================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005MARCH 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]|X| No [ ]
Indicate by check mark whether the Registrants areRegistrant is a large accelerated filers (as
definedfiler, 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).Act.
CMS ENERGY CORPORATION: YesLarge accelerated filer [X] NoAccelerated filer [ ]
Non-Accelerated filer [ ]
CONSUMERS ENERGY COMPANY: YesLarge accelerated filer [ ] NoAccelerated filer [ ]
Non-Accelerated filer [X]
Indicate by check mark whether the Registrants areRegistrant 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]
NumberIndicate the number of shares outstanding of each of the issuer's classes of
common stock at October 31, 2005:April 28, 2006:
CMS ENERGY CORPORATION:
CMS Energy Common Stock, $.01 par value 220,095,482221,147,846
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 SEPTEMBER 30, 2005MARCH 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............................................................. 4Glossary................................................................................................ 3
PART I: FINANCIAL INFORMATION
CMS Energy Corporation
Management's Discussion and Analysis
Executive Overview.............................................Overview........................................................................... CMS - 1
Forward-Looking Statements and Risk Factors....................Factors.................................................. CMS - 2
Results of Operations..........................................Operations........................................................................ CMS - 5
Critical Accounting Policies...................................Policies................................................................. CMS - 10
Capital Resources and Liquidity.............................................................. CMS - 14
Capital Resources and Liquidity................................Outlook...................................................................................... CMS - 20
Outlook........................................................ CMS - 2216
Implementation of New Accounting Standards.....................Standards................................................... CMS - 31
New Accounting Standards Not Yet Effective..................... CMS - 3123
Consolidated Financial Statements
Consolidated Statements of Income ........................................................................................ CMS - 3424
Consolidated Statements of Cash Flows..........................Flows........................................................ CMS - 3727
Consolidated Balance Sheets....................................Sheets.................................................................. CMS - 3828
Consolidated Statements of Common Stockholders' Equity.........Equity....................................... CMS - 4030
Condensed Notes to Consolidated Financial Statements:Statements (Unaudited):
1. Corporate Structure and Accounting Policies................Policies............................................. CMS - 4131
2. Asset Impairment Charges and Sales.........................Contingencies........................................................................... CMS - 4333
3. Contingencies..............................................Financings and Capitalization........................................................... CMS - 4448
4. Financings and Capitalization..............................Earnings Per Share...................................................................... CMS - 5950
5. Earnings Per Share......................................... CMS - 63
6. Financial and Derivative Instruments.......................Instruments.................................................... CMS - 65
7.51
6. Retirement Benefits........................................Benefits..................................................................... CMS - 70
8.57
7. Asset Retirements Obligations..............................Retirement Obligations............................................................ CMS - 7258
8. Executive Incentive Compensation........................................................ CMS - 60
9. Equity Method Investments..................................Investments............................................................... CMS - 7362
10. Reportable Segments .......................................Segments..................................................................... CMS - 74
11. Consolidation of Variable Interest Entities................ CMS - 75
12. Implementation of New Accounting Standards................. CMS - 7663
21
TABLE OF CONTENTS
(CONTINUED)
Page
--------
Consumers Energy Company
Management's Discussion and Analysis
Executive Overview.............................................Overview........................................................................... CE - 1
Forward-Looking Statements and Risk Factors....................Factors.................................................. CE - 2
Results of Operations..........................................Operations........................................................................ CE - 4
Critical Accounting Policies...................................Policies................................................................. CE - 8
Capital Resources and Liquidity.............................................................. CE - 11
Capital Resources and Liquidity................................Outlook...................................................................................... CE - 15
Outlook........................................................13
Implementation of New Accounting Standards................................................... CE - 17
New Accounting Standards Not Yet Effective..................... CE - 2419
Consolidated Financial Statements
Consolidated Statements of Income..............................Income............................................................ CE - 2620
Consolidated Statements of Cash Flows..........................Flows........................................................ CE - 2721
Consolidated Balance Sheets....................................Sheets.................................................................. CE - 2822
Consolidated Statements of Common Stockholder's Equity.........Equity....................................... CE - 3024
Condensed Notes to Consolidated Financial Statements:Statements (Unaudited):
1. Corporate Structure and Accounting Policies................Policies.............................................. CE - 3127
2. Asset Impairment Charges...................................Contingencies............................................................................ CE - 3228
3. Contingencies..............................................Financings and Capitalization............................................................ CE - 3339
4. FinancingsFinancial and Capitalization..............................Derivative Instruments..................................................... CE - 40
5. Retirement Benefits...................................................................... CE - 45
5. Financial and Derivative Instruments.......................6. Asset Retirement Obligations............................................................. CE - 47
7. Executive Incentive Compensation......................................................... CE - 48
6. Retirement Benefits........................................8. Reportable Segments...................................................................... CE - 53
7. Asset Retirement Obligations............................... CE - 55
8. Reportable Segments ....................................... CE - 56
9. Consolidation of Variable Interest Entities................ CE - 57
10. New Accounting Standards Not Yet Effective................. CE - 5750
Quantitative and Qualitative Disclosures about Market Risk...........Risk.............................................. CO - 1
Controls and Procedures..............................................Procedures................................................................................. CO - 1
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.........................................Proceedings...................................................................... CO - 12
Item 1A. Risk Factors............................................................................. CO - 5
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds...............................................Proceeds............................ CO - 57
Item 3. Defaults Upon Senior Securities...........................Securities........................................................ CO - 57
Item 4. Submission of Matters to a Vote of Security Holders.......Holders.................................... CO - 57
Item 5. Other Information.........................................Information...................................................................... CO - 57
Item 6. Exhibits..................................................Exhibits............................................................................... CO - 6
Signatures........................................................7
Signatures........................................................................................ CO - 78
32
GLOSSARY
Certain terms used in the text and financial statements are defined below
ABO........................... Accumulated Benefit Obligation. The liabilities
of a pension plan based on service and pay to
date. This differs from the Projected Benefit
Obligation that is typically disclosed in that
it does not reflect expected future salary
increases.
ALJ...........................AFUDC.............................. Allowance for Funds Used During Construction
ALJ................................ Administrative Law Judge
Alliance RTO.................. Alliance Regional Transmission Organization
APB...........................APB................................ Accounting Principles Board
APB Opinion No. 18............18................. APB Opinion No. 18, "The Equity Method of Accounting for Investments in
Common Stock"
ARO...........................ARO................................ Asset retirement obligation
Articles...................... Articles of Incorporation
Attorney General..............General................... Michigan Attorney General
Bay Harbor....................Harbor......................... a residential/commercial real estate area located near Petoskey,
Michigan. In 2002, CMS Energy sold its interest in Bay Harbor.
bcf........................... Billionbcf................................ One billion cubic feet of gas
Big Rock......................Rock........................... Big Rock Point nuclear power plant, owned by Consumers
Bluewater Pipeline............ Bluewater Pipeline, a 24.9-mile pipeline that
extends from Marysville, Michigan to Armada,
Michigan.
Board of Directors............Directors................. Board of Directors of CMS Energy
CEO...........................CEO................................ Chief Executive Officer
CFO...........................CFO................................ Chief Financial Officer
CFTC............................... Commodity Futures Trading Commission
Clean Air Act.................Act...................... Federal Clean Air Act, as amended
CMS Energy....................Energy......................... CMS Energy Corporation, the parent of Consumers and Enterprises
CMS Energy Common Stock or
common stock...............stock..................... Common stock of CMS Energy, par value $.01 per share
CMS ERM.......................ERM............................ CMS Energy Resource Management Company, formerly CMS MST, a subsidiary
of Enterprises
CMS Field Services............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..........Transmission............... CMS Gas Transmission Company, a subsidiary of Enterprises
CMS Generation................Generation..................... CMS Generation Co., a subsidiary of Enterprises
CMS MST.......................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...............Gas.................... CMS Oil and Gas Company, formerly a subsidiary of Enterprises
Common Stock.................. All classes of Common Stock of CMS Energy and
each of its subsidiaries, or any of them
individually, at the time of an award or grant
under the Performance Incentive Stock Plan
4
Consumers.....................Consumers.......................... Consumers Energy Company, a subsidiary of CMS Energy
CPEE............................... Companhia Paulista de Energia Eletrica, a subsidiary of Enterprises
3
Customer Choice Act...........Act................ Customer Choice and Electricity Reliability Act, a Michigan statute
enacted in June 2000
that allows all retail customers choice of
alternative electric suppliers as of January 1,
2002, provides for full recovery of net
stranded costs and implementation costs,
establishes a five percent reduction in
residential rates, establishes rate freeze and
rate cap, and allows for SecuritizationDCCP............................... Defined Company Contribution Plan
Detroit Edison................Edison..................... The Detroit Edison Company, a non-affiliated company
DIG...........................DIG................................ Dearborn Industrial Generation, LLC, a wholly owned subsidiary of CMS
Generation
DOE...........................DOE................................ U.S. Department of Energy
DOJ...........................DOJ................................ U.S. Department of Justice
EISP..........................Dow................................ The Dow Chemical Company, a non-affiliated company
EISP............................... Executive Incentive Separation Plan
EITF..........................EITF............................... Emerging Issues Task Force
EITF Issue No. 02-03..........02-03............... Issues Involved in Accounting for Derivative Contracts Held for Trading
Purposes and Contracts Involved in Energy Trading and Risk Management
Activities
Enterprises...................Enterprises........................ CMS Enterprises Company, a subsidiary of CMS Energy
EPA...........................EPA................................ U. S. Environmental Protection Agency
EPS...........................EPS................................ Earnings per share
ERISA.........................ERISA.............................. Employee Retirement Income Security Act
Ernst & Young................. Ernst & Young LLP
Exchange Act..................Act....................... Securities Exchange Act of 1934, as amended
FASB..........................FASB............................... Financial Accounting Standards Board
FASB Interpretation No. 46....46(R)...... Revised FASB Interpretation No. 46, Consolidation of Variable Interest
Entities
FERC..........................FERC............................... Federal Energy Regulatory Commission
FMB...........................FIN 47............................. FASB Interpretation No. 47, Accounting for Conditional Asset Retirement
Obligations
FMB................................ First Mortgage Bonds
FMLP..........................FMLP............................... First Midland Limited Partnership, a partnership that holds a lessor
interest in the MCV facility
FSP........................... FASB Staff Position
FTR...........................Facility and an indirect subsidiary of Consumers
FTR................................ Financial transmission right
GAAP..........................GAAP............................... Generally Accepted Accounting Principles
GasAtacama....................GasAtacama......................... An integrated natural gas pipeline and electric generation projectgenerating plant located
in Argentina and Chile, which includes 702 miles of natural gas pipeline
and a 720 MW gross capacity power plant
GCR...........................GCR................................ Gas cost recovery
Goldfields.................... A pipeline businessGVK................................ GVK Facility, a 250 MW gas fired power plant located in Australia,South Central
India, in which CMS EnergyGeneration formerly held a 39.733 percent ownership interest
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
5
Health Care Plan.............. The medical, dental, and prescription drug
programs offered to eligible employees of
Consumers and CMS Energy
IRS...........................IRS................................ Internal Revenue Service
Jorf Lasfar...................Lasfar........................ The 1,356 MW coal-fueled power plant in Morocco, jointly owned by CMS
Generation and ABB Energy Ventures, Inc.
kWh........................... Kilowatt-hour
LORB.......................... Limited Obligation Revenue Bonds
Loy Yang...................... The 2,000Jubail............................. A 240 MW brown coal fueled Loy Yang Anatural gas cogeneration power plant and an associated coal minelocated in Victoria,
Australia,Saudi Arabia,
in which CMS Generation heldowns a 5025 percent ownership interest
Ludington.....................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........................... Thousandmcf................................ One thousand cubic feet of gas
MCV Facility..................Facility....................... A natural gas-fueled, combined-cycle cogeneration facility operated by
the MCV Partnership
MCV Partnership...............Partnership.................... Midland Cogeneration Venture Limited Partnership in which Consumers has
a 49 percent interest through CMS Midland
MCV PPA.......................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..........................&A............................... Management's Discussion and Analysis
MDEQ..........................MDEQ............................... Michigan Department of Environmental Quality
METC............................... Michigan Electric Transmission Company, LLC
Midwest Energy Market.........Market.............. An energy market developed by the MISO to provide day-ahead and
real-time market information and centralized dispatch for market
participants
MISO..........................MISO............................... Midwest Independent Transmission System Operator, Inc.
Moody's....................... Moody's Investors Service, Inc.
MPSC..........................MPSC............................... Michigan Public Service Commission
MSBT.......................... Michigan Single Business Tax
MTH........................... Michigan Transco Holdings, Limited Partnership
MW............................ Megawatts
NEIL..........................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
NMC...........................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...........................NOL................................ Net Operating Loss
NRC...........................NRC................................ Nuclear Regulatory Commission
NYMEX......................... New York Mercantile Exchange
6
OPEB..........................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
Panhandle.....................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...........................PCB................................ Polychlorinated biphenyl
Pension Plan..................Plan....................... The trusteed, non-contributory, defined benefit pension plan of
Panhandle, Consumers and CMS Energy
Price Anderson Act............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..........................PSCR............................... Power supply cost recovery
PURPA.........................PURPA.............................. Public Utility Regulatory Policies Act of 1978
RCP...........................RCP................................ Resource Conservation Plan
ROA...........................ROA................................ Retail Open Access
RRP...........................RRP................................ Renewable Resources Program
RTO........................... Regional Transmission Organization
S&P........................... Standard & Poor's Rating Group, a division of
the McGraw Hill Companies, Inc.
SEC...........................SAB No. 107........................ Staff Accounting Bulletin No. 107, Share-Based Payment
SEC................................ U.S. Securities and Exchange Commission
Section 10d(4) Regulatory Asset......................Asset.... Regulatory asset as described in Section 10d(4) of the Customer Choice
Act, as amended
Securitization................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........................SENECA............................. Sistema Electrico del Estado Nueva Esparta C.S., a subsidiary of
Enterprises
SERP..........................SERP............................... Supplemental Executive Retirement Plan
SFAS..........................SFAS............................... Statement of Financial Accounting Standards
SFAS No. 5....................5......................... SFAS No. 5, "Accounting for Contingencies"
SFAS No. 71...................71........................ SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation"
SFAS No. 87...................87........................ SFAS No. 87, "Employers' Accounting for Pensions"
SFAS No. 98...................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..................106....................... SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions"
SFAS No. 115..................115....................... SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities"
SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities"
7
SFAS No. 123..................123(R).................... SFAS No. 123 "Accounting for Stock-Based
Compensation"(revised 2004), "Share-Based Payment"
SFAS No. 133..................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..................143....................... SFAS No. 143, "Accounting for Asset Retirement Obligations"
Shuweihat.....................Shuweihat.......................... A power and desalination plant of Emirates CMS Power Company, in which
CMS Power Company, in which CMS Generation holds a
20 percent interest
SLAP.......................... Scudder Latin American Power FundGeneration holds a 20 percent interest
6
Special Committee.............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..................... 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.....................Superfund.......................... Comprehensive Environmental Response, Compensation and Liability Act
Taweelah...................... Al Taweelah A2, aTakoradi........................... A 200 MW open-cycle combustion turbine crude oil power and desalination plant of Emirates CMS Power Company,located in
Ghana, in which CMS Generation holdsowns 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
87
(This page intentionally left blank)
98
CmsCMS 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, 2004.2005.
EXECUTIVE OVERVIEW
CMS Energy is an integrated energy company with a business strategy focusedoperating 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. Weprovides
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. Going forward,Although most of our business plan of "building on the basics" will focus on
reducing parent company debt substantially, improving our credit ratings,
growing earnings, restoring a common stock dividend, and positioning usasset sales program is complete, we
still may sell certain remaining businesses or assets as opportunities arise.
We are working to make
new investments consistent with our strengths.reduce Parent debt. In the near term, our new
investments will concentrate on the utility.
Althoughfirst quarter of 2006, we are looking aheadretired
$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 business opportunities, the future holds
important challengesbe a challenge for us. TheNatural 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 reevaluatedto reevaluate the economics of operating
the MCV Facility and determined thatto 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 $1.159
billion was requiredour ownership interest in September 2005. After accounting forthe 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 and income tax impacts, our third quarter 2005 net income was reduced by $369
million. We further reduced our third quarter 2005 net income by $16 million by
impairing certain other assets on our Consolidated Balance Sheets related toowners in the MCV Partnership. WePartnership 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. For additional details
regarding the impairment, see Note 2, Asset Impairment ChargesThe MCV Partnership is working aggressively to reduce costs,
improve operations, and Sales.
Weenhance cash flows.
Going forward, our strategy will continue to be challenged by the substantial increase in natural gas prices.
Priorfocus on:
- managing cash flow issues,
- reducing parent company debt,
- maintaining and growing earnings, and
- positioning us to Hurricane Katrina in August 2005, NYMEX forward natural gas prices
through 2010 were approximately $2 per mcf higher than they were at year-end
2004. The effects of this summer's hurricanes, combined with tight natural gas
supplies, have caused natural gas pricesmake investments that complement our strengths.
As we execute our strategy, we will need to increase even further. Although our
natural gas purchases are recoverable from our utility customers, as gas prices
increase, the amount we pay for natural gas stored as
CMS-1
Cms Energy Corporation
inventory will require additional liquidity due to the timing of the cost
recoveries from our customers. We have requested authority from the MPSC to
recover the gas cost increases experienced by the gas utility. As of October
2005, our gas storage facilities are full and approximately 83 percent of our
gas purchase requirements for the 2005-2006 heating season are under fixed price
contracts.
Our electric utility customer base includesovercome a mix of residential, commercial,
and diversified industrial customers. A sluggish Michigan economy
that has been hurting our industrial sales. Recentfurther hampered by recent negative developments in Michigan's
automotive industry and limited growth in the non-automotive sectors of our
largest industrial segment, could have long-term
impacts oneconomy.
These negative effects will be offset somewhat by the reduction we are
experiencing in ROA load in our commercial and industrial customer base.
Additionally, Michigan's Customer Choice Act allows our electric customers to
buy electric generation service from an alternative electric supplier. As of
October 2005,territory. At March 31, 2006,
alternative electric suppliers arewere providing 754348 MW of generation service to
ROA customers. This is however, down from 877 MW in October 2004,4 percent of our total distribution load and represents a
decrease of 14 percent. We expect this trend down61 percent compared to continue through year end,
but cannotMarch 31, 2005. It is, however, difficult to
predict future load loss.
Our business plan is targeted at predictableROA customer trends.
Finally, successful execution of our strategy will require continuing earnings
growth and debt reduction.
Between 2001 and 2003, we reduced parent debt (ie: excluding Consumers' and
other subsidiaries' debt) by 50 percent. We are now in the second year of a
five-year plan to reduce parent debt further, by about half. In 2005, we retired
higher-interest rate consolidated debt through the use of proceedscash flow contributions from the
issuance of $150 million of CMS Energy senior notes and $875 million of
Consumers' FMB. We also issued 23 million shares of common stock and infused
$550 million into Consumers in 2005. By the end of the first quarter of 2006,
Consumers will extinguish through a defeasance $129 million of 9 percent notes.
These efforts, and others, are designed to lead us to be a strong, reliable
energy company that will be poised to take advantage of opportunities for
further growth.our Enterprises businesses.
FORWARD-LOOKING STATEMENTS AND RISK FACTORSINFORMATION
This Form 10-Q and other written and oral statements that we make contain
forward-looking statements as defined in Rule 3b-6 ofunder the Securities Exchange
Act of 1934, as amended, Rule 175 ofunder the Securities Exchange 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,
as
well asincluding 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,
CMS-2
Cms Energy Corporation
- 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 future Stranded Costs incurred due to customers
choosing alternative energy suppliers,
- 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,
and
- 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 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 adverse impacts of the new Midwest Energy Market upon power
supply and transmission costs,
- 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 atas derivatives,
CMS-3
CMS ERM as derivatives,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,
CMS-3
Cms Energy Corporation
- 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 3,
Contingencies.2, Contingencies, and Part II,
Item 1A. Risk Factors.
CMS-4
CmsCMS Energy Corporation
RESULTS OF OPERATIONS
CMS ENERGY CONSOLIDATED RESULTS OF OPERATIONS
In Millions (except for
per share amounts)
---------------------------------------------------
Three months ended September 30March 31 2006 2005 2004 Change
- ---------------------------------------------------------- ------- ------ ----- ---------------
Net Income (Loss) Available to Common Stockholders $ (265)(27) $ 56150 $ (321)(177)
Basic Earnings (Loss) Per Share $(1.21) $0.35 $(1.56)$(0.12) $ 0.77 $ (0.89)
Diluted Earnings (Loss) Per Share $(1.21) $0.34 $(1.55)$(0.12) $ 0.74 $ (0.86)
------ ----- ------ --------
Electric Utility $ 6229 $ 4933 $ 13(4)
Gas Utility (16) (11) (5)37 58 (21)
Enterprises (260) 59 (319)(Includes MCV Partnership and FMLP interests) (49) 105 (154)
Corporate Interest and Other (51) (49) (2)(45) (46) 1
Discontinued Operations 1 - 8 (8)1
------ ----- ------ CMS Energy--------
Net Income (Loss) Available to Common Stockholders $ (265)(27) $ 56150 $ (321)(177)
====== ===== ====== ========
For the three months ended September 30, 2005, ourMarch 31, 2006, net loss available to common
stockholders was $265$27 million compared to $56 million of net income available
to common stockholdersof $150 million for the three months ended September 30, 2004.2005.
The decrease is primarily due to an impairment charge to property, plant,reflects mark-to-market losses in 2006 on certain long-term gas
contracts and equipmentassociated financial hedges at the MCV Partnership compared to
reflectmark-to-market gains in 2005. Further contributing to the excess of the carrying value of
these assets over their estimated fair values. The decrease also reflects the
absence in 2005 of gains associated with the sale of our interest in Goldfieldswere
mark-to-market losses at CMS ERM and a reduction in net income from our gas
utility as higher operating and
maintenance costs exceeded the benefits derived from increased deliveries and
the increase in revenue resulting from the gas rates surcharge authorized by the
MPSC in October 2004. Partially offsetting these losses are higher earnings at
our electric utility primarily due to lower, weather-driven higher than normal
residential electric utility sales and the collection of an electric surcharge
related to the recovery of costs incurred in the transition to customer choice.
The reduction was also partially offset by increases in the fair value of
certain long-term gas contracts and financial hedges at the MCV Partnership and
interest rate swaps at Taweelah.sales.
Specific changes to net income (loss) available to common stockholders for the
three months ended September 30,March 31, 2006 versus 2005 versus the same period in 2004 are:
In Millions
-----------
- - decrease in earnings from our ownership interest in the MCV Partnership
primarily due to a $385 million impairment charge to property, plant, and
equipment to reflectdecrease in the excess of the carrying value over the estimated
fair values of these assets, offset partially by an increase of $67 million
from operations, primarily due to an increase in fair value of certain long-term gas
contracts and financial hedges, $(318)$ (125)
- - the absencedecrease in net income from CMS ERM primarily due to mark-to-market losses
recorded in 2006 versus gains recorded in 2005, of the gain on the sale of our interest in Goldfields, (29)
- - the absence in 2005 of net gains associated with discontinued operations, (8)
CMS-5
Cms Energy Corporation
(24)
- - decrease in net income from our gas utility primarily due to increasesa reduction
in benefit costs and safety, reliability and customer service expenses offset
partially by increased deliveries and increased revenue associated with the
gas rate surcharge authorized by the MPSC in October of 2004, (5)
- - increase in corporate interest and other expenses primarily due to premiums
paid on the early retirement of a portion of our 9.75 percent senior notes
offset by reduced interest expense, (2)
- - increase in income at our electric utility primarily due to weather-driven
higher than normal residential electric utility sales and the collection of
electric surcharges related to the recovery of MPSC approved costs, offset
partially by increased operating expenses and power supply costs, 13
- - increase in the fair value of interest rate swaps associated with our
investment in Taweelah as we recorded gains in 2005 versus losses in 2004, 13
- - income tax benefit recorded at Enterprises resulting from the American Jobs
Creation Act of 2004, and 10
- - increasewarmer weather in income from CMS ERM primarily due to mark-to-market
adjustments. 5
-----
Total Change $(321)
=====
In Millions (except for
per share amounts)
-----------------------
Nine months ended September 30 2005 2004 Change
- ------------------------------ ------ ----- ------
Net Income (Loss) Available to Common Stockholders $ (88) $ 63 $ (151)
Basic Earnings (Loss) Per Share $(0.42) $0.39 $(0.81)
Diluted Earnings (Loss) Per Share $(0.42) $0.38 $(0.80)
------ ----- ------
Electric Utility $ 141 $ 124 $ 17
Gas Utility 39 46 (7)
Enterprises (126) 36 (162)
Corporate Interest and Other (142) (147) 5
Discontinued Operations - 6 (6)
Accounting Changes - (2) 2
------ ----- ------
CMS Energy Net Income (Loss) Available to Common Stockholders $ (88) $ 63 $ (151)
====== ===== ======
For the nine months ended September 30, 2005, our net loss available to common
stockholders was $88 million, compared to $63 million of net income available to
common stockholders for the nine months ended September 30, 2004. The decrease
is primarily due to an asset impairment charge to property, plant, and equipment
at the MCV Partnership to reflect the excess of the carrying value of these
assets over their estimated fair values. The decrease also reflects the absence
in 2005 of the gain on the sale of our interest in Goldfields and a decrease in
net income at our gas utility due to higher operating costs and depreciation
expense. Partially offsetting these decreases is an increase in the fair value
of certain long-term gas contracts and financial hedges at the MCV Partnership
and the positive impact at our electric utility due to an increase in the
collection of an electric surcharge related to the recovery of costs incurred
in the transition to customer choice, increased regulatory return on capital
expenditures, and weather-driven higher than normal residential electric
utility sales. The reduction was also partially offset by the absence in 2005
of a 2004 Loy Yang investment impairment and tax benefits recorded in 2005
resulting from the American Jobs Creation Act of 2004.
CMS-6
CMS Energy Corporation
Specific changes to net income (loss) available to common stockholders for the
nine months ended September 30, 2005 versus the same period in 2004 are:
In Millions
-----------
2006, (21)
- - decrease in earningsnet income from our ownership interest in the MCV
Partnership primarily due to a $385 million impairment charge
to property, plant, and equipment to reflect the excess of
the carrying value over the estimated fair values of these
assets, offset partially by an increase of $120 million from
operations, primarilyother Enterprises' subsidiaries due to an
increase in fair value of
certain long-term gas contractsoperating and financial hedges, $(265)
- - the absence in 2005 of the gain on the sale of ourmaintenance expense and higher interest in Goldfields, (29)
- - the absence in 2005 of the settlement agreement that DIG and
CMS MST entered into with the purchasers of electric power
and steam from DIG, (8)expense, (5)
- - decrease in net income from our gas utility primarily due to
increases in benefit costs and safety, reliability and
customer service expenses offset partially by increased
deliveries and increased revenue associated with the gas rate
surcharge authorized by the MPSC in October 2004, (7)
- - the absence in 2005 of net gains associated with discontinued
operations, (6)
- - the absence in 2005 of an impairment charge related to the
sale of our Loy Yang investment that was recorded in 2004, 81
- - income tax benefit recorded at Enterprises resulting from the
American Jobs Creation Act of 2004, 33
- - increase in other Enterprises income primarily due to an
increase in earnings from our overseas investments, increased
interest income, and the favorable resolution of a contingent
liability at our Leonard Field storage facility, 21
- - increase in income from our electric utility primarily due to
weather-driven higher than normal electric utility sales,increased operating expenses and a reduction in income from the regulatory
return on capital expenditures, and the collection of
electric surcharges related to the recovery of MPSC approved
costs, offset partially by increased operating expenses and
power supply purchase costs, and customers choosing
alternative suppliers, 17an increase in revenue
from an electric rate order, (4)
- - increase in income from CMS ERM primarily due to
mark-to-market adjustments, 5
- - reductiondecrease in corporate interest and other expenses, partially
offset by premiums paid on the early retirement of a portion
of our 9.75 percent senior notes, and 51
- - the absence in 2005 of a loss recorded in 2004 for the
cumulative effect of a change in accounting principle. 2
-----
TOTAL CHANGE $(151)
=====gains related to discontinued operations. 1
------
Total Change $ (177)
======
CMS-7CMS-5
CMS Energy Corporation
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
--------------------
September 30------------------------
March 31 2006 2005 2004 Change
- ------------ ---- ------------ ------ ------ --------
Three months ended $ 6229 $ 49 $13
Nine months ended $141 $124 $17
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 200533 $ (4)
Reasons for the change:
vs. 2004 vs. 2004
- ----------------------- ------------------ ------------------
Electric deliveries $ 49 $ 8759
Power supply costs and related revenue (31) (42)9
Other operating expenses, other income and non-commodity revenue (14) (45)(59)
Regulatory return on capital expenditures 7 20
General taxes 3 (1)
Fixed(13)
Interest charges 5 71
Income taxes (6) (9)
---- ----(1)
-------
Total change $ 13 $ 17
==== ====(4)
=======
ELECTRIC DELIVERIES: For the three months ended September 30, 2005, electricElectric deliveries increased 1.7decreased 0.1 billion kWh or 16.01.6
percent in the first quarter of 2006 versus the same period in
2004. For the nine months ended September 30, 2005 primarily due to warmer
weather. Despite lower electric deliveries,
increased 1.7 billion kWh or 5.8 percent versus the same period in 2004. The
corresponding increases in electric delivery revenue for both periods wereincreased
primarily due to increased sales to residential customers due to warmer weather andan electric rate order, increased surcharge revenue, offset partially by reducedand 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 revenue from
customers choosing alternative electric suppliers.
On Julyrevenues increased $20 million in the first
quarter of 2006 versus 2005.
Effective January 1, 2004, Consumers2006, we started collecting a surcharge related tothat the recoveryMPSC
authorized under Section 10d(4) of costs incurred in the transition to customer choice.Customer Choice Act. This surcharge
increased electric delivery revenue by $2$11 million forin the three months ended
September 30, 2005 and $12 million for the nine months ended September 30, 2005first quarter of 2006
versus the same periods in 2004. Surcharge revenue related to the recovery of
security2005. In addition, on January 1, 2006, we began recovering customer
choice transition costs and stranded costs increasedfrom our residential customers, thereby increasing
electric delivery revenue by an
additionalanother $3 million forin 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 three months ended September 30, 2005 and $9
million for the nine months ended September 30,first quarter of 2006
versus 2005.
POWER SUPPLY COSTS AND RELATED REVENUE: Our recovery ofIn 2005, power supply costs is
cappedexceeded
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
until January 1, 2006. For the three months
ended September 30, 2005, our underrecovery of power costs allocated to these
capped customers increased by $32 million versus the same period in 2004. For
the nine months ended September 30, 2005, our underrecovery of power costs
allocated to these capped customers increased by $53 million versus the same
period in 2004. Power supply-related costs increased in 2005 primarily due to
higher coal costs and higher priced purchased power to replace the generation
loss from outages at our Palisades and Campbell 3 generating plants.
Partially offsetting these underrecoveries are transmission and nitrogen oxide
allowance expenditures related to our capped customers. To the extent these
costs are not fully recoverable due to the applicationexpired on December 31, 2005. The absence of rate caps we have
deferred theseallows us to record power
supply revenue to offset fully our power supply costs and are requesting recovery under Public Act 141. For the
three months ended September 30, 2005, deferrals of these costs increased by $1
million versus the same period in 2004. For the nine months ended September 30,
2005, deferrals of these costs increased by $11 million versus the same period
in 2004.
CMS-8
CMS Energy Corporation2006.
OTHER OPERATING EXPENSES, OTHER INCOME AND NON-COMMODITY REVENUE: ForIn the three
months ended September 30, 2005,first
quarter of 2006, other operating expenses increased $16$62 million, other income
increased $3$5 million, and non-commodity revenue decreased $1$2 million versus
the same period in 2004. For the nine months ended September 30,
2005, other operating expenses increased $55 million, other income increased $7
million, and non-commodity revenue increased $3 million versus the same period
in 2004.2005.
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 higher 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 increased
primarily due toreflects
changes in actuarial assumptions and the remeasurement of our
pension and OPEB plans to reflect the newlatest collective bargaining agreement
between the Utility Workers Union of America and Consumers.
Benefit expense also
reflects the reinstatement of the employer matching contribution to our 401(k)
plan.
In addition, the increase in other operating expenses reflects increased
underrecovery expense related to the MCV PPA, offset partially by our direct
savings from the RCP. In 1992, a liability was established for estimated future
underrecoveries of power supply costs under the MCV PPA. In 2004, a portion of
the cash underrecoveries continued to reduce this liability until its depletion
in December. In 2005, all cash underrecoveries are expensed directly to income.
Partially offsetting this increased operating expense were the savings from the
RCP approved by the MPSC in January 2005.
The RCP allows us to dispatch the MCV Facility on the basis of natural gas
prices, which will reduce the MCV Facility's annual production of electricity
and, as a result, reduce the MCV Facility's consumption of natural gas. The MCV
Facility's fuel cost savings are first used to offset the cost of replacement
power and fund a renewable energy program. Remaining savings are split between
us and the MCV Partnership. Our direct savings are shared 50 percent with
customers in 2005 and 70 percent thereafter.
The cost associated with the MCV PPA cash underrecoveries, net of our direct
savings from the RCP, increased operating expense $4 million for the nine months
ended September 30, 2005 versus the same period in 2004.
For the three months ended September 30, 2005, the increase in other income is primarily due to higher interest income on short-term cash investments versus
the same periodabsence, in 2004. For the nine months ended September 30,2006, of
expenses recorded in 2005 the
increase in other income is primarily due to higher interest income on
short-term cash investments, offset partially by expenses associated with the early retirement of debt, versus the same period in 2004.
For the three months ended September 30, 2005, thedebt. The
decrease in non-commodity revenue is primarily due to lower transmissionrevenue from
services revenue. For the nine
months ended September 30, 2005, the increaseprovided to METC in non-commodity revenue is
primarily due to higher transmission services revenue.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 increased
income by $7Act. In
December 2005, the MPSC issued an order that authorized us to recover $333
million for the three months ended September 30, 2005 and $20
million for the nine months ended September 30, 2005of Section 10d(4) costs. The order authorized recovery of a lower level
of costs versus the same periods in
2004.
GENERAL TAXES: Forlevel used to record 2005 income.
INTEREST CHARGES: In the three months ended September 30,first quarter of 2006 versus 2005, general taxesinterest charges
decreased versus the same period in 2004 primarily due to lower property tax
expense. For the nine months ended September 30, 2005, general taxes increased
versus the same period in 2004 primarily due to higher MSBT expense, offset
partially by lower property tax expense.
CMS-9
CMS Energy Corporation
FIXED CHARGES: For the three months ended September 30, 2005, fixed charges
reflectaverage debt levels and a 4613 basis point reduction in the
average rate of interest on our debt
and lower average debt levels versus the same period in 2004. For the nine
months ended September 30, 2005, fixed charges reflect a 37 basis point
reduction in the average rate of interest on our debt and higher average debt
levels versus the same period in 2004.rate.
INCOME TAXES: ForIn the three and nine months ended September 30, 2005,first quarter of 2006, income taxes increased versus the same periods in 20042005
primarily due to higher earnings
by the electric utility.adjustment of certain deferred tax balances.
GAS UTILITY RESULTS OF OPERATIONS
In Millions
--------------------
September 30------------------
March 31 2006 2005 2004 Change
- -------------------- ---- ---- ------
Three months ended $(16) $(11) $(5)
Nine months ended $ 3937 $ 46 $(7)
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 200558 $ (21)
Reasons for the change:
vs. 2004 vs. 2004
- ----------------------- ------------------ ------------------
Gas deliveries $ 1 $ -
Gas rate increase 3 24(31)
Gas wholesale and retail services, other gas revenuesrevenue and other income 3 25
Operation and maintenance (14) (31)
General taxes(3)
Depreciation and depreciation (1) (4)
Fixed charges - (2)other deductions (3)
Income taxes 3 4
---- ----11
-----
Total change $ (5) $ (7)
==== ====(21)
=====
GAS DELIVERIES: ForIn the three months ended September 30,first quarter of 2006 versus 2005, higher gas
delivery revenues reflect increased deliveries to our customers versus the same
period in 2004. Gas deliveries, including miscellaneous transportation to
end-use customers, increased 1.4 bcf or 5.5 percent.
For the nine months ended September 30, 2005, gas delivery revenues reflect
slightly lower deliveries to our customers versus the same period in 2004. Gas deliveries,
including miscellaneous transportation to end-use customers, decreased 0.621.9 bcf
or 0.315.1 percent. GAS RATE INCREASE: In December 2003,The decrease in gas deliveries is primarily due to warmer
weather in the MPSC issued an interim gas rate order
authorizing a $19 million annual increase to gas tariff rates. In October 2004,
the MPSC issued a final order authorizing an annual increasefirst quarter of $58 million
through a two-year surcharge. As a result of these orders, gas revenues
increased $3 million for the three months ended September 30,2006 versus 2005 and $24
million forincreased conservation
efforts in response to higher gas prices. Average temperatures in the nine months ended September 30, 2005 versusfirst
quarter of 2006 were 16.7 percent warmer than the same periods in
2004.period last year.
CMS-7
CMS Energy Corporation
GAS WHOLESALE AND RETAIL SERVICES, OTHER GAS REVENUESREVENUE AND OTHER INCOME: ForIn the
three months ended September 30,first quarter of 2006 versus 2005, other incomethe $5 million increase is related primarily
to increased primarily due to
higher interest income on short-term cash investments versus the same period in
2004. For the nine months ended September 30, 2005, other income increased
primarily due to higher interest income on short-term cash investments, offset
partially by expenses associated with the early retirement of debt, versus the
same period in 2004.
CMS-10
CMS Energy Corporationgas wholesale and retail services revenue.
OPERATION AND MAINTENANCE: ForIn the three and nine months ended September 30,
2005,first quarter of 2006, operation and
maintenance expenses increased versus 2005 primarily due to increases inhigher pension and
benefit costs and additional safety, reliability,expense and customer service expenses.expense. Pension and benefit expense
increased primarily due toreflects changes in actuarial assumptions and the remeasurement of our pension and OPEB plans to reflect the
newlatest collective bargaining
agreement between the Utility Workers Union of America and Consumers. BenefitCustomer
service expense also reflectsincreased primarily due to higher uncollectible accounts
expense.
DEPRECIATION AND OTHER DEDUCTIONS: In the reinstatementfirst quarter of the employer
matching contribution to our 401(k) plan.
GENERAL TAXES AND DEPRECIATION: For the three and nine months ended September
30, 2005,2006, depreciation
expense increased versus 2005 primarily due to higher plant in service.
FIXED CHARGES: For the nine months ended September 30, 2005, fixed charges
reflect a 37 basis point reduction in the average rate of interest on our debt
and higher average debt levels versus the same period in 2004.
INCOME TAXES: ForIn the three and nine months ended September 30, 2005,first quarter of 2006, income taxes decreased versus 2005
primarily due to lower earnings by the gas utility.
ENTERPRISES RESULTS OF OPERATIONS
In Millions
---------------------
September 30--------------------------
March 31 2006 2005 2004 Change
- ------------ ----- ------------ ------ ------ --------
Three months ended $(260) $59 $(319)
Nine months ended $(126) $36 $(162)
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005$ (49) $ 105 $ (154)
Reasons for the change:
vs. 2004 vs. 2004
- ----------------------- ------------------ ------------------
Operating revenues $ 123 $ 15537
Cost of gas and purchased power (110) (154)(102)
Fuel costs mark-to-market at MCV 197 361(365)
Earnings from equity method investees 22 155
Gain on sale of assets (44) (40)(3)
Operation and maintenance (3) (6)(17)
General taxes, depreciation, and other income 8 11
Asset impairment charges (1,184) (1,048)32
Fixed charges 2 14(11)
Minority interest 484 397181
Income taxes 186 133
-------89
-------
Total change $ (319) $ (162)
=======(154)
=======
OPERATING REVENUES AND COST OF GAS AND PURCHASED POWER:REVENUES: For the three months ended September 30, 2005, netMarch 31, 2006, operating
revenues increased $123 million versus the
same period in 2004 and the related cost of gas and purchased power cost
increased $110 million versus the same period in 2004. These increases were primarily due to the impact of increased customer demand on
deliveries fuel
costs and purchased power primarily at South American subsidiaries and increased wholesale power sales and related costs at our Michigan generating plants. Also
contributing to the increase in operating revenuethird-party gas sales. These increases were offset
partially by mark-to-market gainslosses on gas contracts at CMS ERM.
