FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 [ X ]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1997 OR [ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission Registrant; State of Incorporation; IRS Employer File Number Address; and Telephone Number Identification No. - ----------- ---------------------------------- ---------- 1-9513 CMS ENERGY CORPORATION 38-2726431 (A Michigan Corporation) Fairlane Plaza South, Suite 1100 330 Town Center Drive Dearborn, Michigan 48126 (313)436-9200 1-5611 CONSUMERS ENERGY COMPANY 38-0442310 (A Michigan Corporation) 212 West Michigan Avenue Jackson, Michigan 49201 (517)788-0550 Indicate by check mark whether the Registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes X No --- --- Number of shares outstanding of each of the issuer's classes of common stock at July 31, 1997: CMS Energy Corporation: CMS Energy Common Stock, $.01 par value 96,034,916 CMS Energy Class G Common Stock, no par value 8,028,975 Consumers Energy Company, $10 par value, privately 84,108,789 held by CMS Energy
2 CMS Energy Corporation and Consumers Energy Company Quarterly reports on Form 10-Q to the Securities and Exchange Commission for the Quarter Ended June 30, 1997 This combined Form 10-Q is separately filed by CMS Energy Corporation and Consumers Energy Company. Information contained herein relating to each individual registrant is filed by such registrant on its own behalf. Accordingly, except for its subsidiaries, Consumers Energy Company makes no representation as to information relating to any other companies affiliated with CMS Energy Corporation. TABLE OF CONTENTS Page Glossary 3 PART I: CMS Energy Corporation Management's Discussion and Analysis 6 Consolidated Statements of Income 21 Consolidated Statements of Cash Flows 22 Consolidated Balance Sheets 23 Consolidated Statements of Common Stockholders' Equity 25 Condensed Notes to Consolidated Financial Statements 26 Report of Independent Public Accountants 36 Consumers Energy Company Management's Discussion and Analysis 37 Consolidated Statements of Income 49 Consolidated Statements of Cash Flows 50 Consolidated Balance Sheets 51 Consolidated Statements of Common Stockholder's Equity 53 Condensed Notes to Consolidated Financial Statements 54 Report of Independent Public Accountants 62 PART II: Item 1. Legal Proceedings 63 Item 4. Submission of Matters to a Vote of Security Holders 63 Item 6. Exhibits and Reports on Form 8-K 64 Signatures 66
3 GLOSSARY Certain terms used in the text and financial statements are defined below. ABATE . . . . . . . . . . . . . . Association of Businesses Advocating Tariff Equity ABB . . . . . . . . . . . . . . . ABB Energy Ventures, Inc. ALJ . . . . . . . . . . . . . . . Administrative Law Judge bcf . . . . . . . . . . . . . . . Billion cubic feet Big Rock. . . . . . . . . . . . . Big Rock Point nuclear power plant, owned by Consumers Board of Directors. . . . . . . . Board of Directors of CMS Energy Btu . . . . . . . . . . . . . . . British thermal unit Class G Common Stock. . . . . . . One of two classes of common stock of CMS Energy, no par value, which reflects the separate performance of the Consumers Gas Group Clean Air Act . . . . . . . . . . Federal Clean Air Act as amended on November 15, 1990 CMS Electric and Gas. . . . . . . CMS Electric and Gas Company, a subsidiary of Enterprises CMS Energy. . . . . . . . . . . . CMS Energy Corporation CMS Energy Common Stock . . . . . One of two classes of common stock of CMS Energy, par value $.01 per share CMS Gas Transmission. . . . . . . CMS Gas Transmission and Storage Company, a subsidiary of Enterprises CMS Generation. . . . . . . . . . CMS Generation Co., a subsidiary of Enterprises CMS Holdings. . . . . . . . . . . CMS Midland Holdings Company, a subsidiary of Consumers CMS Midland . . . . . . . . . . . CMS Midland Inc., a subsidiary of Consumers CMS MST . . . . . . . . . . . . . CMS Marketing, Services and Trading Company, a subsidiary of Enterprises CMS NOMECO. . . . . . . . . . . . CMS NOMECO Oil & Gas Co., a subsidiary of Enterprises Common Stock. . . . . . . . . . . CMS Energy Common Stock and Class G Common Stock Consumers . . . . . . . . . . . . Consumers Energy Company, a subsidiary of CMS Energy Consumers Gas Group . . . . . . . The gas distribution, storage and transportation businesses currently conducted by Consumers and Michigan Gas Storage Court of Appeals. . . . . . . . . Michigan Court of Appeals CTM . . . . . . . . . . . . . . . Centrales Termicas Mendoza, an indirect subsidiary of CMS Generation Detroit Edison. . . . . . . . . . The Detroit Edison Company Dow . . . . . . . . . . . . . . . The Dow Chemical Company EDEER S.A.. . . . . . . . . . . . Empresa Distribuidora de Electricidad de Entre Rios S. A., the electric distribution utility in Entre Rios Province, Argentina ENDESA. . . . . . . . . . . . . . Empresa Nacional de Electricidad S.A., Chile's largest electric generation and transmission company Enterprises . . . . . . . . . . . CMS Enterprises Company, a subsidiary of CMS Energy EPS . . . . . . . . . . . . . . . Earning per share FASB. . . . . . . . . . . . . . . Financial Accounting Standards Board FERC. . . . . . . . . . . . . . . Federal Energy Regulatory Commission FMLP. . . . . . . . . . . . . . . First Midland Limited Partnership GCR . . . . . . . . . . . . . . . Gas cost recovery GTNs. . . . . . . . . . . . . . . CMS Energy General Term Notes, $250 million Series A, $125 million Series B and $150 million Series C GVK . . . . . . . . . . . . . . . GVK Industries, the owner of an independent power project in Jegurupadu, Andhra Pradesh, India in which CMS Generation owns 25.25% kWh . . . . . . . . . . . . . . . Kilowatt-hour Ludington . . . . . . . . . . . . Ludington pumped storage plant, jointly owned by Consumers and Detroit Edison MCV Facility. . . . . . . . . . . A natural gas-fueled, combined-cycle cogeneration facility operated by the MCV Partnership MCV Partnership . . . . . . . . . Midland Cogeneration Venture Limited Partnership MD&A. . . . . . . . . . . . . . . Management's Discussion and Analysis Michigan Gas Storage. . . . . . . Michigan Gas Storage Company, a subsidiary of Consumers MMBtu . . . . . . . . . . . . . . Million British thermal unit MPSC. . . . . . . . . . . . . . . Michigan Public Service Commission MW. . . . . . . . . . . . . . . . Megawatts NRC . . . . . . . . . . . . . . . Nuclear Regulatory Commission Order 888 and Order 889 . . . . . FERC final rules issued on April 24, 1996 Outstanding Shares. . . . . . . . Outstanding shares of Class G Common Stock Palisades . . . . . . . . . . . . Palisades nuclear power plant, owned by Consumers PPA . . . . . . . . . . . . . . . The Power Purchase Agreement between Consumers and the MCV Partnership with a 35-year term commencing in March 1990 PSCR. . . . . . . . . . . . . . . Power supply cost recovery PUHCA . . . . . . . . . . . . . . Public Utility Holding Company Act of 1935 Retained Interest . . . . . . . . The interest in the common stockholders' equity of the Consumers Gas Group that is retained by CMS Energy Retained Interest Shares. . . . . Authorized but unissued shares of Class G Common Stock not held by holders of the Outstanding Shares and attributable to the Retained Interest SEC . . . . . . . . . . . . . . . Securities and Exchange Commission Senior Credit Facilities. . . . . $1.125 billion senior credit facilities consisting of a $400 million 364-day revolving credit facility, $600 million three-year revolving credit facility and a five- year $125 million term loan facility. SFAS. . . . . . . . . . . . . . . Statement of Financial Accounting Standards Superfund . . . . . . . . . . . . Comprehensive Environmental Response, Compensation and Liability Act Terra . . . . . . . . . . . . . . Terra Energy Ltd., an oil and gas exploration and production subsidiary of CMS NOMECO TGN . . . . . . . . . . . . . . . Transportadora de Gas del Norte S. A., a natural gas pipeline located in Argentina (This page intentionally left blank)
6 CMS Energy Corporation Management's Discussion and Analysis The MD&A of this Form 10-Q should be read along with the MD&A in CMS Energy's 1996 Form 10-K. This report contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, including (without limitation) discussions as to expectations, beliefs, plans, objectives and future financial performance, or assumptions underlying or concerning matters discussed in this document. These discussions, and any other discussions contained in this Form 10-Q that are not historical facts, are forward-looking and, accordingly, involve estimates, assumptions and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. In addition to certain contingency matters (and their respective cautionary statements) discussed elsewhere, the Forward-Looking Information section of this MD&A indicates some important factors that could cause actual results or outcomes to differ materially from those addressed in the forward-looking discussions. CMS Energy is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Enterprises is engaged in several domestic and international energy-related businesses including: oil and gas exploration and production; acquisition, development and operation of independent power production facilities; storage, transmission and processing of natural gas; energy marketing, services and trading; and international energy distribution. Consolidated Earnings In Millions, Except Per Share Amounts June 30 1997 1996 Change Three months ended Consolidated Net Income $ 54 $ 50 $ 4 Net Income Attributable to Common Stocks: CMS Energy 52 49 3 Class G 2 1 1 Earnings Per Average Common Share: CMS Energy .55 .54 .01 Class G .16 .16 - Six months ended Consolidated Net Income $138 $138 $ - Net Income Attributable to Common Stocks: CMS Energy 127 125 2 Class G 11 13 (2) Earnings Per Average Common Share: CMS Energy 1.34 1.37 (.03) Class G 1.34 1.66 (.32) Twelve months ended Consolidated Net Income $240 $ 223 $ 17 Net Income Attributable to Common Stocks: CMS Energy 228 207 21 Class G 12 16 (4) Earnings Per Average Common Share: CMS Energy 2.42 2.28 .14 Class G 1.52 2.05 (.53) (a) Class G shares were issued on July 21, 1995. Proforma earnings per share, assuming Class G shares were outstanding during the entire twelve month period ended June 30, 1996, would be $1.96. The increase in earnings for the second quarter of 1997 compared to the same 1996 period reflects Consumers' increased electric sales and gas deliveries partially offset by Consumers' reduced gas wholesale services revenues in 1997. The second quarter of 1997 included recognition of an industry expertise service fee in connection with the Loy Yang A transaction, compared to the second quarter of 1996 which included a nonrecurring gain from the buyout of a power purchase agreement. Consolidated net income for the six months ended June 1997 was the same as the comparable period in 1996. The favorable impact of Consumers' electric rate increase received in February 1996, which benefited the entire first half of 1997, along with improved operating results from the MCV Facility in which Consumers has a 49 percent interest, were offset by Consumers' decreased gas deliveries due to warmer temperatures during the early part of 1997 and Consumers' reduced gas wholesale services revenues in 1997. Consolidated net income for 1997 included the industry expertise service fee, while 1996 had included a nonrecurring gain from the buyout of a power purchase agreement. The increase in earnings for the twelve months ended June 1997 compared to the same 1996 period reflects the favorable impact of Consumers' electric rate increase received in February 1996, revenues from gas services activities, and improved operating results from the MCV Facility. In addition, other operating income increased during the twelve months ended 1997 due to a FERC-ordered refund received by the MCV Partnership from a gas pipeline supplier, the industry expertise fee, and CMS Generation's gain on the sale of a partnership interest. Partially offsetting the increases for the twelve months ended period were decreased Consumers' electric revenues because of special contract discounts negotiated with large industrial customers, decreased Consumers' gas deliveries due to warmer temperatures during the first quarter of 1997, and a 1996 nonrecurring gain on the buyout of a power purchase agreement by a partnership in which CMS Generation owns a 50 percent interest. For further information, see the individual results of operations sections of this MD&A. Cash Position, Investing and Financing CMS Energy's primary ongoing source of operating cash is dividends from its subsidiaries. In the second quarter of 1997, Consumers paid a $70 million common dividend to CMS Energy. In July 1997, Consumers declared a $43 million common dividend to be paid in August 1997. In the first and second quarters of 1997, Enterprises paid common dividends and other distributions of $21 million and $93 million, respectively, to CMS Energy. Operating Activities: CMS Energy's consolidated operating cash requirements are met by its operating and financing activities. CMS Energy's consolidated cash from operations is derived mainly from Consumers' sale and transportation of natural gas, Consumers' generation, transmission, and sale of electricity, CMS NOMECO's sale of oil and natural gas, CMS Gas Transmission's transportation and storage of natural gas and CMS Generation's independent power production of electricity . Consolidated cash from operations totaled $381 million and $486 million for the first six months of 1997 and 1996, respectively. The $105 million decrease resulted from the timing of cash payments related to routine operations. CMS Energy uses its operating cash primarily to expand its international businesses, maintain and expand Consumers' electric and gas systems, retire portions of its long-term debt and pay dividends. Investing Activities: Net cash used in investing activities totaled $935 million and $430 million for the first six months of 1997 and 1996, respectively. The increase of $505 million primarily reflects an increase in capital expenditures and investments in partnerships and unconsolidated subsidiaries during 1997. CMS Energy's 1997 expenditures for its utility and international businesses were $165 million and $734 million, respectively. Financing Activities: Net cash provided by (used in) financing activities totaled $549 million and $(52) million for the first six months of 1997 and 1996, respectively. The increase of $601 in net cash resulted from the issuances of senior unsecured notes , Series C GTNs and convertible quarterly income preferred securities, and a reduction in the paydown of notes payable and bank loans for the first six months of 1997 compared to the first six months of 1996; which was partially offset by the retirement of bonds and other long term debt in 1997. In 1996, CMS Energy filed shelf registration statements with the SEC for the issuance and sale of up to $125 million of Series B GTNs and $150 million Series C GTNs, with net proceeds to be used for general corporate purposes. At June 30, 1997, CMS Energy had $224 million of Series A GTNs, $125 million of Series B GTNs and $87 million of Series C GTNs issued and outstanding with weighted-average interest rates of 7.7 percent, 7.9 percent and 8.0 percent, respectively. In 1996, CMS Energy filed a shelf registration statement with the SEC for the issuance and the sale of up to $500 million of senior and subordinated debt securities. In May 1997, CMS Energy issued $350 million of senior unsecured notes due May 15, 2002, at an interest rate of 8.125 percent. Proceeds were used in part to repay debt and in part to fund CMS Energy's equity investment in the 2,000 MW Loy Yang A electric generating plant and associated mine facilities in the State of Victoria, Australia. In May 1997, CMS Energy and affiliated business trusts filed a shelf registration statement with the SEC for the issuance and the sale of up to $300 million of CMS Energy Common Stock, subordinated debentures, stock purchase contracts, stock purchase units and preferred securities. In June 1997, 3,450,000 units of 7.75 percent convertible quarterly income preferred securities were issued and sold through CMS Energy Trust I, a business trust wholly owned by CMS Energy. Net proceeds from the sale totaled $173 million. CMS Energy Trust I was formed for the sole purpose of issuing quarterly income preferred securities. Its primary asset is approximately $178 million principal amount of 7.75 percent subordinated debentures issued by CMS Energy which mature in 2027. The trust preferred securities are convertible into shares of CMS Energy Common Stock at a rate equivalent to a conversion price of $40.80 per share. Proceeds of the subordinated debentures were used by CMS Energy for general corporate purposes including repayment of debt, capital expenditures, investment in subsidiaries and working capital. CMS Energy's obligations under the subordinated debentures, the indenture under which the subordinated debentures were issued, the declaration of trust and the CMS Energy guarantee provide, in the aggregate, a full irrevocable and unconditional guarantee of payments of distributions and other amounts due on the trust preferred securities. In February and May 1997, CMS Energy paid $52 million in cash dividends to holders of CMS Energy Common Stock and $4 million in cash dividends to holders of Class G Common Stock. In July 1997, the Board of Directors declared quarterly dividends of $.30 per share on CMS Energy Common Stock and $.31 per share on Class G Common Stock to be paid in August 1997, representing an increase in the annualized dividend on CMS Energy Common Stock to $1.20 per share from the previous amount of $1.08 per share (an 11.1 percent increase), and an increase in the annualized dividend on Class G Common Stock to $1.24 per share from the previous dividend of $1.18 per share (a 5.1 percent increase). Other Investing and Financing Matters: At June 30, 1997, CMS Energy had available unsecured, lines of credit and letters of credit totaling $155 million and a $450 million unsecured revolving credit facility. At June 30, 1997 and 1996, the total amount utilized under these facilities was $214 million and $233 million, respectively. In addition, CMS Energy had an unsecured $125 million term loan. On July 3, 1997 CMS Energy refinanced the unsecured revolving credit facility and the term loan with $1.125 billion in Senior Credit Facilities consisting of a $400 million 364-day revolving credit facility, $600 million three-year revolving credit facility and a five-year $125 million term loan facility. At July 31, 1997 the total amount utilized under the Senior Credit Facilities was $379 million and the amount utilized under the $155 million lines of credit and letters of credit was $31 million. Consumers had several unsecured, committed lines of credit totaling $120 million and a $425 million working capital facility available to meet short-term borrowing requirements to finance working capital and gas in storage, and to pay for capital expenditures between long-term financings. At June 30, 1997 and 1996, the total amount outstanding under these facilities was $241 million and $108 million, respectively. Consumers has FERC authorization to issue or guarantee up to $900 million of short-term securities through 1998 and to issue $500 million of long-term securities through November 1998 for refinancing or refunding purposes. An agreement is also in place permitting the sales of certain accounts receivable for up to $500 million. At June 30, 1997 and 1996, receivables sold totaled $266 million and $200 million, respectively. In August 1997, Consumers and an affiliated business trust, Consumers Energy Company Financing II, filed a registration statement with the SEC for the issuance and sale of up to $120 million of trust originated preferred securities. Consumers Energy Company Financing II was formed for the sole purpose of issuing trust originated preferred securities and investing the proceeds in subordinated notes which will be unsecured obligations of Consumers. Consumers will use the net proceeds from the sale of the subordinated notes to redeem, refinance or refund existing long-term securities, which may include first mortgage bonds, stocks, preferred securities or notes. In August 1997, Consumers announced that it will redeem all of the outstanding shares of its $7.45, $7.68, $7.72 and $7.76 preferred stock. This $119 million redemption of preferred stock will take place in September 1997. At June 30, 1997, the book value per share of CMS Energy Common Stock and Class G Common Stock was $17.99 and $12.16 respectively. Consumers' Electric Business Unit Results of Operations Electric Pretax Operating Income: In Millions Three Months Six Months Twelve Months Ended June 30 Ended June 30 Ended June 30 Change Compared to Prior Year 1997 vs 1996 1997 vs 1996 1997 vs 1996 Sales (including special contract discounts) $ 7 $ 4 $ (4) Rate increases and other regulatory issues 1 11 39 Operations and maintenance 2 (1) (7) General taxes and depreciation and other (2) (6) (8) ---- ---- ---- Total change $ 8 $ 8 $ 20 ==== ==== ==== Electric Sales: Total electric sales increased for the quarter ended (1.7 percent), six months ended (1.0 percent), and twelve months ended (2.7 percent) June 30, 1997, over the comparable 1996 periods. The table below reflects electric kWh sales by class of customer for each period: In Billions of kWh Three Months Ended Six Months Ended Twelve Months Ended June 30 1997 1996 Change 1997 1996 Change 1997 1996 Change Residential 2.5 2.4 0.1 5.3 5.4 (0.1) 10.9 11.0 (0.1) Commercial 2.5 2.4 0.1 4.9 4.8 0.1 10.1 9.8 0.3 Industrial 3.4 3.2 0.2 6.4 6.1 0.3 13.2 12.5 0.7 Other 0.6 0.9 (0.3) 1.4 1.6 (0.2) 3.0 2.9 0.1 ---- ---- ---- ---- ---- ---- ---- ---- ---- Total Sales 9.0 8.9 0.1 18.0 17.9 0.1 37.2 36.2 1.0 ==== ==== ==== ==== ==== ==== ==== ==== ==== Power Costs: In Millions June 30 1997 1996 Change Three months ended $ 270 $ 260 $ 10 Six months ended 552 520 32 Twelve months ended 1,119 1,028 91 The cost increases for all periods ended June 30, 1997, reflect greater power purchases from outside sources to meet the increased sales demand. Consumers' Electric Business Unit Issues Power Purchases from the MCV Partnership: Consumers' annual obligation to purchase capacity from the MCV Partnership is 1,240 MW through the termination of the PPA in 2025. The MPSC currently allows Consumers to recover substantially all payments for 915 MW of capacity purchased from the MCV Partnership. Beginning January 1, 