1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly period ended JUNE 30, 2001 ------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition period from ______ to ______ Commission file number 001-16189 --------- NISOURCE INC. ------------- (Exact Name of Registrant as Specified in its Charter) Delaware 35-2108964 --------------------------------------------------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 801 East 86th Avenue, Merrillville, IN 46410 --------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (877) 647-5990 -------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.[X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common Stock, $0.01 Par Value: 206,738,447 shares outstanding at June 30, 2001.
2 NISOURCE INC. FORM 10-Q QUARTERLY REPORT FOR THE QUARTER ENDED JUNE 30, 2001 TABLE OF CONTENTS <TABLE> <CAPTION> Page ---- PART I FINANCIAL INFORMATION - ------ --------------------- <S> <C> <C> Item 1. Financial Statements Statements of Consolidated Income.......................... 3 Consolidated Balance Sheets................................ 4 Statements of Consolidated Cash Flows...................... 6 Statements of Consolidated Common Shareholder's Equity..... 7 Notes to Consolidated Financial Statements................. 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 17 Item 3. Quantitative and Qualitative Disclosures About Market Risk. 36 PART II OTHER INFORMATION - ------ ----------------- Item 1. Legal Proceedings.......................................... 37 Item 2. Changes in Securities and Use of Proceeds.................. 39 Item 3. Defaults Upon Senior Securities............................ 39 Item 4. Submission of Matters to a Vote of Security Holders........ 39 Item 5. Other Information.......................................... 39 Item 6. Exhibits and Reports on Form 8-K........................... 39 Signature.......................................................... 40 </TABLE> 2
3 PART I ITEM 1. FINANCIAL STATEMENTS NISOURCE INC. STATEMENTS OF CONSOLIDATED INCOME (unaudited) <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, ---------------------------- ---------------------- (in millions) 2001 2000 2001 2000 ====================================================================================================================== <S> <C> <C> <C> <C> NET REVENUES Gas Distribution $ 754.3 $ 201.5 $2,797.8 $ 644.5 Gas Transmission and Storage 140.8 30.7 311.2 45.8 Electric 246.0 241.1 492.8 483.0 Exploration and Production 21.7 - 69.9 - Merchant Operations 650.0 474.7 1,875.7 834.1 Other 62.0 55.1 125.5 102.0 - ---------------------------------------------------------------------------------------------------------------------- Gross Revenues 1,874.8 1,003.1 5,672.9 2,109.4 Cost of Sales 1,163.1 679.5 3,863.4 1,360.8 - ---------------------------------------------------------------------------------------------------------------------- Total Net Revenues 711.7 323.6 1,809.5 748.6 - ---------------------------------------------------------------------------------------------------------------------- OPERATING EXPENSES Operation and maintenance 338.1 141.9 704.6 286.4 Depreciation, depletion and amortization 155.0 80.2 316.1 160.2 Other taxes 61.4 18.3 159.3 44.1 Impairment of telecommunication assets 9.2 - 9.2 - - ---------------------------------------------------------------------------------------------------------------------- Total Operating Expenses 563.7 240.4 1,189.2 490.7 - ---------------------------------------------------------------------------------------------------------------------- OPERATING INCOME 148.0 83.2 620.3 257.9 - ---------------------------------------------------------------------------------------------------------------------- OTHER INCOME (DEDUCTIONS) Interest expense, net (149.3) (45.3) (312.6) (89.8) Minority interest (5.1) (5.0) (10.2) (10.0) Dividend requirements on preferred stock of subsidiaries (1.9) (2.0) (3.8) (4.0) Other, net 6.8 1.5 11.4 3.9 - ---------------------------------------------------------------------------------------------------------------------- Total Other Income (Deductions) (149.5) (50.8) (315.2) (99.9) - ---------------------------------------------------------------------------------------------------------------------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES (1.5) 32.4 305.1 158.0 INCOME TAXES 4.8 11.0 127.2 57.5 - ---------------------------------------------------------------------------------------------------------------------- INCOME (LOSS) FROM CONTINUING OPERATIONS (6.3) 21.4 177.9 100.5 - ---------------------------------------------------------------------------------------------------------------------- Income (Loss) from Discontinued Operations - net of taxes (1.7) 2.0 (1.1) 2.5 Change in Accounting- net of taxes - - 4.0 - - ---------------------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) $ (8.0) $ 23.4 $ 180.8 $ 103.0 ===================================================================================================================== BASIC EARNINGS (LOSS) PER SHARE ($) Continuing operations (0.03) 0.18 0.87 0.82 Discontinued operations (0.01) 0.01 (0.01) 0.02 Change in accounting - - 0.02 - - ---------------------------------------------------------------------------------------------------------------------- BASIC EARNINGS (LOSS) PER SHARE (0.04) 0.19 0.88 0.84 - ---------------------------------------------------------------------------------------------------------------------- DILUTED EARNINGS (LOSS) PER SHARE ($) Continuing operations (0.03) 0.17 0.85 0.79 Discontinued operations (0.01) 0.01 (0.01) 0.02 Change in accounting - - 0.02 - - ---------------------------------------------------------------------------------------------------------------------- DILUTED EARNINGS (LOSS) PER SHARE (0.04) 0.18 0.86 0.81 - ---------------------------------------------------------------------------------------------------------------------- BASIC AVERAGE COMMON SHARES OUTSTANDING (MILLIONS) 205.3 120.6 205.2 122.2 DILUTED AVERAGE COMMON SHARES (MILLIONS) 205.3 124.7 209.7 126.4 - ---------------------------------------------------------------------------------------------------------------------- </TABLE> The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 3
4 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> JUNE 30, December 31, (in millions) 2001 2000 ========================================================================================================= (unaudited) <S> <C> <C> ASSETS PROPERTY, PLANT AND EQUIPMENT Utility Plant $ 15,863.7 $ 15,825.3 Accumulated depreciation and amortization (7,507.7) (7,299.4) - --------------------------------------------------------------------------------------------------------- Net utility plant 8,356.0 8,525.9 - --------------------------------------------------------------------------------------------------------- Gas and oil producing properties, full cost method United States cost center 961.1 923.6 Canadian cost center 21.6 19.7 Accumulated depletion (36.8) (9.1) - --------------------------------------------------------------------------------------------------------- Net gas and oil producing properties 945.9 934.2 - --------------------------------------------------------------------------------------------------------- Other property, at cost, less accumulated depreciation 83.2 86.6 - --------------------------------------------------------------------------------------------------------- Net Property, Plant and Equipment 9,385.1 9,546.7 - --------------------------------------------------------------------------------------------------------- INVESTMENTS AND OTHER ASSETS Net assets of discontinued operations 588.5 560.4 Unconsolidated affiliates 103.7 96.1 Assets held for sale 100.3 33.5 Other investments 49.7 54.1 - --------------------------------------------------------------------------------------------------------- Total Investments 842.2 744.1 - --------------------------------------------------------------------------------------------------------- CURRENT ASSETS Cash and cash equivalents 142.7 193.0 Accounts receivable (less reserve of $53.1 and $43.3, respectively) 930.9 1,490.2 Other receivables 30.7 23.5 Gas inventory 186.1 322.5 Underrecovered gas and fuel costs 74.4 396.1 Materials and supplies, at average cost 71.6 68.7 Electric production fuel, at average cost 33.2 15.6 Price risk management assets 479.9 1,568.5 Exchange gas receivable 528.0 615.9 Prepayments and other 292.3 223.6 - --------------------------------------------------------------------------------------------------------- Total Current Assets 2,769.8 4,917.6 - --------------------------------------------------------------------------------------------------------- OTHER ASSETS Regulatory assets 522.5 517.1 Intangible assets, less accumulated amortization 3,673.1 3,603.6 Deferred charges and other 502.5 367.7 - --------------------------------------------------------------------------------------------------------- Total Other Assets 4,698.1 4,488.4 - --------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 17,695.2 $ 19,696.8 ========================================================================================================= </TABLE> The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 4
