ITEM 1. BUSINESS
OVERVIEW OF CONSOLIDATED BUSINESS
NIPSCO Industries, Inc. (Industries) is an energy/utility-based holding company providing electric energy, natural gas and water to the public through its six wholly-owned regulated subsidiaries (Utilities): Northern Indiana Public Service Company (Northern Indiana); Kokomo Gas and Fuel Company (Kokomo Gas); Northern Indiana Fuel and Light Company, Inc. (NIFL); Crossroads Pipeline Company (Crossroads); Indianapolis Water Company (IWC); and Harbour Water Corporation (Harbour). Industries' regulated gas and electric subsidiaries (Northern Indiana, Kokomo Gas, NIFL and Crossroads) are referred to as "Energy Utilities" and its regulated water subsidiaries (IWC and Harbour) are referred to as "Water Utilities."
Industries also provides non-regulated energy/utility-related products and services including energy marketing and trading; power generation; gas transmission, supply and storage; installation, repair and maintenance of underground pipelines; utility line locating and marking; and related products targeted at customer segments principally through the following wholly-owned subsidiaries: NIPSCO Development Company, Inc. (Development); NI Energy Services, Inc. (Services) (formerly known as NIPSCO Energy Services, Inc.); Primary Energy, Inc. (Primary); Miller Pipeline Corporation (Miller); and SM&P Utility Resources, Inc. (SM&P). NIPSCO Capital Markets, Inc. (Capital Markets) handles financing for Industries and its subsidiaries, other than Northern Indiana. These subsidiaries are referred to collectively as "Products and Services." On March 25, 1997, Industries acquired IWC Resources Corporation (IWCR), the holding company for the Water Utilities and five non-utility companies including Miller and SM&P.
On December 18, 1997, Industries and Bay State Gas Company (Bay State) signed a definitive merger agreement under which Industries will acquire all of the common stock of Bay State in a stock-for-stock transaction valued at $40 per Bay State share. The transaction is valued at approximately $540 million. Bay State shareholders will have the option of taking up to 50 percent of the total purchase price in cash. Consummation of the merger is subject to certain closing conditions, including the approval by the shareholders of Bay State as well as the Securities and Exchange Commission, the Federal Energy Regulatory Commission (FERC) and state regulatory agencies in Massachusetts, New Hampshire and Maine. The transaction is expected to be completed in late 1998.
Bay State, one of the largest natural gas utilities in New England, provides natural gas distribution service to more than 300,000 customers in Massachusetts, New Hampshire and Maine. The combined gas utilities will be one of the 10 largest natural gas distribution systems in the nation, servicing more than 1 million gas customers. In addition, Industries and Bay State anticipate entering into a joint marketing agreement early in 1998 that will expand the operations of Bay State's non-regulated energy service companies.
See "Segments of Business" in the Notes to Consolidated Financial Statements and "Selected Supplemental Information" in Item 8 regarding financial information about industry segments and classes of customers served, which note and information are incorporated by reference.
ELECTRIC, GAS AND WATER OPERATIONS
ELECTRIC OPERATIONS. Northern Indiana, Industries' largest and dominant subsidiary, is a public utility operating company incorporated in Indiana on August 2, 1912, engaged in supplying natural gas and electric energy to the public. It operates in 30 counties in the northern part of Indiana, serving an area of about 12,000 square miles with a population of approximately 2,200,000. At December 31, 1997, Northern Indiana served approximately 416,300 customers with electricity.
Northern Indiana owns and operates four coal fired electric generating stations with net capabilities of 3,179,000 kilowatts (kw), two hydroelectric generating plants with net capabilities of 10,000 kw, and four gas fired combustion turbine generating units with net capabilities of 203,000 kw, for a total system net capability of 3,392,000 kw. During the year ended December 31, 1997, Northern Indiana generated 91.8% and purchased 8.2% of its electric requirements.
Northern Indiana's 1997 electric control area peak load (the highest level of electrical utility usage in the control area) of 3,020,920 kw, which includes Northern Indiana, Wabash Valley Power Association, Inc. (WVPA) and Indiana Municipal Power Agency (IMPA) for which Northern Indiana controls interchange operations, was set on July 14, 1997. Northern Indiana's all-time electric control area peak load of 3,161,200 kw was set on July 14, 1995. Northern Indiana's 1997 internal peak load, which excludes WVPA and IMPA, was 2,758,920 kw set on July 14, 1997. Northern Indiana's all-time internal peak load of 2,888,450 kw was set on August 6, 1996.
Northern Indiana's electric system is interconnected with that of American Electric Power, ComEd, Cinergy Services, Inc., Consumers Energy and Central Illinois Public Service Company. Electric energy is purchased from, sold to, or exchanged with various other utilities and power marketers under Northern Indiana's power sales and open access transmission tariffs.
Northern Indiana provides WVPA with transmission and distribution service, operating reserve requirements and capacity deficiency service, and provides IMPA with transmission service, operating reserve requirements and capacity deficiency service, in Northern Indiana's control area. Northern Indiana also engages in sales and services under interconnection agreements with WVPA and IMPA.
WVPA provides service to 12 Rural Electric Membership Corporations (REMC's) located in Northern Indiana's control area. IMPA provides service to the municipal electric system of the city of Rensselaer located in Northern Indiana's control area.
Northern Indiana and WVPA have executed a supplemental agreement for unit peaking capacity and energy. Unit peaking capacity is the capacity used to serve peak demand from a specific peaking generation unit. Pursuant to this agreement, which runs through December 2001, WVPA purchases 90,000 kw of capacity per month.
Northern Indiana has the Town of Argos as a full requirement customer and provides network integration service to seven other municipal wholesale customers. Prior to January 31, 1998, Northern Indiana had full requirement contracts with eight municipal wholesale customers.
Northern Indiana is a member of the East Central Area Reliability Coordination Agreement (ECAR). ECAR is one of nine regional electric reliability councils established to coordinate planning and operations of member companies regionally and nationally.
Fuel Supply. The generating units of Northern Indiana are located at Bailly, Mitchell, Michigan City and Schahfer Generating Stations. Northern Indiana's 13 steam generating units have a net capability of 3,179,000 kw. Coal is the primary source of fuel for all units, except for three, which utilize natural gas. In addition, Northern Indiana's four combustion turbine generating units with a net capability of 203,000 kw are fired by gas. Fuel requirements for Northern Indiana's generation for 1997 were supplied as follows:
In 1997, Northern Indiana used approximately 8.4 million tons of coal at its generating stations. Northern Indiana has established a normal level of coal stock which should provide adequate fuel supply during the year under all conditions.
Annual coal requirements for Northern Indiana's electric generating units through 2002 are estimated to range from 8.5 million tons to 9.3 million tons, depending from year to year upon anticipated sales levels, scheduled maintenance and other variables. These requirements are being or will be met in part under long-term contracts as follows:
- -------- (a) 1.8 million tons in 1998. (b) 1.225 million tons in 1999. Plus or minus 10% per contract year. (c) Plus or minus 20% per contract year. (d) 2000-option year, can terminate December 31, 1999. (e) Tentative new contract 0.25 million in 1998. Plus or minus 10% per contract year. (f) Tentative new contract 1.5 million in 1998. Plus 20% per contract year. Option years in 2001 and 2002 can terminate December 31, 2000.
The average cost of coal consumed in 1997 was $27.42 per ton or 15.43 mills per kilowatt-hour (kwh) generated as compared to $27.50 per ton or 15.79 mills per kwh generated in 1996. Northern Indiana's forecasts indicate that its coal costs will be slightly lower over the next two years.
Coal Reserves. Included in the previous table of coal contracts is a coal mining contract with Cyprus Shoshone Coal Corporation (Cyprus) under which Cyprus is mining Northern Indiana's coal reserves in the Cyprus mine through the year 2001. The costs of the reserves are being recovered through the rate- making process as such coal reserves are used to produce electricity.
Fuel Adjustment Clause. Northern Indiana adjusts metered electric rates through a fuel adjustment clause to reflect changes in fuel costs. See "Summary of Significant Accounting Policies--Fuel Adjustment Clause" in the Notes to Consolidated Financial Statements in Item 8, which note is incorporated by reference.
GAS OPERATIONS.
Northern Indiana. At December 31, 1997, Northern Indiana served approximately 662,500 customers with gas. Northern Indiana supplies natural gas of about 1,000 British thermal units (Btu) per cubic foot. In a 24-hour period ended January 17, 1997, Northern Indiana's 1997 maximum day send-out (the maximum amount of gas delivered through Northern Indiana's distribution system to its end use customers ) was 1.6 million dekatherms (dth). Northern Indiana's total gas send-out for 1997 was 292.6 million dth, compared to 286.1 million dth in 1996.
Agreements have been negotiated with natural gas suppliers to replace former pipeline supplier contracts pursuant to the requirements of FERC Order No. 636 (See "FERC Order No. 636" in the Notes to Consolidated Financial Statements in Item 8, which note is incorporated by reference). Northern Indiana also has producer agreements which allow for the purchase of gas either from gas marketers or producers.
Northern Indiana has firm transportation agreements with pipelines, which allow Northern Indiana to move its gas through the pipelines' transmission systems. In 1997, all of the gas supplied by Northern Indiana was transported by ANR Pipeline Company (ANR), Crossroads Pipeline Company (Crossroads), Midwestern Gas Transmission Company (Midwestern), Natural Gas Pipeline Company of America (Natural), Panhandle Eastern Pipe Line Company (Panhandle), Tennessee Gas Pipeline Company (Tennessee) and Trunkline Gas Company (Trunkline). The transportation rates of Crossroads, and the transportation and storage rates of ANR, Midwestern, Natural, Panhandle, Tennessee and Trunkline to Northern Indiana, are subject to change in accordance with rate proceedings filed with the FERC.
Approximately 69% of Northern Indiana's 1997 gas supply was purchased on the spot market, generally on less than 30-day agreements. The average price per dth (including FERC Order No. 636 transition charges) in 1997 was $3.18 compared to $3.12 in 1996, and the average cost of purchased gas, after adjustment for transition charges billed to transport customers, was $3.08 per dth as compared to $3.02 per dth in 1996.
Northern Indiana has a curtailment plan (a plan which outlines service to be curtailed in the event of limited gas supply) approved by the Indiana Utility Regulatory Commission (Commission). Effective on August 11, 1981, the plan allows unrestricted gas sales by Northern Indiana. There were no firm sales curtailments in 1997 and none are expected during 1998.
Northern Indiana operates an underground gas storage field at Royal Center, Indiana, which currently has a storage capacity of 6.75 million dth. Withdrawals have been made in the 1997-1998 winter of up to 109,036 dth per day. In addition, Northern Indiana has several gas storage service agreements which make possible the withdrawal of substantial quantities of gas from other storage facilities. All of the storage agreements have limitations on the volume and timing of daily withdrawals. These contracts provide in the aggregate for approximately 26.9 million dth of annual stored volume and allow for approximately 540,000 dth of maximum daily withdrawal.
Northern Indiana has a liquefied natural gas plant in LaPorte County which is designed for peak shaving (the process of supplementing gas supply during periods of high demand) and has the following capacities: maximum storage of 4 million dth; maximum liquefaction rate (gas to liquid) of 20,000 dth per day; maximum vaporization rate (output to distribution system) of 300,000 dth per day.
Kokomo Gas. Kokomo Gas is a public utility operating company incorporated in Indiana in 1917, engaged in supplying natural gas to the public. It operates in the city of Kokomo, Indiana and the surrounding area in six counties having a population of approximately 100,000, and served approximately 33,500 customers at December 31, 1997. The Kokomo Gas service territory is contiguous to Northern Indiana's gas service territory.
Kokomo Gas has a liquified natural gas plant in Howard County with the following capacities: maximum storage of 400,000 mcf; maximum liquefaction rate (gas to liquid) of 2,850 mcf per day; maximum vaporization rate (output to distribution system) of 30,000 mcf per day. Kokomo Gas also has a gas holder with a storage capacity of 12,000 mcf.
Kokomo Gas' total gas send-out for 1997 was 8.7 million dth, compared to 8.9 million dth for 1996. Total transportation volumes for industrial customers in 1997 were 3.6 million dth, compared to 3.4 million dth in 1996. Kokomo Gas purchased gas under term agreements from NI-TEX and NESI Energy Marketing L.L.C., (NEM), both subsidiaries of Services, to satisfy all of its system requirements in 1997.
NIFL. NIFL is a public utility operating company incorporated in Indiana in 1906, engaged in supplying natural gas to the public. Headquartered in Auburn, Indiana, it operates in five counties in the northeast corner of the state having a population of approximately 66,700, and served approximately 33,400 customers at December 31, 1997. The NIFL service territory is contiguous to Northern Indiana's gas service territory.
NIFL's total gas send-out for 1997 was 10.8 million dth, compared to 10.9 million dth for 1996. Total transportation volumes for industrial customers in 1997 were 5.6 million dth, compared to 4.9 million dth in 1996. NIFL purchased gas on the spot market from a number of suppliers and also under term agreements from NI-TEX and NEM to satisfy all of its system requirements in 1997.
Crossroads. Crossroads is a natural gas pipeline company which was approved by FERC to operate as an interstate pipeline in May 1995. Crossroads owns and operates a 201-mile, 20-inch pipeline that extends from Schererville, Indiana, in the northwestern corner of the state, where it takes delivery from the interstate pipeline facilities of Natural Gas Pipeline Company of America, to Cygnet, Ohio, located in northwestern Ohio, where it interconnects with facilities owned by Columbia Gas Transmission Corporation. In December 1997, Crossroads announced plans to construct a 20-mile extension of its pipeline facility in Ohio to a point of interconnection with a unit of Consolidated Natural Gas Company.