1996, Consumers was also permitted to recover an average capacity charge of 2.86 cents per kWh for the remaining 325 MW of MCV Facility capacity. The approved average capacity charge increased to 3.62 cents per kWh for 109 MW by January 1, 1997. The recoverable portion of the capacity charge for the last 216 MW of the 325 MW increases each year until it reaches 3.62 cents per kWh in 2004, and remains at this ceiling rate through the end of the PPA term. In 1992, Consumers recognized a loss for the present value of the estimated future underrecoveries of power purchases from the MCV Partnership. Consumers anticipates it will continue to experience cash underrecoveries associated with the PPA as shown below. These after-tax cash underrecoveries were based on the assumption that the MCV Facility would be available to generate electricity 90 percent of the time. However, for the first six months of 1997 the MCV Facility has been available 98.9 percent of the time, resulting in after-tax cash underrecoveries of $20 million. The underrecovery shown in the table below for the year 1997 has been revised to reflect the anticipated availability of the MCV Facility. For further information, see Note 2. In Millions 1997 1998 1999 2000 2001 Estimated cash under- recoveries, net of tax $40 $23 $22 $21 $20 The amount of underrecoveries of power costs continues to be based, in part, on management's best assessment of the future availability of the MCV Facility. If the MCV Facility operates at levels above management's estimate over the remainder of the PPA, future losses will need to be recognized over and above amounts previously recorded and Consumers would experience greater amounts of cash underrecoveries than originally anticipated. Management will continue to evaluate the adequacy of the accrued liability considering actual facility operations. Electric Rate Proceedings: In 1996, the MPSC issued a final order which authorized Consumers to recover costs associated with the purchase of the additional 325 MW of MCV Facility capacity and to accelerate recovery of its nuclear plant investment by increasing prospective annual nuclear plant depreciation expense by $18 million with a corresponding decrease in fossil-fueled generating plant depreciation expense. It also established a direct access program. Rehearing petitions have been ruled upon by the MPSC and resulted in no material changes to the relief granted Consumers. For further discussion on these issues, see Notes 2 and 3. Nuclear Matters: In January 1997, the NRC issued its Systematic Assessment of Licensee Performance report for Palisades. The report rated all areas as good, unchanged from the previous assessment. Consumers is required to make certain calculations and report to the NRC about the continuing ability of the Palisades reactor vessel to withstand postulated pressurized thermal shock events during its remaining license life, in light of the embrittlement of reactor vessel materials over time due to operation in a radioactive environment. Based on continuing analysis of data from testing of similar materials, in 1996, Consumers received an interim Safety Evaluation Report from the NRC indicating that the reactor vessel can be safely operated through 2003, before reaching the NRC's screening criteria for reactor embrittlement. Consumers believes that with a change in fuel management designed to minimize embrittlement, Palisades can be operated to the end of its license life in the year 2007 without annealing of the reactor vessel, but will continue to monitor the matter. Palisades' on-site storage pool for spent nuclear fuel is at capacity. Consequently, NRC-approved dry casks, which are steel and concrete vaults, are being used for temporary on-site storage. For further information, see Note 8. Big Rock will close permanently on August 29, 1997, because management has determined that the plant would be uneconomical to operate in an increasingly competitive environment. The plant was originally scheduled to close May 31, 2000, at the end of the plant's operating license. Plant decommissioning will begin in September 1997 and is expected to take five to ten years to return the site to its original condition. The current decommissioning fund, together with future collections from customers and future earnings of the fund, is expected to be adequate to cover the plant decommissioning expenses. Electric Environmental Matters: The Clean Air Act contains significant environmental constraints under which industry will operate in the future. While certain of the Act's provisions specific to utilities will require that certain capital expenditures be made to comply with nitrogen oxide emission limits, Consumers' generating units are currently operating at or near the sulfur dioxide emission limits that will be effective in the year 2000. Management does not believe that these expenditures will have a material effect on annual operating costs. The Clean Air Act also contains national air quality standards under which industry must operate. Currently, Consumers operates within these standards and meets current ozone and small particle related emission limits. The Act requires the EPA to periodically review the effectiveness of these standards in preventing adverse health affects. The EPA recently revised these standards to increase the restrictions on small particle and ozone related emissions. CMS Energy and Consumers support the bi-partisan effort in Congress to delay implementation of the revised standards until the relationship between the new standards and health improvements is established. In addition, the EPA is reviewing recommendations from the Ozone Transport Assessment Group to reduce ozone transport across state lines. The EPA is expected to require the State of Michigan to impose additional nitrogen oxide reductions goals on Consumers' fossil-fueled generating units. The preliminary estimate of the cost of the changes Consumers may have to make to its fossil-fueled generating units to reduce ozone related emissions is approximately $175 million. A potentially equivalent amount may be needed to comply with the new small particle standards. Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, and believes that these costs are properly recoverable in rates under current ratemaking policies. Consumers is a so-called potentially responsible party at several sites being administered under Superfund. In addition, there are numerous credit worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on current information, management believes it is unlikely that the liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on CMS Energy's financial position, liquidity or results of operations. For further information regarding electric environmental matters, see Note 7. Stray Voltage: A number of lawsuits have been filed against Consumers relating to the effect of so-called stray voltage on certain livestock. As of June 30, 1997, 18 separate stray voltage lawsuits were awaiting trial court action, down from 22 lawsuits as reported at year end 1996. CMS Energy believes that the resolution of the remaining lawsuits will not have a material impact on its financial position, liquidity or results of operations. Consumers Gas Group Results of Operations Gas Pretax Operating Income: In Millions Three Months Six Months Twelve Months Change Compared Ended June 30 Ended June 30 Ended June 30 to Prior Year 1997 vs 1996 1997 vs 1996 1997 vs 1996 Sales $ 3 $(15) $(19) Recovery of gas costs and other issues - - (3) Gas wholesale and retail services activities (5) (7) 4 Operations and maintenance 5 10 4 General taxes, depreciation and other (3) (3) (3) ---- ---- ---- Total change $ - $(15) $(17) ==== ==== ==== Gas Deliveries: Total system deliveries, excluding transport to the MCV Facility and other miscellaneous transportation, increased 5.8 percent for the quarter ended June 30, 1997, but decreased 4.1 percent and 3.7 percent for the six months and twelve months ended June 30, 1997, respectively. The table below indicates total deliveries and the impact of weather. In bcf Three Six Twelve Months Ended Months Ended Months Ended June 30 1997 1996 Change 1997 1996 Change 1997 1996 Change Weather-adjusted deliveries (variance reflects growth) 52 52 - 198 198 - 334 332 2 Impact of weather and leap year 8 5 3 4 13 (9) 9 24 (15) -- -- -- --- --- --- --- --- --- System deliveries transport excluding to MCV Facility 60 57 3 202 211 (9) 343 356 (13) Transport to MCV Facility 14 16 (2) 32 33 (1) 64 60 4 Other Transportation 2 4 (2) 10 18 (8) 18 26 (8) -- -- -- --- --- --- --- --- --- Total deliveries 76 77 (1) 244 262 (18) 425 442 (17) == == == === === === === === === Cost of Gas Sold: In Millions June 30 1997 1996 Change Three months ended $118 $107 $ 11 Six months ended 432 453 (21) Twelve months ended 729 744 (15) The increase for the three months ended June 30, 1997, reflects increased gas sales and slightly higher prices for gas during 1997. The decreases for the six month and twelve month periods ended June 30, 1997, were the result of decreased sales reflecting warmer temperatures and an extra day for leap year in 1996. Consumers Gas Group Issues Gas Rate Proceedings: Consumers entered into a special natural gas transportation contract with one of its transportation customers in response to the customer's proposal to bypass Consumers' system in favor of a competitive alternative. The contract provides for discounted gas transportation rates in an effort to induce the customer to remain on Consumers' system. In 1995, the MPSC approved the contract but stated that the revenue shortfall created by the difference between the contract's discounted rate and the floor price of an MPSC-authorized gas transportation rate must be borne by Consumers' shareholders. In 1995, Consumers filed an appeal with the Court of Appeals, which is still pending, claiming that the MPSC decision denies Consumers the opportunity to earn its authorized rate of return and is therefore unconstitutional. GCR Matters: In 1995, the MPSC issued an order regarding a $44 million (excluding interest) gas supply contract pricing dispute between Consumers and certain intrastate producers. The order stated that Consumers was not obligated to seek prior approval of market-based pricing provisions that were implemented under the contracts in question. The producers subsequently filed a claim of appeal of the MPSC order with the Court of Appeals. Consumers believes the MPSC order correctly concludes that the producers' theories are without merit and will vigorously oppose any claims they may raise, but cannot predict the outcome of this issue. In the GCR reconciliation proceeding for the period April 1995 through March 1996, an issue has arisen questioning whether revenue from gas loaning (which was a new business activity for Consumers) should, in whole or in part, be immediately passed through to customers. The ALJ issued a proposal for decision in January 1997 that agreed with the MPSC staff's position that the gas loaning program uses storage assets of Consumers and therefore recommended that 90 percent of the revenue should be refunded to customers. If the MPSC adopts the ALJ position, $8 million as of June 30, 1997, would be subject to refund. Consumers has not provided a contingency reserve for this potential refund and will continue to oppose this view before the MPSC. Gas Environmental Matters: Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some that formerly housed manufactured gas plant facilities. Data available, and continued internal review of these former manufactured gas plant sites, have resulted in an estimate for all costs related to investigation and remedial action of between $48 million and $98 million. These estimates are based on undiscounted 1997 costs. At June 30, 1997, Consumers has accrued a liability for $48 million and has established a regulatory asset for approximately the same amount. Any significant change in assumptions such as remediation technique, nature and extent of contamination and regulatory requirements, could affect the estimate of remedial action costs for the sites. For further information regarding environmental matters, see Note 7. Oil and Gas Exploration and Production Pretax Operating Income: Pretax operating income for the three and six months ended June 30, 1997 increased $2 million over the comparable periods in 1996, as a result of higher oil production volumes offset by lower oil and gas prices and gas volumes, and higher operating expenses. Pretax operating income for the twelve months ended June 30, 1997 increased $15 million over the twelve months ended June 30, 1996, primarily due to higher sales volumes and oil sales prices and income attributable to the acquisition of Terra. Capital Expenditures: Capital expenditures for the six months ended June 30, 1997 include $13 million in the United States, $21 million in South America and $29 million in Africa. Independent Power Production Pretax Operating Income: Pretax operating income for the three months ended June 30, 1997 was $2 million less than the same period in 1996, primarily reflecting increased ongoing earnings and a $13 million industry expertise service fee in 1997 income, as compared to a $15 million 1996 nonrecurring gain resulting from the buyout of a power purchase agreement by a partnership in which CMS Generation owns a 50 percent interest . Pretax operating income for the six months ended June 30, 1997 was $2 million more than the same period in 1996, primarily reflecting increased operating income resulting from higher electricity sales by the MCV and the industry expertise service fee income in 1997, as compared to the 1996 nonrecurring gains, including the buyout of the power purchase agreement. Pretax operating income for the twelve months ended June 30, 1997 increased $17 million from the same period in 1996, primarily reflecting the industry expertise service fee, improved MCV Partnership earnings and increases in income from other equity investments as compared to the 1996 nonrecurring gains associated with the buyout of a power purchase agreement and a favorable litigation settlement. Capital Expenditures and Other: In the second quarter of 1997, CMS Generation closed financing of the La Plata Cogeneration Plant, a 128 MW natural gas-fueled, combined-cycle power plant currently under construction in Buenos Aires Province, Argentina. The $75 million, limited recourse, financing with the U.S. Overseas Private Investment Corporation is for a term of 12 years. The plant is being built on the site of a petroleum refinery owned and operated by YPF S.A., Argentina's largest oil company, and is scheduled to commence operation during the third quarter of 1997. In 1996, CMS Generation increased its ownership interest in the project from 39 percent to 100 percent by purchasing the remaining 61 percent from a consortium of Argentine investors. In 1996, CMS Generation and an affiliate of ABB signed an agreement with Morocco's national utility, Office National de l'Electricite, for the privatization, expansion and operation of the 1,320 MW Jorf Lasfar coal- fueled power plant located southwest of Casablanca. The agreement covers the purchase and operation of two existing 330 MW electric generating units and construction and operation of another two 330 MW electric generating units by CMS Generation and ABB. CMS Generation and ABB each will hold a 50 percent interest in the plant. CMS Energy posted a $30 million conditional letter of credit to ensure closing under the agreement, which is targeted for the third quarter of 1997 and includes over $1 billion in debt financing. Construction of the additional two units will begin shortly thereafter. In 1996, CMS Generation increased its ownership interest in CTM to 81 percent. In 1996, CTM began a project to repower its electric generating plant in Western Argentina's Mendoza Province. CMS Generation currently plans to invest $185 million to refurbish and repower the facility resulting in an increase in the plant's available net output from 243 MW to 506 MW. In the first quarter of 1997, the plant built by GVK began generating electricity from all three of its combustion turbines. CMS Generation operates the 235 MW plant under contract to GVK. Synchronization of the steam turbine generator of the combined-cycle facility was achieved in June 1997. GVK has received a Government of India counter-guarantee of performance of certain obligations under the power purchase agreement by the Andhra Pradesh State Electricity Board and completed financing in April 1997. As of January 1, 1997, Jamaica Private Power Company achieved commercial operation of the two diesel generators at its 60 MW diesel-fired independent power project in Kingston, Jamaica. CMS Generation, through a subsidiary, holds a 44 percent interest in Jamaica Private Power Company and a 50 percent interest in Private Power Operators Limited, which operates the plant. Construction on the balance of the plant, including the 4 MW waste heat steam turbine, will be complete in the last half of 1997. In the first quarter of 1997, CMS Generation acquired a 29.5 percent interest in a 48 MW oil-fueled plant in Cavite, on the island of Luzon in the Philippines. CMS Generation also completed the purchase of a further interest which increased its ultimate interest to 44 percent. CMS Generation has plans to increase the plant's generating capacity to 63 MW in 1998. In the first quarter of 1997, CMS Generation formed a joint venture with the Thailand-based EGCO Engineering & Services Company Limited, an affiliate of Electric Generating Authority of Thailand, the country's national electric utility, to operate and maintain private power plants in Thailand. The joint venture, known as CMESCO, signed a contract in July 1997 with Thailand's Amata-EGCO Power Limited, to operate and maintain a 170 MW gas-fired cogeneration plant. The combined-cycle power plant is now under construction, with completion scheduled in 1998. In the second quarter of 1997, a consortium comprised of subsidiaries of CMS Generation and Northern States Power as well as Horizon Energy Australia Investments acquired the Loy Yang A power plant, Victoria's largest electric generating plant and Australia's lowest-cost electric generating facility , in a privatization by the Australian State of Victoria. The assets include a 2,000 MW, brown coal-fueled plant and an associated coal mine supplying both the Loy Yang A and B plants. Seventy seven percent of the consortium's $3.7 billion payment to the government was financed on a non-recourse basis to CMS Energy and CMS Generation by a consortium of banks. CMS Generation holds a fifty percent ownership interest and Northern States Power and Horizon Energy Australia Investments each hold twenty five percent. Certain operating and management services for Loy Yang A will be provided by the CMS Generation and Northern States Power subsidiaries and their affiliates. Natural Gas Transmission, Storage and Processing Pretax Operating Income: Pretax operating income for the three months ended June 30, 1997 was $8 million, which was the same as in the 1996 period, primarily reflecting income attributable to the Australian pipeline acquired in 1997 offset by the 1996 gain resulting from the dissolution of the Moss Bluff and Grand Lacs Partnerships. Pretax operating income for the six months ended June 30, 1997 increased $3 million from the same period in 1996 reflecting new pipeline, storage and processing investments (including the Australian pipeline acquisition in 1997), continued growth of existing projects, and a gain on the sale of a portion of the Ames gas gathering system, partially offset by the 1996 gain resulting from the dissolution of the Moss Bluff and Grand Lacs Partnerships. Pretax operating income for the twelve months ended June 30, 1997 increased $8 million from the twelve months ended June 30, 1996, reflecting income attributable to the Australian pipeline acquisition, a gain on the sale of a portion of the Ames gas gathering system and continued growth of existing projects, primarily TGN. Capital Expenditures and Other: CMS Gas Transmission and ENDESA, Chile's largest electricity generation and transmission company, have undertaken an integrated $750 million project to construct a 930 kilometer pipeline and a 720 MW natural gas-fueled, combined cycle generating plant. The pipeline will transport natural gas across the Andes Mountains from northern Argentina to markets in northern Chile. The generating plant is planned to be built in two stages at the end of the pipeline in Chile by a consortium including Enterprises. Construction is scheduled to begin in the fourth quarter of 1997, with gas transportation and plant operations expected in the first quarter of 1999. In the first quarter of 1997, CMS Gas Transmission with Columbia Gas System, Inc., MCN Energy Group and Westcoast Energy announced a proposed $600 million pipeline project to carry up to 650 million cubic feet per day of natural gas to the state of New York and other northeastern markets. The Millennium Pipeline would provide a new, 400-mile link through a connection with the TransCanada pipeline system, flowing western Canadian and U.S. natural gas to northeastern markets. Construction is scheduled to begin mid-1999, and gas deliveries are planned to begin in time for the 1999 winter heating season. In the second quarter of 1997, CMS Gas Transmission acquired a 420- kilometer (260-mile) pipeline near Perth, Australia. Included in the acquisition were 30 bcf of proven natural gas reserves and an associated gas storage facility in pre-operational testing. The pipeline is capable of transporting 120 million cubic feet per day of natural gas to industrial gas users in Perth. Marketing, Services and Trading CMS MST was formed as part of CMS Energy's expansion and reorganization of its energy marketing business. This restructuring is expected to significantly improve CMS Energy's competitive position in the energy marketplace throughout the U.S. and abroad. CMS MST will provide gas, electric, oil and coal marketing, risk management and energy management services throughout the United States and eventually worldwide. Gas marketed for end users was 80 bcf and 58 bcf for the second quarter of 1997 and 1996, respectively. International Energy Distribution In 1996, a seven-company consortium in which CMS Electric and Gas holds a 40 percent interest, acquired 90 percent of the outstanding shares of EDEER S.A. for $160 million. EDEER S.A. serves over 200,000 electric customers, primarily residential and commercial, in a 55,000 square kilometer area. In 