5 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> JUNE 30, December 31, (in millions) 2001 2000 =============================================================================================== (unaudited) <S> <C> <C> CAPITALIZATION AND LIABILITIES CAPITALIZATION Common Stock Equity $ 3,499.5 $ 3,415.2 Preferred Stocks-- Subsidiary Companies Series without mandatory redemption provisions 83.6 83.6 Series with mandatory redemption provisions 48.9 49.1 Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely Company debentures 345.0 345.0 Long-term debt, excluding amounts due within one year 6,125.8 5,802.7 - ----------------------------------------------------------------------------------------------- Total Capitalization 10,102.8 9,695.6 - ----------------------------------------------------------------------------------------------- CURRENT LIABILITIES Current portion of long-term debt 97.5 64.8 Short term borrowings 1,937.1 2,496.7 Accounts payable 492.0 1,117.1 Dividends declared on common and preferred stocks 60.8 1.0 Customer deposits 34.4 32.1 Taxes accrued 195.2 189.3 Interest accrued 69.8 78.0 Overrecovered gas and fuel costs 119.3 - Price risk management liabilities 352.8 1,529.2 Exchange gas payable 261.6 360.5 Current deferred revenue 278.9 451.5 Other accruals 476.1 573.2 - ----------------------------------------------------------------------------------------------- Total Current Liabilities 4,375.5 6,893.4 - ----------------------------------------------------------------------------------------------- OTHER LIABILITIES AND DEFERRED CREDITS Deferred income taxes 1,847.1 1,806.2 Deferred investment tax credits 109.8 114.3 Deferred credits 386.2 337.3 Noncurrent deferred revenue 493.0 498.0 Accrued liability for postretirement benefits 275.6 272.5 Other noncurrent liabilities 105.2 79.5 - ----------------------------------------------------------------------------------------------- Total Other 3,216.9 3,107.8 - ----------------------------------------------------------------------------------------------- COMMITMENTS AND CONTINGENCIES - - - ----------------------------------------------------------------------------------------------- TOTAL CAPITALIZATION AND LIABILITIES $ 17,695.2 $ 19,696.8 =============================================================================================== </TABLE> The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 5
6 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. STATEMENTS OF CONSOLIDATED CASH FLOWS (unaudited) <TABLE> <CAPTION> Six Months Ended June 30, ----------------------- (in millions) 2001 2000 - ------------------------------------------------------------------------------------------------- <S> <C> <C> OPERATING ACTIVITIES Net income $ 180.8 $ 103.0 Adjustments to reconcile net income to net cash from continuing operations: Depreciation, depletion, and amortization 316.1 160.2 Net changes in price risk management activities (2.7) (11.0) Asset impairment 9.2 - Deferred income taxes (99.4) (39.1) Deferred revenue (177.6) - Income from change in accounting (4.0) - Income from discontinued operations 1.1 (2.5) Other, net (9.5) 11.1 - ------------------------------------------------------------------------------------------------- 214.0 221.7 - ------------------------------------------------------------------------------------------------- Changes in components of working capital, net of effect from acquisitions of businesses: Accounts receivable, net 558.0 (51.8) Inventories 115.9 (27.2) Accounts payable (636.1) 80.7 Taxes accrued 70.7 (1.0) (Under) Overrecovered gas and fuel costs 441.0 44.8 Exchange gas receivable/payable (11.0) - Other accruals (60.2) 3.3 Other working capital (160.1) (48.6) - ------------------------------------------------------------------------------------------------- Net Cash from Continuing Operations 532.2 221.9 Net Cash from Discontinued Operations - - - ------------------------------------------------------------------------------------------------- Net Cash from Operating Activities 532.2 221.9 - ------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Capital expenditures (195.5) (100.3) Proceeds from disposition of assets - - Other investing activities, net 15.3 (10.2) - ------------------------------------------------------------------------------------------------- Net Investing Activities (180.2) (110.5) - ------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Issuance of long-term debt 300.0 - Retirement of long-term debt (36.9) (158.6) Change in short-term debt (559.6) 182.0 Retirement of preferred shares (0.3) (1.5) Issuance of common stock 13.5 5.6 Acquisition of treasury stock - (65.8) Dividends paid - common shares (120.2) (66.0) Other financing activities, net - 0.2 - ------------------------------------------------------------------------------------------------- Net Financing Activities (403.5) (104.1) - ------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents (51.5) 7.3 Cash and cash equivalents at beginning of year 193.0 41.4 - ------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 141.5 $ 48.7 ================================================================================================= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid for interest, net of amounts capitalized 320.9 96.7 Cash paid for income taxes 138.0 99.0 - ------------------------------------------------------------------------------------------------- </TABLE> The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 6
7 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. STATEMENTS OF CONSOLIDATED SHAREHOLDER'S EQUITY (unaudited) <TABLE> <CAPTION> ADDITIONAL ACCUM. COMMON TREASURY PAID-IN RETAINED OTHER COMP. COMP. (DOLLARS IN MILLIONS) SHARES SHARES CAPITAL EARNINGS OTHER INCOME TOTAL INCOME - --------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> BALANCE JANUARY 1, 2000 870.9 (472.5) 174.4 774.4 1.1 5.2 1,353.5 Comprehensive Income: Net Income 103.0 103.0 103.0 Other comprehensive income, net of tax: Gain/loss on available for sale securities: Unrealized (0.3) (0.3) (0.3) Realized 0.3 0.3 0.3 Gain/loss on foreign currency translation: Unrealized 0.4 0.4 0.4 - --------------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 103.4 Dividends: Common shares (65.6) (65.6) Treasury shares acquired (65.8) (65.8) Issued: Employee stock purchase plan 0.3 0.4 0.7 Long-term incentive plan 19.4 (14.0) 1.5 Amortization of unearned compensation 2.4 2.4 Equity contract costs (2.0) (2.0) Other 0.8 (2.3) (1.5) - --------------------------------------------------------------------------------------------------------------------------------- BALANCE JUNE 30, 2000 870.9 (518.6) 173.6 809.5 (10.5) 5.6 1,330.5 - --------------------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------------------- BALANCE JANUARY 1, 2001 2.0 - 2,585.1 829.8 (6.1) 4.4 3,415.2 Comprehensive Income: Net Income 180.8 180.8 180.8 Other comprehensive income, net of tax: Gain/loss on foreign currency translation: Unrealized (1.2) (1.2) (1.2) Net unrealized gains on derivatives qualifying as cash flow hedges 65.4 65.4 65.4 - --------------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 245.0 Dividends: Common shares (180.0) (180.0) Treasury shares acquired Issued: Employee stock purchase plan 6.3 (2.1) 4.2 Long-term incentive plan 28.4 (19.1) 9.3 Amortization of unearned compensation 7.7 7.7 Equity contract costs (1.9) (1.9) - --------------------------------------------------------------------------------------------------------------------------------- BALANCE JUNE 30, 2001 2.0 - 2,617.9 830.6 (19.6) 68.6 3,499.5 - --------------------------------------------------------------------------------------------------------------------------------- </TABLE> <TABLE> COMMON TREASURY COMMON TREASURY SHARES (IN THOUSANDS) SHARES SHARES SHARES SHARES - ------------------------------------------------- ----------------------------------------------------- <S> <C> <C> <C> <C> <C> BALANCE JANUARY 1, 2000 147,784 (23,665) BALANCE JANUARY 1, 2001 205,553 - Treasury shares acquired (3,964) Treasury shares acquired Issued: Issued: Employee stock purchase plan 43 Employee stock purchase plan 10 Long-term incentive plan 965 Long-term incentive plan 1,175 - ------------------------------------------------- ----------------------------------------------------- BALANCE JUNE 30, 2000 147,784 (26,601) BALANCE JUNE 30, 2001 206,738 - ================================================= ===================================================== </TABLE> 7
