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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 September 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: 1-4125
NORTHERN INDIANA PUBLIC SERVICE COMPANY
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Indiana 35-0552990
------------------------------- -----------------
(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)
(877) 647-5990
----------------------------------------------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
-------------------------------------------- ----------------------
Series A Cumulative Preferred - No Par Value New York
4-1/4% Cumulative Preferred - $100 Par Value American
Securities registered pursuant to Section 12(g) of the Act: Cumulative Preferred
Stock - $100 Par Value (4-1/2%, 4.22%, 4.88%, 7.44% and 7.50% Series)
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 Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. As of November 1, 2004,
73,282,258 shares of the registrant's Common Shares, no par value, were issued
and outstanding, all held beneficially and of record by NiSource Inc.
NORTHERN INDIANA PUBLIC SERVICE COMPANY
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
TABLE OF CONTENTS
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Statements of Consolidated Income ................................................ 3
Consolidated Balance Sheets....................................................... 4
Statements of Consolidated Cash Flows............................................. 6
Statements of Consolidated Comprehensive Income .................................. 7
Notes to Consolidated Financial Statements........................................ 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................................... 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................ 28
Item 4. Controls and Procedures........................................................... 28
PART II - OTHER INFORMATION
Item 1 Legal Proceedings ................................................................ 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds....................... 29
Item 3 Defaults Upon Senior Securities .................................................. 29
Item 4. Submission of Matters to a Vote of Security Holders............................... 29
Item 5. Other Information................................................................. 29
Item 6. Exhibits ......................................................................... 29
Signature .................................................................................. 30
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NORTHERN INDIANA PUBLIC SERVICE COMPANY
STATEMENTS OF CONSOLIDATED INCOME (UNAUDITED)
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------------- ----------------------------
(in millions) 2004 2003 2004 2003
- ------------- ---------- ---------- ---------- ----------
OPERATING REVENUES
Gas $ 90.6 $ 82.9 $ 654.1 $ 717.2
Gas-affiliated 0.8 1.5 3.3 9.6
Electric 298.7 307.5 818.3 819.3
Electric-affiliated 4.6 7.3 13.3 17.7
---------- ---------- ---------- ----------
Gross Operating Revenues 394.7 399.2 1,489.0 1,563.8
---------- ---------- ---------- ----------
COST OF ENERGY
Gas costs 58.1 56.0 466.8 521.1
Gas costs-affiliated 0.2 0.0 0.2 0.8
Fuel for electric generation 62.2 61.8 170.6 164.6
Fuel for electric generation-affiliated 0.7 1.0 3.4 2.6
Power purchased 23.5 27.7 64.2 72.7
Power purchased-affiliated 6.0 18.4 20.5 46.0
---------- ---------- ---------- ----------
Cost of sales 150.7 164.9 725.7 807.8
---------- ---------- ---------- ----------
Total Net Revenues 244.0 234.3 763.3 756.0
---------- ---------- ---------- ----------
OPERATING EXPENSES
Operation 70.7 65.9 215.9 194.5
Maintenance 16.7 17.7 51.7 52.5
Depreciation and amortization 65.6 64.8 197.2 193.7
Other taxes 19.4 20.9 48.6 69.0
---------- ---------- ---------- ----------
Total Operating Expenses 172.4 169.3 513.4 509.7
---------- ---------- ---------- ----------
UTILITY OPERATING INCOME BEFORE UTILITY
INCOME TAXES 71.6 65.0 249.9 246.3
---------- ---------- ---------- ----------
UTILITY INCOME TAXES 21.1 21.1 84.7 82.4
---------- ---------- ---------- ----------
UTILITY OPERATING INCOME 50.5 43.9 165.2 163.9
---------- ---------- ---------- ----------
OTHER INCOME (DEDUCTIONS) 0.5 (0.4) 1.0 (0.4)
---------- ---------- ---------- ----------
INTEREST
Interest on long-term debt 6.4 9.7 21.1 32.3
Other interest 1.7 (0.1) 3.9 0.7
Other interest-affiliated 2.6 2.4 6.3 6.1
Amortization of premium, reacquisition premium,
discount and expense on debt, net 0.9 0.9 2.7 2.9
---------- ---------- ---------- ----------
Total Interest 11.6 12.9 34.0 42.0
---------- ---------- ---------- ----------
NET INCOME $ 39.4 $ 30.6 $ 132.2 $ 121.5
========== ========== ========== ==========
DIVIDEND REQUIREMENTS ON PREFERRED STOCKS $ 1.1 $ 1.1 $ 3.3 $ 3.4
---------- ---------- ---------- ----------
BALANCE AVAILABLE FOR COMMON SHARES $ 38.3 $ 29.5 $ 128.9 $ 118.1
---------- ---------- ---------- ----------
COMMON DIVIDENDS DECLARED $ - $ 27.4 $ - $ 92.9
---------- ---------- ---------- ----------
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
3
ITEM 1. FINANCIAL STATEMENTS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, December 31,
(in millions) 2004 2003
- ------------- ------------- ------------
unaudited)
ASSETS
UTILITY PLANT, at original cost
Electric $ 4,818.3 $ 4,774.1
Gas 1,514.6 1,494.0
Common 365.3 368.0
------------ ------------
Total Utility Plant 6,698.2 6,636.1
------------ ------------
Less - Accumulated provision for depreciation
and amortization 3,165.1 3,082.7
------------ ------------
Net Utility Plant 3,533.1 3,553.4
------------ ------------
OTHER PROPERTY AND INVESTMENTS 2.3 2.4
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents 1.6 0.3
Restricted cash 7.8 2.6
Accounts receivable (less reserve of $10.6 and $9.6, respectively) 60.3 69.7
Unbilled revenue (less reserve of $0.2 and $0.7, respectively) 31.0 74.2
Materials and supplies, at average cost 44.3 43.8
Electric production fuel, at average cost 26.5 29.0
Natural gas in storage, at last-in, first-out cost 105.0 131.8
Price risk management assets 9.8 4.6
Regulatory assets 18.4 12.4
Prepayments and other 50.3 41.0
------------ ------------
Total Current Assets 355.0 409.4
------------ ------------
OTHER ASSETS:
Regulatory assets 196.2 210.4
Intangible assets 30.8 25.2
Deferred charges and other 6.1 6.6
------------ ------------
Total Other Assets 233.1 242.2
------------ ------------
TOTAL ASSETS $ 4,123.5 $ 4,207.4
============ ============
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
4
ITEM 1. FINANCIAL STATEMENTS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, December 31,
(in millions) 2004 2003
- ------------- -------------- ------------