Gas Cost Adjustment Clause. Metered gas rates are adjusted to reflect the cost of purchased gas, contracted gas storage and storage transportation charges. See "Summary of Significant Accounting Policies--Gas Cost Adjustment Clause" in the Notes to Consolidated Financial Statements in Item 8, which note is incorporated by reference.
WATER OPERATIONS. The Water Utilities supply water for residential, commercial and industrial uses and for fire protection service in Indianapolis, Indiana and surrounding areas. The territory served by the Water Utilities covers an area of approximately 309 square miles in six counties of central Indiana and the Water Utilities served approximately 246,600 customers at December 31, 1997.
The combined maximum daily capacity of the Water Utilities' treatment plants, together with the maximum daily capacity of the three primary well fields, is 235 million gallons per day (MGD). During 1997, the average daily consumption was 127 MGD and the maximum daily consumption was 201 MGD.
The principal sources of IWC's present water supply are the White River, which flows through Indianapolis from north to south and is supplemented by Morse Reservoir on a tributary, Cicero Creek; Fall Creek, which flows through Indianapolis from the northeast and is supplemented by Geist Reservoir; the city of Indianapolis' Eagle Creek Reservoir, located on Eagle Creek in northwest Marion County, from which water is purchased under a long-term contract; Geist Well Field, a ground water supply located downstream of Geist Reservoir; and South Well Field located in southern Marion and northern Johnson Counties.
The three large surface reservoirs are essential to providing an adequate supply during dry periods. Two are used to supplement low stream flows in the White River and Fall Creek, respectively, and water is drawn directly from the third. The reservoirs are designed to maintain an adequate water supply in the event of a repetition of the worst two-year drought ever recorded in the Indianapolis area.
The theoretical dependable supply from the three combined reservoirs represents approximately 65% of the total dependable supply available to IWC with the balance coming from natural stream flow and wells. Wells constitute the source of supply for Harbour.
The Water Utilities have aquifer protection plans for the Geist and South Well Fields. Once fully developed, the Geist Well Field will produce 12 to 15 MGD while the South Well Field will produce 40 to 50 MGD. The protection plans will guide the Water Utilities' development of these newest major sources of supply, and result in land use plans to protect the aquifer systems from potential contamination sources.
PRODUCTS AND SERVICES OF OTHER SUBSIDIARIES
CAPITAL MARKETS. Capital Markets serves as the funding agent for ventures of Industries and its subsidiaries other than Northern Indiana. As of December 31, 1997, Capital Markets had $17.0 million in commercial paper outstanding, having a weighted average interest rate of 7.00%. Capital Markets has a $150 million revolving credit agreement, which provides short-term financing flexibility to Industries and also serves as the back up instrument for the commercial paper program. As of December 31, 1997, there were no borrowings outstanding under this agreement. Capital Markets also has $130 million of money market lines of credit. As of December 31, 1997, $20.1 million of borrowings were outstanding under these lines of credit.
The obligations of Capital Markets are subject to a Support Agreement between Industries and Capital Markets, under which Industries has committed to make payments of interest and principal on Capital Markets' obligations in the event of a failure to pay by Capital Markets. Restrictions in the Support Agreement prohibit recourse on the part of Capital Markets' creditors against the stock and assets of Northern Indiana. Under the terms of the Support Agreement, in addition to the cash flow of cash dividends paid to Industries by any of its consolidated subsidiaries, the assets of Industries, other than the stock and assets of Northern Indiana, are available as recourse for the benefit of Capital Markets creditors. The carrying value of the assets of Industries, other than the assets of Northern Indiana, reflected in the consolidated financial statements of Industries, was approximately $1.3 billion at December 31, 1997.
IWCR. IWCR is a holding company for the Water Utilities and five other wholly- owned subsidiaries. The five wholly-owned subsidiaries are SM&P, Miller, Waterway Holdings, Inc. (WWH), Utility Data Corporation (UDC) and IWC Services, Inc. (IWCS). Additionally, IWCR is a majority partner in the White River Environmental Partnership (WREP) through IWCS.
SM&P performs underground utility locating and marking services in Indiana and 10 other states. SM&P performed approximately 4.2 million locates and had operating income of $2.6 million for the period of April 1997 through December 1997, the period following the acquisition of IWCR. Miller installs, repairs and maintains underground pipelines used in gas, water and sewer transmission and distribution systems. Operating income for Miller for April 1997 through December 1997 was $6.2 million.
DEVELOPMENT. Development makes various investments, including real estate and venture capital investments. Development is an 85% shareholder in Elm Energy and Recycling (UK) Ltd. (Elm Energy), which owns and operates a tire-fueled electric generating plant in Wolverhampton, England. See "Resolution of Elm Energy and Recycling (UK) Ltd. Litigation" in the Notes to Consolidated Financial Statements in Item 8, which note is incorporated by reference.
In 1997, Development invested in multiple-family residential housing developments in South Bend. Development has additional projects within the Utilities' service territories and is considering additional projects within those territories. At December 31, 1997, Development has $30.1 million of investments, at equity, relating to affordable housing projects. These projects are part of the continued commitment by Industries to provide high quality, energy efficient, affordable housing to the residents of a variety of geographic and economic regions served by the Utilities.
SERVICES. Services coordinates the energy-related diversification efforts of Industries. Services has nine active wholly-owned subsidiaries, interests in three limited liability companies and a limited partnership.
NESI Energy Marketing L.L.C. (NEM). NEM, a limited liability company, provides natural gas sales and management services to industrial and commercial customers and is also actively
engaged in energy trading activities. During 1997, NEM had sales of approximately 135.8 million dth.
NESI Power Marketing, Inc. (NPMI). NPMI, a wholly-owned subsidiary of Services, is involved in wholesale power trading activities. During 1997, NPMI had sales of approximately 7.5 million megawatt hours (mwh).
NESI Integrated Energy Resources, Inc. (NIERI). NIERI, a wholly-owned subsidiary of Services, participates in residential and small commercial gas unbundling pilot programs. During 1997, NIERI participated in pilot programs in Grand Rapids, Michigan, East Ohio and South Bend, Indiana.
NIPSCO Energy Services Canada Limited (NESCL). NESCL, a wholly-owned subsidiary of Services, is a Canadian subsidiary formed to hold NESI Canadian investments and companies. In January 1998, NESCL sold its 50% interest in FuelMaker Corporation, a manufacturer of vehicle fueling equipment. NESCL owns Southlake Energy, Inc., (SLAKE) a Canadian oil and gas exploration and production company. As of December 31, 1997, SLAKE had invested $26.7 million in Canadian exploration and development projects with estimated proved reserves of 1.3 million barrels of oil and 26.9 Bcf of natural gas.
NIPSCO Fuel Company, Inc. (Fuel). Fuel, a wholly-owned subsidiary of Services, primarily invests in oil and gas exploration and production properties with activities concentrated in the mid-continent region of the United States. In January 1997, Fuel sold its partnership interest in certain offshore properties to SOCO Offshore, Inc. Effective January 1, 1997, Fuel and four other investors formed Bristol. Fuel contributed properties with a carrying amount of $21.7 million and holds a 64 percent interest in Bristol.
NI-TEX, Inc. (NI-TEX) NI-TEX, a wholly-owned subsidiary of Services, is an intrastate natural gas transmission and supply company in Texas providing gas sales, transportation and storage services. NI-TEX provides gas supply to Northern Indiana, Kokomo Gas and NIFL under spot and/or term contracts. NI- TEX, through joint ventures with industry partners, also owns natural gas transmission and storage facilities located in Texas. Its Laredo-Nueces pipeline affiliate transported 15.2 Bcf of natural gas in 1997. Its Mid-Tex Gas Storage Company affiliate operates a salt dome gas storage facility with an operating capacity of 5.7 Bcf.
NESI Energy Services Company (NESCO). NESCO, a wholly-owned subsidiary of Services, provides energy solutions which enhance competitiveness through cost reductions, modernizing infrastructure and improving cost accountabilities.
Parkway Engineering and Distributing Company, Inc. (PEDCO). PEDCO, a wholly- owned subsidiary of Services, markets energy efficient lighting and lighting solutions.
Green Fuels, Inc. (Greenfuels). Greenfuels, a wholly-owned subsidiary of Services, sells compressed natural gas (CNG) and liquefied natural gas (LNG) for vehicular fuel. Greenfuels provides conversion kits and assists in or performs the conversion of gasoline driven vehicles to CNG in order to expand the market base.
Triumph Natural Gas, Inc. (Triumph). Triumph, a majority-owned subsidiary of Services, is in the final stages of liquidation. Services, as well as certain affiliates and officers, were defendants in a lawsuit brought by certain shareholders and former members of the Board of Directors of Triumph. An out of court settlement was reached in the fourth quarter of 1997.
PRIMARY. Primary arranges energy-related projects for large energy-intensive facilities and has entered into certain commitments in connection with these projects. Primary offers expertise to large energy customers in managing the engineering, construction, operation and maintenance of these energy-related projects. Primary is the parent of the following subsidiaries: Harbor Coal
Company (Harbor Coal); North Lake Energy Corporation (North Lake); Lakeside Energy Corporation (LEC); Portside Energy Corporation (Portside); and Cokenergy, Inc. (CE).
Harbor Coal has invested in a partnership to finance, construct, own and operate a $65 million pulverized coal injection facility which began commercial operation in August 1993. The facility receives raw coal, pulverizes it and delivers it to Inland Steel Company (Inland Steel) for use in the operation of its blast furnaces. Harbor Coal is a 50% partner in the project with an Inland Steel affiliate. Industries has guaranteed the payment and performance of the partnership's obligations under a sale and leaseback of a 50% undivided interest in the facility.
North Lake has entered into a lease for the use of a 75-megawatt energy facility located at Inland Steel. The facility uses steam generated by Inland Steel to produce electricity which is delivered to Inland Steel. The facility began commercial operation in May 1996. Industries has guaranteed North Lake's obligations relative to the lease and certain obligations to Inland Steel relative to the project.
LEC has entered into a lease for the use of a 161-megawatt energy facility located at USS Gary Works. The facility processes high-pressure steam into electricity and low-pressure steam for delivery to USX Corporation-US Steel Group. A fifteen-year tolling agreement with US Steel commenced on April 16, 1997 when the facility was placed in commercial operation. Capital Markets guarantees LEC's security deposit obligations relative to the lease and certain limited LEC obligations to the lessor.
Portside has entered into an agreement with National Steel Corporation (National) to construct and operate a new 63-megawatt energy facility at National's Midwest Division to process natural gas into electricity, process steam and heated water to be provided to National for a fifteen-year period. Portside has entered into a lease for use of the facility. Industries has guaranteed certain Portside obligations to the lessor. Construction of the project began in June 1996 and the facility began commercial operation on September 26, 1997.
CE has entered into a fifteen-year service agreement and a related fifteen- year fuel supply agreement with Inland Steel and the Indiana Harbor Coke Company, LP (Harbor Coke). These agreements provide that CE will construct and operate a new energy facility at Inland Steel's Indiana Harbor Works to scrub flue gases and recover waste heat from the coke facility being constructed by Harbor Coke and produce process steam and electricity from the recovered heat which will be delivered to Inland Steel. CE intends to lease these facilities, once constructed, from a third party. Additionally, CE has entered into an interim agreement, which expires when the lease is established with the third party lessor, under which CE is acting as agent to design, construct and start up the facilities. Capital Markets anticipates guaranteeing certain CE obligations relative to the anticipated lease. Construction of the project began in January 1997. The facility is scheduled to be operational in June 1998.
Primary has advanced approximately $107 million and $42 million, at December 31, 1997 and December 31, 1996, respectively, to the lessors of the energy related projects discussed above.
Primary is evaluating other potential projects with Northern Indiana customers as well as with potential customers outside of Northern Indiana's service territory. Projects under consideration include those which use industrial by-product fuels and natural gas to produce electricity.
REGULATION
HOLDING COMPANY ACT. Industries is exempt from registration with the Securities and Exchange Commission (SEC) as a "registered holding company" under the Public Utility Holding Company Act of 1935, as amended (Holding Company Act). However, prior approval of the SEC is required
under the Holding Company Act if Industries proposes to acquire, directly or indirectly, any securities of other electric or gas public utility companies. There may also be limits on the extent to which Industries and its non-utility subsidiaries can enter into businesses which are not "functionally related" to the electric and gas businesses without raising questions about Industries' exempt status under the Holding Company Act. SEC guidelines established in prior decisions of the SEC require Industries to remain engaged primarily and predominately in the electric and gas businesses and to limit the size of its activities outside of such businesses relative to Industries as a whole.
Industries has no present intention of becoming a registered holding company subject to regulation by the SEC under the Holding Company Act. Industries will file an application with the SEC to retain its exempt status under the Holding Company Act upon the consummation of the merger with Bay State, assuming the acquisition of Bay State is approved by the shareholders of Bay State, the SEC, the FERC and state regulatory agencies in Massachusetts, New Hampshire and Maine.
INDIANA UTILITY REGULATORY COMMISSION. Industries is not subject to regulation by the Commission as long as it is not a public utility. Industries and its non-utility subsidiaries are subject to certain reporting and information access requirements under Indiana law. Furthermore, certain contracts between Industries or its non-utility subsidiaries and the Energy Utilties must be filed with the Commission.
