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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______ TO ______
Commission file number 001-16189
NISOURCE INC.
-------------
(Exact name of registrant as specified in its charter)
Delaware 35-2108964
--------------------------- -----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
801 East 86th Avenue
Merrillville, Indiana 46410
--------------------------- -----------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (877) 647-5990
Indicate by check mark whether the registrant: (1) has 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
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [X] No[ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: Common Stock, $0.01 Par Value:
263,488,662 shares outstanding at July 31, 2004.
NISOURCE INC.
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTER ENDED JUNE 30, 2004
TABLE OF CONTENTS
Page
----
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Statements of Consolidated Income (Loss)..................... 3
Consolidated Balance Sheets.................................. 4
Statements of Consolidated Cash Flows........................ 6
Statements of Consolidated Comprehensive Income (Loss)....... 7
Notes to Consolidated Financial Statements................... 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................ 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk... 43
Item 4. Controls and Procedures...................................... 43
PART II OTHER INFORMATION
Item 1. Legal Proceedings............................................ 44
Item 2. Changes in Securities and Use of Proceeds.................... 45
Item 3. Defaults Upon Senior Securities.............................. 45
Item 4. Submission of Matters to a Vote of Security Holders.......... 46
Item 5. Other Information............................................ 46
Item 6. Exhibits and Reports on Form 8-K............................. 47
Signature............................................................. 48
2
PART I
ITEM 1. FINANCIAL STATEMENTS
NISOURCE INC.
STATEMENTS OF CONSOLIDATED INCOME (LOSS) (UNAUDITED)
Three Months Six Months
Ended June 30, Ended June 30,
------------------------ -----------------------
(in millions, except per share amounts) 2004 2003 2004 2003
- ------------------------------------------------------------- ----------- ----------- ----------- ----------
NET REVENUES
Gas Distribution $ 612.4 $ 546.8 $ 2,263.3 $ 2,289.4
Gas Transmission and Storage 206.5 221.0 551.8 563.2
Electric 272.6 262.1 536.1 526.4
Other 153.5 111.3 367.0 286.8
----------- ----------- ----------- ----------
Gross Revenues 1,245.0 1,141.2 3,718.2 3,665.8
Cost of Sales 628.9 499.4 2,110.1 1,994.3
----------- ----------- ----------- ----------
Total Net Revenues 616.1 641.8 1,608.1 1,671.5
----------- ----------- ----------- ----------
OPERATING EXPENSES
Operation and maintenance 284.7 275.4 608.0 601.9
Depreciation and amortization 127.6 124.9 253.0 249.5
Loss on sale of assets 0.3 0.2 1.0 1.3
Other taxes 46.0 65.5 146.0 170.6
----------- ----------- ----------- ----------
Total Operating Expenses 458.6 466.0 1,008.0 1,023.3
----------- ----------- ----------- ----------
OPERATING INCOME 157.5 175.8 600.1 648.2
----------- ----------- ----------- ----------
OTHER INCOME (DEDUCTIONS)
Interest expense, net (99.6) (114.9) (202.3) (237.9)
Minority interests - - - (2.5)
Dividend requirements on preferred stock of subsidiaries (1.1) (1.1) (2.2) (2.3)
Other, net 0.6 5.9 3.9 10.0
----------- ----------- ----------- ----------
Total Other Income (Deductions) (100.1) (110.1) (200.6) (232.7)
----------- ----------- ----------- ----------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 57.4 65.7 399.5 415.5
INCOME TAXES 22.1 26.4 147.7 153.9
----------- ----------- ----------- ----------
INCOME FROM CONTINUING OPERATIONS 35.3 39.3 251.8 261.6
----------- ----------- ----------- ----------
Loss from Discontinued Operations - net of taxes (0.7) (1.4) (3.7) (4.8)
Loss on Disposition of Discontinued Operations - net of taxes - (362.8) - (318.0)
Change in Accounting - net of taxes - - - (8.8)
----------- ----------- ----------- ----------
NET INCOME (LOSS) $ 34.6 $ (324.9) $ 248.1 $ (70.0)
=========== =========== =========== ==========
BASIC EARNINGS (LOSS) PER SHARE ($)
Continuing operations 0.13 0.15 0.96 1.02
Discontinued operations - (1.39) (0.01) (1.25)
Change in accounting - - - (0.04)
----------- ----------- ----------- ----------
BASIC EARNINGS (LOSS) PER SHARE 0.13 (1.24) 0.95 (0.27)
----------- ----------- ----------- ----------
DILUTED EARNINGS (LOSS) PER SHARE ($)
Continuing operations 0.13 0.15 0.95 1.01
Discontinued operations - (1.38) (0.01) (1.24)
Change in accounting - - - (0.04)
----------- ----------- ----------- ----------
DILUTED EARNINGS (LOSS) PER SHARE 0.13 (1.23) 0.94 (0.27)
----------- ----------- ----------- ----------
DIVIDENDS DECLARED PER COMMON SHARE 0.23 0.29 0.46 0.58
----------- ----------- ----------- ----------
BASIC AVERAGE COMMON SHARES OUTSTANDING (MILLIONS) 262.5 261.3 262.4 257.6
DILUTED AVERAGE COMMON SHARES (MILLIONS) 264.5 263.1 264.6 259.5
----------- ----------- ----------- ----------
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
3
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
CONSOLIDATED BALANCE SHEETS
JUNE 30, December 31,
(in millions) 2004 2003
- ---------------------------------------------------------------------- ----------- -----------
(unaudited)
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Utility Plant $ 16,041.9 $ 15,977.3
----------- -----------
Accumulated depreciation and amortization (7,146.6) (7,095.9)
----------- -----------
Net utility plant 8,895.3 8,881.4
----------- -----------
Other property, at cost, less accumulated depreciation 462.4 409.3
----------- -----------
Net Property, Plant and Equipment 9,357.7 9,290.7
----------- -----------
INVESTMENTS AND OTHER ASSETS
Assets of discontinued operations and assets held for sale 20.7 20.7
Unconsolidated affiliates 96.3 113.2
Other investments 69.9 67.4
----------- -----------
Total Investments 186.9 201.3
----------- -----------
CURRENT ASSETS
Cash and cash equivalents 16.4 27.3
Restricted cash 15.3 22.8
Accounts receivable (less reserve of $74.4 and $54.1, respectively) 311.1 511.1
Unbilled revenue (less reserve of $0.9 and $3.5, respectively) 120.8 303.2
Gas inventory 230.8 429.4
Underrecovered gas and fuel costs 159.1 203.2
Materials and supplies, at average cost 71.8 71.5
Electric production fuel, at average cost 30.5 29.0
Price risk management assets 85.4 74.3
Exchange gas receivable 157.8 174.8
Regulatory Assets 123.9 114.5
Prepayments and other 66.5 101.8
----------- -----------
Total Current Assets 1,389.4 2,062.9
----------- -----------
OTHER ASSETS
Price risk management assets 110.8 114.4
Regulatory assets 581.5 575.5
Goodwill 3,704.0 3,704.0
Intangible assets 520.3 527.2
Deferred charges and other 152.6 147.8
----------- -----------
Total Other Assets 5,069.2 5,068.9
----------- -----------
$ 16,003.2 $ 16,623.8
TOTAL ASSETS =========== ===========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
4
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
JUNE 30, December 31,
(in millions) 2004 2003
- ------------------------------------------------------------------- ----------- -----------
(unaudited)
CAPITALIZATION AND LIABILITIES
CAPITALIZATION
Common Stock Equity $ 4,500.8 $ 4,415.9
Preferred Stocks--
Series without mandatory redemption provisions 81.1 81.1
Long-term debt, excluding amounts due within one year 5,573.1 5,993.4
----------- -----------
Total Capitalization 10,155.0 10,490.4
----------- -----------
CURRENT LIABILITIES
Current portion of long-term debt 366.1 118.3
Short-term borrowings 143.5 685.5
Accounts payable 482.8 496.6
Dividends declared on common and preferred stocks 61.7 1.8
Customer deposits 82.0 80.4
Taxes accrued 254.3 210.8
Interest accrued 82.2 82.4
Overrecovered gas and fuel costs 32.7 29.2
Price risk management liabilities 36.9 36.5
Exchange gas payable 249.5 290.8
Current deferred revenue 25.4 28.2
Regulatory liabilities 85.0 73.7
Accrued liability for postretirement and pension benefits 75.1 56.8
Other accruals 305.1 418.0
----------- -----------
Total Current Liabilities 2,282.3 2,609.0
----------- -----------
OTHER LIABILITIES AND DEFERRED CREDITS
Price risk management liabilities 6.3 0.2
Deferred income taxes 1,612.3 1,595.9
Deferred investment tax credits 82.9 87.3
Deferred credits 59.7 72.7
Noncurrent deferred revenue 92.8 113.0
Accrued liability for postretirement and pension benefits 408.2 406.9
Preferred stock liabilities with mandatory redemption provisions 2.4 2.4
Regulatory liabilities and other removal costs 1,089.7 1,061.6
Other noncurrent liabilities 211.6 184.4
----------- -----------
Total Other 3,565.9 3,524.4
----------- -----------
COMMITMENTS AND CONTINGENCIES - -
----------- -----------
TOTAL CAPITALIZATION AND LIABILITIES $ 16,003.2 $ 16,623.8
=========== ===========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
5
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED)
Six Months Ended June 30, (in millions) 2004 2003
- ------------------------------------------------------------------------ ---------- --------
OPERATING ACTIVITIES
Net income (loss) $ 248.1 $ (70.0)
Adjustments to reconcile net income to net cash from
continuing operations:
Depreciation and amortization 253.0 249.5
Net changes in price risk management activities 2.7 (11.0)
Deferred income taxes and investment tax credits (11.9) 15.7
Deferred revenue (23.0) (3.5)
Amortization of unearned compensation 4.4 2.8
Loss on sale of assets 1.0 1.3
Change in accounting - 8.8
Income from unconsolidated affiliates (0.4) (0.7)
Loss from sale of discontinued operations - 318.0
Loss from discontinued operations 3.7 4.8
Amortization of discount/premium on debt 9.4 9.5
Other 1.2 1.7
Changes in assets and liabilities, net of effect from acquisitions of
businesses:
Restricted cash 7.5 14.9
Accounts receivable and unbilled revenue 377.7 183.3
Inventories 196.7 32.0
Accounts payable (46.7) (35.3)
Customer deposits 1.7 7.8
Taxes accrued 40.0 (21.9)
Interest accrued (0.2) 12.6
(Under) Overrecovered gas and fuel costs 47.7 93.4
Exchange gas receivable/payable 25.5 (158.6)
Other accruals (109.5) (112.6)
Prepayment and other current assets 33.9 17.8
Regulatory assets/liabilities 2.9 6.6
Postretirement and postemployment benefits 19.5 19.7
Deferred credits (13.1) (27.0)
Deferred charges and other noncurrent assets (1.8) 10.1
Other noncurrent liabilities 23.0 22.0
---------- --------
Net Cash Flows from Continuing Operations 1,093.0 591.7
Net Cash Flows used for Discontinued Operations - (119.9)
---------- --------
Net Cash Flows from Operating Activities 1,093.0 471.8
---------- --------
INVESTING ACTIVITIES
Capital expenditures (237.7) (237.8)
Proceeds from disposition of assets 1.6 99.9
Other investing activities (6.5) (11.1)
---------- --------
Net Cash Flows used for Investing Activities (242.6) (149.0)
---------- --------
FINANCING ACTIVITIES
Issuance of long-term debt - 345.3
Retirement of long-term debt (202.5) (465.8)
Change in short-term debt (542.0) (53.7)
Retirement of preferred shares - (345.0)
Issuance of common stock and capital contributed 8.7 348.9
Acquisition of treasury stock (3.7) (1.0)
Dividends paid - common shares (121.8) (147.9)
---------- --------
Net Cash Flows used for Financing Activities (861.3) (319.2)
---------- --------
Increase (decrease) in cash and cash equivalents (10.9) 3.6
Cash and cash equivalents at beginning of year 27.3 31.1
---------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 16.4 $ 34.7
========== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest 194.3 215.7
Interest capitalized 1.2 1.7
Cash paid for income taxes 96.4 145.0
---------- --------
6
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
Three Months Six Months
Ended June 30, Ended June 30,
----------------- -----------------
(in millions) 2004 2003 2004 2003
- ------------------------------------------------------ ------- -------- -------- -------
Net Income (Loss) $ 34.6 $ (324.9) $ 248.1 $ (70.0)
Other comprehensive income, net of tax
Foreign currency translation adjustment - 0.6 0.7 1.5
Net unrealized gains (losses) on cash flow hedges (1.5) 17.0 8.5 25.3
Net gain (loss) on available for sale securities (1.0) 2.0 0.5 -
------- -------- -------- -------
Total other comprehensive income (loss), net of tax (2.5) 19.6 9.7 26.8
------- -------- -------- -------
Total Comprehensive Income (Loss) $ 32.1 $ (305.3) $ 257.8 $ (43.2)
------- -------- -------- -------
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
7
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF ACCOUNTING PRESENTATION
The accompanying unaudited consolidated financial statements for NiSource Inc.
(NiSource) reflect all normal recurring adjustments that are necessary, in the
opinion of management, to present fairly the results of operations in accordance
with accounting principles generally accepted in the United States of America.
The accompanying financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in NiSource's
Annual Report on Form 10-K for the fiscal year ended December 31, 2003. Income
for interim periods may not be indicative of results for the calendar year due
to weather variations and other factors. Certain reclassifications have been
made to the 2003 financial statements to conform to the 2004 presentation.
2. DILUTED AVERAGE COMMON SHARES COMPUTATION
Basic earnings per share (EPS) is computed by dividing income available to
common stockholders by the weighted average number of common shares outstanding
for the period. The weighted average shares outstanding for diluted EPS are
impacted by the incremental effect of the various long-term incentive
compensation plans and the forward equity contracts associated with the Stock
Appreciation Income Linked Securities(SM) (SAILS(SM)), and through February 18,
2003, Corporate Premium Income Equity Securities (Corporate PIES). Effective
February 19, 2003, the forward equity contracts related to the Corporate PIES
were settled as prescribed in the agreements. As a result of the settlement,
13.1 million common shares were issued and are reflected in basic average common
shares. In the 2003 period, the SAILS(SM) were anti-dilutive and therefore not
included in the calculation.
The numerator in calculating both basic and diluted EPS for each year is
reported net income. The computation of diluted average common shares follows:
Three Months Six Months
Ended June 30, Ended June 30,
----------------- -----------------
(in thousands) 2004 2003 2004 2003
- ------------------------------------------------------------ ------- ------- ------- -------
Denominator
Basic average common shares outstanding 262,543 261,259 262,414 257,573
Dilutive potential common shares
Nonqualified stock options 118 75 166 64
Shares contingently issuable under employee stock plans 1,182 1,313 1,182 1,313
SAILS(SM) 40 - 187 -
Shares restricted under employee stock plans 581 491 636 553
------- ------- ------- -------
Diluted Average Common Shares 264,464 263,138 264,585 259,503
------- ------- ------- -------
3. STOCK OPTIONS AND AWARDS
Financial Accounting Standards Board (FASB) Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation" (SFAS No.
123), encourages, but does not require, entities to adopt the fair value method
of accounting for stock-based compensation plans. The fair value method would
require the amortization of the fair value of stock-based compensation at the
date of grant over the related vesting period. NiSource continues to apply the
intrinsic value method of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," for awards granted under its
stock-based compensation plans. The following table illustrates the effect on
net income and EPS as if NiSource had applied the fair value recognition
provisions of SFAS No. 123 to stock-based employee compensation.
8
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
Three Months Six Months
Ended June 30, Ended June 30,
--------------- ---------------
($ in millions, except per share data) 2004 2003 2004 2003
- ------------------------------------------------------------------ ---- ------ ----- -----
NET INCOME (LOSS)
As reported 34.6 (324.9) 248.1 (70.0)
Add: Stock-based employee compensation expense
included in reported net income, net of related
tax effects 1.5 1.0 2.8 2.3
Less: Total stock-based employee compensation expense
determined under the fair value method for all awards,
net of tax (3.1) (2.6) (6.0) (5.6)
---- ------ ----- -----
Pro forma 33.0 (326.5) 244.9 (73.3)
---- ------ ----- -----
EARNINGS PER SHARE
Basic - as reported 0.13 (1.24) 0.95 (0.27)
- pro forma 0.13 (1.25) 0.93 (0.28)
Diluted - as reported 0.13 (1.23) 0.94 (0.27)
- pro forma 0.12 (1.24) 0.93 (0.28)
---- ------ ----- -----
4. REGULATORY MATTERS
Through October 2004, Columbia Gas of Ohio, Inc. (Columbia of Ohio) is operating
under a regulatory stipulation approved by the Public Utilities Commission of
Ohio (PUCO). On October 9, 2003, Columbia of Ohio and other parties filed with
the PUCO an amended stipulation that would govern Columbia of Ohio's regulatory
framework from November 2004 through October 2010. The majority of Columbia of
Ohio's contracts with interstate pipelines expire in October 2004, and the
amended stipulation would permit Columbia of Ohio to renew those contracts for
firm capacity sufficient to meet up to 100% of the design peak day requirements
through October 31, 2005 and up to 95% of the design peak day requirements
through October 31, 2010. Among other things, the amended stipulation would
also: (1) extend Columbia of Ohio's CHOICE(R) program through October 2010; (2)
provide Columbia of Ohio with an opportunity to generate revenues sufficient to
cover the stranded costs associated with the CHOICE(R) program; and (3) allow
Columbia of Ohio to record post-in-service carrying charges on plant placed into
service after October 2004, and to defer the property taxes and depreciation
associated with such plant.