(unaudited)
CAPITALIZATION AND LIABILITIES
CAPITALIZATION
Common shareholder's equity $ 1,111.3 $ 971.8
Preferred Stocks --
Series without mandatory redemption provisions 81.1 81.1
Series with mandatory redemption provisions - -
Long-term debt, excluding amounts due within one year 497.8 682.0
------------ -----------
Total Capitalization 1,690.2 1,734.9
------------ -----------
CURRENT LIABILITIES
Current portion of long-term debt 73.3 32.0
Short-term borrowings-affiliated 504.8 578.4
Accounts payable 96.4 140.1
Accounts payable-affiliated 14.7 19.9
Dividends declared on preferred stocks 1.1 1.1
Customer deposits 54.1 51.1
Taxes accrued 88.4 58.9
Interest accrued 7.3 6.9
Overrecovered fuel costs 2.5 1.1
Overrecovered gas costs 15.1 25.8
Accrued employment costs 22.4 21.4
Price risk management liabilities 0.7 0.5
Accrued liability for postretirement and pension benefits 23.0 13.6
Other accruals 41.3 55.9
------------ -----------
Total Current Liabilities 945.1 1,006.7
------------ -----------
OTHER LIABILITIES AND DEFERRED CREDITS
Deferred income taxes 457.5 472.2
Deferred investment tax credits 51.9 57.2
Deferred credits 19.2 16.9
Accrued liability for postretirement and pension benefits 233.3 224.2
Preferred stock liabilities with mandatory redemption provisions 1.2 2.4
Regulatory liabilities and other removal costs 704.4 667.2
Other noncurrent liabilities 20.7 25.7
------------ -----------
Total Other 1,488.2 1,465.8
------------ -----------
COMMITMENTS AND CONTINGENCIES - -
------------ -----------
TOTAL CAPITALIZATION AND LIABILITIES $ 4,123.5 $ 4,207.4
============ ===========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
5
ITEM 1. FINANCIAL STATEMENTS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED)
Nine Months Ended September 30,(in million) 2004 2003
- ------------------------------------------- ---- ----
OPERATING ACTIVITIES
Net Income $ 132.2 $ 121.5
Adjustments to reconcile net income to net cash:
Depreciation and amortization 197.2 193.7
Net changes in price risk management activities (6.2) 4.6
Deferred income taxes and investment tax credits (32.0) (50.6)
Amortization of unearned compensation 0.2 0.1
Amortization of discount/premium on debt 2.7 3.0
Other (0.7) (1.6)
Changes in assets and liabilities:
Restricted cash (5.2) (3.1)
Accounts receivable and unbilled revenue 53.8 62.0
Inventories 28.9 (117.3)
Accounts payable (38.5) (53.2)
Customer deposits 3.0 8.3
Taxes accrued 32.0 57.8
Interest accrued 0.4 1.4
(Under) Overrecovered gas and fuel costs (9.2) 53.8
Prepayments and other current assets 4.5 (4.8)
Regulatory assets/liabilities 15.8 5.5
Postretirement and postemployment benefits 20.3 (2.1)
Deferred credits 2.2 (41.1)
Other accruals (12.4) 8.3
Deferred charges and other noncurrent assets 0.5 6.5
Other noncurrent liabilities (11.3) 39.0
---------- ----------
Net Cash from Operating Activities 378.2 291.7
---------- ----------
INVESTING ACTIVITIES
Construction expenditures (158.1) (195.4)
Proceeds from disposition of assets 3.6 2.8
Other investing activities - 6.3
---------- ----------
Net Investing Activities (154.5) (186.3)
---------- ----------
FINANCING ACTIVITIES
Retirement of long-term debt (143.0) (124.0)
Change in short-term debt (74.8) 118.1
Retirement of preferred shares (1.2) (0.6)
Dividends paid - common shares - (92.9)
Dividends paid - preferred shares (3.4) (3.4)
---------- ----------
Net Financing Activities (222.4) (102.8)
---------- ----------
Increase (decrease) in cash and cash equivalents 1.3 2.6
Cash and cash equivalents at beginning of period 0.3 4.4
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1.6 $ 7.0
========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest 31.6 36.4
Interest capitalized 0.7 1.6
Cash paid for income taxes 78.4 87.9
---------- ----------
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
6
ITEM 1. FINANCIAL STATEMENTS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME (UNAUDITED)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
(in millions, net of tax) 2004 2003 2004 2003
- ------------------------- ---- ---- ---- ----
Net Income $ 39.4 $ 30.6 $ 132.2 $ 121.5
Other comprehensive loss, net of tax
Net unrealized gains (losses) on cash flow hedges 0.5 (1.3) (1.2) (2.3)
Minimum pension liability adjustment 4.5 18.3 4.5 18.3
---------- ---------- -------- --------
Total other comprehensive income 5.0 17.0 3.3 16.0
---------- ---------- -------- --------
Total Comprehensive Income $ 44.4 $ 47.6 $ 135.5 $ 137.5
========== ========== ======== ========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
7
ITEM 1. FINANCIAL STATEMENTS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
1. BASIS OF ACCOUNTING PRESENTATION
Northern Indiana Public Service Company (Northern Indiana) is a subsidiary of
NiSource Inc. (NiSource). NiSource is an energy holding company that provides
natural gas, electricity and other products and services to approximately 3.7
million customers located within a corridor that runs from the Gulf Coast
through the Midwest to New England. NiSource is a Delaware corporation and a
registered holding company under the Public Utility Holding Company Act of 1935,
as amended.
The accompanying unaudited consolidated financial statements for Northern
Indiana 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 Northern
Indiana'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. REGULATORY MATTERS
Gas Operations Related Matters
On August 11, 1999, the Indiana Utility Regulatory Commission (IURC) approved a
flexible gas cost adjustment (GCA) mechanism for 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. The IURC approved the joint stipulation and agreement, without change, at
their August 18, 2004 administrative meeting.
Northern Indiana's GCA6 annual demand filing, covering the period November 1,
2004 through October 31, 2005 was made on August 26, 2004 and approved by the
IURC on October 20, 2004 for implementation as interim rates, subject to refund,
effective November 1, 2004.
8
ITEM 1. FINANCIAL STATEMENTS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
Northern Indiana, the OUCC, Testimonial Staff of the IURC, and the Marketer
Group (a group which collectively represents 7 marketers participating in
Northern Indiana Choice) filed a Stipulation and Agreement with the IURC on
October 12, 2004, that, among other things, extends the expiration date of the
1997 ARP decision to March 31, 2006. The agreement, if approved by the IURC
extends the expiration date of Northern Indiana's gas incentive mechanism - GCIM
to March 31, 2006 as well. The agreement grandfathers the terms of existing
contracts that marketers have with Choice customers. Lastly, the agreement
establishes a scope for negotiations that parties will follow when convening
within the next several months to establish a long-term resolution of the ARP.