CMS-11
CMS Energy CorporationCOST OF GAS AND PURCHASED POWER: For the ninethree months ended September 30, 2005, operating revenues increased $155
million versusMarch 31, 2006, the same period in 2004 due to increased demand at our South
American subsidiaries, increased wholesale power sales at our Michigan
generating assets and mark to market gains on gas contracts at CMS ERM. Related
cost of gas and purchased power cost increased $154 million versus the same
period in 2004 primarilydecreased operating earnings. The decrease is
due to increasedhigher gas prices and an increase in fuel costs and increased purchased
power associated with higher demand at our South American subsidiaries and our
Michigan generating plants.purchases in order to meet
customer demand.
CMS-8
CMS Energy Corporation
FUEL COSTS MARK-TO-MARKET AT MCV: For the three and nine months ended September
30, 2005,March 31, 2006, the
fuel costs mark-to-market adjustments at the MCV Partnership of certain long-term gas contracts and
financial hedges increasedat 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 increasedthe marking-to-market of certain long term gas
prices.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 increased $22 million for the three months
ended September 30, 2005March 31, 2006 increased by $5 million versus the same period in 2004. The
increase was primarily due to a $13 million increase in the fair value of
interest rate swaps associated with our investment in Taweelah as gains in the
current period replaced the losses recorded on these instruments in the same
period of 2004. Also contributing2005. Contributing to the
increase was an $11$4 million increasefrom Neyveli, which recorded lower earnings in earnings from our investment in Neyveli primarily2005 due
to the settlement of a revenue dispute. These increases were offset partially by the absence of $2penalty on coal purchase commitments and a forced outage, $3 million of earnings from
Goldfields, which we sold in August of 2004.
Equity earnings increased $15 million for the nine months ended September 30,
2005 versus the same period in 2004. The increase was primarilyGasAtacama due to $7a renegotiated power contract, and $2 million in earnings from Shuweihat,and
mark-to-market gains at Jubail, which achieved commercial operations in
the
fourth quarter of 2004, and a $7 million increase in earnings from GasAtacama,
as it is able to import more natural gas from Argentina than in 2004. Also
contributing to the increase were $6 million in higher earnings at Neyveli,
primarily due to the settlement of a revenue dispute, and $3 million of other
increases in earnings.September 2005. These increases were offset partially by the absence of
$8 million inlower earnings from Goldfields, which we sold in August of 2004.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 September 30, 2005, gains on
asset sales decreased $44 million due to a $43 million gain on the sale of
Goldfields and a $1 million gain on the sale of the Bluewater Pipeline in 2004.
ThereMarch 31, 2006, there were no significant
gains or losses on asset sales during this period in
2005.
For the nine months ended September 30, 2005, gains on asset sales decreased $40
million versus the same period in 2004. This is due to a $3 million gain onin 2005 from the sale of
our interest in GVK and a $2 million gain on the sale of SLAP in 2005 versus a $43
million gain on the sale of Goldfields and a $1 million gain on the sale of the
Bluewater Pipeline in 2004.India.
OPERATION AND MAINTENANCE: For the three months ended September 30, 2005,March 31, 2006, operation
and maintenance expenses increased $3 million versus the same period
in 2004.2005. The increase in 2006 was
primarily due to increased operating costs at CPEE and Takoradi, as well as
higher legal fees related to
litigation at DIG and increased costs due to higher electrical production.
For the nine months ended September 30, 2005, operation and maintenance expenses
increased $6 million versus the same period of 2004. The increase in 2005 was
primarily due to higher legal fees related to litigation at DIG, increased costs
due to higher electrical production and increased professional fees at South
American subsidiaries, offset partially by lower legal fees in connection with
arbitration in Argentina.development costs.
GENERAL TAXES, DEPRECIATION, AND OTHER INCOME, NET:INCOME: For the three months ended September 30, 2005,March
31, 2006, the net of general tax expense, depreciation, and other income
increased operating income $8 millioncompared to 2005. This is primarily due to increased interest
income.
CMS-12
CMS Energy Corporation
Forlower
depreciation expense at the nine months ended September 30, 2005, the net of general tax expense,
depreciation and other income increased operating income $11 million primarily
due to increased interest income, net positive foreign exchange activity, and
the reversal of a contingent liability at Leonard Field.
ASSET IMPAIRMENT CHARGES: For the three months ended September 30, 2005, asset
impairment charges increased by $1.184 billion versus the same period in 2004.
The increase relates toMCV Partnership resulting from the impairment of
property, plant, and equipment and lower accretion expense related to prepaid
gas contracts at the
MCV Partnership to reflect the excess of the carrying value of these assets
over their estimated fair values.
For the nine months ended September 30, 2005, asset impairment charges increased
by $1.048 billion versus the same period in 2004. The increase relates to the
impairment of property, plant, and equipment at the MCV Partnership to reflect
the excess of the carrying value of these assets over their estimated fair
values, offset partially by the absence, in 2005, of the Loy Yang impairment
recorded in 2004.CMS ERM.
FIXED CHARGES: For the three and nine months ended September 30, 2005,March 31, 2006, fixed charges
decreasedincreased versus the same periods in 20042005 due to higher interest expense resulting from an increase
in subsidiary debt and interest rates, offset partially by lower expenseexpenses at the
MCV Partnership.
MINORITY INTEREST: For the three and nine months ended September 30,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, net
lossesminority owners shared in the profits of our subsidiaries and the amount
of income attributed to minority interest owners inthem reduced our subsidiaries replaced net gains attributed to minority interest owners for the same periods in 2004.income. The losses relatein 2006 and
gains in 2005 were primarily due to the asset impairment charge to property, plant, and equipment
at the MCV Partnership, partially offset by mark-to-market gainsactivities at the MCV Partnership.
INCOME TAXES: For the three months ended September 30, 2005,March 31, 2006, income tax expense
decreased versus the same period in 2004.2005. The decrease reflectswas due to lower earnings in 20052006, primarily
due to the impairment of property, plant, and equipment at the MCV
Partnership. Also contributing to the decrease were income tax benefits related
to the American Jobs Creation Act.
For the nine months ended September 30, 2005, income tax expense decreasedmark-to-market losses in 2006 versus the same periodgains in 2004. The decrease reflects lower earnings in 2005 due
to the impairment of property, plant, and equipment at the MCV Partnership. Also
contributing to the decrease were income tax benefits related to the American
Jobs Creation Act. The decrease was partially offset by the absence of tax
benefits related to the 2004 Loy Yang investment impairment.2005.
CORPORATE INTEREST AND OTHER RESULTS OF OPERATIONS
In Millions
----------------------
September 30------------------------
March 31 2006 2005 2004 Change
- ------------ ----- ------------- ------ ------ ------
Three months ended $ (51)(45) $(46) $ (49) $(2)
Nine months ended $(142) $(147) $ 51
For the three months ended September 30, 2005March 31, 2006, corporate interest and other net
expenses were $51 million, an increase of $2 million versus the same period in
2004. The increase reflects premiums paid on the early retirement of a portion
of our CMS Energy 9.75 percent senior notes partially offset by a reduction of
corporate interest as well as a reduction in other interest expenses allocated
from the utilities.
For the nine months ended September 30, 2005, corporate interest and other net
expenses were $142was $45 million, a decrease of $5$1 million versus the same period in
2004.2005. The decrease
reflects a reduction in corporate interest as well as a
reduction inexpense due to lower debt levels, lower other interest
expenses allocated from the utilities. The decreaseutility and the absence of additional tax expense
recorded in
interest expense wasCMS-9
CMS Energy Corporation
2005. These decreases were offset partially by a premiumpremiums paid onfor the early
retirementrepurchase
of a portion of our CMS Energy 9.75Energy's 9.875 percent senior notes and the
absence in 2005 of a benefit from the reversal of a currency translation
adjustment related to the sale of Loy Yang that was recorded in 2004.
CMS-13
CMS Energy Corporationhigher legal fees.
DISCONTINUED OPERATIONS: For the three and nine months ended September 30, 2005,
we had no activity from operations accounted for as discontinued. OurMarch 31, 2006, net gainincome
from Discontinued Operations was $8 million$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 September
30, 2004, and $6 million for the nine months ended September 30, 2004.March 31, 2005.
CRITICAL ACCOUNTING CHANGES: In 2004, we recorded a $2 million loss for the cumulative
effect of a change inPOLICIES
The following accounting principle. The loss was the result of a change
in the measurement datepolicies are important to an understanding of our
benefit plans.
CRITICAL ACCOUNTING POLICIESresults 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 the occurrence ofa 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 most significant of these contingencies are our pending class
actions arising out of round-trip trading and gas price reporting, our electric
and gas environmental liabilities, our indemnity and environmental remediation
obligations at Bay Harbor, and the potential underrecoveries from our power
purchase contract with the MCV Partnership.
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.
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 $16.115
billion at September 30, 2005, 52 percent represent long-lived assets and equity
method investments that are subject to this type of analysis. We base our
evaluations of impairment on such indicators as:
- the nature of the assets,
- projected future economic benefits,
- domestic and foreign regulatory and political environments,
- state and federal regulatory and political environments,
- historical and future cash flow and profitability measurements, and
- other external market conditions or factors.
CMS-14
CMS Energy Corporation
If an event occurs or circumstances change in a manner that indicates the
recoverability of a long-lived asset should be assessed, we evaluate the asset
for impairment. An asset held-in-use is evaluated for impairment by calculating
the undiscounted future cash flows expected to result from the use of the asset
and its eventual disposition. If the undiscounted future cash flows are less
than the carrying amount, we recognize an impairment loss. The impairment loss
recognized is the amount by which the carrying amount exceeds the fair value. We
estimate the fair market value of the asset utilizing the best information
available. This information includes quoted market prices, market prices of
similar assets, and discounted future cash flow analyses. An asset considered
held-for-sale is recorded at the lower of its carrying amount or fair value,
less cost to sell.
We also assess our ability to recover the carrying amounts of our equity method
investments. This assessment requires us to determine the fair values of our
equity method investments. The determination of fair value is based on valuation
methodologies including discounted cash flows and the ability of the investee to
sustain an earnings capacity that justifies the carrying amount of the
investment. If the fair value is less than the carrying value and the decline in
value is considered to be other than temporary, an appropriate write-down is
recorded.
Our assessments of fair value using these valuation methodologies represent our
best estimates at the time of the reviews and are consistent with our internal
planning. The estimates we use can change over time, which could have a material
impact on our financial statements.
For additional details on asset impairments, see Note 2, Asset Impairment
Charges and Sales.
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. There have been no material changes to theFor additional details on accounting for financial
instruments, since the year ended December 31, 2004. For details on
financial instruments, see Note 6,5, Financial and Derivative Instruments.
DERIVATIVE INSTRUMENTS: We use the criteria in SFAS No. 133 to accountdetermine 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 derivativesderivative instruments since the year ended December 31, 2004.2005. 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 (i.e., from brokers and banks)valuations), if available.
For certain contracts, market prices and third-party valuations arethis information is not available and we must determine fair values by usinguse mathematical
valuation models.models to value our derivatives. These
valuation models require various inputs
and assumptions, including commodity forward prices, strikemarket 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.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 as of September 30, 2005:at March 31, 2006:
Interest Rates (%) Volatility Rates (%)
------------------ --------------------
Long-term gas contracts associated with the MCV
Partnership 3.864.83 - 4.67 325.34 28 - 6350
Gas-related option contracts 3.95 384.70 46 - 6947
Electricity-related option contracts 3.95 594.70 79 - 74119
CMS-15
CMS Energy Corporation
CommencementEstablishment of the Midwest Energy Market: TheIn 2005, the MISO began operating
the Midwest Energy Market on April 1, 2005. Through operation ofMarket. As a result, the Midwest Energy Market,
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 commencementestablishment of this market does not constituterepresent 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 the potential forwhether 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 the majority of these
contracts (including the MCV PPA), and, therefore, will not be required to mark these contracts to
market.
Implementation of the RCP: The MCV Partnership uses long-term gas contracts to
purchase natural gas as fuel for generation, and to manage gas fuel costs. The
MCV Partnership believes that certain of these contracts qualify as normal
purchases under SFAS No. 133. Accordingly, these contracts are not recognized at
fair value on our Consolidated Balance Sheets. However, asAs a result of implementing the RCP in January 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 consumed as fuel for electric production.used to generate
electricity or steam. Accordingly, these contracts are accounted for as
derivatives, with changes in fair value recorded in earnings each quarter.
ForAdditionally, certain of the nine months ended September 30, 2005,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 recordedrecord any changes in their
fair value in earnings each quarter. As a $242
million gain associated withresult of recording the increasechanges in
fair value of these long-term gas contracts.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 gainloss 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. As a result of mark-to-market gains,
we have recorded derivative assets totaling $298 million associated with the
fair value of long-term gas contracts on our Consolidated Balance Sheets. The
majority of these assets are expected to reverse through earnings during 2005
and 2006 as the gas is purchased, with the remainder reversing between 2007 and
2011.
The MCV Partnership holds natural gas futures and swap contracts to manage price
risk by fixing the price to be paid for natural gas on some of its long-term gas
contracts. Prior to the implementation of the RCP, these futures and swap
contracts were accounted for as cash flow hedges. Since the RCP was implemented
in January 2005, these instruments no longer qualify for cash flow hedge
accounting and any changes in their fair value have been recorded in earnings
each quarter. For the nine months ended September 30, 2005, we recorded a $125
million gain associated with the increase in fair value of these instruments.
This gain is also included in the total Fuel costs mark-to-market at MCV on our
Consolidated Statements of Income. As a result of mark-to-market gains, we have
recorded derivative assets totaling $125 million associated with the fair value
of these instruments on our Consolidated Balance Sheets. The majority of these
assets are expected to be realized during 2005 and 2006 as the futures and swap
contracts settle, with the remainder to be realized during 2007.Income (Loss). Because of the volatility
of the natural gas market, the MCV Partnership expects future earnings
volatility on both theits long-term gas contracts and theits 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, 2004.
The2005.
We include the fair value of the derivative contracts held by CMS ERM is included 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 September 30, 2005:
CMS-16
CMS Energy CorporationMarch 31, 2006:
In Millions
-----------------------------
Non-TradingNon-
Trading Trading Total
------------------ ------- -----
Fair value of contracts outstanding at December 31, 2004 $(199) $2012005 $ 2(63) $ 100 $ 37
Fair value of new contracts when entered into during the period (a) - (1) (1)
Changes in fair value attributable to changes in valuation techniques
and assumptions - - -
Contracts realized or otherwise settled during the period 39 (46)6 (13) (7)
Other changes in fair value (b) (250) 274 24(5) (25) (30)
------- ------- ----- ---- ---
Fair value of contracts outstanding at September 30, 2005 $(410) $428 $18March 31, 2006 $ (62) $ 62 $ -
======= ======= ===== ==== ===
(a) Reflects only the initial premium payments/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/increase (decrease) of forward positions
as well as changes to present value and credit reserves.
Fair Value of Non-Trading Contracts at September 30, 2005
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 (410) (149) (185) (68) (8)(62) (11) (18) (31) (2)
----- ----- ----------- ---- -------
Total $(410) $(149) $(185) $(68) $(8)$ (62) $ (11) $ (18) $(31) $ (2)
===== ===== =========== ==== =======
Fair Value of Trading Contracts at September 30, 2005
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) $ (7) $(39) $(9)(55) $ (13) $ (42) $ - $ -
Prices obtained from external
sources or based on models and
other valuation methods 483 178 223 75 7117 29 55 31 2
----- ------ ------ ---- ----
---- --- ---
Total $428 $171 $184 $66 $ 762 $ 16 $ 13 $ 31 $ 2
===== ====== ====== ==== ==== ==== === ===
MARKET RISK INFORMATION: The following is an update of our risk sensitivities
since the year ended December 31, 2004.2005. These risk sensitivities indicate the potential loss in fair
value, cash flows, or future earnings from our financial instruments, including
our derivative contracts, and other financial instruments based uponassuming a hypothetical 10 percent adverse change in market rates
or prices.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 a 10 percentan adverse change in market
interest rates)rates of 10 percent):
In Millions
September 30, 2005----------------------------------
March 31, 2006 December 31, 2004
------------------2005
-------------- -----------------
Variable-rate financing - before-tax annual earnings exposure $ 2 $ 24
Fixed-rate financing - potential lossREDUCTION in fair value (a) 214 216220 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 CMS-17
CMS Energy Corporation
to be included in the sensitivity analysis, but can
have an impact on financial results.
Commodity Price Risk Sensitivity Analysis (assuming a 10 percentan adverse change in market
prices)prices of 10 percent):
In Millions
--------------------------------------
September 30, 2005-----------------------------------
March 31, 2006 December 31, 2004
------------------2005
-------------- -----------------
Potential REDUCTION in fair value:
Non-trading contracts
Gas supply option contracts $ 3- $ 1
FTRs - -
CMS ERM electric and gas forward contracts 19 101 -
Derivative contracts associated with the MCV Partnership:
Long-term gas contracts (a) (b) 49 1726 39
Gas futures, options, and swaps (b) 59 41
(a) The increased potential reduction in fair value for the MCV Partnership's
long-term gas41 48
Trading contracts is due to the increased number of contracts
accounted for as derivatives as a result of the RCP.
(b) The increased potential reduction in fair value for the MCV Partnership's
long-term gas contracts and gas futures and swaps is due to the significant
increase in natural gas prices from December 31, 2004.
Trading Activity Commodity Price Risk Sensitivity Analysis (assuming a 10
percent adverse change in market prices):
In Millions
--------------------------------------
September 30, 2005 December 31, 2004
------------------ -----------------
Potential REDUCTION in fair value:
Electricity-related option contracts $1 2
$ -Electricity-related swaps 11 13
Gas-related option contracts 1 31
Gas-related swaps and futures (a) 23 73 4
(a) The increased potential reduction in fair value for the gas-related swaps
and futures is due to the significant increase in natural gas prices from
December 31, 2004.
Investment Securities Price Risk Sensitivity Analysis (assuming a 10 percentan adverse
change in market prices)prices of 10 percent):
In Millions
--------------------------------------
September 30, 2005----------------------------------
March 31, 2006 December 31, 2004
------------------2005
--------------- -----------------
Potential REDUCTION in fair value of available-for-sale equity
securities (primarily SERP investments) $5 $5: $ 5 $ 5
Consumers maintains trust funds, as required by the NRC, which may only be used
to fundfor the purpose of
funding certain costs of nuclear plant decommissioning. TheseAt March 31, 2006 and
December 31, 2005, these funds arewere 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. ThoseThese 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 6,5,
Financial and Derivative Instruments.
CMS-18CMS-13
CMS Energy Corporation
INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY
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 with the International Centre for the
Settlement of Investment Disputes (ICSID) in mid-2001, citing breaches by
Argentina under the Argentine-U.S. Bilateral Investment Treaty. In May 2005, an
ICSID tribunal concluded, among other things, that Argentina's economic
emergency did not excuse Argentina from liability. The ICSID tribunal found in
favor of CMS Gas Transmission, and awarded damages of U.S. $133 million, plus
interest.
Under the Rules of the ICSID Convention, Either Party May Seek an Annulment of
the Award From a Newly Constituted Tribunal. Argentina's Application for
Annulment was Formally Registered by ICSID On September 27, 2005
ACCOUNTING FOR PENSION AND OPEB
Pension: We have established external trust funds to provide retirement pension
benefits to our employees under a non-contributory, defined benefit Pension
Plan. We implemented a cash balance plan for certain employees hired after June
30, 2003. On September 1, 2005, we implemented the Defined Company Contribution
Plan.
The Defined Company Contribution Plan provides an employer cash contribution of
5 percent of base pay to the existing Employees' Savings Plan. No employee
contribution is required to receive the plan's employer contribution. All
employees hired on and after September 1, 2005 participate in this plan as part
of their retirement benefit program. Cash balance pension plan participants also
participate in the Defined Company Contribution Plan on September 1, 2005.
Additional pay credits under the cash balance pension plan were discontinued as
of that date. We use SFAS No. 87 to account for pension costs.
401(k): We resumed the employer's match in CMS Energy Stock on our 401(k)
Savings Plan on January 1, 2005. On September 1, 2005, employees enrolled in the
company's 401(k) Savings Plan had their employer match increased from 50 percent
to 60 percent on eligible contributions up to the first six percent of an
employee's wages.
OPEB: We provide postretirement health and life benefits under our OPEB plan to
substantially all our retired employees. We use SFAS No. 106 to account for
other postretirement benefit costs.
Liabilities for both pension and OPEB are recorded on the balance sheet at the
present value of their future obligations, net of any plan assets. The
calculation of the liabilities and associated expenses requires the expertise of
actuaries. Many assumptions are made including:
- life expectancies,
- present-value discount rates,
- expected long-term rate of return on plan assets,
- rate of compensation increases, and
- anticipated health care costs.
CMS-19
CMS Energy Corporation
Any change in these assumptions can change significantly the liability and
associated expenses recognized in any given year.
The following table provides an estimate of our pension cost, OPEB cost, and
cash contributions for the next three years:
In Millions
- ---------------------------------------------------------
Expected Costs Pension Cost OPEB Cost Contributions
- -------------- ------------ --------- -------------
2006 $ 95 $38 $ 82
2007 104 34 184
2008 99 30 112
Actual future pension cost and contributions will depend on future investment
performance, changes in future discount rates, and various other factors related
to the populations participating in the Pension Plan.
For additional details on postretirement benefits, see Note 7, Retirement
Benefits.
OTHER
Other accounting policies that are 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.
ThereThese accounting policies were disclosed in our 2005 Form 10-K and there have
been no material changes to these accounting policies since the year
ended December 31, 2004.changes.
CAPITAL RESOURCES AND LIQUIDITY
OurFactors affecting our liquidity and capital requirements are a function of ourare:
- 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. The market price for natural gas has increased. 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 as gas prices increase. In addition, a few ofrecoveries. We have credit agreements with our commodity suppliers and those
agreements contain terms that have requested nonstandard payment termsresulted in margin calls. Additional margin
calls or other forms of assurances, including
margin calls, in connection with maintenance of ongoing deliveries of gas and
electricity.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
September 2005, Consumers' ability to issue FMB as primary obligations or as collateral
for financing is expected to be limited to $298 million for 12
months, endingthrough September 30,
2006. Beyond 12 months,After September 30, 2006, Consumers' ability to issue FMB in excess of
$298 million is based on achieving a two-times FMB interest coverage rate. Nonetheless, weratio.
We believe the following items will be sufficient to meet our liquidity needs:
- our current level of cash and revolving credit facilities,
and- our ability to access junior secured and unsecured borrowing
capacity in the capital markets, along withand
- our anticipated cash flows from operating and investing activities, will be sufficient to meet our
liquidity needs.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 CMS-20
CMS Energy Corporation
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 September 30, 2005, $989March 31, 2006, $824 million consolidated cash was on hand, which includes
$196$66 million of restricted cash and $423$242 million from the entities consolidated
pursuant to FASB Interpretation No. 46. For additional details, see
Note 11, Consolidation of Variable Interest Entities.46(R).
Our primary ongoing source of cash is dividends and other distributions from our
subsidiaries. For the ninethree months ended September 30, 2005,March 31, 2006, Consumers paid $207$40
million in common stock dividends to CMS Energy.
SUMMARY OF CONSOLIDATED STATEMENTS OF CASH FLOWS:
In Millions
-------------
Nine---------------
Three months ended September 30March 31 2006 2005
2004
- --------------------------------------------------------- ----- -----
Net cash provided by (used in):
Operating activities $ 604173 $ 200262
Investing activities (399) (388)(42) (8)
----- -----
Net cash provided by (used in) operating and investing activities 205 (188)131 254
Financing activities (82) (219)(221) 17
Effect of exchange rates on cash 1 -
----- -----
Net Increase (Decrease) in Cash and Cash Equivalents $ 124 $(407)(89) $ 271
===== =====
OPERATING ACTIVITIES: For the ninethree months ended September 30, 2005,March 31, 2006, net cash
provided by operating activities increased $404was $173 million, a decrease of $89 million
versus the same period
in 2004 due to increases in MCV gas supplier funds on deposit and accounts
payable. The increase in MCV gas supplier funds on deposit and accounts payable
is2005. This was due to the effecttiming of risingpayments for higher priced gas prices.used
during the heating season and other timing differences.
INVESTING ACTIVITIES: For the ninethree months ended September 30, 2005,March 31, 2006, net cash used
in investing activities increased $11was $42 million, an increase of $34 million versus the same period in
20042005.
This was primarily due to an increase in restricted cashthe absence of $267short-term investment proceeds of $109
million combined
with a decrease inand the absence of proceeds from asset sales of $156 million. These changes were$21 million in 2006,
offset by a net increase in short-term investment proceedsrelease of $370 million. The
increase in restricted cash was dueof $128 million in February 2006, which
we used to an irrevocable deposit made with a
trustee to permit a defeasance of Consumers' 9 percent notes by the end of the
first quarter of 2006.extinguish long-term debt-related parties.
FINANCING ACTIVITIES: For the ninethree months ended September 30, 2005,March 31, 2006, net cash used
in financing activities decreased $137was $221 million, an increase of $238 million versus
the same period in
20042005. This was primarily due to neta decrease in proceeds from the issuancedebt issuances of
common stock of $289$691 million, offset by a decreasefewer debt retirements of $168 million in net proceeds from borrowings.$452 million.
For additional details on long-term debt activity, see Note 4,3, Financings and
Capitalization.
OBLIGATIONS AND COMMITMENTS
REVOLVING CREDIT FACILITIES:DIVIDEND RESTRICTIONS: For details on revolving credit facilities,dividend restrictions, see Note 4,3,
Financings and Capitalization.
OFF-BALANCE SHEET ARRANGEMENTS: There have been no material changesCMS Energy and certain of its subsidiaries enter
into various arrangements in off-balance sheetthe normal course of business to facilitate
commercial transactions with third parties. These arrangements since the year ended December 31, 2004.include
indemnifications, letters of credit, surety bonds, and financial and performance
guarantees. For details on guarantee arrangements, see Note 4,
CMS-21
CMS Energy Corporation
Financings and Capitalization, "FASB2, Contingencies,
"Other Contingencies - FASB Interpretation No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others."
DIVIDEND RESTRICTIONS:REVOLVING CREDIT FACILITIES: For details on dividend restrictions,revolving credit facilities, see
Note 4,3, Financings and Capitalization.
DEBT CREDIT RATING: On November 1, 2005, S&P placedCMS-15
CMS Energy'sEnergy Corporation
SALE OF ACCOUNTS RECEIVABLE: For details on the sale of accounts receivable, see
Note 3, Financings and Consumers'
debt credit ratings on CreditWatch with negative implications. S&P indicated
that they expect resolution of the CreditWatch before year end 2005.
OTHER: CMS ERM is a party to a certain gas supply contract whose performance is
backed by a bond issued by American Home Assurance Co. (AHA), a subsidiary of
American International Group, Inc. (AIG), as a jointly liable surety. AHA
currently has a surety obligation of approximately $119 million pursuant to this
contract. This amount amortizes monthly. The gas supply contract requires that
the surety maintain minimum credit ratings of AA- or better from S&P and Aa3 or
better from Moody's. S&P has downgraded the credit ratings of AIG and AHA to AA
and AA+, respectively, with a negative outlook for AIG. Moody's has lowered its
long-term senior debt ratings on AIG and AHA to Aa2 with a stable outlook for
AIG. We cannot predict whether these ratings will decline further; however, we
have several alternatives in the event that AHA no longer meets the minimum
rating requirements. These alternatives include obtaining a letter of credit
under our existing revolving credit agreement, seeking an alternative letter of
credit arrangement or posting available cash as collateral. These alternatives
may have a negative impact on our liquidity.Capitalization.
OUTLOOK
CORPORATE OUTLOOK
During 2005, we will continue to implement a business strategy that involves
improving our balance sheet and providing superior utility operations and
service. This strategy is designed to generate cash to pay down debt and provide
for more predictable future operating revenues and earnings.
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
businesses we retain. The percentage of our future earnings relating to our
larger equity method investments may increase and our total future earnings may
depend more significantly upon the performance of those investments. For
additional details, see Note 9, Equity Method Investments.
Over the next few years, our business plan of "building on the basics"strategy will focus on reducing parent
company debt, substantially, improving our credit
ratings, growing earnings, restoring a common stock dividend, and positioning us to make new investments consistent withthat
complement our strengths. In the near term, our new
investments will concentrate on the utility.
ELECTRIC UTILITY BUSINESS OUTLOOK
GROWTH: We expect the growth in electric deliveries for 2005 to be approximately
four percent. 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 approximately twoabout one and one-half percent per year. However, such growth is
dependent on a modestly growing customer base and recovery of thea 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.
CMS-22
CMS Energy CorporationELECTRIC 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 OctoberNovember
CMS-16
CMS Energy Corporation
2005, DelphiGeneral Motors Corporation,
(Delphi) filed for Chapter 11 bankruptcy protection. Delphi is the nation's
largest automotive supplier headquartered in Troy, Michigan, and is a large industrial customer of Consumers.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 do not believe that this event will
have a material adverse effect on our financial condition. We cannot however, predict the impact of these restructuring plans or
possible future actions by other industrial customers.
THE ELECTRIC CAPACITY NEED FORUM: In January 2006, the Delphi bankruptcy filingMPSC Staff issued a
report on other automotive-related
manufacturing customers or the Michigan industrial base. Continued degradation
of the industrial customer base would have a negative impact on electric utility
revenues.
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
purchasingfuture 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 energy contractsbid 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 physical delivery of
electricity primarily in the summer months and to a lesser degree in the winter
months. We establish a reserve margin target to address various scenarios and
contingencies so that the probability of interrupting service to retail
customers becausedevelopment of a supply shortage is no greater than an industry-recognized
standard. However, even with the reserve margin target, additional spot
purchases during periods when electric prices are high may be required.
We are currently planning for a reserve margin of approximately 11 percent for
summer 2006, or supply resources equal to 111 percent of projected summer peak
load. Of the 2006 supply resources target of 111 percent, we expect to meet
approximately 98 percent from our electric generating plants and long-term power
purchase contracts, and approximately 13 percent from short-term contracts,
options for physical deliveries, and other agreements. We have purchased
capacity andcomprehensive energy contracts covering partially the estimated reserve margin
requirements for 2006 through 2007. As a result, we have recognized an asset of
$6 million for unexpired capacity and energy contracts at September 30, 2005.
COAL DELIVERY DISRUPTIONS: In May 2005, western coal rail carriers experienced
derailments and significant service disruptions due to heavy snow and rain
conditions. These disruptions affected all shippers of western coal from Wyoming
mines as well as coal producers from May 2005 through June 2005. We received
notification that, under contractual Force Majeure provisions, the coal tonnage
not delivered during this period will not be made up. According to recent
announcements, rail repairs will extend through November 2005. Although we
expect some impact on coal shipments during the repair period, we expect our
inventories will remain within historical levels, at least during the upcoming
winter period, though at lower levels than planned before the disruptions
occurred. Based on our present delivery experience, projections, and inventory,
we believe we will have adequate coal supply to allow for normal dispatch of our
coal-fired generating units.
ENERGY MARKET DEVELOPMENT: The MISO began operating the Midwest Energy Market on
April 1, 2005. The Midwest Energy Market includes a day-ahead and real-time
energy market and centralized generation dispatch for market participants. We
are a participant in this energy market. The intention of this market is to meet
load requirements in the region reliably and efficiently, to improve management
of congestion on the grid, and to centralize dispatch of generation throughout
the region. The MISO is now responsibleplan for the reliability and economic
dispatch in the entire MISO area, which covers partsstate of
15 states and Manitoba,
including our service territory. We are presently evaluating what financial
impact, if any, these changes are having on our operations.Michigan. The settlement of charges for each operating day of the Midwest Energy Market
invokes the issuance of multiple settlement statements over a 155-day period.
This extended settlement period is designed to allow for adjustments associated
with the receipt of complete billing information and other adjustments. When
adjustments are necessary, the MISO bills market participants on a retroactive
basis, covering several months. We record adjustments as appropriate when the
MISO notifies us of the revised amounts. The revised amounts may result in
either a positive or a negative expense adjustment. We cannot predict
CMS-23
CMS Energy Corporation
the amount or timing of any MISO billing adjustments.
RENEWABLE RESOURCES PROGRAM: In January 2005, in collaboration with the MPSC, we
established a renewable resources program. Under the RRP, we purchase energy
from approved renewable sources, which include solar, wind, geothermal, biomass,
and hydroelectric suppliers. Customers are able to participate in the RRP in
accordance with tariffs approved by the MPSC. The MPSC has authorized recovery
of above-market costsdirective calls for the RRP by establishing a fund that consists of an
annual contribution from savings generated by the RCP, a surcharge imposed by
the MPSC on all customers, and contributions from customers that choose to
participate in the RRP. In February 2005, the Attorney General filed appealsChairman of the MPSC, orders providing funding forworking in
cooperation with representatives from the RRP inpublic and private sectors, to make
recommendations on Michigan's energy policy by the Michigan Courtend of Appeals.
In August 2005, we secured long-term renewable energy supply contracts. In
October 2005,2006. We will continue
to participate as the MPSC issued an order approving these new supply contracts.
ELECTRIC RATE CASE: In December 2004, we filed an application with the MPSC to
increase our retailaddresses future electric base rates. The electric rate case filing requests
an annual increase in revenues of approximately $320 million. The primary
reasons for the request are load migration to alternative electric suppliers,
increased system maintenance and improvement costs, Clean Air Act-related
expenditures, and employee pension costs. In April 2005, we filed updated debt
and equity information in this case.
In June 2005, the MPSC Staff filed its position in this case, recommending a
base rate increase of $98 million. The MPSC Staff also recommended an 11.25
percent return on equity to establish rates and recognized all of our projected
equity investment (infusions and retained earnings) in 2006. In August 2005, we
revised our request for an annual increase in revenues to approximately $197
million, and the MPSC Staff revised its recommendation to $100 million. In
October 2005, the ALJ issued a proposal for decision recommending a base rate
increase of $112 million and an 11.25 percent authorized return on equity. We
expect a final order from the MPSC in late 2005. If approved as requested, the
rate increase would go into effect in January 2006 and would apply to all retail
electric customers. We cannot predict the amount or timing of the rate increase,
if any, which the MPSC will approve.
BURIAL OF OVERHEAD POWER LINES: In September 2004, the Michigan Court of Appeals
upheld a lower court decision that requires Detroit Edison to obey a municipal
ordinance enacted by the City of Taylor, Michigan. The ordinance requires
Detroit Edison to bury a section of its overhead power lines at its own expense.
Detroit Edison filed an appeal with the Michigan Supreme Court. Unless
overturned by the Michigan Supreme Court, the decision could encourage other
municipalities to adopt similar ordinances, as has occurred or is under
discussion in a few municipalities in our service territory. If incurred, we
would seek recovery of these costs from our customers located in the
municipality affected, subject to MPSC approval. This case has potentially broad
ramifications for the electric utility industry in Michigan. In a similar
matter, in May 2005, we filed a request with the MPSC that asks the MPSC to rule
that the City of East Grand Rapids, Michigan must pay for the relocation of
electric utility facilities required by an ordinance adopted by the city. In
September 2005, we reached a settlement of this particular dispute with the City
of East Grand Rapids, which is in the process of finalization. In October 2005,
the Michigan Supreme Court issued an order in which it agreed to review the
lower court's decision in the City of Taylor matter. The Court also established
a briefing schedule. At this time, we cannot predict the outcome of the broader
issues addressed in the City of Taylor matter.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.
CMS-24
CMS Energy Corporation
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 $815$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
- allowance for funds used during construction (AFUDC) rate.
Our current capital cost estimates include an escalation rate of 2.6 percent and
an AFUDC capitalization rate of 8.3 percent. As of September 2005,March 2006, we have
incurred $589$616 million
in capital expenditures to comply with thesethe federal Clean Air Act and resulting
regulations and anticipate that the remaining $226$203 million of capital
expenditures will be made in 20052006 through 2011. These expenditures include installing selective
catalytic reduction technology at four of our coal-fired electric plants. In addition to modifying
the 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 utilize
nitrogen oxide emissionsrecover from our
customers through the PSCR process. The allowances for years 2006 through 2008, of which 90
percent have been obtained. The cost of the allowances is estimated to average
$5 million per year for 2006 through 2008. The estimatedand their costs are based on the
average cost of the purchased, allocated, and exchanged allowances. The need for
allowances will decrease after 2006 with the installation of selective catalytic
control technology. The cost of the allowances is accounted
for as inventory. The allowance inventory is expensed at the rolling average
cost as the coal-fired electric generating unitsplants emit nitrogen oxide.
TheIn March 2005, the EPA recently adopted athe 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 and nitrogen oxides by 63 percentfrom
2003 levels by 2015. The finalWe plan to meet this rule will require that we runby year round operations of our
Selective Catalytic Reductionselective catalytic control technology units year-round
beginning in 2009 and may require that we purchase additionalto meet nitrogen oxide allowances beginning in 2009. In addition to the selective catalytic reduction
control technology installed to meet the Nitrogen Oxide State Implementation
Plan, our current plan includestargets and
installation of flue gas desulfurization scrubbers. The scrubbers are to be installed by 2014 to meet the Phase I
reduction requirementsat an estimated cost of the Clean Air Interstate Rule at a cost near that of
the Nitrogen Oxide State Implementation Plan.
In May$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 powergenerating
plants by 2010 and further reductions by 2018. WhileThe 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,emissions. However, we
anticipate our capital and operating costs for mercury emissions reductions
are expectedrequired by the Clean Air Mercury Rule to be significantly less than what iswas
required for selective catalytic reduction technology used for nitrogen oxide
compliance.
In August 2005,April 2006, Michigan's governor announced a plan that would result in mercury
emissions reductions of 90 percent by 2015. This plan adopts the MDEQ filed a Motion to Intervene in a court challenge to
certain aspects of EPA'sFederal Clean
Air Mercury Rule asserting thatthrough its first phase, which ends in 2010. After the rule is
inadequate. The MDEQ has not indicatedyear
2010, the direction that it will pursue to meet
or exceed the EPA requirements through a state rulemaking. We are actively
participating in dialog with the MDEQ regarding potential paths for controlling mercury emissions and meetingreduction standards outlined in the EPA requirements. In October 2005,governor's plan
become more stringent than those included in the EPA
announced it would reconsider certain aspects of theFederal 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
cannot predictwill work with the outcomeMDEQ on the details of this proceeding.these rules.
Several legislative proposals have been introduced in the United States Congress
that would require reductions in emissions of greenhouse gases, however, none
have yet been enacted.gases. We cannot
predict
CMS-25
CMS Energy Corporation whether any federal mandatory greenhouse gas emission reduction rules
ultimately will be enacted, or the specific requirements of any such rules.of these rules
and their effect on our operations and financial results.
To the extent that greenhouse gas emission reduction rules come into effect, suchthe
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
and
engage in the greenhouse gas policy developments and will continue to assess and respond to
their potential implications on our business operations.
Water: In March 2004, the EPA issued rules that govern electric generating plant
cooling water intake systems. The new rules require significant reduction in fish
killed by operating equipment. Some of our facilities will be required to comply
with the new rules by 2007. We are currently performing the required studies to determine
the most cost-effective solutions for compliance.
For additional details on electric environmental matters, see Note 3,2,
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. As of October 2005,At March 31, 2006, alternative electric suppliers
arewere providing 754348 MW of generation service to ROA customers. This amount represents a decrease of 14 percent compared to October 2004, and 10is 4 percent
of our total distribution load. Current trends indicateload and represents a continued
reduction in ROA load loss. However, itdecrease of 61 percent compared
to March 31, 2005. It is difficult to predict future ROA customer trends.
Implementation Costs:Section 10d(4) Regulatory Assets: In JuneDecember 2005, the MPSC issued an order
that authorizesauthorized us to recover implementation$333 million in Section 10d(4) costs. Instead of
collecting these costs incurred during 2002evenly 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 2003 totaling $6
million, plus25 percent in the costthird, fourth, and fifth years. In
January 2006, we filed a petition for rehearing with the MPSC that disputed the
aspect of money through the periodorder dealing with the timing of collection.
Weour 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 also pursuing authorizationhearings scheduled for
May 2006 at the FERC for the MISO to reimburse us for
Alliance RTO development costs. Includeddiscuss these charges. These hearings could result in
this amount is $2 million that the
MPSC did not approve as part of our 2002 implementation costs application. The
FERC denied our request for reimbursement, andrefunds or additional transitional charges to us. In April 2006, we are appealingfiled an
agreement with the FERC ruling
atbetween the United States Court of AppealsPJM 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 District of Columbia.potential for refunds or additional transitional charges to
Consumers. We cannot predict the amount, if any, the FERC will approve as recoverable.