On March 11, 2004, the PUCO issued an order that adopted and modified the
stipulation from Columbia of Ohio and a collaborative of parties. The order
extended Columbia of Ohio's CHOICE(R) program. However, the order limited the
time period of the stipulation through December 31, 2007 and declined to
pre-approve the amount of interstate pipeline firm capacity for which Columbia
of Ohio could contract. In addition, the PUCO made other modifications which
would limit Columbia of Ohio's ability to generate additional revenues
sufficient to cover stranded costs, including declining to mandate that natural
gas marketers participating in the CHOICE(R) program obtain 75% of their
interstate capacity directly from Columbia of Ohio and changing the allocation
of revenues generated through off-system sales. The order allows Columbia of
Ohio to record post-in-service carrying charges on plant placed in service after
October 2004 and allows the deferral of property taxes and depreciation
associated with such plant.
On April 9, 2004, Columbia of Ohio and other signatory parties to the
stipulation, consistent with standard regulatory process, petitioned the PUCO
for rehearing on the components which have been modified. That same day the
Office of the Ohio Consumers' Counsel (OCC) also filed an application for
rehearing, and argued that the PUCO should not have permitted Columbia of Ohio
to record post-in-service carrying charges on plant placed into service after
October 2004, and to defer the property taxes and depreciation associated with
such plant. On April 19, 2004, the OCC filed a motion to dismiss the application
for rehearing filed by Columbia of Ohio and other parties.
9
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
On May 5, 2004 the PUCO issued an order on rehearing, in which it denied the
OCC's motion to dismiss and its application for rehearing. The PUCO granted, in
part, the joint application filed by Columbia of Ohio and others. In granting
the joint application for rehearing, in part, the PUCO did the following: (1)
revised the term of the stipulation so that it runs through October 31, 2008;
(2) restored the marketers' responsibility for 75% of CHOICE(R) costs; and (3)
revised the mechanism applicable to Columbia of Ohio's sharing of off-system
sales and capacity release revenue. Under the revised off-system sales/capacity
release revenue sharing mechanism, Columbia of Ohio must now begin sharing such
revenue equally with the customers when the annual revenue exceeds $25 million,
instead of $35 million as originally proposed by Columbia of Ohio and other
collaborative parties.
In a letter docketed on May 12, 2004, Columbia of Ohio and the other signatory
parties to the stipulation accepted the PUCO's modifications. On May 14, 2004,
the OCC filed a Second Application for Rehearing. In the pleading, the OCC
argued that the joint applicants did not meet the statutory requirements for an
application for rehearing, and thus the PUCO's order on rehearing granting
rehearing was unlawful. The OCC also argued that the rehearing was the result of
exclusionary settlement negotiations. The OCC continued to disagree with the
PUCO's treatment of off-system sales and capacity release revenues, and
post-in-service carrying charges and related deferrals.
On June 3, 2004, Columbia of Ohio filed its proposed tariffs and accounting, as
required. On June 9, 2004, the PUCO denied the OCC's Second Application for
Rehearing. On July 29, 2004, the OCC filed an appeal with the Supreme Court of
Ohio, contesting the PUCO's May 5, 2004 order on rehearing, which granted in
part Columbia of Ohio's joint application for rehearing, and the PUCO's June 9,
2004 order, denying the OCC's Second Application for Rehearing.
On December 17, 2003, the PUCO approved an application by Columbia of Ohio and
other Ohio local distribution companies (LDCs) to establish a tracking mechanism
that will provide for recovery of current bad debt expense and for the recovery
over a five-year period of previously deferred uncollected accounts receivable.
As of June 30, 2004, Columbia of Ohio has $46.9 million of uncollected accounts
receivable pending future recovery.
On June 11, 2004, Columbia Gas of Pennsylvania, Inc. (Columbia of Pennsylvania)
signed a settlement agreement ("Settlement Agreement") in its annual gas cost
recovery proceeding with The Office of Consumer Advocate, The Office of Small
Business Advocate, The Office of Trial Staff, and Commercial & Industrial
Intervenors. Under the Settlement Agreement, the signatory parties agreed to
financial incentive mechanisms for off-system sales and capacity release
transactions performed by Columbia of Pennsylvania. Under the incentive
mechanism, customers receive 100% of the total combined proceeds from off-system
sales and capacity release transactions up to a benchmark of $6.0 million. After
the benchmark is reached, Columbia of Pennsylvania will retain 50% of proceeds
from the transactions; however, Columbia of Pennsylvania may never retain more
than 40% of the actual net proceeds generated from off-system sales and capacity
release transactions. The incentive mechanism begins October 1, 2004 and ends on
September 30, 2006.
On August 11, 1999, the Indiana Utility Regulatory Commission (IURC) approved a
flexible gas cost adjustment (GCA) mechanism for Northern Indiana Public Service
Company (Northern Indiana). Under the approved procedure, the demand component
of the adjustment factor will be determined, after hearings and IURC approval,
and made effective on November 1 of each year. The demand component will remain
in effect for one year until a new demand component is approved by the IURC. The
commodity component of the adjustment factor will be determined by monthly
filings, which will become effective on the first day of each calendar month,
subject to refund. The monthly filings do not require IURC approval but will be
reviewed by the IURC during the annual hearing that will take place regarding
the demand component filing. Northern Indiana's GCA factor also includes a gas
cost incentive mechanism which allows the sharing of any cost savings or cost
increases with customers based on a comparison of actual gas supply portfolio
cost to a market-based benchmark price.
Northern Indiana's GCA4 annual demand filing, covering the period November 1,
2002 through October 31, 2003, was made on August 29, 2002 and approved by the
IURC for implementation as interim rates, subject to refund effective November
1, 2002. The Indiana Office of Utility Consumer Counselor (OUCC) filed testimony
indicating that some gas costs, for the month of March 2003, should not be
recovered. On September 10, 2003, the IURC issued an order adjusting the
recovery of costs in March 2003 and reducing recovery by $3.8 million. On
October 8, 2003, the IURC approved the demand component of the adjustment
factor.
10
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
Northern Indiana's GCA5 annual demand filing, covering the period November 1,
2003 through October 31, 2004, was made on August 26, 2003 and approved by the
IURC for implementation as interim rates, subject to refund, effective November
1, 2003. On June 8, 2004, Northern Indiana and the OUCC entered into a joint
stipulation and agreement resolving all issues in GCA5. A hearing was held
before the IURC on July 18, 2004 in support of the settlement. Among the
settlement agreement's provisions, Northern Indiana has agreed to return $3.8
million to its customers over a twelve-month period following IURC approval.
This refund is the resolution of issues similar to those from March 2003. An
additional provision of the agreement was to extend the current Alternative
Regulatory Procedure (ARP), including Northern Indiana's gas cost incentive
mechanism, from the current expiration date of December 31, 2004 to March 31,
2005. An order approving the settlement is expected in the third quarter of
2004. Negotiations are in progress to extend the ARP past March 31, 2005.
On June 20, 2002, Northern Indiana, Ameren Corporation and First Energy
Corporation established terms for joining the Midwest Independent System
Operator (MISO) through participation in an independent transmission company
(ITC). Northern Indiana transferred functional control of its electric
transmission assets to the ITC and MISO on October 1, 2003. As part of Northern
Indiana's use of MISO's transmission service, Northern Indiana will incur new
categories of transmission charges based upon MISO's Federal Energy Regulatory
Commission (FERC)-approved tariff. One of the new categories of charges,
Schedule 10, relates to the payment of administrative charges to MISO for its
continuing management and operations of the transmission system. Northern
Indiana filed a petition on September 30, 2003, with the IURC seeking approval
to establish accounting treatment for the deferral of the Schedule 10 charges
from MISO. On July 21, 2004 the IURC issued an order which denied Northern
Indiana's request for deferred accounting treatment for the MISO Schedule 10
administrative fees. Northern Indiana has taken a charge during the second
quarter 2004 in the amount of $2.1 million related to the MISO administrative
charges deferred through June 30, 2004. The MISO Schedule 10 administrative fees
are currently estimated to be approximately $2.8 million annually. Northern
Indiana is currently evaluating the IURC order to determine whether an appeal
will be filed.
The MISO has initiated the Midwest Market Initiative (MMI), which will develop
the structures and processes to be used to implement an electricity market for
the MISO region. This MMI proposes non-discriminatory transmission service,
reliable grid operation, and the purchase and sale of electric energy in a
competitive, efficient and non-discriminatory manner. MISO has filed with FERC
detailed tariff information, with a planned initial operation date of March 1,
2005. Northern Indiana and EnergyUSA-TPC (TPC) are actively pursuing roles in
the MMI. At the current time, management believes that the MMI will change the
manner in which Northern Indiana and TPC conduct their electric business;
however, at this time management cannot determine the impact the MMI will have
on Northern Indiana or TPC.
Northern Indiana has been recovering the costs of electric power purchased for
sale to its customers through the fuel adjustment clause (FAC). The FAC provides
for costs to be collected if they are below a negotiated cap. If costs exceed
this cap, Northern Indiana must demonstrate that the costs were prudently
incurred to achieve approval for recovery. This negotiated cap agreement is
subject to continuing negotiations. A group of industrial customers challenged
the manner in which Northern Indiana applied costs associated with a specific
interruptible sales tariff. An estimated refund liability was recorded in the
first quarter of 2003. A settlement was reached with the customers and Northern
Indiana recorded the full costs of the settlement. As a result of the
settlement, the industrial customers challenge was withdrawn and dismissed in
January 2004. In addition, as a result of the settlement, Northern Indiana has
sought and received approval by the IURC to reduce the charges under the
interruptible sales tariff. This reduction will remain in effect until the Dean
H. Mitchell Generating Station (Mitchell Station) returns to service.
Currently, Northern Indiana is reviewing options to meet the electric needs of
its customers. This review includes an assessment of Northern Indiana's oldest
generating units, which includes the Mitchell Station. Northern Indiana has
requested proposals from outside companies to provide power under varying terms
and conditions. These proposals are being evaluated. In February 2004, the City
of Gary announced an interest to acquire the land on which the Mitchell Station
is located for economic development, including a proposal to increase the length
of the runways at the Gary International Airport. On May 7, 2004, the City of
Gary filed a petition with the IURC seeking valuation of the Mitchell Station
and determination of the terms and conditions under which the City of Gary would
acquire the Mitchell Station. The procedural schedule for the City of Gary has
been set, and Northern Indiana has filed its Prepared Direct Testimony, stating
that Northern Indiana has no current plans to restart the Mitchell Station.
11
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
On May 25, 2004 Northern Indiana filed a petition for approval of a Purchased
Power and Transmission Tracker Mechanism to recover the cost of purchased power
to meet Northern Indiana's retail electric load requirements and charges imposed
on Northern Indiana by MISO and Grid America. Northern Indiana's direct
testimony is due to be filed by August 6, 2004. The hearing is set for the
fourth quarter of 2004.
On July 9, 2004 a verified joint petition was filed by PSI Energy, Inc.,
Indianapolis Power & Light Company, Northern Indiana and Vectren Energy Delivery
of Indiana, Inc., seeking approval of certain changes in operations that are
likely to result from the MISO's implementation of energy markets, and for
determination of the manner and timing of recovery of costs resulting from the
MISO's implementation of standard market design mechanisms, such as the MISO's
proposed real-time and day-ahead energy markets.
In January 2002, Northern Indiana filed for approval to implement an
environmental cost tracker (ECT). The ECT was approved by the IURC on November
26, 2002. Under the ECT Northern Indiana is permitted to recover (1) allowance
for funds used during construction and a return on the capital investment
expended by Northern Indiana to implement Indiana Department of Environmental
Management's nitrogen oxide State Implementation Plan through an Environmental
Cost Recovery Mechanism (ECRM) and (2) related operation and maintenance and
depreciation expenses once the environmental facilities become operational
through an Environmental Expense Recovery Mechanism (EERM). Under the
Commission's November 26, 2002 order, Northern Indiana is permitted to submit
filings on a semi-annual basis for the ECRM and on an annual basis for the EERM.
Northern Indiana's latest ECRM filing (ECR-3) was for capital expenditures of
$194.1 million, and was made simultaneous with its first EERM filing (EER-1) for
$1.9 million. Over the timeframe required to meet the environmental standards,
Northern Indiana anticipates a total capital investment amounting to
approximately $274.2 million. On February 4, 2004, the IURC approved Northern
Indiana's latest compliance plan with the estimate of $274.2 million. The ECRM
revenues amounted to $7.5 million for the six months ended June 30, 2004, and
$12.6 million from inception to date, while EERM revenues were $0.3 for the
first half of 2004.
5. RESTRUCTURING ACTIVITIES
Since 2000, NiSource has implemented restructuring initiatives to streamline its
operations and realize efficiencies from the acquisition of Columbia Energy
Group (Columbia). The restructuring activities were primarily associated with
reductions in headcount and facility exit costs.
For all of the restructuring plans, a total of approximately 1,600 management,
professional, administrative and technical positions have been identified for
elimination. As of June 30, 2004, approximately 1,560 employees were terminated,
of whom 1 employee and 10 employees were terminated during the quarter and six
months ended June 30, 2004, respectively. As of June 30, 2004 and December 31,
2003, the consolidated balance sheets reflected liabilities of $16.6 million and
$19.5 million related to the restructuring plans, respectively. During the
quarter and six months ended June 30, 2004, $1.2 million and $2.8 million in
payments were made, respectively, in association with the restructuring plans
and a $0.6 million net decrease and $0.1 million net increase, respectively, to
the restructuring liability was recorded mainly to adjust for facility exit
costs. Of the remaining restructuring liability, $13.0 million is related to
facility exit costs.
12
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
6. ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
In May 2004, Columbia Gas Transmission Corporation (Columbia Transmission)
identified certain facilities as being non-core to the operation of the pipeline
system. As a result, Columbia Transmission is in the process of selling these
facilities to third parties. NiSource has accounted for the assets of these
facilities, with a net book value of approximately $14.2 million, as assets held
for sale.
On October 20, 2003, NiSource sold all of the steel-related, "inside-the-fence"
assets of its subsidiary PEI Holdings, Inc. (PEI), to Private Power, LLC
(Private Power). The sale included six PEI operating subsidiaries and the name
"Primary Energy". Private Power paid approximately $325.4 million, comprised of
$113.1 million in cash and the assumption of debt-related liabilities and other
obligations. The assumption of such liabilities and the after tax cash proceeds
from the sale reduced NiSource's debt by $206.3 million. NiSource has accounted
for the assets sold as discontinued operations and has adjusted all periods
presented accordingly.
On August 29, 2003, NiSource sold its exploration and production subsidiary,
Columbia Energy Resources, Inc. (CER), to a subsidiary of Triana Energy Holdings
(Triana). Under the CER sales agreement, Triana , an affiliate of Morgan Stanley
Dean Witter Capital Partners IV, L.P. (MSCP), purchased all of the stock of CER
for $330.0 million, plus the assumption of obligations to deliver approximately
94.0 billion cubic feet of natural gas pursuant to existing forward sales
contracts. The sale transferred 1.1 trillion cubic feet of natural gas reserves.
Approximately $220.0 million of after-tax cash proceeds from the sale were used
to reduce NiSource's debt. In addition, a $213.0 million liability related to
the forward sales contracts was removed from the balance sheet. On January 28,
2003, NiSource's former subsidiary Columbia Natural Resources, Inc. sold its
interest in certain natural gas exploration and production assets in New York
for approximately $95.0 million. NiSource has accounted for CER as discontinued
operations and has adjusted all periods presented accordingly.
During 2002, NiSource decided to exit the telecommunications business. The
results of operations related to Columbia Transmission Communications
Corporation (Transcom) were displayed as discontinued operations on NiSource's
consolidated income statement and its assets and liabilities were separately
aggregated and reflected as assets and liabilities of discontinued operations on
the consolidated balance sheets. On September 15, 2003, NiSource's subsidiary
Columbia sold 100% of its shares in Transcom.
Results from discontinued operations of CER (including the New York State
properties), the six PEI subsidiaries and Transcom are provided in the following
table:
Three Months Six Months
Ended June 30, Ended June 30,
----------------- ------------------
($ in millions) 2004 2003 2004 2003
- ------------------------------------- ------ ------- ------ --------
REVENUES FROM DISCONTINUED OPERATIONS $ - $ 52.6 $ - $ 112.1
------ ------- ------ --------
Loss from discontinued operations (0.7) (5.2) (5.7) (6.0)
Income taxes - (3.8) (2.0) (1.2)
------ ------- ------ --------
NET LOSS FROM DISCONTINUED OPERATIONS $ (0.7) $ (1.4) $ (3.7) $ (4.8)
------ ------- ------ --------
The assets held for sale and assets of discontinued operations were net
property, plant, and equipment of $20.7 million at June 30, 2004 and December
31, 2003.
