10-Q 1 w52219e10-q.txt NORTHERN INDIANA FORM 10-Q ENDING JUNE 30, 2001 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 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 I-4125 NORTHERN INDIANA PUBLIC SERVICE COMPANY --------------------------------------- (Exact name of registrant as specified in its charter) Indiana 35-0552990 ------- ---------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 801 East 86th Avenue, Merrillville, IN 46410 -------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (877) 647-5990 -------------- Securities registered pursuant to Section 12(b) of the Act:

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, and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. As of August 1, 2001, 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. Documents Incorporated by Reference None 2 NORTHERN INDIANA PUBLIC SERVICE COMPANY FORM 10-Q QUARTERLY REPORT FOR THE QUARTER ENDED JUNE 30, 2001 TABLE OF CONTENTS

2 3 PART I ITEM 1. FINANCIAL STATEMENTS

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 3 4 ITEM 1. FINANCIAL STATEMENTS (continued)

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 4 5 ITEM 1. FINANCIAL STATEMENTS (continued)

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 5 6 ITEM 1. FINANCIAL STATEMENTS (continued)

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 6 7 ITEM 1. FINANCIAL STATEMENTS (continued)

7 8 ITEM 1. FINANCIAL STATEMENTS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Accounting Presentation The accompanying unaudited consolidated financial statements for Northern Indiana Public Service Company (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 generally accepted accounting principles. 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, 2000. 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 2000 financial statements to conform to the 2001 presentation. 2. Restructuring Activities In the fourth quarter of 2000, NiSource Inc. (NiSource), Northern Indiana's parent, implemented a plan to restructure its operations as a result of the acquisition of Columbia Energy Group (Columbia). The restructuring plan included a severance program, a transition plan to implement operational efficiency throughout NiSource's operations and a voluntary early retirement program. As a result of the restructuring plan, it is estimated that approximately 37 management, professional, administrative and technical positions have been or will be eliminated at Northern Indiana. As of June 30, 2001, 26 employees had been terminated as a result of the restructuring plan. In 2000, Northern Indiana recorded pre-tax charges of $2.5 million in operating expense representing severance and related benefits costs. This charge included $1.3 million of estimated termination benefits. At June 30, 2001, the consolidated balance sheets reflected a liability of $0.6 million related to the restructuring plan. 3. Accounting Change Effective January 1, 2001, Northern Indiana adopted the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", as subsequently amended by SFAS No. 137 and SFAS No. 138 (collectively referred to as SFAS No. 133). These statements establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and resulting designation. The adoption of this statement on January 1, 2001, resulted in an after-tax increase to other comprehensive income (OCI) of approximately $4 million. The adoption also resulted in the recognition of $16 million of assets and $12 million of liabilities on the consolidated balance sheet. During the second quarter of 2001, approximately $0.6 million of the net gains included in the cumulative effect of a change in accounting principle component of OCI were reclassified into earnings. During the six months ended June 30, 2001, approximately $3.3 million of the net gains included in the cumulative effect of a change in accounting principle component of OCI were reclassified into earnings. Further detail of the assets and liabilities recorded on the consolidated financial statements for the adoption of SFAS No. 133 is as follows:

8 9 ITEM 1. FINANCIAL STATEMENTS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY As stated above, the initial recording of the cumulative effect of this accounting change included unrealized holding gains of $4.0 million. However, the activity for the second quarter 2001 and the first half resulted in unrealized losses on qualifying derivatives of $4.0 million and $3.5 million, respectively, as reported in the Statements of Consolidated Retained Earnings. The activity for the periods included:

Northern Indiana's senior management takes an active role in the risk management process and has developed policies and procedures that require specific administrative and business functions to assist in the identification, assessment and control of various risks. In recognition of the increasingly varied and complex nature of the energy business, Northern Indiana's risk management policies and procedures continue to evolve and are subject to ongoing review and modification. Following is additional information regarding the impact of SFAS No. 133 by segment. Gas Distribution Northern Indiana offers a Price Protection Service as an alternative to the standard gas cost recovery mechanism. This service provides Northern Indiana customers with the option to either lock in their gas cost or place a cap on the total cost that could be charged for any future month specified. In order to hedge the anticipated physical future purchases associated with these obligations, Northern Indiana purchases NYMEX futures and options contracts that correspond to a fixed or capped price and the associated delivery month. The NYMEX futures and options contracts satisfy all definitions of a derivative and they qualify and are designated as a cash flow hedge. Northern Indiana has no net gain or loss recognized in earnings due to ineffectiveness or time value for this program in the reporting period and none of the components of the derivative instruments' value are excluded in its assessment of hedge effectiveness. It is anticipated that during the next 12 months, expiration of futures and options contracts will result in income recognition amounts currently classified in OCI of approximately $5.7 million, which will be included in net income. Northern Indiana has futures and options contracts designated as cash flow hedges through June 2002. At this time Northern Indiana expects to continue its cash flow hedges due to the probability that the forecasted transaction will occur. Northern Indiana is also engaged in writing options that potentially obligate it to purchase or sell gas at the holder's discretion at some future market-based price. These written options are derivative instruments, must be marked to fair value and do not meet the requirement for hedge accounting treatment. Northern Indiana also uses NYMEX derivative contracts to minimize its gas costs. These contracts do not qualify for hedge accounting and must be marked to fair value. Because these derivatives are used within the framework of its gas cost incentive mechanism, Northern Indiana may ultimately share in a portion of the gains or losses on these options with the ratepayers. Regulatory assets or liabilities are recorded to offset the change in the fair value of these derivatives until there is certainty as to the level of sharing, if any. 9 10 ITEM 1. FINANCIAL STATEMENTS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY Electric The adoption and application of SFAS 133 had no impact on this segment. Merchant The adoption and application of SFAS 133 had no impact on this segment. 4. Business Segment Information Effective for the second quarter of 2001, Northern Indiana realigned a portion of its operations and reclassified previously reported operating segment information to conform to the realigned operating structure. The electric wheeling, bulk power and power trading operations were moved from the Electric Operations segment to a new Merchant Operations segment. Northern Indiana's operations are divided into three primary business segments. The Gas Distribution 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. The Merchant Operations segment provides energy-related services including electric wheeling, bulk power and power trading. The following tables provide information about business segments. Adjustments have been made to the segment information to arrive at information included in the results of operations and financial position. Northern Indiana uses operating income as its primary measurement for each of the reported segments and makes decisions on finance, dividends and taxes at the corporate level on a consolidated basis. Operating income is derived from revenues and expenses directly associated with each segment. The adjustments represent the revenues and net pre-tax operating income of Northern Indiana's electric trading business, which are reflected in the Merchant Operations segment but are reported as a component of Other Income (Deductions) in the Statements of Consolidated Income.

10 11 ITEM 1. FINANCIAL STATEMENTS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY Other Income (Deductions) in the Statement of Consolidated Income were comprised of the following items:

5. Recently Issued Accounting Pronouncements On July 20, 2001, FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." The key concepts from the two interrelated Statements include mandatory use of the purchase method in accounting for business combinations, discontinuance of goodwill amortization, a revised framework for testing for goodwill impairment at a "reporting unit" level, and new criteria for the identification and potential amortization of other intangible assets. Other changes to existing accounting standards involve the amount of goodwill to be used in determining the gain or loss on the disposal of assets and a requirement to test goodwill for impairment at least annually under the revised framework. Northern Indiana does not expect the adoption of the Statements to have a material impact on its results of operations. 11 12 ITEM 1. FINANCIAL STATEMENTS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY In July 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." The standard requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The standard is effective for fiscal years beginning after June 15, 2002, with earlier application encouraged. Northern Indiana is currently evaluating the impact that the Statement will have on its results of operations. 12 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NORTHERN INDIANA PUBLIC SERVICE COMPANY CONSOLIDATED RESULTS 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, proposed dispositions, 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, increased competition in deregulated energy markets, weather, fluctuations in supply and demand for energy commodities, growth opportunities for Northern Indiana's regulated businesses, 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 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. SECOND QUARTER AND SIX MONTH RESULTS Net Income Northern Indiana reported net income of $37.4 million for the three months ended June 30, 2001, compared to $43.0 million in the 2000 period. The decrease is attributed to weather 18% warmer than the previous year. For the six months ended June 30, 2001, Northern Indiana reported net income of $125.2 million, a $9.4 million increase from the 2000 period. The increase is attributed to weather 8% colder than the previous year. Net Revenues Total consolidated net revenue (operating revenues less cost of sales) for the three months ended June 30, 2001, was $234.7 million, a $2.4 million decrease over the same period last year. Decreased gas sales to residential and commercial customers due to warmer weather contributed to the decrease. Total consolidated net revenue for the six months ended June 30, 2001, was $548.5 million, a $21.4 million increase over the same period in 2000. Increased gas sales to residential and commercial customers due to colder weather and increased net revenues in merchant operations due to trading activities primarily contributed to the increase. Expenses Operating expenses for the second quarter of 2001 were $158.3 million, a increase of $5.3 million over the same period last year. Operation and maintenance expenses decreased $3.6 million in connection with reduced outside services fees and lower payroll and benefits costs. Depreciation and amortization increased $2.8 million due to plant additions and taxes other than income increased $6.1 million principally due to an adjustment of property tax accruals in 2000. For the six months ended June 30, 2001, operating expenses were $314.6 million, an increase of $3.6 million over the same period last year. Operation and maintenance expenses decreased $11.6 million primarily resulting from a first quarter 2001 refund received on liability insurance premiums, reduced outside services fees and lower payroll and benefits costs. Depreciation and amortization increased $5.4 million due to plant additions and taxes other than income increased $9.8 million principally due to an adjustment of property tax accruals in 2000 and higher gross receipts taxes due to higher gross revenues. Utility Income Taxes Utility income tax expense for the second quarter of 2001 was $19.6 million, compared to $23.6 million in 2000, due to lower pre-tax income in the current period. Utility income tax expense for the first six months of 2001 was $69.7, compared to $64.2 million in 2000, due to higher pre-tax income. 13 14 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 second quarter and first six months ended June 30, 2001 were relatively unchanged from prior year periods. Interest Interest expense was $19.7 million for the second quarter of 2001, compared to $18.8 million in 2000, primarily due to increased short-term debt outstanding, partially offset by lower long-term debt. Interest expense for the first six months of 2001 was $41.1 million, a $3.2 million increase from the 2000 period primarily due to increased short-term debt outstanding, partially offset by lower long-term debt. LIQUIDITY AND CAPITAL RESOURCES Generally, cash flow from operations has provided sufficient liquidity to meet current operating requirements. A significant portion of Northern Indiana's operations, most notably in the gas and electric distribution businesses, are 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. In the summer months, cash receipts for electric sales normally exceed requirements. During other periods of the year, cash on hand, together with 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 first six months of 2001 was $278.5 million, and increase of $49.6 million from the same period in 2000. This increase was primarily due to timing differences associated with gas cost recovery, gas in storage and other working capital items. Northern Indiana satisfies its liquidity requirements primarily through internally generated funds and through intercompany borrowings from NiSource Finance Corp. (NFC), NiSource's financing subisidiary, which in turn borrows under a $2.5 billion revolving credit facility (Credit Facility) that was entered into by NFC with a syndicate of banks during the first quarter of 2001. The Credit Facility will be drawn on to refinance and consolidate essentially all of the existing short-term borrowings of NiSource's subsidiaries, including Northern Indiana, as they come due. This new facility is guaranteed by NiSource. As of June 30, 2001, Northern Indiana had $343.2 million intercompany short-term borrowings outstanding with NFC at a weighted average interest