Section 10d(4) Regulatory Assets: In October 2004, we filed an application with
the MPSC seeking recoveryoutcome of $628 million of Section 10d(4) Regulatory Assets
for the period June 2000 through December 2005. Of the $628 million, $152
million relates to the cost of money. In March 2005, the MPSC Staff filed
testimony recommending the MPSC approve recovery of approximately $323 million
in Section 10d(4) costs, which includes the cost of money through the period of
collection. In June 2005, the ALJ issued a proposal for decision recommending
the MPSC approve recovery of the same Section 10d(4) costs recommended by the
MPSC Staff. However, we may have the opportunity to recover certain costs
included in our application alternatively in other cases pending before the
MPSC. We cannot predict the amount, if any, the MPSC will approve as
recoverable.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 3,2, Contingencies, "Consumers' Electric Utility
Restructuring Matters," and "Consumers' Electric Utility Rate Matters."
CMS-26
CMS Energy Corporation
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.
TheUnder 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 that cash underrecoveries of capacity
and fixed energy payments will aggregate $150of $55 million in 2006 and $39 million in 2007.
However, Consumers' direct savings from 2005 through 2007.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. Further, underIf the MCV Partnership terminates the MCV
PPA, variable energy paymentswe would be required to replace the MCV Partnership are
basedlost 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 cost of coal burnedopen market. We cannot predict
our ability to enter into such contracts at our coal plants and our operation and
maintenance expenses. However, the MCV Partnership's costs of producing
electricitya reasonable price. We are tiedalso
unable to the cost of natural gas. Natural gas prices have
increased substantially in recent years and throughout 2005. In the third
quarter of 2005, the MCV Partnership reevaluated the economics of operating the
MCV Facility and determined that an impairment was required. If natural gas
prices remain at present levels or increase, the operationspredict regulatory approval of the MCV Facilityterms and conditions of such
contracts, or that the MPSC would be adversely affected and could result in the MCV Partnership failing to
meet its financial obligations under the sale and leaseback transactions and
other contracts. We are currently evaluating various alternatives in order to
develop a new long-term strategy with respect to the MCV Facility. For
additional details on the impairmentallow full recovery of the MCV Facility, see Note 2, Asset
Impairment Charges and Sales.our incurred costs.
For additional details on the MCV Partnership, see Note 3,2, Contingencies, "Other
Consumers' Electric Utility Contingencies - The Midland Cogeneration Venture."
NUCLEAR MATTERS: Big Rock: Dismantlement of plant systems is essentially
complete and demolitionDecommissioning 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 has begun. The
restoration project is
on scheduleexpected 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 530475 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 a 30-acreanother area containingof approximately 105 acres
encompassing the Big Rock Independent Spent Fuel Storage Installation (ISFSI),
where eight casks loaded with spent nuclear fuel and other high-level radioactive
waste material are stored, to be returned to a natural state within approximately two
years from the date the DOE beginsfinishes removing the spent nuclear fuel from Big Rock.Rock also
in accordance with the LTP.
Palisades: In August 2005, the NRC completed its performance review of the
Palisades Nuclear Plant for the first half of the calendar year 2005. The NRC
determined that Palisades was operated in a manner that preserved public health
and safety and met all of the NRC's specific "cornerstone objectives." As of
August 2005, all inspection findings were classified as having very low safety
significance and all performance indicators show performance at a level
requiring no additional oversight. Based on the plant's performance, only
regularly scheduled inspections are planned through March 31, 2007. 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 September 2005,March
2006, we have loaded 2229 dry casks with spent nuclear fuel.
CMS-27
CMS Energy Corporation
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. Certain parties are seeking to intervene and
have requested a hearing on the application. The NRC has stated that it expects
to take 22-30 months to review a license renewal application. We expect a decision from the NRC on the
license renewal application in 2007.
In December 2005, we announced plans to sell the Palisades like other nuclear plants, has experienced cracking in reactor head
nozzle penetrations. Repairsplant and
enter into a long-term power purchase agreement with the new owner. Subject to
two nozzles were made in 2004. We have
authorizedreview of the purchaseterms 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
replacement reactor vessel closure head. The
replacement head is being manufacturedlong-term contract for us to purchase power from the plant, and is scheduledvarious other
contingencies. We expect to be installedcomplete the sale in 2007.
For additional informationdetails on nuclear plant decommissioning at Big Rock and
Palisades, see Note 3,2, Contingencies, "Other Consumers' Electric Utility
Contingencies - Nuclear Plant Decommissioning."
Spent nuclear fuel complaint: In March 2003, the Michigan Environmental Council,
the Public Interest Research Group in Michigan, and the Michigan Consumer
Federation filed a complaint with the MPSC, which was served on us by the MPSC
in April 2003. The complaint asks the MPSC to initiate a generic investigation
and contested case to review all facts and issues concerning costs associated
with spent nuclear fuel storage and disposal. The complaint seeks a variety of
relief with respect to Consumers, Detroit Edison, Indiana & Michigan Electric
Company, Wisconsin Electric Power Company, and Wisconsin Public Service
Corporation. The complaint states that amounts collected from customers for
spent nuclear fuel storage and disposal should be placed in an independent
trust. The complaint also asks the MPSC to take additional actions. In May 2003,
Consumers and other named utilities each filed motions to dismiss the complaint.
In September 2005, the MPSC dismissed the complaint.
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 the gas commodity prices,
- Michigan economic conditions,
- the price of competing energy sources or fuels, and
- gas consumption per customer.
In February 2004, we filed an application with the MPSC for a Certificate of
Public Convenience and Necessity to construct a 25-mile gas transmission
pipeline in northern Oakland County. The project is necessary to meet estimated
peak load beginning in the winter of 2005-2006. We started construction of Phase
I of the pipeline in June 2005 and expect Phase I to be completed and in service
by November 2005. We anticipate completion of Phase II of the project in 2008.
In October 2004, we filed an application with the MPSC for a Certificate of
Public Convenience and Necessity to construct a 10.8-mile gas transmission
pipeline in northwestern Wayne County. The project is necessary to meet the
projected capacity demands beginning in the winter of 2007. In August 2005, the
MPSC issued an order approving the application. Construction of the pipeline is
expected to begin in spring of 2006.
CMS-28
CMS Energy Corporation
GAS UTILITY BUSINESS UNCERTAINTIES
Several gas business trends or uncertainties may affect our future financial
results and conditions.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 3,2, 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 an annual plan and reconciliation proceeding.proceedings. For additional details
on gas cost recovery, see Note 3,2, 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, whichwhich:
- reaffirmed the previously orderedpreviously-ordered $34 million reduction in our
depreciation expense. The
October 2004 order alsoexpense,
- required us to undertake a study to determine why our plant removal
costs are in excess of those 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.
TheWe filed the study report with the MPSC has directed usStaff on December 29, 2005.
We are also required to file our next gas depreciation case within 90 days after the latter of:
- the removal cost study filing, or
-
the MPSC issuance of a final order in the pending case related to ARO
accounting. TheWe cannot predict when the MPSC will issue a final order onin the pending case related to ARO
accounting case.
If the depreciation case order is expected inissued after the first quarter of 2006. Wegas general rate case order,
we proposed to incorporate theits results ofinto the gas
depreciation case into gas general rates using a
surcharge mechanism if the
depreciation case order was not issued concurrently with a gas general rate case
order.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. The primary reasons for
the request are recovery of new investments, carrying costs on natural gas
inventory related to higher gas prices, system maintenance, employee benefits,
and low-income assistance. If approved, the request would add approximately 5
percent to the typical residential customer's average monthly bill. The increase
would also affect commercial and industrial customers. 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.
EMERGENCY RULES REGARDING BILLING PRACTICES: On October 18, 2005,In February 2006, the MPSC issued an order adopting emergency rules, effective November 1, 2005 throughStaff 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 31, 2006, regarding billing practicesthe 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 retail customers of electric and
gas utilities subjectfinal rate relief downward to the MPSC's jurisdiction. The emergency rules are to
address the expected substantial increase in heating costs this winter. The
emergency rules address billing cycles, fees, deposits, shutoffs and collection
of unpaid bills.$118
million.
ENTERPRISES OUTLOOK
We are analyzing the potential impactevaluating new development opportunities outside of these emergency rules.
OTHER CONSUMERS' OUTLOOK
COLLECTIVE BARGAINING AGREEMENTS: Approximately 46 percentour 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
Consumers'
employees are represented by the Utility Workers Union of America. The Union
represents operating, maintenance,return, and construction employees and call center
employees. The collective bargaining agreementconsistency with the Union for operating,
maintenance, and construction employees expired on June 1, 2005 and the
CMS-29
CMS Energy Corporation
collective bargaining agreement with the Union for call center employees expired
on August l, 2005. In both cases, new 5-year agreements were reached with the
Union and ratified by their membership.
ENTERPRISES OUTLOOK
Weour 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, South America and the Middle East/North
Africa. We will continue to sell designated assets and investments that are not
consistent with this focus. SENECA operates an electric utility on Margarita Island, Venezuela under a
Concession Agreement with the Venezuelan Ministry of Energy and Mines, now the
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. It
was less than the amount required by the Concession Agreement and no tariff
increases have been granted since then. In July 2003, the MEP approved a fuel
subsidy for SENECA to offset partially the effects of its lower tariff revenues.
The fuel subsidy expired on December 31, 2004. SENECA has sent several letters
to the MEP indicating that the economic circumstances that required the
implementation of the fuel subsidy persist. In the letters, SENECA has informed
the MEP that, unless it objects, SENECA 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 to the letters from the MEP; therefore, SENECA is taking the fuel
subsidy as a credit against billings from Deltaven. Deltaven has continued to
deliver fuel without interruption. We are informed that the government is
considering whether to grant financial relief to SENECA pursuant to its
Concession Agreement obligations. The outcome is uncertain since all
alternatives are still being explored. If timely financial relief is not
approved, the liquidity of SENECA and the valuepercentage of our investment in SENECA
would be impacted adversely.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.
CMS-30
CMSGASATACAMA: 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 Corporationand 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 IMPAIRMENT: As a result ofPARTNERSHIP 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 may be required to reduceand by all of the amount of equity investment included in its
electric and gas rate cases. This could impact Consumers' requested annual
revenue requirements. However, we cannot predict the amount, if any, of such
reduction. For additional information on the impairmentowners of the MCV
Facility,
see Note 2, Asset Impairment ChargesPartnership has decreased significantly and Sales.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. Additionally,Also, we are
named as a party in various litigation matters including, but not limited to,
a shareholder derivative lawsuit, a securities class action lawsuit,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 investigations and litigation,other matters, see Note 3, Contingencies.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
FSP 109-2, ACCOUNTING AND DISCLOSURE GUIDANCE FOR THE FOREIGN EARNINGS
REPATRIATION PROVISION WITHIN THE AMERICAN JOBS CREATION ACT OF 2004: The
American Jobs Creation Act of 2004 creates a one-year opportunity to receive a
tax benefit for U.S. corporations that reinvest dividends from controlled
foreign corporations in the U.S. in a 12-month period (calendar year 2005 for
CMS Energy). In September 2005, we decided on a plan to repatriate $33 million
of foreign earnings during the remainder of 2005. Historically, we recorded
deferred taxes on these earnings. Since this planned repatriation is expected to
qualify for the tax benefit, we reversed $10 million of our deferred tax
liability. This adjustment was recorded as a component of income from continuing
operations in the third quarter of 2005.
We may repatriate additional amounts that may qualify for the repatriation tax
benefit during the remainder of 2005. If successful, our current estimate is
that additional amounts could range between $30 million and $180 million. The
amount of additional repatriation remains uncertain because it is based on
future foreign subsidiary operations, cash flows, financings, and repatriation
limitations. This potential additional repatriation could reduce our recorded
deferred tax liability by $9 million to $23 million. We expect to be in a
position to finalize our assessment regarding any potential repatriation, which
may be higher or lower, in the fourth quarter of 2005.
NEW ACCOUNTING STANDARDS NOT YET EFFECTIVE
SFAS NO. 123R,123(R) AND SAB NO. 107, SHARE-BASED PAYMENT: This StatementSFAS 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 amount over the vesting period of
the awards. This Statement also clarifies and expands SFAS No. 123's guidance in
several areas, including measuring fair value, classifying an award as equity or
as a liability, and attributing compensation cost to reporting periods.
This Statement amends SFAS No. 95, Statement of Cash Flows, to require that
excess tax benefits related to the excess of the tax-deductible amount over the
compensation cost recognized be classified as cash inflows from financing
activities rather than as a reduction of taxes paid in operating activities.
Excess tax benefits are recorded as adjustments to additional paid-in capital.
This Statement is123(R) was effective for us ason
January 1, 2006. We elected to adopt the modified prospective method recognition
provisions of the beginningthis Statement instead of 2006.retrospective restatement. We adopted
the fair value method of accounting for share-based awards effective December
2002. Therefore, we doSFAS No. 123(R) did not expect this statement to have a significant impact on our
results of operations when it becomesbecame effective. FASB INTERPRETATION NO. 47, ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT
OBLIGATIONS: This Interpretation clarifiesWe applied the term "conditional asset
retirement obligation" as used inadditional
guidance provided by SAB No. 107 upon implementation of SFAS No. 143.123(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 term refersproposed SFAS would amend SFAS Nos. 87, 88, 106, and
132(R) and is expected to a legal
obligation to perform an asset retirement activitybe effective for us on December 31, 2006. The most
significant requirement stated in which the timing and (or)
method of settlement are conditional on a future event that may or may not be
withinproposed SFAS is the controlbalance sheet
recognition of the entity. The obligationunderfunded portion of our defined benefit postretirement
plans at the date of adoption. We expect that Consumers will be allowed to performapply
SFAS No. 71 and recognize the asset retirement
activity is unconditional even though uncertainty exists about the
CMS-31
CMS Energy Corporation
timing and (or) method of settlement. Accordingly, an entity is required to
recognizeunderfunded portion as a liability for the fair value of a conditional asset retirement
obligation if the fair value of the liability canregulatory asset. If we
determine that SFAS No. 71 does not apply our equity could be reasonably estimated. The
fair value of a liability for the conditional asset retirement obligation should
be recognized when incurred. This Interpretation also clarifies when an entity
would have sufficient information to estimate reasonably the fair value of an
asset retirement obligation. For us, this Interpretation is effective no later
than December 31, 2005.reduced
significantly. We are in the process of determining the impact of this Interpretation will haveproposed
SFAS on our financial statements upon adoption.
CMS-32
CMS Energy Corporation
(This page intentionally left blank)
CMS-33statements.
CMS-23
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(UNAUDITED)
THREE MONTHS ENDED
NINE MONTHS ENDED
------------------
-----------------
SEPTEMBER 30MARCH 31 2006 2005
2004 2005 2004
- ------------ ------ ------ ------ -------------- ------- -------
In Millions, Except Per Share Amounts
OPERATING REVENUE $1,335 $1,063 $4,421 $3,910$ 2,032 $ 1,845
EARNINGS FROM EQUITY METHOD INVESTEES 40 18 92 7836 31
OPERATING EXPENSES
Fuel for electric generation 215 215 570 577225 177
Fuel costs mark-to-market at MCV (197) - (367) (6)156 (209)
Purchased and interchange power 231 100 439 257150 95
Cost of gas sold 242 142 1,415 1,166946 839
Other operating expenses 262 225 753 667279 234
Maintenance 62 63 178 18580 58
Depreciation, depletion and amortization 121 114 399 366162 156
General taxes 59 64 200 200
Asset impairment charges 1,184 - 1,184 125
------ ------ ------ ------
2,179 923 4,771 3,537
------ ------ ------ ------78 75
------- -------
2,076 1,425
------- -------
OPERATING INCOME (LOSS) (804) 158 (258)(8) 451
OTHER INCOME (DEDUCTIONS)
Accretion expense (4) (6) (14) (18)(2) (5)
Gain on asset sales, net - 46 5 493
Interest and dividends 14 8 39 2217 10
Regulatory return on capital expenditures 17 10 48 283 16
Foreign currency losses, net - (1)
(4) (7)
Other income 10 5 28 147 8
Other expense (13) (1) (25) (5)
------ ------ ------ ------(9) (7)
------- -------
16 24
61 77 83
------ ------ ------ ------------- -------
FIXED CHARGES
Interest on long-term debt 117 124 360 380119 122
Interest on long-term debt - related parties 7 15 23 444 10
Other interest 3 6 13 187 4
Capitalized interest (1) (2) (3) (5)(1)
Preferred dividends of subsidiaries 1 2 3 4
------ ------ ------ ------
127 145 396 441
------ ------ ------ ------1
------- -------
129 136
------- -------
INCOME (LOSS) BEFORE MINORITY INTERESTS (907) 74 (577) 93(121) 339
MINORITY INTERESTS (479) 5 (380) 17
------ ------ ------ ------(OBLIGATIONS), NET (68) 113
------- -------
INCOME (LOSS) BEFORE INCOME TAXES (428) 69 (197) 76(53) 226
INCOME TAX EXPENSE (BENEFIT) EXPENSE (165) 18 (116) 8
------ ------ ------ ------(28) 74
------- -------
INCOME (LOSS) FROM CONTINUING OPERATIONS (263) 51 (81) 68
GAIN(25) 152
INCOME FROM DISCONTINUED OPERATIONS, NET OF
$4 AND $3$1 TAX EXPENSE IN 20042006 1 -
8 - 6
------ ------ ------ ------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING (263) 59 (81) 74
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR
RETIREMENT BENEFITS, NET OF $1 TAX BENEFIT IN 2004 - - - (2)
------ ------ ------ ------------- -------
NET INCOME (LOSS) (263) 59 (81) 72(24) 152
PREFERRED DIVIDENDS 3 2
3 7 9
------ ------ ------ ------------- -------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ (265)(27) $ 56 $ (88) $ 63
====== ====== ====== ======150
======= =======
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-34CMS-24
THREE MONTHS ENDED
NINE MONTHS ENDED
------------------
-----------------
SEPTEMBER 30MARCH 31 2006 2005
2004 2005 2004
- ------------ ------ ------ ------ -------------- ------- -------
In Millions, Except Per Share Amounts
CMS ENERGY
NET INCOME (LOSS)
Net Income (Loss) Available to Common Stockholders $ (265)(27) $ 56 $ (88) $ 63
====== ===== ====== ======150
======= =======
BASIC EARNINGS (LOSS) PER AVERAGE COMMON SHARE
Income (Loss) from Continuing Operations $(1.21) $0.30 $(0.42) $ 0.36(0.13) $ 0.77
Gain from Discontinued Operations 0.01 -
0.05 - 0.04
Loss from Changes in Accounting - - - (0.01)
------ ----- ------ ------------- -------
Net Income (Loss) Attributable to Common Stock $(1.21) $0.35 $(0.42) $ 0.39
====== ===== ====== ======(0.12) $ 0.77
======= =======
DILUTED EARNINGS (LOSS) PER AVERAGE COMMON SHARE
Income (Loss) from Continuing Operations $(1.21) $0.29 $(0.42) $ 0.36(0.13) $ 0.74
Gain from Discontinued Operations 0.01 -
0.05 - 0.03
Loss from Changes in Accounting - - - (0.01)
------ ----- ------ ------------- -------
Net Income (Loss) Attributable to Common Stock $(1.21) $0.34 $(0.42) $ 0.38
====== ===== ====== ======(0.12) $ 0.74
======= =======
DIVIDENDS DECLARED PER COMMON SHARE $ - $ -
$ - $ -------- -------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-35CMS-25
CMS Energy Corporation
(This page intentionally left blank)
CMS-36CMS-26
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINETHREE MONTHS ENDED
---------------------
SEPTEMBER 30------------------
MARCH 31 2006 2005
2004
- ------------ ------- ------------------- ----- -----
In Millions
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (81)(24) $ 72152
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation, depletion and amortization (includes nuclear 162 156
decommissioning of $4$1 per period)
399 366Deferred 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 (48) (28)
Minority interest (380) 17
Fuel costs mark-to-market at MCV (367) (6)
Asset impairment charges 1,184 125
Property tax, capital(3) (16)
Capital lease and other amortization 143 13011 10
Accretion expense 14 182 5
Distributions from related parties less than earnings (21) (57)(15) (2)
Gain on the sale of assets (5) (49)
Cumulative effect of accounting changes - 2(3)
Changes in other assets and liabilities:
Decrease (increase)Increase in accounts receivable and accrued revenues (18) 16
Increase(202) (317)
Decrease in inventories (351) (273)
Increase377 418
Decrease in accounts payable 147 18(111) (25)
Decrease in accrued expenses (182) (82)
Increase(63) (79)
Decrease in MCV gas supplier funds on deposit 275 16
Deferred income taxes and investment tax credit (114) 61(90) (15)
Decrease (increase) in other current and non-current assets - (134)96 (29)
Increase (decrease) in other current and non-current liabilities 9 (12)
------- -------(26) 35
----- -----
Net cash provided by operating activities $ 604173 $ 200262
----- -----
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) $ (435) $ (377)
Investments in partnerships and unconsolidated subsidiaries - (70)$(129) $(149)
Cost to retire property (57) (53)(25) (27)
Restricted cash (149) 118and restricted short-term investments 127 11
Investment in Electric Restructuring Implementation Plan - (1)
Investments in nuclear decommissioning trust funds (5) (4)(17) (1)
Proceeds from nuclear decommissioning trust funds 31 354 7
Proceeds from short-term investments - 295 1,683
Purchase of short-term investments - (186) (1,944)
Maturity of MCV restricted investment securities held-to-maturity 316 59228 126
Purchase of MCV restricted investment securities held-to-maturity (267) (592)(26) (126)
Proceeds from sale of assets 59 215- 21
Other investing (1) 9
------- -------(4) 22
----- -----
Net cash used in investing activities $ (399)(42) $ (388)(8)
----- -----
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes, bonds, and other long-term debt $ 1,08613 $ 839704
Issuance of common stock 289 -6 6
Retirement of bonds and other long-term debt (1,381) (987)(226) (678)
Payment of preferred stock dividends (8) (9)(3) (2)
Payment of capital lease and financial lease obligations (26) (41)(3) (3)
Debt issuance costs, and financing fees, (42) (21)
------- -------and other (8) (10)
----- -----
Net cash used inprovided by (used in) financing activities $(221) $ (82) $ (219)17
----- -----
EFFECT OF EXCHANGE RATES ON CASH 1 -
----- -----
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 124(89) $ (407)
CASH AND CASH EQUIVALENTS FROM EFFECT OF REVISED FASB
INTERPRETATION NO. 46 CONSOLIDATION - 174271
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 847 669
532
------- ------------ -----
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 793758 $ 299
======= =======940
===== =====
CMS-37THE ACCOMPANYING CONDENSED NOTES ARE AN INTREGAL PART OF THESE STATEMENTS.
CMS-27
CMS ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30
2005MARCH 31
2006 DECEMBER 31
(UNAUDITED) 2004
------------2005
----------- -----------
In Millions
ASSETS
PLANT AND PROPERTY (AT COST)
Electric utility $ 8,1298,266 $ 7,9678,204
Gas utility 3,066 2,9953,165 3,151
Enterprises 1,069 3,5171,054 1,068
Other 31 28
------- -------
12,295 14,50725
--------- ---------
12,516 12,448
Less accumulated depreciation, depletion and amortization 5,077 6,135
------- -------
7,218 8,3725,166 5,123
--------- ---------
7,350 7,325
Construction work-in-progress 501 370
------- -------
7,719 8,742
------- -------548 520
--------- ---------
7,898 7,845
--------- ---------
INVESTMENTS
Enterprises 677 729746 712
Other 10 13
23
------- -------
690 752
------- ---------------- ---------
756 725
--------- ---------
CURRENT ASSETS
Cash and cash equivalents at cost, which approximates market 793 669758 847
Restricted cash 196 56
Short-termand restricted short-term investments at cost, which approximates market - 10966 198
Accounts receivable, notes receivable and accrued revenue, less
allowances of $33$32 and $38,$31, respectively 560 5281,017 824
Accounts receivable and notes receivable - related parties 82 5367 54
Inventories at average cost
Gas in underground storage 1,173 856702 1,069
Materials and supplies 89 9092 96
Generating plant fuel stock 118 84104 110
Price risk management assets 260 9173 113
Regulatory assets - postretirement benefits 19 19
Derivative instruments 380 96121 242
Deferred property taxes 116 167166 160
Prepayments and other 154 181
------- -------
3,940 2,999
------- -------129 167
--------- ---------
3,314 3,899
--------- ---------
NON-CURRENT ASSETS
Regulatory Assets
Securitized costs 571 604549 560
Additional minimum pension 466 372399 399
Postretirement benefits 122 139
Capital expenditures return 201 141
Abandoned Midland Project 9 10110 116
Customer Choice Act 213 222
Other 461 411481 484
Price risk management assets 358 214127 165
Nuclear decommissioning trust funds 576 555 575
Goodwill 30 2327
Notes receivable - related parties 199 217186 187
Notes receivable 173 178195 187
Other 621 495
------- -------
3,766 3,379
------- -------716 649
--------- ---------
3,582 3,551
--------- ---------
TOTAL ASSETS $16,115 $15,872
======= =======$ 15,550 $ 16,020
========= =========
CMS-38CMS-28
STOCKHOLDERS' INVESTMENT AND LIABILITIES
SEPTEMBER 30
2005MARCH 31
2006 DECEMBER 31
(UNAUDITED) 2004
------------2005
----------- -----------
In Millions
CAPITALIZATION
Common stockholders' equity
Common stock, authorized 350.0 shares; outstanding 220.0221.0 shares and
195.0220.5 shares, respectively $ 2 $ 2
Other paid-in capital 4,428 4,1404,445 4,436
Accumulated other comprehensive loss (297) (336)(286) (288)
Retained deficit (1,822) (1,734)
------- -------
2,311 2,072(1,855) (1,828)
-------- --------
2,306 2,322
Preferred stock of subsidiary 44 44
Preferred stock 261 261
Long-term debt 6,521 6,4446,714 6,800
Long-term debt - related parties 178 504178
Non-current portion of capital and finance lease obligations 299 315
------- -------
9,614 9,640
------- -------309 308
-------- --------
9,812 9,913
-------- --------
MINORITY INTERESTS 396 733
------- -------354 333
-------- --------
CURRENT LIABILITIES
Current portion of long-term debt, capital and finance leases 312 296319 316
Current portion of long-term debt - related parties - 129 180
Accounts payable 530 391398 511
Accounts payable - related parties 12 1
Accrued interest 115123 145
Accrued taxes 167 312282 331
Price risk management liabilities 237 9068 80
Current portion of gas supply contract obligations 35 3210 10
Deferred income taxes 48 1960 55
MCV gas supplier funds on deposit 295 20103 193
Other 299 269
------- -------
2,168 1,755
------- -------261 342
-------- --------
1,626 2,113
-------- --------
NON-CURRENT LIABILITIES
Regulatory Liabilities
Regulatory liabilities for cost of removal 1,097 1,0441,152 1,120
Income taxes, net 369 357464 455
Other regulatory liabilities 174 173231 178
Postretirement benefits 455 275401 382
Deferred income taxes 538 671253 297
Deferred investment tax credit 75 7965 67
Asset retirement obligation 436 439499 496
Price risk management liabilities 363 213132 161
Gas supply contract obligations 151 17656 61
Other 279 317
------- -------
3,937 3,744
------- -------505 444
-------- --------
3,758 3,661
-------- --------
COMMITMENTS AND CONTINGENCIES (Notes 2, 3 4 and 6)5)
TOTAL STOCKHOLDERS' INVESTMENT AND LIABILITIES $16,115 $15,872
======= =======$ 15,550 $ 16,020
======== ========
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-39CMS-29
CMS ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(UNAUDITED)
THREE MONTHS ENDED
NINE MONTHS ENDED
------------------ ------------------
SEPTEMBER 30MARCH 31 2006 2005
2004 2005 2004
- -------------------- ------- -------
------- --------
In In
Millions
Millions
COMMON STOCK
At beginning and end of period $ 2 $ 2
$ 2 $ 2------- -------
OTHER PAID-IN CAPITAL
At beginning of period 4,422 3,8484,436 4,140 3,846
Common stock repurchased (1) - (1) -
Common stock reacquired - (4) - (5)
Common stock issued 78 6 288 9
Common stock reissued - - 1 -
------- -------1
------- -------
At end of period 4,428 3,850 4,428 3,850
------- -------4,445 4,147
------- -------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Minimum Pension Liability
At beginning of period (26) -(19) (17) -
Minimum pension liability adjustments (a) - (1) (9) (1)
------- --------
------- -------
At end of period (26) (1) (26) (1)
------- -------(19) (17)
------- -------
Investments
At beginning of period 8 8 9 89
Unrealized gain (loss) on investments (a) 12 (1) - (1)
------- -------
------- -------
At end of period 9 7 9 7
------- -------11 8
------- -------
Derivative Instruments
At beginning of period (3) 635 (9)
(8)
Unrealized gain (loss) on derivative instruments (a) 31 5 43 24(4) 18
Reclassification adjustments included in net income (loss) (a) (1) (1) (7) (6)
------- -------(8)
------- -------
At end of period 27 10 27 10
------- -------30 1
------- -------
Foreign Currency Translation
At beginning of period (312) (327)(313) (319) (419)
Loy Yang sale - - - 110
Other foreign currency translations (a) 5 2 12 (16)
------- -------4
------- -------
At end of period (307) (325) (307) (325)
------- -------(308) (315)
------- -------
At end of period (297) (309) (297) (309)
------- -------(286) (323)
------- -------
RETAINED DEFICIT
At beginning of period (1,557) (1,837)(1,828) (1,734) (1,844)
Net income (loss) (a) (263) 59 (81) 72(24) 152
Preferred stock dividends declared (2) (3) (7) (9)
------- -------(2)
------- -------
At end of period (1,822) (1,781) (1,822) (1,781)
------- -------(1,855) (1,584)
------- -------
TOTAL COMMON STOCKHOLDERS' EQUITY $ 2,3112,306 $ 1,762 $ 2,311 $ 1,762
======= =======2,242
======= =======
(a) DISCLOSURE OF OTHER COMPREHENSIVE INCOME (LOSS):
Minimum Pension Liability
Minimum pension liability adjustments net of tax
benefit of $-, $(1), $(5) and $(1), respectively $ - $ (1) $ (9) $ (1)-
Investments
Unrealized gain (loss) on investments, net of tax
of $-, $-,$(1) in 2006 and $- and $-, respectively 1 (1) -in 2005 2 (1)
Derivative Instruments
Unrealized gain (loss) on derivative instruments,
net of tax of $15, $7, $28$(5) in 2006 and $14, respectively 31 5 43 24$9 in 2005 (4) 18
Reclassification adjustments included in net income (loss), net of tax
benefit of $(1), $-, $(7) in 2006 and $(3),
respectively$(6) in 2005 (1) (1) (7) (6)(8)
Foreign currency translation, net 5 2 12 944
Net income (loss) (263) 59 (81) 72
------- -------(24) 152
------- -------
Total Other Comprehensive Income (Loss) $ (227)(22) $ 63 $ (42) $ 182
======= =======165
======= =======
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CMS-40CMS-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 to Consolidated Financial Statements contained in CMS
Energy's Form 10-K for the year ended December 31, 2004.2005. 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 with a business
strategy focusedoperating
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 Revised FASB Interpretation No. 46.46(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 3,2, 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. The gains or losses that result from this processThese foreign currency translation adjustments are shown in
the stockholders' equity section on our Consolidated Balance Sheets. Gains
and losses that arise from exchangeExchange
rate fluctuations on transactions denominated in
CMS-41
CMS Energy Corporation a currency other than the
functional currency, except those that are hedged, are included in determining
net income.
Argentina: At September 30, 2005,March 31, 2006, the netcumulative 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 recorded in the Foreign Currency
Translation component of stockholders' equity using an exchange rate of 2.9203.139 pesos per
U.S. dollar was $263 million. This amount also reflects the effect$265 million, net of recording, at December 31, 2002, U.S. income taxes on temporary differences
between the book and tax bases of foreign investments, including thetax. The net foreign currency translation associated withloss 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 Argentine investments.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 Nine Months Ended
------------------ -----------------
September 30months ended March 31 2006 2005
2004 2005 2004
- ------------ ---- ---- ---- ------------------------------- ------ ------
Other income
Interest and dividends - related parties $ 2 $ 2
$ 7 $ 4
Electric restructuring return 1 2 5 51
Return on stranded and security costs 1 - 4 1
Nitrogen oxide allowance salesRefund of surety bond premium 1 -
2 -
Investment sale gain - 1 - 2
ReversalReduction of contingent liability - - 3 -
All other 5 - 7 2 --- --- --- ---1
------ ------
Total other income $10 $ 5 $28 $14
=== === === ===7 $ 8
====== ======
CMS-32
CMS Energy Corporation
In Millions
-----------------------------------------------------------
Three Months Ended Nine Months Ended
------------------ -----------------
September 30months ended March 31 2006 2005
2004 2005 2004
- ------------ ---- ---- ---- ------------------------------- ------ ------
Other expense
Investment write-down $ - $ - $ (1) $ -
Loss on reacquired and extinguished debt (10) - (16) -
Plant maintenance shut-down - - (2) -(5) (5)
Civic and political expenditures (1) (1)
(2) (2)
Loss on SERP investmentDonations (1) - (1) (1) (2)
All other (2) 1 (3) (1)
---- --- ---- ----
------ ------
Total other expense $(13) $(1) $(25) $(5)
==== === ==== ===$ (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.
CMS-42
CMS Energy Corporation
2: ASSET IMPAIRMENT CHARGES AND SALES
ASSET IMPAIRMENT CHARGES
We evaluate potential impairments of our investments in long-lived assets, other
than goodwill, based on various analyses, including the projection of
undiscounted cash flows, whenever events or changes in circumstances indicate
that the carrying amount of the assets may not be recoverable. If the carrying
amount of the investment or asset exceeds its estimated undiscounted future cash
flows, an impairment loss is recognized and the investment or asset is written
down to its estimated fair value. In the third quarter of 2005, we recorded
Asset impairment charges of $1.184 billion on our Consolidated Statements of
Income. These charges reduced our third quarter 2005 net income by $385 million.
The MCV Partnership's costs of producing electricity are tied to the price of
natural gas, but its revenues do not vary with changes in the price of natural
gas. While the average forward price of natural gas has increased steadily from
2002 through the second quarter of 2005, it remained at a level that suggested
the MCV Partnership's operating cash flow would be sufficient to provide for the
recovery of its assets. However, unforeseen natural and economic events in the
third quarter of 2005 caused a substantial upward spike in NYMEX forward natural
gas prices for the years 2005 through 2010. Additionally, other independent
natural gas long-term forward price forecasting organizations indicated their
intention to raise their forecasts for the price of natural gas generally over
the entire long-term forecast horizon beyond 2010. Our analysis and assessment
of this new information suggests that forward natural gas prices for the period
from 2006 through 2010 will average approximately $9 per mcf. This compares to
the second quarter 2005 NYMEX-quoted average prices for the same forward period
of approximately $7.50 per mcf. Further, this new information indicates that
natural gas prices will average approximately $6.50 per mcf over the long term
beyond 2010. As a result, the MCV Partnership reevaluated the economics of
operating the MCV Facility and determined that an impairment analysis,
considering revised forward natural gas price assumptions, was required. In its
impairment analysis, the MCV Partnership determined the fair value of its fixed
assets by discounting a set of probability-weighted streams of future operating
cash flows at a 4.3 percent risk free interest rate. The carrying value of the
MCV Partnership's fixed assets exceeded the estimated fair value by $1.159
billion. In the third quarter of 2005, the MCV Partnership recorded an
impairment charge of $1.159 billion to recognize the reduction in fair value of
the MCV Facility's fixed assets. As a result, our net income was reduced by $369
million after considering tax effects and minority interest. The MCV
Partnership's fixed assets, which are included on our Consolidated Balance
Sheets and reported under the Enterprises business segment, after reflecting the
impairment charge, are valued at $219 million at September 30, 2005.
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 financial obligations under the sale and
leaseback transactions and other contracts.
Our 49 percent interest in the MCV Partnership is held through Consumers'
wholly-owned subsidiary, CMS Midland. The severe adverse change in the
anticipated economics of the MCV Partnership operations discussed within this
Note also led to our decision to impair certain assets carried on the balance
sheet of CMS Midland. These assets represented interest capitalized during the
construction of the MCV Facility, which were being amortized over the life of
the MCV Facility. In the third quarter of 2005, we recorded an impairment charge
of $25 million ($16 million, net of tax) to reduce the carrying amount of these
assets to zero.
In the first quarter of 2004, an impairment charge of $125 million ($81 million,
net of tax) was recorded to recognize the reduction in fair value as a result of
the sale of Loy Yang. The impairment included a cumulative net foreign currency
translation loss of approximately $110 million. The sale of Loy Yang was
completed in April 2004.
CMS-43
CMS Energy Corporation
ASSET SALES
Gross cash proceeds received from the sale of assets totaled $59 million for the
nine months ended September 30, 2005 and $215 million for the nine months ended
September 30, 2004. The impacts of these sales are included in Gain on assets
sales, net on our Consolidated Statements of Income.
For the nine months ended September 30, 2005, we sold the following assets:
In Millions
------------------
Pretax After-tax
Date sold Business/Project Gain Gain
- --------- ---------------- ------ ---------
February GVK $ 3 $ 2
April Scudder Latin American Power Fund 2 1
April Gas turbine and auxiliary equipment - -
--- ---
Total gain on asset sales $ 5 $ 3
=== ===
For the nine months ended September 30, 2004, we sold the following assets:
In Millions
------------------
Pretax After-tax
Date sold Business/Project Gain Gain
- --------- ---------------- ------ ---------
February Bluewater Pipeline $ 1 $ 1
April Loy Yang - -
May American Gas Index fund 1 1
August Goldfields 45 29
Various Other 2 1
--- ---
Total gain on asset sales $49 $32
=== ===
Although much of our asset sales program is complete, we still may sell certain
remaining businesses that are not strategic to us.
3: CONTINGENCIES
SEC AND OTHER INVESTIGATIONS: As a resultDuring the period of round-tripMay 2000 through January
2002, CMS MST engaged in simultaneous, prearranged commodity trading
transactions by
CMS MST, CMS Energy's Board of Directors established a Special Committee to
investigate matters surroundingin which energy commodities were sold and repurchased at the transactions and retained outside counsel to
assist in the investigation. The Special Committee completed its investigation
and reported its findings to the Board of Directors in October 2002. The Special
Committee concluded, based on an extensive investigation, that thesame
price. These so called round-trip trades were undertaken to raise CMS MST's profile as an energy marketer withhad no impact on previously reported
consolidated net income, earnings per share, or cash flows but had the goaleffect of
enhancing its ability to promote its services to new customers. The
Special Committee found no effort to manipulate the price of CMS Energy Common
Stock or affect energy prices. The Special Committee also made recommendations
designed to prevent any recurrence of this practice. Previously, CMS Energy
terminated its speculative trading businessincreasing operating revenues and revised its risk management
policy. The Board of Directors adopted, and CMS Energy implemented, the
recommendations of the Special Committee.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 CMS-44
CMS Energy Corporation
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, including but not limited to
Consumers which, while established, operated and regulated as a separate legal
entity and publicly traded company, shares a parallel Board of Directors with
CMS Energy. The complaints were filed as purported class actions in the United
States District Court for the Eastern District of Michigan, by shareholders who
allege that they purchased CMS Energy's securities during a purported class
period running from May 2000 through March 2003.affiliates. The cases were consolidated into a
single lawsuit. The consolidated 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 was granted dismissingto dismiss Consumers and three of the individual defendants,
but the court denied the motions to dismiss for CMS Energy and the 13 remaining individual
defendants. Plaintiffs
filed a motion for class certification on April 15, 2005The court issued an opinion and anorder dated March 24, 2006, granting
in part and denying in part plaintiffs' amended motion for class certification on June 20, 2005.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.
SETTLEMENT OF DEMAND FOR ACTION AGAINST OFFICERS AND DIRECTORS: In May 2002, the
Board of Directors ofCMS-33
CMS Energy received a demand, on behalf of a shareholder
of CMS Energy Common Stock, that it commence civil actions (i) to remedy alleged
breaches of fiduciary duties by certain CMS Energy officers and directors in
connection with round-trip trading by CMS MST, and (ii) to recover damages
sustained by CMS Energy as a result of alleged insider trades alleged to have
been made by certain current and former officers of CMS Energy and its
subsidiaries. In December 2002, two new directors were appointed to the Board.