7. RISK MANAGEMENT ACTIVITIES
NiSource uses commodity-based derivative financial instruments to manage certain
risks in its business. NiSource accounts for its derivatives under SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended,
(SFAS No. 133.)
13
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
HEDGING ACTIVITIES. The activity for the second quarter and six months ended
June 30, 2004 and June 30, 2003 affecting accumulated other comprehensive
income, with respect to cash flow hedges included the following:
Three Months Six Months
Ended June 30, Ended June 30,
------------------- -------------------
(in millions, net of tax) 2004 2003 2004 2003
- ----------------------------------------------------------- -------- ------- -------- -------
Net unrealized gains on derivatives qualifying as cash flow
hedges at the beginning of the period $ 101.7 $ 76.1 $ 91.7 $ 67.8
Unrealized hedging gains arising during the period on
derivatives qualifying as cash flow hedges 7.3 21.7 28.6 31.4
Reclassification adjustment for net gain included in net
income (8.8) (4.7) (20.1) (6.1)
-------- ------- -------- -------
Net unrealized gains on derivatives qualifying as cash flow
hedges at the end of the period $ 100.2 $ 93.1 $ 100.2 $ 93.1
-------- ------- -------- -------
Unrealized gains and losses on NiSource's hedges were recorded as price risk
management assets and liabilities along with unrealized gains on NiSource's
marketing and trading portfolios. The accompanying consolidated balance sheets
reflected price risk management assets related to unrealized gains on hedges of
$166.4 million and $165.6 million at June 30, 2004 and December 31, 2003,
respectively, of which $56.2 million and $51.3 million were included in "Current
Assets" and $110.2 million and $114.3 million were included in "Other Assets."
Price risk management liabilities related to unrealized losses on hedges (and
net option premiums) were $14.7 million and $9.5 million at June 30, 2004 and
December 31, 2003, respectively, of which $8.7 million and $9.3 million were
included in "Current Liabilities" and $6.0 million and $0.2 million were
included in "Other Liabilities and Deferred Credits."
During the second quarter 2004, no amounts were recognized in earnings due to
the change in value of certain derivative instruments, and there were no
components of the derivatives' fair values excluded in the assessment of hedge
effectiveness. Also during the second quarter, NiSource reclassified no amounts
from other comprehensive income to earnings, due to the probability that certain
forecasted transactions would not occur. It is anticipated that during the next
twelve months the expiration and settlement of cash flow hedge contracts will
result in income recognition of amounts currently classified in other
comprehensive income of approximately $27.8 million, net of tax.
In addition, Northern Indiana and Bay State Gas Company engage in writing
options that potentially obligate them to purchase or sell gas at the holder's
discretion at some future market-based price. These written options are
derivative instruments, must be marked to fair value and do not meet the
requirement for hedge accounting treatment. Northern Indiana also uses NYMEX
derivative contracts to minimize its gas costs. These contracts do not qualify
for hedge accounting and must be marked to fair value. Because these derivatives
are used within the framework of its gas cost incentive mechanism, regulatory
assets or liabilities are recorded to offset the change in the fair value of
these derivatives. The consolidated balance sheets reflected $1.2 million and
$1.2 million of price risk management assets associated with the programs at
June 30, 2004 and December 31, 2003, respectively. In addition, the consolidated
balance sheets reflected $0.6 million and $0.5 million of price risk management
liabilities associated with the programs at June 30, 2004 and December 31, 2003,
respectively.
For regulatory incentive purposes, the Columbia distribution companies,
comprised of Columbia Gas of Kentucky, Inc., Columbia Gas of Maryland, Inc.,
Columbia Gas of Ohio, Inc., Columbia Gas of Pennsylvania, Inc., and Columbia Gas
of Virginia, Inc. enter into contracts that allow counterparties the option to
sell gas to Columbia LDCs at first of the month prices for a particular month of
delivery. Columbia LDCs charge the counterparties a fee for this option. The
changes in the fair value of the options are primarily due to the changing
expectations of the future intra-month volatility of gas prices. Columbia LDCs
defer a portion of the change in the fair value of the options as either a
regulatory asset or liability in accordance with SFAS No. 71. The remaining
change is recognized currently in earnings. The consolidated balance sheets
reflected $1.2 million and $3.3 million of price risk management liabilities
associated with the programs at June 30, 2004 and December 31, 2003,
respectively.
14
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
On May 12, 2004, Columbia terminated fixed-to-variable interest rate swap
agreements in a notional amount of $663.0 million with five counterparties.
Columbia received an aggregate settlement payment of $1.8 million, which is
being amortized as a reduction to interest expense over the remaining term of
the underlying debt.
On May 12, 2004, NiSource entered into fixed-to-variable interest rate swap
agreements in a notional amount of $660.0 million with six counterparties having
a 6 1/2-year term. NiSource will receive payments based upon a fixed 7.875%
interest rate and pay a floating interest amount based on U.S. 6-month British
Banker Association (BBA) LIBOR plus an average of 3.08% per annum. There was no
exchange of premium at the initial date of the swaps. In addition, each party
has the right to cancel the swaps on May 15, 2009 at mid-market.
MARKETING AND TRADING ACTIVITIES. The operations of TPC primarily involve
commercial and industrial gas sales and power trading.
In April 2003, the gas-related activities (physical commodity sales to
commercial and industrial customers) that had been classified as derivatives
were considered to fall within the normal purchase and sale exception under SFAS
No. 133. Therefore, all gas-related derivatives used to offset the physical
obligations necessary to fulfill these commodity sales were designated as cash
flow hedges.
The fair market values of NiSource's power trading assets and liabilities were
$28.6 million and $26.7 million, respectively, at June 30, 2004 and $21.9
million and $23.4 million, respectively, at December 31, 2003.
8. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
FASB INTERPRETATION NO. 46 (REVISED DECEMBER 2003) -- CONSOLIDATION OF VARIABLE
INTEREST ENTITIES. On January 17, 2003, the FASB issued Interpretation No. 46,
"Consolidation of Variable Interest Entities" (FIN 46R). FIN 46R requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or is entitled to receive a majority of the entity's residual
returns. A company that consolidates a variable interest entity is called the
primary beneficiary of that entity. In general, a variable interest entity is a
corporation, partnership, trust, or any other legal structure used for business
purposes that either (a) does not have equity investors with voting rights, or
(b) has equity investors that do not provide sufficient financial resources for
the entity to support its activities. FIN 46R also requires various disclosures
about variable interest entities that a company is not required to consolidate
but in which it has a significant variable interest. On December 18, 2003, the
FASB deferred the implementation of FIN 46R to the first quarter of 2004. As a
result, NiSource consolidated certain low income housing real estate investments
beginning in the first quarter of 2004. Upon consolidation, NiSource increased
its long-term debt by approximately $40 million.
FASB STAFF POSITION (FSP) NO. FAS 106-2 -- ACCOUNTING AND DISCLOSURE
REQUIREMENTS RELATED TO THE MEDICARE PRESCRIPTION DRUG, IMPROVEMENT AND
MODERNIZATION ACT OF 2003 (FSP 106-2). (SUPERSEDES FSP 106-1-- ACCOUNTING AND
DISCLOSURE REQUIREMENTS RELATED TO THE MEDICARE PRESCRIPTION DRUG, IMPROVEMENT
AND MODERNIZATION ACT OF 2003.) On December 8, 2003, the President of the United
States signed the Medicare Prescription Drug, Improvement and Modernization Act
into law. The Act introduces a prescription drug benefit under Medicare
(Medicare Part D) as well as a federal subsidy to sponsors of retiree health
care benefit plans that provide a benefit that is at least actuarially
equivalent to Medicare Part D. FASB Statement No. 106, "Employers' Accounting
for Postretirement Benefits Other Than Pensions," requires presently enacted
changes in relevant laws to be considered in current period measurements of
postretirement benefit costs and the Accumulated Projected Benefit Obligation.
FSP 106-2 is effective for fiscal interims beginning after June 15, 2004.
NiSource previously elected to defer accounting for the effects of this
pronouncement, as allowed by FSP 106-2, and will adopt FSP 106-2 in the third
quarter of 2004. NiSource is currently evaluating the impact of FSP 106-2 and
believes the impact will not be significant, since NiSource has a restrictive
cap on its retiree post age-65 drug coverage plans.
15
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
9. LEGAL PROCEEDINGS
In the normal course of its business, NiSource and its subsidiaries have been
named as defendants in various legal proceedings. In the opinion of management,
the ultimate disposition of these currently asserted claims will not have a
material adverse impact on NiSource's consolidated financial position. Please
see Item 1, Part II, "Legal Proceedings," contained herein for more specific
information regarding current legal matters.
10. ACCUMULATED OTHER COMPREHENSIVE LOSS
The following table displays the components of Accumulated Other Comprehensive
Loss, which is included in "Common Stock Equity," on the consolidated balance
sheets.
JUNE 30, December 31,
(in millions) 2004 2003
- ----------------------------------------------- ---------- ------------
Foreign currency translation adjustment $ - $ (0.7)
Net unrealized gains on cash flow hedges 100.2 91.7
Loss on available for sale securities (1.3) (1.8)
Minimum pension liability adjustment (150.2) (150.2)
---------- ------------
TOTAL ACCUMULATED OTHER COMPREHENSIVE LOSS, NET $ (51.3) $ (61.0)
---------- ------------
As a part of normal business, NiSource and certain subsidiaries enter into
various agreements providing financial or performance assurance to third parties
on behalf of other subsidiaries. Such agreements include guarantees and stand-by
letters of credit. These agreements are entered into primarily to support or
enhance the creditworthiness otherwise attributed to a subsidiary on a
stand-alone basis, thereby facilitating the extension of sufficient credit to
accomplish the subsidiaries' intended commercial purposes. The total commercial
commitments in existence at June 30, 2004 and the years in which they expire
are:
11. GUARANTEES AND INDEMNITIES
(in millions) Total 2004 2005 2006 2007 2008 After
- ------------------------------- ---------- ------- --------- -------- ------ -------- ---------
Guarantees of subsidaries debt $ 3,843.1 $ 2.7 $ 1,183.2 $ 293.1 $ 32.4 $ 8.7 $ 2,323.0
Guarantees supporting commodity
transactions of subsidiaries 1,389.9 219.7 252.3 669.2 35.1 54.0 159.6
Other guarantees 373.9 - 51.1 - - 10.1 312.7
Lines of credit 143.5 143.5 - - - - -
Letters of credit 119.5 1.2 19.2 1.9 1.0 96.2 -
---------- ------- --------- -------- ------ -------- ---------
Total commercial commitments $ 5,869.9 $ 367.1 $ 1,505.8 $ 964.2 $ 68.5 $ 169.0 $ 2,795.3
---------- ------- --------- -------- ------ -------- ---------
NiSource has guaranteed the payment of $3.8 billion of debt for various
wholly-owned subsidiaries including Whiting Leasing LLC, NiSource Finance Corp.
(NiSource Finance), and through a support agreement, NiSource Capital Markets,
Inc. Other than debt associated with the former PEI subsidiaries that were sold,
the debt is reflected on NiSource's consolidated balance sheet. The subsidiaries
are required to comply with certain financial covenants under the debt indenture
and in the event of default, NiSource would be obligated to pay the debt's
principal and related interest. NiSource does not anticipate its subsidiaries
will have any difficulty maintaining compliance. NiSource Finance also maintains
lines of credit with financial institutions. At June 30, 2004, the amount
outstanding under the lines of credit and guaranteed by NiSource amounted to
$143.5 million. Additionally, NiSource has issued guarantees, which support up
to approximately $1.4 billion of commodity-related payments for its current
subsidiaries involved in energy marketing and trading and those satisfying
requirements under forward gas sales agreements of former subsidiaries. These
guarantees were provided to counterparties in order to facilitate physical and
financial transactions involving natural gas and electricity. To the extent
liabilities exist under the commodity-related contracts subject to these
guarantees, such liabilities are included in the consolidated balance sheets.
16
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
NiSource has issued standby letters of credit of approximately $119.5 million
through financial institutions for the benefit of third parties that have
extended credit to certain subsidiaries. If a subsidiary does not pay amounts
when due under covered contracts, the beneficiary may present its claim for
payment to the financial institution, which will in turn request payment from
NiSource.
NiSource has purchase and sales agreement guarantees totaling $137.5 million,
which guarantee performance of the seller's covenants, agreements, obligations,
liabilities, representations and warranties under the agreements. No amounts
related to the purchase and sales agreement guarantees are reflected in the
consolidated balance sheet.
Management believes that the likelihood NiSource would be required to perform or
otherwise incur any significant losses associated with any of the aforementioned
guarantees is remote.
After the October 20, 2003 sale of six subsidiaries, PEI continues to own
Whiting Clean Energy, Inc. (Whiting Clean Energy). The total of the outstanding
debt guaranteed for Whiting Clean Energy at June 30, 2004 was $325.6 million. As
of June 30, 2004, approximately $302.8 million of debt related to Whiting Clean
Energy was included in NiSource's consolidated balance sheet.
NiSource retains certain operational and financial guarantees with respect to
the former PEI subsidiaries and CER. NiSource has retained guarantees of $153.6
million as of June 30, 2004 of debt outstanding related to three of the former
PEI projects. In addition, NiSource has retained several operational guarantees
related to the former PEI subsidiaries. These operational guarantees are related
to environmental compliance, inventory balances, employee relations, and a
residual future purchase guarantee. The fair value of the guarantees was
determined to be $11.1 million and a portion of the net proceeds in the sale
amount were assumed allocated to the guarantees as prescribed by FASB
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45).
NiSource has retained liabilities related to the CER forward gas sales
agreements with Mahonia II Limited (Mahonia) for guarantees of the forward sales
and for indemnity agreements with respect to surety bonds backing the forward
sales. The guarantees, surety bonds and associated indemnity agreements remain
in place subsequent to the closing of the CER sale and decline over time as
volumes are delivered in satisfaction of the contractual obligations, ending in
February 2006. NiSource will be indemnified by Triana, and MSCP will fund up to
a maximum of $221.0 million of additional equity to Triana to support Triana's
indemnity, for Triana's gas delivery and related obligations to Mahonia. The
MSCP commitment declines over time in concert with the surety bonds and the
guaranteed obligation to deliver gas to Mahonia.
Immediately after the closing of the sale, Triana owned approximately 1.1 Tcf of
proved reserves, and was capitalized with $330.0 million, approximately $200.0
million of which was provided as initial equity by MSCP and the remainder of
which is provided as part of a $500.0 million revolving credit facility.
NiSource believes that the combination of Triana's proved reserves, sufficient
capitalization, and access to the credit facility, combined with the Triana
indemnity and the $221.0 million of further commitments to Triana from MSCP,
adequately offset any risk of losses that may be incurred by NiSource due to
Triana's non-performance under the Mahonia agreements. Accordingly, NiSource has
not recognized a liability related to the retention of the Mahonia guarantees.
12. PENSION AND OTHER POSTRETIREMENT BENEFITS
NiSource used a measurement date of September 30, 2003 for the calculation of
its obligations under the pension and other postretirement benefit plans.
NiSource expects to make contributions of $16.7 million to its pension plans and
$50.4 million to its postretirement medical and life plans in 2004.
17
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
The following table provides the components of the plans' net periodic benefits
cost (benefit) for the second quarter and six months ended June 30, 2004 and
June 30, 2003:
PENSION BENEFITS OTHER BENEFITS
------------------------ ------------------------
Three months ended June 30, (in millions) 2004 2003 2004 2003
- ------------------------------------------ --------- --------- --------- --------
NET PERIODIC COST
Service cost $ 9.8 $ 8.8 $ 2.2 $ 1.8
Interest cost 31.7 32.8 9.9 9.1
Expected return on assets (39.3) (35.4) (3.5) (2.6)
Amortization of transitional obligation - 1.4 2.9 2.9
Amortization of prior service cost 2.4 2.1 0.2 -
Recognized actuarial (gain) loss 4.5 6.4 0.7 (0.9)
--------- --------- --------- --------
NET PERIODIC BENEFITS COST $ 9.1 $ 16.1 $ 12.4 $ 10.3
--------- --------- --------- --------
PENSION BENEFITS OTHER BENEFITS
------------------------ ------------------------
Six months ended June 30, (in millions) 2004 2003 2004 2003
- ------------------------------------------ --------- --------- --------- ---------
NET PERIODIC COST
Service cost $ 19.6 $ 17.6 $ 4.4 $ 3.6
Interest cost 63.4 65.6 19.8 18.2
Expected return on assets (78.6) (70.8) (7.0) (5.2)
Amortization of transitional obligation - 2.8 5.8 5.8
Amortization of prior service cost 4.8 4.2 0.4 -
Recognized actuarial (gain) loss 9.0 12.8 1.4 (1.8)
--------- --------- --------- ---------
NET PERIODIC BENEFITS COST $ 18.2 $ 32.2 $ 24.8 $ 20.6
--------- --------- --------- ---------
13. SALE OF TRADE RECEIVABLES
On May 14, 2004, Columbia of Ohio entered into an agreement to sell, without
recourse, substantially all of its trade receivables, as they originate, to
Columbia of Ohio Receivables Corporation (CORC), a wholly-owned subsidiary of
Columbia of Ohio. CORC, in turn, is party to an agreement, also dated May 14,
2004, in which it sells an undivided percentage ownership interest in the
accounts receivable to a commercial paper conduit sponsored by Dresdner
Kleinwort Wasserstein. The conduit can purchase up to $300.0 million of accounts
receivable under the agreement. The agreements, which replaced prior similar
agreements, expire in May 2005, but can be automatically renewed if mutually
agreed to by both parties. As of June 30, 2004, $164.8 million of accounts
receivable had been sold by CORC.