The Utilities are subject to regulation by the Commission as to rates, service, accounts, issuance of securities and in other respects. The Utilities are also subject to limited regulation by local public authorities.
FEDERAL ENERGY REGULATORY COMMISSION. Industries is not regulated by the FERC, but any subsidiary, including the Energy Utilities, that engages in FERC jurisdictional sales or activities is subject to such regulation.
Northern Indiana's restructuring under Industries was approved by a February 29, 1988 order of the FERC. The order is conditioned upon the FERC's continuing authority to examine the books and records of Industries and its subsidiaries, upon further order of the FERC, and to make such supplemental orders, for good cause, as it may find necessary or appropriate regarding the restructuring.
In 1997, about 4% of Northern Indiana's electric revenues were derived from electric service it furnished at wholesale in interstate commerce to other utility companies, municipalities and WVPA (see "Item 1. Business-Electric Operations" regarding WVPA). Northern Indiana's wholesale rates and operations are subject to the jurisdiction of the FERC. FERC jurisdiction does not extend to the issuance of securities by Northern Indiana, which are regulated by the Commission. The FERC declared Northern Indiana, Kokomo Gas and NIFL exempt from the provisions of the Natural Gas Act.
RATE MATTERS
For information regarding the Energy Utilities' gas rates and gas transition costs, see "FERC Order No. 636" in the Notes to Consolidated Financial Statements in Item 8, which note is incorporated by reference.
Northern Indiana filed a petition for an Alternative Regulatory Plan (ARP) with the Commission on November 29, 1995. Following negotiation and settlement with major intervenors, Northern Indiana submitted a modified ARP to the Commission on May 9, 1997. In its modified
ARP, Northern Indiana proposed to implement new rates and services that would include, among other things, further unbundling of services for additional customer classes, increased customer choice for sources of natural gas supply, negotiated services and prices, an incentive gas cost mechanism and a price protection program. On October 8, 1997, the Commission issued an order approving, in all respects, the modified ARP which became effective November 1, 1997. The first pilot program was launched in January 1998 and the first gas volumes will flow under this program by April 1, 1998. Significantly, the Commission order allows NIERI, a subsidiary of Services and the natural gas marketing affiliate of Northern Indiana, to participate as a supplier in this pilot and in future expansions of supplier choice to other customers on the Northern Indiana system. ERI Services, Inc. and Enron Capital and Trade Resources Corp. filed Petitions for Rehearing of the Commission Order, and during the first quarter of 1998, the Commission denied such Petitions.
On November 14, 1997, IWC petitioned the Commission for approval of new water rates and charges. IWC seeks to increase revenues by approximately $11.9 million, representing a 15.3% increase over test year revenues. Currently, IWC is attempting to negotiate a settlement with the Office of Utility Consumer Counselor resulting in a three step phased-in rate increase. If a settlement cannot be reached, a final hearing on the case is scheduled for June 25, 1998.
COMPETITION
ELECTRIC. The electric energy generation, transmission and distribution business is in a period of fundamental change in the manner in which customers obtain, and energy suppliers provide, energy services. These changes are attributable to changes in technology, the relaxation of regulatory barriers to utilities' respective service territories and efforts to change the manner in which electric utilities are regulated. Federal law and regulations have been amended to provide for open transmission system access, and various states are considering, or have adopted, new regulatory structures to allow access by some or all customers to electric suppliers in addition to their local electric utility.
Currently, electric service territories within the State of Indiana are assigned to the existing suppliers, and boundaries of new territories outside existing municipalities are assigned to the utility having the nearest existing electric distribution lines. Only existing municipal electric utilities may expand their service areas and then only into areas that have been annexed by the municipality, subject to the approval of the Commission and certain other conditions. In municipalities where Northern Indiana renders electric service to the general public as a public utility, no other utility renders electric or gas service, except in Angola, DeMotte, Rome City, Wanatah and Waterloo. In certain municipalities where electric service is supplied by Northern Indiana, NIFL provides competing gas utility service. In localities where Northern Indiana renders gas service only, it competes with electric utilities, municipal or private, for the business for which they render alternative electric service.
Kokomo Gas and NIFL compete with other electric utilities serving customers in their respective service territories.
In both January 1997 and January 1998, legislation was introduced in the Indiana General Assembly addressing electric utility competition and deregulation. The proposed legislation was not adopted but similar legislation may be reintroduced in the future. It is not possible to predict the ultimate effect which competition, subsequent to the passage of such legislation, would have on Industries' future earnings. See "Competition" in the Management's Discussion and Analysis of Financial Condition and Results of Operations, which is incorporated by reference (see Exhibit 13).
GAS. As a result of FERC Order No. 636, Northern Indiana is also subject to competition for gas sales to industrial customers through the ability of these customers, under Northern Indiana's rate provisions, to purchase gas directly from suppliers other than Northern Indiana and have Northern Indiana transport the gas to them. During 1997, gas transportation represented 55% of Northern Indiana's total gas send-out.
Indiana law requires Commission approval before a gas customer of a utility may bypass the utility and make other arrangements for gas service. Any entity which transports gas from outside Indiana for direct sale or delivery to itself or other end-users within the state will be considered a public utility and must obtain a necessity certificate from the Commission in order to engage in such activities.
WATER. The Water Utilities conduct operations, subject to regulation by the Commission, under permit and franchise rights. Under such rights, the Water Utilities may lay, maintain and operate mains and conduits in public streets and ways throughout the area served. The rights granted to the Water Utilities are not exclusive. Competitors include various municipal water utilities, as well as privately owned water utilities, some of which purchase water from the Water Utilities. As the Indianapolis metropolitan area has expanded to include surrounding communities or previously rural areas, the Water Utilities have faced competition for new customers from town or rural water utilities.
EMPLOYEES
Industries had 5,984 employees at December 31, 1997. Of these employees, 2,940 are represented by various local unions. The March 1997 acquisition of IWCR increased employees by 2,074, including 1,110 employees at SM&P, 540 employees at Miller and 355 at the Water Utilities.
ENVIRONMENTAL MATTERS
The Utilities have an ongoing program to remain aware of laws and regulations involved with hazardous waste and other environmental matters. The Utilities intend to continue to evaluate their facilities and properties with respect to these rules and identify any sites that would require corrective action. The Utilities have recorded a reserve of approximately $20 million to cover probable corrective actions as of December 31, 1997; however, environmental regulations and remediation techniques are subject to future change. The ultimate cost could be significant, depending on the extent of corrective actions required. Based upon investigations and management's understanding of current laws and regulations, the Utilities believe that any corrective actions required, after consideration of insurance coverages and contributions from other potentially responsible parties, will not have a significant impact on the results of operations or financial position of Industries. It is not possible for Industries to predict the scope, enforceability or financial impact of other environmental regulations or standards which may be established in the future.
The Utilities are subject to regulation with regard to environmental matters by various federal, state and local authorities. The Utilities cannot forecast the effect of all such regulation upon their generation, transmission or other facilities, or their operations. The Utilities intend to comply with all applicable governmental requirements and have adopted an environmental policy that fosters the pursuit of proactive environmental programs and management.
The application of federal and state restrictions to protect the environment, including but not limited to those described below, involves or may involve review, certification or issuance of permits by various federal, state and local authorities. Such restrictions, particularly in regard to emissions into the air and water, and disposal of solid wastes, may impact the operation of the Utilities' facilities, and may also require substantial investment.
Industries' total capital expenditures from January 1, 1993, through December 31, 1997 for pollution control facilities were approximately $149 million and were financed in part by the sale of Northern Indiana's Pollution Control Notes and Bonds-Jasper County. Industries anticipates expenditures of approximately $15 million for pollution control equipment in the 1998-2002 period which includes anticipated expenditures of approximately $6 million in 1998 and $9 million in 1999. See "Environmental Matters" in the Notes to Consolidated Financial Statements in Item 8, which note is incorporated by reference.
YEAR 2000 COSTS
Industries has several major projects underway to modify portions of its systems for proper functioning in the year 2000. These include a project to evaluate Industries' proprietary software and to work with each of Industries' software vendors to assure that appropriate steps are being take to mitigate the problem in each vendor's software or, in some cases, to replace software with year 2000 compliant software; a project to identify and mitigate problems wherever they exist in Industries' systems (ranging from equipment used in Northern Indiana's generating stations to Industries' phone system that have date information within them); and an initiative to assure that each entity that electronically receives information from Industries or sends information to Industries is aware of the steps that Industries is taking and is taking appropriate steps of its own to address the problem. Consistent with its plan, Industries expects to be year 2000 compliant with some systems as early as third quarter 1998 and other systems no later than the third quarter of 1999.
Industries estimates that costs to become year 2000 compliant will be approximately $10-$15 million, including acquisition costs of new systems which will be capitalized consistent with Industries' accounting policies. Costs related to maintenance or modification of Industries' systems have been and will be expensed as incurred. Industries does not anticipate that the related costs will have a material impact on its results of operations, nor does Industries currently anticipate any disruption of its ability to deliver service as a result of the year 2000 issue.
FORWARD LOOKING STATEMENTS
This report contains forward looking statements within the meaning of the securities laws. Industries cautions that, while it believes such statements to be based on reasonable assumptions and makes such statements in good faith, there can be no assurance that the actual results will not differ materially from such assumptions or that the expectations set forth in the forward looking statements derived from such assumptions will be realized. Investors should be aware of important factors that could have a material impact on future results. These factors include, but are not limited to, weather, the federal and state regulatory environment, the economic climate, regional, commercial, industrial and residential growth in the service territories served by Industries' subsidiaries, customers' usage patterns and preferences, the speed and degree to which competition enters the utility industries, the timing and extent of changes in commodity prices, changing conditions in the capital and equity markets and other uncertainties, all of which are difficult to predict, and many of which are beyond the control of Industries.
ITEM 2.
ITEM 2. PROPERTIES.
OVERVIEW. The physical properties of the Utilities are located in the State of Indiana, except for Crossroads which owns a 202-mile interstate natural gas pipeline running from northwest Indiana to Cygnet, Ohio.
The significant properties owned by other subsidiaries of Industries are: the Southlake Complex, a 325,000 square foot office building located in Merrillville, Indiana, owned by Development; a 36-mile intrastate natural gas pipeline, located in southern Texas, half-owned by NI-TEX; interests in oil and gas exploration and production properties, owned by Fuel; a golf course and surrounding residential development in Chesterton, Indiana, owned by Lake Erie Land Company (a wholly-owned subsidiary of Development); a waste-to-energy generating plant in Wolverhampton, England, owned by Elm Energy; commercial real estate joint ventures, half-owned by KOGAF Enterprises (a wholly-owned subsidiary of Development) located in Kokomo, Indiana; interests in oil and gas producing properties in Canada owned by SLAKE; and parcels of land for development owned by WWH.
ELECTRIC. Northern Indiana owns and operates four coal fired electric generating stations with net capabilities of 3,179,000 kw, two hydroelectric generating plants with net capabilities of 10,000 kw and four gas fired combustion turbine generating units with net capabilities of 203,000 kw, for a total system net capability of 3,392,000 kw.
Northern Indiana has 292 substations with an aggregate transformer capacity of 23,030,500 kva. Its transmission system with voltages from 34,500 to 345,000 consists of 3,052 circuit miles of line. The electric distribution system extends into 21 counties and consists of 7,835 circuit miles of overhead and 1,423 cable miles of underground primary distribution lines operating at various voltages from 2,400 to 12,500 volts. Northern Indiana has distribution transformers having an aggregate capacity of 11,422,999 kva and 438,590 electric watt-hour meters.
GAS. Northern Indiana has an underground storage field at Royal Center and a liquefied natural gas plant in LaPorte County and Kokomo Gas has a liquefied natural gas plant in Howard County, all of which are described under "Item 1. Business-Gas Operations." Northern Indiana has 13,368 miles of gas mains, Kokomo Gas has 752 miles of gas mains and NIFL has 809 miles of gas mains.
WATER. The Water Utilities' properties consist of land, easements, rights (including water rights), buildings, reservoirs, canal, wells, supply lines, purification plants, pumping stations, transmission and distribution pipes, mains and conduits, meters and other facilities used for the collection, purification and storage of water, and the distribution of water to its customers. The water systems extend from well fields and raw water reservoirs on Cicero Creek and Fall Creek, north and northeast of Indianapolis, and from the intake structure in Indianapolis' Eagle Creek Reservoir, northwest of Indianapolis, to the service connections of the ultimate consumers. The Water Utilities have 27,469 fire hydrants and 3,148 miles of water mains.
CHARACTER OF OWNERSHIP. Substantially all of the properties of Northern Indiana and IWC are subject to the lien of their respective First Mortgage Indentures. The principal offices and properties of Industries and its subsidiaries are held in fee and are free from other encumbrances, subject to minor exceptions, none of which is of such a nature as to impair substantially the usefulness of such properties. Many of the offices in various communities served are occupied by subsidiaries of Industries under leases. All properties are subject to liens for taxes, assessments and undetermined charges (if any) incidental to construction, which it is Industries' practice regularly to pay, as and when due, unless contested in good faith. In general, the electric, gas and water lines and mains are located on land not owned in fee but are covered by necessary consents of various governmental authorities or by appropriate rights obtained from owners of private property. Industries does not, however, generally have specific easements from the owners of the property adjacent to public highways over, upon or under which its electric, gas and water lines and mains are located. At the time each of the principal properties was purchased a title search was made. In general, no examination of titles as to rights-of-way for electric, gas and water lines and mains was made, other than examination, in certain cases, to verify the grantors' ownership and the lien status thereof.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Industries and its subsidiaries are parties to various pending proceedings, including suits and claims against them for personal injury, death and property damage. Such proceedings and suits, and the amounts involved are routine litigation and proceedings for the kinds of businesses conducted by Industries and its subsidiaries, except as described under the captions "NESI Energy Marketing Canada Ltd. Litigation," and "Environmental Matters" in the Notes to Consolidated Financial Statements in Item 8, which notes are incorporated by reference. No other material legal proceedings against Industries or its subsidiaries are pending or, to the knowledge of Industries, contemplated by governmental authorities or other parties.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
SUPPLEMENTAL ITEM--EXECUTIVE OFFICERS OF THE REGISTRANT.