rate of 4.27%. MARKET RISK SENSITIVE INSTRUMENTS AND POSITIONS Risk is an inherent part of Northern Indiana's energy businesses and activities. The extent to which Northern Indiana manages each of the various types of risk involved in its businesses is critical to its profitability. Northern Indiana seeks to identify, assess, monitor and manage, in accordance with defined policies and procedures, the following principal risks involved in its energy businesses: commodity market risk, interest rate risk and credit risk. Risk management at Northern Indiana is a multi-faceted process with independent oversight that requires constant communication, judgment and knowledge of specialized products and markets. Northern Indiana's senior management takes an active role in the risk management process and has developed policies and procedures that require specific administrative and business functions to assist in the identification, assessment and control of various risks. In recognition of the increasingly varied and complex nature of the energy business, Northern Indiana's risk management policies and procedures are evolving and subject to ongoing review and modification. The fair market value of Northern Indiana's price risk management assets and liabilities were $110.2 million and $124.3 million at June 30, 2001, respectively, and $32.1 million and $38.7 million at December 31, 2000, respectively. The increase between these two periods was due to increased trading activities. Northern Indiana is exposed, through its various business activities, to trading risks and non-trading risks. The non-trading risks to which Northern Indiana is exposed include interest rate risk and commodity price risk. Northern Indiana's risk management policy permits the use of certain financial instruments to manage its market risk, 14 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY including futures, forwards, options and swaps. Risk management at Northern Indiana is the process by which the organization ensures that the risks to which it is exposed are the risks to which it desires to be exposed to achieve its primary business objectives. Northern Indiana employs various analytic techniques to measure and monitor its market risks, including value-at-risk (VaR) and instrument sensitivity to market factors. VaR represents the potential loss or gain for an instrument or portfolio from adverse changes in market factors, for a specified time period and at a specified confidence level. Non-Trading Risk Northern Indiana is exposed to interest rate risk as a result of changes in interest rates on borrowings under NFC Credit Facility. Interest rates are indexed to short-term market interest rates. At June 30, 2001, intercompany borrowings outstanding with NFC totaled $343.2 million. Based upon average intercompany borrowings with NFC, and outstanding commercial paper and uncommitted lines of credit during 2001, an increase in short-term interest rates of 100 basis points (1%) would have increased interest expense by $2.9 million for the three months ending June 30, 2001 and $6.4 million for the six months ending June 30, 2001. Trading Risk Northern Indiana employs a VaR model to assess the market risk of its energy trading portfolios. Market risk refers to the risk that a change in the level of one or more market prices, rates, indices, volatilities, correlations or other market factors, such as liquidity, will result in losses for a specified position or portfolio. Northern Indiana estimates the one-day VaR across all trading groups that utilize derivatives using either Monte Carlo simulation or variance/covariance at a 95% confidence level. Based on the results of the VaR analysis, the daily market exposure for power trading on an average, high and low basis was $1.7 million, $2.6 million and $1.0 million, respectively, at June 30, 2001. Accounting Change Effective January 1, 2001, Northern Indiana adopted the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as subsequently amended by SFAS No. 137 and SFAS No. 138 (collectively referred to as SFAS No. 133). These statements establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and resulting designation. The adoption of this statement on January 1, 2001, resulted in an after-tax increase to other comprehensive income (OCI) of approximately $4 million. The adoption also resulted in the recognition of $16 million of assets and $12 million of liabilities on the consolidated balance sheet. During the second quarter of 2001 and the first six months, approximately $0.6 million and $3.3 million, respectively, of the net gains included in the cumulative effect of a change in accounting principle component of OCI were reclassified into earnings. Northern Indiana's senior management takes an active role in the risk management process and has developed policies and procedures that require specific administrative and business functions to assist in the identification, assessment and control of various risks. In recognition of the increasingly varied and complex nature of the energy business, Northern Indiana's risk management policies and procedures continue to evolve and are subject to ongoing review and modification. See Note 3, "Accounting Change" for additional information. OTHER INFORMATION Presentation of Segment Information Effective for the second quarter of 2001, Northern Indiana realigned a portion of its operations and reclassified previously reported operating segment information to conform to the realigned operating structure. The electric wheeling, bulk power and power trading operations were moved from the Electric Operations segment to a new Merchant Operations segment. Prior periods have been restated to reflect these changes. 15 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY Competition The regulatory environment applicable to Northern Indiana continues to undergo fundamental changes. These changes have previously had, and will continue to have, an impact on Northern Indiana's operations, structure and profitability. At the same time, competition within the energy industry will create opportunities to compete for new customers and revenues. Management has taken steps to become more competitive and profitable in this changing environment. These initiatives include providing its customers with increased choice for new products and services. 16 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY GAS DISTRIBUTION OPERATIONS