The Board formed a special litigation committee in January 2003 to determine
whether it was in CMS Energy's best interest to bring the action demanded by the
shareholder. The disinterested members of the Board appointed the two new
directors to serve on the special litigation committee.
In December 2003, during the continuing review by the special litigation
committee, CMS Energy was served with a derivative complaint filed by the
shareholder on behalf of CMS Energy in the Circuit Court of Jackson County,
Michigan in furtherance of his demands.
On July 7, 2005, CMS Energy filed with the court a Stipulation of Settlement
that was signed by all parties as well as the special litigation committee. The
judge entered the Final Order and Judgment on August 26, 2005. Pursuant to the
terms of the settlement, on September 5, 2005, CMS Energy received $12 million
from its insurance carriers under its directors and officers liability insurance
program, $7 million of which will be used to pay any reasonable settlement,
judgment or other costs associated with the securities class action lawsuits.
CMS Energy may use the remaining $5 million to pay attorneys' fees and expenses
arising out of the derivative proceeding.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 and Incentive Plan (the Plan). The two cases, filed in July
2002 in United States District Court for the Eastern District of Michigan, were
consolidated by the trial judge and an amended consolidated complaint was filed. Plaintiffs allege breaches of
fiduciary duties under ERISA and seek restitution on behalf of the Plan with
respect to a decline in value of the shares of CMS Energy Common Stock held in
the Plan. Plaintiffs also seekPlan, as well as other equitable relief and legal fees. InOn March 2004, the judge granted in part, but denied in
part, CMS Energy's motion to dismiss
CMS-45
CMS Energy Corporation
the complaint. The judge has conditionally granted plaintiffs' motion for class
certification. A trial date has not been set, but is expected to be no earlier
than mid-2006.1, 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 defend themselves vigorously in
this litigation but cannot predict its outcome.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 Commodity Futures Trading CommissionCFTC 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, a third partyparties
constructed a golf course and a park over several abandoned cement kiln dust
(CKD) piles, leftoverleft 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 (NON), after finding high pH-seephigh-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.
UnderPursuant to the AOC, CMS Energy is generally obligated, among other things, to: (i)
engage in measures to restrict access to seep areas, install methods to
interrupt the flow of seep water to Lake Michigan, and take other measures as
may be required by the EPA under an approved "removal action work plan"; (ii)
investigate and study the extent of hazardous substances at the site, evaluate
alternatives to address a long-term remedy, and issue a report of the
investigation and study; and (iii) within 120 days after EPA approval of the
investigation report, enter into an enforceable agreement with the MDEQ to
address a long-term remedy under certain criteria set forth in the AOC. The EPA approved a final removal action work plan in SeptemberJuly
2005. The EPA-approved removal action workAmong other things, the plan providescalls for fencing of affected
beach-front areas and the installation of an undergroundcollection
trenches to intercept high pH CKD leachate collection
system, among other elements. The EPA's approvals also specify that a backup
"containment and isolation system," involving dams or barriersflow to the lake. Final installation
of the trenches in the lake,
could be requiredwestern-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 certain areas, ifthe East Park leachate release area. The work plan calls
for completion of the collection system is ineffective.trenches in East Park by November 16, 2006.
Several parties have issued demand lettersproperty owners at Bay Harbor made claims for loss or damage to CMS Energy claiming breach of the
indemnification provisions, making requests for payment of their
expenses
related to the NON, and/or claiming damages to property or personal injury with
regard to the matter. Several landowners have threatened litigation in the event
their demands are not met and ownersproperty. The owner of one parcel havehas 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 respondedand 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
indemnification claims by stating that it
had not breached its indemnity obligations, it will comply with the indemnities,
it has restarted the seep water collection facility and it has responded to the
NON.complaint. CMS EnergyLand has entered into CMS-46
CMS Energy Corporation
negotiationsvarious 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,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 associated with this matter
in the amount of $45 million in the fourth quarter of 2004.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 $815$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
- allowance for funds used during construction (AFUDC)an AFUDC capitalization rate.
Our current capital cost estimates include an escalation rate of 2.6 percent and
an AFUDC capitalization rate of 8.38.4 percent. As of September 2005,March 2006, we have
incurred $589$616
million in capital expenditures to comply with thesethe federal Clean Air Act and
resulting regulations and anticipate that the remaining $226$203 million of capital
expenditures will be made in 20052006 through 2011. These expenditures include
installing selective catalytic control reduction technology at four of our
coal-fired electric generating plants. In addition to modifying the 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 utilize
nitrogen oxide emissions allowances for years 2006recover from our customers through 2008, of which 90
percent have been obtained.the PSCR
process. The cost of the allowancesprojected annual expense is estimated to average
$5 million per year for 2006 through 2008. The estimated costs are based on market price forecasts and
forecasts of regulatory provisions, known as progressive flow control, that
restrict the averageusage in any given year of allowances banked from previous years.
The
CMS-35
CMS Energy Corporation
allowances and their cost of the purchased, allocated, and exchanged allowances. The need for
allowances will decrease after 2006 with the installation of selective catalytic
control technology. The cost of the allowances isare accounted for as inventory. The allowance
inventory is expensed at the rolling average cost as the coal-fired electric
generating unitsplants emit nitrogen oxide.
TheIn March 2005, the EPA recently adopted athe 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 and nitrogen oxides by 63 percentfrom
2003 levels by 2015. The final rule will require that we run our Selective Catalytic Reductionselective
catalytic control reduction technology units year-roundyear 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
control technology installed to
meet the Nitrogen Oxide State Implementation
Plan,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 cost near thatsurplus of sulfur dioxide allowances, which were granted by the
Nitrogen Oxide State Implementation Plan.EPA and are accounted for as inventory. In MayJanuary 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 powergenerating
plants by 2010 and further reductions by 2018. WhileThe 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,emissions. However, we
anticipate our capital and
CMS-47
CMS Energy Corporation operating costs for mercury emissions reductions
are expectedrequired by the Clean Air Mercury Rule to be significantly less than what iswas
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. The MDEQ has not indicated the direction that it will pursue to meet
or exceed the EPA requirements through a state rulemaking. We are actively
participating in dialog with the MDEQ regarding potential paths for controlling
mercury emissions and meeting the EPA requirements. 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 modification 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 pastour experience, we
estimate that our share of the total liability for the known Superfund sites
will be between $1$2 million and $9$10 million. At September 30, 2005,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 the Ludington Pumped
Storage facility.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 GTG 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 is assessing the duct burner issue and has beguntook 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 unique 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 this MDEQ letter in
July 2004.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 willincludes 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 is likely tomay involve a
fine, but at this time, the MDEQ has not stated what, if any, fine they will
seek to impose. At this time, the MCV Partnership managementwe cannot predict the financial impact or outcome
of this issue.
CMS-48
CMS Energy Corporation
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, failurefailing 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 the result ofissued 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). All items have been addressed or corrected and theThe MCV Partnership has committed to updatingsubmitted its updated
SWPPP byon December 1, 2005. The MCV Partnership management believes that once it files its updated SWPPP it will
havehas
resolved all issues associated with the Notice Letter and Compliance Inspection
and does not expect any further MDEQ actionactions 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 allegesalleged 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
eight plaintiff qualifying facilitiesplaintiffs have appealed the dismissal of the
circuit court caseMPSC order to the Michigan Court of Appeals. The
qualifying facilitiesplaintiffs also filed suit in the United States Court for the Western District
of Michigan, which the judge subsequently dismissed. The plaintiffs have also
appealed the February 2005 MPSC order in the 2004 PSCR plan casedismissal to the MichiganUnited States Court of Appeals, and have initiated separate legal actions in
federal district court and at the FERC concerning the energy charge calculation
issue. In June 2005, the FERC issued a notice of intent not to act on this
issue. In October 2005, the federal district court dismissed the case.Appeals. We cannot predict
the outcome of the remainingthese appeals.
CONSUMERS' ELECTRIC UTILITY RESTRUCTURING MATTERS
ELECTRIC ROA: We cannot predict the total amountThe Customer Choice Act allows all of our electric supply load that
may be lostcustomers to
buy electric generation service from us or from an alternative electric
suppliers. As of October 2005,supplier. At March 31, 2006, alternative electric suppliers arewere providing 754348
MW of generation service to ROA customers. This amount represents a decrease of 14 percent compared to October 2004, and 10is 4 percent of our total
distribution load.
ELECTRIC RESTRUCTURING PROCEEDINGS: Belowload 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 discussion of our electric
restructuring proceedings.
The following chart summarizes our electric restructuring filings with the MPSC:
Year(s) Years Requested
Proceeding Filed Covered Amount Status
- ---------- ------- ------- --------- ------
Stranded Costs 2002-2004 2000-2003 $137 million(a) The MPSC ruled that we experienced zero
Stranded Costs for 2000 through 2001. The
MPSC approved recovery of $63 million in
Stranded Costs for 2002 through 2003, plus
the cost of money through the period of
collection.
Implementation 1999-2004 1997-2003 $91 million(b) The MPSC allowed $68 million for the years
Costs 1997-2001, plus the cost of money through
the period of collection. The MPSC allowed
$6 million for the years 2002-2003, plus
the cost of money through the period of
collection.
Section 10d(4) 2004 2000-2005 $628 million Application filed with the MPSC in October
Regulatory 2004.
Assets
CMS-49
CMS Energy Corporation
(a) Amount includes the cost of money through the year in which we expectedmechanism pursuant to
receive recovery from the MPSC and assumes recovery of Clean Air Act costs
through the Section 10d(4) Regulatory Asset case.
(b) Amount includes the cost of money through the year prior to the year filed.
Section 10d(4) Regulatory Assets: Section 10d(4) of the Customer
Choice Act allows us to recover certain regulatory assets through deferredprovide recovery of annual capital expenditures in excess of depreciation levels and certain other
expenses incurred priorStranded Costs that occur when customers leave
our system to and throughout the rate freeze and rate cap periods,
including the cost of money. The section also allows deferred recovery of
expenses incurred during the rate freeze and rate cap periods that resultpurchase electricity from changes in taxes, laws, or other state or federal governmental actions.alternative suppliers. In October 2004,November 2005,
we filed an application with the MPSC seeking recovery of $628
million of Section 10d(4) Regulatory Assets for the period June 2000 through
December 2005 consisting of:
- capital expenditures in excess of depreciation,
- Clean Air Act costs,
- other expenses related to changes in law or governmental action
incurred during the rate freeze and rate cap periods, and
-determination of 2004
Stranded Costs. Applying the associated cost of money through the period of collection.
Of the $628 million, $152 million relates to the cost of money.
As allowed by the Customer Choice Act, we accrue and defer for recovery a
portion of our Section 10d(4) Regulatory Assets. In March 2005, the MPSC Staff
filed testimony recommending the MPSC approve recovery of approximately $323
million in Section 10d(4) costs, which includes the cost of money through the
period of collection. In June 2005, the ALJ issued a proposal for decision
recommending that the MPSC approve recovery of the same Section 10d(4) costs
recommended by the MPSC Staff. However, we may have the opportunity to recover
certain costs included in our application alternatively in other cases pending
before the MPSC. We cannot predict the amount, if any, the MPSC will approve as
recoverable. At September 30, 2005, total recorded Section 10d(4) Regulatory
Assets were $201 million.
TRANSMISSION SALE: In May 2002, we sold our electric transmission system to MTH,
a non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect, Inc. We are in arbitration with MTH regarding property tax itemsStranded Cost methodology used in establishing the selling price of our electric transmission system. An
unfavorable outcome could resultprior MPSC
orders, we concluded that we experienced zero Stranded Costs in a reduction of sale proceeds previously
recognized of approximately $2 million to $3 million.2004.
CONSUMERS' ELECTRIC UTILITY RATE MATTERS
ELECTRIC RATE CASE: In December 2004, we filed an application with the MPSC to
increase our retail electric base rates. The electric rate case filing requests
an annual increase in revenues of approximately $320 million. The primary
reasons for the request are load migration to alternative electric suppliers,
increased system maintenance and improvement costs, Clean Air Act-related
expenditures, and employee pension costs. In April 2005, we filed updated debt
and equity information in this case.
In June 2005, the MPSC Staff filed its position in this case, recommending a
base rate increase of $98 million. The MPSC Staff also recommended an 11.25
percent return on equity to establish rates and recognized all of our projected
equity investment (infusions and retained earnings) in 2006. In August 2005, we
revised our request for an annual increase in revenues to approximately $197
million, and the MPSC Staff revised its recommendation to $100 million. In
October 2005, the ALJ issued a proposal for decision recommending a base rate
increase of $112 million and an 11.25 percent authorized return on equity. We
expect a final order from the MPSC in late 2005. If approved as requested, the
rate increase
CMS-50
CMS Energy Corporation
would go into effect in January 2006 and would apply to all retail electric
customers. We cannot predict the amount or timing of the rate increase, if any,
which the MPSC will approve.
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 20062007 through
2007.2010. As a result, we have recognized an asset of $6$72 million for unexpired
capacity and energy contracts at September 30, 2005. As of October 2005,March 31, 2006. At April 2006, we expect the
total premiumcapacity cost of electric capacity and energy contracts for 20052006 to be approximately $8$18
million.
PSCR: The PSCR process is designed to allowallows recovery of all reasonable and prudent power supply
costs that we actually incur. In June 2005, the MPSC issued
an order that approves our 2005 PSCR plan. The 2005 PSCR charge allows us to
recover a portion of our power supply costs from commercial and industrial
customers and, subject to the overall rate caps, from other customers. The
revenuescosts. Revenues from the PSCR charges are subject to reconciliation after review of
actual
costs are reviewed for reasonableness and prudence. In March 2005, we submitted our
2004 PSCR reconciliation filing to the MPSC. In September 2005, we
submitted our 2006 PSCR plan filing to the MPSC. UnlessIn November 2005, we receivesubmitted
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 self-implement this proposed 2006 PSCR charge in January 2006.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 Revised FASB Interpretation No. 46. For
additional details, see Note 9, Consolidation46(R).
Under the MCV PPA, variable energy payments to the MCV Partnership are based on
the cost of Variable Interest Entities.
Thecoal 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 cash 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
payments as follows:
In Millions
------------------
2005 2006 2007
---- ---- ----
Estimated cash underrecoveries $56 $55 $39
Of the 2005 estimate, we expensed $43 million during the nine months ended
September 30, 2005.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 amountamounts 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.
Further, 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
CMS-51
CMS Energy Corporation
increased substantially in recent years and throughout 2005. In the third
quarter of 2005, the MCV Partnership reevaluated the economics of operating the
MCV Facility and determined that an impairment was required. We are evaluating
various alternatives in order to develop a new long-term strategy with respect
to the MCV Facility. For additional details on the impairment of the MCV
Facility, see Note 2, Asset Impairment Charges and Sales.
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 will benefitbenefits our ownership interest in the MCV Partnership.
The substantial MCV Facility fuel cost savings are first used to offset fully
the cost of replacement power. Second, $5 million annually, funded jointly by
Consumers and the MCV Partnership, are contributed to our RRP. Remaining savings
are split between the MCV Partnership and Consumers. Consumers' direct savings
are shared 50 percent with its customers in 2005 and 70 percent in 2006 and
beyond. Consumers' direct savings from the RCP, after allocating a portion to
customers, are used to offset our capacity and fixed energy underrecoveries
expense. Since the MPSC has excluded these underrecoveries from the rate making
process, we anticipate that our savings from the RCP will not affect our return
on equity used in our base rate filings.
In January 2005, Consumers and the MCV Partnership's general partners accepted
the terms of the order andwe 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.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 approximately $83$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: Decommissioning-fundingThe 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 onin March 31, 2004. Excluding additional costs for spent nuclear fuel
storage, due to the DOE's failure to accept this spent nuclear fuel on schedule,
these reports show a decommissioning cost of $361 million for Big Rock and $868
million for Palisades. Since Big Rock is currently in the process of
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 $394$390 million in 2005 dollars.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
CMS-52
CMS Energy Corporation 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 $57$36 million. At this time, we plan to
provide thethis additional amounts neededamount 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, atin addition to the
MPSC.amount we added to the fund, from some alternative source. We cannot predict how the
MPSC will rule on our request.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 costscost estimates
filed in March 2004, that the existing Palisades' surcharge for Palisadesof $6 million needed
to be increased to $25 million annually, beginning January 1, 2006, and
continuing through 2011, our current license expiration date. In June 2004, we
filed an application with2006. A settlement
agreement was approved by the MPSC, seeking approval to increase the surcharge
for recovery of decommissioning costs related to Palisades beginning in 2006. In
September 2004, we announced that we would seek a 20-year license renewal for
Palisades. In January 2005, we filed a settlement agreement with the MPSC that
was agreed to by four of the six parties involved in the proceeding. The
settlement agreement providesproviding 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. In September 2005, the MPSC approved the contested
settlement. Amounts collected from electric retail customers and deposited in trusts,
including trust earnings, are credited to a regulatory liability and
asset retirement obligation.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. Certain parties
are seeking to intervene and have requested a hearing on the application. The
NRC has stated that it expects to take 22-30 months to review a license renewal
application. 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 September 30, 2005, we have recorded aMarch 31, 2006, our DOE liability to the DOE of $144 million, includingis $147
million. This amount includes interest, which is payable prior
toupon 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. On April 29, 2005, the court ruled on various cross-motions for
summary judgment previously filed by the DOE and us. The court denied the DOE's
motions to dismiss Counts I and II of the complaint and its motion seeking
recovery of a one-time fee that is due to be paid by us prior to delivery of the
spent nuclear fuel. The court, however, granted the DOE's motion to recoup the
one-time fee against any award of damages to us. The court further granted our
motion for summary judgment on liability and our motion to dismiss the DOE's
affirmative defense alleging our failure to satisfy a condition precedent. We
filed a motion for reconsideration of the portion of the Court's order dealing
with recoupment, which the Court denied. 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.
CMS-53
CMS Energy Corporation
In July 2002, Congress approved and the President signed a bill designating 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. The United States Congress enacted the
Price-Anderson Act to provide financial liability protection for those parties
who may be liable for a nuclear accident or incident. Part of the Price-Anderson Act's
financial protection is a mandatory industry-wide program 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 2003,2005, we estimated our remaining
costs to be between $37$29 million and $90$71 million, based on 20032005 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 insurance proceeds derived from a
settlement with insurers and MPSC-approved rates. Since 2003, we have spent $14 million on remediation
activities related to the 23 sites. At September 30, 2005,March 31, 2006, we have a
liability of $34$28 million, net of $48$54 million of expenditures incurred to date,
and a regulatory asset of $62$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.
CMS-54
CMS Energy Corporation
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 an annual plan and reconciliation proceeding.
The following table summarizes ourproceedings.
GCR reconciliation filings with the MPSC.
Additional details relatedfor year 2004-2005: In March 2006, a settlement was reached
and submitted to the proceedings follow the table.
Gas Cost Recovery Reconciliation
Net Over-
GCR Year Date Filed Order Date recovery (a) Status
- --------- ---------- ------------- ------------ ------------------------
2003-2004 June 2004 February 2005 $31 million The net overrecovery
includes $1 million and
$5 million GCR net
overrecoveries from
prior GCR years and
interest accrued through
March 2004.
2004-2005 June 2005 PendingMPSC for approval for our 2004-2005 GCR year
reconciliation. The settlement is for a $2 million
(a) Net overrecoveries includenet overrecovery for the GCR
year; it includes interest through March 2005 and refunds that we
CMS-42
CMS Energy Corporation
received from our suppliers whichthat 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 2004,2005 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 20052006
through March 2006.2007. Our request proposed using a GCR factor consisting of:
- a base GCR ceiling factor of $6.98$11.10 per mcf, plus
- a quarterly GCR ceiling price adjustment contingent upon future
events.
TheOur GCR factor can be adjusted monthly, provided it remains at or below the
current ceiling price. The quarterly adjustment mechanism allows an increase in
the GCR ceiling price to reflect a portion of cost increases if the average
NYMEX price for a specified period is greater than that used in calculating the
base GCR factor. The current ceiling price for 2005 is $8.73 per mcf. Actual gas
costs and revenues will be subject to an annual reconciliation proceeding.
In June 2005, four of the five parties filed a settlement agreement; the fifth
party filed a statement of non-objection. The settlement agreement includes a
GCR ceiling price adjustment contingent upon future events.
In September 2005, we filed a motion with the MPSC seeking to reopen our GCR
plan for year 2005-2006. Since the settlement agreement entered into in June
2005, there have been substantial, unanticipated increases in the market price
for natural gas. These increases have been so large that the maximum adjustments
possible under the GCR ceiling price adjustment mechanisms included in the
settlement agreement are not adequate. Unless the maximum allowable GCR factor
is increased, we will experience a substantial GCR underrecovery for the 2005-2006 GCR year. In our filing, we have requested the MPSC to:
- increase the base GCR factor from $6.98 to $9.11billing month of May 2006 is $9.07 per mcf, and
- revise the GCR ceiling price adjustment mechanism increasing the
maximum GCR factor from $8.73 per mcf to $11.21 per mcf.
We are requesting the increase in the maximum allowable GCR factor be effective
as soon as possible but not later than January 1, 2006.
CMS-55
CMS Energy Corporation
On October 6, 2005, the MPSC issued an order reopening evidentiary proceedings.
The MPSC established an expedited contested case proceeding. The MPSC Staff and
intervenors filed testimony and exhibits on October 17, 2005; rebuttal testimony
occurred October 24, 2005. The case is scheduled to be submitted directly to the
Commission without the necessity of the preparation of the ALJ's proposal for
decision on November 21, 2005.
2001 GAS DEPRECIATION CASE: In October and December 2004, the MPSC issued
Opinions and Orders in our gas depreciation case, whichwhich:
- reaffirmed the previously orderedpreviously-ordered $34 million reduction in our
depreciation expense. The
October 2004 order alsoexpense,
- required us to undertake a study to determine why our plant removal
costs are in excess of those 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.
TheWe filed the study report with the MPSC has directed usStaff on December 29, 2005.
We are also required to file our next gas depreciation case within 90 days after the latter of:
- the removal cost study filing, or
-
the MPSC issuance of a final order in the pending case related to ARO
accounting. TheWe cannot predict when the MPSC will issue a final order onin the pending case related to ARO
accounting case.
If the depreciation case order is expected inissued after the first quarter of 2006. Wegas general rate case order,
we proposed to incorporate theits results ofinto the gas
depreciation case into gas general rates using a
surcharge mechanism if the
depreciation case order was not issued concurrently with a gas general rate case
order.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. The primary reasons for
the request are recovery of new investments, carrying costs on natural gas
inventory related to higher gas prices, system maintenance, employee benefits,
and low-income assistance. If approved, the request would add approximately 5
percent to the typical residential customer's average monthly bill. The increase
would also affect commercial and industrial customers. 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
Tennessee.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
CMS-56
CMS Energy Corporation the amount of $110 million, plus
interest and costs, which DFD states represents
the cumulative amount owed by DIG for delays DFD believes DIG caused and for
prior change orders that DIG previously rejected.costs. DFD also filed a construction lien for the $110 million. DIG
inis 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. Terra appealed this matter toAppeals were filed of the Michigan Courtoriginal verdict and a subsequent decision of
Appeals. The Michigan
Court of Appeals reversed the trial court judgment with respect to the
appropriate measure of damages and remanded the case for a new trial on damages.
The trial judge reinstated the judgment against Terra and awarded Terra title to
the minerals. Terra appealed this judgment.remand. The court of appeals heard arguments
on May 19, 2005 and issued an opinion on May 26, 2005
remanding the case to the trial court for a new trial on damages. The plaintiffsAt 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 an application for
leave to appeal with the Michigan Supreme Court.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
year-end.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: OnRULING AND AUDIT: In August 2, 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. Accordingly,
we cannot predictunresolved 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
rulingmatter on future earnings, cash flows, or our present NOL carryforwards.carryforwards remains
uncertain, but could be material. CMS Energy cannot predict the outcome of this
matter.
CMS-45
CMS Energy Corporation
OTHER: CMS Generation does not currently expect to incur material capital costs
at its power facilities for compliance with current U.S. environmental
regulatory standards. In addition to the matters disclosed within this Note, Consumers and
certain other subsidiaries of CMS Energy are parties to certain lawsuits and
administrative proceedings before various courts and governmental agencies
arising from the ordinary course of business. These lawsuits and proceedings may
involve personal injury, property damage, contractual matters, environmental
issues, federal and state taxes, rates, licensing, and other matters.
CMS-57
CMS Energy Corporation
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.
CMS-58
CMS Energy Corporation
4: FINANCINGS AND CAPITALIZATION
Long-term debt is summarized as follows:
In Millions
--------------------------------------
September 30, 2005 December 31, 2004
------------------ -----------------
CMS ENERGY CORPORATION
Senior notes $2,222 $2,175
Other long-term debt 3 225
------ ------
Total - CMS Energy Corporation 2,225 2,400
------ ------
CONSUMERS ENERGY COMPANY
First mortgage bonds 3,175 2,300
Senior notes, bank debt and other 850 1,436
Securitization bonds 378 398
------ ------
Total - Consumers Energy Company 4,403 4,134
------ ------
OTHER SUBSIDIARIES 199 208
------ ------
TOTAL PRINCIPAL AMOUNTS OUTSTANDING 6,827 6,742
Current amounts (286) (267)
Net unamortized discount (20) (31)
------ ------
Total Long-term debt $6,521 $6,444
====== ======
FINANCINGS: The following is a summary of significant long-term debt issuances
and retirements during the nine months ended September 30, 2005:
Principal Interest Rate Issue/Retirement
(In millions) (%) Date Maturity Date
------------- ------------- ---------------- --------------
DEBT ISSUANCES:
CMS ENERGY
Senior notes $ 150 6.30 January 2005 February 2012
CONSUMERS
FMB 250 5.15 January 2005 February 2017
FMB 300 5.65 March 2005 April 2020
FMB insured quarterly notes 150 5.65 April 2005 April 2035
LORB 35 Variable April 2005 April 2035
FMB 175 5.80 August 2005 September 2035
------
TOTAL $1,060
======
DEBT RETIREMENTS:
CMS ENERGY
General term notes $ 220 Various January and Various
February 2005
Senior notes 103 9.875 July through October 2007
September 2005
CONSUMERS
Long-term bank debt 60 Variable January 2005 November 2006
Long-term debt - related parties 180 9.25 January 2005 December 2029
Long-term debt - related parties 73 8.36 February 2005 December 2015
Long-term debt - related parties 124 8.20 February 2005 September 2027
Senior notes 332 6.25 April and May 2005 September 2006
Senior insured quarterly notes 141 6.50 May 2005 October 2028
------
TOTAL $1,233
======
CMS-59
CMS Energy Corporation
By the end of the first quarter of 2006, Consumers will extinguish through a
defeasance $129 million of 9 percent notes. These notes are classified on the
balance sheet as Current portion of long-term debt - related parties.
CAPITALIZATION: In April 2005, we issued 23 million shares of our common stock
at a price of $12.25 per share. We realized net proceeds of $272 million.
REGULATORY AUTHORIZATION FOR FINANCINGS: In April 2005, the FERC issued an
authorization to permit Consumers to issue up to an additional $1.0 billion
($2.0 billion in total) of long-term securities for refinancing or refunding
purposes, and up to an additional $1.0 billion ($2.5 billion in total) of
long-term securities for general corporate purposes during the period ending
June 30, 2006.
Combined with remaining availability from previously issued FERC authorizations,
Consumers can now issue up to:
- $876 million of long-term securities for refinancing or refunding
purposes,
- $1.159 billion of long-term securities for general corporate purposes,
and
- $1.935 billion of long-term FMB to be issued solely as collateral for
other long-term securities.
FMB Indenture Limitations: Irrespective of Consumers' existing FERC
authorization, their ability to issue FMB as primary obligations or as
collateral for financing is governed by certain provisions of their indenture
dated September 1, 1945 and its subsequent supplements. Due to the adverse
impact of the MCV Partnership asset impairment charge recorded in September 2005
on the net earnings coverage test in one of the governing bond-issuance
provisions of the indenture, Consumers expects their ability to issue additional
FMB will be limited to $298 million for 12 months, ending September 30, 2006.
Beyond 12 months, Consumers' ability to issue FMB in excess of $298 million is
based on achieving a two-times FMB interest coverage rate.
REVOLVING CREDIT FACILITIES: The following secured revolving credit facilities
with banks are available at September 30, 2005:
In Millions
-----------------------------------------------------------------------------------------------------------
Outstanding
Company Expiration Date Amount of Facility Amount Borrowed Letters-of-Credit Amount Available
------- --------------- ------------------ --------------- ----------------- ----------------
CMS ENERGY May 18, 2010 $300 $ - $98 $202
CONSUMERS May 18, 2010 500 - 31 469
MCV PARTNERSHIP August 26, 2006 50 - 3 47
CMS Energy and Consumers amended their credit facilities in May 2005. The
amendments extended the terms of the agreements to 2010, reduced certain fees
and interest margins, and reduced CMS Energy's restriction on payment of common
stock dividends.
CAPITAL AND FINANCE LEASE OBLIGATIONS: Our capital leases are comprised mainly
of leased service vehicles and office furniture. At September 30, 2005, capital
lease obligations totaled $52 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
September 30, 2005, finance lease obligations totaled $273 million, which
represents the third-party portion of the MCV Partnership's finance lease
obligation.
CMS-60
CMS Energy Corporation
SALE OF ACCOUNTS RECEIVABLE: Under a revolving accounts receivable sales
program, we currently sell certain accounts receivable to a wholly owned,
consolidated, bankruptcy remote special purpose entity. In turn, the special
purpose entity may sell an undivided interest in up to $325 million of the
receivables. The special purpose entity sold $100 million of receivables as of
September 30, 2005 and $304 million of receivables as of December 31, 2004.
Consumers continues 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. Consumers has 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
---------------
Nine months ended September 30 2005 2004
- ------------------------------ ------ ------
Net cash flow as a result of accounts receivable financing $ (204) $ (247)
Collections from customers $3,782 $3,542
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, dependent on the aggregate amounts of
unrestricted cash and unused commitments under the facility.
Under the provisions of its articles of incorporation, at September 30, 2005,
Consumers had $163 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 nine months ended
September 30, 2005, we received $207 million of common stock dividends from
Consumers.
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 initial recognition and measurement provision of this
Interpretation does not apply to some guarantee contracts, such as product
warranties, derivatives, or guarantees between corporations under common
control, although disclosure of these guarantees is required.
The following table describes our guarantees at September 30, 2005:March 31, 2006:
In Millions
--------------------------------------------------------------------------------------------------------------------------------
Issue Expiration Maximum Carrying
Recourse
Guarantee descriptionDescription Date Date Obligation Amount
provision(b)
- --------------------- -------------------- ---------- ---------- --------
------------
Indemnifications from asset sales and
other agreements(a) Various Variousagreements (a) October 1995 Indefinite $1,147 $ 1 $ -
Standby letters of credit and loans (b) Various Various 64through 129 -
-May 2010
Surety bonds and other indemnifications Various Various 25 -Indefinite 20 -
Other guarantees (c) Various Various 258 - -
Subsidiary guarantee of parent debt May 2005 May 2010 99 - -through 217 1
September 2027
Nuclear insurance retrospective premiums
Various VariousIndefinite 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.
CMS-61(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
(b) Recourse provision indicates the approximate recovery from third parties
including assets held as collateral.
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
sales and other agreements warranties, and other
specific events or circumstances
Standby letters of credit Normal operations of coal power Noncompliance with environmental
plants regulations
plants and inadequate response
to demands for corrective action
Nonperformance
Natural gas transportation Nonperformance
Self-insurance requirement Nonperformance
Nuclear plant closure NonperformanceNon-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
indemnifications permits and licenselicenses
Other guarantees Normal operating activity Nonperformance or non-payment by a
subsidiary under a related contract
Subsidiary guarantee of parent Loan agreement Non-payment by CMS EnergyMCV Partnership's nonperformance or
Agreement to provide power and CMS Enterprises
debt of obligationssteam non-payment under the loan agreementa 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 premiums plants incident
In the ordinary course of business, we enter into agreements containing tax and
other indemnification provisions in connection with a variety of transactions
including transactions for the sale of subsidiaries and assets, equipment
leasing, and financing agreements. While we cannot estimate our maximum exposure
under these indemnities, we consider the probability of liability remote.
We have guaranteed payment of obligations through indemnities, surety bonds and
other guarantees of unconsolidated affiliates and related parties of $446
million at September 30, 2005. Expiration dates vary from December 2005 to
September 2027 or terminate upon payment or cancellation of the obligation. We
monitor these obligations and believe it is unlikely that we would be required
to perform or otherwise incur any material losses associated with the above
obligations.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.
CMS-62At 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 September 2005,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 contingency was met since 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.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, for the three months ended December 31,
2005. Oncecash. Because the
3.375 percent contingently convertible senior notes becameare convertible, which occurred first in June 2005, they heldhold
the characteristics of a current liability. Therefore, in June 2005, we reclassified the 3.375 percent
contingently convertible senior notes from Long-term debt toclassify them as
Current portion of long-term debt, where they will remain during the period that
they are outstanding and convertible. As of October 2005,April 2006, none of the security
holders have notified us of their intention to convert these securities.
5:CMS-49
CMS Energy Corporation
4: EARNINGS PER SHARE
The following tables presenttable presents the basic and diluted earnings per share
computations:computations based on Income (Loss) from Continuing Operations:
In Millions, Except Per Share Amounts
-------------------------------------
Three Months Ended September 30March 31 2006 2005
2004
- ------------------------------- ------ --------------------------------- ------- -------
EARNINGS AVAILABLE TO COMMON STOCKSTOCKHOLDERS
Income (Loss) Fromfrom Continuing Operations $ (263)(25) $ 51152
Less Preferred Dividends (3) (2)
(3)
------ ------------- -------
Income (Loss) Fromfrom Continuing Operations
Available to Common StockStockholders - Basic and$ (28) $ 150
Add conversion of Convertible Debentures (net of tax) - 2
------- -------
Income (Loss) from Continuing Operations
Available to Common Stockholders - Diluted $ (265)(28) $ 48
====== ======152
======= =======
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
Weighted Average Shares - Basic 219.6 161.5219.1 195.3
Add Dilutive Impactdilutive impact of Contingently
Convertible Securities - 3.06.1
Add Dilutiveconversion of Convertible Debentures - 4.2
Add dilutive Stock Options and Warrants - 0.5
------ ------0.7
------- -------
Weighted Average Shares - Diluted 219.6 165.0
====== ======219.1 206.3
======= =======
EARNINGS (LOSS) PER AVERAGE COMMON SHARE
AVAILABLE TO COMMON STOCKSTOCKHOLDERS
Basic $(1.21) $ 0.30
Diluted $(1.21)(0.13) $ 0.29
====== ======
CMS-63
CMS Energy Corporation
In Millions, Except Per Share Amounts
-------------------------------------
Nine Months Ended September 30 2005 2004
- ------------------------------ ------ ------
EARNINGS AVAILABLE TO COMMON STOCK
Income (Loss) From Continuing Operations $ (81) $ 68
Less Preferred Dividends (7) (9)
------ ------
Income (Loss) From Continuing Operations
Available to Common Stock - Basic and0.77
Diluted $ (88)(0.13) $ 59
====== ======
AVERAGE COMMON SHARES OUTSTANDING
APPLICABLE TO BASIC AND DILUTED EPS
Average Shares - Basic 211.0 161.3
Add Dilutive Impact of Contingently
Convertible Securities - 3.0
Add Dilutive Stock Options and Warrants - 0.5
------ ------
Average Shares - Diluted 211.0 164.8
====== ======
EARNINGS (LOSS) PER AVERAGE COMMON SHARE
AVAILABLE TO COMMON STOCK
Basic $(0.42) $ 0.36
Diluted $(0.42) $ 0.36
====== ======0.74
======= =======
Contingently Convertible Securities: Due to antidilution,accounting EPS dilution principles,
there was no impact to diluted EPS from our contingently convertible securities
for the three and nine
months ended September 30, 2005.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: For the three and nine months ended September 30,
2005, dueDue to antidilution,accounting EPS dilution principles, there was
no impact to diluted EPS forfrom stock options and warrants to purchase 3.8for 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 common stock. Fordiluted EPS.
Unvested restricted stock would have contributed an additional 0.9 million
shares to the three and nine
months ended September 30, 2004, sincecalculation 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 for
options and warrants to purchase 4.7 million shares of common stock.
Convertible Debentures: Due to antidilution, the following impacts from our 7.75
percent convertible subordinated debentures. Using the if-converted method, the
debentures were not reflected inwould have:
- increased the numerator of diluted EPS:
- an additional 4.2 million shares of common stock for the three and
nine months ended September 30, 2005 and the three and nine months
ended September 30, 2004,
- aEPS by $2 million from an assumed
reduction of interest expense, net of tax, for the three
months ended September 30, 2005 and the three months ended September
30, 2004, and
- a $7increased the denominator of diluted EPS by 4.2 million reduction of interest expense, net of tax, for the nine
months ended September 30, 2005 and the nine months ended September
30, 2004.shares.
We can revoke the conversion rights if certain conditions are met.
In April 2005, we issued 23 million shares of our common stock. For additional
details, see Note 4, Financings and Capitalization.
CMS-64
CMS Energy Corporation
6:5: 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
-------------------------------------------------------------
September 30, 2005-------------------------------------------------------------------------------
March 31, 2006 December 31, 2004
----------------------------- -----------------------------2005
------------------------------------ ------------------------------------
Fair Unrealized Fair Unrealized
Cost Value Gain (Loss) Cost Value Gain (Loss)
------ ------ ----------- ------ ------ -----------
Long-term debt,
including current amounts $6,807 $7,183 $(376) $6,711 $7,052 $(341)$7,006 $7,086 $ (80) $7,089 $7,315 $ (226)
Long-term debt - related parties,
including current amounts 178 145 33 307 284 23 684 653 31280 27
Available-for-sale securities:
SERP:
Equity securities 35 51 16 34 48 14 33 47 1449 15
Debt securities 18 18 - 20 2017 16 (1) 17 17 -
Nuclear decommissioning investments:
Equity securities 135136 261 125 134 252 117 136 262 126118
Debt securities 288 293 5301 301 - 287 291 302 114
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 1)both:
- an executive oversight committee consisting of senior management
representatives, and
2)- a risk committee consisting of business-unitbusiness unit managers.
Our intention is that any gainsincreases or losses ondecreases in the value of these contracts
will be offset by an opposite movementchange in the value of the item at risk. TheseWe
classify these contracts
are classified as either non-trading or trading.
TheseCMS-51
CMS Energy Corporation
The contracts contain credit risk if the counterparties, including financial
institutions and energy marketers, fail to perform under the agreements. We
reduce this risk through established credit policies, which include performing
financial credit reviews of our counterparties. Determination of our
counterparties' credit quality is based upon a number of factors, including
credit ratings, disclosed financial condition, and collateral requirements.
Where contractual terms permit, we use standard agreements that allow us to net
positive and negative exposures associated with the same counterparty. Based on
these policies, our current exposures, and our credit reserves, we do not expect
a material adverse effect on our financial position or earnings as a result of
counterparty nonperformance.
Contracts used 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 accounted for as a derivative, instrument, it is recorded on the balance sheet as an asset or a liability, at its
fair value. The value recorded isWe then adjusted quarterlyadjust 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 Other Comprehensive Income;accumulated other comprehensive income; otherwise, the changes are reported
in earnings.
CMS-65
CMS Energy Corporation
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 Other Comprehensive Income,accumulated other comprehensive income, those gains andor
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 as of such date recorded in Accumulated Other Comprehensive
Incomeaccumulated 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 recordedthen reclassified to earnings when the
forecasted transaction affects earnings. The ineffective portion, if any, of all
hedges is recognized in earnings.
We use quoted market prices, prices obtained from external sources (i.e.,
brokers and banks), and mathematical valuation models toTo 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. For some derivatives, the time period of the contracts
may extend longer than the time periods for which market quotations for such
contracts are available. Thus, in order to calculate fair value, mathematicalThese models are developed to determinerequire various inputs
into the calculation,and assumptions, including pricecommodity market prices and other variables. Cashvolatilities, as well as
interest rates and contract maturity dates. The cash returns we actually realized fromrealize
on these commitmentscontracts may vary, either positively or negatively, from the results
estimated by
applying mathematicalthat we estimate using these models. As part of determining the fair value ofvaluing our derivatives at
market, we maintain reserves, if necessary, for credit risks based onarising from the
financial condition of counterparties.