8 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Accounting Presentation The accompanying unaudited consolidated financial statements for NiSource Inc. (NiSource) reflect all normal recurring adjustments that are necessary, in the opinion of management, to present fairly the results of operations in accordance with generally accepted accounting principles. The accompanying financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in NiSource's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. Income for interim periods may not be indicative of results for the calendar year due to weather variations and other factors. Certain reclassifications have been made to the 2000 financial statements to conform to the 2001 presentation. 2. Diluted Average Common Shares Computation Basic earnings per share (EPS) is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. The weighted average shares outstanding for diluted EPS include the incremental effect of the various long-term incentive compensation plans. For 2001, the weighted average shares outstanding for diluted EPS also includes the incremental effect of the forward equity contract associated with the Stock Appreciation Income Linked SecuritiesSM (SAILSSM). For 2000, the incremental effect of common shares associated with another equity forward purchase contract, calculated under the reverse treasury stock method is also included in the weighted average shares outstanding for diluted EPS. On December 26, 2000, the contract was terminated. The numerator in calculating both basic and diluted EPS for each year is reported net income. The computation of diluted average common shares follows: <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, -------------------- -------------------- 2001 2000 2001 2000 -------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> DENOMINATOR Basic average common shares outstanding 205,308.8 120,569.5 205,175.1 122,203.7 Dilutive potential common shares - 4,085.4 4,487.5 4,191.8 -------------------------------------------------------------------------------------- Diluted Average Common Shares 205,308.8 124,654.9 209,662.6 126,395.5 -------------------------------------------------------------------------------------- </TABLE> Due to the net loss that was reported for the three months ended June 30, 2001, the addition of potential common shares was anti-dilutive and is therefore not included. 3. Acquisition On November 1, 2000, NiSource completed its acquisition of Columbia Energy Group (Columbia) for an aggregate consideration of approximately $6 billion, consisting of $3,888 million in cash, 72.4 million shares of common stock valued at $1,761 million, and SAILSSM (units consisting of a zero coupon debt security coupled with a forward equity contract in NiSource shares) valued at $114 million. NiSource also assumed approximately $2 billion in Columbia debt. NiSource accounted for the acquisition in accordance with the purchase method of accounting. The purchase price was allocated to the assets and liabilities acquired based on the fair value of those assets and liabilities as of the acquisition date. Based upon the nature of the regulatory environment in which Columbia's rate-regulated subsidiaries operate, the fair value of rate-regulated assets and liabilities are generally considered to be historic cost. The excess of the aggregate purchase price over the estimated fair value of the net assets acquired, approximately $3.7 billion, is reflected as goodwill in the consolidated financial statements and is being amortized on a straight-line basis over forty years. In the second quarter of 2001, NiSource increased goodwill by $63.9 million resulting from a revision of the fair value of the net assets acquired in the acquisition of Columbia Energy Group. The revised estimates were primarily associated with the resolution of some uncertainties surrounding the net assets of Columbia Transmission Communications Corporation (Transcom), the Company's fiber optic network. 8
9 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. NiSource may make additional adjustments to the allocation of the purchase price assumptions based on the ultimate resolution of contingencies existing at the acquisition date. The Company does not anticipate that the final evaluation of these issues will materially affect the allocation of the purchase price. 4. Restructuring Activities During 2000, NiSource implemented a plan to restructure its operations as a result of the acquisition of Columbia discussed above. The restructuring plan included a severance program, a transition plan to implement operational efficiency throughout NiSource's operations and a voluntary early retirement program. As a result of the restructuring plan, it is estimated that approximately 900 management, professional, administrative and technical positions have been or will be eliminated. As of June 30, 2001, approximately 611 employees had been terminated as a result of the restructuring plan. In October 2000, NiSource recorded pre-tax charges of $5.8 million in operating expense representing severance and related benefits costs. This charge included $5.1 million of estimated termination benefits. In addition, NiSource assumed $66.9 million in liabilities related to the restructuring of Columbia's operations representing severance and related benefits costs and relocation of certain operations. At June 30, 2001, the consolidated balance sheet reflected a liability of $40.3 million related to the restructuring plan. 5. Discontinued Operations and Assets Held for Sale The Securities and Exchange Commission (SEC), in its order approving the acquisition of Columbia, required NiSource to divest its water utilities within three years from the date of the acquisition. In January 2001, NiSource adopted a formal plan to dispose of its water utilities within one year. The water utilities operations are reported as discontinued operations. See Note 6 on page 10 for further discussion. Results from discontinued operations of the water utilities are provided in the following table: <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, -------------------------------------------------- ($ in millions) 2001 2000 2001 2000 ---------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Revenues from discontinued operations 27.0 25.9 51.8 49.7 Income (Loss) from discontinued operations (2.0) 3.9 (0.2) 5.8 Income tax expense (benefit) (0.3) 1.9 0.9 3.3 Net income (loss) from discontinued operations (1.7) 2.0 (1.1) 2.5 ---------------------------------------------------------------------------------------------- </TABLE> On May 22, 2000, as a result of its ongoing strategic assessment, Columbia announced that it decided to sell its propane operations, which consists of Columbia Propane Corporation and its subsidiaries (Columbia Propane). On January 31, 2001, Columbia signed a definitive agreement to sell the stock and assets of Columbia Propane to AmeriGas Partners L.P. (AmeriGas) for approximately $208 million, consisting of $155 million of cash and $50 million of AmeriGas partnership common units. The transaction is expected to close in the third quarter of 2001. NiSource has also sold substantially all the assets of Columbia Petroleum Corporation (Columbia Petroleum), a diversified petroleum distribution company. The net assets of the water utilities, Columbia Propane and Columbia Petroleum are reported as net assets of discontinued operations on the consolidated balance sheets. 9
10 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. The net assets of the discontinued operations were as follows: <TABLE> <CAPTION> JUNE 30, December 31, ($ in millions) 2001 2000 ---------------------------------------------------------------------------------------- <S> <C> <C> NET ASSETS OF DISCONTINUED OPERATIONS Accounts receivable, net $ 49.6 $ 107.8 Property, plant and equipment, net 884.8 891.3 Other assets 130.2 173.8 Current liabilities (113.8) (148.2) Debt (91.8) (169.4) Other liabilities (270.5) (294.9) ---------------------------------------------------------------------------------------- NET ASSETS OF DISCONTINUED OPERATIONS $ 588.5 $ 560.4 ---------------------------------------------------------------------------------------- </TABLE> As a result of project delays, cost overruns, and the economics of the fiber optics market that have occurred since the acquisition of Columbia, NiSource recorded a charge of $9.2 million to operating income in the second quarter of 2001, related to Transcom, a fiber optics telecommunications network. In September and October 2000, management held discussions with investment banking firms seeking strategic options for the Transcom assets. Although significant uncertainties existed surrounding the estimated costs to complete the fiber optic network, time to market in a competitive environment, and delays due to construction deficiencies and environmental issues, the decision was made to complete the Transcom network and sell the assets. The Company has received subsequent information pertaining to the estimated construction costs and delays. Consequently, management has concluded that the carrying value of the telecommunication assets exceeds the realizable value by approximately $89.2 million. Given the resolution of certain uncertainties related to Transcom that existed when NiSource acquired Columbia, the purchase price allocation relating to the Transcom assets is now essentially complete and goodwill resulting from the acquisition of Columbia has been increased by the after-tax impact of the excess carrying amount of $52.0 million. 