On September 21, 2004, Northern Indiana petitioned the IURC under the ARP
statutory requirements to permit a two-year pilot low-income energy assistance
program. The program, filed under the name NIPSCO Winter Warmth provides, if
approved, approximately $4.0 million of assistance for customer security
deposits and bill assistance for qualifying low-income customers presently
disconnected for non-payment or at risk for disconnection. As proposed, Northern
Indiana will fund this program through a monthly $0.50 charge to residential and
general service customers and an annual contribution of $200,000 from Northern
Indiana.
Electric Operations Related Matters
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 recorded 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, and recognized $0.9 million in MISO fees
in the third quarter 2004. The MISO Schedule 10 administrative fees are
currently estimated to be approximately $2.8 million annually. On October 6,
2004, the IURC denied Northern Indiana's Motion for Reconsideration. Northern
Indiana filed its notice of appeal and this matter is pending.
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 the
FERC detailed tariff information, with a planned initial operation date of March
1, 2005. Northern Indiana is actively pursuing a role in the MMI. At the current
time, management believes that the MMI will change the manner in which Northern
Indiana conducts its electric business; however, at this time management cannot
determine the impact the MMI will have on Northern Indiana.
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. On October 8, 2004,
Northern Indiana requested proposals from wholesale power marketers to provide
power under varying terms and conditions. These proposals will be evaluated
after the submittal date on November 5, 2004. Northern Indiana
9
ITEM 1. FINANCIAL STATEMENTS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
requested similar proposals during 2003 which were not executed. 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. Interveners, including the Indiana Office of Utility Consumer
Council, filed direct testimony on October 12, 2004. The IURC hearing of the
City of Gary petition is scheduled for the fourth quarter of 2004.
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 was filed on August 6, 2004. The hearing in this matter is also
scheduled 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. The hearing in this matter is
scheduled for the first quarter of 2005.
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-4) was made in August 2004 for
capital expenditures of $231.3 million. Northern Indiana's first annual EERM
filing (EER-1) was made in February 2004 for $1.9 million. On February 4, 2004,
the IURC approved Northern Indiana's latest compliance plan with the estimate of
$274.2 million. On October 8, 2004, Northern Indiana filed for approval of the
revised cost estimates to meet the environmental standards. Northern Indiana
anticipates a total capital investment amounting to approximately $305 million.
The ECRM revenues amounted to $12.8 million for the nine months ended September
30, 2004, and $18.0 million from inception to date, while EERM revenues were
$0.8 million for the first nine months of 2004.
3. RESTRUCTURING ACTIVITIES
Since 2000, NiSource has implemented restructuring initiatives to streamline its
operations and realize efficiencies from the acquisition of Columbia Energy
Group. The restructuring activities were primarily associated with reductions in
headcount.
For all of the restructuring plans, a total of approximately 180 management,
professional, administrative and technical positions have been identified for
elimination at Northern Indiana. As of September 30, 2004, 162 employees were
terminated. At September 30, 2004 and December 31, 2003, the consolidated
balance sheets reflected liabilities of $1.1 million and $1.2 million related to
the restructuring plans, respectively. During the third quarter and nine months
ended September 30, 2004, the restructuring plan liability was reduced by $0.1
million due to a reduction in estimated costs related to the reorganization
initiatives. The reduction in the estimated liability was reflected in operation
and maintenance expense.
10
ITEM 1. FINANCIAL STATEMENTS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
4. RISK MANAGEMENT ACTIVITIES
Northern Indiana uses commodity-based derivative financial instruments to manage
certain risks in its business. Northern Indiana accounts for its derivatives
under Financial Accounting Standards Board's (FASB) Statement of Financial
Accounting Standards (SFAS) No. 133 "Accounting for Derivative Instruments and
Hedging Activities," as amended, (SFAS No. 133).
HEDGING ACTIVITIES. The activity for the third quarter and nine months ended
September 30, 2004 and September 30, 2003 affecting accumulated other
comprehensive income, with respect to cash flow hedges included the following:
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
(in millions, net of tax) 2004 2003 2004 2003
- ------------------------- -------- -------- -------- --------
Unrealized gains on derivatives qualifying as cash flow
hedges at the beginning of the period $ 0.9 $ 1.3 $ 2.6 $ 2.3
Unrealized hedging gains (losses) arising during the
period of derivatives qualifying as cash flow hedges 1.0 (0.5) 1.6 (2.7)
Reclassification adjustment for net loss (gain) included
in net income (0.5) (0.8) (2.8) 0.4
-------- -------- -------- --------
Net unrealized gains on derivatives qualifying as cash
flow hedges at the end of the period $ 1.4 $ - $ 1.4 $ -
-------- -------- -------- --------
Unrealized gains and losses on Northern Indiana's hedges were recorded as price
risk management assets and liabilities. The accompanying consolidated balance
sheets reflected price risk management assets of $9.8 million and $4.6 million
at September 30, 2004 and December 31, 2003, respectively, which were included
in "Current Assets." Price risk management liabilities were $0.7 million and
$0.5 million at September 30, 2004 and December 31, 2003, respectively, all of
which were included in "Current Liabilities."
During the third quarter 2004, there were no components of the derivatives' fair
values excluded in the assessment of hedge effectiveness. Also, during the third
quarter, Northern Indiana 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 $1.2 million, net of tax.
In addition, Northern Indiana engages in writing options that potentially
obligate Northern Indiana 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 for certain programs to minimize risk associated with gas price
volatility. These derivative hedging programs must be marked to fair value, but,
because these derivatives are used within the framework of their respective gas
cost recovery mechanisms, regulatory assets or liabilities are recorded to
offset the change in the fair value of these derivatives. The consolidated
balance sheets reflected zero and $0.2 million at September 30, 2004 and
December 31, 2003, respectively, of price risk management liabilities associated
with these programs.
11
ITEM 1. FINANCIAL STATEMENTS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
5. 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.
Northern Indiana adopted FIN 46R on January 1, 2004. The adoption of FIN 46R had
no impact on Northern Indiana's financial position or results of operations.
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 the first interim or annual period beginning after
June 15, 2004. Northern Indiana had previously elected to defer accounting for
the effects of this pronouncement, as allowed by FSP 106-1. On July 1, 2004,
NiSource adopted the provisions of FSP 106-2. Northern Indiana was not impacted
by the adoption by NiSource FSP 106-2.
6. LEGAL PROCEEDINGS
In the normal course of its business, Northern Indiana has been named as a
defendant 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 Northern Indiana's consolidated financial position.
7. ACCUMULATED OTHER COMPREHENSIVE LOSS
The following table displays the components of Accumulated Other Comprehensive
Loss, which is included in "Common shareholder's equity," on the consolidated
balance sheets.