The majority of our commodity purchase orand sale contracts are not subject to
derivative accounting under SFAS No. 133 because 1)because:
- they do not have a notional amount identified(that is, a number of units
specified in the contract, 2)a derivative instrument, such as MW of electricity or
bcf of natural gas),
- they qualify for the normal purchases and sales exception, or
3)- 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 that 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 and the significant transportation costs that would be incurred to
deliver the power to the closest active energy market (the Cinergy hub in Ohio).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 to our financial
statements.material. For our
electric capacity and energy contracts, we believe that we willwould be able to
apply the normal purchases and sales exception to the majority of these
contracts (including the MCV PPA), and, therefore, willwould not be required to mark
these contracts to market.
TheCMS-52
CMS Energy Corporation
In 2005, the MISO began operating the Midwest Energy Market on April 1, 2005. Through
operation ofMarket. As a result, the
Midwest Energy Market, 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 commencementestablishment of this market does
not constituterepresent 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 the potential forwhether or not an active energy
market may exist in Michigan.
CMS-66
CMS Energy Corporation
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
-------------------------------------------------------
September 30, 2005------------------------------------------------------------------------------
March 31, 2006 December 31, 2004
-------------------------- --------------------------2005
------------------------------------ ------------------------------------
Fair Unrealized Fair Unrealized
Derivative Instruments Cost Value Gain (Loss) Cost Value Gain (Loss)
- ---------------------- --------- ----- ----------- ---- ----- ---------------- ----------
Non-trading:
Interest rate riskGas supply option contracts $ - $ - $ - $ -1 $ (1) $ (1)
Gas supply option contracts 2 6 4 2 - (2)
FTRs - 1 1 - - - 1 1
Derivative contracts associated with the MCV
Partnership:
Long-term gas contracts (a) - 298 29893 93 - 56 56205 205
Gas futures, options, and swaps (a) - 297 297144 144 - 64 64223 223
CMS ERM contracts:
Non-trading electric / gas contracts - (410) (410)(62) (62) - (199) (199)(63) (63)
Trading electric / gas contracts (b) (2) 62 64 (3) 428 431 (4) 201 205100 103
Derivative contracts associated with equity
investments in:
Shuweihat - (25) (25)(16) (16) - (25) (25)(20) (20)
Taweelah (35) (21) 14(12) 23 (35) (24) 11(17) 18
Jorf Lasfar - (10) (10)(7) (7) - (11) (11)(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 interest rate risk contracts, gas supply option contracts, FTRs, and the
derivative contracts associated with the MCV Partnership is
included in Derivative
instruments, Other assets, or Other liabilities on our Consolidated Balance
Sheets. TheWe include the fair value of the derivative contracts held by CMS ERM is included 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.
INTEREST RATE RISK CONTRACTS: We use interest rate contracts, such as swaps and
collars, to hedge the risk associated with forecasted interest payments on
variable-rate debt and to reduce the impact of interest rate fluctuations. As of
September 30, 2005, we held a floating-to-fixed interest rate swap and an
interest rate collar, effectively hedging long-term variable-rate debt with a
notional amount of $24 million. The notional amount reflects the principal
amount of variable-rate debt being fixed.
For those interest rate contracts that do not qualify for hedge accounting
treatment, we record changes in fair value in earnings as part of Other income.
For interest rate contracts designated as cash flow hedges, we record changes in
the fair value of these contracts in Other Comprehensive Income. There was no
ineffectiveness associated with any of the interest rate contracts that
qualified for cash flow hedge accounting treatment. At September 30, 2005, we
have recorded an unrealized loss of less than $1 million, net of tax, in
Accumulated other comprehensive loss related to these cash flow hedges. We
expect to reclassify this amount as a decrease to earnings during the next 12
months, primarily to offset the variable-rate interest expense on hedged debt.
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. The mark-to-marketAs 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
CMS-67
CMS Energy Corporation
earnings and recorded on the balance sheet as a regulatory asset or liability as
part ofliability.
FTRs: With the GCR process. At September 30, 2005, we had purchased fixed-priced
weather-based gas supply call options and had sold fixed-priced gas supply put
options. We had not purchased any fixed-priced gas supply call options.
FTRS: As partestablishment 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 as fuel for generation,it needs to generate electricity and to manage gas fuel costs.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 are not recognized at fair value on our Consolidated Balance Sheets at September 30, 2005.March 31, 2006.
The MCV Partnership also heldholds certain long-term gas contracts that diddo not
qualify as normal purchases at September 30, 2005, because these contracts containedcontain volume optionality.
In addition, as a result of implementing the RCP in January 2005, a significant portion
of long-term gas contracts no longer qualify as normal purchases, because the
gas will not be consumed as fuel for
electric production.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 ninethree months ended September 30, 2005,March 31, 2006, we recorded
a $242$111 million gainloss, before considering tax effects and minority interest,
associated with the increasedecrease in fair value of these long-term gas contracts.
This gainloss is included in the total Fuel costs mark-to-market at MCV on our
Consolidated Statements of Income. As a result of mark-to-market gains, we have
recorded derivative assets totaling $298 million associated with the fair value
of long-term gas contracts on our Consolidated Balance Sheets.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.
The majorityWe 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 derivative assets, are expectedwhich represent cumulative net
mark-to-market gains, to reverse as losses through earnings during 20052006 and 20062007
as the gas is purchased, with the remainder reversing between 20072008 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 3,2, Contingencies, "Other Consumers'
Electric Utility Contingencies - The Midland Cogeneration Venture."
Gas Futures, Options, and Swaps: The MCV Partnership enters into natural gas
futures, contracts, option contracts,options, and over-the-counter swap transactions in order to hedge
against unfavorable changes in the market price of natural gas in future
months when gas is expected to be needed. Thesegas. The MCV
Partnership uses these financial instruments are used
principally to secure anticipated natural gas requirements necessary for
projected electric and steam sales, and to lock in sales pricesto:
- ensure an adequate supply of natural gas previously obtained in order to optimizefor the MCV Partnership's existing gas
supply, storage,projected
generation and transportation arrangements. At September 30, 2005, the MCV
Partnership only held natural gas futures and swaps.
The contracts that are used to secure anticipated natural gas requirements
necessary for projected electricsales of electricity and steam, sales qualify as cash flow hedges
under SFAS No. 133. There was no ineffectiveness associated with any of these
cash flow hedges. At September 30, 2005, we have recorded a cumulative net gain
of $57 million, net of tax, in Accumulated other comprehensive loss relating to
our proportionate share of the cash flow hedges held by the MCV Partnership.
This balance represents natural gas futures, options, and
swaps with maturities
ranging from October 2005 to December 2009, of which $15 million of this gain,
net of tax, is expected to be reclassified as an increase to earnings during the
next 12 months as the contracts settle, offsetting the costs of gas purchases.
The MCV Partnership also holds natural gas futures and swap contracts to- 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, thesethe futures and swap contracts were accounted for as
cash flow hedges. Since the RCP was implemented in January 2005, these instruments no
longer qualify for cash flow hedge accounting and we record any
CMS-68
CMS Energy Corporation changes in their
fair value have been recorded in earnings each quarter. For the ninethree months ended September 30, 2005,March 31, 2006,
we recorded a $125$45 million gainloss, before considering tax effects and minority
interest, associated with the increasedecrease in fair value of these instruments. This
gainloss is included in the total Fuel costs mark-to-market at MCV on our
Consolidated Statements of Income. As a result of mark-to-market gains, we have recorded derivative assets
totaling $125 million associated with the fair value of these instruments on our
Consolidated Balance Sheets, which is included in the Gas futures and swaps
amount in the Derivative Instruments table above.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. The
majorityWe expect
almost all of these derivative assets are expectedfutures, options, and swap contracts to be realized during
2005 and
2006 as the futures and swap contracts settle, with the remainder to be realized during 2007. For
further details on the RCP, see Note 3,2, Contingencies, "Other Consumers'
Electric Utility Contingencies - The Midland Cogeneration Venture."
The MCV Partnership also engages in cost mitigation activities to offset fixed
charges incurred in operating the MCV Facility. These cost mitigation activities
may include the use of futures and options contracts to purchase and/or sell
natural gas to maximize the use of the transportation and storage contracts when
it is determined that they will not be needed for the MCV Facility operation.
Although these cost mitigation activities do serve to offset the fixed monthly
charges, these activities are not considered a normal course of business for the
MCV Partnership and do not qualify as hedges. Therefore, the mark-to-market
gains and losses from these cost mitigation activities are recorded in earnings
each quarter. For the nine months ended September 30, 2005, we recorded a $4
million loss associated with the decrease in fair value of futures used in these
cost mitigation activities.
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 forward contracts for the future purchase and sale of electricity
and 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, such asincluding swaps,
options, and futures, to manage the commodity price risks associated with its
forward purchase and salessale contracts as well asand with generation assets owned by CMS
Energy or its subsidiaries. These financial contracts are classified as trading
activities.
Non-tradingIn accordance with SFAS No. 133, non-trading and trading contracts that meet the definition of a derivative under
SFAS No. 133qualify
as derivatives are recorded as assets or liabilities in the financial statements
at the fair value of the contracts. Gains or losses arising fromon our Consolidated Balance Sheets.
The resulting assets and liabilities are marked to market each quarter, and
changes in fair value of these contracts are recognizedrecorded in earnings as a component of Operating
Revenue in the period in which the changes occur. GainsRevenue. For trading contracts, these gains and losses on trading
contracts 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 (i.e.,(that is, on an accrual
basis).
DERIVATIVE CONTRACTS ASSOCIATED WITH EQUITY INVESTMENTS: At September 30, 2005,March 31, 2006, some
of our equity method investees held 1)held:
- interest rate contracts that hedged the risk associated with
variable-rate debt, and
2)- foreign exchange contracts that hedged the foreign currency risk
associated with payments to be made under operating and maintenance
service agreements.
The accounting for these
instruments depends on whether they qualify for cash flow hedge accounting
treatment. For the contracts that qualify as cash flow hedges, weWe record our proportionate share of the change in fair value of these contracts
in Other
Comprehensive Income. For thoseAccumulated other comprehensive loss if the contracts that do not qualify asfor cash flow
hedges,hedge accounting; otherwise, we record our
proportionateCMS-55
CMS Energy Corporation
share of the change in fair value of these
contracts in Earnings from Equity Method Investees.
CMS-69
CMS Energy Corporation
FOREIGN EXCHANGE DERIVATIVES: In the past,At times, we have useduse forward exchange and option
contracts to hedge the equity value relating to investments in foreign
operations. These contracts limitedlimit the risk from currency exchange rate movements
because gains and losses on such contracts offset losses and gains,
respectively, on the hedged investments. At September 30, 2005,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 September 30, 2005,March 31, 2006, our total foreign
currency translation adjustment was a net loss of $307$308 million, which included a
net hedging loss of $26 million, net of tax, related to settled contracts.
7: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 after June 30,between July
1, 2003 and August 31, 2005,
- a defined company contribution planDCCP for employees hired on or after September 1, 2005,
- benefits to certain management employees under SERP,
- a defined contribution 401(k) plan,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.
On September 1, 2005, we implementedEffective January 11, 2006, the Defined Company Contribution Plan. The
Defined Company Contribution Plan provides an employer contributionMPSC electric rate order authorized Consumers to
include $33 million of 5 percent
of base payelectric pension expense in its electric rates. Due to
the existing Employees' Savings Plan. No employee contribution is
requiredvolatility of these particular costs, the order also established a pension
equalization mechanism to receivetrack actual costs. If actual pension expenses are
greater than the plan's employer contribution. All employees hired on$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 after September 1, 2005 participaterefunded to our
customers. The difference between pension expense allowed in this plan as partour electric rates
and pension expense under SFAS No. 87 resulted in a $3 million net reduction in
pension expense and establishment of their retirement
benefit program. Cash balance pension plan participants also participate in the
Defined Company Contribution Plan on September 1, 2005. Additional pay credits
under the cash balance pension plan were discontinued as of that date. The
Defined Company Contribution Plan costa corresponding regulatory asset for the
ninethree months ended September 30,
2005 wasending 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.
On January 1, 2005, we resumed the employer's matchmillion net reduction
in CMS Energy Stock on our
401(k) Savings Plan. On September 1, 2005, employees enrolled in the company's
401(k) Savings Plan had their employer match increased from 50 percent to 60
percent on eligible contributions up to the first six percentOPEB expense and establishment of an employee's
wages. The total 401(k) Savings Plan costa corresponding regulatory asset for the
ninethree months ended September
30, 2005 was $9 million.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 was
signed into law in December 2003. The Act establishes a prescription drug
benefit under Medicare (Medicare Part D), and a federal subsidy, which is
tax-exempt, to sponsors of retiree health care benefit plans that provide a
benefit that is actuarially equivalent to Medicare Part D. We believe our plan
is actuarially equivalent to Medicare Part D.
CMS-70ending March 31, 2006.
CMS-57
CMS Energy Corporation
Costs: The following table recaps the costs incurred in our retirement benefits
plans:
In Millions
-----------------------------------------------------------------------------------------
Pension --------------------------------------
September 30OPEB
--------------------- ---------------------
Three Months Ended Nine Months EndedMarch 31 2006 2005 2006 2005
- ------------ ------------------ -----------------
2005 2004 2005 2004
---- ---- ---- ------------------------------- ------ ------ ------ ------
Service cost $ 912 $ 10 $ 346 $ 296
Interest expense 15 17 64 5321 19 16 16
Expected return on plan assets (17) (26) (80) (80)(22) (25) (14) (14)
Amortization of:
Net loss 11 3 25 107 5 4
Prior service cost 2 1 1 5 4
---- ---- ---- ----(3) (2)
------ ------ ------ ------
Net periodic pension cost $ 19 $ 5 $ 48 $ 16
==== ==== ==== ====
In Millions
--------------------------------------
OPEB
--------------------------------------
September 30 Three Months Ended Nine Months Ended24 12 10 10
Regulatory adjustment (3) - ------------ ------------------ -----------------
2005 2004 2005 2004
---- ---- ---- ----
Service cost $ 6 $ 5 $ 17 $ 15
Interest expense 15 14 47 43
Expected return on plan assets (14) (12) (42) (36)
Amortization of:
Net loss 6 3 15 8
Prior service cost (3) (2) (7) (7)
---- ---- ---- ----- -
------ ------ ------ ------
Net periodic postretirement
benefit cost after regulatory adjustment $ 21 $ 12 $ 10 $ 8 $ 30 $ 23
==== ==== ==== ====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 ninethree
months ended September 30,March 31, 2006 and 2005 was less than $1 million.
We remeasured our Pension and OPEB obligations as of April 30, 2005 to
incorporate the effects of the collective bargaining agreement reached between
the Utility Workers Union of America and Consumers. The Pension plan
remeasurement increased our ABO by $127 million. Net periodic pension cost is
expected to increase $14 million for 2005.
The Pension plan remeasurement resulted in an unfunded ABO of $208 million. The
unfunded ABO is the amount by which the ABO exceeds the fair value of the plan
assets. SFAS No. 87 states that the pension liability shown on the balance sheet
must be at least equal to the unfunded ABO. As such, we increased our additional
minimum liability by $145 million to $564 million at June 30, 2005. Consistent
with MPSC guidance, Consumers recognized the cost of its minimum pension
liability adjustment as a regulatory asset. This adjustment increased our
regulatory assets by $94 million and intangible assets by $38 million and
reduced Accumulated other comprehensive loss by $9 million (net of income
taxes).
The OPEB plan remeasurement increased our accumulated postretirement benefit
obligation by $50 million, with an expected total increase in benefit costs of
$3 million for 2005.
CMS-71
CMS Energy Corporation
8:7: 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. For our
regulated utility, as required by SFAS No. 71, we account for the implementation
of this standard by recording regulatory assets and liabilities instead of a
cumulative effect of a change in accounting principle.
The fair value of ARO liabilities has been calculated using an expected present
value technique. This technique reflects assumptions such as costs, inflation,
and profit margin that third parties would consider to assume the settlement of
the obligation. Fair value, to the extent possible, should include a market risk
premium for unforeseeable circumstances. No market risk premium was included in
our ARO fair value estimate since a reasonable estimate could not be made. If a
five percent market risk premium were assumed, our ARO liability would increase
by $22$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.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:
September 30, 2005March 31, 2006 In Millions
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
- --------------- ---------- ----------------- -----
Palisades-decommission plant site 1972 Palisades nuclear plant $537$554
Big Rock-decommission plant site 1962 Big Rock nuclear plant 1822
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 ---
CMS-72
CMS Energy Corporation
In Millions
--------------------------------------------------------------------------------------------------------------------------------------------------
ARO ARO
Liability Cash flow Liability
ARO Description 12/31/0405 Incurred Settled Accretion Revisions 9/30/053/31/06
- --------------- --------- -------- ------- --------- --------- ---------
Palisades-decommission $350$ 375 $ - $ - $19$ 6 $ - $369$ 381
Big Rock-decommission 3027 - (33) 11(4) 1 - 824
JHCampbell intake line - - - - - -
Coal ash disposal areas 54 - (3) 4- 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 2 - (1)1 - - 1 ----- 2
Asbestos abatement 36 - (2) - - 34
------ ------- ------ ------ --- ---- --- --- ----------
Total $439$ 496 $ - $(37) $34$ (6) $ 9 $ - $436
====$ 499
====== ======= ====== ====== === ==== === === ==========
OnIn October 14, 2004, the MPSC initiated a generic proceeding to review SFAS No. 143,
FERC Order No. 631, (Accounting,Accounting, Financial Reporting, and Rate Filing
Requirements for Asset Retirement Obligations),Obligations, and related accounting and
ratemaking issues for MPSC-jurisdictional electric and gas utilities. Utilities
filed responses toOn
December 5, 2005, the Order in March 2005; the MPSC Staff and intervenors filed
responses in May 2005;ALJ issued a proposal for decision is expected in December 2005.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 as involving 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 $5$15 million for the
three months ended September 30, 2005March 31, 2006 and $13$2 million for the three months ended
September 30, 2004 and $21 million for the nine months ended September 30, 2005
and $57 million for the nine months ended September 30, 2004.March 31, 2005. The most significant of these investments are:
-is our 50 percent
interest in Jorf Lasfar, and
- our 40 percent interest in Taweelah.
CMS-73
CMS Energy CorporationLasfar.
Summarized financial information for these equity method investmentsJorf Lasfar is as follows:
Income Statement Data
In Millions
--------------------------------------
JORF LASFAR Three Months Ended Nine Months EndedMarch 31, 2006 Jorf Lasfar
- --------------------------------- -----------
------------------ -----------------
September 30 2005 2004 2005 2004
- ------------ ---- ---- ----- -----
Operating revenue $123 $120 $ 382 $ 332118
Operating expenses (82) (82) (255) (203)
---- ---- -----78
-----
Operating income 41 38 127 12940
Other expense, net (16) (13) (44) (42)
---- ---- -----15
-----
Net income $ 25
$ 25 $ 83 $ 87
==== ==== ===== =====
Income Statement Data
In Millions
--------------------------------------
TAWEELAH
Three Months Ended Nine Months EndedMarch 31, 2005 Jorf Lasfar
- --------------------------------- -----------
------------------ -----------------
September 30 2005 2004 2005 2004
- ------------ ---- ---- ---- ----
Operating revenue $ 27 $ 26 $ 77 $ 74130
Operating expenses (9) (8) (28) (30)
---- ---- ---- ----83
-----
Operating income 18 18 49 4447
Other income (expense),expense, net 4 (28) (20) (20)
---- ---- ---- ----14
-----
Net income (loss) $ 22 $(10) $ 29 $ 24
==== ==== ==== ====33
=====
CMS-62
CMS Energy Corporation
10: REPORTABLE SEGMENTS
Our reportable segments are strategicconsist of business units organized and managed by the nature of thetheir
products and services each provides.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.
CMS-74
CMS Energy Corporation
The "Other" segment includes corporate interest and other and discontinued
operations, and the cumulative effect of accounting changes.operations. The following table
showstables show our financial information by reportable
segment:
In Millions
-------------------------------------------------------------
Three Months Ended Nine Months Ended
------------------ -----------------
September 30March 31 2006 2005
2004 2005 2004
- ------------ ------ ------ ------ --------------------------------- ------- -------
Operating RevenueRevenues
Electric utility $ 793729 $ 704 $2,065 $1,945628
Gas utility 219 171 1,566 1,3761,041 992
Enterprises 323 188 790 589
------ ------ ------ ------
Total Operating Revenue $1,335 $1,063 $4,421 $3,910
====== ====== ====== ======262 225
------- -------
$ 2,032 $ 1,845
======= =======
Net Income (Loss) Available to Common Stockholders
Electric utility $ 6229 $ 49 $ 141 $ 12433
Gas utility (16) (11) 39 4637 58
Enterprises (260) 59 (126) 36(49) 105
Other (51) (41) (142) (143)
------ ------ ------ ------
Total Net Income (Loss)
Available to Common
Stockholders(44) (46)
------- -------
$ (265)(27) $ 56 $ (88) $ 63
====== ====== ====== ======150
======= =======
In Millions
--------------------------------------
September 30, 2005March 31, 2006 December 31, 2004
------------------2005
-------------- -----------------
Total Assets
Electric utility (a) $ 7,5847,864 $ 7,2897,743
Gas utility (a) 3,650 3,1873,193 3,600
Enterprises 4,536 4,9803,651 4,130
Other 345 416842 547
------- -------
Total Assets $16,115 $15,872$15,550 $16,020
======= =======
(a) Amounts include a portion of ourConsumers' other common assets attributable to
both the electric and gas utility businesses.
11: CONSOLIDATION OF VARIABLE INTEREST ENTITIES
We are the primary beneficiary of both the MCV Partnership and the FMLP. We have
a 49 percent partnership interest in the MCV Partnership and a 46.4 percent
partnership interest in the FMLP. Consumers is the primary purchaser of power
from the MCV Partnership through a long-term power purchase agreement. The FMLP
holds a 75.5 percent lessor interest in the MCV Facility, which results in
Consumers holding a 35 percent lessor interest in the MCV Facility.
Collectively, these interests make us the primary beneficiary of these entities.
Therefore, we consolidated these partnerships into our consolidated financial
statements for all periods presented. These partnerships have third-party
obligations totaling $480 million at September 30, 2005. Property, plant, and
equipment serving as collateral for these obligations has a carrying value of
$219 million at September 30, 2005. The creditors of these partnerships do not
have recourse to the general credit of CMS Energy.
We are the primary beneficiary of three other variable interest entities. We
have 50 percent partnership interests each in the T.E.S. Filer City Station
Limited Partnership, the Grayling Generating Station Limited
CMS-75
CMS Energy Corporation
Partnership, and the Genesee Power Station Limited Partnership. Additionally, we
have operating and management contracts and are the primary purchaser of power
from each partnership through long-term power purchase agreements. Collectively,
these interests make us the primary beneficiary as defined by the
Interpretation. Therefore, we consolidated these partnerships into our
consolidated financial statements for all periods presented. These partnerships
have third-party obligations totaling $109 million at September 30, 2005.
Property, plant, and equipment serving as collateral for these obligations has a
carrying value of $164 million at September 30, 2005. Other than outstanding
letters of credit and guarantees of $5 million, the creditors of these
partnerships do not have recourse to the general credit of CMS Energy.
Additionally, we hold interests in variable interest entities in which we are
not the primary beneficiary. The following chart details our involvement in
these entities at September 30, 2005:
Name Investment Operating Total
(Ownership Nature of the Involvement Balance Agreement with Generating
Interest) Entity Country Date (In Millions) CMS Energy Capacity
- --------- ------------- ------------ ----------- ------------- -------------- ----------
Taweelah United Arab
(40%) Generator Emirates 1999 $ 76 Yes 777 MW
Jubail (25%) Generator Saudi Arabia 2001 $ 1 Yes 250 MW
Shuweihat United Arab
(20%) Generator Emirates 2001 $ 39 Yes 1,500 MW
---- --------
Total $116 2,527 MW
==== ========
Our maximum exposure to loss through our interests in these variable interest
entities is limited to our investment balance of $116 million, and letters of
credit, guarantees, and indemnities relating to Taweelah and Shuweihat totaling
$47 million.
12: IMPLEMENTATION OF NEW ACCOUNTING STANDARDS
FSP 109-2, ACCOUNTING AND DISCLOSURE GUIDANCE FOR THE FOREIGN EARNINGS
REPATRIATION PROVISION WITHIN THE AMERICAN JOBS CREATION ACT OF 2004: The
American Jobs Creation Act of 2004 creates a one-year opportunity to receive a
tax benefit for U.S. corporations that reinvest dividends from controlled
foreign corporations in the U.S. in a 12-month period (calendar year 2005 for
CMS Energy). In September 2005, we decided on a plan to repatriate $33 million
of foreign earnings during the remainder of 2005. Historically, we recorded
deferred taxes on these earnings. Since this planned repatriation is expected to
qualify for the tax benefit, we reversed $10 million of our deferred tax
liability. This adjustment was recorded as a component of income from continuing
operations in the third quarter of 2005.
We may repatriate additional amounts that may qualify for the repatriation tax
benefit during the remainder of 2005. If successful, our current estimate is
that additional amounts could range between $30 million and $180 million. The
amount of additional repatriation remains uncertain because it is based on
future foreign subsidiary operations, cash flows, financings, and repatriation
limitations. This potential additional repatriation could reduce our recorded
deferred tax liability by $9 million to $23 million. We expect to be in a
position to finalize our assessment regarding any potential repatriation, which
may be higher or lower, in the fourth quarter of 2005.
CMS-76
CMS Energy Corporation
NEW ACCOUNTING STANDARDS NOT YET EFFECTIVE
SFAS NO. 123R, SHARE-BASED PAYMENT: This Statement 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 amount over the vesting period of
the awards. This Statement also clarifies and expands SFAS No. 123's guidance in
several areas, including measuring fair value, classifying an award as equity or
as a liability, and attributing compensation cost to reporting periods.
This Statement amends SFAS No. 95, Statement of Cash Flows, to require that
excess tax benefits related to the excess of the tax-deductible amount over the
compensation cost recognized be classified as cash inflows from financing
activities rather than as a reduction of taxes paid in operating activities.
Excess tax benefits are recorded as adjustments to additional paid-in capital.
This Statement is effective for us as of the beginning of 2006. We adopted the
fair value method of accounting for share-based awards effective December 2002.
Therefore, we do not expect this statement to have a significant impact on our
results of operations when it becomes effective.
FASB INTERPRETATION NO. 47, ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT
OBLIGATIONS: This Interpretation clarifies 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 that may or may not be
within the control of the entity. The obligation to perform the asset retirement
activity is unconditional even though uncertainty exists about the timing and
(or) method of settlement. Accordingly, an entity is required to recognize a
liability for the fair value of a conditional asset retirement obligation if the
fair value of the liability can be reasonably estimated. The fair value of a
liability for the conditional asset retirement obligation should be recognized
when incurred. This Interpretation also clarifies when an entity would have
sufficient information to estimate reasonably the fair value of an asset
retirement obligation. For us, this Interpretation is effective no later than
December 31, 2005. We are in the process of determining the impact this
Interpretation will have on our financial statements upon adoption.
CMS-77CMS-63
CMS Energy Corporation
(This page intentionally left blank)
CMS-78CMS-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, 2004.2005.
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. Weprovides 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.
Going forward,We are focused on growing the equity base of our business plancompany and have been
refinancing our debt to reduce interest rate costs. In 2006, we received $200
million of "building on the basics" will focus
on improving our credit ratings, growing earnings,cash contributions from CMS Energy and positioning uswe extinguished, through a
legal defeasance, $129 million of 9 percent related party notes.
Working capital and cash flow continue to make
new investments consistent with our strengths.
Although we are looking ahead to business opportunities, the future holds
important challengesbe a challenge for us. TheNatural 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 reevaluatedto reevaluate the economics of operating
the MCV Facility and determined thatto 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 $1.159
billion was requiredour ownership interest in September 2005. After accounting forthe 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 and income tax impacts, our third quarter 2005 net income was reduced by $369
million. We further reduced our third quarter 2005 net income by $16 million by
impairing certain other assets on our Consolidated Balance Sheets related toowners in the MCV
Partnership. WeCE-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. For additional details
regarding the impairment, see Note 2, Asset Impairment Charges.
WeThe MCV Partnership is
working aggressively to reduce costs, improve operations, and enhance cash
flows.
Going forward, our strategy will continue to be challenged by the substantial increasefocus on:
- managing cash flow issues,
- maintaining and growing earnings, and
- investing in natural gas prices.
Priorour utility system to Hurricane Katrina in August 2005, NYMEX forward natural gas prices
through 2010 were approximately $2 per mcf higher than they were at year-end
2004. The effects of this summer's hurricanes, combinedenable us to meet our customer
commitments, comply with tight natural gas
supplies, have caused natural gas pricesincreasing environmental performance
standards, and maintain adequate supply and capacity.
As we execute our strategy, we will need to increase even further. Although our
natural gas purchases are recoverable from our customers, as gas prices
increase, the amount we pay for natural gas stored as inventory will require
additional liquidity due to the timing of the cost recoveries from our
customers. We have requested authority from the MPSC to recover the gas cost
increases experienced by the gas
CE-1
Consumers Energy Company
utility. As of October 2005, our gas storage facilities are full and
approximately 83 percent of our gas purchase requirements for the 2005-2006
heating season are under fixed price contracts.
Our electric utility customer base includesovercome a mix of residential, commercial,
and diversified industrial customers. A sluggish Michigan economy
that has been hurting our industrial sales. Recentfurther hampered by recent negative developments in Michigan's
automotive industry and limited growth in the non-automotive sectors of our
largest industrial segment, could have long-term
impacts oneconomy.
These negative effects will be offset somewhat by the reduction we are
experiencing in ROA load in our commercial and industrial customer base.
Additionally, Michigan's Customer Choice Act allows our electric customers to
buy electric generation service from an alternative electric supplier. As of
October 2005,territory. At March 31, 2006,
alternative electric suppliers arewere providing 754348 MW of generation service to
ROA customers. This is however, down from 877 MW in October 2004,4 percent of our total distribution load and represents a
decrease of 14 percent. We expect this trend down61 percent compared to continue through year end,
but cannotMarch 31, 2005. It is, however, difficult to
predict future load loss.
We are focused on growing the equity base of our company and refinancing our
debt to reduce interest rate costs. In 2005, we retired higher-interest rate
debt through the use of proceeds from the issuance of $875 million of FMB. We
also received cash contributions from CMS Energy of $550 million in 2005. By the
end of the first quarter of 2006, we will extinguish through a defeasance $129
million of 9 percent notes. These efforts, and others, are designed to lead us
to be a strong, reliable utility company that will be poised to take advantage
of opportunities for further growth.ROA customer trends.
FORWARD-LOOKING STATEMENTS AND RISK FACTORSINFORMATION
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,
as
well asincluding 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 future Stranded Costs incurred due to customers
choosing alternative energy suppliers,
- 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,
and
- 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,
- potential adverse impacts of the new Midwest Energy Market upon power
supply and transmission costs,
- 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,
CE-3
Consumers Energy Company
- 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,
- limitations on our ability to control the development or operation of
projects in which our subsidiaries have a minority interest,
- disruptions in the normal commercial insurance and surety bond
markets that may increase costs or reduce traditional insurance
coverage, particularly terrorism and sabotage insurance and
performance bonds,
- other business or investment considerations that may be disclosed
from time to time in Consumers' or CMS Energy's SEC filings, or in
other publicly issued written documents, and
- other uncertainties that are difficult to predict, and many of which
are beyond our control.
For additional information regarding these and other uncertainties, see the
"Outlook" section included in this MD&A, Note 3,
Contingencies.2, Contingencies, and Part II,
Item 1A. Risk Factors.
RESULTS OF OPERATIONS
NET INCOME AVAILABLE TO COMMON STOCKHOLDER
In Millions
---------------------
THREE MONTHS ENDED SEPTEMBER 30---------------------------------
Three months ended March 31 2006 2005 2004 CHANGEChange
- ---------------------------------------------------------- ----- --------- ------
Electric $ 6229 $ 4933 $ 13(4)
Gas (16) (11) (5)37 58 (21)
Other (Includes MCV Partnership interest) (322) (4) (318)(56) 66 (122)
----- --------- -----
Net income (loss) available to common stockholder $(276) $ 34 $(310)10 $ 157 $(147)
===== ========= =====
For the three months ended September 30, 2005, our net loss available to our
common stockholder was $276 million, compared to $34 million ofMarch 31, 2006, net income available to our common
stockholder was $10 million, compared to $157 million for the three months ended
September 30,
2004.March 31, 2005. The decrease is primarily due to an impairment charge to property, plant,reflects mark-to-market losses in 2006 on certain
long-term gas contracts and equipmentassociated financial hedges at the MCV Partnership
compared to reflect the excess of the carrying value
of these assets over their estimated fair value.mark-to-market gains in 2005. The decrease also reflects a reduction
in net income from our gas utility asdue to lower, weather-driven sales, and
higher operating and maintenance costs exceeded the benefits derived from increased deliveries and
the increase in revenue resulting from the gas rates surcharge authorized by the
MPSC in October of 2004.at our electric utility. Partially
offsetting these losses is an increase in the
fair value of certain long-term gas contracts and financial hedges at the MCV
Partnership, andare higher earnings at our electric utility revenues primarily due to weather-driven higher than normal residential electric utility sales and the
collection of an
electric surcharge related to the recovery of costs incurredrate increase authorized in the transition to customer choice.December 2005.
CE-4
Consumers Energy Company
Specific changes to net income (loss) available to our common stockholder for the three months ended September 30,2006
versus 2005 versus the same period in 2004 are:
In Millions
-----------
- - decrease in earnings related tofrom our ownership interest in the MCV partnershipPartnership primarily due to
an impairment charge to property,
plant,a decrease in the fair value of certain long-term gas contracts and equipment to reflect the excess of the carrying
value over the estimated fair values of the assets, $(385)financial hedges, $ (125)
- - decreaseincrease in earnings due to increased operating expenses primarily due to higher depreciation and amortization
expense, higher pension and benefitelectric maintenance expense, and higher underrecoverycustomer service expense, related to the MCV PPA, offset
partially by our direct savings from the RCP, (21)(44)
- - decrease in earnings due to an underrecovery of power supplygas delivery revenue primarily due to non-recoverable power supply costs
related to capped customers,warmer weather, (20)
- - increasedecrease in earnings from our ownership interest in the MCV
Partnership primarily due to the increase in fair value of
certain long-term gas contracts and financial hedges (the
MPSC's approval of the RCP resulted in the MCV Partnership
recognizing the increase in fair value of additional gas
contracts beginning January 2005), 67
- - increase inreturn on electric delivery revenue due to warmer weather
and increased surcharge revenue, 32
- - increase in earnings due to lower fixed charges, 5
- - increase in electric utility earnings due to the return on capital expenditures in excess of our depreciation base
as allowed by the Customer Choice Act, 5(8)
- - increase in electric delivery revenue primarily due to the MPSC's December 2005
electric rate order, 38
- - increase in earnings due to lower general taxesthe expiration of rate caps that, in 2005, would not allow us
to fully recover our power supply costs from our residential customers, and other
income, and 46
- - increase in gas delivery revenue due to higher deliveriesother income and the MPSC's October 2004 final gas rate order. 3
-----interest charges. 6
-------
Total Change $(310)
=====$ (147)
=======
In Millions
----------------------
Nine months ended September 30 2005 2004 Change
- ------------------------------ ------ ---- ------
Electric $ 141 $124 $ 17
Gas 39 46 (7)
Other (Includes MCV Partnership interest) (267) (9) (258)
----- ---- -----
Net income (loss) available to common stockholder $ (87) $161 $(248)
===== ==== =====
For the nine months ended September 30, 2005, our net loss available to our
common stockholder was $87 million, compared to $161 million of net income
available to our common stockholder for the nine months ended September 30,
2004. The decrease is primarily due to an impairment charge to property, plant,
and equipment at the MCV Partnership to reflect the excess of the carrying
value of these assets over their estimated fair value. The decrease also
reflects a reduction in net income at our gas utility due to higher operating
costs and depreciation expenses. Partially offsetting these losses is an
increase in the fair value of certain long-term gas contracts and financial
hedges at the MCV Partnership, and the positive impact at our electric utility
due to an increase in the collection of an electric surcharge related to the
recovery of costs incurred in the transition to customer choice, increased
regulatory return on capital expenditures,
CE-5
Consumers Energy Company
and weather driven higher than normal residential electric sales.
Specific changes to net income (loss) available to our common stockholder for
the nine months ended September 30, 2005 versus the same period in 2004 are:
In Millions
-----------
- - decrease in earnings related to our ownership interest in the
MCV partnership due to an impairment charge to property,
plant, and equipment to reflect the excess of the carrying
value over the estimated fair values of these assets, $(385)
- - decrease in earnings due to increased operating expenses
primarily due to higher depreciation and amortization
expense, higher pension and benefit expense, and higher
underrecovery expense related to the MCV PPA, offset
partially by our direct savings from the RCP, (51)
- - decrease in earnings due to an underrecovery of power supply
revenue primarily due to non-recoverable power supply costs
related to capped customers, (27)
- - increase in earnings from our ownership interest in the MCV
Partnership primarily due to the increase in fair value of
certain long-term gas contracts and financial hedges (the
MPSC's approval of the RCP resulted in the MCV Partnership
recognizing the increase in fair value of additional gas
contracts beginning January 2005), 120
- - increase in electric delivery revenue due to warmer weather
and increased surcharge revenue, 57
- - increase in gas delivery revenue due to the MPSC's October
2004 final gas rate order, 16
- - increase in electric utility earnings due to the return on
capital expenditures in excess of our depreciation base as
allowed by the Customer Choice Act, and 13
- - increase in earnings due to lower fixed charges. 9
-----
Total Change $(248)
=====
CE-6
Consumers Energy Company
ELECTRIC UTILITY RESULTS OF OPERATIONS
In Millions
--------------------
September 30--------------------------
March 31 2006 2005 2004 Change
- -------------------- ---- ---- ------
Three months ended $29 $33 $ 62 $ 49 $13
Nine months ended $141 $124 $17
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005(4)
Reasons for the change:
vs. 2004 vs. 2004
- ----------------------- ------------------ ------------------
Electric deliveries $ 49 $ 8759
Power supply costs and related revenue (31) (42)9
Other operating expenses, other income and non-commodity revenue (14) (45)(59)
Regulatory return on capital expenditures 7 20
General taxes 3 (1)
Fixed(13)
Interest charges 5 71
Income taxes (6) (9)
---- ----(1)
------
Total change $ 13 $ 17
==== ====(4)
======
ELECTRIC DELIVERIES: For the three months ended September 30, 2005, electricElectric deliveries increased 1.7decreased 0.1 billion kWh or 16.01.6
percent in the first quarter of 2006 versus the same period in
2004. For the nine months ended September 30, 2005 primarily due to warmer
weather. Despite lower electric deliveries,
increased 1.7 billion kWh or 5.8 percent versus the same period in 2004. The
corresponding increases in electric delivery revenue for both periods wereincreased
primarily due to increased sales to residential customers due to warmer weather andan electric rate order, increased surcharge revenue, offset partially by reducedand 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 revenue from
customers choosing alternative electric suppliers.
On Julyrevenues increased $20 million in the first
quarter of 2006 versus 2005.
Effective January 1, 2004, Consumers2006, we started collecting a surcharge related tothat the recoveryMPSC
authorized under Section 10d(4) of costs incurred in the transition to customer choice.Customer Choice Act. This surcharge
increased electric delivery revenue by $2$11 million forin the three months ended
September 30, 2005 and $12 million for the nine months ended September 30, 2005first quarter of 2006
versus the same periods in 2004. Surcharge revenue related to the recovery of
security2005. In addition, on January 1, 2006, we began recovering customer
CE-5
Consumers Energy Company
choice transition costs and stranded costs increasedfrom our residential customers, thereby increasing
electric delivery revenue by an
additionalanother $3 million forin 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 three months ended September 30, 2005 and $9
million for the nine months ended September 30,first quarter of 2006
versus 2005.
POWER SUPPLY COSTS AND RELATED REVENUE: Our recovery ofIn 2005, power supply costs is
cappedexceeded
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
until January 1, 2006. For the three months
ended September 30, 2005, our underrecovery of power costs allocated to these
capped customers increased by $32 million versus the same period in 2004. For
the nine months ended September 30, 2005, our underrecovery of power costs
allocated to these capped customers increased by $53 million versus the same
period in 2004. Power supply-related costs increased in 2005 primarily due to
higher coal costs and higher priced purchased power to replace the generation
loss from outages at our Palisades and Campbell 3 generating plants.