6. Sale of Water Utility Operations In July 2001, NiSource and the City of Indianapolis (City) signed a letter of intent for NiSource to sell the assets of the Indianapolis Water Company and other assets of NiSource's IWC Resources (IWCR) Corporation and its subsidiaries for $522.5 million, which includes $132.4 million in IWCR debt. In the transaction, NiSource will retain $80 million of long-term Indianapolis Water Company debt. As part of the agreement, the City has committed to offering IWCR employees comparable employment following completion of the sale and will honor all collective bargaining agreements. The divestiture of IWCR was required as part of the order by the SEC approving the November 2000 acquisition of Columbia Energy Group. Closing of the sale is contingent upon the receipt of all necessary consents, including approval by the Indiana Utility Regulatory Commission and the ability of the City to obtain financing. 7. Accounting Change Effective January 1, 2001, NiSource adopted the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", as subsequently amended by SFAS No. 137 and SFAS No. 138 (collectively referred to as SFAS No. 133). These statements establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and resulting designation. 10
11 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. The adoption of this statement on January 1, 2001, resulted in a cumulative after-tax increase to net income of approximately $4 million and an after-tax reduction to other comprehensive income (OCI) of approximately $17 million. The adoption also resulted in the recognition of $178 million of assets and $212.8 million of liabilities on the consolidated balance sheet. Additionally, the adoption resulted in the reduction of hedged risk basis of $3.8 million and the reclassification of deferred revenue to OCI of $17.9 million. During the second quarter of 2001 and year-to-date, approximately $5.4 million and $11.6 million, respectively, of the net losses previously included in the cumulative effect of a change in accounting principle component of OCI were reclassified into earnings. Further detail of the assets and liabilities recorded on the consolidated financial statements for the adoption of SFAS No. 133 is as follows: <TABLE> <CAPTION> (in millions) ASSETS LIABILITIES ---------------------------------------------------------------------------- <S> <C> <C> Price Risk Management $ 161.6 $ 219.9 Deferred Taxes - (7.1) Regulatory 16.4 - Debt - (3.8) Deferred Revenue - (17.9) ---------------------------------------------------------------------------- TOTAL $ 178.0 $ 191.1 ---------------------------------------------------------------------------- </TABLE> As stated above, the initial recording of the cumulative effect of this accounting change included unrealized holding losses of $17.0 million. However, the activity for the first half of 2001 and the second quarter resulted in unrealized gains on qualifying derivatives of $65.5 million and $36.8, respectively. The activity for the periods included: <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, -------------- -------------- (in millions) 2001 2001 ------------------------------------------------------------------------------------------------ <S> <C> <C> UNREALIZED GAINS ON DERIVATIVES QUALIFYING AS CASH FLOW HEDGES: Unrealized holding losses arising during the period due to cumulative effect of a change in accounting principle, recognized at January 1, 2001, net of tax $ - $ (17.0) Unrealized holding gains arising during the period on derivatives qualifying as cash flow hedges, net of tax 32.2 71.6 Reclassification adjustment for net loss included in net income, net of tax (including losses of $5.4 and $11.6 million, respectively, related to the cumulative effect of change in accounting principle) 4.6 10.9 ------------------------------------------------------------------------------------------------ Net unrealized gains on derivatives qualifying as cash flow hedges, net of tax $ 36.8 $ 65.5 ------------------------------------------------------------------------------------------------ </TABLE> NiSource's senior management takes an active role in the risk management process and has developed policies and procedures that require specific administrative and business functions to assist in the identification, assessment and control of various risks. In recognition of the increasingly varied and complex nature of the energy business, NiSource's risk management policies and procedures continue to evolve and are subject to ongoing review and modification. Following is additional information regarding the impact of SFAS No. 133 by segment. 11
12 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. Gas Distribution For regulatory incentive purposes, the Columbia gas distribution subsidiaries (Columbia LDCs) enter into contracts that allow counterparties the option to sell gas to Columbia LDCs at specified prices during specified periods of time. Columbia LDCs charge the counterparties a fee for this option. The changes in the fair value of the options are primarily due to the difference between the cost of gas during the contracted delivery period and the market price of gas during that same period. Columbia LDCs defer a portion of the change in the fair value of the options as either a regulatory asset or liability in accordance with SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation." The remaining change is recognized currently in earnings. Northern Indiana Public Service Company (Northern Indiana) offers a Price Protection Service as an alternative to the standard gas cost recovery mechanism. This service provides Northern Indiana customers with the option to either lock in their gas cost or place a cap on the total cost that could be charged for any future month specified. In order to hedge the anticipated physical future purchases associated with these obligations, Northern Indiana purchases NYMEX futures and options contracts that correspond to a fixed or capped price and the associated delivery month. The NYMEX futures and options contracts satisfy all definitions of a derivative and they qualify and are designated as a cash flow hedge. Northern Indiana has no net gain or loss recognized in earnings due to ineffectiveness or time value for this program in the reporting period and none of the components of the derivative instruments' value are excluded in its assessment of hedge effectiveness. It is anticipated that during the next 12 months, expiration of futures and options contracts will result in income recognition of amounts currently classified in OCI of approximately $5.7 million, which will be included in net income. Northern Indiana has futures and options contracts designated as cash flow hedges through June 2002. At this time Northern Indiana expects to continue its cash flow hedges due to the probability that the forecasted transaction will occur. Northern Utilities, Inc. offers a Guaranteed Price Service Program as an alternative to the standard gas cost recovery mechanism. This service provides Bay State customers with the option to lock in their gas cost. In order to hedge the anticipated physical future purchases associated with these obligations, Bay State purchases NYMEX futures that correspond to a fixed price and the associated delivery month. The NYMEX futures contracts satisfy all definitions of a derivative. Because these derivatives are used within the framework of the overall gas cost incentive mechanism, regulatory assets or liabilities are recorded to offset the change in the fair value of these derivatives. Northern Indiana and Bay State Gas Company also engage in writing options that potentially obligate them to purchase or sell gas at the holder's discretion at some future market-based price. These written options are derivative instruments, must be marked to fair value and do not meet the requirement for hedge accounting treatment. Northern Indiana also uses NYMEX derivative contracts to minimize its gas costs. These contracts do not qualify for hedge accounting and must be marked to fair value. Because these derivatives are used within the framework of its gas cost incentive mechanism, Northern Indiana may ultimately share in a portion of the gains or