SEPTEMBER 30, December 31,
(in millions, net of tax) 2004 2003
- ------------------------- ---- ----
Net unrealized gains on cash flow hedges $ 1.4 $ 2.6
Minimum pension liability adjustment (119.8) (124.3)
--------- ---------
Total Accumulated Other Comprehensive Loss, net $ (118.4) $ (121.7)
--------- ---------
8. PENSION AND OTHER POSTRETIREMENT BENEFITS
Northern Indiana participates in the NiSource pension and postretirement benefit
plans. NiSource used a measurement date of September 30, 2003 for the
calculation of its obligations under the pension and other postretirement
benefit plans. Northern Indiana recognized $4.0 million and $8.1 million in
allocated pension expenses, and $7.0 million and $5.0 million in other benefit
expenses for the third quarter of 2004 and the third quarter of 2003,
respectively. Northern Indiana recognized $11.9 million and $24.4 million in
allocated pension
12
ITEM 1. FINANCIAL STATEMENTS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
expenses, and $21.1 million and $15.1 million in other benefit expenses for the
first nine months of 2004 and the first nine months of 2003, respectively.
Northern Indiana does not expect to make contributions to the pension plan in
2004. However, Northern Indiana expects to contribute $20.3 million to the
postretirement medical and life plans in 2004.
9. BUSINESS SEGMENT INFORMATION
Northern Indiana's operations are divided into three primary business segments.
The Gas Distribution Operations segment provides natural gas service and
transportation for residential, commercial and industrial customers in Indiana.
The Electric Operations segment provides electric service in 21 counties in the
northern part of Indiana and engages in electric wholesale and wheeling
transactions. The Other Operations segment includes the results of NIPSCO
Receivables Corporation (NRC), a wholly-owned subsidiary of Northern Indiana,
whose sole activity is to purchase accounts receivable from Northern Indiana and
sell these accounts to a commercial paper conduit, within the limits of the
agreement between NRC and the conduit. NRC commenced operations on December 30,
2003.
The following tables provide information about Northern Indiana business
segments. Northern Indiana uses operating income (loss) as its primary
measurement for each of the reporting segments. Operating income (loss) is
derived from revenues and expenses directly associated with each segment.
($ in millions) GAS ELECTRIC OTHER TOTAL
- --------------- --- -------- ----- -----
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004
Operating revenues 91.4 303.3 - 394.7
Utility operating income (loss) before utility income taxes (23.6) 95.4 (0.2) 71.6
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003
Operating revenues 84.4 314.8 - 399.2
Utility operating income (loss) before utility income taxes (24.5) 89.5 - 65.0
----- ---- ----
($ in millions) GAS ELECTRIC OTHER TOTAL
- --------------- --- -------- ----- -----
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
Operating revenues 657.4 831.6 - 1,489.0
Utility operating income (loss) before utility income taxes 14.4 236.2 (0.7) 249.9
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
Operating revenues 726.8 837.0 - 1,563.8
Utility operating income before utility income taxes 40.1 206.2 - 246.3
---- ----- -----
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
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 Northern Indiana's 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, Northern Indiana 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 Northern
Indiana, 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 Northern Indiana'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 Northern Indiana's businesses, increased competition in
deregulated energy markets, dealings with third parties over whom Northern
Indiana has no control, 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
Northern Indiana. 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 Northern Indiana's Annual Report on Form 10-K for the fiscal year ended
December 31, 2003.
CONSOLIDATED REVIEW
RESULTS OF OPERATIONS
THE QUARTER ENDED SEPTEMBER 30, 2004
Net Income
Northern Indiana reported net income of $39.4 million for the three months ended
September 30, 2004, an increase of $8.8 million as compared to the $30.6 million
recorded in the 2003 period.
Net Revenues
Total consolidated net revenues (gross revenues less cost of sales) for the
three months ended September 30, 2004, were $244.0 million, a $9.7 million
increase from the same period last year. Gas net revenues for the third quarter
2004 were $33.1 million, an increase of $4.7 million from the same period in
2003. The increase in net revenues was primarily a result of increased
residential, commercial and industrial non-weather related gas sales of $6.4
million and the impact of regulatory refunds which reduced net revenues in the
third quarter of 2003 by $3.8 million. These increases were partially offset by
warmer weather in the gas markets for the third quarter of 2004 compared with
the same period in 2003 amounting to $1.9 million and lower non-traditional
revenues of $2.9 million. In the third quarter 2004, electric net revenues of
$210.9 million increased by $5.0 million from the comparable 2003 period. Net
revenue increased primarily due to environmental trackers of $4.3 million,
increased transmission revenues of $2.1 million, and the impact of reserves of
$3.0 million recorded for regulatory refunds in the 2003 period. These increases
were partially offset by a reduction of $6.2 million in net revenues resulting
from cooler weather in the electric market for the current period compared to
the prior period.
Expenses
Operating expenses for the third quarter 2004 were $172.4 million, an increase
of $3.1 million from the 2003 period. The increase was primarily due to the
increase in operation and maintenance expenses of $3.8 million for the third
quarter 2004. The increase in operation and maintenance expenses is a result of
increased employee and administrative expense of $2.6 million, increased
insurance expenses of $1.9 million and an adjustment to employee insurance
reserves in 2003 of $3.3 million. In addition, depreciation and amortization
expense increased
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
$0.8 million mainly due to plant additions. These increased costs were partially
offset by reduced electric production maintenance expenses of $2.7 million and
decreased environmental and uncollectibles accounts expenses of $1.5 million,
and the reduction in estimated property tax expenses of $2.2 million.
Utility Income Taxes
Utility income tax expenses for the third quarter 2004 were favorably impacted
by the reversal of a $5.7 million tax reserve.
Other Income (Deductions)
Other Income (Deductions) for the third quarter were $0.5 million, an increase
of $0.9 million compared to the 2003 period, primarily due to a decrease in
administrative fees associated with the sale of accounts receivable.
Interest
Interest expense for the third quarter 2004 was $11.6 million, a decrease of
$1.3 million compared to the 2003 period, primarily due to a reduction in
long-term debt and lower average long-term interest rates.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2004
Net Income
Northern Indiana reported net income of $132.2 million for the nine months ended
September 30, 2004, an increase of $10.7 million as compared to the $121.5
million recorded in the 2003 period.
Net Revenues
Total consolidated net revenues (gross revenues less cost of sales) for the nine
months ended September 30, 2004, were $763.3 million, a $7.3 million increase
from the same period last year. Gas net revenues for the first nine months of
2004 were $190.4 million, a decrease of $14.5 million from the same period in
2003. The decrease in net revenues was primarily a result of reductions in
residential and commercial gas sales due to warmer weather during the winter
heating season in 2004 compared with the same period in 2003 amounting to $9.5
million and lower non-traditional revenues of $7.8 million, partially offset by
the impact of regulatory refunds which reduced net revenues in the third quarter
of 2003 by $3.8 million. In the first nine months of 2004, electric net revenues
were $572.9 million, an increase of $21.8 million from the comparable 2003
period as a result of higher net revenues from environmental trackers of $11.0
million, an increase in non-weather-related usage and customer count of $7.4
million and the effect of reserves recorded for regulatory refunds of $12.3
million in the comparable 2003 period. These increases were partially offset by
unfavorable weather amounting to $6.0 million, the majority of which occurred in
the current quarter, and a decrease in net revenues of $3.2 million as a result
of a reduced interruptible sales tariff for industrial customers approved by the
Indiana Utility Regulatory Commission (IURC) earlier this year.