Partially offsetting these underrecoveries are transmission and nitrogen oxide
allowance expenditures related to our capped customers. To the extent these
costs are not fully recoverable due to the applicationexpired on December 31, 2005. The absence of rate caps we have
deferred theseallows us to record power
supply revenue to offset fully our power supply costs and are requesting recovery under Public Act 141. For the
three months ended September 30, 2005, deferrals of these costs increased by $1
million versus the same period in 2004.
CE-7
Consumers Energy Company
For the nine months ended September 30, 2005, deferrals of these costs
increased by $11 million versus the same period in 2004.2006.
OTHER OPERATING EXPENSES, OTHER INCOME AND NON-COMMODITY REVENUE: ForIn the three
months ended September 30, 2005,first
quarter of 2006, other operating expenses increased $16$62 million, other income
increased $3$5 million, and non-commodity revenue decreased $1$2 million versus
the same period in 2004. For the nine months ended September 30,
2005, other operating expenses increased $55 million, other income increased $7
million, and non-commodity revenue increased $3 million versus the same period
in 2004.2005.
The increase in other operating expenses reflects higher operating and
maintenance expense, customer service expense, depreciation and amortization
expense, and higher 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 increased
primarily due toreflects
changes in actuarial assumptions and the remeasurement of our
pension and OPEB plans to reflect the newlatest collective bargaining agreement
between the Utility Workers Union of America and Consumers.
Benefit expense also
reflects the reinstatement of the employer matching contribution to our 401(k)
plan.
In addition, the increase in other operating expenses reflects increased
underrecovery expense related to the MCV PPA, offset partially by our direct
savings from the RCP. In 1992, a liability was established for estimated future
underrecoveries of power supply costs under the MCV PPA. In 2004, a portion of
the cash underrecoveries continued to reduce this liability until its depletion
in December. In 2005, all cash underrecoveries are expensed directly to income.
Partially offsetting this increased operating expense were the savings from the
RCP approved by the MPSC in January 2005.
The RCP allows us to dispatch the MCV Facility on the basis of natural gas
prices, which will reduce the MCV Facility's annual production of electricity
and, as a result, reduce the MCV Facility's consumption of natural gas. The MCV
Facility's fuel cost savings are first used to offset the cost of replacement
power and fund a renewable energy program. Remaining savings are split between
us and the MCV Partnership. Our direct savings are shared 50 percent with
customers in 2005 and 70 percent thereafter.
The cost associated with the MCV PPA cash underrecoveries, net of our direct
savings from the RCP, increased operating expense $4 million for the nine months
ended September 30, 2005 versus the same period in 2004.
For the three months ended September 30, 2005, the increase in other income is primarily due to higher interest income on short-term cash investments versus
the same periodabsence, in 2004. For the nine months ended September 30,2006, of
expenses recorded in 2005 the
increase in other income is primarily due to higher interest income on
short-term cash investments, offset partially by expenses associated with the early retirement of debt, versus the same period in 2004.
For the three months ended September 30, 2005, thedebt. The
decrease in non-commodity revenue is primarily due to lower transmissionrevenue from
services revenue. For the nine
months ended September 30, 2005, the increaseprovided to METC in non-commodity revenue is
primarily due to higher transmission services revenue.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 increased
income by $7Act. In
December 2005, the MPSC issued an order that authorized us to recover $333
million for the three months ended September 30, 2005 and $20
million for the nine months ended September 30, 2005of Section 10d(4) costs. The order authorized recovery of a lower level
of costs versus the same periods in
2004.
CE-8
Consumers Energy Company
GENERAL TAXES: Forlevel used to record 2005 income.
INTEREST CHARGES: In the three months ended September 30,first quarter of 2006 versus 2005, general taxesinterest charges
decreased versus the same period in 2004 primarily due to lower property tax
expense. For the nine months ended September 30, 2005, general taxes increased
versus the same period in 2004 primarily due to higher MSBT expense, offset
partially by lower property tax expense.
FIXED CHARGES: For the three months ended September 30, 2005, fixed charges
reflectaverage debt levels and a 4613 basis point reduction in the
average rate of interest on our debt
and lower average debt levels versus the same period in 2004. For the nine
months ended September 30, 2005, fixed charges reflect a 37 basis point
reduction in the average rate of interest on our debt and higher average debt
levels versus the same period in 2004.rate.
INCOME TAXES: ForIn the three and nine months ended September 30, 2005,first quarter of 2006, income taxes increased versus the same periods in 20042005
primarily due to higher earnings
by the electric utility.adjustment of certain deferred tax balances.
CE-6
Consumers Energy Company
GAS UTILITY RESULTS OF OPERATIONS
In Millions
--------------------
September 30-------------------------
March 31 2006 2005 2004 Change
- -------------------- ---- ---- ------
Three months ended $(16) $(11) $(5)
Nine months ended$37 $58 $ 39 $ 46 $(7)
==== ==== ===
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005(21)
Reasons for the Change: Vs. 2004 Vs. 2004
- ----------------------- ------------------ ------------------
change:
Gas deliveries $ 1 $ -
Gas rate increase 3 24(31)
Gas wholesale and retail services, other gas revenuesrevenue and other income 3 25
Operation and maintenance (14) (31)
General taxes(3)
Depreciation and depreciation (1) (4)
Fixed charges - (2)other deductions (3)
Income taxes 3 4
---- ----11
-------
Total change $ (5) $ (7)
==== ====(21)
=======
GAS DELIVERIES: ForIn the three months ended September 30,first quarter of 2006 versus 2005, higher gas
delivery revenues reflect increased deliveries to our customers versus the same
period in 2004. Gas deliveries, including miscellaneous transportation to
end-use customers, increased 1.4 bcf or 5.5 percent.
For the nine months ended September 30, 2005, gas delivery revenues
reflect slightly lower deliveries to our customers versus the same period in
2004. Gas deliveries,
including miscellaneous transportation to end-use customers, decreased 0.621.9 bcf
or 0.315.1 percent. GAS RATE INCREASE: In December 2003,The decrease in gas deliveries is primarily due to warmer
weather in the MPSC issued an interim gas rate order
authorizing a $19 million annual increase to gas tariff rates. In October 2004,
the MPSC issued a final order authorizing an annual increasefirst quarter of $58 million
through a two-year surcharge. As a result of these orders, gas revenues
increased $3 million for the three months ended September 30,2006 versus 2005 and $24
million forincreased conservation
efforts in response to higher gas prices. Average temperatures in the nine months ended September 30, 2005 versusfirst
quarter of 2006 were 16.7 percent warmer than the same periods in
2004.
CE-9
Consumers Energy Companyperiod last year.
GAS WHOLESALE AND RETAIL SERVICES, OTHER GAS REVENUESREVENUE AND OTHER INCOME: ForIn the
three months ended September 30,first quarter of 2006 versus 2005, other incomethe $5 million increase is related primarily
to increased primarily due to
higher interest income on short-term cash investments versus the same period in
2004. For the nine months ended September 30, 2005, other income increased
primarily due to higher interest income on short-term cash investments, offset
partially by expenses associated with the early retirement of debt, versus the
same period in 2004.gas wholesale and retail services revenue.
OPERATION AND MAINTENANCE: ForIn the three and nine months ended September 30,
2005,first quarter of 2006, operation and
maintenance expenses increased versus 2005 primarily due to increases inhigher pension and
benefit costs and additional safety, reliability,expense and customer service expenses.expense. Pension and benefit expense
increased primarily due toreflects changes in actuarial assumptions and the remeasurement of our pension and OPEB plans to reflect the
newlatest collective bargaining
agreement between the Utility Workers Union of America and Consumers. BenefitCustomer
service expense also reflectsincreased primarily due to higher uncollectible accounts
expense.
DEPRECIATION AND OTHER DEDUCTIONS: In the reinstatementfirst quarter of the employer
matching contribution to our 401(k) plan.
GENERAL TAXES AND DEPRECIATION: For the three and nine months ended September
30, 2005,2006, depreciation
expense increased versus 2005 primarily due to higher plant in service.
FIXED CHARGES: For the nine months ended September 30, 2005, fixed charges
reflect a 37 basis point reduction in the average rate of interest on our debt
and higher average debt levels versus the same period in 2004.
INCOME TAXES: ForIn the three and nine months ended September 30, 2005,first quarter of 2006, income taxes decreased versus 2005
primarily due to lower earnings by the gas utility.
OTHER RESULTS OF OPERATIONS
In Millions
---------------------
September 30------------------------------
March 31 2006 2005 2004 Change
- ------------ ------------- ---- ---------- -------
Three months ended $(322) $(4) $(318)
Nine months ended $(267) $(9) $(258)
===== === =====$(56) $ 66 $ (122)
ForIn the three months ended September 30, 2005,first quarter of 2006, other operations decreased net income by $322loss was $56 million, a
decrease of $318$122 million in income versus the same
period in 2004.2005. The change is primarily due to a $318$125
million decrease in earnings related tofrom our ownership interest in
CE-7
Consumers Energy Company
the MCV Partnership, primarily due to an
impairment charge to property, plant, and equipment to reflect the excess of the
carrying value of these assets over their estimated fair value. Partially
offsetting the impairment charge is an increasemark-to-market losses in the fair value of2006 on certain
long termlong-term gas contracts and relatedassociated financial hedges at the MCV Partnership.
For the nine months ended September 30, 2005, other operations decreased net
income by $267 million, a decrease of $258 millionPartnership,
compared to mark-to-market gains on these contracts in income versus the same
period in 2004.2005.
CRITICAL ACCOUNTING POLICIES
The change is primarily due to a $265 million decrease in
earnings related to our ownership interest in the MCV Partnership duefollowing accounting policies are important to an impairment charge to property, plant,understanding of our
results of operations and equipment to reflect the excessfinancial condition and should be considered an
integral part of the
carrying value of these assets over their estimated fair value. Partially
offsetting the impairment charge is an increase in the fair value of certain
long term gas contracts and related financial hedges at the MCV Partnership.
CE-10
Consumers Energy Company
CRITICAL ACCOUNTING POLICIESour 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 the occurrence ofa 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 most significant of theseSignificant contingencies are our electric and gas
environmental liabilities, and the potential underrecoveries from our power
purchase contract with the MCV Partnership, all of which are discussed in the "Outlook" section
included in this MD&A.
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 $13.061
billion at September 30, 2005, 55 percent represent long-lived assets and equity
method investments that are subject to this type of analysis. We base our
evaluations of impairment on such indicators as:
- the nature of the assets,
- projected future economic benefits,
- regulatory and political environments,
- state and federal regulatory and political environments,
- historical and future cash flow and profitability measurements, and
- other external market conditions or factors.
If an event occurs or circumstances change in a manner that indicates the
recoverability of a long-lived asset should be assessed, we evaluate the asset
for impairment. An asset held-in-use is evaluated for impairment by calculating
the undiscounted future cash flows expected to result from the use of the asset
and its eventual disposition. If the undiscounted future cash flows are less
than the carrying amount, we recognize an impairment loss. The impairment loss
recognized is the amount by which the carrying amount exceeds the fair value. We
estimate the fair market value of the asset utilizing the best information
available. This information includes quoted market prices, market prices of
similar assets, and discounted future cash flow analyses. An asset considered
held-for-sale is recorded at the lower of its carrying amount or fair value,
less cost to sell.
We also assess our ability to recover the carrying amounts of our equity method
investments. This assessment requires us to determine the fair values of our
equity method investments. The determination of fair value is based on valuation
methodologies including discounted cash flows and the ability of the investee to
sustain an earnings capacity that justifies the carrying amount of the
investment. If the fair value is less than the carrying value and the decline in
value is considered to be other than temporary, an
CE-11
Consumers Energy Company
appropriate write-down is recorded.
Our assessments of fair value using these valuation methodologies represent our
best estimates at the time of the reviews and are consistent with our internal
planning. The estimates we use can change over time, which could have a material
impact on our financial statements.
For additional details on asset impairments, see Note 2, Asset Impairment
Charges.
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. There have been no material changes to theFor additional details on accounting for financial
instruments, since the year ended December 31, 2004. For details on
financial instruments, see Note 5,4, Financial and Derivative Instruments.
DERIVATIVE INSTRUMENTS: We use the criteria in SFAS No. 133 to accountdetermine 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 derivativesderivative instruments since the year ended December 31, 2004.2005. 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 (i.e., from brokers and banks)valuations), if available.
For certain contracts, market prices and third-party valuations arethis information is not available and we must determine fair values by usinguse mathematical
valuation models.models to value our derivatives. These
valuation models require various inputs
and assumptions, including commodity forward prices, strikemarket 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.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 as of September 30, 2005:at March 31, 2006:
Interest Rates (%) Volatility Rates (%)
------------------ --------------------
Long-term gas contracts associated with the MCV
Partnership 3.864.83 - 4.67 325.34 28 - 63
Gas supply option contracts 3.95 67 - 6950
CommencementEstablishment of the Midwest Energy Market: TheIn 2005, the MISO began operating
the Midwest Energy Market on April 1, 2005. Through operation ofMarket. As a result, the Midwest Energy Market,
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 commencementestablishment of this market does not constituterepresent 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 the potential forwhether 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: The MCV Partnership uses long-term gas contracts to
purchase natural gas as fuel for generation, and to manage gas fuel costs. The
MCV Partnership believes that certain of these contracts qualify as normal
purchases under SFAS No. 133. Accordingly, these contracts are not recognized at
fair value on our Consolidated Balance Sheets. However, asAs a result of implementing the RCP in January 2005, a
significant portion of the MCV Partnership's long-term gas contracts no longer
qualify as normal CE-12
Consumers Energy Company
purchases because the gas will not be consumed as fuel for electric production.used to generate
electricity or steam. Accordingly, these contracts are accounted for as
derivatives, with changes in fair value recorded in earnings each quarter.
ForAdditionally, certain of the nine months ended
September 30, 2005,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 recordedrecord any changes in their
fair value in earnings each quarter. As a $242 million gain associated withresult of recording the increasechanges in
fair value of these long-term gas contracts.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 gainloss 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.
As a result of mark-to-market gains, we have recorded derivative assets totaling
$298 million associated with the fair value of long-term gas contracts on our
Consolidated Balance Sheets. The majority of these assets are expected to
reverse through earnings during 2005 and 2006 as the gas is purchased, with the
remainder reversing between 2007 and 2011.
The MCV Partnership holds natural gas futures and swap contracts to manage price
risk by fixing the price to be paid for natural gas on some of its long-term gas
contracts. Prior to the implementation of the RCP, these futures and swap
contracts were accounted for as cash flow hedges. Since the RCP was implemented
in January 2005, these instruments no longer qualify for cash flow hedge
accounting and any changes in their fair value have been recorded in earnings
each quarter. For the nine months ended September 30, 2005, we recorded a $125
million gain associated with the increase in fair value of these instruments.
This gain is also included in the total Fuel costs mark-to-market at MCV on our
Consolidated Statements of Income. As a result of mark-to-market gains, we have
recorded derivative assets totaling $125 million associated with the fair value
of these instruments on our Consolidated Balance Sheets. The majority of these
assets are expected to be realized during 2005 and 2006 as the futures and swap
contracts settle, with the remainder to be realized during 2007. Because of the volatility of the
natural gas market, the MCV Partnership expects future earnings volatility on
both theits long-term gas contracts and theits 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 the year ended December 31, 2004.2005. These risk sensitivities indicate the potential loss in fair
value, cash flows, or future earnings from our financial instruments, including
our derivative contracts, and other financial instruments based uponassuming a hypothetical 10 percent adverse change in market rates
or prices.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 a 10 percentan adverse change in market
interest rates)rates of 10 percent):
In Millions
--------------------------------------
September 30, 2005---------------------------------------
March 31, 2006 December 31, 2004
------------------2005
-------------- -----------------
Variable-rate financing - before tax annual earnings exposure $ 21 $ 23
Fixed-rate financing - potential lossREDUCTION in fair value (a) 148 149 138
(a) Fair value exposure could only be realized if we repurchased all of our
fixed-rate financing.
Commodity Price Risk Sensitivity Analysis (assuming a 10 percentan adverse change in market
prices)prices of 10 percent):
In Millions
--------------------------------------
September 30, 2005March 31, 2006 December 31, 2004
------------------2005
-------------- -----------------
Potential REDUCTION in fair value:
Gas supply option contracts $ 3- $ 1
FTRs - -
Derivative contracts associated with the MCV Partnership:
Long-term gas contracts (a) (b) 49 1726 39
Gas futures, options, and swaps (b) 59 41 48
(a) The increased potential reduction in fair value for the MCV Partnership's
long-term gas contracts is
CE-13
Consumers Energy Company
due to the increased number of contracts accounted for as derivatives as a
result of the RCP.
(b) The increased potential reduction in fair value for the MCV Partnership's
long-term gas contracts and gas futures and swaps is due to the significant
increase in natural gas prices from December 31, 2004.
Investment Securities Price Risk Sensitivity Analysis (assuming a 10 percentan adverse
change in market prices)prices of 10 percent):
In Millions
--------------------------------------
September 30, 2005---------------------------------------
March 31, 2006 December 31, 2004
------------------2005
-------------- -----------------
Potential REDUCTION in fair value of available-for-sale equity securities
(SERP investments and investments in CMS Energy common stock) $6 $5$ 5 $ 6
We maintain trust funds, as required by the NRC, which may only be used to fundfor the purpose of funding
certain costs of nuclear plant decommissioning. TheseAt March 31, 2006 and December
31, 2005, these funds arewere 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. ThoseThese 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 5,4,
Financial and Derivative Instruments.
ACCOUNTING FOR PENSION AND OPEB
Pension: We have established external trust funds to provide retirement pension
benefits to our employees under a non-contributory, defined benefit Pension
Plan. We implemented a cash balance plan for certain employees hired after June
30, 2003. On September 1, 2005, we implemented the Defined Company Contribution
Plan.
The Defined Company Contribution Plan provides an employer contribution of 5
percent of base pay to the existing Employees' Savings Plan. No employee
contribution is required to receive the plan's employer cash contribution. All
employees hired on and after September 1, 2005 participate in this plan as part
of their retirement benefit program. Cash balance pension plan participants also
participate in the Defined Company Contribution Plan on September 1, 2005.
Additional pay credits under the cash balance pension plan were discontinued as
of that date. We use SFAS No. 87 to account for pension costs.
401(k): We resumed the employer's match in CMS Energy Stock on our 401(k)
Savings Plan on January 1, 2005. On September 1, 2005, employees enrolled in the
company's 401(k) Savings Plan had their employer match increased from 50 percent
to 60 percent on eligible contributions up to the first six percent of an
employee's wages.
OPEB: We provide postretirement health and life benefits under our OPEB plan to
substantially all our retired employees. We use SFAS No. 106 to account for
other postretirement benefit costs.
Liabilities for both pension and OPEB are recorded on the balance sheet at the
present value of their future obligations, net of any plan assets. The
calculation of the liabilities and associated expenses requires the expertise of
actuaries. Many assumptions are made including:
CE-14
Consumers Energy Company
- life expectancies,
- present-value discount rates,
- expected long-term rate of return on plan assets,
- rate of compensation increases, and
- anticipated health care costs.
Any change in these assumptions can change significantly the liability and
associated expenses recognized in any given year.
The following table provides an estimate of our pension cost, OPEB cost, and
cash contributions for the next three years:
In Millions
----------------------------------------
Expected Costs Pension Cost OPEB Cost Contributions
- -------------- ------------ --------- -------------
2006 $89 $38 $ 81
2007 98 34 176
2008 93 30 109
Actual future pension cost and contributions will depend on future investment
performance, changes in future discount rates, and various other factors related
to the populations participating in the Pension Plan.
For additional details on postretirement benefits, see Note 6, Retirement
Benefits.
OTHER
Other accounting policies that are 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.
ThereThese accounting policies were disclosed in our 2005 Form 10-K and there have
been no material changes to these accounting policies since the year
ended December 31, 2004.changes.
CAPITAL RESOURCES AND LIQUIDITY
OurFactors affecting our liquidity and capital requirements are a function of ourare:
- 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. The market price for natural gas has increased. 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 as gas prices increase. In addition, a few ofrecoveries. We have credit agreements with our commodity suppliers and those
agreements contain terms that have requested nonstandard payment termsresulted in margin calls. Additional margin
calls or other forms of assurances, including
margin calls, in connection with maintenance of ongoing deliveries of gas and
electricity.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 CE-15
Consumers Energy Company
Partnership asset impairment charge recorded in September
2005, our ability to issue FMB as primary obligations or as collateral for
financing is expected to be limited to $298 million for 12 months, endingthrough September 30, 2006.
Beyond 12
months,After September 30, 2006, our ability to issue FMB in excess of $298 million is
based on achieving a two-times FMB interest coverage rate. Nonetheless, weratio.
We believe the following items will be sufficient to meet our liquidity needs:
- our current level of cash and revolving credit facilities,
and- our ability to access junior secured and unsecured borrowing
capacity in the capital markets, along withand
- our anticipated cash flows from operating and investing activities, will be
sufficient to meet our liquidity needs.activities.
CASH POSITION, INVESTING, AND FINANCING
Our operating, investing, and financing activities meet consolidated cash needs.
At September 30, 2005, $662March 31, 2006, $508 million consolidated cash was on hand, which includes
$184$55 million of restricted cash and $416$234 million from the entities consolidated
pursuant to FASB Interpretation No. 46. For additional details, see
Note 9, Consolidation of Variable Interest Entities.46(R).
CE-11
Consumers Energy Company
SUMMARY OF CONSOLIDATED STATEMENTS OF CASH FLOWS:
In Millions
-------------
Nine---------------------
Three Months Ended September 30March 31 2006 2005
2004
- ------------------------------ ----- -------------------------------- ------ ------
Net cash provided by (used in):
Operating activities $ 67775 $ 325321
Investing activities (547) (431)
----- -----(29) (152)
------ ------
Net cash provided by (used in)
Operatingoperating and investing activities 130 (106)46 169
Financing activities 177 10
----- -----(9) 178
------ ------
Net Increase (Decrease) in Cash and Cash Equivalents $ 30737 $ (96)
===== =====347
====== ======
OPERATING ACTIVITIES: For the ninethree months ended September 30, 2005,March 31, 2006, net cash
provided by operating activities increased $352was $75 million, a decrease of $246 million
versus the same period
in 2004 due to increases in MCV gas supplier funds on deposit and accounts
payable, partially offset by an increase in inventories. The increase in MCV gas
supplier funds on deposit, accounts payable, and inventories is2005. This decrease was due to the effecttiming of risingpayments for higher priced
gas prices.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 ninethree months ended September 30, 2005,March 31, 2006, net cash used
in investing activities increased $116was $29 million, a decrease of $123 million versus the same period in
2004 primarily due to an increase in restricted cash on hand of $129 million.
The increase in restricted cash2005.
This decrease was due to an irrevocable deposit made with a
trusteethe release of restricted cash in February 2006, which
we used to permit a defeasance of our 9 percent notes by the end of the first
quarter of 2006.extinguish long-term debt - related parties.
FINANCING ACTIVITIES: For the ninethree months ended September 30, 2005,March 31, 2006, net cash provided byused
in financing activities increased $167was $9 million, versus the same period
in 2004 due to an increase of $400$187 million in stockholder's contributions fromversus 2005.
This increase was primarily due to the parent,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 net proceeds from borrowingspayments of $229common stock dividends of $78
million.
For additional details on long-term debt activity, see Note 4,3, Financings and
Capitalization.
OBLIGATIONS AND COMMITMENTS
REVOLVING CREDIT FACILITIES:DIVIDEND RESTRICTIONS: For details on revolving credit facilities,dividend restrictions, see Note 4,3,
Financings and Capitalization.
OFF-BALANCE SHEET ARRANGEMENTS: There have been no material changesWe enter into various arrangements in off-balance sheetthe normal
course of business to facilitate commercial transactions with third parties.
These arrangements since the year ended December 31, 2004.include indemnifications, letters of credit and surety bonds.
For details on guarantee arrangements, see Note CE-16
Consumers Energy Company
4, Financings and Capitalization, "FASB2, Contingencies, "Other
Contingencies -FASB Interpretation No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others."
DIVIDEND RESTRICTIONS:REVOLVING CREDIT FACILITIES: For details on dividend restrictions,revolving credit facilities, see
Note 4,3, Financings and Capitalization.
DEBT CREDIT RATING: On November 1, 2005, S&P placed CMS Energy'sSALE OF ACCOUNTS RECEIVABLE: For details on the sale of accounts receivable, see
Note 3, Financings and Consumers'
debt credit ratings on CreditWatch with negative implications. S&P indicated
that they expect resolution of the CreditWatch before year end 2005.Capitalization.
CE-12
Consumers Energy Company
OUTLOOK
ELECTRIC BUSINESS OUTLOOK
GROWTH: We expect the growth in electric deliveries for 2005 to be approximately
four percent. 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 approximately twoabout one and one-half percent per year. However, such growth is
dependent on a modestly growing customer base and recovery of thea 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 fromfirm 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 OctoberNovember 2005, DelphiGeneral Motors
Corporation,
(Delphi) filed for Chapter 11 bankruptcy protection. Delphi is the nation's
largest automotive supplier headquartered in Troy, Michigan, and is a large industrial customer of Consumers.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 do not believe that this event will
have a material adverse effect on our financial condition. We cannot however, predict the impact of the Delphi bankruptcy filing onthese restructuring plans or
possible future actions by other automotive-related
manufacturing customers or the Michigan industrial base. Continued degradation
of the industrial customer base would have a negative impact on electric utility
revenues.
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. We establish a reserve margin target to address various scenarios and
contingencies so that the probability of interrupting service to retail
customers because of a supply shortage is no greater than an industry-recognized
standard. However, even with the reserve margin target, additional spot
purchases during periods when electric prices are high may be required.
We are currently planning for a reserve margin of approximately 11 percent for
summer 2006, or supply resources equal to 111 percent of projected summer peak
load. Of the 2006 supply resources target of 111 percent, we expect to meet
approximately 98 percent from our electric generating plants and long-term power
purchase contracts, and approximately 13 percent from short-term contracts,
options for physical deliveries, and other agreements. We have purchased
capacity and energy contracts covering partially the estimated reserve margin
requirements for 2006 through 2007. As a result, we have recognized an asset of
$6 million for unexpired capacity and energy contracts at September 30, 2005.
COAL DELIVERY DISRUPTIONS: In May 2005, western coal rail carriers experienced
derailments and significant service disruptions due to heavy snow and rain
conditions. These disruptions affected all shippers of western coal from Wyoming
mines as well as coal producers from May 2005 through June 2005. We received
notification that, under contractual Force Majeure provisions, the coal tonnage
not
CE-17customers.
CE-13
Consumers Energy Company
delivered during this period will not be made up. According to recent
announcements, rail repairs will extend through November 2005. Although we
expect some impactTHE ELECTRIC CAPACITY NEED FORUM: In January 2006, the MPSC Staff issued a
report on coal shipments during the repair period, we expect our
inventories will remain within historical levels, at least during the upcoming
winter period, though at lower levels than planned before the disruptions
occurred. Based on our present delivery experience, projections, and inventory,
we believe we will have adequate coal supply to allow for normal dispatch of our
coal-fired generating units.
ENERGY MARKET DEVELOPMENT: The MISO began operating the Midwest Energy Market on
April 1, 2005. The Midwest Energy Market includes a day-ahead and real-time
energy market and centralized generation dispatch for market participants. We
are a participant in this energy market. The intention of this market is to meet
load requirementsfuture electric capacity in the region reliablystate 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 efficiently, to improve managementbid 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 congestion on the grid, and to centralize dispatch of generation throughout
the region. The MISO is now responsibleMichigan issued an executive directive
calling for the reliability and economic
dispatch in the entire MISO area, which covers partsdevelopment of 15 states and Manitoba,
including our service territory. We are presently evaluating what financial
impact, if any, these changes are having on our operations.
The settlement of charges for each operating day of the Midwest Energy Market
invokes the issuance of multiple settlement statements over a 155-day period.
This extended settlement period is designed to allow for adjustments associated
with the receipt of complete billing information and other adjustments. When
adjustments are necessary, the MISO bills market participants on a retroactive
basis, covering several months. We record adjustments as appropriate when the
MISO notifies us of the revised amounts. The revised amounts may result in
either a positive or a negative expense adjustment. We cannot predict the amount
or timing of any MISO billing adjustments.
RENEWABLE RESOURCES PROGRAM: In January 2005, in collaboration with the MPSC, we
established a renewable resources program. Under the RRP, we purchasecomprehensive energy from approved renewable sources, which include solar, wind, geothermal, biomass,
and hydroelectric suppliers. Customers are able to participate in the RRP in
accordance with tariffs approved by the MPSC. The MPSC has authorized recovery
of above-market costsplan for the RRP by establishing a fund that consistsstate of
an
annual contribution from savings generated byMichigan. The directive calls for the RCP, a surcharge imposed by
the MPSC on all customers, and contributions from customers that choose to
participate in the RRP. In February 2005, the Attorney General filed appealsChairman of the MPSC, orders providing funding forworking in
cooperation with representatives from the RRP inpublic and private sectors, to make
recommendations on Michigan's energy policy by the Michigan Courtend of Appeals.
In August 2005, we secured long-term renewable energy supply contracts. In
October 2005,2006. We will continue
to participate as the MPSC issued an order approving these new supply contracts.
ELECTRIC RATE CASE: In December 2004, we filed an application with the MPSC to
increase our retailaddresses future electric base rates. The electric rate case filing requests
an annual increase in revenues of approximately $320 million. The primary
reasons for the request are load migration to alternative electric suppliers,
increased system maintenance and improvement costs, Clean Air Act-related
expenditures, and employee pension costs. In April 2005, we filed updated debt
and equity information in this case.
In June 2005, the MPSC Staff filed its position in this case, recommending a
base rate increase of $98 million. The MPSC Staff also recommended an 11.25
percent return on equity to establish rates and recognized all of our projected
equity investment (infusions and retained earnings) in 2006. In August 2005, we
revised our request for an annual increase in revenues to approximately $197
million, and the MPSC Staff revised its recommendation to $100 million. In
October 2005, the ALJ issued a proposal for decision recommending a base rate
increase of $112 million and an 11.25 percent authorized return on equity. We
expect a final order from the MPSC in late 2005. If approved as requested, the
rate increase would go into effect in January 2006 and would apply to all retail
electric customers. We cannot predict
CE-18
Consumers Energy Company
the amount or timing of the rate increase, if any, which the MPSC will approve.
BURIAL OF OVERHEAD POWER LINES: In September 2004, the Michigan Court of Appeals
upheld a lower court decision that requires Detroit Edison to obey a municipal
ordinance enacted by the City of Taylor, Michigan. The ordinance requires
Detroit Edison to bury a section of its overhead power lines at its own expense.
Detroit Edison filed an appeal with the Michigan Supreme Court. Unless
overturned by the Michigan Supreme Court, the decision could encourage other
municipalities to adopt similar ordinances, as has occurred or is under
discussion in a few municipalities in our service territory. If incurred, we
would seek recovery of these costs from our customers located in the
municipality affected, subject to MPSC approval. This case has potentially broad
ramifications for the electric utility industry in Michigan. In a similar
matter, in May 2005, we filed a request with the MPSC that asks the MPSC to rule
that the City of East Grand Rapids, Michigan must pay for the relocation of
electric utility facilities required by an ordinance adopted by the city. In
September 2005, we reached a settlement of this particular dispute with the City
of East Grand Rapids, which is in the process of finalization. In October 2005,
the Michigan Supreme Court issued an order in which it agreed to review the
lower court's decision in the City of Taylor matter. The Court also established
a briefing schedule. At this time, we cannot predict the outcome of the broader
issues addressed in the City of Taylor matter.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 $815$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
- allowance for funds used during construction (AFUDC) rate.
Our current capital cost estimates include an escalation rate of 2.6 percent and
an AFUDC capitalization rate of 8.3 percent. As of September 2005,March 2006, we have
incurred $589$616 million
in capital expenditures to comply with thesethe federal Clean Air Act and resulting
regulations and anticipate that the remaining $226$203 million of capital
expenditures will be made in 20052006 through 2011. These expenditures include installing selective
catalytic reduction technology at four of our coal-fired electric plants. In addition to modifying
the 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 utilize
nitrogen oxide emissionsrecover from our
customers through the PSCR process. The allowances for years 2006 through 2008, of which 90
percent have been obtained. The cost of the allowances is estimated to average
$5 million per year for 2006 through 2008. The estimatedand their costs are based on the
average cost of the purchased, allocated, and exchanged allowances. The need for
allowances will decrease after 2006 with the installation of selective catalytic
control technology. The cost of the allowances is accounted
for as inventory. The allowance inventory is expensed at the rolling average
cost as the coal-fired electric generating unitsplants emit nitrogen oxide.
CE-19
Consumers Energy Company
TheIn March 2005, the EPA recently adopted athe 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 and nitrogen oxides by 63 percentfrom
2003 levels by 2015. The finalWe plan to meet this rule will require that we runby year round operations of our
Selective Catalytic Reductionselective catalytic control technology units year-round
beginning in 2009 and may require that we purchase additionalto meet nitrogen oxide allowances beginning in 2009. In addition to the selective catalytic reduction
control technology installed to meet the Nitrogen Oxide State Implementation
Plan, our current plan includestargets and
installation of flue gas desulfurization scrubbers. The scrubbers are to be installed by 2014 to meet the Phase I
reduction requirementsat an estimated cost of the Clean Air Interstate Rule at a cost near that of
the Nitrogen Oxide State Implementation Plan.
In May$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 powergenerating
plants by 2010 and further reductions by 2018. WhileThe 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,emissions. However, we
anticipate our capital and operating costs for mercury emissions reductions
are expectedrequired by the Clean Air Mercury Rule to be significantly less than what iswas
required for selective catalytic reduction technology used for nitrogen oxide
compliance.
CE-14
Consumers Energy Company
In August 2005,April 2006, Michigan's governor announced a plan that would result in mercury
emissions reductions of 90 percent by 2015. This plan adopts the MDEQ filed a Motion to Intervene in a court challenge to
certain aspects of EPA'sFederal Clean
Air Mercury Rule asserting thatthrough its first phase, which ends in 2010. After the rule is
inadequate. The MDEQ has not indicatedyear
2010, the direction that it will pursue to meet
or exceed the EPA requirements through a state rulemaking. We are actively
participating in dialog with the MDEQ regarding potential paths for controlling mercury emissions and meetingreduction standards outlined in the EPA requirements. In October 2005,governor's plan
become more stringent than those included in the EPA
announced it would reconsider certain aspects of theFederal 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
cannot predictwill work with the outcomeMDEQ on the details of this proceeding.these rules.
Several legislative proposals have been introduced in the United States
Congress that would require reductions in emissions of greenhouse gases, however, none
have yet been enacted.gases. We
cannot predict whether any federal mandatory greenhouse gas emission reduction
rules ultimately will be enacted, or the specific requirements of any such rules.of these
rules and their effect on our operations and financial results.
To the extent that greenhouse gas emission reduction rules come into effect,
suchthe 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
and
engage in the greenhouse gas policy developments and will continue to assess and respond to
their potential implications on our business operations.
Water: In March 2004, the EPA issued rules that govern electric generating plant
cooling water intake systems. The new rules require significant reduction in fish
killed by operating equipment. Some of our facilities will be required to comply
with the new rules by 2007. We are currently performing the required studies to determine
the most cost-effective solutions for compliance.
For additional details on electric environmental matters, see Note 3,2,
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. As of October 2005,At March 31, 2006, alternative electric suppliers
arewere providing 754348 MW of generation service to ROA customers. This amount represents a decrease of 14 percent compared to October 2004, and 10is 4 percent
of our total distribution load. Current trends indicateload and represents a continued
reduction in ROA load loss. However, itdecrease of 61 percent compared
to March 31, 2005. It is difficult to predict future ROA customer trends.
CE-20
Consumers Energy Company
Implementation Costs:Section 10d(4) Regulatory Assets: In JuneDecember 2005, the MPSC issued an order
that authorizesauthorized us to recover implementation$333 million in Section 10d(4) costs. Instead of
collecting these costs incurred during 2002evenly 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 2003 totaling $6
million, plus25 percent in the costthird, fourth, and fifth years. In
January 2006, we filed a petition for rehearing with the MPSC that disputed the
aspect of money through the periodorder dealing with the timing of collection.
Weour 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 also pursuing authorizationhearings scheduled for
May 2006 at the FERC for the MISO to reimburse us for
Alliance RTO development costs. Includeddiscuss these charges. These hearings could result in
this amount is $2 million that the
MPSC did not approve as part of our 2002 implementation costs application. The
FERC denied our request for reimbursement, andrefunds or additional transitional charges to us. In April 2006, we are appealingfiled an
agreement with the FERC ruling
atbetween the United States Court of AppealsPJM 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 District of Columbia.potential for refunds or additional transitional charges to
Consumers. We cannot predict the amount, if any, the FERC will approve as recoverable.
Section 10d(4) Regulatory Assets: In October 2004, we filed an application with
the MPSC seeking recoveryoutcome of $628 million of Section 10d(4) Regulatory Assets
for the period June 2000 through December 2005. Of the $628 million, $152
million relates to the cost of money. In March 2005, the MPSC Staff filed
testimony recommending the MPSC approve recovery of approximately $323 million
in Section 10d(4) costs, which includes the cost of money through the period of
collection. In June 2005, the ALJ issued a proposal for decision recommending
the MPSC approve recovery of the same Section 10d(4) costs recommended by the
MPSC Staff. However, we may have the opportunity to recover certain costs
included in our application alternatively in other cases pending before the
MPSC. We cannot predict the amount, if any, the MPSC will approve as
recoverable.this matter.
For additional details and material changes relating to the restructuring of the
electric utility industry and electric rate matters, see Note 3,2, 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.
TheUnder 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 that cash underrecoveries of capacity
and fixed energy payments will aggregate $150of $55 million in 2006 and $39 million in 2007.
However, Consumers' direct savings from 2005 through 2007.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. Further, underIf the MCV Partnership terminates the MCV
PPA, variable energy paymentswe would be required to replace the MCV Partnership are
basedlost 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 cost of coal burnedopen market. We cannot predict
our ability to enter into such contracts at our coal plants and our operation and
maintenance expenses. However, the MCV Partnership's costs of producing
electricitya reasonable price. We are tiedalso
unable to the cost of natural gas. Natural gas prices have
CE-21
Consumers Energy Company
increased substantially in recent years and throughout 2005. In the third
quarter of 2005, the MCV Partnership reevaluated the economics of operating the
MCV Facility and determined that an impairment was required. If natural gas
prices remain at present levels or increase, the operationspredict regulatory approval of the MCV Facilityterms and conditions of such
contracts, or that the MPSC would be adversely affected and could result in the MCV Partnership failing to
meet its financial 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. For additional details
on the impairmentallow full recovery of the MCV Facility, see Note 2, Asset Impairment Charges.our incurred costs.
For additional details on the MCV Partnership, see Note 3,2, Contingencies, "Other
Electric Contingencies - The Midland Cogeneration Venture."
NUCLEAR MATTERS: Big Rock: Dismantlement of plant systems is essentially
complete and demolitionDecommissioning 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 has begun. The
restoration project is
on scheduleexpected 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
530475 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
a 30-acreanother area containingof approximately 105 acres encompassing the Big Rock Independent
Spent Fuel Storage Installation (ISFSI), where eight
CE-16
Consumers Energy Company
casks loaded with spent nuclear fuel and other high-level radioactive waste material are
stored, to be returned to a natural state within approximately two years from
the date the DOE beginsfinishes removing the spent nuclear fuel from Big Rock.Rock also in
accordance with the LTP.
Palisades: In August 2005, the NRC completed its performance review of the
Palisades Nuclear Plant for the first half of the calendar year 2005. The NRC
determined that Palisades was operated in a manner that preserved public health
and safety and met all of the NRC's specific "cornerstone objectives." As of
August 2005, all inspection findings were classified as having very low safety
significance and all performance indicators show performance at a level
requiring no additional oversight. Based on the plant's performance, only
regularly scheduled inspections are planned through March 31, 2007. 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 September 2005,March
2006, we have loaded 2229 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. Certain parties are seeking to intervene and
have requested a hearing on the application. The NRC has stated that it expects
to take 22-30 months to review a license renewal application. We expect a decision from the NRC on the
license renewal application in 2007.
In December 2005, we announced plans to sell the Palisades like other nuclear plants, has experienced cracking in reactor head
nozzle penetrations. Repairsplant and
enter into a long-term power purchase agreement with the new owner. Subject to
two nozzles were made in 2004. We have
authorizedreview of the purchaseterms 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
replacement reactor vessel closure head. The
replacement head is being manufacturedlong-term contract for us to purchase power from the plant, and is scheduledvarious other
contingencies. We expect to be installedcomplete the sale in 2007.