On December 30, 2003, Northern Indiana entered into an agreement to sell,
without recourse, all of its trade receivables, as they originate, to NIPSCO
Receivables Corporation (NRC), a wholly-owned subsidiary of Northern Indiana.
NRC, in turn, is party to an agreement in which it sells an undivided percentage
ownership interest in the accounts receivable to a commercial paper conduit. The
conduit can purchase up to $200 million of accounts receivable under the
agreement. The agreements expire in December 2004. As of June 30, 2004, NRC had
sold $135.6 million of accounts receivable.
14. BUSINESS SEGMENT INFORMATION
Operating segments are components of an enterprise for which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance.
During the second quarter 2003, NiSource re-aligned its reportable segments to
reflect the announced sale of its exploration and production operations. As of
the second quarter 2003, NiSource no longer reported an Exploration and
Production Operations segment. In addition, the PEI subsidiaries sold are
reported as discontinued operations. All periods have been adjusted to conform
with the realignment.
18
ITEM 1. FINANCIAL STATEMENTS (continued)
NISOURCE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
NiSource's operations are divided into four primary business segments. The Gas
Distribution Operations segment provides natural gas service and transportation
for residential, commercial and industrial customers in Ohio, Pennsylvania,
Virginia, Kentucky, Maryland, Indiana, Massachusetts, Maine and New Hampshire.
The Gas Transmission and Storage Operations segment offers gas transportation
and storage services for LDCs, marketers and industrial and commercial customers
located in northeastern, mid-Atlantic, midwestern and southern states and the
District of Columbia. The Electric Operations segment provides electric service
in 21 counties in the northern part of Indiana and engages in electric wholesale
and wheeling transactions. The Other Operations segment primarily includes gas
marketing, power marketing and trading and ventures focused on distributed power
generation technologies, including cogeneration facilities, fuel cells and
storage systems.
The following tables provide information about NiSource's business segments.
NiSource uses operating income (loss) as its primary measurement for each of the
reporting segments and makes decisions on finance, dividends and taxes at the
corporate level on a consolidated basis. Segment revenues include intersegment
sales to affiliated subsidiaries, which are eliminated in consolidation.
Affiliated sales are recognized on the basis of prevailing market prices,
regulated prices or at levels provided for under contractual agreements.
Operating income (loss) is derived from revenues and expenses directly
associated with each segment.
Three Months Six Months
Ended June 30, Ended June 30,
------------------------- --------------------------
(in millions) 2004 2003 2004 2003
- ---------------------------- ----------- --------- ----------- ----------
REVENUES
GAS DISTRIBUTION
Unaffiliated $ 702.1 $ 653.9 $ 2,560.3 $ 2,604.1
Intersegment 0.9 4.9 4.0 14.3
----------- --------- ----------- ----------
Total 703.0 658.8 2,564.3 2,618.4
----------- --------- ----------- ----------
GAS TRANSMISSION AND STORAGE
Unaffiliated 133.3 141.9 300.2 304.8
Intersegment 61.4 53.4 131.3 126.5
----------- --------- ----------- ----------
Total 194.7 195.3 431.5 431.3
----------- --------- ----------- ----------
ELECTRIC OPERATIONS
Unaffiliated 263.8 255.9 519.6 511.8
Intersegment 3.6 3.5 8.7 10.4
----------- --------- ----------- ----------
Total 267.4 259.4 528.3 522.2
----------- --------- ----------- ----------
OTHER
Unaffiliated 136.5 82.3 320.3 213.4
Intersegment 9.1 10.4 14.2 23.7
----------- --------- ----------- ----------
Total 145.6 92.7 334.5 237.1
----------- --------- ----------- ----------
Adjustments and eliminations (65.7) (65.0) (140.4) (143.2)
----------- --------- ----------- ----------
CONSOLIDATED REVENUES $ 1,245.0 $ 1,141.2 $ 3,718.2 $ 3,665.8
----------- --------- ----------- ----------
OPERATING INCOME (LOSS)
Gas Distribution $ 15.1 $ 56.8 $ 300.1 $ 371.0
Gas Transmission and Storage 73.5 87.3 184.9 198.6
Electric 82.0 64.1 140.8 116.7
Other (8.1) (10.4) (26.3) (24.3)
Corporate (5.0) (22.0) 0.6 (13.8)
----------- --------- ----------- ----------
CONSOLIDATED OPERATING INCOME $ 157.5 $ 175.8 $ 600.1 $ 648.2
----------- --------- ----------- ----------
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
NISOURCE INC.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Management's Discussion and Analysis, including statements regarding market
risk sensitive instruments, contains "forward-looking statements," within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Investors and
prospective investors should understand that many factors govern whether any
forward-looking statement contained herein will be or can be realized. Any one
of those factors could cause actual results to differ materially from those
projected. These forward-looking statements include, but are not limited to,
statements concerning NiSource Inc.'s (NiSource) plans, objectives, expected
performance, expenditures and recovery of expenditures through rates, stated on
either a consolidated or segment basis, and any and all underlying assumptions
and other statements that are other than statements of historical fact. From
time to time, NiSource may publish or otherwise make available forward-looking
statements of this nature. All such subsequent forward-looking statements,
whether written or oral and whether made by or on behalf of NiSource, are also
expressly qualified by these cautionary statements. All forward-looking
statements are based on assumptions that management believes to be reasonable;
however, there can be no assurance that actual results will not differ
materially.
Realization of NiSource's objectives and expected performance is subject to a
wide range of risks and can be adversely affected by, among other things,
weather, fluctuations in supply and demand for energy commodities, growth
opportunities for NiSource's businesses, increased competition in deregulated
energy markets, dealings with third parties over whom NiSource has no control,
actual operating experience of acquired assets, the regulatory process,
regulatory and legislative changes, changes in general economic, capital and
commodity market conditions, and counter-party credit risk, many of which risks
are beyond the control of NiSource. In addition, the relative contributions to
profitability by each segment, and the assumptions underlying the
forward-looking statements relating thereto, may change over time.
The following Management's Discussion and Analysis should be read in conjunction
with NiSource's Annual Report on Form 10-K for the fiscal year ended December
31, 2003.
CONSOLIDATED REVIEW
EXECUTIVE SUMMARY
NiSource generates nearly all of its net revenue through the sale, distribution,
and transmission and storage of natural gas and the generation, transmission and
distribution of electricity, which are rate regulated. A significant portion of
NiSource's operations, most notably in the gas distribution, gas transportation
and electric businesses, is subject to seasonal fluctuations in sales. During
the heating season, which is primarily from November through March, and the
cooling season, which is primarily from June through September, net revenues
from gas and electric sales and transportation services are more significant
than in other months.
For the second quarter of 2004, income from continuing operations was $35.3
million, or $0.13 per share, while for the six months ended June 30, 2004,
NiSource reported income from continuing operations of $251.8 million, or $0.96
per share. This compares to income from continuing operations of $39.3 million,
or $0.15 per share, for the year-ago quarter and income from continuing
operations of $261.6 million, or $1.02 per share for the period ended June 30,
2003. Warmer weather during the crucial winter heating season, as compared to
the period a year ago, partially offset by a reduced estimate of property tax
expense, were the primary factors affecting NiSource's second quarter and
year-to-date results for 2004. Additionally, continued actions to reduce debt
have resulted in significant improvements to NiSource's balance sheet and
reduced interest expense. All per share amounts are basic earnings per share.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
The second quarter of 2004 was marked by many key factors that contributed to
our results. Weather in the markets served by NiSource's natural gas utility and
pipeline companies was approximately 10 percent warmer than normal and 11
percent warmer compared with the year-ago period. In addition, both this quarter
and the second quarter of 2003 reflect lower interruptible transmission service
revenues than those that have been historically realized by NiSource's pipeline
business. Management has evaluated operational and market conditions, and
anticipates that there will be fewer opportunities for interruptible revenue on
an ongoing basis. Also, with a reduction in the company's debt and lower average
long-term borrowing rates, interest expense for the second quarter of 2004
decreased by $15.2 million, or 13.2 percent, compared with the year-ago period.
NiSource continues to improve its capital structure, with a total debt to total
capitalization ratio of 57 percent, compared with 60 percent at year-end 2003.
The decrease in the total debt to total capitalization ratio from December 31,
2003 is a result of a seasonal reduction in short-term debt due to lower working
capital requirements.
NiSource will continue to build value and customer trust by capitalizing on its
super-regional utility and pipeline operations. NiSource will focus on:
continuing to standardize its operations and improve on predictability and
reliability; continuing to deliver the best possible service at the lowest cost;
continuing to develop innovative ways to help our customers manage heating bills
and gas price volatility, with products such as a fixed-price option; continuing
to find ways to control the cost of generating electricity; and pursuing
projects that will bring long-term attractively priced gas supplies to the
market.
RESULTS OF OPERATIONS
THE QUARTER ENDED JUNE 30, 2004
Net Income
NiSource reported net income of $34.6 million, or $0.13 per share, for the three
months ended June 30, 2004, compared to a net loss of $324.9 million, or $1.24
loss per share, for the second quarter 2003. Operating income was $157.5
million, a decrease of $18.3 million from the same period in 2003. NiSource's
net income reflects the impact of the discontinued operations, a $364.2 million
loss in the second quarter of 2003, which included the sale of Columbia Energy
Resources (CER) and all of the steel-industry-related, inside-the-fence project
entities of PEI Holdings, Inc. ( PEI). All per share amounts are basic earnings
per share.
Net Revenues
Total consolidated net revenues (gross revenues less cost of sales) for the
three months ended June 30, 2004, were $616.1 million, a $25.7 million decrease
from the same period last year. The decrease in gas net revenues was primarily a
result of reduced residential and commercial natural gas sales and deliveries of
approximately $6.0 million due to warmer weather, and lower non-traditional
revenue amounting to $6.1 million during the second quarter of 2004 compared
with the same period in 2003. In addition, transmission and storage net revenues
decreased by $4.4 million due to a reduction in interruptible service revenues
primarily due to lower throughput, which were partially offset by an increase in
demand charge revenues. The reduction in gas distribution revenue and
transmission and storage revenue were partially offset by a $6.8 million
increase in electric net revenue for the 2004 quarter, which was due to greater
customer usage and favorable weather. The comparable 2003 period was also
favorably impacted by adjustments for gas costs associated with certain
customers of about $14.3 million.
Expenses
Operating expenses for the second quarter 2004 were $458.6 million, a decrease
of $7.4 million from the 2003 period. The second quarter of 2004 was favorably
impacted by litigation settlements of $3.3 million and an adjustment of
insurance reserves of $5.8 million. These 2004 benefits compared to 2003
benefits that included insurance adjustments and recoveries of $13.1 million and
the reversal of a litigation reserve upon settlement amounting to $6.6 million.
Taking into consideration these items impacting both 2004 and 2003 operation and
maintenance expenses, quarter-over-quarter, baseline operation and maintenance
expenses were essentially flat. Other taxes expense for the second quarter 2004
was $19.5 million lower than the second quarter of 2003 mainly as a result of
reducing an accrual for estimated property tax expense.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
Other Income (Deductions)
Interest expense, net was $99.6 million for the quarter, a decrease of $15.3
million compared to the second quarter 2003. The decrease was the result of a
quarter-over-quarter reduction in debt balances along with lower average
long-term borrowing rates attributable to debt refinancings completed during
2003.
Income Taxes
Income tax expense for the second quarter 2004 was $22.1 million, a decrease of
$4.3 million compared to the 2003 period, due to lower pre-tax income.
Discontinued Operations
The after-tax loss from discontinued operations was $0.7 million for the second
quarter 2004 versus an after-tax loss from discontinued operations of $364.2
million in the second quarter of 2003. The current quarter after-tax loss from
discontinued operations is a result of residual liabilities associated with the
sale of NiSource's exploration and production subsidiary, CER, in August 2003.
For the comparable quarter in 2003, the after-tax loss of $362.8 million was
related to the sales of CER, and all of the steel-industry-related,
inside-the-fence project entities of its subsidiary PEI. NiSource accounted for
the CER and PEI subsidiaries as discontinued operations as of June 30, 2003.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2004
Net Income
NiSource reported net income of $248.1 million, or $0.95 per share, for the six
months ended June 30, 2004, compared to a net loss of $70.0 million, or $0.27
loss per share, for the first six month of 2003. Operating income was $600.1
million, a decrease of $48.1 million from the same period in 2003. NiSource's
net income reflects the impact of the discontinued operations sales, a $318.0
million loss in the second quarter of 2003, which included CER and all of the
steel-industry-related, inside-the-fence project entities of PEI. All per share
amounts are basic earnings per share.
Net Revenues
Total consolidated net revenues (gross revenues less cost of sales) for the six
months ended June 30, 2004, were $1,608.1 million, a $63.4 million decrease from
the same period last year. The decrease in gas net revenues was primarily a
result of reduced residential and commercial natural gas sales and deliveries
due to warmer weather of approximately $22.6 million, reduced revenue from cost
trackers of $13.6 million and lower non-traditional revenue amounting to $9.2
million during the first half of 2004 compared with the same period in 2003.
Both the six-months ended June 30, 2004, and the six-months ended June 30, 2003,
reflect lower interruptible transmission service revenues than those that have
been historically realized, driving a $3.1 million decrease in transmission net
revenue. Management has evaluated operational and market conditions, and
anticipates that there will be fewer opportunities for interruptible revenue on
an ongoing basis. The reduction in gas distribution revenue and transmission
revenue was partially offset by a $16.8 million increase in electric net revenue
for the first six months of 2004, which was due to greater customer usage and
favorable weather. The comparable 2003 period was also favorably impacted by
adjustments for gas costs associated with certain customers.
Expenses
Operating expenses for the first six months of 2004 were $1,008.0 million, a
decrease of $15.3 million from the 2003 period. Other taxes expense for the
first half of 2004 was $24.6 million lower than the first half of 2003 mainly as
a result of reducing an accrual for estimated property tax expense. Operation
and maintenance expenses for the first half of 2004 were $6.1 million higher
than they were in first half of 2003. The six months ended June 30, 2004,
benefited from the reversal of a reserve upon settlement of a lawsuit of $14.3
million and the adjustment of insurance reserves of $5.1 million, and was
reduced by the write-down of a regulatory asset amounting to $8.6 million. The
comparable 2003 period was favorably impacted by insurance adjustments and
recoveries of $13.1 million and the reversal of litigation reserves upon the
settlement of lawsuits amounting to $19.2 million.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
Other Income (Deductions)
Interest expense, net was $202.3 million for the first six months of 2004
compared to $237.9 million for the first six months of last year. This decrease
of $35.6 million was mainly due to a reduction in short-term debt balances and
lower average long-term borrowing rates attributable to debt refinancings
completed during 2003.
Income Taxes
Income tax expense for the first six months of 2004 was $147.7 million, a
decrease of $6.2 million compared to the 2003 period, due to lower pre-tax
income.
Discontinued Operations
The after-tax loss from discontinued operations was $3.7 million for the six
months ended June 30, 2004 versus an after-tax loss from discontinued operations
of $322.8 million for the comparable 2003 period. The current period's after-tax
loss from discontinued operations is a result of residual liabilities associated
with the sale of CER in August 2003. For the six months ended June 30, 2003 the
after-tax loss of $362.8 million was related to the sales of CER, and all of the
steel-industry-related, inside-the-fence project entities of PEI.
Change in Accounting
The change in accounting in the first half of 2003 of $8.8 million, net-of-tax,
resulted from the cumulative effect of adopting the Financial Accounting
Standards Board statement on asset retirement obligations.
LIQUIDITY AND CAPITAL RESOURCES
Generally, cash flow from operations has provided sufficient liquidity to meet
operating requirements. A significant portion of NiSource's operations, most
notably in the gas distribution, gas transportation and electric businesses, is
subject to seasonal fluctuations in cash flow. During the heating season, which
is primarily from November through March, cash receipts from gas sales and
transportation services typically exceed cash requirements. During the summer
months, cash on hand, together with the seasonal increase in cash flows from the
electric business during the summer cooling season and external short-term and
long-term financing, is used to purchase gas to place in storage for heating
season deliveries, perform necessary maintenance of facilities, make capital
improvements in plant and expand service into new areas.