17 18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY GAS DISTRIBUTION OPERATIONS Northern Indiana's natural gas distribution operations (Gas Distribution) serves over 680,000 customers in the northern part of Indiana. Regulatory Matters At the Federal level, gas industry deregulation began in the mid-1980s when the Federal Energy Regulatory Commission (FERC) required interstate pipelines to provide nondiscriminatory transportation services pursuant to unbundled rates. This regulatory change permitted large industrial and commercial customers to purchase their gas supplies either from a local distribution company (LDC) or directly from competing producers and marketers, which would then use the LDC's facilities to transport the gas. More recently, the focus of deregulation in the gas industry has shifted to retail customers at the state level. Northern Indiana pursues initiatives that give retail customers the opportunity to purchase natural gas directly from marketers and to use Gas Distribution's facilities for transportation services. Once fully implemented, these programs would reduce Gas Distribution's commodity sales function and provide all customer classes with the opportunity to obtain gas supplies from alternative merchants. As these programs expand to all customers, regulations will have to be implemented to provide for the recovery of transition capacity costs and other transition costs incurred by a utility serving as the supplier of last resort if the marketing company cannot supply the gas. Transition capacity costs are created as customers enroll in these programs and purchase their gas from other suppliers, leaving Gas Distribution with pipeline capacity it has contracted for, but no longer needs. Gas Distribution is currently recovering, or has the opportunity to recover, the costs resulting from the unbundling of its services and believes that most of such future costs and costs resulting from being the supplier of last resort will be mitigated or recovered. Market Conditions Weather in Northern Indiana's market area for the second quarter of 2001 was 25% warmer than normal and 7% warmer than normal for the six month period. Throughput Total volumes sold and transported of 45.2 million dekatherms (MDth) for the second quarter of 2001 decreased 15.0 MDth from the same period last year primarily due to weather 18% warmer than 2000, lower transportation volumes to industrial customers and decreased off-system sales. Total volumes sold and transported of 132.2 MDth for the first six months of 2001 decreased 34.7 MDth from the same period in 2000 due to lower transportation volumes to industrial customers and decreased off-system sales. Net Revenues Net revenues for the three months ended June 30, 2001 were $43.4 million, down $2.2 million from the same period in 2000, primarily due to weather 18% warmer than the second quarter of 2000. Net revenues for the six months ended June 30, 2001 were $169.0 million, up $21.2 million from the same period in 2000, primarily due to weather 8% colder than the first six months of 2000. Operating Income (Loss) Operating loss for the second quarter of 2001 of $6.3 million increased $3.5 million from the same period in 2000, primarily due to the effect of 18% warmer weather. Depreciation and amortization increased $1.2 million due to plant additions. Taxes other than income taxes increased $0.6 million due to gross receipts taxes. These increases in expenses were partially offset by a $0.5 million decrease in operation and maintenance expenses primarily resulting from reduced outside service fees and lower labor and benefit costs. Operating income for the first six months of 2001 of $67.5 million increased $18.8 million from the same period in 2000, primarily due to the effect of 8% colder weather. Depreciation and amortization increased $2.3 million due to plant additions. Taxes other than income taxes increased $3.9 million principally due to an adjustment of a reversal of property tax accruals in 2000. These increases in expenses were partially offset by a $3.8 million decrease in operations and maintenance expenses primarily resulting from a first quarter of 2001 refund on liability insurance premiums, reduced outside service fees and lower labor and benefit costs. 18 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY ELECTRIC OPERATIONS