Expenses
Operating expenses for the nine months ended September 30, 2004 were $513.4
million, an increase of $3.7 million over the 2003 period. Operation and
maintenance expenses increased $20.6 million mainly due to increased employee
and administrative expenses of $9.3 million, an adjustment to employee insurance
reserves in 2003 of $6.8 million, $3.0 million in Midwest Independent System
Operation (MISO) administrative fees, a $4.2 million expense related to a
redemption premium from the early extinguishment of certain medium-term notes,
increased insurance expense of $1.9 million, a $2.0 million increase in
environmental reserves and a $1.8 million increase in outside services. In
addition, depreciation and amortization expense increased $3.5 million mainly
due to plant additions. These increased costs were partially offset by reversal
of certain claims reserves upon settlement in the second quarter of 2004 of $5.7
million, reduced electric production maintenance expenses of $2.4 million,
decreased uncollectibles accounts expenses of $1.9 million, a $25.3 million
reduction in estimated property tax expenses and the $5.4 million increase in
sales tax expenses.
Utility Income Taxes
Utility income tax expenses for the nine months ended September 30, 2004 were
$84.7 million, compared to $82.4 million in 2003, due to increased pre-tax
income, offset by the reversal of a $5.7 million tax reserve.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
Other Income (Deductions)
Other Income (Deductions) for the nine months ended September 30, 2004 were $1.0
million, an increase of $1.4 million compared to the 2003 period, primarily due
to a decrease in administrative fees associated with the sale of accounts
receivable.
Interest
Interest expense for the nine months ended September 30, 2004 was $34.0 million,
a decrease of $8.0 million compared to the 2003 period, primarily due to a
reduction in long-term debt and lower average long-term interest rates.
LIQUIDITY AND CAPITAL RESOURCES
Generally, cash flow from operations has provided sufficient liquidity to meet
operating requirements. A significant portion of Northern Indiana's operations,
most notably in the gas distribution 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 operations for the nine months ended September 30, 2004 was $378.2
million. Net cash from operations increased $86.5 million from the comparable
period a year ago, mainly as a result of an increase in cash flow from working
capital. The increase in cash flow from working capital was $64.8 million,
principally driven by reduced purchases of gas inventories.
During July 2004, Northern Indiana redeemed $32.0 million of its medium-term
notes, with an average interest rate of 6.53%.
During February 2004, Northern Indiana redeemed $111.1 million of its
medium-term notes with an average interest rate of 7.49%. The associated
redemption premium of $4.2 million was charged to operating expense.
Northern Indiana satisfies its liquidity requirements primarily through
internally generated funds and through intercompany borrowings from the NiSource
Money Pool. Northern Indiana may borrow a maximum of $1.0 billion through the
NiSource Money Pool as approved by the Securities and Exchange Commission under
the Public Utility Holding Company Act of 1935. NiSource Finance Corp. (NFC)
provides funding to the NiSource Money Pool from external borrowing sources.
During March 2004, NFC 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 credit facility is guaranteed by NiSource. As of September 30,
2004, Northern Indiana had $504.8 million of intercompany short-term borrowings
outstanding at an interest rate of 2.35%. As of December 31, 2003, Northern
Indiana had $578.4 million of intercompany short-term borrowings outstanding at
an interest rate of 1.74%.
Sale of Trade Receivables
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, but can be renewed if
mutually agreed to by both parties. As of September 30, 2004, NRC had sold
$105.0 million of accounts receivable.
MARKET RISK DISCLOSURES
Through its various business activities, Northern Indiana is exposed to risk
including commodity price, interest rate and credit risks. Northern Indiana's
risk management policy permits the use of certain financial instruments to
manage its commodity price risk, including futures, forwards, options and swaps.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
Non-Trading Risks
Commodity price risk resulting from non-trading activities at Northern Indiana
is limited, since current regulations allow recovery of prudently incurred
purchased power, fuel and gas costs through the rate-making process. If Indiana
were to explore regulatory reform, Northern Indiana may expand the number of
services that it would provide that would not have the benefit of the
traditional rate-making process and may be more exposed to commodity price risk.
Northern Indiana enters into certain sales contracts with customers based upon a
fixed sales price and varying volumes, which are ultimately dependent upon the
customer's supply requirements. Northern Indiana utilizes derivative financial
instruments to reduce the commodity price risk based on modeling techniques to
anticipate these future supply requirements.
Northern Indiana is exposed to interest rate risk as a result of changes in
interest rates on intercompany borrowings with NFC. These borrowings have
interest rates that are indexed to short-term market interest rates. At
September 30, 2004, the outstanding borrowings totaled $504.8 million. Based
upon average borrowings during 2004, an increase in short-term interest rates of
100 basis points (1%) would have increased interest expense by $1.2 million and
$3.4 million for the quarter and nine months ended September 30, 2004,
respectively.
Due to the nature of the industry, credit risk is a factor in many of Northern
Indiana'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. 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 Northern Indiana's
exposures vary with changes in market prices, Northern Indiana also estimates
the potential credit exposure over the remaining term of transactions through
statistical analysis of market prices. In determining exposure, Northern Indiana
considers collateral and master netting agreements, which are used to reduce
individual counterparty credit risk.
OFF BALANCE SHEET ARRANGEMENTS
At September 30, 2004, there have been no material changes in Northern Indiana's
purchase commitments and operating leases obligations from those reported in
Northern Indiana's Form 10-K for the year ended December 31, 2003.
In addition, Northern Indiana has sold certain accounts receivable. Northern
Indiana's accounts receivable program qualifies for sale accounting because it
meets 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 agreement, 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. Northern Indiana does not retain any interest in the receivables
under these programs.