Net cash from continuing operations for the six months ended June 30, 2004 was
$1,093.0 million. Net cash from continuing operations increased $501.3 million
from the comparable period a year-ago, mainly as a result of increased cash flow
from working capital. The increase in cash flow from working capital was $540.9
million, driven largely by increased factoring of accounts receivable through
the expanded accounts receivable sales agreements, decreased gas inventories and
the timing of the recovery of gas and fuel costs.
During July 2004, NiSource redeemed $32.0 million of Northern Indiana Public
Service Company (Northern Indiana) medium-term notes, with an average interest
rate of 6.53%.
During April 2004, NiSource redeemed $80.0 million of NiSource Capital Markets,
Inc. medium-term notes, with an average interest rate of 7.39%.
During February 2004, Northern Indiana redeemed $111.1 million of its
medium-term notes and Bay State Gas Company redeemed $10.0 million of its
medium-term notes, with an average interest rate of 7.49% and 7.63%,
respectively. The associated redemption premium was $4.6 million, of which $4.2
million was charged to expense and $0.4 million was recorded as a regulatory
asset.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
Credit Facilities
During March 2004, NiSource obtained a new $500 million 364-day credit facility
and a $750 million 3-year credit facility with a syndicate of banks led by
Barclays Capital. The new facilities replaced an expiring $1.25 billion credit
facility. NiSource had outstanding credit facility advances of $143.5 million at
June 30, 2004, at a weighted average interest rate of 2.3%, and advances of
$685.5 million at December 31, 2003, at a weighted average interest rate of
1.82%. As of June 30, 2004 and December 31, 2003, NiSource had $114.4 million
and $121.4 million of standby letters of credit outstanding, respectively. At
June 30, 2004, $96.2 million of the $114.4 million total outstanding letters of
credit resided within a separate bi-lateral letter of credit arrangement with
Barclays Bank which NiSource obtained during February 2004. As of June 30, 2004,
$1,088.3 million of credit was available under the credit facilities. In
addition, NiSource had standby letters of credit of $5.1 million and $4.9
million as of June 30, 2004 and December 31, 2003, respectively, issued under
another credit facility.
Sale of Trade Receivables
On May 14, 2004, Columbia Gas of Ohio, Inc. (Columbia of Ohio) entered into an
agreement to sell, without recourse, substantially all of its trade receivables,
as they originate, to Columbia of Ohio Receivables Corporation (CORC), a
wholly-owned subsidiary of Columbia of Ohio. CORC, in turn, is party to an
agreement, also dated May 14, 2004, in which it sells an undivided percentage
ownership interest in the accounts receivable to a commercial paper conduit
sponsored by Dresdner Kleinwort Wasserstein. The conduit can purchase up to
$300.0 million of accounts receivable under the agreement. The agreements, which
replaced prior similar agreements, expire in May 2005, but can be automatically
renewed if mutually agreed to by both parties. As of June 30, 2004, $164.8
million of accounts receivable had been sold by CORC.
On December 30, 2003, Northern Indiana entered into an agreement to sell,
without recourse, all of its trade receivables, as they originate, to NIPSCO
Receivables Corporation (NRC), a wholly-owned subsidiary of Northern Indiana.
NRC, in turn, is party to an agreement in which it sells an undivided percentage
ownership interest in the accounts receivable to a commercial paper conduit. The
conduit can purchase up to $200 million of accounts receivable under the
agreement. The agreements expire in December 2004. As of June 30, 2004, NRC had
sold $135.6 million of accounts receivable.
MARKET RISK DISCLOSURES
Through its various business activities, NiSource is exposed to both non-trading
and trading risks. The non-trading risks to which NiSource is exposed include
interest rate risk, commodity market risk and credit risk of its subsidiaries.
The risk resulting from trading activities consists primarily of commodity
market and credit risks. NiSource's risk management policy permits the use of
certain financial instruments to manage its market risk, including futures,
forwards, options and swaps.
Various analytical techniques are employed to measure and monitor NiSource's
market and credit risks, including value-at-risk and instrument sensitivity to
market factors (VaR). VaR represents the potential loss or gain for an
instrument or portfolio from changes in market factors, for a specified time
period and at a specified confidence level.
Non-Trading Risks
Commodity price risk resulting from non-trading activities at NiSource's
rate-regulated subsidiaries is limited, since current regulations allow recovery
of prudently incurred purchased power, fuel and gas costs through the
rate-making process. As states experiment with regulatory reform, these
subsidiaries may begin providing services without the benefit of the traditional
rate-making process and may be more exposed to commodity price risk.
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
NiSource is exposed to interest rate risk as a result of changes in interest
rates on borrowings under revolving credit agreements and lines of credit, which
have interest rates that are indexed to short-term market interest rates. At
June 30, 2004, the combined borrowings outstanding under these facilities
totaled $143.5 million. NiSource is also exposed to interest rate risk due to
changes in interest rates on fixed-to-variable interest rate swaps that hedge
the fair value of long-term debt. The principal amount of such long-term debt
subject to interest rate hedges at June 30, 2004 was $1,160.0 million. Based
upon average borrowings under agreements subject to fluctuations in short-term
market interest rates during the second quarter 2004, an increase in short-term
interest rates of 100 basis points (1%) would have increased interest expense by
$4.4 million and $9.6 million for the quarter and six months ended June 30,
2004, respectively.
On May 12, 2004, Columbia terminated fixed-to-variable interest rate swap
agreements in a notional amount of $663.0 million with five counterparties.
Columbia received an aggregate settlement payment of $1.8 million, which is
being amortized as a reduction to interest expense over the remaining term of
the underlying debt.
On May 12, 2004, NiSource entered into fixed-to-variable interest rate swap
agreements in a notional amount of $660.0 million with six counterparties having
a 6 1/2-year term. NiSource will receive payments based upon a fixed 7.875%
interest rate and pay a floating interest amount based on U.S. 6-month British
Banker Association (BBA) LIBOR plus an average of 3.08% per annum. There was no
exchange of premium at the initial date of the swaps. In addition, each party
has the right to cancel the swaps on May 15, 2009 at mid-market.
Due to the nature of the industry, credit risk is a factor in many of NiSource's
business activities. Credit risk arises because of the possibility that a
customer, supplier or counterparty will not be able or willing to fulfill its
obligations on a transaction on or before the settlement date. For derivative
contracts such as interest rate swaps, credit risk arises when counterparties
are obligated to pay NiSource the positive fair value or receivable resulting
from the execution of contract terms. Exposure to credit risk is measured in
terms of both current and potential exposure. Current credit exposure is
generally measured by the notional or principal value of financial instruments
and direct credit substitutes, such as commitments, standby letters of credit
and guarantees. Because many of NiSource's exposures vary with changes in market
prices, NiSource also estimates the potential credit exposure over the remaining
term of transactions through statistical analyses of market prices. In
determining exposure, NiSource considers collateral and master netting
agreements, which are used to reduce individual counterparty credit risk.
Trading Risks
The transactions associated with NiSource's power trading operations give rise
to various risks, including market risks resulting from the potential loss from
adverse changes in the market prices of electricity. The power trading
operations market and trade over-the-counter contracts for the purchase and sale
of electricity. Those contracts within the power trading portfolio that require
settlement by physical delivery are often net settled in accordance with
industry standards.
Fair value represents the amount at which willing parties would transact an
arms-length transaction. Fair value is determined by applying a current price to
the associated contract volume for a commodity. The current price is derived
from one of three sources including actively quoted markets such as the New York
Mercantile Exchange (NYMEX), other external sources including electronic
exchanges and over-the-counter broker-dealer markets, as well as financial
models such as the Black-Scholes option pricing model.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
The fair values of the contracts related to NiSource's trading operations, the
activity affecting the changes in the fair values during the second quarter of
2004, the sources of the valuations of the contracts during 2004 and the years
in which the remaining contracts mature are:
Three Months Ended Six Months Ended
(in millions) June 30, 2004 June 30, 2004
- ----------------------------------------------------------------------------------------------------------------
Fair value of contracts outstanding at the beginning of the period $ - $ (1.5)
Contracts realized or otherwise settled during the period (including
net option premiums received) 1.1 (1.6)
Fair value of new contracts entered into during the period (1.3) (4.4)
Other changes in fair values during the period 2.1 9.4
------------------ ----------------
Fair value of contracts outstanding at the end of the period $ 1.9 $ 1.9
------------------ ----------------
(in millions) 2004 2005 2006 2007 2008 After
- ----------------------------------- ------- -------- ------- ------ ------ ------
Prices actively quoted $ - $ - $ - $ - $ - $ -
Prices from other external sources 1.0 0.2 - - - -
Prices based on models/other method 2.7 (2.0) - - - -
------- -------- ------- ------ ------ ------
Total fair values $ 3.7 $ (1.8) $ - $ - $ - $ -
------- -------- ------- ------ ------ ------
The caption "Prices from other external sources" generally includes contracts
traded on electronic exchanges and over-the-counter contracts whose value is
based on published indices or other publicly available pricing information.
Contracts shown within "Prices based on models/other method" are generally
valued employing the widely used Black-Scholes option-pricing model.
Market Risk Measurement
Market risk refers to the risk that a change in the level of one or more market
prices, rates, indices, volatilities, correlations or other market factors, such
as liquidity, will result in losses for a specified position or portfolio.
NiSource calculates a one-day VaR at a 95% confidence level for the power
trading group and the gas marketing group that utilize a variance/covariance
methodology. Based on the results of the VaR analysis, the daily market exposure
for power trading on an average, high and low basis was $0.2 million, $0.4
million and effectively zero, during the second quarter of 2004, respectively.
The daily market exposure for the gas marketing portfolio on an average, high
and low basis was $0.1 million, $0.2 million and $0.1 million during the second
quarter of 2004, respectively. Prospectively, management has set the VaR limits
at $2.5 million for power trading and $0.5 million for gas marketing. Exceeding
the VaR limits would result in management actions to reduce portfolio risk.
Refer to "Risk Management Activities" in Note 7 of the Notes to Consolidated
Financial Statements for further discussion of NiSource's risk management.
OFF BALANCE SHEET ARRANGEMENTS
NiSource has issued guarantees that support up to approximately $1.4 billion of
commodity-related payments for its current subsidiaries involved in energy
marketing and power trading and to satisfy requirements under forward gas sales
agreements of a former subsidiary. These guarantees were provided to
counterparties to facilitate physical and financial transactions involving
natural gas and electricity. To the extent liabilities exist under the
commodity-related contracts subject to these guarantees, such liabilities are
included in the consolidated balance sheets. In addition, NiSource has other
guarantees, purchase commitments, operating leases, lines of credit and letters
of credit outstanding. Refer to Note 7, Risk Management Activities, and Note 11,
Guarantees and Indemnities, of the Notes to Consolidated Financial Statements
for further discussion of NiSource's off balance sheet arrangements.
In addition, NiSource subsidiaries have sold certain accounts receivable.
NiSource's accounts receivable programs qualify for sale accounting because they
meet the conditions specified in the Statement of Financial Accounting Standards
(SFAS) No. 140 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." In the agreements, all transferred assets have
been isolated from the transferor and put presumptively beyond the reach of the
transferor and its creditors, even in bankruptcy or other receivership. NiSource
does not retain any interest in the receivables under these programs.
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
OTHER INFORMATION
Bargaining Unit Contract
Northern Indiana reached an agreement with its bargaining unit employees to
replace the contract agreements that expired May 31, 2004. The new agreements
are for five years, expiring May 31, 2009.
RESULTS AND DISCUSSION OF SEGMENT OPERATIONS
Presentation of Segment Information
NiSource's operations are divided into four primary business segments; Gas
Distribution Operations, Gas Transmission and Storage Operations, Electric
Operations, and Other Operations.
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
GAS DISTRIBUTION OPERATIONS
Three Months Six Months
Ended June 30, Ended June 30,
--------------------- -----------------------
(in millions) 2004 2003 2004 2003
- ------------- -------- -------- ---------- ----------
NET REVENUES
Sales Revenues $ 627.8 $ 576.4 $ 2,307.3 $ 2,352.8
Less: Cost of gas sold 462.0 385.3 1,742.8 1,729.3
-------- -------- ---------- ----------
Net Sales Revenues 165.8 191.1 564.5 623.5
Transportation Revenues 75.2 82.4 257.0 265.6
-------- -------- ---------- ----------
Net Revenues 241.0 273.5 821.5 889.1
-------- -------- ---------- ----------
OPERATING EXPENSES
Operation and maintenance 145.7 135.4 329.0 319.2
Depreciation and amortization 48.6 47.9 96.3 95.5
Other taxes 31.6 33.4 96.1 103.4
-------- -------- ---------- ----------
Total Operating Expenses 225.9 216.7 521.4 518.1
-------- -------- ---------- ----------
Operating Income $ 15.1 $ 56.8 $ 300.1 $ 371.0
======== ======== ========= ==========
REVENUES ($ IN MILLIONS)
Residential 335.8 378.5 1,450.9 1,555.1
Commercial 116.8 135.0 512.7 552.7
Industrial 38.0 37.1 118.7 110.5
Transportation 75.2 82.4 257.0 265.6
Off System Sales 114.5 17.4 155.3 60.6
Other 22.7 8.4 69.7 73.9
-------- -------- ---------- ----------
Total 703.0 658.8 2,564.3 2,618.4
-------- -------- ---------- ----------
SALES AND TRANSPORTATION (MMDTH)
Residential sales 27.6 29.5 137.4 150.8
Commercial sales 11.6 12.1 53.0 58.0
Industrial sales 5.3 3.9 13.4 12.1
Transportation 112.8 103.8 300.0 286.1
Off System Sales 19.0 2.6 26.0 5.3
Other 0.1 2.0 0.1 2.2
-------- -------- ---------- ----------
Total 176.4 153.9 529.9 514.5
-------- -------- ---------- ----------
HEATING DEGREE DAYS 434 486 3,158 3,371
NORMAL HEATING DEGREE DAYS 483 485 3,138 3,120
% COLDER (WARMER) THAN NORMAL (10%) 0% 1% 8%
CUSTOMERS
Residential 2,303,083 2,303,356
Commercial 211,704 213,982
Industrial 5,863 5,999
Transportation 753,654 744,324
Other 61 65
-------- -------- ---------- ----------
Total - - 3,274,365 3,267,726
-------- -------- ---------- ----------
NiSource's natural gas distribution operations serve approximately 3.3 million
customers in nine states: Ohio, Indiana, Pennsylvania, Massachusetts, Virginia,
Kentucky, Maryland, New Hampshire and Maine. The regulated subsidiaries offer
both traditional bundled services as well as transportation only for customers
that purchase gas from alternative suppliers. The operating results reflect the
temperature-sensitive nature of customer demand with over 72% of annual
residential and commercial throughput affected by seasonality. As a result,
segment operating income is higher in the first and fourth quarters reflecting
the heating demand during the winter season.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
GAS DISTRIBUTION OPERATIONS (CONTINUED)
Regulatory Matters
Through October 2004, Columbia of Ohio is operating under a regulatory
stipulation approved by the Public Utilities Commission of Ohio (PUCO). On
October 9, 2003, Columbia of Ohio and other parties filed with the PUCO an
amended stipulation that would govern Columbia of Ohio's regulatory framework
from November 2004 through October 2010. The majority of Columbia of Ohio's
contracts with interstate pipelines expire in October 2004, and the amended
stipulation would permit Columbia of Ohio to renew those contracts for firm
capacity sufficient to meet up to 100% of the design peak day requirements
through October 31, 2005 and up to 95% of the design peak day requirements
through October 31, 2010. Among other things, the amended stipulation would
also: (1) extend Columbia of Ohio's CHOICE(R) program through October 2010; (2)
provide Columbia of Ohio with an opportunity to generate revenues sufficient to
cover the stranded costs associated with the CHOICE(R) program; and (3) allow
Columbia of Ohio to record post-in-service carrying charges on plant placed into
service after October 2004, and to defer the property taxes and depreciation
associated with such plant.
On March 11, 2004, the PUCO issued an order that adopted and modified the
stipulation from Columbia of Ohio and a collaborative of parties. The order
extended Columbia of Ohio's CHOICE(R) program. However, the order limited the
time period of the stipulation through December 31, 2007 and declined to
pre-approve the amount of interstate pipeline firm capacity for which Columbia
of Ohio could contract. In addition, the PUCO made other modifications which
would limit Columbia of Ohio's ability to generate additional revenues
sufficient to cover stranded costs, including declining to mandate that natural
gas marketers participating in the CHOICE(R) program obtain 75% of their
interstate capacity directly from Columbia of Ohio and changing the allocation
of revenues generated through off-system sales. The order allows Columbia of
Ohio to record post-in-service carrying charges on plant placed in service after
October 2004 and allows the deferral of property taxes and depreciation
associated with such plant.
On April 9, 2004, Columbia of Ohio and other signatory parties to the
stipulation, consistent with standard regulatory process, petitioned the PUCO
for rehearing on the components which have been modified. That same day the
Office of the Ohio Consumers' Counsel (OCC) also filed an application for
rehearing, and argued that the PUCO should not have permitted Columbia of Ohio
to record post-in-service carrying charges on plant placed into service after
October 2004, and to defer the property taxes and depreciation associated with
such plant. On April 19, 2004, the OCC filed a motion to dismiss the application
for rehearing filed by Columbia of Ohio and other parties.