1996, the Entre Rios Province transferred ownership and operating management of EDEER S.A. to the consortium. As of June 30, 1997 year to date sales were 523,111 MW. Forward-Looking Information Forward-looking information is included throughout this Form 10-Q. Material contingencies are also described in the Condensed Notes to Consolidated Financial Statements and should be read accordingly. Some important factors that could cause actual results or outcomes to differ materially from those discussed in the forward-looking statements include prevailing domestic and foreign governmental policies and regulatory actions (including those of the FERC and the MPSC) with respect to rates, industry and rate structure, operation of nuclear power facilities, acquisition and disposal of assets and facilities, operation and construction of plant facilities, operation and construction of natural gas pipeline and storage facilities, recovery of the cost of purchased power or natural gas, decommissioning costs, and present or prospective wholesale and retail competition, among others. The business and profitability of CMS Energy are also influenced by economic and geographic factors, including political and economic risks (particularly those associated with international development and operations, including currency fluctuation), changes in environmental laws and policies, weather conditions, competition for retail and wholesale customers, pricing and transportation of commodities, market demand for energy, inflation, capital market conditions, unanticipated development project delays or changes in project costs, and the ability to secure agreement in pending negotiations (particularly for projects in development), among other important factors. All such factors are difficult to predict, contain uncertainties that may materially affect actual results, and may be beyond the control of CMS Energy. Capital Expenditures: CMS Energy estimates the following capital expenditures, including new lease commitments and investments in partnerships and unconsolidated subsidiaries, will total $3.6 billion over the next three years. Cash generated by operations is expected to satisfy a substantial portion of capital expenditures. Nevertheless, CMS Energy will continue to evaluate capital markets in 1997 as a potential source of financing its subsidiaries' investing activities. CMS Energy estimates capital expenditures by business segment over the next three years as follows: In Millions Years Ended December 31 1997 1998 1999 Consumers electric operations (a) $ 275 $ 285 $ 275 Consumers gas operations (a) 115 105 105 Oil and gas exploration and production 135 150 160 Independent power production (b) 750 314 124 Natural gas transmission and storage 108 170 81 International energy distribution 120 125 125 Marketing, services and trading 17 21 25 ------ ------ ------ $1,520 $1,170 $ 895 ====== ====== ====== (a) These amounts include an attributed portion of Consumers' anticipated capital expenditures for plant and equipment common to both the electric and gas businesses. (b) The 1997 amount includes approximately $500 million for the acquisition of a 50 percent ownership interest in the Loy Yang A electric generating plant in Australia. CMS Energy currently plans to invest $445 million from 1997 to 1999 in its oil and gas exploration and production operations, primarily in North and South America, offshore West Africa and North Africa. CMS Energy also plans to invest $1.2 billion in its independent power production operations from 1997 to 1999 to pursue acquisitions and development of electric generating plants in the United States, Latin America, Southern Asia, Australia, the Pacific Rim region and North Africa. Investments totaling $359 million from 1997 to 1999 are planned to continue development of non-utility natural gas storage, gathering and pipeline operations both domestically and internationally. CMS Energy plans to invest $370 million from 1997 to 1999 in its international energy distribution operations related to international expansion. CMS MST plans to invest $63 million from 1997 to 1999 to provide gas, electric, oil and coal marketing, risk management and energy management services throughout the United States and eventually worldwide. These estimates are prepared for planning purposes and are subject to revision. Consumers Electric Outlook: Consumers expects average annual growth of two percent per year in electric system sales over the next five years, based on the current industry and regulatory configuration in Michigan. Actual electric sales in future periods may be affected by abnormal weather, changing economic conditions, or the developing competitive market for electricity. Consumers continues to work toward retaining its current retail service customers by offering electric rates that are competitive with those of other energy providers, and by improving reliability and customer communications. Consumers is also planning for a future environment in which direct access to alternative sources of energy supply is the predominant means by which retail service customers obtain their power requirements. Consumers' electric retail service is affected by competition in several areas, including the potential installation of cogeneration or other self- generation facilities by larger industrial customers; the formation of municipal utilities that would displace retail service to an entire community; competition from other utilities that offer flexible rate arrangements designed to encourage movement of facilities or production to their service areas; economic development competition between utilities; MPSC direct access programs and potential electric industry restructuring caused by regulatory decisions and new state or federal legislation. In 1996, the MPSC reduced the rate subsidization of residential customers by large industrial and commercial customers. In addition, in an effort to meet the challenge of competition, Consumers contracted with some of its largest industrial customers to serve certain facilities a number of years into the future. These contracts have been approved by the MPSC. FERC issued Orders 888 and 889, as amended on rehearing, requiring utilities to provide open access to the interstate transmission grid for wholesale transactions. Several FERC requirements have been implemented. However, one unresolved issue concerns the Michigan Electric Power Coordination Center Pool, currently operated jointly by Consumers and Detroit Edison. Consumers proposes to maintain the benefits of the pool, while Detroit Edison seeks to terminate the power pool agreement. The FERC is expected to rule on this issue in 1997. In response to utility filings previously solicited by the MPSC, in June 1997, the MPSC issued an order relating to the restructuring of the electric power industry in Michigan. The order proposes a phase-in of 150 MW annually of Consumers' retail load for competition beginning January 1, 1998. By January 1, 2002, all customers would be free to choose (that is, have direct-access to) their electric generation suppliers. The order would allow utilities to recover prudently incurred transition costs through a transmission charge applicable through the year 2007 for all direct-access retail customers. The MPSC requested the utilities to file proposals for a true-up mechanism to adjust transition charge revenues depending upon both actual sales and market prices of power to the extent that they are different from original estimates. Consumers subsequently filed a modified plan that has a true-up for sales and a true-up for power purchases only. The 1997 June order further states that securitization may be another alternative for recovery of transition costs, but recognizes that state legislation is required before securitization can be implemented. Michigan legislative consideration of a securitization process is expected this fall. Consumers expects the legislation to provide for immediate recovery of transition costs in exchange for an immediate rate reduction for all customers, with a securitization charge to be paid by all customers over a period of 15 years (the expected term of the rate reduction bonds issued in the securitization), as discussed further below. Consumers has filed responsive data and proposals to the June order asking the MPSC to take certain actions designed to implement Consumers' view of how electric restructuring should occur, including the approval of specific transition charges, but also seeking a rehearing on several issues, including whether the MPSC has the statutory authority to mandate restructuring on a basis which an electric utility would not accept voluntarily. Other parties filed claims of appeal with the Michigan Court of Appeals. The MPSC also decided in a July 1997 order to commence a number of different contested case proceedings to address certain selected issues on which it desired still more information. The expedited schedules for these hearings would have all of them concluded and submitted to the MPSC for decision by mid-October. Pretrial activity will occur in August, hearings in September and briefing in late September and early October. Consumers' March 1997 information estimated for the MPSC that, through 2007, Consumers would recover $1.9 billion (as revised in a June 1997 filing) of transition costs through a transition charge to direct-access customers. A separate charge to direct-access customers would also recover implementation costs totaling an additional $200 million. Alternatively, if Consumers recovers transition costs through securitization, the resulting securitization charge would be paid by all Consumers customers to service $4 billion of rate reduction bonds. The $4 billion in rate reduction bonds represents the net present value of: 1) the $1.9 billion of costs that Consumers would otherwise have recovered in the transition charge to direct access customers; and 2) the costs that Consumers would otherwise have recovered from customers on bundled rates before getting choice of generation suppliers. Consumers' data indicate that the rates to be paid by all customers under the securitization alternative result in more than a $200 million annual savings to those customers when compared to the rates they would pay without securitization because the assumed 15-year repayment period of the bonds allows the cost reimbursement by the customers to be spread out over a longer period, and because securitization allows securitized costs to be financed at a lower rate. Consumers currently applies the utility accounting standard, SFAS 71, that recognizes the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities related to its generation, transmission and distribution operations in its financial statements. If rate recovery of generation-related costs becomes unlikely or uncertain, whether due to competition or regulatory action, this accounting standard may no longer apply to Consumers' generation segment. Such a change could result in either full recovery of generation-related regulatory assets (net of related regulatory liabilities) or a loss, depending on whether Consumers' regulators adopt a transition mechanism for the recovery of all or a portion of these net regulatory assets. Based on a current evaluation of the various factors and conditions that are expected to affect future cost recovery, Consumers believes even if it was to discontinue application of SFAS 71 for the generation segment of its business, that its regulatory assets, including those related to generation, are probable of future recovery . Consumers Gas Group Outlook: Consumers currently anticipates gas deliveries (excluding transportation to the MCV Facility and off-system deliveries) to grow on an average annual basis between one and two percent over the next five years based primarily on a steadily growing customer base. Consumers has several strategies to increase load requirements. These strategies include increased efforts to promote natural gas to both current and potential customers that are using other fuels for space and water heating. Consumers also plans additional capital expenditures to construct new gas mains that are expected to expand Consumers' system. Actual gas deliveries in future periods may be affected by abnormal weather, alternative energy prices, changes in competitive conditions, and the level of natural gas consumption. Consumers is also offering a variety of energy-related services to its customers focused upon appliance maintenance, home safety, and home security. In 1996 the MPSC issued an order requesting Consumers and other local gas distribution companies, whose rates are regulated by the MPSC, to develop pilot programs that would allow customers to purchase gas directly from other suppliers and have the gas transported through local pipelines. These pilot programs are to last for two years and are intended to help the MPSC determine whether it is appropriate to extend this option to all retail customers. In December 1996, the MPSC approved Consumers' pilot program for 40,000 customers in Bay County. The first customer solicitation ended in March 1997 and resulted in one percent of the customers choosing an alternative supplier for the next year. Another solicitation period will begin in late 1997 for the period April 1998 - March 1999; expected customer interest is unknown at this time. Based on a regulated utility accounting standard, SFAS 71, Consumers is allowed to defer certain costs to the future and record regulatory assets, based on the recoverability of those costs through the MPSC's approval. Consumers has evaluated its regulatory assets related to its gas business, and believes that sufficient regulatory assurance exists to provide for the recovery of these deferred costs. Other New Accounting Standards: In 1997, the FASB issued SFAS 128, Earnings per Share, which is effective for year end 1997 financial statements. The Earnings per Share statement requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Basic EPS excludes such dilution. CMS Energy is in the process of quantifying the effect of applying the statement.
21 <TABLE> CMS Energy Corporation Consolidated Statements of Income (Unaudited) <CAPTION> Three Months Ended Six Months Ended Twelve Months Ended June 30 1997 1996 1997 1996 1997 1996 In Millions, Except Per Share Amounts <S> <C> <C> <C> <C> <C> <C> Operating Revenue Electric utility $ 598 $ 581 $1,218 $1,172 $2,492 $2,366 Gas utility 220 209 718 757 1,242 1,273 Oil and gas exploration and production 33 31 68 62 136 114 Independent power production 42 37 71 64 147 114 Natural gas transmission, storage and processing 27 16 53 28 87 43 Marketing, services and trading 114 61 213 132 339 232 Other 2 3 8 6 18 17 ------ ------ ------ ------ ------ ------ 1,036 938 2,349 2,221 4,461 4,159 ------ ------ ------ ------ ------ ------ Operating Expenses Operation Fuel for electric generation 71 70 140 143 293 292 Purchased power - related parties 146 146 297 286 600 532 Purchased and interchange power 53 44 115 91 226 204 Cost of gas sold 235 165 651 576 1,072 957 Other 167 172 336 342 731 709 ------ ------ ------ ------ ------ ------ 672 597 1,539 1,438 2,922 2,694 Maintenance 42 38 83 78 183 173 Depreciation, depletion and amortization 107 99 238 223 456 433 General taxes 48 45 109 104 207 202 ------ ------ ------ ------ ------ ------ 869 779 1,969 1,843 3,768 3,502 ------ ------ ------ ------ ------ ------ Pretax Operating Income (Loss) Electric utility 104 96 210 202 419 399 Gas utility 23 23 101 116 143 160 Oil and gas exploration and production 11 9 20 18 41 26 Independent power production 25 27 35 33 70 53 Natural gas transmission, storage and processing 8 8 17 14 29 21 Marketing, services and trading - - 1 2 1 3 Other (4) (4) (4) (7) (10) (5) ------ ------ ------ ------ ------ ------ 167 159 380 378 693 657 ------ ------ ------ ------ ------ ------ Other Income (Deductions) Accretion income 2 2 4 5 9 11 Accretion expense (4) (7) (9) (14) (17) (29) Other, net 1 1 2 3 - 5 ------ ------ ------ ------ ------ ------ (1) (4) (3) (6) (8) (13) ------ ------ ------ ------ ------ ------ Fixed Charges Interest on long-term debt 66 59 126 116 240 227 Other interest 11 8 22 19 46 43 Capitalized interest (4) (2) (7) (4) (11) (10) Preferred dividends 7 7 14 14 28 28 Preferred securities distributions 3 2 5 4 9 4 ------ ------ ------ ------ ------ ------ 83 74 160 149 312 292 ------ ------ ------ ------ ------ ------ Income Before Income Taxes 83 81 217 223 373 352 Income Taxes 29 31 79 85 133 129 ------ ------ ------ ------ ------ ------ Consolidated Net Income $ 54 $ 50 $ 138 $ 138 $ 240 $ 223 ====== ====== ====== ====== ====== ====== Net Income Attributable to Common Stocks CMS Energy $ 52 $ 49 $ 127 $ 125 $ 228 $ 207 Class G $ 2 $ 1 $ 11 $ 13 $ 12 $ 16 Average Common Shares Outstanding CMS Energy 95 92 95 92 94 91 Class G 8 8 8 8 8 8 Earnings Per Average Common Share CMS Energy $ .55 $ .54 $ 1.34 $ 1.37 $ 2.42 $ 2.28 Class G $ .16 $ .16 $ 1.34 $ 1.66 $ 1.52 $ 2.05 Dividends Declared Per Common Share CMS Energy $ .27 $ .24 $ .54 $ .48 $ 1.05 $ .96 Class G $ .295 $ .28 $ .59 $ .56 $ 1.18 $ 1.12 ====== ====== ====== ====== ====== ====== <FN> The accompanying condensed notes are an integral part of these statements. </TABLE>
22 <TABLE> CMS Energy Corporation Consolidated Statements of Cash Flows (Unaudited) <CAPTION> Six Months Ended Twelve Months Ended June 30 1997 1996 1997 1996 In Millions <S> <C> <C> <C> <C> Cash Flows from Operating Activities Consolidated net income $ 138 $ 138 $ 240 $ 223 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear decommissioning of $24, $24, $49 and $51, respectively) 238 223 456 433 Deferred income taxes and investment tax credit 23 17 52 35 Capital lease and debt discount amortization 22 22 41 48 Accretion expense 9 14 17 29 Accretion income - abandoned Midland project (4) (5) (9) (11) Power purchases (30) (27) (66) (94) Undistributed earnings of related parties (23) (41) (45) (69) Other (4) 8 8 13 Changes in other assets and liabilities 12 137 (138) 156 ----- ----- ------- ----- Net cash provided by operating activities 381 486 556 763 ----- ----- ------- ----- Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (365) (251) (773) (506) Investments in partnerships and unconsolidated subsidiaries (534) (133) (564) (355) Investments in nuclear decommissioning trust funds (24) (24) (49) (51) Cost to retire property, net (11) (12) (31) (34) Acquisition of companies, net of cash acquired - (20) - (10) Deferred demand-side management costs - (5) - (10) Other (14) - (6) (8) Proceeds from sale of property 13 15 77 36 ----- ----- ------- ----- Net cash used in investing activities (935) (430) (1,346) (938) ----- ----- ------- ----- Cash Flows from Financing Activities Proceeds from bank loans, notes and bonds 581 385 629 556 Proceeds from preferred securities 173 97 173 97 Issuance of common stock 30 16 109 161 Increase (decrease) in notes payable, net (87) (233) 138 (201) Payment of common stock dividends (56) (48) (111) (95) Retirement of bonds and other long-term debt (49) - (86) (31) Repayment of bank loans (22) (247) (31) (256) Payment of capital lease obligations (21) (22) (39) (40) Retirement of common stock - - (1) (1) ----- ----- ------- ----- Net cash provided by (used in) financing activities 549 (52) 781 190 ----- ----- ------- ----- Net Increase (Decrease) in Cash and Temporary Cash Investments (5) 4 (9) 15 Cash and Temporary Cash Investments, Beginning of Period 56 56 60 45 ----- ----- ------- ----- Cash and Temporary Cash Investments, End of Period $ 51 $ 60 $ 51 $ 60 ===== ===== ======= ===== <FN> The accompanying condensed notes are an integral part of these statements. </TABLE>
23 <TABLE> CMS Energy Corporation Consolidated Balance Sheets <CAPTION> ASSETS June 30 June 30 1997 December 31 1996 (Unaudited) 1996 (Unaudited) In Millions <S> <C> <C> <C> Plant and Property (At Cost) Electric $6,467 $6,333 $6,177 Gas 2,467 2,337 2,309 Oil and gas properties (full-cost method) 1,195 1,140 1,114 Other 99 94 90 ------ ------ ------ 10,228 9,904 9,690 Less accumulated depreciation, depletion and amortization 5,120 4,867 4,843 ------ ------ ------ 5,108 5,037 4,847 Construction work-in-progress 281 243 247 ------ ------ ------ 5,389 5,280 5,094 ------ ------ ------ Investments Independent power production 846 317 308 First Midland Limited Partnership (Note 2) 237 232 228 Natural gas transmission, storage and processing 234 233 238 Midland Cogeneration Venture Limited Partnership (Note 2) 148 134 110 Other 90 86 88 ------ ------ ------ 1,555 1,002 972 ------ ------ ------ Current Assets Cash and temporary cash investments at cost, which approximates market 51 56 60 Accounts receivable and accrued revenue, less allowances of $9, $10 and $3, respectively (Note 4) 339 374 290 Inventories at average cost Gas in underground storage 125 186 109 Materials and supplies 92 86 83 Generating plant fuel stock 28 30 23 Deferred income taxes 28 48 21 Prepayments and other 138 235 160 ------ ------ ------ 801 1,015 746 ------ ------ ------ Non-current Assets Postretirement benefits 419 435 450 Nuclear decommissioning trust funds 443 386 339 Abandoned Midland Project 103 113 122 Other 426 384 428 ------ ------ ------ 1,391 1,318 1,339 ------ ------ ------ Total Assets $9,136 $8,615 $8,151 ====== ====== ====== </TABLE>
24 <TABLE> <CAPTION> STOCKHOLDERS' INVESTMENT AND LIABILITIES June 30 June 30 1997 December 31 1996 (Unaudited) 1996 (Unaudited) In Millions <S> <C> <C> <C> Capitalization Common stockholders' equity $1,814 $1,702 $1,575 Preferred stock of subsidiary 356 356 356 Company-obligated mandatorily redeemable preferred securities of Consumers Power Company Financing I (a) 100 100 100 Company-obligated convertible preferred securities of CMS Energy Trust I (b) 173 - - Long-term debt 3,077 2,842 3,116 Non-current portion of capital leases 89 103 94 ------ ------ ------ 5,609 5,103 5,241 ------ ------ ------ Current Liabilities Current portion of long-term debt and capital leases 690 409 131 Notes payable 246 333 108 Accounts payable 286 348 289 Accrued taxes 191 262 204 Accounts payable - related parties 65 63 59 Accrued interest 50 47 51 Power purchases (Note 2) 47 47 90 Accrued refunds 7 8 25 Other 171 206 181 ------ ------ ------ 1,753 1,723 1,138 ------ ------ ------ Non-current Liabilities Deferred income taxes 691 698 646 Postretirement benefits 524 521 533 Power purchases (Note 2) 157 178 207 Deferred investment tax credit 156 161 166 Regulatory liabilities for income taxes, net 81 66 57 Other 165 165 163 ------ ------ ------ 1,774 1,789 1,772 ------ ------ ------ Commitments and Contingencies (Notes 2, 3, 6, 7 and 8) Total Stockholders' Investment and Liabilities $9,136 $8,615 $8,151 ====== ====== ====== <FN> (a) As described in Note 4 to the Consolidated Financial Statements, the primary asset of Consumers Power Company Financing I is $103 million principal amount of 8.36% subordinated interest notes due 2015 from Consumers. (b) As described in Note 4 to the Consolidated Financial Statements, the primary asset of CMS Energy Trust I is $178 million principal amount of 7.75% convertible subordinated debentures due 2027 from CMS Energy. The accompanying condensed notes are an integral part of these statements. </TABLE>