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
Northern Indiana's operations are divided into three primary business segments:
Gas Distribution Operations, Electric Operations and Other Operations. The Other
Operations segment includes the results of NRC, a wholly-owned subsidiary of
Northern Indiana, whose sole activity is to purchase accounts receivable from
Northern Indiana and sell these accounts to a commercial paper conduit, within
the limits of the agreement between NRC and the conduit. NRC commenced
operations on December 30, 2003.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
GAS DISTRIBUTION OPERATIONS
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
( in millions) 2004 2003 2004 2003
- -------------- ---- ---- ---- ----
NET REVENUES
Sales revenues $ 83.8 $ 78.1 $ 620.3 $ 690.9
Less: Cost of gas sold 58.3 56.0 467.0 521.9
------------ ------------ ------------ ------------
Net Sales Revenues 25.5 22.1 153.3 169.0
Transportation Revenues 7.6 6.3 37.1 35.9
------------ ------------ ------------ ------------
Net Revenues 33.1 28.4 190.4 204.9
------------ ------------ ------------ ------------
OPERATING EXPENSES
Operation and maintenance 30.0 26.6 90.6 79.6
Depreciation and amortization 21.5 21.3 64.6 62.9
Other taxes 5.2 5.0 20.8 22.3
------------ ------------ ------------ ------------
Total Operating Expenses 56.7 52.9 176.0 164.8
------------ ------------ ------------ ------------
Operating Income (Loss) $ (23.6) $ (24.5) $ 14.4 $ 40.1
============ ============ ============ ============
REVENUES ($ IN MILLIONS)
Residential 42.5 35.8 409.6 451.1
Commercial 16.0 13.8 138.6 167.9
Industrial 18.4 20.2 94.5 92.3
Transportation 7.6 6.2 37.1 35.9
Deferred Gas Costs 4.2 3.6 (39.2) (52.3)
Other 2.7 4.8 16.8 31.9
------------ ------------ ------------ ------------
Total 91.4 84.4 657.4 726.8
------------ ------------ ------------ ------------
SALES AND TRANSPORTATION (MMDTH)
Residential Sales 3.8 3.8 39.8 43.3
Commercial Sales 1.7 1.5 15.6 17.7
Industrial Sales 3.1 2.7 10.8 10.2
Transportation 34.3 29.4 118.4 103.7
Other - 0.2 0.1 1.2
------------ ------------ ------------ ------------
Total 42.9 37.6 184.7 176.1
------------ ------------ ------------ ------------
HEATING DEGREE DAYS 78 152 3,863 4,245
NORMAL HEATING DEGREE DAYS 110 110 3,944 3,912
% COLDER (WARMER) THAN NORMAL (29%) 38% (2%) 9%
CUSTOMERS
Residential 593,211 594,383
Commercial 45,558 46,867
Industrial 2,986 3,154
Transportation 54,720 46,632
Other 11 14
------------ ------------
TOTAL 696,486 691,050
------------ ------------
Northern Indiana's natural gas distribution operations serve approximately
696,000 customers in the northern part of Indiana. Northern Indiana offers 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.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
GAS DISTRIBUTION OPERATIONS (CONTINUED)
Regulatory Matters
On August 11, 1999, the Indiana Utility Regulatory Commission (IURC) approved a
flexible gas cost adjustment (GCA) mechanism for 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. The IURC approved the joint stipulation and agreement, without change, at
their August 18, 2004 administrative meeting.
Northern Indiana's GCA6 annual demand filing, covering the period November 1,
2004 through October 31, 2005 was made on August 26, 2004 and approved by the
IURC on October 20, 2004 for implementation as interim rates, subject to refund,
effective November 1, 2004.
Northern Indiana, the OUCC, Testimonial Staff of the IURC, and the Marketer
Group (a group which collectively represents 7 marketers participating in
Northern Indiana Choice) filed a Stipulation and Agreement with the IURC on
October 12, 2004, that, among other things, extends the expiration date of the
1997 ARP decision to March 31, 2006. The agreement, if approved by the IURC
extends the expiration date of Northern Indiana's gas incentive mechanism - GCIM
to March 31, 2006 as well. The agreement grandfathers the terms of existing
contracts that marketers have with Choice customers. Lastly, the agreement
establishes a scope for negotiations that parties will follow when convening
within the next several months to establish a long-term resolution of the ARP.
On September 21, 2004, Northern Indiana petitioned the IURC under the ARP
statutory requirements to permit a two-year pilot low-income energy assistance
program. The program, filed under the name NIPSCO Winter Warmth provides, if
approved, approximately $4.0 million of assistance for customer security
deposits and bill assistance for qualifying low-income customers presently
disconnected for non-payment or at risk for disconnection. As proposed, Northern
Indiana will fund this program through a monthly $0.50 charge to residential and
general service customers and an annual contribution of $200,000 from Northern
Indiana.
Environmental Matters
In January of 2004, Northern Indiana signed a multi-site Voluntary Remediation
Program Order addressing 13 former manufactured gas plant sites with the Indiana
Department of Environmental Management. Previously Northern Indiana, together
with other potentially responsible parties, had entered into similar agreements
with the
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
GAS DISTRIBUTION OPERATIONS (CONTINUED)
Indiana Department of Environmental Management for 11 additional sites, which
Northern Indiana is required to investigate, and to the extent necessary, clean
up.
Weather
In general, Northern Indiana 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 Northern
Indiana's distribution region. The temperature base for measuring heating degree
days (i.e. the estimated average daily temperature at which heating load begins)
is 65 degrees.
For the third quarter of 2004, weather was 29% warmer than normal and 49% warmer
than the third quarter of 2003.
For the first nine months of 2004, weather was 2% warmer than normal and 9%
warmer than the first nine months of 2003.
Throughput
Northern Indiana sold and transported 42.9 million dekatherms (MMDth) for the
third quarter 2004, as compared to 37.6 million MMDth from the same period last
year. The increase in MMDth's was mainly due to increased transport throughput.
Total volumes sold and transported were 184.7 MMDth for the first nine months of
2004, an increase of 8.6 MMDth from the same period in 2003, primarily due to
increased transportation, partially offset by a reduction of residential and
commercial sales.
Net Revenues
Net revenues for the third quarter ended September 30, 2004 were $33.1 million,
an increase of $4.7 million from the same period in 2003. The increase in net
revenues was primarily a result of increased residential, commercial and
industrial non-weather related gas sales of $6.4 million and the impact of
regulatory refunds which reduced net revenues in the third quarter of 2003 by
$3.8 million. These increases were partially offset by lower non-traditional
revenues of $2.9 million.
Net revenues for the first nine months of 2004 were $190.4 million, a decrease
of $14.5 million from the same period in 2003. The decrease in net revenues was
primarily a result of reductions in residential and commercial gas sales due to
warmer weather in 2004 compared with the same period in 2003 amounting to $9.5
million and lower non-traditional revenues of $7.8 million, partially offset by
the impact of regulatory refunds which reduced net revenues in the third quarter
of 2003 by $3.8 million.
Operating Income
For the third quarter of 2004, operating loss was $23.6 million compared to a
loss of $24.5 million from the same period in 2003. The improvement was mainly
attributable to increased net revenues of $4.7 million discussed above,
partially offset by $3.4 million increase in operation and maintenance expenses.
The increase in operating expense was primarily due to higher employee and
administrative expenses of $3.2 million and increased insurance expense of $0.9
million. Partially offsetting these increases were decreased environmental and
uncollectible accounts expense of $1.8 million. In addition, the 2003 period
benefited from a $1.5 million adjustment to employee insurance reserves.