losses on these options with the ratepayers. Regulatory assets or liabilities are recorded to offset the change in the fair value of these derivatives until there is certainty as to the level of sharing, if any. Exploration and Production In conjunction with certain fixed price gas delivery commitments, Columbia Energy Resources, Inc. (Columbia Resources) has purchased financial basis swaps to transfer basis risk from the counterparty back to Columbia Resources. Because these transactions by definition are derivatives and do not qualify for hedge accounting, the mark to fair value of these swaps will directly impact earnings. Additionally, Columbia Resources has engaged in commodity and basis swaps to hedge the anticipated future sale of natural gas. These contracts are derivatives and are designated as cash flow hedges of anticipated future sales. The fair value of these derivatives will be recorded in OCI until the related sale occurs. Any ineffectiveness will be charged to earnings. Columbia Resources has a net gain of approximately $0.5 million recognized in earnings due to time value in the reporting period and has not excluded components of the derivatives' values in its assessment of hedge effectiveness. It is anticipated that during the next 12 months, expiration of forward swap contracts will result in income recognition for amounts currently classified in OCI of approximately $15.2 million, which will be included in net income. Columbia 12
13 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. Resources has forward derivative contracts designated as cash flow hedges through December 2002. At this time, Columbia Resources expects to continue the majority of its cash flow hedges due to the probability that the forecasted events will occur. Merchant Operations EnergyUSA-TPC Corp. (TPC) is affected by SFAS No. 133 on a corporate basis relative to certain intercompany sales contracts. These contracts on a stand-alone basis are trading contracts to TPC; however, because counterparties are consolidated affiliates, TPC may not mark them to fair value on a consolidated basis. Certain corresponding, offsetting third-party forward purchase commitments or long futures contracts are designated as cash flow hedges. The mark to fair value impact of the effective portions of these hedges is offset in OCI. The impact of remaining sales contracts without offsetting purchase commitments/futures is recorded currently in earnings on a consolidated basis. There is no net gain or loss recognized in earnings due to ineffectiveness or time value in the reporting period and no components of the derivatives' values have been excluded in the assessment of hedge effectiveness. It is anticipated that during the next 12 months, expiration of forward contracts will result in loss recognition of amounts currently classified in OCI of approximately $0.9 million, which will be included in net income. NiSource has designated certain TPC forward derivative contracts as cash flow hedges through September 2003. At this time, NiSource expects to continue its cash flow hedges due to the probability that the forecasted transactions will occur. Primary Energy, Inc. (Primary Energy) finances, builds and operates cogeneration plants that convert waste products into alternative forms of energy. Primary Energy finances the construction of these facilities by creating synthetic leases. A portion of the synthetic lease payment floats with a referenced interest rate, thus exposing Primary Energy to interest rate risks. Primary Energy engages in interest rate swaps to fix the floating payment and designates these instruments as cash flow hedges. They are assessed to effectively hedge the cash flow risk of the anticipated lease payments. Any earnings impact of changes in the swap's fair value is charged to OCI until the calculation period is settled. Any ineffectiveness is charged currently to earnings. Primary Energy has no net gain or loss recognized in earnings due to ineffectiveness or time value in the reporting period and it has not excluded any component of the derivative instrument's value in its assessment of hedge effectiveness. It is anticipated that during the next twelve months, expiration of interest rate swap contracts will result in loss recognition of amounts currently classified in OCI of approximately $0.7 million, which will be included in net income. Primary Energy has interest rate swap contracts designated as cash flow hedges through June 2002. At this time, Primary Energy expects to continue its cash flow hedges due to the probability that the forecasted transactions will occur. Other Columbia Energy Services, Inc. (Columbia Energy Services) has fixed price gas delivery commitments to three municipalities in the United States. Columbia Energy Services entered into a forward purchase agreement with a gas supplier, wherein the supplier will fulfill the delivery obligation requirements at a slight premium to index. In order to hedge this anticipated future purchase of gas from the gas supplier, Columbia Energy Services entered into pay fixed/receive floating swaps priced at the locations designated for physical delivery. These swaps are designated as cash flow hedges of the anticipated purchases. Any impact of changes in the swaps' fair values is included in OCI until the sales are completed. Any ineffectiveness is included in earnings. Columbia Energy Services has no net gain or loss recognized in earnings due to ineffectiveness or time value in the reporting period and it has not excluded any component of the derivative instruments' value in its assessment of hedge effectiveness. It is anticipated that during the next 12 months, expiration of forward swap contracts will result in income recognition of amounts currently classified in OCI of approximately $13.6 million, which will be included in net income. Columbia Energy Services has forward swap contracts designated as cash flow hedges through December 2008. At this time, Columbia Energy Services expects to continue its cash flow hedges due to the probability that the forecasted transactions will occur. Gas Transmission and Storage The adoption and application of SFAS 133 had no impact on this segment. 13
14 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. Electric Operations The adoption and application of SFAS 133 had no impact on this segment. Interest Rate Swaps Columbia utilizes fixed-to-floating interest rate swap agreements to modify the interest characteristics of a portion of its outstanding long-term debt. As a result of these transactions, $300 million of Columbia's long-term debt is now subject to fluctuations in interest rates. Columbia has no net gain or loss recognized in earnings due to ineffectiveness or time value in this reporting period. Columbia has not excluded any component of the derivative instruments' value in its assessments of hedge effectiveness. 8. Recently Issued Accounting Pronouncements On July 20, 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." The key concepts from the two interrelated Statements include mandatory use of the purchase method in accounting for business combinations, discontinuance of goodwill amortization, a revised framework for testing for goodwill impairment at a "reporting unit" level, and new criteria for the identification and potential amortization of other intangible assets. Other changes to existing accounting standards involve the amount of goodwill to be used in determining the gain or loss on the disposal of assets and a requirement to test goodwill for impairment at least annually under the revised framework. The Business Combinations Statement is generally effective for combinations that are initiated after June 30, 2001. The Statement on Goodwill and Other Intangible Assets is effective for fiscal years beginning after December 15, 2001; however, for business combinations consummated after June 30, 2001, the requirements to discontinue goodwill amortization are effective upon issuance of the Statements. The first part of the annual impairment test is to be performed within six months of adopting the Statement on Goodwill and Other Intangible Assets. NiSource will adopt the provisions of the Business Combinations Statement on July 1, 2001, and the Goodwill and Other Intangible Assets Statement on January 1, 2002. Although NiSource is currently evaluating the impact that the Statements will have on its results of operations, the Company expects the adoption of the Statement on Goodwill and Other Intangibles to have a significant favorable impact on operating income beginning January 1, 2002. It is estimated that NiSource will amortize approximately $95.0 million of goodwill during 2001. Effective January 1, 2002, goodwill will no longer be subject to amortization. In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." The Statement requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to then its present value, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The Statement is effective for fiscal years beginning after June 15, 2002, with earlier application encouraged. NiSource is currently evaluating the impact that the Statement will have on its results of operations. 14