On May 5, 2004 the PUCO issued an order on rehearing, in which it denied the
OCC's motion to dismiss and its application for rehearing. The PUCO granted, in
part, the joint application filed by Columbia of Ohio and others. In granting
the joint application for rehearing, in part, the PUCO did the following: (1)
revised the term of the stipulation so that it runs through October 31, 2008;
(2) restored the marketers' responsibility for 75% of CHOICE(R) costs; and (3)
revised the mechanism applicable to Columbia of Ohio's sharing of off-system
sales and capacity release revenue. Under the revised off-system sales/capacity
release revenue sharing mechanism, Columbia of Ohio must now begin sharing such
revenue equally with the customers when the annual revenue exceeds $25 million,
instead of $35 million as originally proposed by Columbia of Ohio and other
collaborative parties.
In a letter docketed on May 12, 2004, Columbia of Ohio and the other signatory
parties to the stipulation accepted the PUCO's modifications. On May 14, 2004,
the OCC filed a Second Application for Rehearing. In the pleading, the OCC
argued that the joint applicants did not meet the statutory requirements for an
application for rehearing, and thus the PUCO's order on rehearing granting
rehearing was unlawful. The OCC also argued that the rehearing was the result of
exclusionary settlement negotiations. The OCC continued to disagree with the
PUCO's treatment of off-system sales and capacity release revenues, and
post-in-service carrying charges and related deferrals.
On June 3, 2004, Columbia of Ohio filed its proposed tariffs and accounting, as
required. On June 9, 2004, the PUCO denied the OCC's Second Application for
Rehearing. On July 29, 2004, the OCC filed an appeal with the Supreme Court of
Ohio, contesting the PUCO's May 5, 2004 order on rehearing, which granted in
part Columbia of Ohio's joint application for rehearing, and the PUCO's June 9,
2004 order, denying the OCC's Second Application for Rehearing.
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
GAS DISTRIBUTION OPERATIONS (CONTINUED)
On December 17, 2003, the PUCO approved an application by Columbia of Ohio and
other Ohio local distribution companies (LDCs) to establish a tracking mechanism
that will provide for recovery of current bad debt expense and for the recovery
over a five-year period of previously deferred uncollected accounts receivable.
As of June 30, 2004, Columbia of Ohio has $46.9 million of uncollected accounts
receivable pending future recovery.
On June 11, 2004, Columbia Gas of Pennsylvania, Inc. (Columbia of Pennsylvania)
signed a settlement agreement ("Settlement Agreement") in its annual gas cost
recovery proceeding with The Office of Consumer Advocate, The Office of Small
Business Advocate, The Office of Trial Staff, and Commercial & Industrial
Intervenors. Under the Settlement Agreement, the signatory parties agreed to
financial incentive mechanisms for off-system sales and capacity release
transactions performed by Columbia of Pennsylvania. Under the incentive
mechanism, customers receive 100% of the total combined proceeds from off-system
sales and capacity release transactions up to a benchmark of $6.0 million. After
the benchmark is reached, Columbia of Pennsylvania will retain 50% of proceeds
from the transactions; however, Columbia of Pennsylvania may never retain more
than 40% of the actual net proceeds generated from off-system sales and capacity
release transactions. The incentive mechanism begins October 1, 2004 and ends on
September 30, 2006.
On August 11, 1999, the Indiana Utility Regulatory Commission (IURC) approved a
flexible gas cost adjustment (GCA) mechanism for Northern Indiana Public Service
Company (Northern Indiana). Under the approved procedure, the demand component
of the adjustment factor will be determined, after hearings and IURC approval,
and made effective on November 1 of each year. The demand component will remain
in effect for one year until a new demand component is approved by the IURC. The
commodity component of the adjustment factor will be determined by monthly
filings, which will become effective on the first day of each calendar month,
subject to refund. The monthly filings do not require IURC approval but will be
reviewed by the IURC during the annual hearing that will take place regarding
the demand component filing. Northern Indiana's GCA factor also includes a gas
cost incentive mechanism which allows the sharing of any cost savings or cost
increases with customers based on a comparison of actual gas supply portfolio
cost to a market-based benchmark price.
Northern Indiana's GCA4 annual demand filing, covering the period November 1,
2002 through October 31, 2003, was made on August 29, 2002 and approved by the
IURC for implementation as interim rates, subject to refund effective November
1, 2002. The Indiana Office of Utility Consumer Counselor (OUCC) filed testimony
indicating that some gas costs, for the month of March 2003, should not be
recovered. On September 10, 2003, the IURC issued an order adjusting the
recovery of costs in March 2003 and reducing recovery by $3.8 million. On
October 8, 2003, the IURC approved the demand component of the adjustment
factor.
Northern Indiana's GCA5 annual demand filing, covering the period November 1,
2003 through October 31, 2004, was made on August 26, 2003 and approved by the
IURC for implementation as interim rates, subject to refund, effective November
1, 2003. On June 8, 2004, Northern Indiana and the OUCC entered into a joint
stipulation and agreement resolving all issues in GCA5. A hearing was held
before the IURC on July 18, 2004 in support of the settlement. Among the
settlement agreement's provisions, Northern Indiana has agreed to return $3.8
million to its customers over a twelve-month period following IURC approval.
This refund is the resolution of issues similar to those from March 2003. An
additional provision of the agreement was to extend the current Alternative
Regulatory Procedure (ARP), including Northern Indiana's gas cost incentive
mechanism, from the current expiration date of December 31, 2004 to March 31,
2005. An order approving the settlement is expected in the third quarter of
2004. Negotiations are in progress to extend the ARP past March 31, 2005.
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
GAS DISTRIBUTION OPERATIONS (CONTINUED)
All of the Columbia distribution companies presently hold long-term contracts
for pipeline and storage services with its affiliate pipelines, Columbia Gas
Transmission Corporation (Columbia Transmission) and Columbia Gulf Transmission
Company (Columbia Gulf), and a majority of those contracts expire on October 31,
2004. The Columbia distribution companies are comprised of Columbia Gas of
Kentucky, Inc., Columbia Gas of Maryland, Inc., Columbia Gas of Ohio, Inc.,
Columbia Gas of Pennsylvania, Inc., and Columbia Gas of Virginia, Inc. Each
distribution company continues to discuss its plan to renew pipeline and storage
contracts with industry stakeholders to ensure the continued ability to serve
the requirements of firm customers in a tightening capacity market. All contract
negotiations between the distribution companies and Columbia Transmission and
Columbia Gulf are expected to be resolved prior to the contracts expiring. In
addition, certain contracts will be subject to the approval of the respective
state regulatory agencies. On April 29, 2004, the Pennsylvania Public Utility
Commission approved a request by Columbia of Pennsylvania, Inc. to renew its
pipeline and storage contracts with Columbia Transmission and Columbia Gulf.
Pursuant to this approval, Columbia of Pennsylvania's storage contracts and
approximately half of its pipeline contracts will be renewed for terms of
fifteen years, while the remaining pipeline contracts will be renewed on a
tiered basis for terms ranging from five or ten years. Columbia of Pennsylvania,
Inc. will also acquire additional capacity to meet customer requirements on peak
days. In addition, on August 3, 2004, the Virginia State Corporation Commission
approved a request by Columbia of Virginia, Inc. to renew its pipeline and
storage contracts with Columbia Transmission and Columbia Gulf. Pursuant to
this approval, Columbia of Virginia's storage and pipeline contracts with
Columbia Transmission and Columbia Gulf will be renewed for terms of fifteen
years.
Environmental Matters
In January of 2004, Northern Indiana and Kokomo Gas and Fuel Company signed a
multi-site Voluntary Remediation Program Order addressing 14 former manufactured
gas plant sites with the Indiana Department of Environmental Management.
Northern Indiana Fuel and Light Company, Inc. expects to enter into a similar
agreement for an additional site. Previously Northern Indiana, together with
other potentially responsible parties, had entered into similar agreements with
the Indiana Department of Environmental Management for 11 additional sites, for
which Northern Indiana is required to investigate, and to the extent necessary,
clean up.
Weather
In general, NiSource calculates the weather related revenue variance based on
changing customer demand driven by weather variance from normal heating
degree-days. Normal is evaluated using heating degree days across the NiSource
distribution region. While the temperature base for measuring heating
degree-days (i.e. the estimated average daily temperature at which heating load
begins) varies slightly across the region, the NiSource composite measurement is
based on 62 degrees.
Weather in the Gas Distribution Operation's territories for the second quarter
of 2004 was 10% warmer than normal and 11% warmer than the second quarter of
2003.
For the first six months of 2004, weather was 1% colder than normal. However,
the first six months of 2004 was still 6% warmer than the first six months of
2003.
Throughput
Total volumes sold and transported of 176.4 million dekatherms (MMDth) for the
second quarter of 2004 increased 22.5 MMDth from the same period last year
primarily due to increased lower margin off-system sales, partially offset by
reduced residential and commercial sales as a result of warmer weather.
For the six month period ended June 30, 2004, total volumes sold and transported
were 529.9 MMDth, an increase of 15.4 MMDth from the same period in 2003
primarily reflecting increased off-system sales and transportation in the first
half of 2004 compared to the first half of 2003, partly offset by a reduction of
residential and commercial sales.
Net Revenues
Net revenues for the three months ended June 30, 2004 were $241.0 million, a
decrease of $32.5 million from the same period in 2003. The decrease in net
revenues was primarily a result of reduced residential and commercial sales of
$6.0 million due to warmer weather and reduced non-traditional revenue of $6.1
million in the 2004 period, while the 2003 period was favorably affected by
adjustments recorded for gas costs associated with certain customers.
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
GAS DISTRIBUTION OPERATIONS (CONTINUED)
For the six month period ended June 30, 2004, net revenues were $821.5 million,
a $67.6 million decrease from the same period in 2003, largely due to reduced
residential and commercial sales as a result of warmer weather of $22.7 million,
lower cost tracker and gross receipts tax revenues of $13.6 million that are
generally offset in operating expenses, and lower non-traditional revenues.
Operating Income
For the second quarter of 2004, Gas Distribution Operations reported operating
income of $15.1 million, a decrease of $41.7 million from the same period in
2003. The decrease was mainly attributable to lower net revenue of $32.5 million
discussed above and increased operating expenses due primarily to insurance
refunds and adjustments of $8.9 million in the 2003 period and a revised
allocation methodology of corporate employee and administrative cost of $4.8
million that lowered expenses in the 2003 period, partially offset by the
reversal of certain claims reserves in the 2004 period. In addition, Other taxes
was impacted by a reduction of an accrual for estimated property tax expense of
$4.7 million, offset by a $5.0 million increase in sales tax accrual during the
2004 period.
Operating income for the first six months of 2004 totaled $300.1 million, a
$70.9 decrease compared to the same period in 2003 largely due to lower net
revenues of $67.6 million discussed above. In addition, operating expenses
increased slightly, due to increased employee and administrative expenses,
insurance refunds and adjustments of $5.2 million in the 2003 period and an
adjustment to change the allocation of corporate employee and administrative
expenses of $4.8 million in the 2003 period, reduced by lower cost tracker and
gross receipts tax offset in revenues. In addition, other taxes was impacted by
a reduction of an accrual for estimated property tax expense of $4.7 million,
offset by a $5.0 million increase in sales tax accrual during the 2004 period.
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
GAS DISTRIBUTION OPERATIONS (CONTINUED)
Three Months Six Months
Ended June 30, Ended June 30,
--------------------- ---------------------
(in millions) 2004 2003 2004 2003
- ------------------------------ -------- -------- -------- --------
OPERATING REVENUES
Transportation revenues $ 148.4 $ 148.0 $ 336.7 $ 335.0
Storage revenues 44.5 44.6 89.7 89.3
Other revenues 1.8 2.7 5.1 7.0
-------- -------- -------- --------
Total Operating Revenues 194.7 195.3 431.5 431.3
Less: Cost of gas sold 6.5 2.7 10.4 7.1
-------- -------- -------- --------
Net Revenues 188.2 192.6 421.1 424.2
-------- -------- -------- --------
OPERATING EXPENSES
Operation and maintenance 71.1 63.3 149.4 141.2
Depreciation and amortization 29.4 27.7 57.7 55.6
Loss on sale of assets 0.3 0.2 0.3 0.2
Other taxes 13.9 14.1 28.8 28.6
-------- -------- -------- --------
Total Operating Expenses 114.7 105.3 236.2 225.6
-------- -------- -------- --------
Operating Income $ 73.5 $ 87.3 $ 184.9 $ 198.6
======== ======== ======== ========
THROUGHPUT (MMDTH)
Columbia Transmission
Market Area 168.4 171.5 575.3 606.3
Columbia Gulf
Mainline 140.6 173.7 300.6 353.7
Short-haul 20.9 29.3 47.9 58.6
Columbia Pipeline Deep Water 4.3 1.9 8.7 3.4
Crossroads Gas Pipeline 9.8 8.4 20.5 16.1
Granite State Pipeline 5.7 6.6 19.6 21.0
Intrasegment eliminations (144.5) (168.1) (298.7) (336.6)
-------- -------- -------- --------
Total 205.2 223.3 673.9 722.5
-------- -------- -------- --------
NiSource's Gas Transmission and Storage Operations segment consists of the
operations of Columbia Transmission, Columbia Gulf, Columbia Deep Water Service
Company, Crossroads Pipeline Company and Granite State Gas Transmission, Inc. In
total NiSource owns a pipeline network of approximately 16,000 miles extending
from offshore in the Gulf of Mexico to New York and the eastern seaboard. The
pipeline network serves customers in nineteen northeastern, mid-Atlantic,
midwestern and southern states, as well as the District of Columbia. In
addition, the NiSource gas transmission and storage operations segment operates
one of the nation's largest underground natural gas storage systems.
Pipeline Firm Service Contracts
The services of Columbia Transmission and Columbia Gulf consist of open access
transportation services, and open access storage services in the case of
Columbia Transmission. These services are provided primarily to LDCs. The
majority of the firm contracts currently in effect with Columbia Gas and
Columbia Gulf expire in late 2004. Customer decisions on capacity
re-subscription are affected by many factors, including decisions by state
regulators on the treatment of pipeline capacity agreements in the context of
LDC unbundling proceedings. Numerous LDCs have already committed to extending
their long-term capacity commitments and the companies are in discussions with a
number of other firm capacity holders regarding future capacity commitments.
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
GAS TRANSMISSION AND STORAGE OPERATIONS (CONTINUED)
Regulatory Matters
On February 28, 2003, Columbia Transmission filed with Federal Energy Regulatory
Commission (FERC) certain scheduled annual rate adjustments, designated as the
Transportation Costs Rate Adjustment (TCRA), Retainage Adjustment Mechanism
(RAM), and Electric Power Cost Adjustment (EPCA). These filings sought recovery,
during the period April 1, 2003 through March 31, 2004, of certain expenses
relating to transportation costs incurred by Columbia Transmission on
interconnecting pipelines and electric costs incurred in the operation of
certain compressors (TCRA and EPCA, respectively), as well as quantities of gas
required by Columbia Transmission to operate its pipeline system RAM. The
recovery of each of these costs occurs through a "tracker" which ensures full
recovery of actual expenses. Each of the three filings was conditionally
accepted by FERC subject to refund and the filing of additional data by Columbia
Transmission. On October 1, 2003, FERC issued an order accepting Columbia
Transmission's TCRA filing, and accepting the full recovery of upstream
transportation costs. On February 11, 2004, FERC issued an order regarding the
annual EPCA filing, which upheld Columbia Transmission's ability to fully
recover its electric costs, but required Columbia Transmission to implement a
separate EPCA rate to recover electric power costs incurred by a newly expanded
electric-powered compressor station from specific customers. The order also
limits Columbia Transmission's ability to prospectively discount its EPCA rates.
Management does not believe this order will have a material financial impact. On
April 14, 2004 the FERC issued an order accepting Columbia Transmission's RAM
filing and approving the full recovery of gas required in system operations.
FERC will permit parties to pursue certain issues raised in the 2003 filing in
connection with consideration of Columbia Transmission's 2004 RAM filing, which
became effective April 1, 2004, and is currently pending.
Environmental Matters
On April 1, 2004, U.S. Environmental Protection Agency (EPA) issued its final
Phase II nitrogen oxide (NOx) regulation establishing NOx budgets for states.
States will be developing State Implementation Plans (SIPs) which may impact
certain compressor station engines/turbines owned by Columbia Transmission and
Columbia Gulf. Columbia Transmission and Columbia Gulf will continue to closely
monitor the development of SIPs, but anticipates that the cost will not be
material.
The EPA has issued maximum achievable control technology (MACT) standards for
hazardous air pollutants for stationary combustion turbines and reciprocating
internal combustion engines. The final standards for turbines do not impose any
compliance costs. The MACT for internal reciprocating internal combustion
engines will only impact one Columbia Transmission facility and the estimated
cost of compliance is expected to be immaterial.