- -------- *Subsidiary of Industries. **Also a Director. (a) Industries acquired IWCR in March 1997.
The terms of office of executive officers of Industries are established by Industries' Board of Directors (Board) each year, and each officer serves until the next annual meeting of the Board and/or until his/her successor is duly elected. Throughout the past five years, each of the executive officers of Industries has been continuously in the business of Industries or its subsidiaries, except for Mr. Abcouwer .
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Industries' common shares are listed and traded on the New York, Chicago and Pacific exchanges. The table below indicates the high and low sales price of Industries' common shares, on the composite tape, during the periods indicated. On December 16, 1997, the Board of Directors authorized a two-for-one split of Industries' common stock. Shareholders received one additional common share for each common share held. The stock split was paid February 20, 1998, to shareholders of record at the close of business on January 30, 1998. The common share cash dividend paid February 20, 1998 was payable on pre-split common shares. The sales prices and common dividends reported have been restated to reflect the two-for-one stock split.
As of February 26, 1998, Industries had 37,441 common shareholders of record.
The policy of the Board has been to declare dividends on a quarterly basis payable on or about the 20th day of February, May, August and November, Industries paid quarterly common dividends of $0.21 per share during 1996 and quarterly common dividends of $0.225 per share during 1997. At its December 16, 1997 meeting, the Board increased the quarterly common dividend to $0.24 per share, payable February 20, 1998.
Holders of Industries' common shares are entitled to receive dividends when, as and if declared by the Board out of funds legally available therefor. Although the Board currently intends to consider the payment of regular quarterly cash dividends on common shares, the timing and amount of future dividends will depend on the earnings of Northern Indiana and other subsidiaries, their financial condition, cash requirements, any restrictions in financing agreements and other factors deemed relevant by the Board. During the next few years, it is expected that the great majority of earnings available for distribution of dividends will depend upon dividends paid to Industries by Northern Indiana.
The following limitations on payment of dividends and issuance of preferred stock apply to Northern Indiana:
When any bonds are outstanding under its First Mortgage Indenture, Northern Indiana may not pay cash dividends on its stock (other than preferred or preference stock) or purchase or retire common shares, except out of earned surplus or net profits computed as required under the provisions of the maintenance and renewal fund. At December 31, 1997, Northern Indiana has approximately $146.3 million of retained earnings (earned surplus) available for the payment of dividends. Future common share dividends by Northern Indiana will depend upon adequate retained earnings, adequate future earnings and the absence of adverse developments.
So long as any shares of Northern Indiana's cumulative preferred stock are outstanding, no cash dividends shall be paid on its common shares in excess of 75% of the net income available therefore for the preceding calendar year unless the aggregate of the capital applicable to stocks subordinate as to assets and dividends, would equal or exceed 25% of the sum of all obligations evidenced by bonds, notes, debentures or other securities, plus the total capital and surplus. At December 31, 1997, the sum of the capital applicable to stocks subordinate to the cumulative preferred stock plus the surplus was equal to 42% of the total capitalization including surplus.
In connection with the foregoing discussion, see "Common Share Dividend" in the Notes to Consolidated Financial Statements in Item 8, which note is incorporated by reference.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Information regarding results of operations, liquidity and capital resources, environmental matters and competition is reported in the 1997 Annual Report to Shareholders under "Management's Discussion and Analysis of Financial Condition and Results of Operations", which information is incorporated by reference (see Exhibit 13).
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding market risk is reported in the 1997 Annual Report to Shareholders under "Management's Discussion and Analysis of Financial Condition and Results of Operations--Market Risk Sensitive Instruments and Positions", which information is incorporated by reference (see Exhibit 13).
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
NIPSCO INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF INCOME
- -------- * Amounts have been restated to reflect two-for-one stock split.
The accompanying notes to consolidated financial statements are an integral part of this statement.
NIPSCO INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEET
The accompanying notes to consolidated financial statements are an integral part of this statement.
NIPSCO INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF CAPITALIZATION
The accompanying notes to consolidated financial statements are an integral part of this statement.
NIPSCO INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF LONG-TERM DEBT
The accompanying notes to consolidated financial statements are an integral part of this statement.
NIPSCO INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
- -------- * Net of effect from purchase of IWC Resources Corporation.
The accompanying notes to consolidated financial statements are an integral part of this statement.
NIPSCO INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF COMMON SHAREHOLDERS' EQUITY
- ------- * Amounts restated to reflect two-for-one stock split.
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HOLDING COMPANY STRUCTURE
NIPSCO Industries, Inc. (Industries) is an energy/utility-based holding company providing electric energy, natural gas and water to the public through its six wholly-owned regulated subsidiaries (Utilities): Northern Indiana Public Service Company (Northern Indiana); Kokomo Gas and Fuel Company (Kokomo Gas); Northern Indiana Fuel and Light Company, Inc. (NIFL); Crossroads Pipeline Company (Crossroads); Indianapolis Water Company (IWC); and Harbour Water Corporation (Harbour). Industries' regulated gas and electric subsidiaries (Northern Indiana, Kokomo Gas, NIFL and Crossroads) are referred to as "Energy Utilities"; and regulated water subsidiaries (IWC and Harbour) are referred to as "Water Utilities."
On March 25, 1997, Industries acquired IWC Resources Corporation (IWCR). IWCR's subsidiaries include two regulated water utilities (IWC and Harbour) and five non-utility companies providing utility-related services including installation, repair and maintenance of underground pipelines and utility line locating and marking. The two primary non-utility subsidiaries are Miller Pipeline Corporation (Miller) and SM&P Utility Resources, Inc. (SM&P).
Industries also provides non-regulated energy/utility-related services including energy marketing and trading; power generation; gas transmission, supply and storage; installation, repair and maintenance of underground pipelines; utility line locating and marking; and related products targeted at customer segments principally through the following wholly-owned subsidiaries: NIPSCO Development Company, Inc. (Development); NIPSCO Energy Services, Inc. (Services); Primary Energy, Inc. (Primary); Miller; and SM&P. NIPSCO Capital Markets, Inc. (Capital Markets) handles financing for Industries and its subsidiaries, other than Northern Indiana. These subsidiaries are referred to collectively as "Products and Services."
On December 18, 1997, Industries and Bay State Gas Company signed a definitive merger agreement under which Industries will acquire all of the common stock of Bay State Gas Company in a stock-for-stock transaction. Refer to Purchase of Bay State Gas Company in Notes to Consolidated Financial Statements for a more detailed discussion of the proposed acquisition.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of majority-owned subsidiaries of Industries after the elimination of significant intercompany accounts and transactions. Investments for which Industries has at least a 20% interest and certain joint ventures are accounted for under the equity method. Investments with less than a 20% interest are accounted for under the cost method. Certain reclassifications were made to conform the prior years' financial statements to the current presentation.
The prior period operating results related to "Products and Services" were previously reported under the caption "Other Income (Deductions)" in the Consolidated Statement of Income. Accordingly, these results have been reclassified to conform to the current presentation.
The accompanying consolidated financial statements of Industries include nine months of operating results for IWCR for the period ended December 31, 1997.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Operating Revenues
Utility revenues are recorded based on estimated service rendered, but are billed to customers monthly on a cycle basis. Energy marketing revenues are recognized as the related commodity is delivered to customers. Construction revenues are recognized on the percentage of completion method whereby revenues are recognized in proportion to costs incurred over the life of each project. Industries records provisions for losses on construction contracts, if any, in the period in which such losses become probable.
Depreciation and Maintenance
The Energy Utilities provide depreciation on a straight-line method over the remaining service lives of the electric, gas and common properties. The weighted average provisions, as a percentage of the cost of original depreciable utility plant, were approximately 4.3% for 1997, 4.2% for 1996 and 4.1% for 1995.
The Water Utilities provide depreciation on the original cost of utility plant in service using a composite annual rate of 1.9% for 1997.
The Utilities follow the practice of charging maintenance and repairs, including the cost of renewals of minor items of property, to maintenance expense accounts, except for repairs of transportation and service equipment which are charged to clearing accounts and redistributed to operating expense and other accounts. When property which represents a retirement unit is replaced or removed, the cost of such property is credited to utility plant, and such cost, together with the cost of removal less salvage, is charged to the accumulated provision for depreciation.
Amortization of Software Costs
Industries has capitalized software relating to various technology functions. At the date of installation, Industries estimates that the specific software will have a useful life between five and ten years. The FERC prescribes certain amortization periods, and Industries' management has determined that, on average, these are reasonable useful life estimates for the portfolio of capitalized software. The Energy Utilities include these amortization estimates, based on useful life, in their quarterly filings with the Indiana state regulatory commission.
Plant Acquisition Adjustments
Utility plant includes amounts representing the excess of purchase price over underlying book values associated with the acquisitions of Kokomo Gas, NIFL, IWC and Harbour. These amounts are $197.7 million (see Purchase of IWC Resources Note) and $40.6 million at December 31, 1997 and December 31, 1996, respectively, and are being amortized over a forty-year period from the respective dates of acquisition.
Intangible Assets
The excess of cost over the fair value of the net assets of non-utility subsidiaries acquired is stated as goodwill and is being amortized on a straight-line basis over a weighted average period of 34 years. Other intangible assets approximating $7.7 million are being amortized over a period of eight years. Industries assesses the recoverability of its intangible assets on a periodic basis to
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
confirm that expected future cash flows will be sufficient to support the recorded intangible assets. Accumulated amortization of intangibles at December 31, 1997, was approximately $1.1 million.
Coal Reserves
Northern Indiana has a long-term mining contract to mine its coal reserves through the year 2001. The costs of these reserves are being recovered through the rate-making process as such coal reserves are used to produce electricity.
Power Purchased
Power purchases and net interchange power with other electric utilities under interconnection agreements are included in Cost of Sales under the caption "Power purchased."
Accounts Receivable
At December 31, 1997, Northern Indiana had sold $100 million of its accounts receivable under a sales agreement which expires May 31, 2002.
Customer Advances and Contributions in Aid of Construction
IWC allows developers to install and provide for the installation of water main extensions, which are to be transferred to IWC upon completion. The cost of the main extensions and the amount of any funds advanced for the cost of water mains installed are included in customer advances for construction and are generally refundable to the customer over a period of ten years. Advances not refunded within ten years are permanently transferred to contributions in aid of construction.
Statement of Cash Flows
For purposes of the Consolidated Statement of Cash Flows, Industries considers temporary cash investments with an original maturity of three months or less to be cash equivalents.
Cash paid during the periods reported for income taxes and interest was as follows:
Fuel Adjustment Clause
All metered electric rates contain a provision for adjustment in charges for electric energy to reflect increases and decreases in the cost of fuel and the fuel cost of purchased power through operation of a fuel adjustment clause. As prescribed by order of the Indiana Utility Regulatory Commission (Commission) applicable to metered retail rates, the adjustment factor has been calculated based on the estimated cost of fuel and the fuel cost of purchased power in a future three-month period. If two statutory requirements relating to expense and return levels are satisfied, any under-recovery or over-recovery caused by variances between estimated and actual cost in a given three-month period will be included in a future filing. Northern Indiana records any under-recovery or over-recovery as a current asset or current liability until such time as it is billed or refunded to its customers. The fuel adjustment factor is subject to a quarterly hearing by the Commission and remains in effect for a three-month period.
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Gas Cost Adjustment Clause
All metered gas rates contain an adjustment factor which reflects the cost of purchased gas, contracted gas storage and storage transportation charges. The Energy Utilities record any under-recovery or over-recovery as a current asset or current liability until such time as it is billed or refunded to their customers. The gas cost adjustment factor for Northern Indiana is subject to a quarterly hearing by the Commission and remains in effect for a three-month period. The gas cost adjustment factors for Kokomo Gas and NIFL are subject to semi-annual hearings by the Commission and remain in effect for a six-month period. If the statutory requirement relating to the level of return is satisfied, any under-recovery or over-recovery caused by variances between estimated and actual cost in a given three- or six-month period will be included in a future filing. See "FERC Order No. 636" for a discussion of gas transition cost charges.
Natural Gas in Storage
Northern Indiana's natural gas in storage is valued using the last-in, first-out (LIFO) inventory methodology. Based on the average cost of gas purchased in December 1997 and 1996 the estimated replacement cost of gas in storage (current and non-current) at December 31, 1997 and 1996 exceeded the stated LIFO cost by approximately $42 million and $96 million, respectively. Certain other subsidiaries of Industries have natural gas in storage valued at average cost.