25 <TABLE> CMS Energy Corporation Consolidated Statements of Common Stockholders' Equity (Unaudited) <CAPTION> Three Months Ended Six Months Ended Twelve Months Ended June 30 1997 1996 1997 1996 1997 1996 In Millions <S> <C> <C> <C> <C> <C> <C> Common Stock At beginning and end of period $ 1 $ 1 $ 1 $ 1 $ 1 $ 1 ------ ------ ------ ------ ------ ------ Other Paid-in Capital At beginning of period 2,062 1,959 2,045 1,951 1,967 1,740 Common stock reacquired - - - - (1) (1) Common stock issued: CMS Energy 12 7 28 14 104 101 Class G 1 1 2 2 5 126 Common stock reissued - - - - - 1 ------ ------ ------ ------ ------ ------ At end of period 2,075 1,967 2,075 1,967 2,075 1,967 ------ ------ ------ ------ ------ ------ Revaluation Capital At beginning of period (6) (8) (6) (8) (8) 1 Change in unrealized investment-gain (loss) - - - - 2 (9) ------ ------ ------ ------ ------ ------ At end of period (6) (8) (6) (8) (6) (8) ------ ------ ------ ------ ------ ------ Retained Earnings (Deficit) At beginning of period (282) (411) (338) (475) (385) (513) Consolidated net income 54 50 138 138 240 223 Common stock dividends declared: CMS Energy (26) (22) (52) (44) (102) (87) Class G (2) (2) (4) (4) (9) (8) ------ ------ ------ ------ ------ ------ At end of period (256) (385) (256) (385) (256) (385) ------ ------ ------ ------ ------ ------ Total Common Stockholders' Equity $1,814 $1,575 $1,814 $1,575 $1,814 $1,575 ====== ====== ====== ====== ====== ====== <FN> The accompanying condensed notes are an integral part of these statements. </TABLE>
26 CMS Energy Corporation Condensed Notes to Consolidated Financial Statements These financial statements and their related condensed notes should be read along with the consolidated financial statements and notes contained in the 1996 Form 10-K of CMS Energy Corporation that includes the Report of Independent Public Accountants. Certain prior year amounts have been reclassified to conform with the presentation in the current year. In the opinion of management, the unaudited information herein reflects all adjustments necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. 1: Corporate Structure and Basis of Presentation CMS Energy is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Enterprises is engaged in several domestic and international energy-related businesses including: oil and gas exploration and production; acquisition, development and operation of independent power production facilities; storage, transmission and processing of natural gas; energy marketing, services and trading; and international energy distribution. CMS Energy uses the equity method of accounting for investments in companies and partnerships where it has more than a 20 percent but less than a majority ownership interest and includes these results in operating income. For the three, six and twelve month periods ended June 30, 1997, undistributed equity earnings were $10 million, $23 million and $46 million, respectively, and $20 million, $41 million and $69 million for the three, six and twelve months periods ended June 30, 1996. 2: The Midland Cogeneration Venture The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990 and to supply electricity and steam to Dow. Consumers, through two wholly owned subsidiaries, holds the following assets related to the MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through the FMLP, a 35 percent lessor interest in the MCV Facility. Summarized Statements of Income for CMS Midland and CMS Holdings: In Millions Three Months Ended Six Months Ended Twelve Months Ended June 30 1996 1997 1996 1997 1996 1997 Pretax operating income $10 $10 $18 $12 $46 $28 Income taxes and other 3 3 5 3 13 7 --- --- --- --- --- --- Net income $ 7 $ 7 $13 $ 9 $33 $21 === === === === === === Power Purchases from the MCV Partnership: Consumers' annual obligation to purchase capacity from the MCV Partnership is 1,240 MW through the termination of the PPA in 2025. The PPA provides that Consumers is to pay the MCV Partnership a minimum levelized average capacity charge of 3.77 cents per kWh, a fixed energy charge, and a variable energy charge based primarily on Consumers' average cost of coal consumed. Consumers is recovering capacity charges averaging 3.62 cents per kWh for 915 MW of capacity, the fixed energy charge, and the prescribed energy charges associated with the scheduled deliveries within certain hourly availability limits, whether or not those deliveries are scheduled on an economic basis. Beginning January 1, 1996, Consumers was also permitted to recover an average capacity charge of 2.86 cents per kWh for the remaining 325 MW of MCV Facility capacity. The approved average capacity charge increased to 3.62 cents per kWh for 109 MW by January 1, 1997. The recoverable portion of the capacity charge for the last 216 MW of the 325 MW increases each year until it reaches 3.62 cents per kWh in 2004, and remains at this ceiling rate through the end of the PPA term. Consumers previously recognized a loss in 1992 for the present value of the estimated future underrecoveries of power costs under the PPA. At June 30, 1997 and December 31, 1996, the after-tax present value of the PPA liability totaled $133 million and $147 million, respectively. The reduction in the liability since December 31, 1996 reflects after-tax cash underrecoveries of $20 million partially offset by after-tax accretion expense of $6 million. The undiscounted after-tax amount associated with the liability totaled $520 million at June 30, 1997. Consumers anticipates it will continue to experience cash underrecoveries associated with the PPA as shown below. These after-tax cash underrecoveries were based on the assumption that the MCV Facility would be available to generate electricity 90 percent of the time. However, for the first six months of 1997 the MCV Facility has been available 98.9 percent of the time resulting in the $20 million of after-tax cash underrecoveries. The underrecovery shown in the table below for the year 1997 has been revised to reflect the anticipated availability of the MCV Facility. In Millions 1997 1998 1999 2000 2001 Estimated cash underrecoveries, net of tax $40 $23 $22 $21 $20 The amount of underrecoveries of power costs continues to be based, in part, on management's best assessment of the future availability of the MCV Facility. If the MCV Facility operates at levels above management's estimate over the remainder of the PPA, future losses will need to be recognized over and above amounts previously recorded and Consumers would experience greater amounts of cash underrecoveries than originally anticipated. Management will continue to evaluate the adequacy of the accrued liability considering actual facility operations. PSCR Matters Related to Power Purchases from the MCV Partnership: As part of a 1995 decision in the PSCR reconciliation case for 1993, the MPSC disallowed a portion of the costs related to purchases from the MCV Partnership, and instead assumed recovery of those costs from wholesale customers. Consumers believed this was contrary to the terms of an earlier 1993 settlement order and appealed. The MCV Partnership and ABATE also filed separate appeals of this order. In November 1996, the Court of Appeals affirmed the MPSC's 1995 order. Consumers and the MCV Partnership filed petitions for rehearing of the Court of Appeals opinion, which were denied in January 1997. 3: Rate Matters Electric Proceedings: In 1996, the MPSC issued a final order which authorized Consumers to recover costs associated with the purchase of the additional 325 MW of MCV Facility capacity (see Note 2) and to accelerate recovery of its nuclear plant investment by increasing prospective annual nuclear plant depreciation expense by $18 million with a corresponding decrease in fossil-fueled generating plant depreciation expense. It also established an experimental direct access program. Customers having a maximum demand of at least 2 MW are eligible to purchase generation services directly from any eligible third-party power supplier. The program is limited to 650 MW of sales, of which 410 MW has already been filled by existing contracts. An additional 140 MW may be filled by new special contracts which the MPSC has approved or by direct access customers. The remaining 100 MW must be made available solely to direct access customers for at least 18 months. In April 1997, a lottery was held to select the customers to purchase 100 MW by direct access. Direct access for this 100 MW is expected to begin during the third quarter of 1997. In May 1997, the MPSC authorized Consumers to collect $17 million from electric customers through a one-time surcharge pertaining to the 1994 PSCR reconciliation. Electric Restructuring: In response to utility filings previously solicited by the MPSC, in June 1997, the MPSC issued an order relating to the restructuring of the electric power industry in Michigan. The order proposes a phase-in of 150 MW annually of Consumers' retail load for competition beginning January 1, 1998. By January 1, 2002, all customers would be free to choose (that is, have direct-access to) their electric generation suppliers. The order would allow utilities to recover prudently incurred transition costs through a transmission charge applicable through the year 2007 for all direct-access retail customers. The MPSC requested the utilities to file proposals for a true-up mechanism to adjust transition charge revenues depending upon both actual sales and market prices of power to the extent that they are different from original estimates. Consumers subsequently filed a modified plan that has a true- up for sales and a true-up for power purchases only. The 1997 June order further states that securitization may be another alternative for recovery of transition costs, but recognizes that state legislation is required before securitization can be implemented. Michigan legislative consideration of a securitization process is expected this fall. Consumers expects the legislation to provide for immediate recovery of transition costs in exchange for an immediate rate reduction for all customers, with a securitization charge to be paid by all customers over a period of 15 years (the expected term of the rate reduction bonds issued in the securitization), as discussed further below. Consumers has filed responsive data and proposals to the June order asking the MPSC to take certain actions designed to implement Consumers' view of how electric restructuring should occur, including the approval of specific transition charges, but also seeking a rehearing on several issues, including whether the MPSC has the statutory authority to mandate restructuring on a basis which an electric utility would not accept voluntarily. Other parties filed claims of appeal with the Michigan Court of Appeals. The MPSC also decided in a July 1997 order to commence a number of different contested case proceedings to address certain selected issues on which it desired still more information. The expedited schedules for these hearings would have all of them concluded and submitted to the MPSC for decision by mid-October. Pretrial activity will occur in August, hearings in September and briefing in late September and early October. Consumers' March 1997 information estimated for the MPSC that, through 2007, Consumers would recover $1.9 billion (as revised in a June 1997 filing) of transition costs through a transition charge to direct-access customers. A separate charge to direct-access customers would also recover implementation costs totaling an additional $200 million. Alternatively, if Consumers recovers transition costs through securitization, the resulting securitization charge would be paid by all Consumers customers to service $4 billion of rate reduction bonds. The $4 billion in rate reduction bonds represents the net present value of: 1) the $1.9 billion of costs that Consumers would otherwise have recovered in the transition charge to direct access customers; and 2) the costs that Consumers would otherwise have recovered from customers on bundled rates before getting choice of generation suppliers. Consumers' data indicate that the rates to be paid by all customers under the securitization alternative result in more than a $200 million annual savings to those customers when compared to the rates they would pay without securitization because the assumed 15-year repayment period of the bonds allows the cost reimbursement by the customers to be spread out over a longer period, and because securitization allows securitized costs to be financed at a lower rate. Consumers currently applies the utility accounting standard, SFAS 71, that recognizes the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities related to its generation, transmission and distribution operations in its financial statements. If rate recovery of generation-related costs becomes unlikely or uncertain, whether due to competition or regulatory action, this accounting standard may no longer apply to Consumers' generation segment. Such a change could result in either full recovery of generation-related regulatory assets (net of related regulatory liabilities) or a loss, depending on whether Consumers' regulators adopt a transition mechanism for the recovery of all or a portion of these net regulatory assets. Based on a current evaluation of the various factors and conditions that are expected to affect future cost recovery, Consumers believes even if it was to discontinue application of SFAS 71 for the generation segment of its business, that its regulatory assets, including those related to generation, are probable of future recovery. Gas Proceedings: In the GCR reconciliation proceeding for the period April 1995 through March 1996, an issue has arisen questioning whether revenue from gas loaning (which was a new business activity for Consumers) should, in whole or in part, be immediately passed through to customers. The ALJ issued a proposal for decision in January 1997 that agreed with the MPSC staff's position that the gas loaning program uses storage assets of Consumers and therefore recommended that 90 percent of the revenue should be refunded to customers. If the MPSC adopts the ALJ position,$8 million as of June 30, 1997, would be subject to refund. Consumers has not provided a contingency reserve for this potential refund and will continue to oppose this view before the MPSC. In 1996, the MPSC authorized Consumers to implement a pilot gas transportation program in Bay County, Michigan. The pilot program provides residential and small commercial customers the opportunity to purchase gas from suppliers other than Consumers for a two-year period beginning April 1997. Out of the 40,000 eligible customers, only 500 volunteered to participate in the program. Consumers will retain its role as transporter and distributor of this gas. In 1995, the MPSC issued an order regarding a $44 million (excluding interest) gas supply contract pricing dispute between Consumers and certain intrastate producers. The order stated that Consumers was not obligated to seek prior approval of market-based pricing changes that were implemented under the contracts in question. The producers subsequently filed a claim of appeal of the MPSC order with the Court of Appeals. Consumers believes the MPSC order correctly concludes that the producers' theories are without merit and will vigorously oppose any claims they may raise, but cannot predict the outcome of this issue. Resolution of the issues discussed in this note is not expected to have a material effect on CMS Energy's financial position or results of operations. 4: Short-Term and Long-Term Financings, and Capitalization CMS Energy At June 30, 1997, CMS Energy had available unsecured, lines of credit and letters of credit totaling $155 million and a $450 million unsecured revolving credit facility. At June 30, 1997 and 1996, the total amount utilized under these facilities was $214 million and $233 million, respectively. In addition, CMS Energy had an unsecured $125 million term loan. On July 3, 1997 CMS Energy refinanced the unsecured revolving credit facility and the term loan with $1.125 billion in Senior Credit Facilities consisting of a $400 million 364-day revolving credit facility, $600 million three-year revolving credit facility and a five-year $125 million term loan facility. At July 31, 1997 the total amount utilized under the Senior Credit Facilities was $379 million and the amount utilized under the $155 million lines of credit and letters of credit was $31 million. At June 30, 1997, CMS Energy had $224 million of Series A GTNs, $125 million of Series B GTNs and $87 million of Series C GTNs issued and outstanding with weighted-average interest rates of 7.7 percent, 7.9 percent and 8.0 percent, respectively. In May 1997, CMS Energy issued $350 million of senior unsecured notes due May 15, 2002, at an interest rate of 8.125 percent. Proceeds were used in part to repay debt and in part to fund CMS Energy's equity investment in the 2,000 MW Loy Yang A electric generating plant and associated mine facilities in the State of Victoria, Australia. In May 1997, CMS Energy and affiliated business trusts filed a shelf registration statement with the SEC for the issuance and the sale of up to $300 million of CMS Energy Common Stock, subordinated debentures, stock purchase contracts, stock purchase units and preferred securities. In June 1997, 3,450,000 units of 7.75 percent convertible quarterly income preferred securities were issued and sold through CMS Energy Trust I, a business trust wholly owned by CMS Energy. Net proceeds from the sale totaled $173 million. CMS Energy Trust I was formed for the sole purpose of issuing quarterly income preferred securities. Its primary asset is approximately $178 million principal amount of 7.75 percent subordinated debentures issued by CMS Energy which mature in 2027. The trust preferred securities are convertible into shares of CMS Energy Common Stock at a rate equivalent to a conversion price of $40.80 per share. Proceeds of the subordinated debentures were used by CMS Energy for general corporate purposes including repayment of debt, capital expenditures, investment in subsidiaries and working capital. CMS Energy's obligations under the subordinated debentures, the indenture under which the subordinated debentures were issued, the declaration of trust and the CMS Energy guarantee provide, in the aggregate, a full irrevocable and unconditional guarantee of payments of distributions and other amounts due on the trust preferred securities. Consumers Consumers has FERC authorization to issue or guarantee up to $900 million of short-term debt through 1998. Consumers has an unsecured $425 million facility, and unsecured committed lines of credit aggregating $120 million that are used to finance seasonal working capital requirements. At June 30, 1997, a total of $241 million was outstanding at a weighted average interest rate of 6.2 percent, compared with $108 million outstanding at June 30, 1996, at a weighted average interest rate of 6.1 percent. Consumers has also in place a $500 million trade receivables purchase and sale program. At June 30, 1997 and 1996, receivables sold under the agreement totaled $266 million and $200 million, respectively. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold. In 1996, four million shares of 8.36 percent trust originated preferred securities were issued and sold through Consumers Power Company Financing I, a business trust wholly owned by Consumers. Net proceeds from the sale totaled $97 million. Consumers Power Company Financing I was formed for the sole purpose of issuing the trust originated preferred securities. Its primary asset is $103 million principal amount of 8.36 percent unsecured subordinated deferrable interest notes issued by Consumers which mature in 2015. Consumers' obligations with respect to the trust originated preferred securities under the notes, under the indenture under which the notes have been issued, under Consumers' guarantee of the trust originated preferred securities, and under the declaration by the trust, taken together, constitute a full and unconditional guarantee by Consumers of the trust's obligations under the trust originated preferred securities. In August 1997, Consumers and an affiliated business trust, Consumers Energy Company Financing II, filed a registration statement with the SEC for the issuance and sale of up to $120 million of trust originated preferred securities. Consumers Energy Company Financing II was formed for the sole purpose of issuing trust originated preferred securities and investing the proceeds in subordinated notes which will be unsecured obligations of Consumers. Consumers will use the net proceeds from the sale of the subordinated notes to redeem, refinance or refund existing long-term securities, which may include first mortgage bonds, stocks, preferred securities or notes. In August 1997, Consumers announced that it will redeem all of the outstanding shares of its $7.45, $7.68, $7.72 and $7.76 preferred stock. This $119 million redemption of preferred stock will take place in September 1997. 5: Earnings Per Share and Dividends Earnings per share attributable to Common Stock for the three, six and twelve month periods ended June 30, 1997 and the three and six months ended June 30, 1996 reflect the performance of the Consumers Gas Group. Earnings per share attributable to Common Stock for the twelve months ended June 30, 1996 reflect the performance of the Consumers Gas Group since initial issuance of Class G Common Stock during the third quarter of 1995. The Class G Common Stock has participated in earnings and dividends from its issue date. The allocation of earnings (loss) attributable to each class of common stock and the related amounts per share are computed by considering the weighted average number of shares outstanding. Earnings (loss) attributable to Outstanding Shares are equal to Consumers Gas Group net income (loss) multiplied by a fraction; the numerator is the weighted average number of Outstanding Shares during the period and the denominator is the weighted average number of Outstanding Shares and Retained Interest Shares during the period. The earnings attributable to Class G Common Stock on a per share basis for the three months ended June 30, 1997 and 1996 are based on 24.30 percent of the income of the Consumers Gas Group and 23.72 percent of the income of the Consumers Gas Group since the initial issuance, respectively. In February and May 1997, CMS Energy paid a dividend of $.27 per share on CMS Energy Common Stock and $.295 per share on Class G Common Stock. In July 1997, the Board of Directors declared a quarterly dividend of $.30 per share on CMS Energy Common Stock and $.31 per share on Class G Common Stock to be paid in August 1997. 