On April 15, 2004 EPA finalized the 8-hour ozone non-attainment area
designations. Following designation of the 8-hour ozone non-attainment areas,
the Clean Air Act provides for a process for promulgation of rules specifying a
compliance level, compliance deadline, and necessary controls to be implemented
within designated areas. Resulting state rules could require additional
reductions in NOx. Columbia Transmission and Columbia Gulf will closely monitor
implementation of the rules. While the outcome of such rulemakings is uncertain,
the cost could be significant.
Proposed Millennium Pipeline Project
The proposed Millennium Pipeline Project (Millennium), in which Columbia
Transmission is participating and will serve as developer and operator, will
provide access to a number of supply and storage basins and the Dawn, Ontario
trading hub. The project is now being marketed in two phases. Phase 1 of the
project is an expansion of the Algonquin Pipeline extending from Ramapo, N.Y and
connecting to the Empire State Pipeline (Empire), an existing pipeline that
originates at the Canadian border and extends easterly to near Syracuse. Empire
will construct a lateral pipeline southward to connect with Millennium near
Corning, N.Y. Phase 2 would cross the Hudson River, linking to the New York City
metropolitan market.
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
GAS TRANSMISSION AND STORAGE OPERATIONS (CONTINUED)
On September 19, 2002, the FERC issued its order granting final certificate
authority for the original Millennium project and specified that Millennium may
not begin construction until certain environmental and other conditions are met.
One such condition, impacting Phase 2 of the project, is compliance with the
Coastal Zone Management Act, which is administered by the State of New York's
Department of State (NYDOS). NYDOS has determined that the Hudson River crossing
plan is not consistent with the Act. Millennium's appeal of that decision to the
United States Department of Commerce was denied. Millennium filed an appeal of
the U.S. Department of Commerce ruling relating to the project's Hudson River
crossing plan in the U.S. Federal District Court on February 13, 2004. The
procedural schedule calls for all briefings to be completed by January 14, 2005.
During the second quarter of 2004, a NiSource affiliate purchased an additional
interest in the project. NiSource intends to find another sponsor by the end of
2004 to purchase this interest. The other sponsors remain the same and they are
Columbia Transmission, Westcoast Energy, Inc. (subsidiary of Duke Energy Corp.)
and MCN Energy Group, Inc. (subsidiary of DTE Energy Co.).
Throughput
Throughput for the Gas Transmission and Storage Operations segment totaled 205.2
MMDth for the second quarter 2004, compared to 223.3 MMDth for the same period
in 2003. The decrease of 18.1 MMDth is due mainly to a continued decline of
offshore natural gas production.
Throughput for the six months ended June 30, 2004 was 673.9 MMDth, a decrease of
48.6MMDth from the same period in 2003 due to warmer weather in the first half
of 2004 than for the comparable period in 2003, and a continued decline of
offshore natural gas production, and other non-weather factors.
Net Revenues
Net revenues were $188.2 million for the second quarter 2004, a decrease of $4.4
million from the same period in 2003. Net revenues decreased due to a reduction
in interruptible service revenues primarily due to lower throughput, which were
partially offset by an increase in demand charge revenues.
Net revenues were $421.1 million for the six months ended June 30, 2004, a
slight decrease of $3.1 million from the comparable 2003 period. The 2003 period
was unfavorably impacted by higher costs to meet customer demand during a period
of sustained cold weather in the Northeast market areas during the first quarter
of 2003. Both the six-months ended 2004 and the first half of 2003 reflect lower
interruptible transmission service revenues than those that have been
historically realized. Management has evaluated operational issues and market
conditions and anticipates that there will be fewer opportunities for
interruptible revenue on an ongoing basis. Also, net revenues decreased due to
lower throughput, which was partially offset by an increase in demand charge
revenues.
Operating Income
Operating income was $73.5 million for the second quarter of 2004, a decrease of
$13.8 million from the second quarter of 2003. Operating income was mainly
affected by reduced net revenues discussed above and a reversal of a litigation
reserve of $6.6 million relating to a lawsuit that was settled in the second
quarter of 2003.
For the first six months of 2004, operating income was $184.9 million, a $13.7
million decrease from the first six months of 2003. The decrease was mainly
attributable to reduced revenues discussed above and increased operation and
maintenance expenses largely due to the reversal of a litigation reserve of $6.6
million relating to a lawsuit that was settled in the second quarter of 2003.
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
ELECTRIC OPERATIONS
Three Months Six Months
Ended June 30, Ended June 30,
-------------------------- --------------------------
(in millions) 2004 2003 2004 2003
- ------------------------------- ---------- ---------- ---------- ----------
NET REVENUES
Sales revenues $ 267.4 $ 259.4 $ 528.3 $ 522.2
Less: Cost of sales 84.9 83.7 166.3 177.0
---------- ---------- ---------- ----------
Net Revenues 182.5 175.7 362.0 345.2
---------- ---------- ---------- ----------
OPERATING EXPENSES
Operation and maintenance 58.8 52.9 119.1 110.4
Depreciation and amortization 44.4 43.6 88.5 87.3
Other taxes (2.7) 15.1 13.6 30.8
---------- ---------- ---------- ----------
Total Operating Expenses 100.5 111.6 221.2 228.5
---------- ---------- ---------- ----------
Operating Income $ 82.0 $ 64.1 $ 140.8 $ 116.7
========== ========== ========== ==========
REVENUES ($ IN MILLIONS)
Residential 66.7 62.4 137.9 134.6
Commercial 73.2 69.7 143.6 136.4
Industrial 102.5 93.4 203.8 191.3
Wholesale 11.4 25.8 22.8 45.4
Other 13.6 8.1 20.2 14.5
---------- ---------- ---------- ----------
Total 267.4 259.4 528.3 522.2
---------- ---------- ---------- ----------
SALES (GIGAWATT HOURS)
Residential 694.2 639.1 1,448.7 1,428.7
Commercial 899.4 859.2 1,759.5 1,710.7
Industrial 2,327.2 2,205.4 4,665.4 4,478.9
Wholesale 289.5 751.5 559.4 1,293.4
Other 33.8 27.5 66.2 61.2
---------- ---------- ---------- ----------
Total 4,244.1 4,482.7 8,499.2 8,972.9
---------- ---------- ---------- ----------
COOLING DEGREE DAYS 205 113 205 113
NORMAL COOLING DEGREE DAYS 227 224 227 224
% WARMER (COLDER) THAN NORMAL (10%) (50%) (10%) (50%)
ELECTRIC CUSTOMERS
Residential 388,824 384,750
Commercial 49,635 48,694
Industrial 2,516 2,560
Wholesale 25 28
Other 776 796
---------- ----------
Total 441,776 436,828
---------- ----------
NiSource generates and distributes electricity, through its subsidiary Northern
Indiana, to approximately 442 thousand customers in 21 counties in the northern
part of Indiana. The operating results reflect the temperature-sensitive nature
of customer demand with annual sales affected by temperatures in the northern
part of Indiana. As a result, segment operating income is generally higher in
the second and third quarters, reflecting cooling demand during the summer
season.
36
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
ELECTRIC OPERATIONS (CONTINUED)
Market Conditions
The regulatory frameworks applicable to Electric Operations continue to be
affected by fundamental changes that will impact Electric Operations' structure
and profitability. Notwithstanding those changes, competition within the
industry will create opportunities to compete for new customers and revenues.
Management has taken steps to improve operating efficiencies in this changing
environment and improve the transmission interconnections with neighboring
electric utilities.
Regulatory Matters
During 2002, Northern Indiana settled matters related to an electric rate
review. On September 23, 2002, the IURC issued an order adopting most aspects of
the settlement. The order approving the settlement provides that electric
customers of Northern Indiana will receive bill credits of approximately $55.1
million each year, for a cumulative total of $225 million, for the minimum
49-month period, beginning on July 1, 2002. The order also provides that 60% of
any future earnings beyond a specified cap will be retained by Northern Indiana.
Credits amounting to $26.8 million and $24.3 million were recognized for
electric customers for the first half of 2004 and 2003, respectively.
On June 20, 2002, Northern Indiana, Ameren Corporation and First Energy
Corporation established terms for joining the Midwest Independent System
Operator (MISO) through participation in an independent transmission company
(ITC). Northern Indiana transferred functional control of its electric
transmission assets to the ITC and MISO on October 1, 2003. As part of Northern
Indiana's use of MISO's transmission service, Northern Indiana will incur new
categories of transmission charges based upon MISO's Federal Energy Regulatory
Commission (FERC)-approved tariff. One of the new categories of charges,
Schedule 10, relates to the payment of administrative charges to MISO for its
continuing management and operations of the transmission system. Northern
Indiana filed a petition on September 30, 2003, with the IURC seeking approval
to establish accounting treatment for the deferral of the Schedule 10 charges
from MISO. On July 21, 2004 the IURC issued an order which denied Northern
Indiana's request for deferred accounting treatment for the MISO Schedule 10
administrative fees. Northern Indiana has taken a charge during the second
quarter 2004 in the amount of $2.1 million related to the MISO administrative
charges deferred through June 30, 2004. The MISO Schedule 10 administrative fees
are currently estimated to be approximately $2.8 million annually. Northern
Indiana is currently evaluating the IURC order to determine whether an appeal
will be filed.
The MISO has initiated the Midwest Market Initiative (MMI), which will develop
the structures and processes to be used to implement an electricity market for
the MISO region. This MMI proposes non-discriminatory transmission service,
reliable grid operation, and the purchase and sale of electric energy in a
competitive, efficient and non-discriminatory manner. MISO has filed with FERC
detailed tariff information, with a planned initial operation date of March 1,
2005. Northern Indiana and EnergyUSA-TPC (TPC) are actively pursuing roles in
the MMI. At the current time, management believes that the MMI will change the
manner in which Northern Indiana and TPC conduct their electric business;
however, at this time management cannot determine the impact the MMI will have
on Northern Indiana or TPC.
Northern Indiana has been recovering the costs of electric power purchased for
sale to its customers through the fuel adjustment clause (FAC). The FAC provides
for costs to be collected if they are below a negotiated cap. If costs exceed
this cap, Northern Indiana must demonstrate that the costs were prudently
incurred to achieve approval for recovery. This negotiated cap agreement is
subject to continuing negotiations. A group of industrial customers challenged
the manner in which Northern Indiana applied costs associated with a specific
interruptible sales tariff. An estimated refund liability was recorded in the
first quarter of 2003. A settlement was reached with the customers and Northern
Indiana recorded the full costs of the settlement. As a result of the
settlement, the industrial customers challenge was withdrawn and dismissed in
January 2004. In addition, as a result of the settlement, Northern Indiana has
sought and received approval by the IURC to reduce the charges under the
interruptible sales tariff. This reduction will remain in effect until the Dean
H. Mitchell Generating Station (Mitchell Station) returns to service.
37
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
ELECTRIC OPERATIONS (CONTINUED)
Currently, Northern Indiana is reviewing options to meet the electric needs of
its customers. This review includes an assessment of Northern Indiana's oldest
generating units, which includes the Mitchell Station. Northern Indiana has
requested proposals from outside companies to provide power under varying terms
and conditions. These proposals are being evaluated. In February 2004, the City
of Gary announced an interest to acquire the land on which the Mitchell Station
is located for economic development, including a proposal to increase the length
of the runways at the Gary International Airport. On May 7, 2004, the City of
Gary filed a petition with the IURC seeking valuation of the Mitchell Station
and determination of the terms and conditions under which the City of Gary would
acquire the Mitchell Station. The procedural schedule for the City of Gary has
been set, and Northern Indiana has filed its Prepared Direct Testimony, stating
that Northern Indiana has no current plans to restart the Mitchell Station.
On May 25, 2004 Northern Indiana filed a petition for approval of a Purchased
Power and Transmission Tracker Mechanism to recover the cost of purchased power
to meet Northern Indiana's retail electric load requirements and charges imposed
on Northern Indiana by MISO and Grid America. Northern Indiana's direct
testimony is due to be filed by August 6, 2004. The hearing is set for the
fourth quarter of 2004.
On July 9, 2004 a verified joint petition was filed by PSI Energy, Inc.,
Indianapolis Power & Light Company, Northern Indiana and Vectren Energy Delivery
of Indiana, Inc., seeking approval of certain changes in operations that are
likely to result from the MISO's implementation of energy markets, and for
determination of the manner and timing of recovery of costs resulting from the
MISO's implementation of standard market design mechanisms, such as the MISO's
proposed real-time and day-ahead energy markets.
In January 2002, Northern Indiana filed for approval to implement an
environmental cost tracker (ECT). The ECT was approved by the IURC on November
26, 2002. Under the ECT Northern Indiana is permitted to recover (1) allowance
for funds used during construction and a return on the capital investment
expended by Northern Indiana to implement Indiana Department of Environmental
Management's nitrogen oxide State Implementation Plan through an Environmental
Cost Recovery Mechanism (ECRM) and (2) related operation and maintenance and
depreciation expenses once the environmental facilities become operational
through an Environmental Expense Recovery Mechanism (EERM). Under the
Commission's November 26, 2002 order, Northern Indiana is permitted to submit
filings on a semi-annual basis for the ECRM and on an annual basis for the EERM.
Northern Indiana's latest ECRM filing (ECR-3) was for capital expenditures of
$194.1 million, and was made simultaneous with its first EERM filing (EER-1) for
$1.9 million. Over the timeframe required to meet the environmental standards,
Northern Indiana anticipates a total capital investment amounting to
approximately $274.2 million. On February 4, 2004, the IURC approved Northern
Indiana's latest compliance plan with the estimate of $274.2 million. The ECRM
revenues amounted to $7.5 million for the six months ended June 30, 2004, and
$12.6 million from inception to date, while EERM revenues were $0.3 for the
first half of 2004.
Environmental Matters
AIR. On April 15, 2004, the U.S. Environmental Protection Agency (EPA) finalized
the 8-hour ozone non-attainment area designations. Following designation of the
8-hour ozone non-attainment areas, the Clean Air Act provides for a process for
promulgation of rules specifying a compliance level, compliance deadline, and
necessary controls to be implemented within designated areas over the next few
years. Resulting state rules could require additional reductions in NOx
emissions from coal-fired boilers including Northern Indiana's electric
generating stations. Until the rules are promulgated, the potential impact on
Northern Indiana is uncertain. Northern Indiana will continue to closely monitor
developments in this area.
On June 28 and 29, 2004, the EPA responded to the states' initial
recommendations for EPA designation of areas meeting and not meeting the
National Ambient Air Quality Standards (NAAQS) for fine particles. (Fine
particles are those less than or equal to 2.5 micrometers in diameter and are
also referred to as PM2.5.) The states will have 120 days to comment on or
dispute these recommendations. Once the designations are finalized, states will
need to initiate rulemaking that would seek emissions reductions to bring the
designated areas into attainment. Northern Indiana will continue to closely
monitor developments in this area.
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
ELECTRIC OPERATIONS (CONTINUED)
On April 15, 2004, the EPA proposed amendments to its July 1999 Regional Haze
Rule that requires states to set periodic goals for improving visibility in 156
natural areas across the United States. These amendments would apply to the
provisions of the regional haze rule that require emissions controls known as
best available retrofit technology (BART) for BART eligible industrial
facilities emitting air pollutants that reduce visibility. Under the rule,
states would be required to develop rules that specify the stringency, type of
reductions, and controls that could be applied to BART eligible sources
consistent with EPA guidance. The BART eligible sources, including many of the
boilers at Northern Indiana's electric generating stations, have the potential
to emit more than 250 tons a year of visibility impairing emissions, and fall
within one of 26 categories, including utility and industrial boilers. States
must develop implementation rules by January 2008. Resulting rules could require
additional reductions of NOx, sulfur dioxide (SO2) and particulate matter from
coal-fired boilers including Northern Indiana's electric generating stations.
Until the state rules are promulgated, the potential impact on Northern Indiana
is uncertain. Northern Indiana will continue to closely monitor developments in
this area.
The EPA Administrator signed a Supplemental Notice of Proposed Rulemaking on May
18, 2004. This rule requires that each state must submit to EPA a plan that
demonstrates it will meet its assigned statewide Clean Air Interstate Rule SO2
and NOx emissions budget. The final EPA rule is expected by late Fall, 2004.
Until the Federal and State rules are promulgated, the potential impact is
uncertain. Northern Indiana will continue to closely monitor developments in
this area.
In March 2004, the State of North Carolina filed a petition under Section 126 of
the Clean Air Act seeking EPA imposition of additional NOx and SO2 reductions
from electrical generating units in 13 states, including Indiana. The EPA is
addressing the issues raised by North Carolina in other current regulatory
initiatives that are being monitored by Northern Indiana.
WATER. On February 16, 2004, the EPA Administrator signed the Phase II Rule of
the Clean Water Act Section 316(b) which requires all large existing steam
electric generating stations to meet certain performance standards to reduce the
mortality of aquatic organisms at their cooling water intake structures. EPA has
delayed the publication of the rule to complete additional revisions. The rule
was reissued on July 9, 2004 and becomes effective on September 7, 2004. Under
this rule, plants will either have to demonstrate that the performance of their
existing fish protection systems meet the new standards or develop new systems
whose compliance is based on any of five options. Northern Indiana is assessing
the specific impacts of the final Phase II rule on its four (4) generating
stations.