Hedging Activities
Industries utilizes a variety of commodity-based derivative financial instruments to reduce the price risk inherent in its natural gas and electric power marketing activities. The gains and losses on these derivative financial instruments are deferred (Other Current Assets or Other Current Liabilities) pursuant to an identified risk reduction strategy. Such deferrals are recognized in income concurrent with the disposition of the underlying physical commodity. In certain circumstances, a derivative financial instrument will serve to hedge the acquisition cost of gas injected into storage. In this situation, the gain or loss on the derivative financial instrument is deferred as part of the cost basis of gas in storage and recognized upon the ultimate disposition of the natural gas. If a derivative financial instrument contract is terminated early because it is probable that a transaction or anticipated transaction will not occur, any gain or loss as of such date is immediately recognized in earnings. If a derivative financial instrument contract is terminated early for other economic reasons, any gain or loss as of the termination date is deferred and recorded when the associated transaction or anticipated transaction affects earnings.
Industries' gas subsidiaries use commodity futures contracts, options and swaps to hedge the impact of natural gas price fluctuations related to its business activities, including price risk related to the physical location of the natural gas (basis risk). As of December 31, 1997, Industries had open derivative financial instruments representing hedges of natural gas sales of 8.9 billion cubic feet (Bcf), natural gas purchases and inventories of 13.4 Bcf and net basis differentials of 33.4 Bcf. The net deferred loss on these derivative financial instruments as of December 31, 1997 was not material.
Industries purchases options to hedge price risk associated with a portion of its fixed price purchase and sale commitments related to electricity. The deferred premiums paid on these options as of December 31, 1997 were not material.
Refer to "Market Risk Sensitive Instruments and Positions" in Management's Discussion and Analysis of Financial Condition and Results of Operations. See Industries Form 8-K, pages 8-9.
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Impact of Accounting Standards
In July 1997, FASB issued SFAS No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The objective of the statement is to report a measure of all changes in equity of an enterprise that result from transactions or other economic events during the period other than transactions with shareholders. Industries will be required to display items of other comprehensive income including, but not limited to, changes in its unrealized holding gains or losses on its available-for-sale securities and foreign currency translation adjustments. Industries will adopt this statement effective January 1, 1998.
Regulatory Assets
The Utilities' operations are subject to the regulation of the Commission and, in the case of the Energy Utilities, the Federal Energy Regulatory Commission (FERC). Accordingly, the Utilities' accounting policies are subject to the provisions of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation." The Utilities monitor changes in market and regulatory conditions and the resulting impact of such changes in order to continue to apply the provisions of SFAS No. 71 to some or all of their operations. As of December 31, 1997 and December 31, 1996, the regulatory assets identified below represent probable future revenue to the Utilities associated with certain incurred costs as these costs are recovered through the rate-making process. Regulatory assets were comprised of the following items:
If a portion of the Utilities' operations becomes no longer subject to the provisions of SFAS No. 71, a write-off of certain regulatory assets might be required, unless some form of transition cost recovery is established by the appropriate regulatory body which would meet the requirements under generally accepted accounting principles for continued accounting as regulatory assets during such recovery period.
Carrying Charges and Deferred Depreciation
Upon completion of R. M. Schahfer Units 17 and 18, Northern Indiana capitalized the carrying charges and deferred depreciation in accordance with orders of the Commission until the
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
cost of each unit was allowed in rates. Such carrying charges and deferred depreciation are being amortized over the remaining life of each unit.
Northern Indiana has capitalized carrying charges and deferred depreciation and certain operating expenses relating to its scrubber service agreement for its Bailly Generating Station in accordance with an order of the Commission. Pursuant to such order, capitalization of carrying charges and deferral of depreciation and certain operating expenses ceased on December 31, 1995. The accumulated balance of the deferred costs and related carrying charges is being amortized over the remaining life of the scrubber service agreement.
Allowance for Funds Used During Construction
Allowance for funds used during construction (AFUDC) is charged to construction work in progress during the period of construction and represents the net cost of borrowed funds used for construction purposes and a reasonable rate upon other (equity) funds. Under established regulatory rate practices, after the construction project is placed in service, Northern Indiana is permitted to include in the rates charged for utility services (a) a fair return on and (b) depreciation of such AFUDC included in plant in service.
At January 1, 1995, a pretax rate of 6.0% for all construction was being used; effective January 1, 1996, the rate decreased to 5.5% and effective January 1, 1997, the rate remained at 5.5%.
Foreign Currency Translation
Translation gains or losses are based upon the end-of-period exchange rate and are recorded as a separate component of common shareholders' equity.
Investments In Real Estate
Development invests in a series of affordable housing projects within the Utilities' service territory. These investments include certain tax benefits, including low-income housing tax credits and tax deductions for operating losses of the housing projects. Development accounts for these investments using the equity method. Investments, at equity, include $30.1 million and $24.1 million relating to affordable housing projects at December 31, 1997 and December 31, 1996, respectively.
Income Taxes
Deferred income taxes are recognized as costs in the rate-making process by the commissions having jurisdiction over the rates charged by the Utilities. Deferred income taxes are provided as a result of provisions in the income tax law that either require or permit certain items to be reported on the income tax return in a different period than they are reported in the financial statements. These taxes are reversed by a debit or credit to deferred income tax expense as the temporary differences reverse. Investment tax credits have been deferred and are being amortized to income over the life of the related property.
RESOLUTION OF TAX MATTER
In 1991, the Internal Revenue Service (IRS) issued a notice of deficiency for Northern Indiana's taxes for the years 1982 through 1985 ($3,785,250 per year plus interest) relating to interest payments on $70 million of 17 1/4% Notes issued in 1981 by Northern Indiana's former foreign subsidiary, Northern Indiana Public Service Finance N.V. (Finance). The IRS maintained that interest paid on the Notes should have been subject to United States tax withholding. Northern Indiana challenged the assessment in the United States Tax Court (Tax Court) and the
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Tax Court ruled in favor of Northern Indiana, finding that the interest paid on the Notes was not subject to United States tax withholding. The IRS appealed the Tax Court's decision to the U. S. Court of Appeals for the Seventh Circuit (Court of Appeals) and Northern Indiana filed a cross appeal. On June 6, 1997, the Court of Appeals issued an order affirming in full the favorable Tax Court order. The IRS did not appeal the decision of the Court of Appeals.
RESOLUTION OF ELM ENERGY AND RECYCLING (UK) LTD. LITIGATION
Development is an 85% shareholder in Elm Energy and Recycling (UK) Ltd. (Elm), which owns and operates a tire-fueled electric generating plant in Wolverhampton, England (Project). In 1995, the Project failed certain performance and reliability tests which had been established under a contract between Elm and TBV Power Limited (TBV), a company jointly owned by subsidiaries of the Tarmac PLC Group and Black & Veatch. Elm "rejected" the Project in accordance with the contract, and the independent Project engineer then certified that 29.6 million British Pounds Sterling (approximately $48.9 million at December 31, 1997) were to be reimbursed by TBV to Elm. TBV filed suit in the English courts to enjoin enforcement of the decision and to allege certain breaches of the underlying construction contract. Elm counterclaimed, and Elm and Development also sought additional remedies at law, in both the United States and the United Kingdom, for damages and/or sanctions against TBV, Tarmac PLC Group, Black & Veatch and its chairman. Black & Veatch counterclaimed against Elm and Development.
In September 1997, a settlement was reached on mutually agreed terms which resulted in the dismissal, with prejudice, of all litigation in the United States and the United Kingdom relating to the Project (Elm Litigation Settlement). Concurrently, Elm reached a settlement with its banks pursuant to which the banks were paid a portion of the proceeds received by Elm in the Elm Litigation Settlement in exchange for the banks agreeing to forgive Elm's remaining bank debt and to release all security interests they had in the Project. The Elm Litigation Settlement was not material to the results of operations or financial position of Industries. Elm is continuing to operate the Project and Development provides financing to support its operations.
NESI ENERGY MARKETING CANADA LTD. LITIGATION
On October 31, 1996, Services' wholly-owned subsidiary NIPSCO Energy Services Canada Ltd. (NESI Canada) acquired 70% of the outstanding shares of Chandler Energy Inc., a gas marketing and trading company located in Calgary, Alberta, and subsequently renamed it NESI Energy Marketing Canada Ltd. (NEMC). Between November 1 and November 27, 1996, gas prices in the Calgary market increased dramatically. As a result, NEMC was selling gas, pursuant to contracts entered into prior to the acquisition date, at prices substantially below its costs to acquire such gas. On November 27, 1996, NEMC ceased doing business and sought protection from its creditors under the Companies' Creditors Arrangement Act, a Canadian corporate reorganization statute. NEMC was declared bankrupt as of December 12, 1996.
Certain creditors of NEMC have filed claims against Industries, Services, Capital Markets and NESI Canada, alleging certain misrepresentations relating to NEMC's financial condition and claiming damages. Industries and its affiliates intend to vigorously defend against such claims and any other claims seeking to assert that any party other than NEMC is responsible for NEMC's liabilities. Industries has fully reserved its investment in NEMC. Management believes that any additional loss relating to NEMC would not be material to the results of operations or financial position of Industries.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FERC ORDER NO. 636
The Energy Utilities have recorded approximately $138 million of interstate pipeline transition costs since December 1993 to reflect the impact of FERC Order No. 636, a majority of which costs have been paid to the pipeline suppliers. The Energy Utilities expect that additional transition costs will not be significant. The Commission has approved the recovery of these FERC- allowed transition costs on a volumetric basis from sales and transportation customers. Regulatory assets, in amounts corresponding to the costs recorded but not yet collected, have been recorded to reflect the ultimate recovery of these costs.
ENVIRONMENTAL MATTERS
The Utilities have an ongoing program to remain aware of laws and regulations involved with hazardous waste and other environmental matters. The Utilities intend to continue to evaluate their facilities and properties with respect to these rules and identify any sites that would require corrective action. The Utilities have recorded a reserve of approximately $20 million to cover probable corrective actions as of December 31, 1997; however, environmental regulations and remediation techniques are subject to future change. The ultimate cost could be significant, depending on the extent of corrective actions required. Based upon investigations and management's understanding of current laws and regulations, the Utilities believe that any corrective actions required, after consideration of insurance coverages and contributions from other potentially responsible parties, will not have a significant impact on the results of operations or financial position of Industries.
Because of major investments made in modern environmental control facilities and the use of low-sulfur coal, all of Northern Indiana's electric production facilities now comply with the specific sulfur dioxide limitations contained in the acid deposition provisions of the Clean Air Act Amendments of 1990 (CAAA). Reflecting this compliance, on December 31, 1997, Indiana Department of Environmental Management (IDEM) issued the Phase II Acid Rain permits for all four of Northern Indiana's electric generating stations. As discussed below, however, other provisions of the CAAA impose additional requirements on Northern Indiana.
On December 19, 1996, the Environmental Protection Agency (EPA) promulgated rules for Phase II of the Acid Rain nitrogen oxides (NOx) reduction program. For Phase I, during the summer of 1997, the EPA formally approved the Acid Rain Early Election permits for the pulverized coal units at D. H. Mitchell and R. M. Schahfer stations. The permits establish the Phase I limits for the NOx emissions on these units until 2007. On December 23, 1997, Northern Indiana submitted an Acid Rain Phase II NOx Compliance Plan to IDEM which included additional controls for two cyclone fired boilers and a plan for emission averaging to achieve the NOx limits for the system by 2000. Northern Indiana plans a project to demonstrate a cost effective combustion control technique on the Unit 12 cyclone fired boiler at Michigan City during 1998. The CAAA also contain other provisions that could lead to limitations on emissions of hazardous air pollutants which may require significant capital expenditures for control of these emissions. Northern Indiana cannot predict what these requirements will be or the costs of complying with these potential requirements.
On October 10, 1997, the EPA proposed a rule under the nonattainment provisions of the CAAA to reduce emissions transported across state boundaries that allegedly are contributing to nonattainment of the one hour ozone standard in downwind states. Because NOx is considered a precursor or cause of ozone formation, the EPA proposed significant NOx reductions for 22 states, including Indiana, to address the ozone transport issue. These proposals, and any resulting NOx emission limitations, arise under different provisions of the CAAA than the Acid Rain NOx program and could result in additional, more restrictive emission limitations than are imposed
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
under the Acid Rain Program. The EPA has encouraged states to achieve the reductions by requiring controls on electric utilities and large boilers. Northern Indiana is evaluating the EPA's proposal and evaluating potential requirements that could result from any final rule.
The EPA issued final rules on July 18, 1997, revising the National Ambient Air Quality Standards for ozone and particulate matter. The revised standards begin a regulatory process that may lead to reductions in particulate, NOx emissions and possibly sulfur dioxide emissions, from coal-fired boilers (including Northern Indiana's generating stations) beyond reductions required in the Acid Rain and nonattainment provisions of the CAAA. Northern Indiana cannot predict the costs of complying with future control requirements to meet these new standards. Northern Indiana will continue to closely monitor developments in this area and anticipates that the exact nature of the impact of the new standards on its operations will not be known for some time.
The EPA has notified Northern Indiana that it is a "potentially responsible party" (PRP) under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) and may be required to share in the cost of cleanup of several waste disposal sites identified by the EPA. The sites are in various stages of investigation, analysis and remediation. At each of the sites, Northern Indiana is one of several PRPs, and it is expected that remedial costs, as provided under CERCLA, will be shared among them. At some sites Northern Indiana and/or the other named PRPs are presently working with the EPA to clean up the sites and avoid the imposition of fines or added costs.