6: Risk Management Activities and Derivative Transactions CMS Energy and its subsidiaries use a variety of derivative instruments (derivatives), including futures contracts, swaps and forward contracts, to manage exposure to fluctuations in commodity prices, interest rates and foreign exchange rates. In order for derivatives to initially qualify for hedge accounting the following criteria must be met: 1) the item to be hedged exposes the enterprise to price, interest or exchange rate risk; and 2) the derivative reduces that exposure and is designated as a hedge. Derivative instruments contain credit risk if the counterparties, including financial institutions and energy marketers, fail to perform under the agreements. However, CMS Energy minimizes such risk by performing financial credit reviews using, among other things, publicly available credit ratings of such counterparties. The risk of nonperformance by the counterparties is considered remote. Commodity Price Hedges: CMS Energy accounts for its commodity price derivatives as hedges, and as such, defers any changes in market value and gains and losses resulting from settlements until the hedged transaction is complete. If there was a loss of correlation between the changes in (1) the market value of the commodity price contracts and (2) the market price ultimately received for the hedged item, and the impact was material, the open commodity price contracts would be marked to market and gains and losses would be recognized in the income statement currently. CMS NOMECO periodically enters into oil and gas price hedging arrangements to mitigate its exposure to price fluctuations on the sale of crude oil and natural gas. As of December 31, 1996, CMS NOMECO had 1997 commodity price contracts on 13.8 bcf of gas at prices ranging from $1.92 to $2.80 per MMBtu and on 2.0 million barrels of oil at prices ranging from $19.50 to $22.90 per barrel. During the first six months of 1997, CMS NOMECO has made net payments of $2.7 million for settlement of 1997 contracts on 8.3 bcf of gas and 1.8 million bbls of oil. CMS NOMECO also has one arrangement which is used to fix the prices that CMS NOMECO will pay to supply gas for the years 2001 through 2006 by purchasing the economic equivalent of 10,000 MMBtu per day at a fixed price, escalating at 8 percent per year thereafter, starting at $2.82 per MMBtu in 2001. The settlement periods are each a one-year period ending December 31, 2001 through 2006 on 3.65 million MMBtu. If the floating price, essentially the then current Gulf Coast spot price, for a period is higher than the fixed price, the seller pays CMS NOMECO the difference, and vice versa. If a party's exposure at any time exceeds $5 million, that party is required to obtain a letter of credit in favor of the other party for the excess over $5 million and up to $10 million. At June 30, 1997, neither party was required to post a letter of credit. CMS MST uses natural gas futures contracts and swaps (which require a net cash payment for the difference between a fixed and variable price). Interest Rates Hedges: CMS Energy and some of its subsidiaries enter into interest rate swap agreements to exchange variable rate interest payment obligations to fixed rate obligations without exchanging the underlying notional amounts. These agreements convert variable rate debt to fixed rate debt in order to reduce the impact of interest rate fluctuations. The notional amounts parallel the underlying debt levels and are used to measure interest to be paid or received and do not represent the amount of exposure to credit loss. The notional amount of CMS Energy's and its subsidiaries' interest rate swaps was $1.0 billion at June 30, 1997. The difference between the amounts paid and received under the swaps is accrued and recorded as an adjustment to interest expense over the life of the hedged agreement. Foreign Exchange Hedges: Forward exchange contracts are used to hedge certain receivables, payables, and long term debt relating to foreign investments. The purpose of the CMS Energy's foreign currency hedging activities is to protect the company from the risk that US dollar net cash flows resulting from sales to foreign customers and purchases from foreign suppliers and the repayment of non-US dollar borrowings may be adversely affected by changes in exchange rates. These contracts do not subject CMS Energy to risk from exchange rate movements because gains and losses on such contracts offset losses and gains, respectively, on assets and liabilities being hedged. The notional amount of the outstanding foreign exchange contracts was $20 million at June 30, 1997. 7: Commitments and Contingencies Environmental Matters: Consumers is a so-called potentially responsible party at several sites being administered under Superfund. Superfund liability is joint and several and along with Consumers, there are numerous credit worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based upon past negotiations, Consumers estimates that its share of the total liability for the known sites will be between $2 million and $9 million. At June 30, 1997, Consumers has accrued $2 million for its estimated losses. Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. Consumers has prepared plans for remedial investigation/feasibility studies for several of these sites. Four of the five plans submitted by Consumers have been approved by the appropriate environmental regulatory authority in the State of Michigan. Findings for the two completed remedial investigations indicate that the expenditures for those two sites are likely to be less than the amounts projected before the studies were performed. However, these findings may not be representative of all of the sites. Data available to Consumers and its continued internal review have resulted in an estimate for all costs related to investigation and remedial action for all 23 sites of between $48 million and $98 million. These estimates are based on undiscounted 1997 costs. At June 30, 1997, Consumers has accrued a liability of $48 million and has established a regulatory asset for approximately the same amount. Any significant change in assumptions, such as remediation technique, nature and extent of contamination, and legal and regulatory requirements, could affect the estimate of remedial action costs for the sites. In accordance with an MPSC rate order issued in 1996, environmental clean-up costs above the amount currently being recovered in rates will be deferred and amortized over ten years. Rate recognition of amortization expense will not begin until after a prudence review in a general rate case. The order authorizes current recovery of $1 million annually. Consumers is continuing discussions with certain insurance companies regarding coverage for some or all of the costs that may be incurred for these sites. The Clean Air Act contains provisions that limit emissions of sulfur dioxide and nitrogen oxides and require emissions monitoring. Consumers' coal-fueled electric generating units burn low-sulfur coal and are currently operating at or near the sulfur dioxide emission limits that will be effective in the year 2000. The Act's provisions required Consumers to make capital expenditures totaling $40 million to install equipment at certain generating units. Consumers estimates capital expenditures for in-process and proposed modifications at other coal- fueled units to be an additional $45 million by the year 2000. Management believes that Consumers' annual operating costs will not be materially affected as a result of these expenditures. The Clean Air Act also contains national air quality standards under which industry must operate. Currently, Consumers operates within these standards and meets current ozone and small particle related emission limits. The Act requires the EPA to periodically review the effectiveness of these standards in preventing adverse health affects. The EPA recently revised these standards to increase the restrictions on small particle and ozone related emissions. CMS Energy and Consumers support the bi-partisan effort in Congress to delay implementation of the revised standards until the relationship between the new standards and health improvements is established. In addition, the EPA is reviewing recommendations from the Ozone Transport Assessment Group to reduce ozone transport across state lines. The EPA is expected to require the State of Michigan to impose additional nitrogen oxide reductions goals on Consumers' fossil-fueled generating units. The preliminary estimate of the cost of the changes Consumers may have to make to its fossil-fueled generating units to reduce ozone related emissions is approximately $175 million. A potentially equivalent amount may be needed to comply with the new small particle standards. Capital Expenditures: CMS Energy estimates capital expenditures, including investments in unconsolidated subsidiaries and new lease commitments, of $1,520 million for 1997, $1,170 million for 1998 and $895 million for 1999. For further information regarding capital expenditures, see Forward-Looking Information in the MD&A. Other: As of June 30, 1997, CMS Energy and Enterprises have guaranteed up to $110 million in contingent obligations of unconsolidated affiliates and unrelated parties. A number of lawsuits have been filed against Consumers relating to the effect of so-called stray voltage on certain livestock. Claimants contend that stray voltage results when low-level electrical currents present in grounded electrical systems are diverted from their intended path. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns and has an ongoing mitigation program to modify the service of all customers with livestock. As of June 30, 1997, Consumers had 18 separate stray voltage lawsuits awaiting trial court action, down from 22 lawsuits as reported at year end 1996. In addition to the matters disclosed in these notes, Consumers and certain other subsidiaries of CMS Energy are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies arising from the ordinary course of business and involving personal injury, property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing and other matters. Estimated losses for certain contingencies discussed in this note have been accrued. Resolution of these contingencies is not expected to have a material impact on Consumers' financial position or results of operations. 8: Nuclear Matters Consumers has loaded 13 dry storage casks with spent nuclear fuel at Palisades. Consumers plans to load four additional casks at Palisades later this year pending approval by the NRC. In June 1997, the NRC approved the process for unloading spent fuel from a cask with minor weld flaws. Consumers intends to transfer the spent fuel to a new transportable cask when one is available. The supplier for the design and fabrication of the transportable cask has been selected and design work is proceeding. Consumers is required to make certain calculations and report to the NRC about the continuing ability of the Palisades reactor vessel to withstand postulated pressurized thermal shock events during its remaining license life, in light of the embrittlement of reactor vessel materials over time due to operation in a radioactive environment. Based on continuing analysis of data from testing of similar materials, in 1996, Consumers received an interim Safety Evaluation Report from the NRC indicating that the reactor vessel can be safely operated through 2003 before reaching the NRC's screening criteria for reactor embrittlement. Consumers believes that with fuel management designed to minimize embrittlement, Palisades can be operated to the end of its license life in the year 2007 without annealing of the reactor vessel, but will continue to monitor the matter. Big Rock will close permanently on August 29, 1997, because management has determined that the plant would be uneconomical to operate in an increasingly competitive environment. The plant was originally scheduled to close May 31, 2000, at the end of the plant's operating license. Plant decommissioning will begin in September 1997 and is expected to take five to ten years to return the site to its original condition. The current decommissioning fund, together with future collections from customers and future earnings of the fund, is expected to be adequate to cover the plant decommissioning expenses. 9: Supplemental Cash Flow Information For purposes of the Statement of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Other cash flow activities and non-cash investing and financing activities for the periods ended June 30 were: In Millions Six Months Ended Twelve Months Ended 1997 1996 1997 1996 Cash transactions Interest paid (net of amounts capitalized) $135 $122 $267 $233 Income taxes paid (net of refunds) 46 45 83 60 Non-cash transactions Nuclear fuel placed under capital lease $ 3 $ 1 $ 31 $ 4 Other assets placed under capital leases 3 1 5 4 Common Stock issued to acquire companies - - - 66 Assumption of debt - - - 4 Capital leases refinanced - - - 21
ARTHUR ANDERSEN LLP Report of Independent Public Accountants ---------------------------------------- To CMS Energy Corporation: We have reviewed the accompanying consolidated balance sheets of CMS ENERGY CORPORATION (a Michigan corporation) and subsidiaries as of June 30, 1997 and 1996, the related consolidated statements of income and common stockholders' equity for the three-month, six-month and twelve- month periods then ended, and the related consolidated statements of cash flows for the six-month and twelve-month periods then ended. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet and consolidated statement of preferred stock of CMS Energy Corporation and subsidiaries as of December 31, 1996, and the related consolidated statements of income, common stockholders' equity and cash flows for the year then ended (not presented herein), and, in our report dated January 24, 1997, we expressed an unqualified opinion on those statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 1996, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. Arthur Andersen LLP Detroit, Michigan, August 11, 1997.
37 Consumers Energy Company Management's Discussion and Analysis The MD&A of this Form 10-Q should be read along with the MD&A in Consumers' 1996 Form 10-K. This report contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, including (without limitation) discussions as to expectations, beliefs, plans, objectives and future financial performance, or assumptions underlying or concerning matters discussed in this document. These discussions, and any other discussions contained in this Form 10-Q that are not historical facts, are forward-looking and, accordingly, involve estimates, assumptions and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. In addition to certain contingency matters (and their respective cautionary statements) discussed elsewhere, the Forward-Looking Information section of this MD&A indicates some important factors that could cause actual results or outcomes to differ materially from those addressed in the forward-looking discussions. Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan, and is the principal subsidiary of CMS Energy, a holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Consolidated Earnings In Millions June 30 1997 1996 Change Three months ended $ 54 $ 49 $ 5 Six months ended 141 143 (2) Twelve months ended 258 244 14 The increase in earnings for the second quarter of 1997 compared to the same 1996 period reflects increased electric sales and gas deliveries partially offset by reduced gas wholesale services revenues in 1997. The decrease in earnings for the six months ended 1997 compared to the same 1996 period reflects decreased gas deliveries due to warmer temperatures during the early part of 1997 and reduced gas wholesale services revenues in 1997. Partially offsetting these decreases were the favorable impact of an electric rate increase received in February 1996 which benefited the entire first half of 1997, along with improved operating results from the MCV Facility in which Consumers has a 49 percent interest. The increase in earnings for the twelve months ended 1997 compared to the same 1996 period reflects the favorable impact of an electric rate increase received in February 1996, revenues from gas services activities, and improved operating results from the MCV Facility. In addition, other operating income increased during the twelve months ended 1997 due to a FERC-ordered refund received by the MCV Partnership from a gas pipeline supplier. Partially offsetting the increases for the twelve months ended period were decreased electric revenues because of special contract discounts negotiated with large industrial customers and decreased gas deliveries due to warmer temperatures during the first quarter of 1997. For further information, see the Electric and Gas Utility Results of Operations sections and Note 3. Cash Position, Investing and Financing Operating Activities: Cash from operations is derived from the sale and transportation of natural gas and the generation, transmission, and sale of electricity. Cash from operations totaled $413 million and $453 million for the first six months of 1997 and 1996, respectively. The $40 million decrease resulted from the timing of cash payments related to routine operations. Operating cash is used primarily to maintain and expand electric and gas systems, retire portions of long-term debt, and pay dividends. Investing Activities: Cash used in investing activities totaled $205 million and $223 million for the first six months of 1997 and 1996, respectively. The cash was used primarily for capital expenditures. Financing Activities: Cash used in financing activities totaled $201 million and $237 million for the first six months of 1997 and 1996, respectively. The decrease of $36 million in cash used reflects a $141 million reduction in the paydown of notes payable for the first six months of 1997 compared to 1996; this retirement was partially offset by the 1997 absence of $97 million proceeds from preferred securities that were sold in 1996. Other Investing and Financing Matters: Several unsecured, committed lines of credit totaling $120 million and a $425 million working capital facility are available to meet short-term borrowing requirements to finance working capital and gas in storage, and to pay for capital expenditures between long-term financings. At June 30, 1997 and 1996, the total amount outstanding under these facilities was $241 million and $108 million, respectively. Consumers has FERC authorization to issue or guarantee up to $900 million of short-term securities through 1998 and to issue $500 million of long-term securities through November 1998 for refinancing or refunding purposes. An agreement is also in place permitting the sales of certain accounts receivable for up to $500 million. At June 30, 1997 and 1996, receivables sold totaled $266 million and $200 million, respectively. In August 1997, Consumers and an affiliated business trust, Consumers Energy Company Financing II, filed a registration statement with the SEC for the issuance and sale of up to $120 million of trust originated preferred securities. Consumers Energy Company Financing II was formed for the sole purpose of issuing trust originated preferred securities and investing the proceeds in subordinated notes which will be unsecured obligations of Consumers. Consumers will use the net proceeds from the sale of the subordinated notes to redeem, refinance or refund existing long-term securities, which may include first mortgage bonds, stocks, preferred securities or notes. In August 1997, Consumers announced that it will redeem all of the outstanding shares of its $7.45, $7.68, $7.72 and $7.76 preferred stock. This $119 million redemption of preferred stock will take place in September 1997. Electric Utility Results of Operations Electric Pretax Operating Income: In Millions June 30 1997 1996 Change Three months ended $104 $ 96 $ 8 Six months ended 210 202 8 Twelve months ended 419 399 20 Electric pretax operating income for all periods ending June 30, 1997, benefited from the favorable impact of increased electric sales. Electric pretax operating income for the first half of 1997 and the twelve months ended 1997 also benefited from the impact of an electric rate increase received in February 1996. The first half of 1997 reflects six months of rate increase compared to five months for the comparable period in 1996. The twelve months ended 1997 reflects a full twelve months of rate increase compared with five months for the comparable period in 1996. These increases in each period were partly offset by decreased revenues because of special contract discounts negotiated with large industrial customers. The following table quantifies these impacts on Pretax Operating Income: In Millions Three Months Six Months Twelve Months Ended June 30 Ended June 30 Ended June 30 Change Compared to Prior Year 1997 vs 1996 1997 vs 1996 1997 vs 1996 Sales (including special $ 7 $ 4 $ (4) contract discounts) Rate increases and other 1 11 39 regulatory issues Operations and maintenance 2 (1) (7) General taxes and depreciation (2) (6) (8) and other ---- ---- ---- Total change $ 8 $ 8 $ 20 ==== ==== ==== Electric Sales: Total electric sales increased for the quarter ended (1.7 percent), six months ended (1.0 percent), and twelve months ended (2.7 percent) June 30, 1997, over the comparable 1996 periods. The table below reflects electric kWh sales by class of customer for each period: <TABLE> <CAPTION> In Billions of kWh Three Months Ended Six Months Ended Twelve Months Ended June 30 1997 1996 Change 1997 1996 Change 1997 1996 Change <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Residential 2.5 2.4 0.1 5.3 5.4 (0.1) 10.9 11.0 (0.1) Commercial 