15 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. 9. Business Segment Information Effective for the second quarter of 2001, NiSource realigned a portion of its operations and reclassified previously reported operating segment information to conform to the realigned operating structure. The realignment affected three previously reported segments, and included moving all ongoing operations of Energy Marketing and certain operations from the Electric Operations and Other segments to the newly created Merchant Operations segment. The electric wheeling, bulk power, and power trading operations were moved from the Electric Operations segment to Merchant Operations, and the Company's Primary Energy subsidiary, that develops on-site, industrial-based energy solutions, was moved from Other to Merchant Operations. NiSource's operations are divided into six primary business segments. The Gas Distribution segment provides natural gas service and transportation for residential, commercial and industrial customers in Ohio, Pennsylvania, Virginia, Kentucky, Maryland, Indiana, Massachusetts, Maine and New Hampshire. The Electric Operations segment provides electric service in 21 counties in the northern part of Indiana. The Gas Transmission and Storage segment offers gas transportation and storage services for local distribution companies, marketers and industrial and commercial customers located in northeastern, mid-Atlantic, midwestern and southern states and the District of Columbia. The Exploration and Production segment explores for, develops, produces and markets gas and oil in the United States and in Canada. The Merchant Operations segment provides energy-related services including gas marketing, electric wheeling, bulk power, power trading and asset management services to local distribution companies (LDC), wholesale, commercial and industrial customers, and participates in the development of non-rate regulated power projects. The Other segment participates in real estate, telecommunications and other businesses. The following tables provide information about business segments. NiSource uses operating income as its primary measurement for each of the reported segments and makes decisions on finance, dividends and taxes at the corporate level on a consolidated basis. Segment revenues include intersegment sales to affiliated subsidiaries, which are eliminated in consolidation. Affiliated sales are recognized on the basis of prevailing market, regulated prices or at levels provided for under contractual agreements. Operating income is derived from revenues and expenses directly associated with each segment. 15
16 ITEM 1. FINANCIAL STATEMENTS (continued) NISOURCE INC. <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, --------------------------- ---------------------------- ($ in millions) 2001 2000 2001 2000 =============================================================================================== <S> <C> <C> <C> <C> REVENUES GAS DISTRIBUTION Unaffiliated 761.0 194.4 2,812.4 631.6 Intersegment 5.9 24.6 18.5 60.0 - ----------------------------------------------------------------------------------------------- Total 766.9 219.0 2,830.9 691.6 - ----------------------------------------------------------------------------------------------- GAS TRANSMISSION AND STORAGE Unaffiliated 144.5 11.8 331.5 25.7 Intersegment 71.9 2.0 178.7 2.0 - ----------------------------------------------------------------------------------------------- Total 216.4 13.8 510.2 27.7 - ----------------------------------------------------------------------------------------------- ELECTRIC OPERATIONS Unaffiliated 246.2 241.1 492.9 483.1 Intersegment 0.5 0.7 1.1 1.3 - ----------------------------------------------------------------------------------------------- Total 246.7 241.8 494.0 484.4 - ----------------------------------------------------------------------------------------------- EXPLORATION AND PRODUCTION Unaffiliated 20.3 - 72.1 - Intersegment 26.6 - 28.5 - - ----------------------------------------------------------------------------------------------- Total 46.9 - 100.6 - - ----------------------------------------------------------------------------------------------- MERCHANT OPERATIONS Unaffiliated 659.5 487.7 1,880.9 842.6 Intersegment 40.1 22.1 100.6 45.0 - ----------------------------------------------------------------------------------------------- Total 699.6 509.8 1,981.5 887.6 - ----------------------------------------------------------------------------------------------- OTHER Unaffiliated 41.4 56.8 78.4 104.7 Intersegment - 10.4 - 20.2 - ----------------------------------------------------------------------------------------------- Total 41.4 67.2 78.4 124.9 - ----------------------------------------------------------------------------------------------- Adjustments and eliminations (143.1) (48.5) (322.7) (106.8) - ----------------------------------------------------------------------------------------------- CONSOLIDATED REVENUES 1,874.8 1,003.1 5,672.9 2,109.4 - ----------------------------------------------------------------------------------------------- </TABLE> <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, --------------------------- ---------------------------- ($ in millions) 2001 2000 2001 2000 - ----------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> OPERATING INCOME (LOSS) Gas Distribution 1.1 (7.5) 289.1 88.7 Gas Transmission and Storage 64.7 0.5 188.9 1.3 Electric Operations 73.8 79.3 147.5 154.2 Exploration and Production 15.7 - 36.9 - Merchant Operations 19.8 18.8 19.4 37.6 Other (16.0) 0.1 (45.1) (5.3) Corporate and Adjustments (11.1) (8.0) (16.4) (18.6) - ----------------------------------------------------------------------------------------------- CONSOLIDATED OPERATING INCOME 148.0 83.2 620.3 257.9 - ----------------------------------------------------------------------------------------------- </TABLE> 16
17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NISOURCE INC. CONSOLIDATED RESULTS The Management's Discussion and Analysis, including statements regarding market risk sensitive instruments, contains "forward-looking statements," within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Investors and prospective investors should understand that many factors govern whether any forward-looking statement contained herein will be or can be realized. Any one of those factors could cause actual results to differ materially from those projected. These forward-looking statements include, but are not limited to, statements concerning NiSource's plans, proposed dispositions, objectives, expected performance, expenditures and recovery of expenditures through rates, stated on either a consolidated or segment basis, and any and all underlying assumptions and other statements that are other than statements of historical fact. From time to time, NiSource may publish or otherwise make available forward-looking statements of this nature. All such subsequent forward-looking statements, whether written or oral and whether made by or on behalf of NiSource, are also expressly qualified by these cautionary statements. All forward-looking statements are based on assumptions that management believes to be reasonable; however, there can be no assurance that actual results will not differ materially. Realization of NiSource's objectives and expected performance is subject to a wide range of risks and can be adversely affected by, among other things, increased competition in deregulated energy markets, weather, fluctuations in supply and demand for energy commodities, successful consummation of proposed acquisitions and dispositions, growth opportunities for NiSource's regulated and non-regulated businesses, dealings with third parties over whom NiSource has no control, actual operating experience of acquired assets, NiSource's ability to integrate acquired operations into its operations, the regulatory process, regulatory and legislative changes, changes in general economic, capital and commodity market conditions, and counter-party credit risk, many of which factors are beyond the control of NiSource. In addition, the relative contributions to profitability by each segment, and the assumptions underlying the forward-looking statements relating thereto, may change over time. The following Management's Discussion and Analysis should be read in conjunction with NiSource's Annual Report on Form 10-K for the fiscal year ended December 31, 2000 (Form 10-K). SECOND QUARTER RESULTS Net Income NiSource reported a net loss of $8.0 million, or $0.04 per share, for the three months ended June 30, 2001, compared to net income