CMS-PB

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2007, for CMS Energy Corporation (the parent holding company) and its primary subsidiary, Consumers Energy Company (a combination electric and gas utility serving Michigan's Lower Peninsula). The filing reflects a strategic shift where CMS Energy is divesting international and non-strategic assets to reduce debt and focus on core utility operations. Key strategic actions during the period included the sale of the Palisades nuclear plant to Entergy and multiple international asset sales.

Key Financial Metrics

CMS Energy Corporation (Consolidated)

• Net Income (Loss) Available to Common Stockholders:
  • Three months ended June 30, 2007: $33 million (vs. $72 million in 2006).
  • Six months ended June 30, 2007: ($182 million) loss (vs. $45 million income in 2006).
• Earnings Per Share (Diluted):
  • Three months: $0.15 (vs. $0.31 in 2006).
  • Six months: ($0.82) loss (vs. $0.20 in 2006).
• Operating Revenue:
  • Three months: $1,319 million (vs. $1,219 million in 2006).
  • Six months: $3,508 million (vs. $3,116 million in 2006).
• Cash Flow (Six Months):
  • Operating Activities: $401 million provided.
  • Investing Activities: $1,479 million provided (driven by asset sales).
  • Financing Activities: ($342 million) used.
  • Ending Cash Balance: $1.891 billion.
• Debt: Total long-term debt was $5.407 billion at June 30, 2007, down from $6.200 billion at year-end 2006.

Consumers Energy Company

• Net Income Available to Common Stockholder:
  • Three months ended June 30, 2007: $44 million (vs. $35 million in 2006).
  • Six months ended June 30, 2007: $156 million (vs. $45 million in 2006).
• Operating Revenue:
  • Three months: $1,247 million.
  • Six months: $3,302 million.
• Cash Flow (Six Months):
  • Operating Activities: $559 million provided.
  • Investing Activities: $290 million provided.
  • Financing Activities: $446 million provided (primarily due to parent company capital infusions).
  • Ending Cash Balance: $1.332 billion.

Material Changes vs. Prior Period

The consolidated results for CMS Energy were significantly impacted by non-recurring items and asset sales, while the utility operations (Consumers) showed improvement.

• Asset Sales and Discontinued Operations: CMS Energy recorded significant gains from discontinued operations in the quarter ($91 million) but a net loss from discontinued operations for the six-month period ($87 million) due to the disposal of international businesses. Major sales included:
  • Palisades nuclear plant to Entergy ($380 million).
  • International businesses in the Middle East, Africa, and India to TAQA ($900 million).
  • Argentine and Michigan non-utility assets to Lucid Energy ($130 million).
• Impairment Charges: CMS Energy recorded $280 million in asset impairment charges for the six months ended June 30, 2007, primarily related to investments in TGN (Argentina), GasAtacama, Jamaica, and PowerSmith. There were no such charges in the prior year period.
• Utility Performance:
  • Electric Utility: Net income increased due to favorable weather driving higher deliveries and lower nuclear operating costs following the Palisades sale. However, revenue was offset by the accounting treatment of the Palisades sale (financing transaction).
  • Gas Utility: Net income increased significantly due to an MPSC-authorized rate increase and favorable weather increasing gas deliveries.
• Legal and Tax Items: The absence of a $54 million tax benefit recorded in 2006 (from an IRS audit resolution) negatively impacted 2007 earnings. Additionally, a $24 million charge was recorded in Q2 2007 related to the rescission of a natural gas contract with Quicksilver Resources.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Strategy: CMS Energy intends to complete the sale of remaining international Enterprises assets by the end of 2007 to reduce parent debt and invest in the utility business. A quarterly dividend of $0.05 per share was reinstated in January 2007.
• Electric Outlook: Electric deliveries are expected to grow about 1% in 2007. The company is pursuing a "Balanced Energy Initiative" and has agreed to purchase a 946 MW gas-fired power plant in Zeeland, Michigan, for $517 million (expected to close in early 2008).
• Gas Outlook: Gas deliveries are projected to decline slightly in 2007 on a weather-adjusted basis due to conservation and economic conditions.
• Rate Cases: Consumers Energy filed an electric rate case seeking an 11.25% return on equity and a $282 million annual revenue increase (amended filing). A gas rate case seeks an 11.25% return on equity and an $88 million annual increase.

Risks and Contingencies

• Regulatory Investigations: CMS Energy is under investigation by the DOJ regarding "round-trip" trading by a former subsidiary (CMS MST). A settlement of two related securities class action lawsuits was preliminarily approved for $200 million (CMS Energy's share approx. $123 million).
• Environmental Compliance: Significant capital expenditures are required for Clean Air Act compliance (estimated remaining $53 million for NOx controls and up to $700 million for Clean Air Interstate Rule compliance by 2015). There is uncertainty regarding the cost of complying with new EPA water intake rules and potential greenhouse gas regulations.
• MCV Partnership: Consumers Energy expects to exercise a "regulatory-out" provision in September 2007 to limit payments to the Midland Cogeneration Venture (MCV) Partnership. The MCV Partnership opposes this and may terminate the power purchase agreement, potentially affecting reserve margins.
• Nuclear Matters: While Palisades was sold, Consumers retains liability for spent nuclear fuel storage costs due to the DOE's failure to accept fuel on schedule. A $156 million DOE liability remains.

Investor Verification Checklist

• Asset Sale Proceeds: Verify the final closing adjustments and cash proceeds received from the Palisades sale and international asset divestitures.
• Legal Settlements: Monitor the final court approval and payment schedule for the $200 million securities class action settlement.
• Regulatory Outcomes: Track the MPSC decisions on the pending electric and gas rate cases, specifically the approval of the Zeeland power plant purchase and the return on equity.
• MCV PPA Status: Confirm the outcome of the regulatory-out provision exercise in September 2007 and any potential termination of the MCV power purchase agreement.
• Environmental Costs: Review updates on EPA rulings regarding water intake systems and greenhouse gas regulations, as these could materially impact future capital expenditures.
• Dividend Sustainability: Assess the impact of the reinstated dividend on cash flows given the company's debt reduction strategy.