2.5 2.4 0.1 4.9 4.8 0.1 10.1 9.8 0.3 Industrial 3.4 3.2 0.2 6.4 6.1 0.3 13.2 12.5 0.7 Other 0.6 0.9 (0.3) 1.4 1.6 (0.2) 3.0 2.9 0.1 --- --- ---- ---- ---- ---- ---- ---- ---- Total Sales 9.0 8.9 0.1 18.0 17.9 0.1 37.2 36.2 1.0 === === === ==== ==== === ==== ==== ==== </TABLE> Power Costs: In Millions June 30 1997 1996 Change Three months ended $ 270 $ 260 $ 10 Six months ended 552 520 32 Twelve months ended 1,119 1,028 91 The cost increases for all periods ended June 30, 1997, reflect greater power purchases from outside sources to meet the increased sales demand. Electric Utility Issues Power Purchases from the MCV Partnership: Consumers' annual obligation to purchase capacity from the MCV Partnership is 1,240 MW through the termination of the PPA in 2025. The MPSC currently allows Consumers to recover substantially all payments for 915 MW of capacity purchased from the MCV Partnership. Beginning January 1, 1996, Consumers was also permitted to recover an average capacity charge of 2.86 cents per kWh for the remaining 325 MW of MCV Facility capacity. The approved average capacity charge increased to 3.62 cents per kWh for 109 MW by January 1, 1997. The recoverable portion of the capacity charge for the last 216 MW of the 325 MW increases each year until it reaches 3.62 cents per kWh in 2004, and remains at this ceiling rate through the end of the PPA term. In 1992, Consumers recognized a loss for the present value of the estimated future underrecoveries of power purchases from the MCV Partnership. Consumers anticipates it will continue to experience cash underrecoveries associated with the PPA as shown below. These after-tax cash underrecoveries were based on the assumption that the MCV Facility would be available to generate electricity 90 percent of the time. However, for the first six months of 1997 the MCV Facility has been available 98.9 percent of the time, resulting in after-tax cash underrecoveries of $20 million. The underrecovery shown in the table below for the year 1997 has been revised to reflect the anticipated availability of the MCV Facility. For further information, see Note 2. In Millions 1997 1998 1999 2000 2001 Estimated cash underrecoveries, $40 $23 $22 $21 $20 net of tax The amount of underrecoveries of power costs continues to be based, in part, on management's best assessment of the future availability of the MCV Facility. If the MCV Facility operates at levels above management's estimate over the remainder of the PPA, future losses will need to be recognized over and above amounts previously recorded and Consumers would experience greater amounts of cash underrecoveries than originally anticipated. Management will continue to evaluate the adequacy of the accrued liability considering actual facility operations. Electric Rate Proceedings: In 1996, the MPSC issued a final order which authorized Consumers to recover costs associated with the purchase of the additional 325 MW of MCV Facility capacity and to accelerate recovery of its nuclear plant investment by increasing prospective annual nuclear plant depreciation expense by $18 million with a corresponding decrease in fossil-fueled generating plant depreciation expense. It also established a direct access program. Rehearing petitions have been ruled upon by the MPSC and resulted in no material changes to the relief granted Consumers. For further discussion on these issues, see Notes 2 and 3. Nuclear Matters: In January 1997, the NRC issued its Systematic Assessment of Licensee Performance report for Palisades. The report rated all areas as good, unchanged from the previous assessment. Consumers is required to make certain calculations and report to the NRC about the continuing ability of the Palisades reactor vessel to withstand postulated pressurized thermal shock events during its remaining license life, in light of the embrittlement of reactor vessel materials over time due to operation in a radioactive environment. Based on continuing analysis of data from testing of similar materials, in 1996, Consumers received an interim Safety Evaluation Report from the NRC indicating that the reactor vessel can be safely operated through 2003, before reaching the NRC's screening criteria for reactor embrittlement. Consumers believes that with a change in fuel management designed to minimize embrittlement, Palisades can be operated to the end of its license life in the year 2007 without annealing of the reactor vessel, but will continue to monitor the matter. Palisades' on-site storage pool for spent nuclear fuel is at capacity. Consequently, NRC-approved dry casks, which are steel and concrete vaults, are being used for temporary on-site storage. For further information, see Note 6. Big Rock will close permanently on August 29, 1997, because management has determined that the plant would be uneconomical to operate in an increasingly competitive environment. The plant was originally scheduled to close May 31, 2000, at the end of the plant's operating license. Plant decommissioning will begin in September 1997 and is expected to take five to ten years to return the site to its original condition. The current decommissioning fund, together with future collections from customers and future earnings of the fund, is expected to be adequate to cover the plant decommissioning expenses. Electric Environmental Matters: The Clean Air Act contains significant environmental constraints under which industry will operate in the future. While certain of the Act's provisions specific to utilities will require that certain capital expenditures be made to comply with nitrogen oxide emission limits, Consumers' generating units are currently operating at or near the sulfur dioxide emission limits that will be effective in the year 2000. Management does not believe that these expenditures will have a material effect on annual operating costs. The Clean Air Act also contains national air quality standards under which industry must operate. Currently, Consumers operates within these standards and meets current ozone and small particle related emission limits. The Act requires the EPA to periodically review the effectiveness of these standards in preventing adverse health affects. The EPA recently revised these standards to increase the restrictions on small particle and ozone related emissions. Consumers supports the bi-partisan effort in Congress to delay implementation of the revised standards until the relationship between the new standards and health improvements is established. In addition, the EPA is reviewing recommendations from the Ozone Transport Assessment Group to reduce ozone transport across state lines. The EPA is expected to require the State of Michigan to impose additional nitrogen oxide reductions goals on Consumers' fossil-fueled generating units. The preliminary estimate of the cost of the changes Consumers may have to make to its fossil-fueled generating units to reduce ozone related emissions is approximately $175 million. A potentially equivalent amount may be needed to comply with the new small particle standards. Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, and believes that these costs are properly recoverable in rates under current ratemaking policies. Consumers is a so-called potentially responsible party at several sites being administered under Superfund. In addition, there are numerous credit worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on current information, management believes it is unlikely that the liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on its financial position, liquidity or results of operations. For further information regarding electric environmental matters, see Note 5. Stray Voltage: A number of lawsuits have been filed against Consumers relating to the effect of so-called stray voltage on certain livestock. As of June 30, 1997, 18 separate stray voltage lawsuits were awaiting trial court action, down from 22 lawsuits as reported at year end 1996. Consumers believes that the resolution of the remaining lawsuits will not have a material impact on its financial position, liquidity or results of operations. Gas Utility Results of Operations Gas Pretax Operating Income: In Millions June 30 1997 1996 Change Three months ended $ 23 $ 23 $ - Six months ended 101 116 (15) Twelve months ended 143 160 (17) Gas pretax operating income, while flat for the three month period, decreased in both the six month and twelve month periods ended June 30, 1997, as a result of decreased gas deliveries due to warmer temperatures during the first quarter of 1997 and an extra day for leap year in 1996. The first half of 1997 also reflects higher depreciation and general taxes, partially offset by lower operation and maintenance expenses. The decrease in gas pretax operating income for the twelve months ended June 30, 1997, also reflects higher depreciation and general taxes from increased investments to serve new customers, partially offset by lower operations expenses and benefits from gas services activities. The following table quantifies these impacts on Pretax Operating Income: In Millions Three Months Six Months Twelve Months Ended June 30 Ended June 30 Ended June 30 Change Compared to 1997 vs 1996 1997 vs 1996 1997 vs 1996 Prior Year Sales $ 3 $(15) $(19) Recovery of gas costs and - - (3) other issues Gas wholesale and retail (5) (7) 4 services activities Operations and maintenance 5 10 4 General taxes, depreciation and other (3) (3) (3) ----- ---- ---- Total change $ - $(15) $(17) ===== ==== ==== Gas Deliveries: Total system deliveries, excluding transport to the MCV Facility and other miscellaneous transportation, increased 5.8 percent for the quarter ended June 30, 1997, but decreased 4.1 percent and 3.7 percent for the six months and twelve months ended June 30, 1997, respectively. The table below indicates total deliveries and the impact of weather. <TABLE> <CAPTION> In bcf Three Months Ended Six Months Ended Twelve Months Ended June 30 1997 1996 Change 1997 1996 Change 1997 1996 Change <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Weather-adjusted deliveries (variance reflects growth) 52 52 - 198 198 - 334 332 2 Impact of weather and leap year 8 5 3 4 13 (9) 9 24 (15) --- --- --- --- --- --- --- --- --- System deliveries excluding transport to MCV Facility 60 57 3 202 211 (9) 343 356 (13) Transport to MCV Facility 14 16 (2) 32 33 (1) 64 60 4 Other Transportation 2 4 (2) 10 18 (8) 18 26 (8) --- --- --- --- --- --- --- --- --- Total deliveries 76 77 (1) 244 262 (18) 425 442 (17) === === === === === === === === === </TABLE> Cost of Gas Sold: In Millions June 30 1997 1996 Change Three months ended $118 $107 $ 11 Six months ended 432 453 (21) Twelve months ended 729 744 (15) The increase for the three months ended June 30, 1997, reflects increased gas sales and slightly higher prices for gas during 1997. The decreases for the six month and twelve month periods ended June 30, 1997, were the result of decreased sales reflecting warmer temperatures and an extra day for leap year in 1996. Gas Utility Issues Gas Rate Proceedings: Consumers entered into a special natural gas transportation contract with one of its transportation customers in response to the customer's proposal to bypass Consumers' system in favor of a competitive alternative. The contract provides for discounted gas transportation rates in an effort to induce the customer to remain on Consumers' system. In 1995, the MPSC approved the contract but stated that the revenue shortfall created by the difference between the contract's discounted rate and the floor price of an MPSC-authorized gas transportation rate must be borne by Consumers' shareholders. In 1995, Consumers filed an appeal with the Court of Appeals, which is still pending, claiming that the MPSC decision denies Consumers the opportunity to earn its authorized rate of return and is therefore unconstitutional. GCR Matters: In 1995, the MPSC issued an order regarding a $44 million (excluding interest) gas supply contract pricing dispute between Consumers and certain intrastate producers. The order stated that Consumers was not obligated to seek prior approval of market-based pricing provisions that were implemented under the contracts in question. The producers subsequently filed a claim of appeal of the MPSC order with the Court of Appeals. Consumers believes the MPSC order correctly concludes that the producers' theories are without merit and will vigorously oppose any claims they may raise, but cannot predict the outcome of this issue. In the GCR reconciliation proceeding for the period April 1995 through March 1996, an issue has arisen questioning whether revenue from gas loaning (which was a new business activity for Consumers) should, in whole or in part, be immediately passed through to customers. The ALJ issued a proposal for decision in January 1997 that agreed with the MPSC staff's position that the gas loaning program uses storage assets of Consumers and therefore recommended that 90 percent of the revenue should be refunded to customers. If the MPSC adopts the ALJ position, $8 million as of June 30, 1997, would be subject to refund. Consumers has not provided a contingency reserve for this potential refund and will continue to oppose this view before the MPSC. Gas Environmental Matters: Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some that formerly housed manufactured gas plant facilities. Data available, and continued internal review of these former manufactured gas plant sites, have resulted in an estimate for all costs related to investigation and remedial action of between $48 million and $98 million. These estimates are based on undiscounted 1997 costs. At June 30, 1997, Consumers has accrued a liability for $48 million and has established a regulatory asset for approximately the same amount. Any significant change in assumptions such as remediation technique, nature and extent of contamination and regulatory requirements, could affect the estimate of remedial action costs for the sites. For further information regarding environmental matters, see Note 5. Forward-Looking Information Forward-looking information is included throughout this report. Material contingencies are also described in the Notes to Consolidated Financial Statements and should be read accordingly. Some important factors that could cause actual results or outcomes to differ materially from those discussed in the forward-looking statements include prevailing governmental policies and regulatory actions (including those of the FERC and the MPSC) with respect to rates, industry and rate structure, operation of nuclear power facilities, acquisition and disposal of assets and facilities, operation and construction of plant facilities, operation and construction of natural gas pipeline and storage facilities, recovery of the cost of purchased power or natural gas, decommissioning costs, and present or prospective wholesale and retail competition, among others. The business and profitability of Consumers are also influenced by economic and geographic factors, including political and economic risks, changes in environmental laws and policies, weather conditions, competition for retail and wholesale customers, pricing and transportation of commodities, market demand for energy, inflation, capital market conditions, and the ability to secure agreement in pending negotiations, among other important factors. All such factors are difficult to predict, contain uncertainties that may materially affect actual results, and may be beyond the control of Consumers. Capital Expenditures: Consumers estimates the following capital expenditures, including new lease commitments, by company and by business segment over the next three years. These estimates are prepared for planning purposes and are subject to revision. In Millions Years Ended December 31 1997 1998 1999 Consumers Construction $360 $349 $348 Nuclear fuel lease 14 23 13 Capital leases other than nuclear fuel 13 15 16 Michigan Gas Storage 3 3 3 ---- ---- ---- $390 $390 $380 ==== ==== ==== Electric utility operations (a) $275 $285 $275 Gas utility operations (a) 115 105 105 ---- ---- ---- $390 $390 $380 ==== ==== ==== (a) These amounts include an attributed portion of Consumers' anticipated capital expenditures for plant and equipment common to both the electric and gas utility businesses. Electric Outlook: Consumers expects average annual growth of two percent per year in electric system sales over the next five years, based on the current industry and regulatory configuration in Michigan. Actual electric sales in future periods may be affected by abnormal weather, changing economic conditions, or the developing competitive market for electricity. Consumers continues to work toward retaining its current retail service customers by offering electric rates that are competitive with those of other energy providers, and by improving reliability and customer communications. Consumers is also planning for a future environment in which direct access to alternative sources of energy supply is the predominant means by which retail service customers obtain their power requirements. Consumers' electric retail service is affected by competition in several areas, including the potential installation of cogeneration or other self- generation facilities by larger industrial customers; the formation of municipal utilities that would displace retail service to an entire community; competition from other utilities that offer flexible rate arrangements designed to encourage movement of facilities or production to their service areas; economic development competition between utilities; MPSC direct access programs and potential electric industry restructuring caused by regulatory decisions and new state or federal legislation. In 1996, the MPSC reduced the rate subsidization of residential customers by large industrial and commercial customers. In addition, in an effort to meet the challenge of competition, Consumers contracted with some of its largest industrial customers to serve certain facilities a number of years into the future. These contracts have been approved by the MPSC. FERC issued Orders 888 and 889, as amended on rehearing, requiring utilities to provide open access to the interstate transmission grid for wholesale transactions. Several FERC requirements have been implemented. However, one unresolved issue concerns the Michigan Electric Power Coordination Center Pool, currently operated jointly by Consumers and Detroit Edison. Consumers proposes to maintain the benefits of the pool, while Detroit Edison seeks to terminate the power pool agreement. The FERC is expected to rule on this issue in 1997. In response to utility filings previously solicited by the MPSC, in June 1997, the MPSC issued an order relating to the restructuring of the electric power industry in Michigan. The order proposes a phase-in of 150 MW annually of Consumers' retail load for competition beginning January 1, 1998. By January 1, 2002, all customers would be free to choose (that is, have direct-access to) their electric generation suppliers. The order would allow utilities to recover prudently incurred transition costs through a transmission charge applicable through the year 2007 for all direct-access retail customers. The MPSC requested the utilities to file proposals for a true-up mechanism to adjust transition charge revenues depending upon both actual sales and market prices of power to the extent that they are different from original estimates. Consumers subsequently filed a modified plan that has a true-up for sales and a true-up for power purchases only. The June 1997 order further states that securitization may be another alternative for recovery of transition costs, but recognizes that state legislation is required before securitization can be implemented. Michigan legislative consideration of a securitization process is expected this fall. Consumers expects the legislation to provide for immediate recovery of transition costs in exchange for an immediate rate reduction for all customers, with a securitization charge to be paid by all customers over a period of 15 years (the expected term of the rate reduction bonds issued in the securitization), as discussed further below. Consumers has filed responsive data and proposals to the June order asking the MPSC to take certain actions designed to implement Consumers' view of how electric restructuring should occur, including the approval of specific transition charges, but also seeking a rehearing on several issues, including whether the MPSC has the statutory authority to mandate restructuring on a basis which an electric utility would not accept voluntarily. Other parties filed claims of appeal with the Michigan Court of Appeals. The MPSC also decided in a July 1997 order to commence a number of different contested case proceedings to address certain selected issues on which it desired still more information. The expedited schedules for these hearings would have all of them concluded and submitted to the MPSC for decision by mid-October. Pretrial activity will occur in August, hearings in September and briefing in late September and early October. Consumers' March 1997 information estimated for the MPSC that, through 2007, Consumers would recover $1.9 billion (as revised in a June 1997 filing) of transition costs through a transition charge to direct-access customers. A separate charge to direct-access customers would also recover implementation costs totaling an additional $200 million. Alternatively, if Consumers recovers transition costs through securitization, the resulting securitization charge would be paid by all Consumers customers to service $4 billion of rate reduction bonds. The $4 billion in rate reduction bonds represents the net present value of: 1) the $1.9 billion of costs that Consumers would otherwise have recovered in the transition charge to direct access customers; and 2) the costs that Consumers would otherwise have recovered from customers on bundled rates before getting choice of generation suppliers. Consumers' data indicate that the rates to be paid by all customers under the securitization alternative result in more than a $200 million annual savings to those customers when compared to the rates they would pay without securitization because the assumed 15-year repayment period of the bonds allows the cost reimbursement by the customers to be spread out over a longer period, and because securitization allows securitized costs to be financed at a lower rate. Consumers currently applies the utility accounting standard, SFAS 71, that recognizes the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities related to its generation, transmission and distribution operations in its financial statements. If rate recovery of generation-related costs becomes unlikely or uncertain, whether due to competition or regulatory action, this accounting standard may no longer apply to Consumers' generation segment. Such a change could result in either full recovery of generation-related regulatory assets (net of related regulatory liabilities) or a loss, depending on whether Consumers' regulators adopt a transition mechanism for the recovery of all or a portion of these net regulatory assets. Based on a current evaluation of the various factors and conditions that are expected to affect future cost recovery, Consumers believes even if it was to discontinue application of SFAS 71 for the generation segment of its business, that its regulatory assets, including those related to generation, are probable of future recovery. Gas Outlook: Consumers currently anticipates gas deliveries (excluding transportation to the MCV Facility and off-system deliveries) to grow on an average annual basis between one and two percent over the next five years based primarily on a steadily growing customer base. Consumers has several strategies to increase load requirements. These strategies include increased efforts to promote natural gas to both current and potential customers that are using other fuels for space and water heating. Consumers also plans additional capital expenditures to construct new gas mains that are expected to expand Consumers' system. Actual gas deliveries in future periods may be affected by abnormal weather, alternative energy prices, changes in competitive conditions, and the level of natural gas consumption. Consumers is also offering a variety of energy-related services to its customers focused upon appliance maintenance, home safety, and home security. In 1996 the MPSC issued an order requesting Consumers and other local gas distribution companies, whose rates are regulated by the MPSC, to develop pilot programs that would allow customers to purchase gas directly from other suppliers and have the gas transported through local pipelines. These pilot programs are to last for two years and are intended to help the MPSC determine whether it is appropriate to extend this option to all retail customers. In December 1996, the MPSC approved Consumers' pilot program for 40,000 customers in Bay County. The first customer solicitation ended in March 1997 and resulted in one percent of the customers choosing an alternative supplier for the next year. Another solicitation period will begin in late 1997 for the period April 1998 - March 1999; expected customer interest is unknown at this time. Based on a regulated utility accounting standard, SFAS 71, Consumers is allowed to defer certain costs to the future and record regulatory assets, based on the recoverability of those costs through the MPSC's approval. Consumers has evaluated its regulatory assets related to its gas business, and believes that sufficient regulatory assurance exists to provide for the recovery of these deferred costs. Other New Accounting Standards: In 1997, the FASB issued SFAS 128, Earnings per Share and SFAS 129, Disclosure of Information about Capital Structure, which are effective for year end 1997 financial statements. In 1997, the FASB also issued SFAS 130, Reporting Comprehensive Income and SFAS 131, Disclosures about Segments of an Enterprise and Related Information, each of which will require expanded disclosures effective for 1998. Consumers does not expect the application of these statements to have a material effect on its financial position, liquidity or results of operations. (This page intentionally left blank)
<TABLE> Consumers Energy Company Consolidated Statements of Income (Unaudited) <CAPTION> Three Six Twelve Months Ended Months Ended Months Ended June 30 1997 1996 1997 1996 1997 1996 In Millions <S> <C> <C> <C> <C> <C> <C> Operating Revenue Electric $ 598 $ 581 $1,218 $1,172 $2,492 $2,366 Gas 220 209 718 757 1,242 1,273 Other 11 9 20 13 50 31 ------ ------ ------ ------ ------ ------ 829 799 1,956 1,942 3,784 3,670 ------ ------ ------ ------ ------ ------ Operating Expenses Operation Fuel for electric generation 71 70 140 143 293 292 Purchased power - related parties 146 146 297 286 600 532 Purchased and interchange power 53 44 115 91 226 204 Cost of gas sold 118 107 432 453 729 744 Other 131 141 260 273 573 579 ------ ----- ------ ------ ------ ------ 519 508 1,244 1,246 2,421 2,351 Maintenance 41 37 80 76 178 170 Depreciation, depletion and amortization 87 82 199 190 379 367 General taxes 45 42 103 99 196 193 ------ ------ ------ ------ ------ ------ 692 669 1,626 1,611 3,174 3,081 ------ ------ ------ ------ ------ ------ Pretax Operating Income Electric 104 96 210 202 419 399 Gas 23 23 101 116 143 160 Other 10 11 19 13 48 30 ------ ------ ------ ------ ------ ------ 137 130 330 331 610 589 ------ ------ ------ ------ ------ ------ Other Income (Deductions) Dividends from affiliates 4 4 9 9 17 17 Accretion income 2 2 4 5 9 11 Accretion expense (4) (7) (9) (14) (17) (29) Other, net - - - - (4) 2 ------ ------ ------ ------ ------ ------ 2 (1) 4 - 5 1 ------ ------ ------ ------ ------ ------ Interest Charges Interest on long-term debt 35 35 69 69 139 139 Other interest 7 7 16 14 32 35 Capitalized interest - (1) - (1) (1) (3) ------ ------ ------ ------ ------ ------ 42 41 85 82 170 171 ------ ------ ------ ------ ------ ------ Net Income Before Income Taxes 97 88 249 249 445 419 Income Taxes 34 30 90 88 151 143 ------ ------ ------ ------ ------ ------ Net Income 63 58 159 161 294 276 Preferred Stock Dividends 7 7 14 14 28 28 Preferred Securities Distributions 2 2 4 4 8 4 ------ ------ ------ ------ ------ ------ Net Income Available to Common Stockholder $ 54 $ 49 $ 141 $ 143 $ 258 $ 244 ====== ====== ====== ====== ====== ====== <FN> The accompanying condensed notes are an integral part of these statements. </TABLE>
50 <TABLE> Consumers Energy Company Consolidated Statements of Cash Flows (Unaudited) <CAPTION> Six Months Ended Twelve Months Ended June 30 1997 1996 1997 1996 In Millions <S> <C> <C> <C> <C> Cash Flows from Operating Activities Net income $ 159 $ 161 $ 294 $ 276 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, depletion and amortization (includes nuclear decommissioning of $24, $24, $49 and $51, respectively) 199 190 379 367 Capital lease and other amortization 21 21 40 40 Deferred income taxes and investment tax credit 16 25 39 40 Accretion expense 9 14 17 29 Accretion income - abandoned Midland project (4) (5) (9) (11) Undistributed earnings of related parties (20) (12) (50) (30) Power purchases (30) (27) (66) (94) Other 3 3 5 5 Changes in other assets and liabilities 60 83 (17) 128 ----- ----- ----- ----- Net cash provided by operating activities 413 453 632 750 ----- ----- ----- ----- Cash Flows from Investing Activities Capital expenditures (excludes assets placed under capital lease) (165) (184) (391) (423) Investments in nuclear decommissioning trust funds (24) (24) (49) (51) Cost to retire property, net (11) (12) (31) (34) Other (5) 2 (6) 2 Deferred demand-side management costs - (5) - (10) ----- ----- ----- ----- Net cash used in investing activities (205) (223) (477) (516) ----- ----- ----- ----- Cash Flows from Financing Activities Increase (decrease) in notes payable, net (92) (233) 133 (201) Payment of common stock dividends (70) (75) (195) (75) Payment of capital lease obligations (21) (21) (39) (38) Payment of preferred stock dividends (14) (14) (28) (28) Preferred securities distributions (4) (4) (8) (4) Proceeds from preferred securities - 97 - 97 Contribution from stockholder - 13 - 13 Retirement of bonds and other long-term debt - - (37) (1) Proceeds from bank loans - - 23 - ----- ----- ----- ----- Net cash used in financing activities (201) (237) (151) (237) ----- ----- ----- ----- Net Increase (Decrease) in Cash and Temporary Cash Investments 7 (7) 4 (3) Cash and Temporary Cash Investments, Beginning of Period 4 14 7 10 ----- ----- ----- ----- Cash and Temporary Cash Investments, End of Period $ 11 $ 7 $ 11 $ 7 ===== ===== ===== ===== <FN> The accompanying condensed notes are an integral part of these statements. </TABLE>
<TABLE> Consumers Energy Company Consolidated Balance Sheets <CAPTION> ASSETS June 30 June 30 1997 December 31 1996 (Unaudited) 1996 (Unaudited) In Millions <S> <C> <C> <C> Plant (At original cost) Electric $6,467 $6,333 $6,177 Gas 2,270 2,203 2,229 Other 25 26 26 ------ ------ ------ 8,762 8,562 8,432 Less accumulated depreciation, depletion and amortization 4,490 4,269 4,276 ------ ------ ------ 4,272 4,293 4,156 Construction work-in-progress 119 158 226 ------ ------ ------ 4,391 4,451 4,382 ------ ------ ------ Investments Stock of affiliates 302 298 340 First Midland Limited Partnership (Note 2) 237 232 228 Midland Cogeneration Venture Limited Partnership (Note 2) 148 134 110 Other 10 8 9 ------ ------ ------ 697 672 687 ------ ------ ------ Current Assets Cash and temporary cash investments at cost, which approximates market 11 4 7 Accounts receivable and accrued revenue, less allowances of $8, $10 and $2, respectively (Note 4) 80 148 104 Accounts receivable - related parties 87 63 26 Inventories at average cost Gas in underground storage 125 186 109 Materials and supplies 75 68 73 Generating plant fuel stock 28 30 23 Postretirement benefits 25 25 25 Deferred income taxes 14 27 22 Prepayments and other 78 183 112 ------ ------ ------ 523 734 501 ------ ------ ------ Non-current Assets Postretirement benefits 419 435 450 Nuclear decommissioning trust funds 443 386 339 Abandoned Midland Project 103 113 122 Other 240 234 288 ------ ------ ------ 1,205 1,168 1,199 ------ ------ ------ Total Assets $6,816 $7,025 $6,769 ====== ====== ====== </TABLE>
<TABLE> <CAPTION> STOCKHOLDERS' INVESTMENT AND LIABILITIES June 30 June 30 1997 December 31 1996 (Unaudited) 1996 (Unaudited) In Millions <S> <C> <C> <C> Capitalization Common stockholder's equity Common stock $ 841 $ 841 $ 841 Paid-in-capital 504 504 504 Revaluation capital 41 37 31 Retained earnings since December 31, 1992 368 297 305 ------ ------ ------ 1,754 1,679 1,681 Preferred stock 356 356 356 Company-obligated mandatorily redeemable preferred securities of Consumers Power Company Financing I (a) 100 100 100 Long-term debt 1,612 1,900 1,925 Non-current portion of capital leases 88 100 92 ------ ------ ------ 3,910 4,135 4,154 ------ ------ ------ Current Liabilities Current portion of long-term debt and capital leases 390 98 83 Accrued taxes 154 211 151 Accounts payable 149 212 170 Notes payable 241 333 108 Accounts payable - related parties 70 68 65 Power purchases (Note 2) 47 47 90 Accrued interest 32 33 37 Accrued refunds 7 8 25 Other 131 176 165 ------ ------ ------ 1,221 1,186 894 ------ ------ ------ Non-current Liabilities Deferred income taxes 642 646 620 Postretirement benefits 501 500 514 Power purchases (Note 2) 157 178 207 Deferred investment tax credit 154 159 164 Regulatory liabilities for income taxes, net 81 66 57 Other 150 155 159 ------ ------ ------ 1,685 1,704 1,721 ------ ------ ------ Commitments and Contingencies (Notes 2, 3, 5 and 6) Total Stockholders' Investment and Liabilities $6,816 $7,025 $6,769 ====== ====== ====== <FN> (a) As described in Note 4 to the Consolidated Financial Statements, the primary asset of Consumers Power Company Financing I is $103 million principal amount of 8.36% subordinated interest notes due 2015 from Consumers. The accompanying condensed notes are an integral part of these statements. </TABLE>
<TABLE> Consumers Energy Company Consolidated Statements of Common Stockholder's Equity (Unaudited) <CAPTION> Three Months Ended Six Months Ended Twelve Months Ended June 30 1997 1996 1997 1996 1997 1996 In Millions <S> <C> <C> <C> <C> <C> <C> Common Stock At beginning and end of period $ 841 $ 841 $ 841 $ 841 $ 841 $ 841 ------- ------- ------- ------- ------- ------- Other Paid-in Capital At beginning of period 504 504 504 491 504 491 Stockholder's contribution - - - 13 - 13 ------- ------- ------- ------- ------- ------- At end of period 504 504 504 504 504 504 ------- ------- ------- ------- ------- ------- Revaluation Capital At beginning of period 36 29 37 29 31 19 Change in unrealized investment- gain (loss) 5 2 4 2 10 12 ------- ------- ------- ------- ------- ------- At end of period 41 31 41 31 41 31 ------- ------- ------- ------- ------- ------- Retained Earnings At beginning of period 384 331 297 237 305 136 Net income 63 58 159 161 294 276 Common stock dividends declared (70) (75) (70) (75) (195) (75) Preferred stock dividends declared (7) (7) (14) (14) (28) (28) Preferred securities distributions (2) (2) (4) (4) (8) (4) ------- ------- ------- ------- ------- ------- At end of period 368 305 368 305 368 305 ------- ------- ------- ------- ------- ------- Total Common Stockholder's Equity $ 1,754 $ 1,681 $ 1,754 $ 1,681 $ 1,754 $ 1,681 ======= ======= ======= ======= ======= ======= <FN> The accompanying condensed notes are an integral part of these statements. </TABLE>
54 Consumers Energy Company Condensed Notes to Consolidated Financial Statements These financial statements and their related condensed notes should be read along with the consolidated financial statements and notes contained in the Consumers 1996 Form 10-K that includes the Report of Independent Public Accountants. In the opinion of management, the unaudited information herein reflects all adjustments necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. 1: Corporate Structure Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan, and is the principal subsidiary of CMS Energy, a holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. 2: The Midland Cogeneration Venture The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990 and to supply electricity and steam to Dow. Consumers, through two wholly owned subsidiaries, holds the following assets related to the MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings holds, through the FMLP, a 35 percent lessor interest in the MCV Facility. Summarized Statements of Income for CMS Midland and CMS Holdings: <TABLE> <CAPTION> In Millions Three Months Ended Six Months Ended Twelve Months Ended June 30 1996 1997 1996 1997 1996 1997 <S> <C> <C> <C> <C> <C> <C> Pretax operating income $10 $10 $18 $12 $46 $28 Income taxes and other 3 3 5 3 13 7 --- --- --- --- --- --- Net income $ 7 $ 7 $13 $ 9 $33 $21 === === === === === === </TABLE> Power Purchases from the MCV Partnership: Consumers' annual obligation to purchase capacity from the MCV Partnership is 1,240 MW through the termination of the PPA in 2025. The PPA provides that Consumers is to pay the MCV Partnership a minimum levelized average capacity charge of 3.77 cents per kWh, a fixed energy charge, and a variable energy charge based primarily on Consumers' average cost of coal consumed. Consumers is recovering capacity charges averaging 3.62 cents per kWh for 915 MW of capacity, the fixed energy charge, and the prescribed energy charges associated with the scheduled deliveries within certain hourly availability limits, whether or not those deliveries are scheduled on an economic basis. Beginning January 1, 1996, Consumers was also permitted to recover an average capacity charge of 2.86 cents per kWh for the remaining 325 MW of MCV Facility capacity. The approved average capacity charge increased to 3.62 cents per kWh for 109 MW by January 1, 1997. The recoverable portion of the capacity charge for the last 216 MW of the 325 MW increases each year until it reaches 3.62 cents per kWh in 2004, and remains at this ceiling rate through the end of the PPA term. Consumers previously recognized a loss in 1992 for the present value of the estimated future underrecoveries of power costs under the PPA. At June 30, 1997 and December 31, 1996, the after-tax present value of the PPA liability totaled $133 million and $147 million, respectively. The reduction in the liability since December 31, 1996 reflects after-tax cash underrecoveries of $20 million partially offset by after-tax accretion expense of $6 million. The undiscounted after-tax amount associated with the liability totaled $520 million at June 30, 1997. Consumers anticipates it will continue to experience cash underrecoveries associated with the PPA as shown below. These after-tax cash underrecoveries were based on the assumption that the MCV Facility would be available to generate electricity 90 percent of the time. However, for the first six months of 1997 the MCV Facility has been available 98.9 percent of the time resulting in the $20 million of after-tax cash underrecoveries. The underrecovery shown in the table below for the year 1997 has been revised to reflect the anticipated availability of the MCV Facility. In Millions 1997 1998 1999 2000 2001 Estimated cash underrecoveries, $40 $23 $22 $21 $20 net of tax The amount of underrecoveries of power costs continues to be based, in part, on management's best assessment of the future availability of the MCV Facility. If the MCV Facility operates at levels above management's estimate over the remainder of the PPA, future losses will need to be recognized over and above amounts previously recorded and Consumers would experience greater amounts of cash underrecoveries than originally anticipated. Management will continue to evaluate the adequacy of the accrued liability considering actual facility operations. PSCR Matters Related to Power Purchases from the MCV Partnership: As part of a 1995 decision in the PSCR reconciliation case for 1993, the MPSC disallowed a portion of the costs related to purchases from the MCV Partnership, and instead assumed recovery of those costs from wholesale customers. Consumers believed this was contrary to the terms of an earlier 1993 settlement order and appealed. The MCV Partnership and ABATE also filed separate appeals of this order. In November 1996, the Court of Appeals affirmed the MPSC's 1995 order. Consumers and the MCV Partnership filed petitions for rehearing of the Court of Appeals opinion, which were denied in January 1997. 3: Rate Matters Electric Proceedings: In 1996, the MPSC issued a final order which authorized Consumers to recover costs associated with the purchase of the additional 325 MW of MCV Facility capacity (see Note 2) and to accelerate recovery of its nuclear plant investment by increasing prospective annual nuclear plant depreciation expense by $18 million with a corresponding decrease in fossil-fueled generating plant depreciation expense. It also established an experimental direct access program. Customers having a maximum demand of at least 2 MW are eligible to purchase generation services directly from any eligible third-party power supplier. The program is limited to 650 MW of sales, of which 410 MW has already been filled by existing contracts. An additional 140 MW may be filled by new special contracts which the MPSC has approved or by direct access customers. The remaining 100 MW must be made available solely to direct access customers for at least 18 months. In April 1997, a lottery was held to select the customers to purchase 100 MW by direct access. Direct access for this 100 MW is expected to begin during the third quarter of 1997. In May 1997, the MPSC authorized Consumers to collect $17 million from electric customers through a one-time surcharge pertaining to the 1994 PSCR reconciliation. Electric Restructuring: In response to utility filings previously solicited by the MPSC, in June 1997, the MPSC issued an order relating to the restructuring of the electric power industry in Michigan. The order proposes a phase-in of 150 MW annually of Consumers' retail load for competition beginning January 1, 1998. By January 1, 2002, all customers would be free to choose (that is, have direct-access to) their electric generation suppliers. The order would allow utilities to recover prudently incurred transition costs through a transmission charge applicable through the year 2007 for all direct-access retail customers. The MPSC requested the utilities to file proposals for a true-up mechanism to adjust transition charge revenues depending upon both actual sales and market prices of power to the extent that they are different from original estimates. Consumers subsequently filed a modified plan that has a true- up for sales and a true-up for power purchases only. The June 1997 order further states that securitization may be another alternative for recovery of transition costs, but recognizes that state legislation is required before securitization can be implemented. Michigan legislative consideration of a securitization process is expected this fall. Consumers expects the legislation to provide for immediate recovery of transition costs in exchange for an immediate rate reduction for all customers, with a securitization charge to be paid by all customers over a period of 15 years (the expected term of the rate reduction bonds issued in the securitization), as discussed further below. Consumers has filed responsive data and proposals to the June order asking the MPSC to take certain actions designed to implement Consumers' view of how electric restructuring should occur, including the approval of specific transition charges, but also seeking a rehearing on several issues, including whether the MPSC has the statutory authority to mandate restructuring on a basis which an electric utility would not accept voluntarily. Other parties filed claims of appeal with the Michigan Court of Appeals. The MPSC also decided in a July 1997 order to commence a number of different contested case proceedings to address certain selected issues on which it desired still more information. The expedited schedules for these hearings would have all of them concluded and submitted to the MPSC for decision by mid-October. Pretrial activity will occur in August, hearings in September and briefing in late September and early October. Consumers' March 1997 information estimated for the MPSC that, through 2007, Consumers would recover $1.9 billion (as revised in a June 1997 filing) of transition costs through a transition charge to direct-access customers. A separate charge to direct-access customers would also recover implementation costs totaling an additional $200 million. Alternatively, if Consumers recovers transition costs through securitization, the resulting securitization charge would be paid by all Consumers customers to service $4 billion of rate reduction bonds. The $4 billion in rate reduction bonds represents the net present value of: 1) the $1.9 billion of costs that Consumers would otherwise have recovered in the transition charge