of $23.4 million, or $0.19 per share, in the 2000 period. The results for 2001 and 2000 are not directly comparable due to the acquisition of Columbia Energy Group (Columbia) completed on November 1, 2000, as discussed in Note 3 on page 8. All per share amounts are basic earnings per share. Revenues Total consolidated net revenues (gross revenues less cost of sales) for the three months ended June 30, 2001, were $711.7 million, a $388.1 million increase over the same period last year. The increase is primarily attributable to the acquisition of Columbia. Expenses Operating expenses for the second quarter of 2001 were $563.7 million, as compared to $240.4 million in the 2000 period primarily due to the acquisition of Columbia. Operating expenses included additional goodwill amortization related to the Columbia acquisition of $25.4 million and the impairment of the telecommunications network, partially offset by a $6.4 million pre-tax gain on the exchange of an aircraft. See "Other - Telecommunications Network" on page 35 for more information. Other Income (Deductions) Interest expense was $149.3 million for the quarter, compared to $45.3 million in the second quarter of 2000, due to borrowing for the acquisition of Columbia, the interest on the Columbia outstanding debt and increased short-term borrowings due to the carrying costs associated with the elevated price of natural gas. Other, net for the second quarter of 2001 increased income by $6.8 million, compared to $1.5 million in the 2000 period, primarily due to additional interest income. 17
18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. Income Taxes Income tax expense for the second quarter of 2001 was $4.8 million, compared to $11.0 million in the 2000 period, due to lower pre-tax income in the current period and a higher effective tax rate because the amortization of goodwill is not tax deductible. Discontinued Operations Discontinued operations, which reflect NiSource's water operations, posted an after-tax loss of $1.7 million for the second quarter of 2001, compared to a gain of $2.0 million in the second quarter of 2000. The change is primarily attributed to interest expense. SIX MONTH RESULTS Net Income NiSource reported net income of $180.8 million, or $.88 per share, for the six months ended June 30, 2001, compared to $103.0 million, or $.84 per share, in the 2000 period. The results for 2001 and 2000 are not directly comparable due to the acquisition of Columbia. Revenues Total consolidated net revenues (gross revenues less cost of sales) for the six months ended June 30, 2001, were $1,809.5 million, a $1,060.9 million increase over the same period last year. The increase was primarily attributable to the acquisition of Columbia and increased gas sales by the distribution segment due to colder weather than the same period last year. Expenses Operating expenses for the first six months of 2001 were $1,189.2 million, compared to $490.7 million in the 2000 period. The change is primarily due to the acquisition of Columbia and the associated goodwill amortization of $50.3 million. Operating expenses also included the settlement of a lawsuit related to Market Hub Partners, L.P. (MHP) and the impairment of the telecommunication assets. Other Income (Deductions) Interest expense was $312.6 million for the six months, compared to $89.8 million in the first half of 2000, due to borrowing for the acquisition of Columbia, the interest on the Columbia outstanding debt and increased carrying costs of gas purchases due to higher prices for natural gas. Other, net for the first six months of 2001 increased income by $11.4 million, compared to an increase of $3.9 million in the 2000 period, primarily due to additional interest income. Income Taxes Income tax expense for the first six months of 2001 was $127.2 million, compared to $57.5 million in the 2000 period, due to higher pre-tax income in the current period and a higher effective tax rate. Change in Accounting Principle On January 1, 2001, NiSource adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" as subsequently amended by SFAS No. 137 and SFAS No. 138. This change in accounting, net of taxes, contributed $4.0 million to net income at adoption. Discontinued Operations Discontinued operations, which reflect NiSource's water operations, posted an after-tax loss of $1.1 million for the first half of 2001, compared to operating income of $2.5 million in the same period last year. The decrease is primarily due to higher interest expense. 18
19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. LIQUIDITY AND CAPITAL RESOURCES Generally, cash flow from operations has provided sufficient liquidity to meet current operating requirements. A significant portion of NiSource's operations, most notably in the gas and electric distribution businesses, is subject to seasonal fluctuations in cash flow. During the heating season, which is primarily from November through March, cash receipts from gas sales and transportation services typically exceed cash requirements. In the summer months, cash receipts for electric sales normally exceed requirements. During other periods of the year, cash on hand, together with external short-term and long-term financing, is used to purchase gas to place in storage for heating season deliveries, perform necessary maintenance of facilities, make capital improvements in plant and expand service into new areas. Net cash from operations for the first six months of 2001 was $532.2 million, an increase of $310.3 million from the same period in 2000 due to the acquisition of Columbia. During March 2001, NiSource, through its financing subsidiary NiSource Finance Corp. (NiSource Finance), entered into a new $2.5 billion revolving credit facility with a syndicate of banks. The new facility was subsequently drawn on to refinance and consolidate essentially all of NiSource's short-term borrowings. The new credit facility is guaranteed by NiSource. At June 30, 2001 and December 31, 2000, NiSource had $1,937.1 million and $2,078.8 million of commercial paper outstanding, respectively. The weighted average interest rate on commercial paper outstanding as of June 30, 2001 and December 31 2000 was 4.27% and 7.44%, respectively. NiSource had no short-term notes payable at June 30, 2001 and $417.9 million at December 31, 2000 at a weighted average interest rate of 7.78%. On April 6, 2001, NiSource Finance issued $300 million of unsecured two-year notes guaranteed by NiSource, paying a 5.75% coupon and maturing on April 15, 2003. At June 30, 2001, NiSource had $52.1 million of standby letters of credit outstanding. At December 31, 2000, NiSource had $128.5 million of standby letters of credit outstanding. MARKET RISK SENSITIVE INSTRUMENTS AND POSITIONS Risk is an inherent part of NiSource's energy businesses and activities. The extent to which NiSource manages each of the various types of risk involved in its businesses is critical to its profitability. NiSource seeks to identify, assess, monitor and manage, in accordance with defined policies and procedures, the following principal risks involved in its energy businesses: commodity market risk, interest rate risk and credit risk. Risk management at NiSource is a multi-faceted process with independent oversight that requires constant communication, judgment and knowledge of specialized products and markets. NiSource's senior management takes an active role in the risk management process and has developed policies and procedures that require specific administrative and business functions to assist in the identification, assessment and control of various risks. In recognition of the increasingly varied and complex nature of the energy business, NiSource's risk management policies and procedures continue to evolve and are subject to ongoing review and modification. The fair market value of NiSource's price risk management assets and liabilities were $480.9 million and $360.3 million at June 30, 2001, respectively, and $1,608.9 million and $1,568.6 million at December 31, 2000, respectively. The significant decrease in these assets and liabilities that occurred between these two periods was due primarily to sharply lower energy prices, and to a lesser extent, reduced trading activities. NiSource is exposed, through its various business activities, to trading risks and non-trading risks. The non-trading risks to which NiSource is exposed include interest rate risk and commodity price risk of its subsidiaries and certain gas marketing activities. Trading risks consist primarily of commodity price risks resulting from trading activities. NiSource's risk management policy permits the use of certain financial instruments to manage its market risk, including futures, forwards, options and swaps. Risk management at NiSource is the process by which the organization ensures that the risks to which it is exposed are the risks to which it desires to be exposed to achieve its primary business objectives. NiSource employs various analytic techniques to measure and monitor its market risks, 19