REMEDIATION. Northern Indiana is a potentially responsible party under the
Comprehensive Environmental Response Compensation and Liability Act and similar
State laws at two waste disposal sites and shares in the cost of their cleanup
with other potentially responsible parties. At one site, investigations are
ongoing and final costs of clean up have not yet been determined. At the second
site, Northern Indiana has entered into EPA Administrative Orders on Consent to
perform an interim action that includes providing a municipal water supply
system for approximately 275 homes. Northern Indiana has also agreed to conduct
a Remedial Investigation and Feasibility Study in the vicinity of the third
party, state-permitted landfill where Northern Indiana contracted for fly ash
disposal.
Sales
Electric sales for the second quarter 2004 were 4,244.1 gwh, a decrease of 238.6
gwh compared to the 2003 period, mainly as a result of decreased wholesale
transaction sales, which were offset in part by modest improvements in
residential, commercial and industrial sales. Residential and commercial sales
improved due to an increase in the number of customers and higher usage, while
industrial sales increased due to increased demand from the steel industry.
Electric sales for the first six months of 2004 was 8,499.2 gwh, a decrease of
473.7 gwh compared to the 2003 period, as a result of decreased wholesale
transaction sales, partially offset by increased residential, commercial, and
industrial sales.
39
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
ELECTRIC OPERATIONS (CONTINUED)
Net Revenues
In second quarter 2004, electric net revenues of $182.5 million increased by
$6.8 million from the comparable 2003 period. The increase was primarily a
result of increased customer usage and customer count of $9.0 million and
favorable weather during the quarter, slightly offset by lower wholesale power
revenue.
In the first six months of 2004, electric net revenues were $362.0 million, an
increase of $16.8 million from the comparable 2003 period as a result of
increased customer usage and customer count of $8.2 million, favorable weather,
and $6.8 million in environmental cost tracker revenues. In addition, Electric
Operations was affected by regulatory items that reduced net revenues by $8.5
million in the comparable 2003 period. These increases in Electric Operations
revenues for the first half of 2004 were partially offset by increased
regulatory revenue credits of $4.6 million and reduced wholesale revenues of
$1.6 million.
Operating Income
Operating income for the second quarter 2004 was $82.0 million, an increase of
$17.9 million from the same period in 2003. This increase for the comparative
quarters was primarily due to the increase in net revenue mentioned above and a
reduction of an accrual for estimated property tax expense. These increases to
operating income were partially offset by a $5.9 million increase in operation
and maintenance expenses due primarily to higher employee and administrative
expenses of $4.8 million and a $2.1 million charge taken for MISO administrative
fees. The increased expenses were partially reduced by a $3.2 million reversal
of certain claims reserves upon settlement.
Operating income for the first six months of 2004 was $140.8 million, an
increase of $24.1 million from the same period in 2003. The increase was
primarily due to increased net revenue mentioned above and a reduction of an
accrual for estimated property tax expense. Operation and maintenance expenses
increased $8.7 million due mainly to higher employee and administrative expenses
of $3.3 million, a $2.1 million charge taken for MISO administrative fees, and
an expense of $3.3 million recorded in the first quarter of 2004, representing
Electric Operations' portion of the redemption premium from the early
extinguishment of certain medium-term notes at Northern Indiana. These increased
expenses were reduced by a $3.2 million reversal of certain claims reserves upon
settlement.
40
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
OTHER OPERATIONS
Three Months Six Months
Ended June 30, Ended June 30,
--------------------------- ---------------------------
(in millions) 2004 2003 2004 2003
- ------------- ----------- ----------- ----------- -----------
NET REVENUES
Products and services revenue $ 145.6 $ 92.7 $ 334.5 $ 237.1
Less: Cost of products purchased 139.8 86.8 328.5 224.7
----------- ----------- ----------- -----------
Net Revenues 5.8 5.9 6.0 12.4
----------- ----------- ----------- -----------
OPERATING EXPENSES
Operation and maintenance 9.8 12.1 22.8 26.6
Depreciation and amortization 3.0 3.3 5.9 6.2
Loss on sale or impairment of assets - - 0.7 1.1
Other taxes 1.1 0.9 2.9 2.8
----------- ----------- ----------- -----------
Total Operating Expenses 13.9 16.3 32.3 36.7
----------- ----------- ----------- -----------
Operating Loss $ (8.1) $ (10.4) $ (26.3) $ (24.3)
=========== =========== =========== ===========
The Other Operations segment participates in energy-related services including
gas marketing, power trading and ventures focused on distributed power
generation technologies, fuel cells and storage systems. PEI operates the
Whiting Clean Energy, Inc. (Whiting Clean Energy) project, which is a 525mw
cogeneration facility that uses natural gas to produce electricity for sale in
the wholesale markets and also provides steam for industrial use. Additionally,
the Other Operations segment is involved in real estate and other businesses.
PEI Holdings, Inc.
WHITING CLEAN ENERGY. PEI's Whiting Clean Energy project at BP's Whiting,
Indiana refinery was placed in service in 2002. Initially, the facility was not
able to deliver steam to BP to the extent originally contemplated without plant
modifications. Whiting Clean Energy has reached an agreement in principle with
the engineering, procurement and construction contractor, which requires the
contractor to pay for a portion of the necessary plant modifications. Whiting
Clean Energy is also pursuing recovery from the insurance provider for
construction delays and necessary plant modifications.
PEI estimates that the facility will operate at a loss in the near term based on
the current market view of forward pricing for gas and electricity. For 2003,
the after-tax loss was approximately $30.0 million and the expected 2004
after-tax loss is expected to be similar to 2003. During the first half of 2004,
Whiting Clean Energy continued to experience losses due to the market for
wholesale power and the contract requirements to run the plant at a level to
produce steam required by the BP refinery in Whiting, Indiana. These contract
requirements currently are being renegotiated. The profitability of the project
in future periods will be dependent on, among other things, prevailing prices in
the energy markets and regional load dispatch patterns. Because of the expected
losses from this facility and decreases in estimated forward pricing for
electricity versus changes in gas prices, an impairment study was performed in
the first quarter of 2003 on this facility in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets". The study
indicated that, at that time, no impairment charge was necessary.
However, the study includes many estimates and assumptions for the 40-year
estimated useful life of the facility. Changes in these estimates and
assumptions, such as forward prices for electricity and gas, volatility in the
market, etc., could result in a situation where total undiscounted net revenues
are less than the carrying value of the facility, which would result in a
write-down that could be significant.
Net Revenues
Net revenues of $5.8 million for the second quarter of 2004 remained consistent
with the same period a year-ago. For the first six months of 2004, net revenues
were $6.0 million, a $6.4 million decrease compared to the same period in 2003.
The decrease was mainly due to reduced revenues from the Whiting Clean Energy
facility of $4.4 million and lower power trading revenues.
41
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NISOURCE INC.
OTHER OPERATIONS (CONTINUED)
Operating Income
The Other segment reported an operating loss of $8.1 million for the second
quarter of 2004, versus an operating loss of $10.4 million for the comparable
period 2003. The improvement was a result of lower operation and maintenance
expense due to a reduction in employee and administrative expenses during the
second quarter of 2004 as compared the same period in 2003.
For the first six months of 2004, operating loss was $26.3 million compared to
an operating loss of $24.3 million for the comparable 2003 period due to
increased losses of $3.2 million associated with Whiting Clean Energy and lower
power trading revenues. Operation and maintenance expense decreased in the 2004
period as a result of a reduction in employee and administrative expenses during
the first half of 2004 as compared the same period in 2003 and a reversal of a
litigation reserve during the first half of 2004.
42
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
NISOURCE INC.
For a discussion regarding quantitative and qualitative disclosures about market
risk see Management's Discussion and Analysis of Financial Condition and Results
of Operations under "Market Risk Sensitive Instruments and Positions."
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
NiSource's chief executive officer and its chief financial officer, after
evaluating the effectiveness of NiSource's disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), have concluded based
on the evaluation required by paragraph (b) of Exchange Act Rules 13a-15 and
15d-15 that, as of the end of the period covered by this report. NiSource's
disclosure controls and procedures were adequate and effective to ensure that
material information relating to NiSource and its consolidated subsidiaries
would be made known to them by others within those entities.
Changes in Internal Controls
There was no change in NiSource's internal control over financial reporting
during the fiscal quarter covered by this report that has materially affected,
or is reasonably likely to materially affect, NiSource's internal control over
financial reporting.
43
PART II
ITEM 1. LEGAL PROCEEDINGS
NISOURCE INC.
1. VIRGINIA NATURAL GAS, INC. V. COLUMBIA GAS TRANSMISSION CORP., FEDERAL
ENERGY REGULATORY COMMISSION (FERC)
On January 13, 2004, Virginia Natural Gas, Inc. (VNG) filed with FERC a
"Complaint Seeking Compliance with the Natural Gas Act and with
Regulations and Certificate Orders of the Federal Energy Regulatory
Commission and Seeking Remedies" in Docket No. RP04-139. VNG alleged
various violations during the Winter of 2002-2003 by Columbia Transmission
of its firm service obligations to VNG. VNG sought monetary damages and
remedies (exceeding $37 million), and also sought certain prospective
remedies. On July 29, 2004, FERC issued an order in which it refused to
grant VNG any monetary damages and said such claims are best determined by
a court of law. FERC also agreed with Columbia Transmission, that Columbia
Transmission had not abandoned its obligation to provide service and that
it had not inappropriately continued interruptible service to the
detriment of firm service. However, FERC did find that Columbia
Transmission had failed to exercise sufficient due diligence in its
modifications to or its operation of vaporization equipment at its
Chesapeake LNG facility and that Columbia Transmission had failed to
deliver gas to VNG at 250 psig as called for by the agreement between VNG
and Columbia Transmission. FERC declined VNG's request to award damages in
this case and, as noted above, stated that any claim for damages could
best be determined by a court of law.
2. STAND ENERGY CORPORATION, ET AL. V. COLUMBIA GAS TRANSMISSION CORPORATION,
ET AL KANAWHA COUNTY COURT, WEST VIRGINIA, ATLANTIGAS CORPORATION V.
NISOURCE, ET AL, U.S. DISTRICT COURT, NORTHERN DISTRICT OF MARYLAND AND
TRIAD ENERGY RESOURCES, ET AL. V. NISOURCE, ET AL
In June 2002, Atlantigas Corporation filed a complaint in the U.S.
District Court, District of Columbia. In March 2003, Triad Energy
Resources filed a similar complaint in the U.S. District Court, District
of Columbia. On September 29, 2003, the Atlantigas complaint was dismissed
for lack of personal jurisdiction and Atlantigas filed a new complaint in
the U.S. District Court of Northern Maryland on October 27, 2003. Based on
the Court's decision on personal jurisdiction in Atlantigas, the
plaintiffs in the Triad case dismissed that case on October 31, 2003 from
the District of Columbia and indicated that the case would be refiled in
another jurisdiction. On July 14, 2004, Stand Energy Corporation filed a
complaint in Kanawha County Court in West Virginia and on or about July
22, Atlantigas filed a voluntary notice of dismissal without prejudice in
the case in the U.S. District Court of Northern Maryland, citing its
joinder as a plaintiff in the Stand Energy case. All of these complaints
contain allegations against various NiSource companies, including Columbia
Transmission and Columbia Gulf, and assert that those companies and
certain "select shippers" engaged in an "illegal gas scheme" that violated
federal anti-trust and state law. The "illegal gas scheme" complained of
by the plaintiffs relates to the Columbia Transmission and Columbia Gulf
gas imbalance transactions that were the subject of the FERC enforcement
staff investigation and subsequent settlement approved in October 2000. An
answer in the Stand Energy case is due on August 14, 2004.
44
ITEM 1. LEGAL PROCEEDINGS (continued)
NISOURCE INC.
3. UNITED STATES OF AMERICA EX REL. JACK J. GRYNBERG V. COLUMBIA GAS
TRANSMISSION CORP., ET AL., U.S. DISTRICT COURT, E.D. LOUISIANA
The plaintiff filed a complaint in 1997, under the False Claims Act, on
behalf of the United States of America, against approximately seventy
pipelines, including Columbia Gulf and Columbia Transmission. The
plaintiff claimed that the defendants had submitted false royalty reports
to the government (or caused others to do so) by mis-measuring the volume
and heating content of natural gas produced on Federal land and Indian
lands. The Plaintiff's original complaint was dismissed without prejudice
for misjoinder of parties and for failing to plead fraud with specificity.
The plaintiff then filed over sixty-five new False Claims Act complaints
against over 330 defendants in numerous Federal courts. One of those
complaints was filed in the Federal District Court for the Eastern
District of Louisiana against Columbia and thirteen affiliated entities.
Plaintiff's second complaint, filed in 1997, repeats the mis-measurement
claims previously made and adds valuation claims alleging that the
defendants have undervalued natural gas for royalty purposes in various
ways, including sales to affiliated entities at artificially low prices.
Most of the Grynberg cases were transferred to Federal court in Wyoming in
1999.
The defendants, including the Columbia defendants, have filed motions to
dismiss for lack of subject matter jurisdiction in this case.
4. TAWNEY, ET AL. V. COLUMBIA NATURAL RESOURCES, INC., ROANE COUNTY, WV
CIRCUIT COURT
The Plaintiffs, who are royalty owners, filed a lawsuit in early 2003
against Columbia Natural Resources alleging that Columbia Natural
Resources underpaid royalties by improperly deducting post-production
costs and not paying a fair value for the gas produced from their leases.
Plaintiffs seek the alleged royalty underpayment and punitive damages
claiming that Columbia Natural Resources fraudulently concealed the
deduction of post-production charges. In February 2004, the court
certified the case as a class action that includes any person who, after
January 1, 1980, received or is due royalties from Columbia Natural
Resources (and its predecessors or successors) on lands lying within the
boundary of the State of West Virginia. All individuals, corporations,
agencies, departments or instrumentalities of the United States of America
are excepted from the class. Although NiSource sold Columbia Natural
Resources in 2003, it remains obligated to manage this litigation and also
remains at least partly liable for any damages awarded to the plaintiffs.
Columbia Natural Resources appealed the decision certifying the class and
the Supreme Court of West Virginia denied the appeal. Trial is scheduled
for July 5, 2005.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
45
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NISOURCE INC.
On May 11, 2004, NiSource held its Annual Meeting of Stockholders. On the March
16, 2004 record date, NiSource had 263,302,932 shares of common stock
outstanding, each of which was entitled to one vote at the meeting. The
following items were voted upon and approved by the requisite number of shares
present in person or by proxy at the meeting:
Votes For Votes Against Abstentions
--------- ------------- -----------
Ratify appointment of Deloitte & Touche LLP 223,258,822 3,947,982 1,763,421
Votes For Votes Withheld
--------- --------------
Directors:
Steven C. Beering 214,487,092 14,483,133
Dennis E. Foster 222,087,788 6,882,437
Richard L. Thompson 223,142,752 5,827,473
Carolyn Y. Woo 222,011,931 6,958,294
ITEM 5. OTHER INFORMATION
None
46
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
NISOURCE INC. 53
(a) Exhibits
(10.1) NiSource Corporate Incentive Plan dated July 16, 2004 and effective
as of January 1, 2004.
(10.2) Pension Restoration Plan for Nisource Inc. and Affiliates, as
amended and restated effective January 1, 2004.
(10.3) Savings Restoration Plan for Nisource Inc. and Affiliates, as
amended and restated effective January 1, 2004.
(10.4) Nisource Inc. Nonemployee Director Stock Incentive Plan, as amended
and restated effective January 1, 2004.
(10.5) Nisource Inc. Supplemental Executive Retirement Plan, as amended
and restated effective January 1, 2004.
(10.6) Agreement dated September 1, 2002, with Samuel W. Miller, Jr.
(31.1) Certification of Gary L. Neale, Chief Executive Officer, pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
(31.2) Certification of Michael W. O'Donnell, Chief Financial Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(32.1) Certification of Gary L. Neale, Chief Executive Officer, pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(32.2) Certification of Michael W. O'Donnell, Chief Financial Officer,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Pursuant to Item 601(b)(4)(iii) of Regulation S-K, NiSource hereby agrees to
furnish the U.S. Securities and Exchange Commission, upon request, any
instrument defining the rights of holders of long-term debt of NiSource not
filed as an exhibit herein. No such instrument authorizes long-term debt
securities in excess of 10% of the total assets of NiSource and its subsidiaries
on a consolidated basis.
(b) Reports on Form 8-K
The following reports on Form 8-K were filed during the second quarter of
2004:
Financial
Item Reported Statements Included Date of Event Date Filed
- ------------- ------------------- ------------- ----------
7, 12 Y 4/30/2004 4/30/2004
9 N 5/11/2004 5/11/2004
9 N 5/18/2004 5/18/2004
9 N 6/1/2004 6/01/2004
47
SIGNATURE
NISOURCE INC.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NiSource Inc.
------------------
(Registrant)
Date: August 6, 2004 By: /s/ Jeffrey W. Grossman
-------------------------------
Jeffrey W. Grossman
Vice President and Controller
(Principal Accounting Officer
and Duly Authorized Officer)
48