In December 1997, at the Summit on Climate Change in Kyoto, Japan, 159 nations formally agreed to targets reducing worldwide levels of greenhouse gases. If the U.S. Senate ratifies the agreement, the Kyoto Protocol would impose an obligation on the United States to reduce its emissions of greenhouse gas to a level seven percent below 1990 levels during the period 2008 to 2012. The impact of this agreement on Northern Indiana is uncertain. Northern Indiana, as a charter member of the Department of Energy's Climate Challenge Program, the electric industries' voluntary reduction effort, has already implemented over 21 projects to voluntarily reduce greenhouse gases emissions. Northern Indiana continues to investigate methods to address reduction in carbon dioxide emissions and will monitor the development of U.S. climate change policy.
The Energy Utilities have instituted a program to investigate former manufactured-gas plants where one of them is the current or former owner. The Energy Utilities have identified twenty-eight of these sites and made visual inspections of these sites. Initial samplings have been conducted at eighteen sites. Follow-up investigations have been conducted at seven sites and remedial measures have been selected at four sites. The Energy Utilities will continue their program to assess and cleanup sites.
During the course of various investigations, the Energy Utilities have identified impacts to soil, groundwater, sediment and surface water from former manufactured-gas plants. At three sites where residues were noted seeping into rivers, Northern Indiana notified the IDEM and the EPA and immediately took steps to contain the material. The Energy Utilities have worked with IDEM or the EPA on investigation or remedial activities at several sites. Three of the sites have been enrolled in the IDEM Voluntary Remediation Program (VRP). The goal of placing these sites in the VRP is to obtain IDEM approval of the selection and implementation of whatever remedial measures, if any, may be required. The Energy Utilities anticipate placing additional sites in the VRP after remedial measures have been selected.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Northern Indiana and Indiana Gas Company, Inc. (Indiana Gas) have entered into an agreement covering cost sharing and management of investigation and remediation programs at five former manufactured-gas plant sites at which both companies or their predecessors were former operators or owners. One of these sites is the Lafayette site which Indiana Gas had previously notified Northern Indiana is being investigated and remediated pursuant to an administrative order with IDEM. Northern Indiana also notified Cinergy Services, Inc. (Cinergy) (formerly PSI Energy, Inc.) that it was a former owner or operator of seven former manufactured-gas plants at which Northern Indiana had conducted or was planning investigation or remediation activities. In December 1996, Northern Indiana sent a written demand to Cinergy related to one of these sites, Goshen. Northern Indiana demanded that Cinergy pay Northern Indiana for costs Northern Indiana has already incurred and to be incurred to implement the needed remedy at the Goshen site. In August 1997, Northern Indiana filed suit in federal court against Cinergy seeking recovery of those costs.
In 1994, the Energy Utilities approached various companies that provided insurance coverage which the Energy Utilities believe covers costs related to actions taken at former manufactured-gas plants. There has been litigation between Northern Indiana and various insurance companies over covered costs. Northern Indiana has filed claims in state court against various insurance companies, seeking coverage for costs associated with several former manufactured-gas plants and damages for alleged misconduct by some of the insurance companies. The state court action is now proceeding. Northern Indiana has received cash settlements from several of the insurance companies.
The possibility that exposure to electric and magnetic fields (EMF) emanating from power lines, household appliances and other electric sources may result in adverse health effects has been the subject of public, governmental and media attention. Recently, researchers from the National Cancer Institute and the Childhood Cancer Group reported they found no evidence magnetic fields in homes increase the risk of childhood leukemia. This study follows an EMF report released late last year by the U.S. National Research Council of the National Academy of Sciences, which concluded, after examining more than 500 EMF studies spanning 17 years, that, among other things, there was insufficient evidence to consider EMF a threat to human health. Despite the reports' findings, future research appropriations are continuing to be dedicated to explore this issue.
The Water Utilities are subject to pollution control and water quality control regulations, including those issued by the EPA, IDEM, the Indiana Water Pollution Control Board and the Indiana Department of Natural Resources. Under the Federal Clean Water Act and Indiana's regulations, IWC must obtain National Pollutant Discharge Elimination System (NPDES) permits for discharges from its water treatment stations. Applications for renewal of any expiring permits have been filed and are the subject of ongoing discussions with, but have not been finalized by, IDEM. These permits continue in effect pending review of the current applications.
Under the Federal Safe Drinking Water Act (SDWA), the Water Utilities are subject to regulation by the EPA for the quality of water sold and treatment techniques used to make the water potable. The EPA promulgates nationally applicable maximum contaminant levels (MCLs) for contaminants found in drinking water. Management believes its water utilities are currently in compliance with all MCLs promulgated to date. The EPA has continuing authority, however, to issue additional regulations under the SDWA. In August 1996, Congress amended the SDWA to allow the EPA more authority to weigh the costs and benefits of regulations being considered in some, but not all, cases. The 1996 amendments do not, however, reduce the number of new standards previously required. Such standards promulgated could be costly and require substantial changes in the Water Utilities' operations. The Water Utilities would expect to recover
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the costs of such changes through their water rates; however, such recovery may not necessarily be timely.
Under a 1991 law enacted by the Indiana Legislature, a water utility may petition the Commission for prior approval of its plans and estimated expenditures required to comply with provisions of, and regulations under, the Federal Clean Water Act and SDWA. Upon obtaining such approval, a water utility may include, to the extent of its estimated costs as approved by the Commission, such costs in its rate base for rate-making purposes and recover its costs of developing and implementing the approved plans if statutory standards are met. The capital costs for such new systems, equipment or facilities or modifications of existing facilities may be included in a water utility's rate base upon completion of construction of the project or any part thereof. While use of this statute is voluntary on the part of a water utility, if utilized, it should allow water utilities a greater degree of confidence in recovering major costs incurred to comply with environmentally related laws on a timely basis.
INCOME TAXES
Industries uses the liability method of accounting for income taxes under which deferred income taxes are recognized, at currently enacted income tax rates, to reflect the tax effect of temporary differences between the financial statement and tax bases of assets and liabilities.
To the extent certain deferred income taxes of the Utilities are recoverable or payable through future rates, regulatory assets and liabilities have been established. Regulatory assets are primarily attributable to undepreciated AFUDC-equity and the cumulative net amount of other income tax timing differences for which deferred taxes had not been provided in the past, when regulators did not recognize such taxes as costs in the rate-making process. Regulatory liabilities are primarily attributable to the Utilities' obligation to credit to ratepayers deferred income taxes provided at rates higher than the current federal tax rate currently being credited to ratepayers using the average rate assumption method and unamortized deferred investment tax credits.
The components of the net deferred income tax liability at December 31, 1997 and 1996, are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Federal and state income taxes as set forth in the Consolidated Statement of Income are comprised of the following:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
PENSION PLANS
Industries and its subsidiaries have four noncontributory, defined benefit retirement plans covering the majority of their employees. Benefits under the plans reflect the employees' compensation, years of service and age at retirement.
The plans' funded status as of December 31, 1997 and 1996 are as follows:
The accumulated benefit obligation is the present value of future pension benefit payments and is based on the plan benefit formula without considering expected future salary increases. The projected benefit obligation considers estimated future salary increases. Discount rates of 7.00% and 7.75% and rates of increase in compensation levels of 4.5% and 5.5% were used to determine the accumulated benefit obligation and projected benefit obligation at December 31, 1997 and 1996, respectively. The increase in the accumulated benefit obligation at December 31, 1997 is mainly caused by the decrease in the discount rate from 7.75% to 7.00%.
The following items are the components of provisions for pensions for the years ended December 31, 1997, 1996 and 1995:
Assumptions used in the valuation and determination of 1997, 1996 and 1995 pension expense were as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The plans' assets are invested primarily in common stocks, bonds and notes.
IWCR participates in several industry-wide, multi-employer pension plans for certain of its union employees at Miller. These plans provide for monthly benefits based on length of service. Specified amounts per compensated hour for each employee are contributed to the trustees of these plans. Contributions of $1.7 million were made to these plans for the nine-month period ended December 31, 1997. The relative position of each employer participating in these plans with respect to the actuarial present value of accumulated plan benefits and net assets available for benefits is not available.
POSTRETIREMENT BENEFITS
Industries provides certain health care and life insurance benefits for retired employees. The majority of Industries' employees may become eligible for those benefits if they reach retirement age while working for Industries. The expected cost of such benefits is accrued during the employees' years of service.
Northern Indiana's rate-making had historically included the cost of providing these benefits based on the related insurance premiums. On December 30, 1992, the Commission authorized the accrual method of accounting for postretirement benefits for rate-making purposes consistent with SFAS No. 106 "Employers' Accounting for Postretirement Benefits Other than Pensions," and authorized the deferral of the differences between the net periodic postretirement benefits costs and the insurance premiums paid for such benefits as a regulatory asset until such time as the accrual cost method could be reflected in the rate-making process.
On June 11, 1997, the Commission issued an order approving the inclusion of accrual-based postretirement benefit costs in the rate-making process to be effective February 1, 1997 for electric rates and March 1, 1997 for gas rates. These costs include an amortization of the existing regulatory asset consistent with the remaining amortization period for the transition obligation. Northern Indiana discontinued its cost deferral and began amortizing its regulatory asset concurrent with these dates.
IWC's current rates include postretirement benefit costs on an accrual basis, including amortization of the regulatory asset that arose prior to inclusion of these costs in rates. IWC currently remits to a grantor trust amounts collected in rates.
The following table sets forth the plans accumulated postretirement benefit obligation as of December 31, 1997 and 1996:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A discount rate of 7% and a pre-Medicare medical trend rate of 8% declining to a long-term rate of 5% and a discount rate of 7.75% and a pre-Medicare medical trend rate of 9% declining to a long-term rate of 6% were used to determine the accumulated postretirement benefit obligation at December 31, 1997 and 1996, respectively.
The increase in the accumulated postretirement benefit obligation (APBO) was primarily attributable to the inclusion of IWCR's APBO and the decrease in the discount rate from 7.75% to 7.00%.
Net periodic postretirement benefit costs, before consideration of the rate- making discussed above, for the years ended December 31, 1997, 1996 and 1995 include the following components:
The following assumptions were used to determine net periodic postretirement benefit costs:
The pre-Medicare medical trend rates used for 1997, 1996 and 1995 were 8% declining to a long-term rate of 6%, 9% declining to a long-term rate of 6%, and 11% declining to a long-term rate of 7%, respectively. The effect of a 1% increase in the assumed health care cost trend rates for each future year would increase the accumulated postretirement benefit obligation at December 31, 1997, by approximately $27.1 million and increase the aggregate of the service and interest cost components of plan costs by approximately $2.9 million for the year ended December 31, 1997. Amounts disclosed above could be changed significantly in the future by changes in health care costs, work force demographics, interest rates, or plan changes.
PREFERRED AND PREFERENCE STOCKS
Industries is authorized to issue 20,000,000 shares of Preferred Stock, without par value. Effective March 2, 1990, 2,000,000 shares of the Industries' Series A Junior Participating Preferred Shares were reserved for issuance pursuant to the Share Purchase Rights Plan described in Common Shares. In November 1990, Industries issued and sold 350,000 shares of 8.75% Series Cumulative Preferred Shares through a private placement for $35 million. Pursuant to mandatory redemption provisions, all the shares were redeemed by Industries on January 12, 1996, for $100 per share plus accrued dividends.
The authorized classes of par value and no par value cumulative preferred and preference stocks of Northern Indiana are as follows: Cumulative Preferred--$100 par value--2,400,000 shares; Cumulative Preferred--no par value--3,000,000 shares; Cumulative Preference--$50 par value--2,000,000 shares (none outstanding); and Cumulative Preference--no par value--
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3,000,000 shares (none issued). The authorized class of cumulative preferred stock of IWC is $100 par value--300,000 shares.
The Preferred shareholders of Northern Indiana and IWC have no voting rights, except in the event of default on the payment of four consecutive quarterly dividends, or as required by Indiana law to authorize additional preferred shares, or by the Articles of Incorporation in the event of certain merger transactions.
The redemption prices at December 31, 1997, for the cumulative preferred stock, which is redeemable solely at the option of Northern Indiana and IWC, in whole or in part, at any time upon thirty days' notice, are as follows:
The redemption prices at December 31, 1997, as well as sinking fund provisions, for the cumulative preferred stock subject to mandatory redemption requirements, or whose redemption is outside the control of Northern Indiana, are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Sinking fund requirements with respect to redeemable preferred stocks outstanding at December 31, 1997 for each of the four years subsequent to December 31, 1998 are as follows:
STOCK SPLIT
On December 16, 1997, the Board of Directors authorized a two-for-one split of Industries' common stock. Shareholders received one additional common share for each common share held. The stock split was paid February 20, 1998, to shareholders of record at the close of business on January 30, 1998. All references to number of common shares reported for the period including per share amounts, stock option data and market prices of Industries' common stock have been restated to reflect the two-for-one stock split as if it had occurred at the beginning of the earliest period. The common share cash dividend paid February 20, 1998, was paid on pre-split common shares.
COMMON SHARE DIVIDEND
During the next few years, Industries expects that the great majority of earnings available for distribution of dividends will depend upon dividends paid to Industries by Northern Indiana. Northern Indiana's Indenture provides that it will not declare or pay any dividends on any class of capital stock (other than preferred or preference stock) except out of earned surplus or net profits of Northern Indiana. At December 31, 1997, Northern Indiana had approximately $146.3 million of retained earnings (earned surplus) available for the payment of dividends. Future dividends will depend upon adequate retained earnings, adequate future earnings and the absence of adverse developments.
EARNINGS PER SHARE
At December 31, 1997, Industries adopted SFAS No. 128 "Earnings per Share." The adoption of this statement required Industries to present basic earnings per share and diluted earnings per share in place of primary earnings per share.