to direct access customers; and 2) the costs that Consumers would otherwise have recovered from customers on bundled rates before getting choice of generation suppliers. Consumers' data indicate that the rates to be paid by all customers under the securitization alternative result in more than a $200 million annual savings to those customers when compared to the rates they would pay without securitization because the assumed 15-year repayment period of the bonds allows the cost reimbursement by the customers to be spread out over a longer period, and because securitization allows securitized costs to be financed at a lower rate. Consumers currently applies the utility accounting standard, SFAS 71, that recognizes the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities related to its generation, transmission and distribution operations in its financial statements. If rate recovery of generation-related costs becomes unlikely or uncertain, whether due to competition or regulatory action, this accounting standard may no longer apply to Consumers' generation segment. Such a change could result in either full recovery of generation-related regulatory assets (net of related regulatory liabilities) or a loss, depending on whether Consumers' regulators adopt a transition mechanism for the recovery of all or a portion of these net regulatory assets. Based on a current evaluation of the various factors and conditions that are expected to affect future cost recovery, Consumers believes even if it was to discontinue application of SFAS 71 for the generation segment of its business, that its regulatory assets, including those related to generation, are probable of future recovery. Gas Proceedings: In the GCR reconciliation proceeding for the period April 1995 through March 1996, an issue has arisen questioning whether revenue from gas loaning (which was a new business activity for Consumers) should, in whole or in part, be immediately passed through to customers. The ALJ issued a proposal for decision in January 1997 that agreed with the MPSC staff's position that the gas loaning program uses storage assets of Consumers and therefore recommended that 90 percent of the revenue should be refunded to customers. If the MPSC adopts the ALJ position,$8 million as of June 30, 1997, would be subject to refund. Consumers has not provided a contingency reserve for this potential refund and will continue to oppose this view before the MPSC. In 1996, the MPSC authorized Consumers to implement a pilot gas transportation program in Bay County, Michigan. The pilot program provides residential and small commercial customers the opportunity to purchase gas from suppliers other than Consumers for a two-year period beginning April 1997. Out of the 40,000 eligible customers, only 500 volunteered to participate in the program. Consumers will retain its role as transporter and distributor of this gas. In 1995, the MPSC issued an order regarding a $44 million (excluding interest) gas supply contract pricing dispute between Consumers and certain intrastate producers. The order stated that Consumers was not obligated to seek prior approval of market-based pricing changes that were implemented under the contracts in question. The producers subsequently filed a claim of appeal of the MPSC order with the Court of Appeals. Consumers believes the MPSC order correctly concludes that the producers' theories are without merit and will vigorously oppose any claims they may raise, but cannot predict the outcome of this issue. Resolution of the issues discussed in this note is not expected to have a material effect on Consumers' financial position or results of operations. 4: Short-Term Financings and Capitalization Consumers has FERC authorization to issue or guarantee up to $900 million of short-term debt through 1998. Consumers has an unsecured $425 million facility, and unsecured committed lines of credit aggregating $120 million that are used to finance seasonal working capital requirements. At June 30, 1997, a total of $241 million was outstanding at a weighted average interest rate of 6.2 percent, compared with $108 million outstanding at June 30, 1996, at a weighted average interest rate of 6.1 percent. Consumers has also in place a $500 million trade receivables purchase and sale program. At June 30, 1997 and 1996, receivables sold under the agreement totaled $266 million and $200 million, respectively. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold. Consumers uses interest rate swaps (derivatives) to manage exposure to fluctuations in interest rates. In order for derivatives to initially qualify for hedge accounting the following criteria must be met: 1) the item to be hedged exposes the enterprise to interest rate risk; and 2) the derivative reduces that exposure and is designated as a hedge. Derivative instruments contain credit risk if the counterparties, including financial institutions, fail to perform under the agreements. However, Consumers minimizes such risk by performing financial credit reviews using, among other things, publicly available credit ratings of such counterparties. The risk of nonperformance by the counterparties is considered remote. Consumers enters into interest rate swap agreements to exchange variable rate interest payment obligations for fixed rate obligations. These agreements convert variable rate debt to fixed rate debt in order to reduce the impact of interest rate fluctuations. The hedged amounts are used to measure interest to be paid or received and do not represent the amount of exposure to credit loss. The hedged amount of Consumers' interest rate swaps was $463 million at June 30, 1997. The difference between the amounts paid and received under the swaps is accrued and recorded as an adjustment to interest expense over the life of the hedged agreement. In 1996, four million shares of 8.36 percent trust originated preferred securities were issued and sold through Consumers Power Company Financing I, a business trust wholly owned by Consumers. Net proceeds from the sale totaled $97 million. Consumers Power Company Financing I was formed for the sole purpose of issuing the trust originated preferred securities. Its primary asset is $103 million principal amount of 8.36 percent unsecured subordinated deferrable interest notes issued by Consumers which mature in 2015. Consumers' obligations with respect to the trust originated preferred securities under the notes, under the indenture under which the notes have been issued, under Consumers' guarantee of the trust originated preferred securities, and under the declaration by the trust, taken together, constitute a full and unconditional guarantee by Consumers of the trust's obligations under the trust originated preferred securities. In August 1997, Consumers and an affiliated business trust, Consumers Energy Company Financing II, filed a registration statement with the SEC for the issuance and sale of up to $120 million of trust originated preferred securities. Consumers Energy Company Financing II was formed for the sole purpose of issuing trust originated preferred securities and investing the proceeds in subordinated notes which will be unsecured obligations of Consumers. Consumers will use the net proceeds from the sale of the subordinated notes to redeem, refinance or refund existing long-term securities, which may include first mortgage bonds, stocks, preferred securities or notes. In August 1997, Consumers announced that it will redeem all of the outstanding shares of its $7.45, $7.68, $7.72 and $7.76 preferred stock. This $119 million redemption of preferred stock will take place in September 1997. Under the provisions of its Articles of Incorporation at June 30, 1997, Consumers had $326 million of unrestricted retained earnings available to pay common dividends. In July 1997, Consumers declared a $43 million common dividend to be paid in August 1997. 5: Commitments and Contingencies Environmental Matters: Consumers is a so-called potentially responsible party at several sites being administered under Superfund. Superfund liability is joint and several and along with Consumers, there are numerous credit worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based upon past negotiations, Consumers estimates that its share of the total liability for the known sites will be between $2 million and $9 million. At June 30, 1997, Consumers has accrued $2 million for its estimated losses. Under the Michigan Natural Resources and Environmental Protection Act, Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. Consumers has prepared plans for remedial investigation/feasibility studies for several of these sites. Four of the five plans submitted by Consumers have been approved by the appropriate environmental regulatory authority in the State of Michigan. Findings for the two completed remedial investigations indicate that the expenditures for those two sites are likely to be less than the amounts projected before the studies were performed. However, these findings may not be representative of all of the sites. Data available to Consumers and its continued internal review have resulted in an estimate for all costs related to investigation and remedial action for all 23 sites of between $48 million and $98 million. These estimates are based on undiscounted 1997 costs. At June 30, 1997, Consumers has accrued a liability of $48 million and has established a regulatory asset for approximately the same amount. Any significant change in assumptions, such as remediation technique, nature and extent of contamination, and legal and regulatory requirements, could affect the estimate of remedial action costs for the sites. In accordance with an MPSC rate order issued in 1996, environmental clean-up costs above the amount currently being recovered in rates will be deferred and amortized over ten years. Rate recognition of amortization expense will not begin until after a prudence review in a general rate case. The order authorizes current recovery of $1 million annually. Consumers is continuing discussions with certain insurance companies regarding coverage for some or all of the costs that may be incurred for these sites. The Clean Air Act contains provisions that limit emissions of sulfur dioxide and nitrogen oxides and require emissions monitoring. Consumers' coal-fueled electric generating units burn low-sulfur coal and are currently operating at or near the sulfur dioxide emission limits that will be effective in the year 2000. The Act's provisions required Consumers to make capital expenditures totaling $40 million to install equipment at certain generating units. Consumers estimates capital expenditures for in-process and proposed modifications at other coal- fueled units to be an additional $45 million by the year 2000. Management believes that Consumers' annual operating costs will not be materially affected as a result of these expenditures. The Clean Air Act also contains national air quality standards under which industry must operate. Currently, Consumers operates within these standards and meets current ozone and small particle related emission limits. The Act requires the EPA to periodically review the effectiveness of these standards in preventing adverse health affects. The EPA recently revised these standards to increase the restrictions on small particle and ozone related emissions. Consumers supports the bi-partisan effort in Congress to delay implementation of the revised standards until the relationship between the new standards and health improvements is established. In addition, the EPA is reviewing recommendations from the Ozone Transport Assessment Group to reduce ozone transport across state lines. The EPA is expected to require the State of Michigan to impose additional nitrogen oxide reductions goals on Consumers' fossil-fueled generating units. The preliminary estimate of the cost of the changes Consumers may have to make to its fossil-fueled generating units to reduce ozone related emissions is approximately $175 million. A potentially equivalent amount may be needed to comply with the new small particle standards. Capital Expenditures: Consumers estimates capital expenditures, including new lease commitments, of $390 million for 1997, $390 million for 1998 and $380 million for 1999. For further information regarding capital expenditures, see Forward-Looking Information in the MD&A. Other: A number of lawsuits have been filed against Consumers relating to the effect of so-called stray voltage on certain livestock. Claimants contend that stray voltage results when low-level electrical currents present in grounded electrical systems are diverted from their intended path. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns and has an ongoing mitigation program to modify the service of all customers with livestock. As of June 30, 1997, Consumers had 18 separate stray voltage lawsuits awaiting trial court action, down from 22 lawsuits as reported at year end 1996. In addition to the matters disclosed in these notes, Consumers and certain of its subsidiaries are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies arising from the ordinary course of business and involving personal injury, property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing and other matters. Estimated losses for certain contingencies discussed in this note have been accrued. Resolution of these contingencies is not expected to have a material impact on Consumers' financial position or results of operations. 6: Nuclear Matters Consumers has loaded 13 dry storage casks with spent nuclear fuel at Palisades. Consumers plans to load four additional casks at Palisades later this year pending approval by the NRC. In June 1997, the NRC approved the process for unloading spent fuel from a cask with minor weld flaws. Consumers intends to transfer the spent fuel to a new transportable cask when one is available. The supplier for the design and fabrication of the transportable cask has been selected and design work is proceeding. Consumers is required to make certain calculations and report to the NRC about the continuing ability of the Palisades reactor vessel to withstand postulated pressurized thermal shock events during its remaining license life, in light of the embrittlement of reactor vessel materials over time due to operation in a radioactive environment. Based on continuing analysis of data from testing of similar materials, in 1996, Consumers received an interim Safety Evaluation Report from the NRC indicating that the reactor vessel can be safely operated through 2003 before reaching the NRC's screening criteria for reactor embrittlement. Consumers believes that with fuel management designed to minimize embrittlement, Palisades can be operated to the end of its license life in the year 2007 without annealing of the reactor vessel, but will continue to monitor the matter. Big Rock will close permanently on August 29, 1997, because management has determined that the plant would be uneconomical to operate in an increasingly competitive environment. The plant was originally scheduled to close May 31, 2000, at the end of the plant's operating license. Plant decommissioning will begin in September 1997 and is expected to take five to ten years to return the site to its original condition. The current decommissioning fund, together with future collections from customers and future earnings of the fund, is expected to be adequate to cover the plant decommissioning expenses. 7: Supplemental Cash Flow Information For purposes of the Statement of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Other cash flow activities and non-cash investing and financing activities were: In Millions Six Months Ended Twelve Months Ended June 30 1997 1996 1997 1996 Cash transactions Interest paid (net of amounts capitalized) $ 82 $ 73 $127 $160 Income taxes paid (net of refunds) 82 74 167 71 Non-cash transactions Nuclear fuel placed under capital lease $ 3 $ 1 $ 31 $ 4 Other assets placed under capital leases 3 1 5 4 Capital leases refinanced - - - 21
ARTHUR ANDERSEN LLP Report of Independent Public Accountants ---------------------------------------- To Consumers Energy Company: We have reviewed the accompanying consolidated balance sheets of CONSUMERS ENERGY COMPANY (a Michigan corporation and wholly owned subsidiary of CMS Energy Corporation) and subsidiaries as of June 30, 1997 and 1996, the related consolidated statements of income and common stockholder's equity for the three-month, six-month and twelve-month periods then ended, and the related consolidated statements of cash flows for the six-month and twelve-month periods then ended. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet and consolidated statements of long-term debt and preferred stock of Consumers Energy Company and subsidiaries as of December 31, 1996, and the related consolidated statements of income, common stockholder's equity and cash flows for the year then ended (not presented herein), and, in our report dated January 24, 1997, we expressed an unqualified opinion on those statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 1996, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. Arthur Andersen LLP Detroit, Michigan, August 11, 1997.
63 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The discussion below is limited to an update of developments that have occurred in various judicial and administrative proceedings, many of which are more fully described in CMS Energy's and Consumers' Form 10-K for the year ended December 31, 1996, and in their Form 10-Q for the quarter ended March 31, 1997. Reference is made to the Condensed Notes to the Consolidated Financial Statements included herein for additional information regarding various pending administrative and judicial proceedings involving rate, operating and environmental matters. CMS ENERGY EXEMPTION UNDER PUHCA CMS Energy is exempt from registration under PUHCA. In addition to a specific challenge to CMS Energy's exemption, there have been various generic administrative and legislative proposals to repeal or revise PUHCA in recent years. In April 1997, a bill was introduced in the United States Senate which would repeal PUHCA without at the same time deregulating the electric industry. The bill was referred to the Senate Banking, Housing and Urban Affairs Committee, the chairman of which is a cosponsor of the bill, and amended by that Committee in June 1997 with a recommendation that the bill pass as amended. STRAY VOLTAGE LAWSUITS Consumers has a number of lawsuits relating to so-called stray voltage, which results when small electrical currents present in grounded electric systems are diverted from their intended path. At June 30, 1997, Consumers had 18 separate stray voltage cases awaiting action at the trial court level. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the Companies' Annual Meeting of Shareholders held on May 27, 1997, the shareholders ratified the appointment of Arthur Andersen LLP as independent auditors of CMS Energy and Consumers for the year ended December 31, 1997. The vote at CMS Energy was 86,906,827 in favor and 352,140 against, with 465,200 abstaining. The vote at Consumers was 84,866,362 in favor and 4,059 against, with 13,020 abstaining. At the same meeting for CMS Energy, the shareholders voted against a shareholder's proposal to adopt a five point program addressing Consumers' operating as a "Utility of Choice" and under "Utility of Choice" guidelines. The vote was 3,600,909 in favor and 70,227,954 against, with 2,846,922 abstaining. At the same meeting, shareholders elected all twelve nominees for the office of director for both CMS Energy and Consumers. The total number of votes cast at CMS Energy was 87,724,167. The votes for individual nominees were as follows: CMS ENERGY CORPORATION ______________________ Number of Votes: For Withheld Total William T. McCormick, Jr. 86,817,436 906,731 87,724,167 John M. Deutch 86,888,001 836,166 87,724,167 James J. Duderstadt 86,868,342 855,825 87,724,167 Kathleen R. Flaherty 86,884,359 839,808 87,724,167 Victor J. Fryling 86,870,424 853,743 87,724,167 Earl D. Holton 86,899,200 824,967 87,724,167 Michael G. Morris 86,862,154 862,013 87,724,167 William U. Parfet 86,908,188 815,979 87,724,167 Percy A. Pierre 86,898,422 825,745 87,724,167 Kenneth Whipple 86,896,028 828,139 87,724,167 John B. Yasinsky 86,906,005 818,162 87,724,167 The total number of votes cast at Consumers was 84,883,441. The votes for individual nominees were as follows: CONSUMERS ENERGY COMPANY ________________________ Number of Votes For Withheld Total William T. McCormick, Jr. 84,871,696 11,745 84,883,441 John M. Deutch 84,871,988 11,453 84,883,441 James J. Duderstadt 84,871,658 11,783 84,883,441 Kathleen R. Flaherty 84,872,116 11,325 84,883,441 Victor J. Fryling 84,872,843 10,598 84,883,441 Earl D. Holton 84,871,668 11,773 84,883,441 Michael G. Morris 84,872,743 10,698 84,883,441 William U. Parfet 84,872,149 11,292 84,883,441 Percy A. Pierre 84,872,694 10,747 84,883,441 Kenneth Whipple 84,871,433 12,008 84,883,441 John B. Yasinsky 84,872,803 10,638 84,883,441 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) List of Exhibits (4) - CMS Energy: Credit Agreement dated as of July 2, 1997 among CMS Energy, The Banks, the Administrative Agent, Collateral Agent, Documentation Agent, Syndication Agent, Co-Agents and Lead Manager, all as defined therein, and the Exhibits and Schedules thereto. (12) - CMS Energy: Statements regarding computation of Ratio of Earnings to Fixed Charges (15)(a) - CMS Energy: Letter of Independent Public Accountant (15)(b) - Consumers: Letter of Independent Public Accountant (27)(a) - CMS Energy: Financial Data Schedule (27)(b) - Consumers: Financial Data Schedule (99) - CMS Energy: Consumers Gas Group Financials (b) Reports on Form 8-K Current Reports on Form 8-K dated June 5, 1997 and June 11, 1997 were filed by each of CMS Energy and Consumers, and a Current Report on Form 8- K dated July 1, 1997 was filed by CMS Energy, all covering matters pursuant to "Item 5. Other Events."
66 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, each registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature for each undersigned company shall be deemed to relate only to matters having reference to such company or its subsidiary. CMS ENERGY CORPORATION (Registrant) Dated: August 14, 1997 By A. M. Wright ---------------------- Alan M. Wright Senior Vice President, Chief Financial Officer and Treasurer CONSUMERS ENERGY COMPANY (Registrant) Dated: August 14, 1997 By A. M. Wright ---------------------- Alan M. Wright Senior Vice President, Chief Financial Officer