For the first nine months of 2004, operating income was $14.4 million, a
decrease of $25.7 million from the same period in 2003. The decrease was mainly
attributable to lower net revenues of $14.5 million discussed above, and a $11.0
million increase in operation and maintenance expenses. Operating expenses
increased due to higher employee and administrative expenses of $7.9 million,
increased environmental costs of $1.8 million and increased insurance expense
of $0.9 million. In addition, $0.9 million in expense was recorded in the first
quarter related to Gas Operations' portion of redemption premium from the early
extinguishment of certain medium-term notes. A $3.0 million adjustment to
employee insurance reserves in 2003 contributed to the year-over-year increase
in operating expenses. These increased expenses were partially offset by a
reversal of certain claims reserves upon settlement in the second quarter of
2004 of $2.5 million and lower uncollectible accounts expense of $2.2 million.
In addition, a $4.7 million reversal of an accrual for prior years estimated
property taxes and a reduction in the
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
GAS DISTRIBUTION OPERATIONS (CONTINUED)
current year accrual of $1.2 million was partially offset by a $5.0 million
increase in sales tax accrual during the second quarter of 2004. Depreciation
expense increased $1.7 million due to asset additions.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
ELECTRIC OPERATIONS
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
( in millions) 2004 2003 2004 2003
- -------------- ---- ---- ---- ----
NET REVENUES
Sales Revenues $ 303.3 $ 314.8 $ 831.6 $ 837.0
Less: Cost of sales 92.4 108.9 258.7 285.9
-------- --------- -------- ---------
Net Revenues 210.9 205.9 572.9 551.1
-------- --------- -------- ---------
OPERATING EXPENSES
Operation and maintenance 57.2 57.0 176.3 167.4
Depreciation and amortization 44.1 43.5 132.6 130.8
Other taxes 14.2 15.9 27.8 46.7
-------- --------- -------- ---------
Total Operating Expenses 115.5 116.4 336.7 344.9
-------- --------- -------- ---------
Operating Income $ 95.4 $ 89.5 $ 236.2 $ 206.2
======== ========= ======== =========
REVENUES ($ IN MILLIONS)
Residential 86.9 94.7 224.8 229.3
Commercial 78.8 84.0 222.4 220.4
Industrial 100.3 90.9 304.1 282.2
Wholesale 18.8 34.0 41.6 79.4
Other 18.5 11.2 38.7 25.7
-------- --------- -------- ---------
Total 303.3 314.8 831.6 837.0
-------- --------- -------- ---------
SALES (GIGAWATT HOURS)
Residential 923.7 1,008.1 2,372.4 2,436.8
Commercial 990.1 1,011.8 2,749.6 2,722.5
Industrial 2,295.3 2,176.4 6,960.7 6,655.3
Wholesale 504.2 911.8 1,063.6 2,205.2
Other 31.0 36.0 97.2 97.2
-------- --------- -------- ---------
Total 4,744.3 5,144.1 13,243.5 14,117.0
-------- --------- -------- ---------
COOLING DEGREE DAYS 377 459 582 572
NORMAL COOLING DEGREE DAYS 576 584 803 808
% WARMER (COOLER) THAN NORMAL (35%) (21%) (28%) (29%)
CUSTOMERS
Residential 389,878 386,227
Commercial 49,983 48,984
Industrial 2,518 2,548
Wholesale 26 19
Other 777 795
-------- ---------
Total 443,182 438,573
-------- ---------
Northern Indiana generates and distributes electricity to approximately 443,000
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.
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
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
ELECTRIC OPERATIONS (CONTINUED)
improve operating efficiencies in this changing environment.
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 $41.9 million and $39.8 million were recognized for
electric customers for the first nine months 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 recorded 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, and recognized $0.9 million in MISO fees
in the third quarter 2004. The MISO Schedule 10 administrative fees are
currently estimated to be approximately $2.8 million annually. On October 6,
2004, the IURC denied Northern Indiana's Motion for Reconsideration. Northern
Indiana filed its notice of appeal and this matter is pending.
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 the
FERC detailed tariff information, with a planned initial operation date of March
1, 2005. Northern Indiana is actively pursuing a role in the MMI. At the current
time, management believes that the MMI will change the manner in which Northern
Indiana conducts its electric business; however, at this time management cannot
determine the impact the MMI will have on Northern Indiana.
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. On October 8, 2004,
Northern Indiana requested proposals from wholesale power marketers to provide
power under varying terms and conditions. These proposals will be evaluated
after the submittal date on November 5, 2004. Northern Indiana requested similar
proposals during 2003 which were not executed. 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
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
ELECTRIC OPERATIONS (CONTINUED)
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. Interveners, including the Indiana Office of
Utility Consumer Council, filed direct testimony on October 12, 2004. The IURC
hearing of the City of Gary petition is scheduled for the fourth quarter of
2004.
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 was filed on August 6, 2004. The hearing in this matter is also
scheduled 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. The hearing in this matter is
scheduled for the first quarter of 2005.
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-4) was made in August 2004 for
capital expenditures of $231.3 million. Northern Indiana's first annual EERM
filing (EER-1) was made in February 2004 for $1.9 million. On February 4, 2004,
the IURC approved Northern Indiana's latest compliance plan with the estimate of
$274.2 million. On October 8, 2004, Northern Indiana filed for approval of the
revised cost estimates to meet the environmental standards. Northern Indiana
anticipates a total capital investment amounting to approximately $305 million.
The ECRM revenues amounted to $12.8 million for the nine months ended September
30, 2004, and $18.0 million from inception to date, while EERM revenues were
$0.8 million for the first nine months of 2004.
Environmental Matters
AIR. In December 2001, the U.S. Environmental Protection Agency (EPA) approved
regulations developed by the State of Indiana to comply with the EPA's
additional nitrogen oxide (NOx) State Implementation Plan (SIP) call. The NOx
SIP call requires certain states, including Indiana, to reduce NOx levels from
several sources, including industrial and utility boilers, to lower regional
transport of ozone. Compliance with the NOx limits contained in these rules was
required by May 31, 2004. To comply with the rule, Northern Indiana developed a
NOx Compliance plan and is currently in compliance with the NOx limits. In
implementing the NOx compliance plan, Northern Indiana has expended
approximately $264.2 million as of September 30, 2004 to install NOx reduction
technology at each of its active generating stations and estimates total capital
costs of approximately $305 million. Actual compliance costs may vary depending
on a number of factors including market demand and resource constraints,
uncertainty of future equipment and construction costs, and the potential need
for additional control technology.
In March 2004, the State of North Carolina filed a petition under Section 126 of
the Clean Air Act seeking the EPA imposition of additional NOx and sulfur
dioxide (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.