Basic earnings per share was computed by dividing net income, reduced for preferred dividends, by the average number of common shares outstanding during the period. The diluted earnings per share calculation assumes conversion of nonqualified stock options into common shares. As a result of adopting the statement, previously reported earnings per share information was restated. The effect of this accounting change on previously reported earnings per share data was insignificant.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The net income, preferred dividends and shares used to compute basic and diluted earnings per share is presented in the following table:
COMMON SHARES
Industries has 200,000,000 common shares authorized without par value. The number of common shares authorized was not affected by the two-for-one stock split.
Share Purchase Rights Plan
On February 27, 1990, the Board of Directors of Industries (Board) declared a dividend distribution of one Right for each outstanding common share of Industries to shareholders of record on March 12, 1990. The Rights are not currently exercisable. Each Right, when exercisable, would initially entitle the holder to purchase from Industries one two-hundredth of a share of Series A Junior Participating Preferred Share, without par value, of Industries at a price of $30 per one two-hundredth of a share. In certain circumstances, if an acquirer obtained 25% of Industries' outstanding shares, or merged into Industries or Industries into the acquirer, the Rights would entitle the holders to purchase Industries' or the acquirer's common shares for one-half of the market price. The Rights will not dilute Industries' common shares nor affect earnings per share unless they become exercisable for common shares. The Plan was not adopted in response to any specific attempt to acquire control of Industries.
COMMON SHARE REPURCHASES
The Board has authorized the repurchase of Industries' common shares. At December 31, 1997, Industries had purchased approximately 44.0 million shares since 1989 at an average price of $14.18 per share. Approximately 8.0 million additional common shares may be repurchased under the Board's authorization. The number of shares purchased, additional shares that may be repurchased and average price of shares repurchased have been restated to reflect the two-for- one stock split.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
LONG-TERM INCENTIVE PLAN
Industries has two long-term incentive plans for key management employees that were approved by shareholders on April 13, 1988 (1988 Plan) and April 13, 1994 (1994 Plan), each of which provides for the issuance of up to 5.0 million of Industries' common shares to key employees through 1998 and 2004, respectively. At December 31, 1997, there were 9,156 shares and 3,879,500 shares reserved for future awards under the 1988 Plan and 1994 Plan, respectively. The 1988 Plan and 1994 Plan permit the following types of grants, separately or in combination: nonqualified stock options, incentive stock options, restricted stock awards, stock appreciation rights and performance units. No incentive stock options or performance units were outstanding at December 31, 1997. Under both Plans, the exercise price of each option equals the market price of Industries' common shares on the date of grant. Each option's maximum term is ten years and vests one year from the date of grant.
The stock appreciation rights (SARs) may be exercised only in tandem with stock options on a one-for-one basis and are payable in cash, Industries' common shares, or a combination thereof. Restricted stock awards are restricted as to transfer and are subject to forfeiture for specific periods from the date of grant. Restrictions on shares awarded in 1995 lapse five years from date of grant and vesting is variable from 0% to 200% of the number awarded, subject to specific earnings per share and stock appreciation goals. Restrictions on shares awarded in 1997 and 1996 lapse two years from date of grant and vesting is variable from 0% to 100% of the number awarded, subject to specific performance goals. If a participant's employment is terminated prior to vesting other than by reason of death, disability or retirement, restricted shares are forfeited. There were 542,666, 524,000 and 661,000 restricted shares outstanding at December 31, 1997, 1996 and 1995, respectively.
The Industries' Nonemployee Director Stock Incentive Plan, which was approved by shareholders, provides for the issuance of up to 200,000 of Industries' common shares to nonemployee directors of Industries. The Plan provides for awards of common shares which vest in 20% per year increments, with full vesting after five years. The Plan also allows the award of nonqualified stock options in the future. If a director's service on the Board is terminated for any reason other than death or disability, any common shares not vested as of the date of termination are forfeited. As of December 31, 1997, 65,500 shares were issued under the Plan.
Industries accounts for these plans under Accounting Principles Board Opinion No. 25, under which no compensation cost has been recognized for nonqualified stock options. The compensation cost that has been charged against net income for restricted stock awards was $1.8 million and $2.1 million for the year ending December 31, 1997 and 1996, respectively. Had compensation cost for stock options been determined consistent with SFAS No. 123 "Accounting for Stock--Based Compensation," Industries' net income and earnings per average common share would have been reduced to the following pro forma amounts:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The fair value of each option granted used to determine pro forma net income is estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in the years ended December 31, 1997 and 1996, respectively: risk-free interest rate of 6.29% and 6.39%, expected dividend yield of $0.87 and $0.84 per share, expected option term of five and one-quarter years and five years and expected volatility of 12.7% and 13.2%.
Changes in outstanding shares under option and SARs for 1995, 1996 and 1997, are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes information about non-qualified stock options at December 31, 1997:
OPTIONS OUTSTANDING
OPTIONS EXERCISABLE
LONG-TERM DEBT
The sinking fund requirements of long-term debt outstanding at December 31, 1997 (including the maturity of Northern Indiana's first mortgage bonds: Series T, 7.50%, due April 1, 2002; Northern Indiana's medium-term notes due from March 20, 2000 to June 12, 2002; and NDC Douglas Properties, Inc.'s notes payable due December 22, 1999 and August 15, 2002; IWC's first mortgage bonds: Series 5.20%, due May 1, 2001 and Series 8.00%, due December 15, 2001; and IWCR's senior notes payable, due March 15, 2001), for each of the four years subsequent to December 31, 1998 are as follows:
Unamortized debt expense, premium and discount on long-term debt applicable to outstanding bonds are being amortized over the lives of such bonds. Reacquisition premiums are being deferred and amortized. These premiums are not earning a return during the recovery period.
Northern Indiana's Indenture dated August 1, 1939, as amended and supplemented, securing the first mortgage bonds issued by Northern Indiana, constitutes a direct first mortgage lien upon substantially all property and franchises, other than expressly excepted property, owned by Northern Indiana.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
On May 28, 1997, Northern Indiana was authorized to issue and sell up to $217,692,000 of its Medium-Term Notes, Series E, with various maturities, for purposes of refinancing certain first mortgage bonds and medium-term notes. As of December 31, 1997, $139.0 million of the medium-term notes had been issued with various interest rates and maturities. The proceeds from these issuances were used to pay short-term debt incurred to redeem its First Mortgage Bonds, Series N, and to pay at maturity various issues of Medium-Term Notes, Series D.
IWC's first mortgage bonds are secured by its utility plant. Provisions of trust indentures related to the 8% Series Bonds require annual sinking or improvement payments amounting to 1/2% of the maximum aggregate amount outstanding. As permitted, this requirement has been satisfied by substituting a portion of permanent additions to utility plant.
On February 13, 1996, Capital Markets issued $75 million of 7 3/4% Junior Subordinated Deferrable Interest Debentures, Series A, due March 31, 2026 (Debentures) pursuant to an underwritten public offering. Proceeds from the sale of the Debentures were used to pay short-term debt incurred to redeem on January 12, 1996 Industries' $35 million of 8.75% Preferred Shares, pursuant to mandatory redemption, and to pay other short-term debt of Capital Markets.
Between March 27, 1997 and May 7, 1997, Capital Markets issued and sold $300 million of medium-term notes with various interest rates and maturities. The proceeds from these issuances were used for the purchase of IWCR and to pay outstanding short-term obligations of Capital Markets.
On December 1, 1997, Capital Markets issued $75 million of 6.78% Senior Notes due December 1, 2027. Proceeds from the sale of these notes were primarily used to pay Capital Markets' Zero Coupon Notes which matured December 1, 1997. The remaining balance of the proceeds will be used for Industries' general corporate purposes.
The obligations of Capital Markets are subject to a Support Agreement between Industries and Capital Markets, under which Industries has committed to make payments of interest and principal on Capital Markets' obligations in the event of a failure to pay by Capital Markets. Restrictions in the Support Agreement prohibit recourse on the part of Capital Markets' creditors against the stock and assets of Northern Indiana. Under the terms of the Support Agreement, in addition to the cash flow of cash dividends paid to Industries by any of its consolidated subsidiaries, the assets of Industries, other than the stock and assets of Northern Indiana, are available as recourse for the benefit of Capital Markets' creditors. The carrying value of the assets of Industries, other than the assets of Northern Indiana, reflected in the consolidated financial statements of Industries, is approximately $1.3 billion at December 31, 1997.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CURRENT PORTION OF LONG-TERM DEBT
At December 31, 1997 and 1996, Industries' current portion of long-term debt due within one year was as follows:
SHORT-TERM BORROWINGS
Northern Indiana and Capital Markets make use of commercial paper to fund short-term working capital requirements.
Northern Indiana has a $250 million revolving Credit Agreement with several banks which terminates August 19, 1999. As of December 31, 1997, there were no borrowings outstanding under this agreement. In addition, Northern Indiana has $14.2 million in lines of credit which run to May 31, 1998. The credit pricing of each of the lines varies from either the lending banks' commercial prime or market rates. Northern Indiana has agreed to compensate the participating banks with arrangements that vary from no commitment fees to a combination of fees which are mutually satisfactory to both parties. As of December 31, 1997, there were no borrowings under these lines of credit. The Credit Agreement and lines of credit are also available to support the issuance of commercial paper.
Northern Indiana also has $273.5 million of money market lines of credit. As of December 31, 1997 and 1996, $47.5 million and $79.0 million of borrowings were outstanding under these lines of credit.
Northern Indiana has a $50 million uncommitted finance facility. At December 31, 1997, there were no borrowings outstanding under this facility.
Capital Markets has a $150 million revolving Credit Agreement which will terminate August 19, 1999. This facility provides short-term financing flexibility to Industries and also serves as the back-up instrument for a commercial paper program. As of December 31, 1997, there were no borrowings outstanding under this agreement.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Capital Markets also has $130 million of money market lines of credit. As of December 31, 1997 and 1996, $20.1 million and $27.0 million, respectively, of borrowings were outstanding under these lines of credit.
IWCR and its subsidiaries have lines of credit with banks aggregating $73.7 million. At December 31, 1997, $48.9 million of borrowings were outstanding under these lines of credit.
At December 31, 1997 and 1996, Industries' short-term borrowings were as follows:
OPERATING LEASES
On April 1, 1990, Northern Indiana entered into a twenty-year agreement for the rental of office facilities from Development at a current annual rental payment of approximately $3.4 million.
The following is a schedule, by years, of future minimum rental payments, excluding those to associated companies, required under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1997:
The consolidated financial statements include rental expense for all operating leases as follows:
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
COMMITMENTS
Industries estimates that approximately $1.019 billion will be expended for construction purposes for the period from January 1, 1998 to December 31, 2002. Substantial commitments have been made by the Utilities in connection with their programs.
Northern Indiana has entered into a service agreement with Pure Air, a general partnership between Air Products and Chemicals, Inc. and Mitsubishi Heavy Industries America, Inc., under which Pure Air provides scrubber services to reduce sulfur dioxide emissions for Units 7 and 8 at Bailly Generating Station. Services under this contract commenced on June 15, 1992 with annual charges approximating $20 million. The agreement provides that, assuming various performance standards are met by Pure Air, a termination payment would be due if Northern Indiana terminates the agreement prior to the end of the twenty-year contract period.
Northern Indiana has entered into an agreement with IBM to perform all data center, application development and maintenance and desktop management of Northern Indiana.
PRIMARY ENERGY
Primary arranges energy-related projects for large energy-intensive facilities and has entered into certain commitments with these projects. Primary offers large energy customers, nationwide, expertise in managing the engineering, construction, operation and maintenance of these energy-related projects. Primary is the parent of the following subsidiaries: Harbor Coal Company (Harbor Coal); North Lake Energy Corporation (North Lake); Lakeside Energy Corporation (LEC); Portside Energy Corporation (Portside); and Cokenergy, Inc. (CE).
Harbor Coal has invested in a partnership to finance, construct, own and operate a $65 million pulverized coal injection facility which began commercial operation in August 1993. The facility receives raw coal, pulverizes it and delivers it to Inland Steel Company (Inland Steel) for use in the operation of its blast furnaces. Harbor Coal is a 50% partner in the project with an Inland Steel affiliate. Industries has guaranteed the payment and performance of the partnership's obligations under a sale and leaseback of a 50% undivided interest in the facility.
North Lake has entered into a lease for the use of a 75-megawatt energy facility located at Inland Steel. The facility uses steam generated by Inland Steel to produce electricity which is delivered to Inland Steel. The facility began commercial operation in May 1996. Industries has guaranteed North Lake's obligations relative to the lease and certain obligations to Inland Steel relative to the project.
LEC has entered into a lease for the use of a 161-megawatt energy facility located at USS Gary Works. The facility processes high-pressure steam into electricity and low-pressure steam for delivery to USX Corporation-US Steel Group. The fifteen-year tolling agreement with US Steel commenced on April 16, 1997 when the facility was placed in commercial operation. Capital Markets guarantees LEC's security deposit obligations relative to the lease and certain limited LEC obligations to the lessor.
Portside has entered into an agreement with National Steel Corporation (National) to utilize a new 63-megawatt energy facility at National's Midwest Division to process natural gas into electricity, process steam and heated water for a fifteen-year period. Portside has entered into a lease with a third-party lessor for use of the facility. Industries has guaranteed certain Portside obligations to the lessor. Construction of the project began in June 1996 and the facility began commercial operation on September 26, 1997.