19 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY ELECTRIC OPERATIONS Northern Indiana generates and distributes electricity approximately 430,000 customers in 21 counties in the northern part of Indiana. Northern Indiana owns and operates four coal-fired electric generating stations with a net capability of 3,179 megawatts (mw), four gas-fired combustion turbine generating units with a net capability of 203 mw and two hydroelectric generating plants with a net capability of 10 mw. These facilities provide for a total system net capability of 3,392 mw. Northern Indiana is interconnected with five neighboring electric utilities. Market Conditions The regulatory frameworks applicable to electric operations are undergoing fundamental changes. These changes have previously had, and will continue to have, an impact on Northern Indiana's electric operations, structure and profitability. At the same time, competition within the industry will create opportunities to compete for new customers and revenues. Management has taken steps to become more competitive and profitable in this changing environment, including converting some of its generating units to allow use of lower cost, low sulfur coal and improving the transmission interconnections with neighboring electric utilities. Regulatory Matters FERC issued Order No. 888-A in 1996 that required all public utilities owning, controlling or operating transmission lines to file non-discriminatory open-access tariffs and offer wholesale electricity suppliers and marketers the same transmission service they provide themselves. On June 30, 2000, the D.C. Circuit Court of Appeals upheld FERC's open access orders in all major respects, although the U.S. Supreme Court on February 26, 2001 agreed to review the case. In 1997, FERC accepted for filing Northern Indiana's open-access transmission tariff. On December 20, 1999, FERC issued Order 2000 addressing the formation and operation of Regional Transmission Organizations (RTOs). The rule is intended to eliminate pricing inequities in the provision of wholesale transmission service. On October 16, 2000, Northern Indiana filed with the FERC indicating that it is committed to joining an RTO and on February 28, 2001 joined the Alliance RTO. The Alliance RTO expects to be fully operational by FERC's December 15, 2001 deadline. The Alliance RTO companies serve a population of 41 million within 178,800 square miles in 11 states and own 57,100 miles of transmission lines. During the course of a regularly scheduled review, referred to as a Level 1 review, the staff of the Indiana Utility Regulatory Commission (IURC) made a preliminary determination, based on unadjusted historical financial information filed by Northern Indiana, that Northern Indiana was earning returns that were in excess of its last rate order and generally established standards. Despite holding meetings with the IURC staff during 2000 to explain several adjustments that needed to be made to the filed information to make such an analysis meaningful, the staff has recommended that a formal investigation be performed. The IURC has ordered that an investigation begin. On June 18, Northern Indiana and several other parties filed their case-in-chief. Northern Indiana's testimony indicated that if rates are to be changed, they should be increased. Other parties indicated that rates should be reduced. Management is unable at this time to determine if a broader analysis, which would be performed through a formal investigation, could result in a rate adjustment that would be higher or lower than currently allowed rates. Management intends to vigorously oppose any efforts to reduce rates that may result from this investigation. Environmental Matters AIR. During 1998, the United States Environmental Protection Agency (EPA) issued a final rule, the nitrogen oxides (NOx) State Implementation Plan (SIP) call, requiring certain states, including Indiana to reduce NOx levels from several sources, including industrial and utility boilers. At a June 6, 2001 meeting, the Air Pollution Control Board of Indiana adopted as final the Indiana NOx control rule to meet the requirements of the EPA NOx SIP call. Before it will become Indiana regulation the rule must be signed by the Attorney General and Governor. Preliminary estimates of Northern Indiana's NOx control compliance costs range from $200 to $300 million. Actual compliance costs may be more than preliminary estimates due to a number of factors including: market demand/resource constraints, uncertainty of future equipment and construction costs, and the potential need for additional control technology. 20 21 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY The EPA has initiated enforcement actions against several electric utilities alleging violations of the new source review provisions of the Clean Air Act. Northern Indiana has received and is in the process of responding to information requests from the EPA on this subject. It is impossible at this time to predict the result of EPA's review of Northern Indiana's information responses. The EPA is in the process of developing a program to address regional haze. The new administration announced that the EPA would move forward with rules that mandate the states to require power plants built between 1962 and 1977 to install the "best available retrofit technology" or BART. The BART program will target for control by 2013 those pollutants that limit visibility - particulate, sulfur dioxide and/or nitrogen oxides. Until the program is developed, Northern Indiana cannot predict the cost of complying with these rules. WATER. The Great Lakes Water Quality Initiative ("GLI") program is expected to add new water quality standards for facilities that discharge into the Great Lakes watershed, including Northern Indiana's three electric generating stations located on Lake Michigan. The State of Indiana has promulgated its regulations for this water discharge permit program and has received final EPA approval. As promulgated, the regulations would provide the Indiana Department of Environmental Management (IDEM) with the authority to grant water quality criteria variances and exemptions for non-contact cooling water. However, the EPA revised the variance language and other minor provisions of IDEM's GLI rule. The EPA by and large left the non-contact cooling water exemption intact; however, a separate agreement between the EPA and IDEM on interpretation of this exemption still leaves uncertainty as to its impact. The EPA change to the variance rule has prompted litigation by the affected industrial parties and the EPA/IDEM agreement on the non-contact cooling water exemption may be subject to future litigation. Northern Indiana expects that IDEM will issue a proposed permit renewal for each of its lakeside stations. Pending the outcome of litigation and the proposed permit renewal requirements, the costs of complying with these requirements cannot be predicted at this time. Sales Electric sales for the second three months of 2001 were 3,832.2 million kilowatt-hours (kwh), a decrease of 82.1 million kwh, compared to the 2000 period, primarily reflecting decreased industrial sales due to a decline in production in the steel industry, partially offset by increased commercial sales. For the six months ended June 30, 2001, electric sales were 7,707.7 million kwh, a decrease of 254.6 million kwh compared to the 2000 period, reflecting decreased industrial sales due to decline in production in the steel industry, partially offset by increased residential and commercial sales. Net Revenues In the second quarter of 2001, electric net revenues of $183.1 million decreased by $0.3 million over the 2000 period. This reflects decreased production in the steel industry on industrial sales, partially offset by increased commercial sales. The cost of fuel for electric generation in 2001 increased $2.6 million compared to 2000. The average cost per kwh generated increased 10% from 2000 to 1.50 cents per kwh in 2001. In the first six months of 2001, electric net revenues of $364.0 million decreased $1.4 million over the 2000 period. The decrease is primarily due to lower production in the steel industry, partially offset by increase in growth on residential and commercial sales. The cost of fuel for electric generation in 2001 decreased $3.3 million compared to 2000. The average cost per kwh generated increased 7% from 2000 to 1.46 cents per kwh in 2001. Operating Income Operating income for the second quarter of 2001 was $74.7 million, a decrease of $4.5 million over the 2000 period. Depreciation and amortization increased $1.6 million primarily due to plant additions. Taxes other than income increased $5.6 million principally due to an adjustment of property tax accruals in 2000. These increases in expenses were partially offset by a $3.0 million decrease in operation and maintenance expenses primarily resulting from reduced outside service fees and lower labor and benefit costs. Operating income for the first six months of 2001 was $151.5 million, a decrease of $2.7 million over the same period in 2000. Depreciation and 21 22 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY amortization increased $3.1 million primarily due to plant additions. Taxes other than income increased $6.0 million principally due to an adjustment of property tax accruals in 2000. These increases in expenses were partially offset by a $7.8 million decrease in operation and maintenance expenses primarily resulting from a first quarter of 2001 refund on liability insurance premiums, and reduced labor and benefit costs. 22 23 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NORTHERN INDIANA PUBLIC SERVICE COMPANY MERCHANT OPERATIONS

