,000,000 Comerica Bank $ 17,000,000 Fifth Third Bank $ 17,000,000 LaSalle Bank Midwest National Association $ 17,000,000 SunTrust Bank $ 17,000,000 Wells Fargo Bank National Association $ 17,000,000 Huntington National Bank $ 14,000,000 The Norinchukin Bank $ 9,000,000 AGGREGATE COMMITMENT $300,000,000
2-1 SCHEDULE 3 NOTICE INFORMATION Consumers Energy Company: One Energy Plaza Jackson, MI 49201 Attention: Beverly S. Burger Phone: (517) 788-2541 Facsimile: (517) 788-0412 E-Mail: bsburger@cmsenergy.com Barclays Bank PLC: Barclays Bank PLC, New York Branch 200 Park Avenue, 4th Floor New York, NY 10166 Telephone: 212-412-7693 Telecopier: 212-412-7600 Attention: David Barton Email: davide.barton@barcap.com With a copy to: Barclays Bank PLC/Global Services Unit 200 Cedar Knolls Road Whippany, New Jersey 07981 Telephone: 973-576-3251 Telecopier: 973-576-3014 Attention: May Wong Email: may.wong@barcap.com 3-1 EX-31.(A) 3 k04805exv31wxay.txt CMS - SECTION 302 CERTIFICATION OF CEO Exhibit (31)(a) CERTIFICATION OF DAVID W. JOOS I, David W. Joos, 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 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)), and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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 d) 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 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: May 3, 2006 By: /s/ David W. Joos ----------------------------- David W. Joos President and Chief Executive Officer EX-31.(B) 4 k04805exv31wxby.txt CMS - SECTION 302 CERTIFICATION OF CFO 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 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)), and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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 d) 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 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: May 3, 2006 By /s/ Thomas J. Webb --------------------------------- Thomas J. Webb Executive Vice President and Chief Financial Officer EX-31.(C) 5 k04805exv31wxcy.txt CONSUMERS ENERGY COMPANY - SECTION 302 CERTIFICATION OF CEO Exhibit (31)(c) CERTIFICATION OF DAVID W. JOOS I, David W. Joos, 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 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)), and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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 d) 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 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: May 3, 2006 By: /s/ David W. Joos ------------------------------- David W. Joos Chief Executive Officer EX-31.(D) 6 k04805exv31wxdy.txt CONSUMERS ENERGY COMPANY - SECTION 302 CERTIFICATION OF CFO 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 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)), and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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 d) 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 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: May 3, 2006 By /s/ Thomas J. Webb ---------------------------------- Thomas J. Webb Executive Vice President and Chief Financial Officer EX-32.(A) 7 k04805exv32wxay.txt CMS - SECTION 906 CERTIFICATION OF CEO 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 March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), David W. Joos, as President 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/ David W. Joos - -------------------------------------- Name: David W. Joos Title: President and Chief Executive Officer Date: May 3, 2006 /s/ Thomas J. Webb - -------------------------------------- Name: Thomas J. Webb Title: Executive Vice President and Chief Financial Officer Date: May 3, 2006 EX-32.(B) 8 k04805exv32wxby.txt CONSUMERS ENERGY COMPANY - SECTION 906 CERTIFICATION 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 March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), David W. Joos, as 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/ David W. Joos - -------------------------------------- Name: David W. Joos Title: Chief Executive Officer Date: May 3, 2006 /s/ Thomas J. Webb - -------------------------------------- Name: Thomas J. Webb Title: Executive Vice President and Chief Financial Officer Date: May 3, 2006 -----END PRIVACY-ENHANCED MESSAGE-----