For additional informationdetails on nuclear plant decommissioning at Big Rock and
Palisades, see Note 3,2, Contingencies, "Other Electric Contingencies - Nuclear
Plant Decommissioning."
Spent nuclear fuel complaint: In March 2003, the Michigan Environmental Council,
the Public Interest Research Group in Michigan, and the Michigan Consumer
Federation filed a complaint with the MPSC, which was served on us by the MPSC
in April 2003. The complaint asks the MPSC to initiate a generic investigation
and contested case to review all facts and issues concerning costs associated
with spent nuclear fuel storage and disposal. The complaint seeks a variety of
relief with respect to Consumers, Detroit Edison, Indiana & Michigan Electric
Company, Wisconsin Electric Power Company, and Wisconsin Public Service
Corporation. The complaint states that amounts collected from customers for
spent nuclear fuel storage and disposal should be placed in an independent
trust. The complaint also asks the MPSC to take additional actions. In May 2003,
Consumers and other named utilities each filed motions to dismiss the complaint.
In September 2005, the MPSC dismissed the complaint.
CE-22
Consumers Energy Company
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.
In February 2004, we filed an application with the MPSC for a Certificate of
Public Convenience and Necessity to construct a 25-mile gas transmission
pipeline in northern Oakland County. The project is necessary to meet estimated
peak load beginning in the winter of 2005-2006. We started construction of Phase
I of the pipeline in June 2005 and expect Phase I to be completed and in service
by November 2005. We anticipate completion of Phase II of the project in 2008.
In October 2004, we filed an application with the MPSC for a Certificate of
Public Convenience and Necessity to construct a 10.8-mile gas transmission
pipeline in northwestern Wayne County. The project is necessary to meet the
projected capacity demands beginning in the winter of 2007. In August 2005, the
MPSC issued an order approving the application. Construction of the pipeline is
expected to begin in spring of 2006.
GAS BUSINESS UNCERTAINTIES
Several gas business trends or uncertainties may affect our future financial
results and conditions.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 3,2, 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 an annual plan and reconciliation
proceeding.proceedings. For additional details on gas cost recovery, see Note 3,2,
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, whichwhich:
- reaffirmed the previously orderedpreviously-ordered $34 million reduction in our
depreciation expense. The
October 2004 order alsoexpense,
- required us to undertake a study to determine why our plant removal
costs are in excess of those 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.
CE-23
Consumers Energy Company
TheWe filed the study report with the MPSC has directed usStaff on December 29, 2005.
We are also required to file our next gas depreciation case within 90 days after the latter of:
- the removal cost study filing, or
-
the MPSC issuance of a final order in the pending case related to ARO
accounting. TheWe cannot predict when the MPSC will issue a final order onin the pending case related to ARO
accounting case.
If the depreciation case order is expected inissued after the first quarter of 2006. Wegas general rate case order,
we proposed to incorporate theits results ofinto the gas
depreciation case into gas general rates using a
surcharge mechanism if the
depreciation case order was not issued concurrently with a gas general rate case
order.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. The primary reasons for
the request are recovery of new investments, carrying costs on natural gas
inventory related to higher gas prices, system maintenance, employee benefits,
and low-income assistance. If approved, the request would add approximately 5
percent to the typical residential customer's average monthly bill. The increase
would also affect commercial and industrial customers. 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.
EMERGENCY RULES REGARDING BILLING PRACTICES: On October 18, 2005,In February 2006, the MPSC issued an order adopting emergency rules, effective November 1, 2005 throughStaff 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 31, 2006, regarding billing practicesthe 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 retail customers of electric and
gas utilities subjectfinal rate relief downward to the MPSC's jurisdiction. The emergency rules are to
address the expected substantial increase in heating costs this winter. The
emergency rules address billing cycles, fees, deposits, shutoffs and collection
of unpaid bills. We are analyzing the potential impact of these emergency rules.$118
million.
OTHER OUTLOOK
COLLECTIVE BARGAINING AGREEMENTS: Approximately 46 percent of our employees are
represented by the Utility Workers Union of America. The Union represents
operating, maintenance, and construction employees and call center employees.
The collective bargaining agreement with the Union for operating, maintenance,
and construction employees expired on June 1, 2005 and the collective bargaining
agreement with the Union for call center employees expired on August l, 2005. In
both cases, new 5-year agreements were reached with the Union and ratified by
their membership.
MCV IMPAIRMENT: As a result ofPARTNERSHIP NEGATIVE EQUITY: Due to the impairment of the MCV Facility we may be
required to reduceand
operating losses from mark-to-market adjustments on derivative instruments, the
amountvalue of the equity investment included in our electricheld by Consumers and gas rate cases. This could impact our requested annual revenue requirements.
However, we cannot predictby all of the amount, if any, of such reduction. For additional
information on the impairmentowners of the MCV
Facility, see Note 2, Asset Impairment
Charges.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 these investigationsthis investigation and litigation, see Note 3,2,
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
NOT YET EFFECTIVE
SFAS NO. 123R,123(R) AND SAB NO. 107, SHARE-BASED PAYMENT: This StatementSFAS 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 amount over the vesting period of
the awards. This Statement also clarifies and expands SFAS No. 123's guidance in
several areas, including measuring fair value, classifying an award as equity or
as a liability, and attributing compensation cost to reporting periods.
CE-24
Consumers Energy Company
This Statement amends SFAS No. 95, Statement of Cash Flows, to require that
excess tax benefits related to the excess of the tax-deductible amount over the
compensation cost recognized be classified as cash inflows from financing
activities rather than as a reduction of taxes paid in operating activities.
Excess tax benefits are recorded as adjustments to additional paid-in capital.
This Statement is123(R) was effective for us ason
January 1, 2006. We elected to adopt the modified prospective method recognition
provisions of the beginningthis Statement instead of 2006.retrospective restatement. We adopted
the fair value method of accounting for share-based awards effective December
2002. Therefore, we doSFAS No. 123(R) did not expect this statement to have a significant impact on our
results of operations when it becomesbecame effective. FASB INTERPRETATION NO. 47, ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT
OBLIGATIONS: This Interpretation clarifiesWe applied the term "conditional asset
retirement obligation" as used inadditional
guidance provided by SAB No. 107 upon implementation of SFAS No. 143.123(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 term refersproposed SFAS would amend SFAS Nos. 87, 88, 106, and
132(R) and is expected to a legal
obligation to perform an asset retirement activitybe effective for us on December 31, 2006. The most
significant requirement stated in which the timing and (or)
method of settlement are conditional on a future event that may or may not be
withinproposed SFAS is the controlbalance sheet
recognition of the entity. The obligationunderfunded portion of our defined benefit postretirement
plans at the date of adoption. We expect that we will be allowed to performapply SFAS
No. 71 and recognize the asset retirement
activity is unconditional even though uncertainty exists about the timing and
(or) method of settlement. Accordingly, an entity is required to recognizeunderfunded portion as a liability for the fair value of a conditional asset retirement obligation if the
fair value of the liability canregulatory asset. If we
determine that SFAS No. 71 does not apply, our equity could be reasonably estimated. The fair value of a
liability for the conditional asset retirement obligation should be recognized
when incurred. This Interpretation also clarifies when an entity would have
sufficient information to estimate reasonably the fair value of an asset
retirement obligation. For us, this Interpretation is effective no later than
December 31, 2005.reduced
significantly. We are in the process of determining the impact of this Interpretation will haveproposed
SFAS on our financial statements upon adoption.
CE-25statements.
CE-19
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30 2005 2004 2005 2004
- ------------ ------ ---- ------ -------
In Millions
Three Months Ended
-------------------------
March 31 2006 2005
- -------- -------- --------
OPERATING REVENUE $1,025 $885 $3,673 $3,355
EARNINGS FROM EQUITY METHOD INVESTEES 1 1 1 1$ 1,782 $ 1,632
OPERATING EXPENSES
Fuel for electric generation 183 194 494 524172 154
Fuel costs mark-to-market at MCV (197) - (367) (6)156 (209)
Purchased and interchange power 145 71 272 171110 64
Purchased power - related parties 19 18 50 4917
Cost of gas sold 133 89 1,115 947
Cost of gas sold - related parties - - - 1816 740
Other operating expenses 212 181 601 529215 188
Maintenance 53 56 155 16371 52
Depreciation, depletion, and amortization 113 104 369 335152 145
General taxes 46 51 164 163
Asset impairment charges 1,184 - 1,184 -
------ ---- ------ ------
1,891 764 4,037 2,876
------ ---- ------ ------65 65
-------- --------
1,775 1,216
-------- --------
OPERATING INCOME (LOSS) (865) 122 (363) 4807 416
OTHER INCOME (DEDUCTIONS)
Accretion expense - (1) (1) (3)
Interest and dividends 9 4 24 11
Gain on asset sales, net - 1 - 110 5
Regulatory return on capital expenditures 17 10 48 283 16
Other income 6 3 16 74 4
Other expense (2) (2) (10) (4)
------ ---- ------ ------
30 15 77 40
------ ---- ------ ------(3) (6)
-------- --------
14 19
-------- --------
INTEREST CHARGES
Interest on long-term debt 70 70 217 21572 72
Interest on long-term debt - related parties 3 11 12 331 7
Other interest - 4 4 113 2
Capitalized interest (2) (1)
(2) (3) (5)
------ ---- ------ ------
72 83 230 254
------ ---- ------ -------------- --------
74 80
-------- --------
INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTERESTS (907) 54 (516) 266(53) 355
MINORITY INTERESTS (483) 1 (386) 12
------ ---- ------ ------(OBLIGATIONS), NET (72) 111
-------- --------
INCOME (LOSS) BEFORE INCOME TAXES (424) 53 (130) 25419 244
INCOME TAX (BENEFIT) EXPENSE (148) 19 (44) 91
------ ---- ------ ------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (276) 34 (86) 163
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR RETIREMENT BENEFITS,
NET OF $- TAX BENEFIT IN 2004 - - - (1)
------ ---- ------ ------9 87
-------- --------
NET INCOME (LOSS) (276) 34 (86) 162
PREFERRED STOCK DIVIDENDS - - 1 1
------ ---- ------ ------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDER $ (276)10 $ 34 $ (87) $ 161
====== ==== ====== ======157
======== ========
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-26CE-20
\
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
-----------------
SEPTEMBER 30In Millions
Three Months Ended
---------------------
March 31 2006 2005
2004
- ------------ --------------- ------ In Millions------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (86)10 $ 162157
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion, and amortization (includes nuclear
decommissioning of $4$1 per period) 369 335
Gain on sale of assets - (1)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 (48) (28)
Minority interest (386) 12
Fuel costs mark-to-market at MCV (367) (6)
Asset impairment charges 1,184 -
Property tax, capital(3) (16)
Capital lease and other amortization 138 132
Cumulative effect of change in accounting - 19 8
Changes in assets and liabilities:
Increase in accounts receivable and accrued revenue (44) (13)
Increase(238) (325)
Decrease in inventories (351) (273)
Increase366 401
Decrease in accounts payable 140 27(82) (8)
Decrease in accrued expenses (153) (130)
Increase(85) (46)
Decrease in MCV gas supplier funds on deposit 275 16
Deferred income taxes and investment tax credit (97) 91(90) (15)
Decrease (increase) in other current and non-current assets 66 (17)(4) 74
Increase (decrease) in other current and non-current liabilities 37 17
------- -----7 (19)
------ ------
Net cash provided by operating activities $ 677 $ 325
------- -----75 321
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (excludes assets placed under capital lease) $ (419) $(368)(125) (145)
Cost to retire property (57) (53)(25) (27)
Restricted cash on hand (163) (34)and restriced short-term investments 128 (1)
Investments in Electric Restructuring Implementation Plan - (1)
Investments in nuclear decommissioning trust funds (5) (4)(17) (1)
Proceeds from nuclear decommissioning trust funds 31 354 7
Proceeds from short-term investments - 145 717
Purchase of short-term investments - (141) (726)
Maturity of MCV restricted investment securities held-to-maturity 316 59228 126
Purchase of MCV restricted investment securities held-to-maturity (267) (592)
Cash proceeds from sale of assets 1 2(26) (126)
Other investing 4 12
-
------- ----------- ------
Net cash used in investing activities $ (547) $(431)
------- -----(29) (152)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of long-termlong term debt $ 910 $ 828- 550
Retirement of long-term debt (1,020) (717)(136) (444)
Payment of common stock dividends (207) (187)
Payment of preferred stock dividends (1) (2)(40) (118)
Payment of capital and finance lease obligations (26) (41)(3) (3)
Stockholder's contribution, 550 150net 200 200
Decrease in notes payable, net (27) -
Debt issuance costs and financing fees (29) (21)
------- -----costs (3) (7)
------ ------
Net cash provided by (used in) financing activities $ 177 $ 10
------- -----(9) 178
------ ------
Net Increase (Decrease) in Cash and Cash Equivalents $ 307 $ (96)
Cash and Cash Equivalents from Effect of Revised FASB
Interpretation No. 46 Consolidation - 17437 347
Cash and Cash Equivalents, Beginning of Period 416 171
46
------- ----------- ------
Cash and Cash Equivalents, End of Period $ 478453 $ 124
======= =====518
====== ======
CE-27THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-21
CONSUMERS ENERGY COMPANY
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30In Millions
---------------------------
March 31
2006 December 31
(Unaudited) 2005
DECEMBER 31
(UNAUDITED) 2004
------------ ----------- In Millions-----------
ASSETS
PLANT AND PROPERTY (AT COST)
Electric $ 8,1298,266 $ 7,9678,204
Gas 3,066 2,9953,165 3,151
Other 222 2,523
------- -------
11,417 13,485227 227
--------- ---------
11,658 11,582
Less accumulated depreciation, depletion, and amortization 4,756 5,665
------- -------
6,661 7,8204,855 4,804
--------- ---------
6,803 6,778
Construction work-in-progress 489 353
------- -------
7,150 8,173
------- -------538 509
--------- ---------
7,341 7,287
--------- ---------
INVESTMENTS
Stock of affiliates 37 2528 33
Other 8 19
------- -------
45 44
------- -------4 7
--------- ---------
32 40
--------- ---------
CURRENT ASSETS
Cash and cash equivalents at cost, which approximates market 478 171
Short-term investments at cost, which approximates market - 4453 416
Restricted cash 184 21and restricted short-term investments 55 183
Accounts receivable, notes receivable, and accrued revenue,
less allowances of $10$14 in 2006 and $10, respectively 413 374$13 in 2005 887 653
Accounts receivable - related parties 10 188 9
Inventories at average cost
Gas in underground storage 1,172 855702 1,068
Materials and supplies 70 6772 75
Generating plant fuel stock 97 6683 80
Deferred property taxes 115 165164 159
Regulatory assets - postretirement benefits 19 19
Derivative instruments 380121 242
Prepayments and other 96 Other 50 95
------- -------
2,988 1,951
------- -------70
--------- ---------
2,660 2,974
--------- ---------
NON-CURRENT ASSETS
Regulatory Assetsassets
Securitized costs 571 604549 560
Additional minimum pension 466 372399 399
Postretirement benefits 122 139
Capital expenditures return 201 141
Abandoned Midland Project 9 10110 116
Customer Choice Act 213 222
Other 461 411481 484
Nuclear decommissioning trust funds 576 555
575
Other 493 391
------- -------
2,878 2,643
------- -------582 520
--------- ---------
2,910 2,856
--------- ---------
TOTAL ASSETS $13,061 $12,811
======= =======$ 12,943 $ 13,157
========= =========
CE-28THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-22
STOCKHOLDER'S EQUITYINVESTMENT AND LIABILITIES
SEPTEMBER 30In Millions
---------------------------
March 31
2006 December 31
(Unaudited) 2005
DECEMBER 31
(UNAUDITED) 2004
------------ ----------- In Millions-----------
CAPITALIZATION
Common stockholder's equity
Common stock, authorized 125.0 shares; outstanding
84.1 shares for all periods $ 841 $ 841
Paid-in capital 1,482 9321,832 1,632
Accumulated other comprehensive income 76 3158 72
Retained earnings since December 31, 1992 314 608
------- -------
2,713 2,412203 233
--------- ---------
2,934 2,778
Preferred stock 44 44
Long-term debt 4,310 4,000
Long-term debt - related parties - 3264,297 4,303
Non-current portion of capital leases and finance lease obligations 299 315
------- -------
7,366 7,097
------- -------309 308
--------- ---------
7,584 7,433
--------- ---------
MINORITY INTERESTS 322 657
------- -------264 259
--------- ---------
CURRENT LIABILITIES
Current portion of long-term debt, capital leases and finance leases 111 147112 112
Current portion of long-term debt - related parties - 129
180Notes payable - related parties - 27
Accounts payable 410 267292 372
Accounts payable - related parties 11 1423 25
Accrued interest 59 8366 82
Accrued taxes 133 254322 400
Deferred income taxes 48 2060 55
MCV gas supplier funds on deposit 295 20103 193
Other 233 218
------- -------
1,429 1,203
------- -------190 251
--------- ---------
1,168 1,646
--------- ---------
NON-CURRENT LIABILITIES
Deferred income taxes 1,240 1,350956 1,027
Regulatory Liabilitiesliabilities
Regulatory liabilities for cost of removal 1,097 1,0441,152 1,120
Income taxes, net 369 357464 455
Other 174 173regulatory liabilities 231 178
Postretirement benefits 367 207325 308
Asset retirement obligations 434 436496 494
Deferred investment tax credit 75 7965 67
Other 188 208
------- -------
3,944 3,854
------- -------
COMMITMENTS AND CONTINGENCIES238 170
--------- ---------
3,927 3,819
--------- ---------
Commitments and Contingencies (Notes 2, 3, 4, and 5)4)
TOTAL STOCKHOLDER'S EQUITYINVESTMENT AND LIABILITIES $13,061 $12,811
======= =======$ 12,943 $ 13,157
========= =========
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-29CE-23
CONSUMERS ENERGY COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ --------------------
SEPTEMBER 30 2005 2004 2005 2004
- ------------ ------ ------ ------ -----------
In Millions
Three Months Ended
March 31 2006 2005
- -------- --------- ---------
COMMON STOCK
At beginning and end of period (a) $ 841 $ 841
$ 841 $ 841
------ ------ ------ --------------- ---------
OTHER PAID-IN CAPITAL
At beginning of period 1,482 6821,632 932 682
Stockholder's contribution - 150 550 150
------ ------ ------ ------200 200
--------- ---------
At end of period 1,482 832 1,482 832
------ ------ ------ ------1,832 1,132
--------- ---------
ACCUMULATED OTHER COMPREHENSIVE INCOME
(LOSS)
Minimum Pension Liability
At beginning of period (2) - (1) -
Minimum pension liability
adjustment (b) - (1) (1) (1)
------ ------ ------ ------
At beginning and end of period (2) (1)
(2) (1)
------ ------ ------ --------------- ---------
Investments
At beginning of period 18 10 12 9
Unrealized gain (loss) on investments (b) (2) 3
- 9 1
------ ------ ------ --------------- ---------
At end of period 21 10 21 10
------ ------ ------ ------16 15
--------- ---------
Derivative Instrumentsinstruments
At beginning of period 32 1656 20
8
Unrealized gain (loss) on derivative instruments (b) 27 14 50 27(10) 16
Reclassification adjustments included in net income (loss) (b) (2) (1) (13) (6)
------ ------ ------ ------(10)
--------- ---------
At end of period 57 29 57 29
------ ------ ------ ------44 26
--------- ---------
Total Accumulated Other Comprehensive Income 76 38 76 38
------ ------ ------ ------58 40
--------- ---------
RETAINED EARNINGS
At beginning of period 630 543233 608 521
Net income (loss) (276) 34 (86) 16210 157
Cash dividends declared - Common Stock (40) (82) (207) (187)
Cash dividends declared - Preferred Stock - - (1) (1)
------ ------ ------ ------(118)
--------- ---------
At end of period 314 495 314 495
------ ------ ------ ------203 647
--------- ---------
TOTAL COMMON STOCKHOLDER'S EQUITY $2,713 $2,206 $2,713 $2,206
====== ====== ====== ======$ 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 (Loss):Income:
In Millions
-------------------
Three Months Ended
March 31 2006 2005
- -------- ----- -----
Minimum Pension Liabilityr
Minimum pension liability adjustment, net of tax of
$-, $(1), $-, and $(1), respectively $ - $(1) $ (1) $ (1)
Investments
Unrealized gain (loss) on investments, net of tax of
$(1) in 2006 and $2 $-, $5, and $1, respectivelyin 2005 $ (2) $ 3
- 9 1
Derivative Instrumentsinstruments
Unrealized gain (loss) on derivative instruments, net of tax of
$15, $7, $27,$(5) in 2006 and $14, respectively 27 14 50 27$9 in 2005 (10) 16
Reclassification adjustments included in net income, net of tax
benefit of $(1), $(1), $(7), in 2006 and $(3), respectively$(6) in 2005 (2) (1) (13) (6)(10)
Net income (loss) (276) 34 (86) 16210 157
----- --- ---- ---------
Total Other Comprehensive Income (Loss) $(248) $46 $(41) $183$ (4) $ 166
===== === ==== =========
THE ACCOMPANYING CONDENSED NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CE-30CE-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 to Consolidated Financial Statements contained in the
Consumers' Form 10-K for the year ended December 31, 2004.2005. 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 Revised FASB Interpretation
No. 46.46(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 3,2, Contingencies.
CE-31REVENUE 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 Nine Months Ended
------------------ -----------------
September 30March 31 2006 2005
2004 2005 2004
- --------------------------------------- ---- ----
---- ----
Other income
Electric restructuring return $ 1 $ 2 $ 5 $ 51
Return on stranded and security costs 1 - 4 1
Nitrogen oxide allowance sales 1 - 2 -
Gain on stock - - 1 -1
All other 3 1 4 1
--- ---
--- ---
Total other income $ 64 $ 3 $16 $ 7
=== ===4
=== ===
In Millions
-------------------------------------------------------
Three Months Ended Nine Months Ended
------------------ -----------------
September 30March 31 2006 2005
2004 2005 2004
- --------------------------------------- ---- ----
---- ----
Other expense
Loss on reacquired debt $ - $ - $ (6) $ -(5)
Civic and political expenditures (1) (1)
(2) (2)
Loss on SERP investmentDonations (1) -
All other (1) (1) (1)
Other -
- (1) (1)
--- --- ---- -------
Total other expense $(2) $(2) $(10) $(4)
=== ===$ (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: ASSET IMPAIRMENT CHARGES
We evaluate potential impairments of our investments in long-lived assets, other
than goodwill, based on various analyses, including the projection of
undiscounted cash flows, whenever events or changes in circumstances indicate
that the carrying amount of the assets may not be recoverable. If the carrying
amount of the investment or asset exceeds its estimated undiscounted future cash
flows, an impairment loss is recognized and the investment or asset is written
down to its estimated fair value. In the third quarter of 2005, we recorded
Asset Impairment charges of $1.184 billion on our Consolidated Statements of
Income. These charges reduced our third quarter 2005 net income by $385 million.
The MCV Partnership's costs of producing electricity are tied to the price of
natural gas, but its revenues do not vary with changes in the price of natural
gas. While the average forward price of natural gas has increased steadily from
2002 through the second quarter of 2005, it remained at a level that suggested
the MCV Partnership's operating cash flow would be sufficient to provide for the
recovery of its assets. However, unforeseen natural and economic events in the
third quarter of 2005 caused a substantial upward spike in NYMEX forward natural
gas prices for the years 2005 through 2010. Additionally, other independent
natural gas long-term forward price forecasting organizations indicated their
CE-32
Consumers Energy Company
intention to raise their forecasts for the price of natural gas generally over
the entire long-term forecast horizon beyond 2010. Our analysis and assessment
of this new information suggests that forward natural gas prices for the period
from 2006 through 2010 will average approximately $9 per mcf. This compares to
the second quarter 2005 NYMEX-quoted average prices for the same forward period
of approximately $7.50 per mcf. Further, this new information indicates that
natural gas prices will average approximately $6.50 per mcf over the long term
beyond 2010. As a result, the MCV Partnership reevaluated the economics of
operating the MCV Facility and determined that an impairment analysis,
considering revised forward natural gas price assumptions, was required. In its
impairment analysis, the MCV Partnership determined the fair value of its fixed
assets by discounting a set of probability-weighted streams of future operating
cash flows at a 4.3 percent risk free interest rate. The carrying value of the
MCV Partnership's fixed assets exceeded the estimated fair value by $1.159
billion. In the third quarter of 2005, the MCV Partnership recorded an
impairment charge of $1.159 billion to recognize the reduction in fair value of
the MCV Facility's fixed assets. As a result, our net income was reduced by $369
million after considering tax effects and minority interest. The MCV
Partnership's fixed assets, which are included on our Consolidated Balance
Sheets, after reflecting the impairment charge, are valued at $219 million at
September 30, 2005.
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 financial obligations under the sale and
leaseback transactions and other contracts.
Our 49 percent interest in the MCV Partnership is held through our wholly-owned
subsidiary, CMS Midland. The severe adverse change in the anticipated economics
of the MCV Partnership operations discussed within this Note also led to our
decision to impair certain assets carried on the balance sheet of CMS Midland.
These assets represented interest capitalized during the construction of the MCV
Facility, which were being amortized over the life of the MCV Facility. In the
third quarter of 2005, we recorded an impairment charge of $25 million ($16
million, net of tax) to reduce the carrying amount of these assets to zero.
3: CONTINGENCIES
SEC AND OTHER INVESTIGATIONS: As a resultDuring the period of round-tripMay 2000 through January
2002, CMS MST engaged in simultaneous, prearranged commodity trading
transactions by
CMS MST, CMS Energy's Board of Directors established a Special Committee to
investigate matters surroundingin which energy commodities were sold and repurchased at the transactions and retained outside counsel to
assist in the investigation. The Special Committee completed its investigation
and reported its findings to the Board of Directors in October 2002. The Special
Committee concluded, based on an extensive investigation, that thesame
price. These so called round-trip trades were undertaken to raise CMS MST's profile as an energy marketer withhad no impact on previously reported
consolidated net income, earnings per share, or cash flows but had the goaleffect of
enhancing its ability to promote its services to new customers. The
Special Committee found no effort to manipulate the price of CMS Energy Common
Stock or affect energy prices. The Special Committee also made recommendations
designed to prevent any recurrence of this practice. Previously, CMS Energy
terminated its speculative trading businessincreasing operating revenues and revised its risk management
policy. The Board of Directors adopted, and CMS Energy implemented, the
recommendations of the Special Committee.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, including but not limited to
Consumers which, while established, operated and regulated as a separate legal
entity and publicly traded company, shares a parallel Board of Directors with
CMS Energy. The
CE-33
Consumers Energy Company
complaints were filed as purported class actions in the United States District
Court for the Eastern District of Michigan, by shareholders who allege that they
purchased CMS Energy's securities during a purported class period running from
May 2000 through March 2003.affiliates. The cases were consolidated into a
single lawsuit.
The consolidated 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 was granted dismissingto dismiss Consumers and three of the individual defendants,
but the court denied the motions to dismiss for CMS Energy and the 13 remaining individual
defendants. Plaintiffs filed a motion for
class certification on April 15, 2005The court issued an opinion and anorder dated March 24, 2006, granting
in part and denying in part plaintiffs' amended motion for class certification on June 20, 2005.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 and Incentive Plan (the Plan). The two cases, filed in July
2002 in United States District Court for the Eastern District of Michigan, were
consolidated by the trial judge and an amended consolidated complaint was filed. Plaintiffs allege breaches of
fiduciary duties under ERISA and seek restitution on behalf of the Plan with
respect to a decline in value of the shares of CMS Energy Common Stock held in
the Plan. Plaintiffs also seekPlan, as well as other equitable relief and legal fees. InOn March 2004, the judge granted in part, but denied in
part, CMS Energy's motion to dismiss the complaint. The judge has conditionally
granted plaintiffs' motion for class certification. A trial date has not been
set, but is expected to be no earlier than mid-2006.1, 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 defend themselves vigorously in this litigation but cannot predict its
outcome.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 $815$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
- allowance for funds used during construction (AFUDC)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 8.38.4 percent. As of September 2005,March 2006, we have
incurred $589$616
million in capital expenditures to comply with thesethe federal Clean Air Act and
resulting regulations and anticipate that the remaining $226$203 million of capital
expenditures will be made in 20052006 through 2011. These expenditures include
installing selective catalytic control reduction technology at four of our
coal-fired electric generating plants. In addition to modifying the 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 utilize
nitrogen oxide emissions allowances for years 2006recover from our customers through 2008, of which 90
percent have been obtained.the PSCR
process. The cost of the allowancesprojected annual expense is estimated to average
$5 million per year
CE-34
Consumers Energy Company
for 2006 through 2008. The estimated costs are based on market price forecasts and
forecasts of regulatory provisions, known as progressive flow control, that
restrict the averageusage in any given year of allowances banked from previous years.
The allowances and their cost of the
purchased, allocated, and exchanged allowances. The need for allowances will
decrease after 2006 with the installation of selective catalytic control
technology. The cost of the allowances isare accounted for as inventory. The allowance
inventory is expensed at the rolling average cost as the coal-fired electric
generating unitsplants emit nitrogen oxide.
TheIn March 2005, the EPA recently adopted athe 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 and nitrogen oxides by 63 percentfrom
2003 levels by 2015. The final rule will require that we run our Selective Catalytic Reductionselective
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
control technology installed to
meet the Nitrogen Oxide State Implementation
Plan,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 cost near thatsurplus of sulfur dioxide allowances, which were granted by the
Nitrogen Oxide State Implementation Plan.EPA and are accounted for as inventory. In MayJanuary 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 powergenerating
plants by 2010 and further reductions by 2018. WhileThe 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,emissions. However, we
anticipate our capital and operating costs for mercury emissions reductions
are expectedrequired by the Clean Air Mercury Rule to be significantly less than what iswas
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. The MDEQ has not indicated the direction that it will pursue to meet
or exceed the EPA requirements through a state rulemaking. We are actively
participating in dialog with the MDEQ regarding potential paths for controlling
mercury emissions and meeting the EPA requirements. 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 modification 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 pastour experience, we
estimate that our share of the total liability for the known Superfund sites
will be between $1$2 million and $9$10 million. At September 30, 2005,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 the Ludington Pumped
Storage facility.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.
CE-35
Consumers Energy Company
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 GTG 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 is assessing the duct burner issue and has beguntook 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 unique 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 this MDEQ letter in
July 2004.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 willincludes 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 is likely tomay involve a
fine, but at this time, the MDEQ has not stated what, if any, fine they will
seek to impose. At this time, the MCV Partnership managementwe 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, failurefailing 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 the result ofissued 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). All items have been addressed or corrected and theThe
MCV Partnership has committed to updatingsubmitted its updated SWPPP byon December 1, 2005. The MCV
Partnership management believes that once it files its updated SWPPP it will
havehas 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 allegesalleged 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
eight plaintiff qualifying facilitiesplaintiffs have appealed the dismissal of the
circuit court caseMPSC order to the Michigan Court of Appeals. The
qualifying facilitiesplaintiffs also filed suit in the United States Court for the Western District
of Michigan, which the judge subsequently dismissed. The plaintiffs have also
appealed the February 2005 MPSC order in the 2004 PSCR plan casedismissal to the MichiganUnited States Court of Appeals, and have initiated separate legal actions in
federal district court and at the FERC concerning the energy charge calculation
issue. In June 2005, the FERC issued a notice of intent not to act on this
issue. In October 2005, the federal district court dismissed the case.Appeals. We cannot predict
the outcome of the remainingthese appeals.
ELECTRIC RESTRUCTURING MATTERS
ELECTRIC ROA: We cannot predict the total amountThe Customer Choice Act allows all of our electric supply load that
may be lostcustomers to
buy electric generation service from us or from an alternative electric
suppliers. As of October 2005,supplier. At March 31, 2006, alternative electric suppliers arewere providing 754348
MW of generation service to ROA customers. This amount represents a decrease of 14 percent compared to October 2004, and 10is 4 percent of our total
distribution load.
CE-36
Consumers Energy Company
ELECTRIC RESTRUCTURING PROCEEDINGS: Belowload 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 discussion of our electric
restructuring proceedings.
The following chart summarizes our electric restructuring filings with the MPSC:
Year(s) Years Requested
Proceeding Filed Covered Amount Status
- ---------- ----- ------ --------- ------
Stranded Costs 2002-2004 2000-2003 $137 million (a) The MPSC ruled that we experienced zero Stranded Costs
for 2000 through 2001. The MPSC approved recovery of
$63 million in Stranded Costs for 2002 through 2003,
plus the cost of money through the period of
collection.
Implementation Costs 1999-2004 1997-2003 $91 million (b) The MPSC allowed $68 million for the years 1997-2001,
plus the cost of money through the period of
collection. The MPSC allowed $6 million for the years
2002-2003, plus the cost of money through the period
of collection.
Section 10d(4) Regulatory Assets 2004 2000-2005 $628 million Application filed with the MPSC in October 2004.
(a) Amount includes the cost of money through the year in which we expectedmechanism pursuant to
receive recovery from the MPSC and assumes recovery of Clean Air Act costs
through the Section 10d(4) Regulatory Asset case.
(b) Amount includes the cost of money through the year prior to the year filed.
Section 10d(4) Regulatory Assets: Section 10d(4) of the Customer
Choice Act allows us to recover certain regulatory assets through deferredprovide recovery of annual capital expenditures in excess of depreciation levels and certain other
expenses incurred priorStranded Costs that occur when customers leave
our system to and throughout the rate freeze and rate cap periods,
including the cost of money. The section also allows deferred recovery of
expenses incurred during the rate freeze and rate cap periods that resultpurchase electricity from changes in taxes, laws, or other state or federal governmental actions.alternative suppliers. In October 2004,November 2005,
we filed an application with the MPSC seeking recovery of $628
million of Section 10d(4) Regulatory Assets for the period June 2000 through
December 2005 consisting of:
- capital expenditures in excess of depreciation,
- Clean Air Act costs,
- other expenses related to changes in law or governmental action
incurred during the rate freeze and rate cap periods, and
-determination of 2004
Stranded Costs. Applying the associated cost of money through the period of collection.
Of the $628 million, $152 million relates to the cost of money.
CE-37
Consumers Energy Company
As allowed by the Customer Choice Act, we accrue and defer for recovery a
portion of our Section 10d(4) Regulatory Assets. In March 2005, the MPSC Staff
filed testimony recommending the MPSC approve recovery of approximately $323
million in Section 10d(4) costs, which includes the cost of money through the
period of collection. In June 2005, the ALJ issued a proposal for decision
recommending that the MPSC approve recovery of the same Section 10d(4) costs
recommended by the MPSC Staff. However, we may have the opportunity to recover
certain costs included in our application alternatively in other cases pending
before the MPSC. We cannot predict the amount, if any, the MPSC will approve as
recoverable. At September 30, 2005, total recorded Section 10d(4) Regulatory
Assets were $201 million.
TRANSMISSION SALE: In May 2002, we sold our electric transmission system to MTH,
a non-affiliated limited partnership whose general partner is a subsidiary of
Trans-Elect, Inc. We are in arbitration with MTH regarding property tax itemsStranded Cost methodology used in establishing the selling price of our electric transmission system. An
unfavorable outcome could resultprior MPSC
orders, we concluded that we experienced zero Stranded Costs in a reduction of sale proceeds previously
recognized of approximately $2 million to $3 million.2004.
ELECTRIC RATE MATTERS
ELECTRIC RATE CASE: In December 2004, we filed an application with the MPSC to
increase our retail electric base rates. The electric rate case filing requests
an annual increase in revenues of approximately $320 million. The primary
reasons for the request are load migration to alternative electric suppliers,
increased system maintenance and improvement costs, Clean Air Act-related
expenditures, and employee pension costs. In April 2005, we filed updated debt
and equity information in this case.
In June 2005, the MPSC Staff filed its position in this case, recommending a
base rate increase of $98 million. The MPSC Staff also recommended an 11.25
percent return on equity to establish rates and recognized all of our projected
equity investment (infusions and retained earnings) in 2006. In August 2005, we
revised our request for an annual increase in revenues to approximately $197
million, and the MPSC Staff revised its recommendation to $100 million. In
October 2005, the ALJ issued a proposal for decision recommending a base rate
increase of $112 million and an 11.25 percent authorized return on equity. We
expect a final order from the MPSC in late 2005. If approved as requested, the
rate increase would go into effect in January 2006 and would apply to all retail
electric customers. We cannot predict the amount or timing of the rate increase,
if any, which the MPSC will approve.
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 20062007 through
2007.2010. As a result, we have recognized an asset of $6$72 million for unexpired
capacity and energy contracts at September 30, 2005. As of October 2005,March 31, 2006. At April 2006, we expect the
total premiumcapacity cost of electric capacity and energy contracts for 20052006 to be approximately $8$18
million.
CE-32
Consumers Energy Company
PSCR: The PSCR process is designed to allowallows recovery of all reasonable and prudent power supply
costs that we actually incur. In June 2005, the MPSC issued
an order that approves our 2005 PSCR plan. The 2005 PSCR charge allows us to
recover a portion of our power supply costs from commercial and industrial
customers and, subject to the overall rate caps, from other customers. The
revenuescosts. Revenues from the PSCR charges are subject to reconciliation after review of
actual
costs are reviewed for
CE-38
Consumers Energy Company reasonableness and prudence. In March 2005, we submitted our 2004 PSCR
reconciliation filing to the MPSC. In September 2005, we
submitted our 2006 PSCR plan filing to the MPSC. UnlessIn November 2005, we receivesubmitted
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 self-implement this proposed 2006 PSCR charge in January 2006.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 Revised FASB Interpretation No. 46. For
additional details, see Note 9, Consolidation of Variable Interest Entities.
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
cash underrecoveries of capacity and fixed energy payments as follows:
In Millions
------------------
2005 2006 2007
---- ---- ----
Estimated cash underrecoveries $56 $55 $39
Of the 2005 estimate, we expensed $43 million during the nine months ended
September 30, 2005.
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 amount 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. 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.
Further, under46(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 the third
quarter of 2005, the MCV Partnership reevaluated the
economics of operating the MCV Facility and determined thatrecorded an impairment was required.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.
For additional detailsFurther, 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 impairmentcapacity and fixed energy payments recoverable from
customers subsequent to September 15, 2007 may affect negatively the financial
performance of the MCV Facility, see Note 2, Asset Impairment Charges.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 will benefitbenefits our ownership interest in the MCV Partnership.
CE-39
Consumers Energy Company
The substantial MCV Facility fuel cost savings are first used to offset fully
the cost of replacement power. Second, $5 million annually, funded jointly by
Consumers and the MCV Partnership, are contributed to our RRP. Remaining savings
are split between the MCV Partnership and Consumers. Consumers' direct savings
are shared 50 percent with its customers in 2005 and 70 percent in 2006 and
beyond. Consumers' direct savings from the RCP, after allocating a portion to
customers, are used to offset our capacity and fixed energy underrecoveries
expense. Since the MPSC has excluded these underrecoveries from the rate making
process, we anticipate that our savings from the RCP will not affect our return
on equity used in our base rate filings.
In January 2005, Consumers and the MCV Partnership's general partners accepted
the terms of the order andwe 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.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 approximately $83$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: Decommissioning-fundingThe 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 onin March 31, 2004. Excluding additional costs for spent nuclear fuel
storage, due to the DOE's failure to accept this spent nuclear fuel on schedule,
these reports show a decommissioning cost of $361 million for Big Rock and $868
million for Palisades. Since Big Rock is currently in the process of
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 $394$390 million in 2005 dollars.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 $57$36 million. At this time, we plan to provide
thethis additional amounts neededamount from our corporate funds, and, subsequent to the
completion in 2007 of radiological decommissioning work, seek recovery of such
expenditures, atin addition to the MPSC.amount we added to the fund, from some
alternative source. We cannot predict how the MPSC will rule on our
request.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 costscost
estimates filed in March 2004, that the existing Palisades' surcharge for Palisadesof $6
million needed to be increased to $25 million annually, beginning January 1, 2006, and
continuing through 2011, our current license expiration date. In June 2004, we
filed an application with2006.