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CE has entered into a fifteen-year service agreement with Inland Steel and the Indiana Harbor Coke Company, LP (Harbor Coke), a subsidiary of Sun Company, Inc. This agreement provides that CE will utilize a new energy facility at Inland Steel's Indiana Harbor Works to scrub flue gases and recover waste heat from the coke facility being constructed by Harbor Coke and produce process steam and electricity from the recovered heat which will be delivered to Inland Steel. CE intends to lease these facilities, once constructed, from a third party. Additionally, CE has entered into an interim agreement, which expires when the lease is established with the third party lessor, under which CE is acting as agent to design, construct and start up the facilities. Capital Markets anticipates guaranteeing certain CE obligations relative to the anticipated lease. Construction of the project began in January 1997. The facility is scheduled to be operational in June 1998.
Primary has advanced approximately $107 million and $42 million, at December 31, 1997 and December 31, 1996, respectively, to the lessors of the energy related projects discussed above. These net advances are included in "Other Receivables" in the Consolidated Balance Sheet and as a component of operating activities in the Consolidated Statement of Cash Flows.
Primary is evaluating other potential projects with Northern Indiana customers as well as with potential customers outside of Northern Indiana's service territory. Projects under consideration include those which use industrial by-product fuels and natural gas to produce electricity.
PURCHASE OF IWC RESOURCES CORPORATION
On March 25, 1997, Industries acquired all the outstanding common stock of IWCR for $290.5 million. Industries financed this transaction with debt of approximately $83.0 million and issuance of approximately 10.6 million Industries' common shares. Industries accounted for the acquisition as a purchase. The purchase price was allocated to the assets and liabilities acquired based on their fair values.
Following is a summary of the assets acquired and liabilities assumed in the acquisition of IWCR:
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
IWCR's largest subsidiary, IWC, provides water service to approximately 246,600 customers in Indianapolis and adjacent counties. In addition, IWCR owns an underground utility locating and marking service business and one of the nation's major gas pipeline construction companies.
PURCHASE OF BAY STATE GAS COMPANY
On December 18, 1997, Industries and Bay State Gas Company (Bay State) signed a definitive merger agreement under which Industries will acquire all of the common stock of Bay State in a stock-for-stock transaction valued at $40 per Bay State share. The transaction is valued at approximately $540 million. Bay State shareholders will have the option of taking up to 50 percent of the total purchase price in cash. Consummation of the merger is subject to certain closing conditions, including the approval by the shareholders of Bay State as well as the Securities and Exchange Commission, FERC and state regulatory agencies in Massachusetts, New Hampshire and Maine. The transaction is expected to be completed in late 1998.
Bay State, one of the largest natural gas utilities in New England, provides natural gas distribution service to more than 300,000 customers in Massachusetts, New Hampshire and Maine. The combined company will be one of the 10 largest natural gas distribution systems in the nation, servicing more than 1 million gas customers. In addition, Industries and Bay State anticipate entering into a joint marketing agreement early in 1998 that will expand the operations of Bay State's non-regulated energy service companies.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and cash equivalents: The carrying amount approximates fair value because of the short maturity of those instruments.
Investments: The fair value of some investments is estimated based on market prices for those or similar investments.
Long-term debt/Preferred stock: The fair value of long-term debt and preferred stock is estimated based on the quoted market prices for the same or similar issues or on the rates offered to Industries for securities of the same remaining maturities. Certain premium costs associated with the early settlement of long-term debt are not taken into consideration in determining fair value.
The carrying values and estimated fair values of Industries' financial instruments are as follows:
The majority of the long-term debt relates to utility operations. The Utilities are subject to regulation and gains or losses may be included in rates over a prescribed amortization period, if in fact settled at amounts approximating those above.
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CUSTOMER CONCENTRATIONS
Industries' utility subsidiaries supply natural gas, electric energy and water. Natural gas and electric energy are supplied to the northern third of Indiana. The Water Utilities serve central Indiana. Although the Energy Utilities have a diversified base of residential and commercial customers, a substantial portion of their electric and gas industrial deliveries are dependent upon the basic steel industry. The following table shows the basic steel industry percentage of gas revenue (including transportation services) and electric revenue for 1997, 1996 and 1995:
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
QUARTERLY FINANCIAL DATA The following data summarize certain operating results for each of the quarters of 1997 and 1996:
- -------- (a) Amounts restated to reflect two-for-one stock split. (b) Because of the combined mathematical effect of common shares repurchased and issued and the cyclical nature of net income during the year, the sum of earnings per share for any four quarterly periods may vary slightly from the earnings per share for the equivalent twelve-month period.
NIPSCO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
SEGMENTS OF BUSINESS
Industries' primary businesses provide natural gas, electric energy, water and energy/utility-related products and services. The reportable items for these segments for the years 1997, 1996 and 1995 are as follows:
- -------- (a) Utility plant less accumulated provision for depreciation and amortization, materials and supplies, electric production fuel, natural gas in storage, fuel and gas cost adjustment clauses, unamortized R. M. Schahfer Units 17 and 18 carrying charges and deferred depreciation, Bailly scrubber carrying charges and deferred depreciation, and FERC Order No. 636 transition costs.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of NIPSCO Industries, Inc.:
We have audited the accompanying consolidated balance sheet and consolidated statements of capitalization and long-term debt of NIPSCO Industries, Inc. (an Indiana corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, common shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These consolidated financial statements and the schedules referred to below are the responsibility of Industries' management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NIPSCO Industries, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules appearing in Item 14(a)(2) listed on page 61 are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Chicago, Illinois January 30, 1998
SELECTED SUPPLEMENTAL INFORMATION
- -------- **Includes deferred fuel cost revenue of $(5,223), $1,980 and $8,688, respectively.
- -------- ***Amounts are for the period April 1997 through December 1997.
- -------- Notes: (a) Amounts restated to reflect two-for-one stock split. (b) Including AFUDC.
- ------- Notes: (a) Amounts restated to reflect two-for-one stock split. (b) Including AFUDC.
- ------- Notes: (a) Amounts restated to reflect two-for-one stock split. (b) Including AFUDC. (c) Earnings per share were reduced by $0.36 due to the $82.0 million refund, less associated tax benefits of $30.3 million, related to the Bailly N1 generating unit.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information regarding executive officers is included as a supplemental item at the end of Item 4 of Part I of this Form 10-K.
Information regarding directors is included at pages 2-7 in the Notice of Annual Meeting and Proxy Statement dated March 9, 1998, for Annual Meeting to be held April 8, 1998, which information is incorporated by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Information regarding executive compensation is included at pages 9-12 and 14-20 in the Notice of Annual Meeting and Proxy Statement dated March 9, 1998, for Annual Meeting to be held April 8, 1998, which information is incorporated by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information regarding security ownership of certain beneficial owners and management is included at pages 8-9 in the Notice of Annual Meeting and Proxy Statement dated March 9, 1998, for Annual Meeting to be held April 8, 1998, which information is incorporated by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information regarding certain relationships and related transactions is included at page 7 in the Notice of Annual Meeting and Proxy Statement dated March 9, 1998, for Annual Meeting to be held April 8, 1998, which information is incorporated by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) (1) The Financial Statements filed herewith as a part of this report on Form 10-K are as follows:
Consolidated Financial Statements - Consolidated Statement of Income for the years ended December 31, 1997, 1996 and 1995 Consolidated Balance Sheet at December 31, 1997 and 1996 Consolidated Statement of Capitalization at December 31, 1997 and 1996 Consolidated Statement of Long-term Debt at December 31, 1997 and 1996 Consolidated Statement of Cash Flows for the years ended December 31, 1997, 1996 and 1995 Consolidated Statement of Common Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995 Notes to Consolidated Financial Statements Report of Independent Public Accountants Selected Supplemental Information
(2) The following is a list of the Financial Statement Schedules filed herewith as part of this report on Form 10-K:
(3) Exhibits- The exhibits filed herewith as a part of this report on Form 10-K are listed on the Exhibit Index included on pages 72-75. Each management contract or compensatory plan or arrangement of Industries listed on the Exhibit Index is separately identified by an asterisk.
(b) Reports on Form 8-K None
SIGNATURES
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, HEREUNTO DULY AUTHORIZED.
NIPSCO Industries, Inc. (Registrant)
March 24, 1998 /s/ Gary L. Neale Date ________________________________ By___________________________________ Gary L. Neale, Its Chairman and President
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
NIPSCO INDUSTRIES, INC. AND SUBSIDIARIES
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEET
The accompanying notes to condensed financial statements are an integral part of this statement.
NIPSCO INDUSTRIES, INC. AND SUBSIDIARIES
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENT OF INCOME
- -------- *Amounts restated to reflect two-for-one stock split paid February 20, 1998, to shareholders of record at the close of business on January 30, 1998.
The accompanying notes to condensed financial statements are an integral part of this statement.
NIPSCO INDUSTRIES, INC. AND SUBSIDIARIES
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENT OF CASH FLOWS
The accompanying notes to condensed financial statements are an integral part of this statement.
NIPSCO INDUSTRIES, INC. AND SUBSIDIARIES
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. DIVIDENDS FROM SUBSIDIARIES
Cash dividends paid to NIPSCO Industries, Inc. (Industries) by its consolidated subsidiaries were (in thousands of dollars): $188,175, $184,750 and $183,475 in 1997, 1996, and 1995, respectively.
2. SUPPORT AGREEMENT
The obligations of NIPSCO Capital Markets, Inc. (Capital Markets) are subject to a Support Agreement between Industries and Capital Markets, under which Industries has committed to make payments of interest and principal on Capital Markets' obligations in the event of a failure to pay by Capital Markets. Restrictions in the Support Agreement prohibit recourse on the part of Capital Markets' creditors against the stock and assets of Northern Indiana Public Service Company (Northern Indiana) which are owned by Industries. Under the terms of the Support Agreement, in addition to the cash flow of cash dividends paid to Industries by any of its consolidated subsidiaries, the assets of Industries, other than the stock and assets of Northern Indiana, are available as recourse for the benefit of Capital Markets' creditors. The carrying value of the assets of Industries, other than the assets of Northern Indiana, reflected in the consolidated financial statements of Industries, was approximately $1.3 billion at December 31, 1997.
3. CONTINGENCIES
Industries and its subsidiaries are parties to various pending proceedings, including suits and claims against them for personal injury, death and property damage. Such proceedings and suits, and the amounts involved are routine litigation and proceedings for the kinds of businesses conducted by Industries and its subsidiaries, except as described under the captions "NESI Energy Marketing Canada Ltd. Litigation," and "Environmental Matters" in the Notes to Consolidated Financial Statements in Item 8, which notes are incorporated by reference. No other material legal proceedings against Industries or its subsidiaries are pending or, to the knowledge of Industries, contemplated by governmental authorities or other parties.
4. CHANGES IN ACCOUNTING PRINCIPLES
At December 31, 1997, Industries adopted Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings per Share." As a result of adopting SFAS No. 128, previously reported earnings per share information has been restated. The effect of this accounting change on previously reported earnings per share data is insignificant.
The net income, preferred dividends and shares used to compute basic and diluted earnings per share is presented in the following table:
5. STOCK SPLIT
On December 16, 1997, the Board of Directors authorized a two-for-one split of Industries' common stock. Shareholders received one additional common share for each common share held. The stock split was paid February 20, 1998, to shareholders of record at the close of business on January 30, 1998. All references to number of shares reported for the period including per share amounts and stock option data of Industries' common stock have been restated to reflect the two-for-one stock split. The common share cash dividend paid February 20, 1998 was paid on pre-split common shares.
6. PURCHASE OF IWC RESOURCES CORPORATION
On March 25, 1997, Industries acquired all the outstanding common stock of IWCR for $290.5 million. Industries financed this transaction with debt of approximately $83.0 million and issuance of approximately 10.6 million Industries' common shares. Industries accounted for the acquisition as a purchase. The purchase price was allocated to the assets and liabilities acquired based on their fair values.
7. PURCHASE OF BAY STATE GAS COMPANY
On December 18, 1997, Industries and Bay State Gas Company (Bay State) signed a definitive merger agreement under which Industries will acquire all of the common stock of Bay State in a stock-for-stock transaction valued at $40 per Bay State share. The transaction is valued at approximately $540 million. Bay State shareholders will have the option of taking up to 50 percent of the total purchase price in cash. Consummation of the merger is subject to certain closing conditions, including the approval by the shareholders of Bay State as well as the Securities and Exchange Commission, FERC and state regulatory agencies in Massachusetts, New Hampshire and Maine. The transaction is expected to be completed in late 1998.
Bay State, one of the largest natural gas utilities in New England, provides natural gas distribution service to more than 300,000 customers in Massachusetts, New Hampshire and Maine. The combined gas utilities will be one of the 10 largest natural gas distribution systems in the nation, servicing more than 1 million gas customers. In addition, Industries and Bay State anticipate entering into a joint marketing agreement early in 1998 that will expand the operations of Bay State's non-regulated energy service companies.
NIPSCO INDUSTRIES, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
TWELVE MONTHS ENDED DECEMBER 31, 1997
- -------- (a) Industries acquired IWCR in March 1997.
NIPSCO INDUSTRIES, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
TWELVE MONTHS ENDED DECEMBER 31, 1996
NIPSCO INDUSTRIES, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
TWELVE MONTHS ENDED DECEMBER 31, 1995
EXHIBIT INDEX
- -------- *Management contract or compensatory plan arrangement of NIPSCO Industries Inc.