On April 15, 2004, the EPA finalized the 8-hour ozone non-attainment area
designations. After designation, the Clean Air Act provides for a process for
promulgation of rules specifying a compliance level, compliance deadline,
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
ELECTRIC OPERATIONS (CONTINUED)
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 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 the EPA guidance. The BART eligible sources include facilities
that were built between 1962 and 1977, 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, 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 the 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.
On June 28 and 29, 2004, the EPA responded to the states' initial
recommendations for the 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.
In late 1999 the EPA initiated a New Source Review enforcement action against
several industries including the electric utility industry concerning rule
interpretations that have been the subject of recent (prospective) reform
regulations. Northern Indiana has received and responded to the EPA information
requests on this subject, most recently in June 2002. The EPA issued a Notice of
Violation (NOV) to Northern Indiana on September 29, 2004, for alleged
violations of the Clean Air Act and the SIP. Specifically, the NOV alleges that
modifications were made to certain boiler units at the Michigan City, Schahfer,
and Bailly Generating Stations without obtaining appropriate air permits for the
modifications. Northern Indiana has held an initial meeting with the EPA to
discuss the violations alleged in the NOV but is unable, at this time, to
predict the timing or likely outcome of this EPA action.
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 meet certain performance standards to reduce the
mortality of aquatic organisms at their cooling water intake structures. The 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. Specific impacts of
the final Phase II rule on the four (4) Northern Indiana generating stations are
in the process of being determined at this time.
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
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
ELECTRIC OPERATIONS (CONTINUED)
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 third quarter 2004 were 4,744.3 gwh, a decrease of 399.8
gwh compared to the 2003 period, mainly as a result of 18% cooler weather than
the comparable period and decreased wholesale transaction sales, which was
offset in part by an improvement in industrial sales due to increased demand
from the steel industry.
Electric sales for the first nine months of 2004 was 13,243.5 gwh, a decrease of
873.5 gwh compared to the 2003 period, as a result of the cooler weather during
the third quarter and decreased wholesale transaction sales.
Net Revenues
In the third quarter 2004, electric net revenues of $210.9 million increased by
$5.0 million from the comparable 2003 period. Net revenue increased primarily
due to environmental trackers of $4.3 million, increased transmission revenues
of $2.1 million, and the impact of reserves of $3.0 million recorded for
regulatory refunds in the 2003 period. These increases were partially offset by
a reduction of $6.2 million in net revenues resulting from cooler weather in the
current period.
In the first nine months of 2004, electric net revenues were $572.9 million, an
increase of $21.8 million from the comparable 2003 period due to higher net
revenues from environmental trackers of $11.0 million, and an increase in
non-weather-related usage and customer count of $7.4 million and the effect of
reserves recorded for regulatory refunds of $12.3 million in the comparable 2003
period. These increases were partially offset by unfavorable weather amounting
to $6.0 million, the majority of which occurred in the current quarter and a
decrease in net revenues of $3.2 million as a result of a reduced interruptible
sales tariff for industrial customers approved by the IURC earlier this year.
Operating Income
Operating income for the third quarter 2004 was $95.4 million, an increase of
$5.9 million from the same period in 2003. This increase for the comparative
quarters was primarily due to the increase in net revenue mentioned above.
Operating expenses decreased due to reduced electric production maintenance
expenses of $2.7 million, a $1.7 million reduction of an accrual for estimated
property tax expense, and a $0.6 million decrease in employee and administrative
expenses. These decreases in operating expenses were partially offset by an
increase in insurance expense of $1.0 million, MISO administrative fees of $0.9
million in the current quarter and the impact of a $1.8 million adjustment to a
reserve for employee insurance in the 2003 period.
Operating income for the first nine months of 2004 was $236.2 million, an
increase of $30.0 million from the same period in 2003. The increase was
primarily due to increased net revenue mentioned above and an overall reduction
in operating expenses of $8.2 million. Contributing to current period expense
savings was a reduction of an accrual for prior year estimated property taxes of
$14.9 million and a reduction in the current year accrual of $4.5 million.
Operation and maintenance expenses increased $8.9 million due mainly to an
adjustment to an insurance reserve of $3.8 million recorded in 2003, 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, MISO administrative expenses of
$3.0 million recognized this year, higher outside services expense of $1.8
million and higher employee and administrative expenses of $1.4 million. These
increases in operation and maintenance expenses were partially offset by a $3.2
million reversal of claims reserves upon settlement in the second quarter of
2004, lower electric production maintenance expense of $2.4 million, and $1.5
million in property insurance reimbursements.
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
NORTHERN INDIANA PUBLIC SERVICE COMPANY
OTHER OPERATIONS
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
( in millions) 2004 2003 2004 2003
- -------------- ---- ---- ---- ----
Net Revenues $ - $ - $ - $ -
-------- --------- -------- ---------
Total Operating Expenses 0.2 - 0.7 -
-------- --------- -------- ---------
Operating Loss $ (0.2) $ - $ (0.7) $ -
-------- --------- -------- ---------
The Other Operations segment includes the results of NRC, a wholly-owned
subsidiary of Northern Indiana, whose sole activity is to purchase accounts
receivable from Northern Indiana and sell these accounts to a commercial paper
conduit, within the limits of the agreement between NRC and the conduit. NRC
commenced operations on December 30, 2003.
27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
NORTHERN INDIANA PUBLIC SERVICE COMPANY
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
Northern Indiana's principal executive officer and its principal financial
officer, after evaluating the effectiveness of Northern Indiana'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, Northern Indiana's disclosure controls and procedures were
adequate and effective to ensure that material information relating to Northern
Indiana and its consolidated subsidiaries would be made known to them by others
within those entities.
Changes in Internal Controls
There was no change in Northern Indiana'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, Northern Indiana's
internal control over financial reporting.
28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
NORTHERN INDIANA PUBLIC SERVICE COMPANY
ENVIRONMENTAL PROTECTION AGENCY NOTICE OF VIOLATION
On September 29, 2004, the United States Environmental Protection Agency, (EPA)
issued a Notice of Violation (NOV) to Northern Indiana Public Service Company
(Northern Indiana) for alleged violations of the Clean Air Act and the Indiana
State Implementation Plan. The NOV alleges that modifications were made to
certain boiler units at three of Northern Indiana's power plants without
obtaining appropriate air permits for the modifications. Northern Indiana has
met with the EPA to discuss the violations alleged in the NOV.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(31.1) Certification of Mark T. Maassel, Principal Executive Officer, pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
(31.2) Certification of William M. O'Malley, Principal Financial Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(32.1) Certification of Mark T. Maassel, Principal Executive Officer, pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(32.2) Certification of William M. O'Malley, Principal Financial Officer,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
29
SIGNATURE
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.
Northern Indiana Public Service Company
---------------------------------------------------
(Registrant)
Date: November 2, 2004 By: /s/ Jeffrey W. Grossman
---------------------------------------------------
Jeffrey W. Grossman
Vice President
(Duly Authorized Officer)
30