A settlement agreement was approved by the MPSC, seeking approval to increase the surcharge
for recovery of decommissioning costs related to
CE-40
Consumers Energy Company
Palisades beginning in 2006. In September 2004, we announced that we would seek
a 20-year license renewal for Palisades. In January 2005, we filed a settlement
agreement with the MPSC that was agreed to by four of the six parties involved
in the proceeding. The settlement agreement providesproviding 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. In September 2005, the MPSC
approved the contested settlement. Amounts collected from electric retail customers and deposited in
trusts, including trust earnings, are credited to a regulatory liability and asset retirement obligation.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. Certain parties
are seeking to intervene and have requested a hearing on the application. The
NRC has stated that it expects to take 22-30 months to review a license renewal
application. 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 September 30, 2005, we have recorded aMarch 31, 2006, our DOE liability to the DOE of $144 million, includingis $147
million. This amount includes interest, which is payable prior
toupon 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. On April 29, 2005, the court ruled on various cross-motions for
summary judgment previously filed by the DOE and us. The court denied the DOE's
motions to dismiss Counts I and II of the complaint and its motion seeking
recovery of a one-time fee that is due to be paid by us prior to delivery of the
spent nuclear fuel. The court, however, granted the DOE's motion to recoup the
one-time fee against any award of damages to us. The court further granted our
motion for summary judgment on liability and our motion to dismiss the DOE's
affirmative defense alleging our failure to satisfy a condition precedent. We
filed a motion for reconsideration of the portion of the Court's order dealing
with recoupment, which the Court denied. 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 July 2002, Congress approved and the President signed a bill designating 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.
CE-41
Consumers Energy Company
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. The United States Congress enacted the
Price-Anderson Act to provide financial liability protection for those parties
who may be liable for a nuclear accident or incident. Part of the Price-Anderson Act's
financial protection is a mandatory industry-wide program 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 2003,2005, we estimated our remaining
costs to be between $37$29 million and $90$71 million, based on 20032005 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 insurance proceeds derived from a
settlement with insurers and MPSC-approved rates. Since 2003, we have spent $14 million on remediation
activities related to the 23 sites. At September 30, 2005,March 31, 2006, we have a
liability of $34$28 million, net of $48$54 million of expenditures incurred to date,
and a regulatory asset of $62$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.
CE-42
Consumers Energy Company
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 an annual plan and reconciliation proceeding.
The following table summarizes ourproceedings.
GCR reconciliation filings with the MPSC.
Additional details relatedfor year 2004-2005: In March 2006, a settlement was reached
and submitted to the proceedings follow the table.
Gas Cost Recovery Reconciliation
Net Over-
GCR Year Date Filed Order Date recovery (a) Status
- --------- ---------- ------------- ------------ ------------------------
2003-2004 June 2004 February 2005 $31 million The net overrecovery
includes $1 million and
$5 million GCR net
overrecoveries from
prior GCR years and
interest accrued through
March 2004.
2004-2005 June 2005 PendingMPSC for approval for our 2004-2005 GCR year
reconciliation. The settlement is for a $2 million
(a) Net overrecoveries includenet overrecovery for the GCR
year; it includes interest through March 2005 and refunds that we received from
our suppliers whichthat 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 2004,2005 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 20052006
through March 2006.2007. Our request proposed using a GCR factor consisting of:
- a base GCR ceiling factor of $6.98$11.10 per mcf, plus
- a quarterly GCR ceiling price adjustment contingent upon future
events.
TheOur GCR factor can be adjusted monthly, provided it remains at or below the
current ceiling price. The quarterly adjustment mechanism allows an increase in
the GCR ceiling price to reflect a portion of cost increases if the average
NYMEX price for a specified period is greater than that used in calculating the
base GCR factor. The current ceiling price for 2005 is $8.73 per mcf. Actual gas
costs and revenues will be subject to an annual reconciliation proceeding.
In June 2005, four of the five parties filed a settlement agreement; the fifth
party filed a statement of non-objection. The settlement agreement includes a
GCR ceiling price adjustment contingent upon future events.
In September 2005, we filed a motion with the MPSC seeking to reopen our GCR
plan for year 2005-2006. Since the settlement agreement entered into in June
2005, there have been substantial, unanticipated increases in the market price
for natural gas. These increases have been so large that the maximum adjustments
possible under the GCR ceiling price adjustment mechanisms included in the
settlement agreement are not adequate. Unless the maximum allowable GCR factor
is increased, we will experience a substantial GCR underrecovery for the 2005-2006 GCR year. In our filing, we have requested the MPSC to:
- increase the base GCR factor from $6.98 to $9.11billing month of May 2006 is $9.07 per mcf, and
- revise the GCR ceiling price adjustment mechanism increasing the
maximum GCR factor from $8.73 per mcf to $11.21 per mcf.
CE-43
Consumers Energy Company
We are requesting the increase in the maximum allowable GCR factor be effective
as soon as possible but not later than January 1, 2006.
On October 6, 2005, the MPSC issued an order reopening evidentiary proceedings.
The MPSC established an expedited contested case proceeding. The MPSC Staff and
intervenors filed testimony and exhibits on October 17, 2005; rebuttal testimony
occurred October 24, 2005. The case is scheduled to be submitted directly to the
Commission without the necessity of the preparation of the ALJ's proposal for
decision on November 21, 2005.
2001 GAS DEPRECIATION CASE: In October and December 2004, the MPSC issued
Opinions and Orders in our gas depreciation case, whichwhich:
- reaffirmed the previously orderedpreviously-ordered $34 million reduction in our
depreciation expense. The
October 2004 order alsoexpense,
- required us to undertake a study to determine why our plant removal
costs are in excess of those 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.
TheWe filed the study report with the MPSC has directed usStaff on December 29, 2005.
We are also required to file our next gas depreciation case within 90 days after the latter of:
- the removal cost study filing, or
-
the MPSC issuance of a final order in the pending case related to ARO
accounting. TheWe cannot predict when the MPSC will issue a final order onin the pending case related to ARO
accounting case.
If the depreciation case order is expected inissued after the first quarter of 2006. Wegas general rate case order,
we proposed to incorporate theits results ofinto the gas
depreciation case into gas general rates using a
surcharge mechanism if the
depreciation case order was not issued concurrently with a gas general rate case
order.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. The primary reasons for
the request are recovery of new investments, carrying costs on natural gas
inventory related to higher gas prices, system maintenance, employee benefits,
and low-income assistance. If approved, the request would add approximately 5
percent to the typical residential customer's average monthly bill. The increase
would also affect commercial and industrial customers. 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: OnRULING AND AUDIT: In August 2, 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. Accordingly,
we cannot predictunresolved 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
rulingmatter on future earnings, cash flows, or our present NOL carryforwards.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.
CE-44
Consumers Energy Company
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.
4: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
--------------------------------------
September 30, 2005------------------------------------------
March 31, 2006 December 31, 2004
------------------2005
-------------- -----------------
First mortgage bonds $3,175 $2,300$ 3,175 $ 3,175
Senior notes bank debt and other 850 1,436853 852
Securitization bonds 378 398
------ ------362 369
---------- ----------
Principal amounts outstanding 4,403 4,1344,390 4,396
Current amounts (85) (118)(85)
Net unamortized discount (8) (16)
------ ------(8)
---------- ----------
Total Long-term debt $4,310 $4,000
====== ======$ 4,297 $ 4,303
========== ==========
FINANCINGS:DEBT RETIREMENTS: The following is a summary of significant long-term debt
issuances
and retirements during the ninethree months ended September 30, 2005:March 31, 2006:
Principal Interest Rate Issue/Retirement
(In(in millions) Rate (%) Date Maturity Date
------------- -------- ---------------- ------------- ------------------ --------------
DEBT ISSUANCES
FMB $250 5.15 January 2005 February 2017
FMB 300 5.65 March 2005 April 2020
FMB insured quarterly notes 150 5.65 April 2005 April 2035
LORB 35 Variable April 2005 April 2035
FMB 175 5.80 August 2005 September 2035
----
TOTAL $910
====
DEBT RETIREMENTS
Long-term bank debt $ 60 Variable January 2005 November 2006
Long-term debt - related parties 180 9.25 January 2005 December 2029
Long-term debt - related parties 73 8.36$ 129 9.00 February 2005 December 2015
Long-term debt - related parties 124 8.20 February 2005 September 2027
Senior notes 332 6.25 April and May 2005 September 2006 Senior insured quarterly notes 141 6.50 May 2005 October 2028
----
TOTAL $910
====June 2031
By the end of the first quarter of 2006, we will extinguish through a defeasance
$129 million of 9 percent notes. We classified the notes on the balance sheet as
Current portion of long-term debt - related parties.
REGULATORY AUTHORIZATION FOR FINANCINGS: In April 2005, the FERC issued an
authorization to permit us to issue up to an additional $1.0 billion ($2.0
billion in total) of long-term securities for refinancing or refunding purposes,
and up to an additional $1.0 billion ($2.5 billion in total) of long-term
securities for general corporate purposes during the period ending June 30,
2006.
CE-45CE-39
Consumers Energy Company
Combined with remaining availability from previously issued FERC authorizations,
we can now issue up to:
- $876 million of long-term securities for refinancing or refunding
purposes,
- $1.159 billion of long-term securities for general corporate purposes,
and
- $1.935 billion of long-term FMB to be issued solely as collateral for
other long-term securities.
FMB Indenture Limitations: Irrespective of our existing FERC authorization, our
ability to issue FMB as primary obligations or as collateral for financing is
governed by certain provisions of our indenture dated September 1, 1945 and its
subsequent supplements. Due to the adverse impact of the MCV Partnership asset
impairment charge recorded in September 2005 on the net earnings coverage test
in one of the governing bond-issuance provisions of the indenture, we expect our
ability to issue additional FMB will be limited to $298 million for 12 months,
ending September 30, 2006. Beyond 12 months, our ability to issue FMB in excess
of $298 million is based on achieving a two-times FMB interest coverage rate.
REVOLVING CREDIT FACILITIES: The following secured revolving credit facilities
with banks are available at September 30, 2005:March 31, 2006:
In Millions
Outstanding -----------
Amount of Amount OutstandingLetters-of- Amount
Company Expiration Date Facility Borrowed Letters-of-CreditCredit Available
- ---------------------- --------------- --------- -------- ----------------- --------------------- -----------
Consumers March 30, 2007 $ 300 $ - $ - $ 300
Consumers May 18, 2010 $500 $500 - $31 $46936 464
MCV Partnership August 26, 2006 50 - 3 472 48
We amendedIn 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 credit facilityarticles of incorporation, at
March 31, 2006, we had $149 million of unrestricted retained earnings available
to pay common stock dividends. Covenants in May 2005. The amendment extendedour debt facilities cap common stock
dividend payments at $300 million in a calendar year. For the termthree months ended
March 31, 2006, we paid $40 million in common stock dividends to CMS Energy.
Also, the provisions of the agreementFederal Power Act and the Natural Gas Act
effectively restrict dividends to 2010 and reduced certain fees and interest margins.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
September 30, 2005,March 31, 2006, capital lease obligations totaled $52$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 September 30, 2005,March 31, 2006, finance lease obligations totaled $273$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 currently sell certain accounts receivable to a wholly owned, consolidated,
bankruptcy remote special purpose entity. In turn, the special purpose entity
may sell an undivided interest in up to $325 million of the receivables. The
special purpose entity sold $100no receivables at March 31, 2006 and $325 million of
receivables as of
September 30, 2005 and $304 million of receivables as ofat December 31, 2004.2005. 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 notneither recorded a gain or loss on the
receivables sold ornor retained interest in the receivables sold.
CE-46
Consumers Energy Company
Certain cash flows under our accounts receivable sales program are shown in the
following table:
In Millions
---------------
Nine----------------------
Three months ended September 30March 31 2006 2005
2004
- ------------------------------ ------ --------------------------------- ------- -------
Net cash flow as a result of accounts receivable financing $ (204)(325) $ (247)(304)
Collections from customers $3,782 $3,542
====== ======$1,817 $ 1,592
DIVIDEND RESTRICTIONS: Under the provisions of our articles of incorporation, at
September 30, 2005, we had $163 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 nine
months ended September 30, 2005, we paid $207 million in common stock dividends
to CMS Energy.
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 initial recognition and measurement provision of this
Interpretation does not apply to some guarantee contracts, such as product
warranties, derivatives, or guarantees between corporations under common
control, although disclosure of these guarantees is required.
The following table describes our guarantees at September 30, 2005:
In Millions
-------------
Issue Expiration Maximum Carrying Recourse
Guarantee Description Date Date Obligation Amount Provision (a)
- --------------------- -------- ---------- ---------- -------- -------------
Standby letters of credit Various Various $ 31 $ - $ -
Surety bonds Various Various 6 - -
Performance guarantee Jan 1987 Mar 2015 85 - -
Nuclear insurance retrospective premiums Various Various 135 - -
======= ======= ==== === ===
(a) Recourse provision indicates the approximate recovery from third parties
including assets held as collateral.
CE-47
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
Nuclear plant closure Nonperformance
Surety bonds Normal operating activity, permits and Nonperformance
license
Performance guarantee Agreement to provide power and steam Termination of the Steam and Electric Power
to Dow Agreement by Dow due to MCV's nonperformance
Nuclear insurance retrospective Normal operations of nuclear plants Call by NEIL and Price-Anderson Act for nuclear
premiums incident
In the ordinary course of business, we enter into agreements containing
indemnification provisions in connection with a variety of transactions
including financing agreements. While we cannot estimate our maximum exposure
under these indemnities, we consider the probability of liability remote.
5:4: 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-48CE-40
Consumers Energy Company
The cost and fair value of our long-term financial instruments are as follows:
In Millions
-------------------------------------------------------------
September 30, 2005--------------------------------------------------------------------------------
March 31, 2006 December 31, 2004
----------------------------- -----------------------------2005
------------------------------------- -------------------------------------
Fair Unrealized Fair Unrealized
Cost Value Gain (Loss) Cost Value Gain (Loss)
------ ------ ----------- ------ ------ -----------
Long-term debt,
$4,395 $4,455 $(60) $4,118 $4,232 $(114)
including current amounts $4,382 $4,304 $ 78 $4,388 $4,393 $ (5)
Long-term debt - related parties,
including current amounts - - - 129 132 (3) 506 518 (12)131 (2)
Available-for-sale securities:
Common stock of CMS Energy 10 37 2729 19 10 25 1533 23
SERP:
Equity securities 16 23 7 16 22 6 15 21 6
Debt securities 8 7 (1) 8 - 9 98 -
Nuclear decommissioning investments:
Equity securities 135136 261 125 134 252 117 136 262 126118
Debt securities 288 293 5301 301 - 287 291 302 11
====== ====== ==== ====== ====== =====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
1)both:
- an executive oversight committee consisting of senior management
representatives, and
2)- a risk committee consisting of business-unitbusiness unit managers.
Our intention is that any gainsincreases or losses ondecreases in the value of these contracts
will be offset by an opposite movementchange in the value of the item at risk. We enter
into all of these contracts for purposes other than trading.
TheseThe contracts contain credit risk if the counterparties, including financial
institutions and energy marketers, fail to perform under the agreements. We
reduce this risk through established credit policies, which include performing
financial credit reviews of our counterparties. Determination of our
counterparties' credit quality is based upon a number of factors, including
credit ratings, disclosed financial condition, and collateral requirements.
Where contractual terms permit, we use standard agreements that allow us to net
positive and negative exposures associated with the same counterparty. Based on
these policies and our current exposures, we do not expect a material adverse
effect on our financial position or earnings as a result of counterparty
nonperformance.
Contracts used 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 accounted for as a derivative, instrument, it is recorded on the balance sheet as an asset or a liability, at its
fair value. The value recorded isWe then adjusted quarterlyadjust 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 Other Comprehensive Income;accumulated other comprehensive income; otherwise, the changes are reported
in earnings.
CE-49
Consumers Energy Company
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 Other Comprehensive Income,accumulated other comprehensive income, those gains andor
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 as of such date recorded in Accumulatedaccumulated 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 recordedthen reclassified to earnings when the
forecasted transaction affects earnings. The ineffective portion, if any, of all
hedges is recognized in earnings.
We use quoted market prices, prices obtained from external sources (i.e.,
brokers and banks), and mathematical valuation models toTo 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. For some derivatives, the time period of the contracts
may extend longer than the time periods for which market quotations for such
contracts are available. Thus, in order to calculate fair value, mathematicalThese models are developed to determinerequire various inputs
into the calculation,and assumptions, including pricecommodity market prices and other variables. Cashvolatilities, as well as
interest rates and contract maturity dates. The cash returns we actually realized fromrealize
on these commitmentscontracts may vary, either positively or negatively, from the results
estimated by
applying mathematicalthat we estimate using these models. As part of determining the fair value ofvaluing our derivatives at
market, we maintain reserves, if necessary, for credit risks based onarising from the
financial condition of counterparties.
The majority of our commodity purchase orand sale contracts are not subject to
derivative accounting under SFAS No. 133 because 1)because:
- they do not have a notional amount identified(that is, a number of units
specified in the contract, 2)a derivative instrument, such as MW of electricity or
bcf of natural gas),
- they qualify for the normal purchases and sales exception, or
3)- 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 that we purchase. Similarly, our electric capacity and energy
contracts are not derivatives due to the lack of an active energy market in
Michigan and
the significant transportation costs that would be incurred to deliver the power
to the closest active energy market (the Cinergy hub in Ohio).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 to our financial statements.material. For our electric
capacity and energy contracts, we believe that we willwould be able to apply the
normal purchases and sales exception, and, therefore, willwould not be required to
mark these contracts to market.
TheIn 2005, the MISO began operating the Midwest Energy Market on April 1, 2005. Through
operation ofMarket. As a result, the
Midwest Energy Market, 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 commencementestablishment of this market does
not constituterepresent the development of an active energy market in Michigan, as defined
by SFAS No.133.No. 133. However, as the Midwest Energy Market matures, we will continue
to monitor its activity level and evaluate the potential forwhether or not an active energy
market may exist in Michigan.
CE-50CE-42
Consumers Energy Company
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
------------------------------------------------------
September 30, 2005-------------------------------------------------------------------------
March 31, 2006 December 31, 2004
------------------------- --------------------------2005
-------------------------------- -------------------------------
Fair Unrealized Fair Unrealized
Derivative Instruments Cost Value Gain Cost Value Gain (Loss)
- ---------------------- ---- ----- -------------- ---- ----- -----------
Gas supply option contracts $2$- $ 6- $ 4 $2 $-- $1 $ (1) $ (2)
FTRs - 1 1 - - - 1 1
Derivative contracts associated with the MCV
Partnership:
Long-term gas contracts (a) - 298 29893 93 - 56 56205 205
Gas futures, options, and swaps (a) - 297 297144 144 - 64 64223 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 is included 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. TheAs 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 as part ofliability.
FTRs: With the GCR process. At September 30, 2005,
we had purchased fixed-priced weather-based gas supply call options and had sold
fixed-priced gas supply put options. We had not purchased any fixed-priced gas
supply call options.
FTRS: As partestablishment 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 as fuel for generation,it needs to generate electricity and to manage gas fuel costs.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 are not recognized at fair value on our Consolidated Balance Sheets at September 30, 2005.March 31, 2006.
The MCV Partnership also heldholds certain long-term gas contracts that diddo not
qualify as normal purchases at September 30, 2005, because these contracts containedcontain volume optionality.
In addition, as a result of implementing the RCP in January 2005, a significant portion
of long-term gas contracts no longer qualify as normal purchases, because the
gas will not be consumed as fuel for
electric production.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 ninethree months ended September 30, 2005,March 31, 2006, we recorded
a $242$111 million gainloss, before considering tax effects and minority interest,
associated with the increasedecrease in fair value of these long-term gas contracts.
This gainloss is included in the total Fuel costs mark-to-market at MCV on our
Consolidated Statements of Income. As a result of mark-to-market gains, we have
recorded derivative assets totaling $298 million associated with the fair value
of long-term gas contracts on our Consolidated Balance Sheets. 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.
The majorityCE-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 derivative assets, are expectedwhich represent cumulative net
mark-to-market gains, to reverse as losses through earnings during 20052006 and 20062007
as the gas is purchased, with the remainder reversing CE-51
Consumers Energy Company
between 20072008 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 3,2, Contingencies, "Other Electric
Contingencies - The Midland Cogeneration Venture."
Gas Futures, Options, and Swaps: The MCV Partnership enters into natural gas
futures, contracts, option contracts,options, and over-the-counter swap transactions in order to hedge
against unfavorable changes in the market price of natural gas in future
months when gas is expected to be needed. Thesegas. The MCV
Partnership uses these financial instruments are used
principally to secure anticipated natural gas requirements necessary for
projected electric and steam sales, and to lock in sales pricesto:
- ensure an adequate supply of natural gas previously obtained in order to optimizefor the MCV Partnership's existing gas
supply, storage,projected
generation and transportation arrangements. At September 30, 2005, the MCV
Partnership only held natural gas futures and swaps.
The contracts that are used to secure anticipated natural gas requirements
necessary for projected electricsales of electricity and steam, sales qualify as cash flow hedges
under SFAS No. 133. There was no ineffectiveness associated with any of these
cash flow hedges. At September 30, 2005, we have recorded a cumulative net gain
of $57 million, net of tax, in Accumulated other comprehensive income relating
to our proportionate share of the cash flow hedges held by the MCV Partnership.
This balance represents natural gas futures, options, and
swaps with maturities
ranging from October 2005 to December 2009, of which $15 million of this gain,
net of tax, is expected to be reclassified as an increase to earnings during the
next 12 months as the contracts settle, offsetting the costs of gas purchases.
The MCV Partnership also holds natural gas futures and swap contracts to- 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, thesethe futures and swap contracts were accounted for as
cash flow hedges. Since the RCP was implemented in January 2005, these instruments no
longer qualify for cash flow hedge accounting and we record any changes in their
fair value have been recorded in earnings each quarter. For the ninethree months ended September 30, 2005,March 31, 2006,
we recorded a $125$45 million gainloss, before considering tax effects and minority
interest, associated with the increasedecrease in fair value of these instruments. This
gainloss is included in the total Fuel costs mark-to-market at MCV on our
Consolidated Statements of Income. As a result of mark-to-market gains,
we have recorded derivative assets totaling $125 million associated with the
fair value of these instruments on our Consolidated Balance Sheets, which is
included in the Gas futures and swaps amount in the Derivative Instruments table
above. 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. The majorityWe expect
almost all of these derivative assets are
expectedfutures, options, and swap contracts to be realized during
2005 and 2006 as the futures and swap contracts settle, with the remainder to be realized during 2007. For
further details on the RCP, see Note 3,2, Contingencies, "Other Electric
Contingencies - The Midland Cogeneration Venture."
The MCV Partnership also engages in cost mitigation activitiesCREDIT RISK: Our swaps and forward contracts contain credit risk, which is the
risk that counterparties will fail to offset fixed
charges incurred in operating the MCV Facility. These cost mitigation activities
may include the use of futuresperform 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 options contracts to purchase and/or sell
natural gas to maximize the use of the transportation and storage contracts when
it is determined that they will not be needed for the MCV Facility operation.
Although these cost mitigation activities do serve to offset the fixed monthly
charges, these activities are not considered a normal course of business for the
MCV Partnership and do not qualify as hedges. Therefore, the mark-to-market
gains and losses from these cost mitigation activities are recorded in earnings
each quarter. For the nine months ended September 30, 2005, we recorded a $4
million loss associated with the decrease in fair value of futures used in these
cost mitigation activities.
CE-52other
CE-44
Consumers Energy Company
6: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 after June 30,between July
1, 2003 and August 31, 2005,
- a defined company contribution planDCCP for employees hired on or after September 1, 2005,
- benefits to certain management employees under SERP,
- a defined contribution 401(k) plan,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.
On September 1, 2005, we implementedEffective January 11, 2006, the Defined Company Contribution Plan. The
Defined Company Contribution Plan provides an employer cash contributionMPSC electric rate order authorized us to
include $33 million of 5
percent of base payelectric pension expense in our electric rates. Due to
the existing Employees' Savings Plan. No employee
contribution is requiredvolatility of these particular costs, the order also established a pension
equalization mechanism to receivetrack actual costs. If actual pension expenses are
greater than the plan's employer contribution. All
employees hired on$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 after September 1, 2005 participaterefunded to our
customers. The difference between pension expense allowed in this plan as partour electric rates
and pension expense under SFAS No. 87, resulted in a $3 million net reduction in
pension expense and establishment of their retirement benefit program. Cash balance pension plan participants also
participate in the Defined Company Contribution Plan on September 1, 2005.
Additional pay credits under the cash balance pension plan were discontinued as
of that date. The Defined Company Contribution Plan costa corresponding regulatory asset for the
ninethree months ended September 30, 2005 wasending 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.
On January 1, 2005, we resumed the employer's matchmillion net reduction
in CMS Energy Stock on our
401(k) Savings Plan. On September 1, 2005, employees enrolled in the company's
401(k) Savings Plan had their employer match increased from 50 percent to 60
percent on eligible contributions up to the first six percentOPEB expense and establishment of an employee's
wages. The total 401(k) Savings Plan costa corresponding regulatory asset for the
ninethree months ended September
30, 2005 was $9 million.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 was
signed into law in December 2003. The Act establishes a prescription drug
benefit under Medicare (Medicare Part D), and a federal subsidy, which is
tax-exempt, to sponsors of retiree health care benefit plans that provide a
benefit that is actuarially equivalent to Medicare Part D. We believe our plan
is actuarially equivalent to Medicare Part D.
CE-53
Consumers Energy Companyending March 31, 2006.
Costs: The following table recaps the costs incurred in our retirement benefits
plans:
In Millions
----------------------------------------------------------------------------------
Pension --------------------------------------
SEPTEMBER 30OPEB
----------------- ------------------
Three Months Ended Nine Months EndedMarch 31 2006 2005 2006 2005
- ------------ ------------------ -----------------
2005 2004 2005 2004
---- ---- ---- ------------------------------- ----- ----- ----- -----
Service cost $12 $ 9 $ 106 $ 32 $ 295
Interest expense 19 18 16 15 17 60 53
Expected return on plan assets (17) (26) (75) (80)(20) (23) (14) (13)
Amortization of:
Net loss 11 3 25 10 7 5 5
Prior service cost 2 1 1 4 4
---- ---- ---- ----(3) (2)
--- --- --- ---
Net periodic pension cost $ 19 $ 5 $ 46 $ 16
==== ==== ==== ====
In Millions
--------------------------------------
OPEB
--------------------------------------
SEPTEMBER 30 Three Months Ended Nine Months Ended23 12 10 10
Regulatory adjustment (3) - ------------ ------------------ -----------------
2005 2004 2005 2004
---- ---- ---- ----
Service cost $ 7 $ 4 $ 17 $ 13
Interest expense 15 14 45 41
Expected return on plan assets (14) (11) (40) (34)
Amortization of:
Net loss 5 3 15 9
Prior service cost (3) (2) (7) (6)
---- ---- ---- ----- -
--- --- --- ---
Net periodic postretirement
benefit cost $ 10 $ 8 $ 30 $ 23
==== ==== ==== ====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 ninethree
months ended September 30,March 31, 2006 and 2005 was less than $1 million.
We remeasured our Pension and OPEB obligations as of April 30, 2005 to
incorporate the effects of the collective bargaining agreement reached between
the Utility Workers Union of America and Consumers. The Pension plan
remeasurement increased our ABO by $127 million. Net periodic pension cost is
expected to increase $12 million for 2005.
The Pension plan remeasurement resulted in an unfunded ABO of $208 million. The
unfunded ABO is the amount by which the ABO exceeds the fair value of the plan
assets. SFAS No. 87 states that the pension liability shown on the balance sheet
must be at least equal to the unfunded ABO. As such, we increased our additional
minimum liability by $129 million to $521 million at June 30, 2005. Consistent
with MPSC guidance, we recognized the cost of our minimum pension liability
adjustment as a regulatory asset. This adjustment increased our regulatory
assets by $94 million and intangible assets by $35 million.
The OPEB plan remeasurement increased our accumulated postretirement benefit
obligation by $41 million, with an expected total increase in benefit costs of
$2 million for 2005.
CE-54CE-46
Consumers Energy Company
7:6: 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. As
required by SFAS No. 71, we accounted for the implementation of this standard by
recording regulatory assets and liabilities instead of a cumulative effect of a
change in accounting principle.
The fair value of ARO liabilities has been calculated using an expected present
value technique. This technique reflects assumptions such as costs, inflation,
and profit margin that third parties would consider to assume the settlement of
the obligation. Fair value, to the extent possible, should include a market risk
premium for unforeseeable circumstances. No market risk premium was included in
our ARO fair value estimate since a reasonable estimate could not be made. If a
five percent market risk premium were assumed, our ARO liability would increase
by $22$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.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 are based oninclude 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:
September 30, 2005March 31, 2006 In Millions
------------ ---------------------------------------------------------------------------------------------------------------------------
In Service Trust
ARO Description Date Long Lived Assets Fund
- --------------- -------------- ----------------- ---------
Palisades - decommission plant site 1972 Palisades nuclear plant $537$554
Big Rock - decommission plant site 1962 Big Rock nuclear plant 1822
JHCampbell intake/discharge water line 1980 Plant intake/discharge water line 1980 Plant intake/discharge water line-
Closure of coal ash disposal areas Various Generating plants coal ash areas -
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 storage fields -
Indoor gas services equipment relocations Various Gas meters located inside structures -
Asbestos abatement 1973 Electric and gas utility plant -
CE-55CE-47
Consumers Energy Company
In Millions
-----------------------------------------------------------------------------------------------------
ARO ARO
Liability Cash flow Liability
ARO Description 12/31/0405 Incurred Settled Accretion Revisions 9/30/053/31/06
- --------------- ----------------- -------- ------- --------- --------- ----------------
Palisades - decommission $350$375 $ - $- $6 $ - $19 $ - $369$381
Big Rock - decommission 3027 - (33) 11(4) 1 - 824
JHCampbell intake line - - - - - -
Coal ash disposal areas 54 - (3) 4- 1 - 55
Wells at gas storage fields 1 - - - - 1
Indoor gas services relocations 1 - - - - 1
---- ---Asbestos abatement 36 - (2) - - 34
---- --- --- -- --- ----
Total $436$494 $ - $(36) $34$(6) $8 $ - $434
==== ===$496
==== === === == === ====
OnIn October 14, 2004, the MPSC initiated a generic proceeding to review SFAS No. 143,
FERC Order No. 631, (Accounting,Accounting, Financial Reporting, and Rate Filing
Requirements for Asset Retirement Obligations),Obligations, and related accounting and
ratemaking issues for MPSC-jurisdictional electric and gas utilities. Utilities
filed responses toOn
December 5, 2005, the Order in March 2005; the MPSC Staff and intervenors filed
responses in May 2005;ALJ issued a proposal for decision is expected in December 2005.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 as involving 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 Nine Months Ended
------------------ -----------------
September 30March 31 2006 2005
2004 2005 2004
- ------------ --------------------------------- ---- ----- -----------
Operating revenue
Electric $ 794 $704 $2,071 $1,947$729 $628
Gas 219 171 1,566 1,3761,041 992
Other 12 10 36 32
------ ---- ------ ------12
------- -------
Total Operating Revenue $1,025 $885 $3,673 $3,355
====== ==== ====== ======$ 1,782 $ 1,632
======= =======
Net income (loss) available to common stockholder
Electric $ 62 $ 49 $ 141 $ 12429 $33
Gas (16) (11) 39 4637 58
Other (322) (4) (267) (9)
------ ---- ------ ------(56) 66
------- -------
Total Net (Loss) Income Available to Common Stockholder $ (276)10 $ 34 $ (87) $ 161
====== ==== ====== ======157
======= =======
CE-56CE-50
Consumers Energy Company
In Millions
--------------------------------------
September 30, 2005----------------------------------------
March 31, 2006 December 31, 2004
------------------2005
-------------- -----------------
Assets
Electric (a) $ 7,5847,864 $ 7,2897,743
Gas (a) 3,650 3,1873,193 3,600
Other 1,827 2,335
------- -------1,886 1,814
-------- --------
Total Assets $13,061 $12,811
======= =======$ 12,943 $ 13,157
======== ========
(a) Amounts include a portion of our other common assets attributable to both
the electric and gas utility businesses.
9: CONSOLIDATION OF VARIABLE INTEREST ENTITIES
We are the primary beneficiary of both the MCV Partnership and the FMLP. We have
a 49 percent partnership interest in the MCV Partnership and a 46.4 percent
partnership interest in the FMLP. Consumers is the primary purchaser of power
from the MCV Partnership through a long-term power purchase agreement. The FMLP
holds a 75.5 percent lessor interest in the MCV Facility, which results in
Consumers holding a 35 percent lessor interest in the MCV Facility.
Collectively, these interests make us the primary beneficiary of these entities.
Therefore, we consolidated these partnerships into our consolidated financial
statements for all periods presented. These partnerships have third-party
obligations totaling $480 million at September 30, 2005. Property, plant, and
equipment serving as collateral for these obligations has a carrying value of
$219 million at September 30, 2005. The creditors of these partnerships do not
have recourse to the general credit of Consumers.
10: NEW ACCOUNTING STANDARDS NOT YET EFFECTIVE
SFAS NO. 123R, SHARE-BASED PAYMENT: This Statement 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 amount over the vesting period of
the awards. This Statement also clarifies and expands SFAS No. 123's guidance in
several areas, including measuring fair value, classifying an award as equity or
as a liability, and attributing compensation cost to reporting periods.
This Statement amends SFAS No. 95, Statement of Cash Flows, to require that
excess tax benefits related to the excess of the tax-deductible amount over the
compensation cost recognized be classified as cash inflows from financing
activities rather than as a reduction of taxes paid in operating activities.
Excess tax benefits are recorded as adjustments to additional paid-in capital.
This Statement is effective for us as of the beginning of 2006. We adopted the
fair value method of accounting for share-based awards effective December 2002.
Therefore, we do not expect this statement to have a significant impact on our
results of operations when it becomes effective.
FASB INTERPRETATION NO. 47, ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT
OBLIGATIONS: This Interpretation clarifies 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 that may or may not be
within the control of the entity. The obligation to perform the asset retirement
activity is unconditional even though uncertainty exists about the timing and
(or) method of settlement. Accordingly, an entity is required to recognize a
liability for the fair value of a conditional asset retirement obligation if the
fair value of the liability can
CE-57CE-51
Consumers Energy Company
be reasonably estimated. The fair value of a liability for the conditional asset
retirement obligation should be recognized when incurred. This Interpretation
also clarifies when an entity would have sufficient information to estimate
reasonably the fair value of an asset retirement obligation. For us, this
Interpretation is effective no later than December 31, 2005. We are in the
process of determining the impact this Interpretation will have on our financial
statements upon adoption.
CE-58page 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, asdue 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 the end of such period,remediation, its disclosure controls and procedures are
effective.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: ThereExcept 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, 2004.2005. Reference is also made to the Condensed Notes to the Consolidated
Financial Statements, in particular, Note 3,2, Contingencies, for CMS Energy and
Note 3,2, Contingencies, for Consumers, included herein for additional information
regarding various pending administrative and judicial proceedings involving
rate, operating, regulatory and environmental matters.
CO-1
CMS ENERGY
SEC REQUEST
On August 5, 2004, CMS Energy received a request from the SEC that CMS Energy
voluntarily produce all documents and data relating to the SEC's inquiry into
payments made to the 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. OnThe SEC
subsequently issued a formal order of private investigation on this matter on
August 1, 2005,2005. 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.
SETTLEMENT OF DEMAND FOR ACTION AGAINST OFFICERS AND DIRECTORS
In May 2002, the Board of Directors of CMS Energy received a demand, on behalf
of a shareholder of CMS Energy Common Stock, that it commence civil actions (i)
to remedy alleged breaches of fiduciary duties by certain CMS Energy officers
and directors in connection with round-trip trading by CMS MST, and (ii) to
recover damages sustained by CMS Energy as a result of alleged insider trades
alleged to have been made by certain current and former officers of CMS Energy
and its subsidiaries. In December 2002, two new directors were appointed to the
Board. The Board formed a special litigation committee in January 2003 to
determine whether it was in CMS Energy's best interest to bring the action
demanded by the shareholder. The disinterested members of the Board appointed
the two new directors to serve on the special litigation committee.
In December 2003, during the continuing review by the special litigation
committee, CMS Energy was served with a derivative complaint filed by the
shareholder on behalf of CMS Energy in the Circuit Court of Jackson County,
Michigan in furtherance of his demands.
On July 7, 2005, CMS Energy filed with the court a Stipulation of Settlement
that was signed by all parties as well as the special litigation committee. The
judge entered the Final Order and Judgment on August 26, 2005. Pursuant to the
terms of the settlement, on September 5, 2005, CMS Energy received $12 million
from its insurance carriers under its directors and officers liability insurance
program, $7 million of which will be used to pay any reasonable settlement,
judgment or other costs associated with the securities class action lawsuits.
CMS Energy may use the remaining $5 million to pay attorneys' fees and expenses
arising out of the derivative proceeding.
GAS INDEX PRICE REPORTING LITIGATION
In August 2003, Cornerstone Propane Partners, L.P. (Cornerstone) filedOn 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 putativeconsolidated class
action complaintlawsuit filed in the United States District Court for the Southern
District of New York against CMS EnergyYork. Cornerstone Propane Partners, L.P. filed the original
complaint in August 2003 as a putative class action and dozens of other energy
companies. The Cornerstone complaintit was subsequentlylater
consolidated with two similar complaints filed by other plaintiffs. The plaintiffs filed aamended
consolidated complaint, onfiled in January 20, 2004. The consolidated complaint alleges2004, alleged that false natural gas
price reporting by the defendants manipulated the prices of NYMEX natural gas
futures and options. The complaint containscontained two counts under the Commodity
Exchange Act, one for manipulation and one for aiding and abetting violations.
On September 30, 2005,The settlement agreement among the court entered an order granting
plaintiffs' motion for class certification.
CO-2
Plaintiffs are seeking to have the class recover actual damages and costs,
including attorneys fees. CMS Energy is no longer a defendant, however,plaintiffs, CMS MST and CMS Field Services
are namedrequires 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 defendants. (CMS Energy sold CMS Field
Serviceswell as any legal fees awarded to Cantera Natural Gas, LLC, which changed the name of CMS Field
Services to Cantera Gas Company.plaintiffs' attorneys. CMS Energy
is required to indemnify Cantera
Natural Gas, LLC with respect toestablished a reserve for this action.)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.
CO-3
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. DefendantsOn August 10, 2005, certain
defendants, including CMS MST, filed a motion to stay
proceedings pending resolutiondismiss 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 and plaintiffs have filedthe case to Kansas state court. On January
23, 2006, a response, objecting to defendants' motion. The parties are considering further
extendingconditional transfer order transferring the time to answer or otherwise respondcase to the complaint until afterMDL
proceeding was issued. On February 7, 2006, plaintiffs filed an opposition to
the motion to remand is decided.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,
including but not limited to Consumers which, while established, operated and
regulated as a separate legal entity and publicly traded company, shares a
parallel Board of Directors with CMS Energy. The complaints were filed as
purported class actions in the United States District Court for the Eastern
District of Michigan, by shareholders who allege that they purchased CMS
Energy's securities during a purported class period running from May 2000
through March 2003.affiliates.
The cases were consolidated into a single lawsuit. The
consolidated 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 was
granted dismissingto dismiss
Consumers and three of the individual defendants, but the
court denied the motions to
dismiss for CMS Energy and the 13 remaining individual defendants. Plaintiffs filed a motion for class certification on
April 15, 2005The court issued
an opinion and anorder dated March 24, 2006, granting in part and denying in part
plaintiffs' amended motion for class certification on June 20, 2005.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.
CO-4
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 and Incentive Plan (the Plan). The two cases, filed in July 2002 in
United States District Court for the Eastern District of Michigan, were
consolidated by the trial judge and an amended consolidated complaint was filed. Plaintiffs allege breaches of fiduciary
duties under ERISA and seek restitution on behalf of the Plan with respect to a
decline in value of the shares of CMS Energy Common Stock held in the Plan. Plaintiffs also seekPlan, as
well as other equitable relief and legal fees. InOn March 2004, the judge granted in part, but denied in
part, CMS Energy's motion to dismiss the complaint. The judge has conditionally
granted plaintiffs' motion for class certification. A trial date has not been
set, but is expected to be no earlier than mid-2006.1, 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 defend themselves vigorously in this litigation but cannot predict its
outcome.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 20062007 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 19,
2005.15,
2006. In any event if CMS Energy has not received written notice of any matter
to be proposed at that meeting by March 4, 2006,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.
CO-5
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-6CO-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: November 1, 2005May 3, 2006 By: /s/ Thomas J. Webb
----------------------------------------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
CONSUMERS ENERGY COMPANY
(Registrant)
Dated: November 1, 2005May 3, 2006 By: /s/ Thomas J. Webb
----------------------------------------------------------------
Thomas J. Webb
Executive Vice President and
Chief Financial Officer
CO-7CO-8
CMS ENERGY AND CONSUMERS EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
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