Northern Indiana provides non-regulated electric power generation trading, wheeling and bulk sales. Revenues Total sales revenues of $251.9 million for the second quarter of 2001 increased $128.6 million over the 2000 second quarter. The increase in sales revenues primarily reflected an increase in trading activity and higher energy prices. Net revenues for the second quarter of 2001 were $14.1 million, an increase of $1.1 million over the same period last year. The improvement is due primarily to increased trading activities. Total sales revenues of $375.2 million for the first six months of 2001 increased $176.3 million over the 2000 period. The increase in sales revenues primarily reflected an increase in trading activity and higher energy prices. Net revenues for the first six months of 2001 were $26.6 million, compared to $21.5 million in the same period last year. The increase is due primarily to increased trading activities. Operating Income Merchant Operations had operating income of $12.4 million for the second quarter of 2001 compared to operating income of $11.7 million for the same period last year. The increase is primarily due to the increased net revenues discussed above. For the six months ended June 30, 2001, Merchant Operations had operating income of $24.3 million compared to operating income of $19.5 for the same period in 2000. The increase is primarily due to the increase in net revenues discussed above. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For a discussion regarding quantitative and qualitative disclosures about market risk, see page 14 of the Management's Discussion and Analysis of Financial Condition and Results of Operations under "Market Risk Sensitive Instruments and Positions." 23 24 PART II NORTHERN INDIANA PUBLIC SERVICE COMPANY ITEM 1. LEGAL PROCEEDINGS None ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On April 11, 2001, by written consent in lieu of the Annual Meeting of Shareholders, the sole shareholder of Northern Indiana elected Stephen P. Adik, Patrick J. Mulchay and Jeffrey W. Yundt to serve as directors until the 2002 Annual Meeting of Shareholders. ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K None 24 25 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: August 9, 2001 By: /s/ Jeffrey W. Grossman ----------------------------------- Jeffrey W. Grossman Vice President (Duly Authorized Officer) 25

NORTHERN INDIANA PUBLIC SERVICE CO 10-Q