20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. including value-at-risk (VaR) and instrument sensitivity to market factors. VaR represents the potential loss or gain for an instrument or portfolio from adverse changes in market factors, for a specified time period and at a specified confidence level. Non-Trading Risk NiSource is exposed to interest rate risk as a result of changes in interest rates on borrowings under revolving credit agreements and lines of credit. These instruments have interest rates that are indexed to short-term market interest rates. At June 30 2001, and December 31, 2000, the combined borrowings outstanding under these facilities totaled $1,937.1 million and $2,496.7 million, respectively. Based upon average borrowings under these agreements, a change in short-term interest rates of 100 basis points (1%) would have increased or decreased interest expense by $4.3 million for the three months ended June 30, 2001, $10.2 million for the six months ended June 30, 2001 and $15.7 million for the twelve months ended December 31, 2000. For a discussion of non-trading commodity price and credit risk, please see the Management's Discussion and Analysis of Financial Condition and Results of Operations in the Form 10-K. Trading Risk NiSource employs a VaR model to assess the market risk of its energy trading portfolios. Market risk refers to the risk that a change in the level of one or more market prices, rates, indices, volatilities, correlations or other market factors, such as liquidity, will result in losses for a specified position or portfolio. NiSource estimates the one-day VaR across all trading groups that utilize derivatives using either Monte Carlo simulation or variance/covariance at a 95% confidence level. Based on the results of the VaR analysis, the daily market exposure for power trading on an average, high and low basis was $1.7 million, $2.6 million and $1.0 million, respectively, at June 30, 2001. The daily VaR for the gas trading portfolio on an average, high and low basis was $0.5 million, $1.0 million and $0.2 million at June 30, 2001, respectively. Accounting Change Effective January 1, 2001, NiSource adopted the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", as subsequently amended by SFAS No. 137 and SFAS No. 138 (collectively referred to as SFAS No. 133). These statements establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and resulting designation. The adoption of this statement on January 1, 2001, resulted in a cumulative after-tax increase to net income of approximately $4 million and an after-tax reduction to other comprehensive income (OCI) of approximately $17 million. The adoption also resulted in the recognition of $178 million of assets and $212.8 million of liabilities on the consolidated balance sheet. Additionally, the adoption resulted in the reduction of hedged risk basis of $3.8 million and the elimination of prior hedge accounting balances of $17.9 million. Approximately $11.6 million of the net losses included in the cumulative effect of a change in accounting principle component of OCI were reclassified into earnings during the first six months of 2001. NiSource's senior management takes an active role in the risk management process and has developed policies and procedures that require specific administrative and business functions to assist in the identification, assessment and control of various risks. In recognition of the increasingly varied and complex nature of the energy business, NiSource's risk management policies and procedures continue to evolve and are subject to ongoing review and modification. See Note 7, "Accounting Change" for additional information. 20
21 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. OTHER INFORMATION Presentation of Segment Information As a result of the November 1, 2000 acquisition of Columbia, NiSource revised its presentation of primary business segment information. Columbia's gas transmission and storage and exploration and production businesses are now reported as business segments of NiSource. Columbia's gas distribution operations have been combined with NiSource's gas distribution business. Effective for the second quarter of 2001, NiSource realigned a portion of its operations and reclassified previously reported operating segment information to conform to the realigned operating structure. The realignment affected three previously reported segments, and included moving all ongoing operations of Energy Marketing and certain operations from the Electric Operations and Other segments to the newly created Merchant Operations segment. The electric wheeling, bulk power, and power trading operations were moved from the Electric Operations segment to Merchant Operations, and the Company's Primary Energy subsidiary, that develops on-site, industrial-based energy solutions, was moved from Other to Merchant Operations. Prior periods have been restated to reflect these changes. Competition The regulatory environment applicable to NiSource's rate-regulated subsidiaries continues to undergo fundamental changes. These changes previously had, and will continue to have, an impact on NiSource's operations, structure and profitability. At the same time, competition within the energy industry will create opportunities to compete for new customers and revenues. Management has taken steps to become more competitive and profitable in this changing environment. These initiatives include partnering on energy projects with major industrial customers, providing NiSource's customers with increased choice for new products and services, acquiring companies that increase NiSource's scale of operations and establishing subsidiaries that develop new energy-related products for residential, commercial and industrial customers, including the development of distributed generation technologies. 21
22 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. GAS DISTRIBUTION OPERATIONS <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, ----------------------------- ----------------------------- ($ in millions) 2001 2000 2001 2000 =============================================================================================== <S> <C> <C> <C> <C> NET REVENUES Sales Revenues 696.1 201.0 2,607.6 638.2 Less: Cost of gas sold 533.3 134.8 2,020.0 415.3 - ----------------------------------------------------------------------------------------------- Net Sales Revenues 162.8 66.2 587.6 222.9 Transportation Revenues 70.8 18.0 223.3 53.4 - ----------------------------------------------------------------------------------------------- Net Revenues 233.6 84.2 810.9 276.3 - ----------------------------------------------------------------------------------------------- OPERATING EXPENSES Operation and maintenance 151.4 51.1 317.4 104.6 Depreciation and amortization 55.3 32.1 119.8 64.2 Other taxes 25.8 8.5 84.6 18.8 - ----------------------------------------------------------------------------------------------- Total Operating Expenses 232.5 91.7 521.8 187.6 - ----------------------------------------------------------------------------------------------- Operating Income 1.1 (7.5) 289.1 88.7 =============================================================================================== REVENUES ($ IN MILLIONS) Residential 334.3 112.3 1,608.0 404.1 Commercial 120.2 44.9 613.3 153.8 Industrial 22.8 12.8 96.2 35.9 Transportation 70.8 18.0 223.3 53.4 Other 218.8 31.0 290.1 44.4 - ----------------------------------------------------------------------------------------------- Total 766.9 219.0 2,830.9 691.6 - ----------------------------------------------------------------------------------------------- SALES AND TRANSPORTATION (MDTH) Residential sales 26.6 13.6 141.1 56.1 Commercial sales 11.1 6.8 56.7 24.4 Industrial sales 2.2 2.3 8.4 7.0 Transportation 104.0 54.4 269.1 122.4 Other 47.2 3.5 56.2 14.7 - ----------------------------------------------------------------------------------------------- Total 191.1 80.6 531.5 224.6 - ----------------------------------------------------------------------------------------------- HEATING DEGREE DAYS 496 590 3,402 3,551 NORMAL HEATING DEGREE DAYS 662 750 3,692 4,004 % COLDER (WARMER) THAN NORMAL (25%) (21%) (8%) (11%) CUSTOMERS Residential 2,330,114 943,106 Commercial 212,838 85,747 Industrial 5,889 3,743 Transportation 640,441 33,208 - ----------------------------------------------------------------------------------------------- Total 3,189,282 1,065,804 - ----------------------------------------------------------------------------------------------- </TABLE> 22
23 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. NiSource's natural gas distribution operations (Gas Distribution) serve approximately 3.2 million customers in nine states. Through its wholly-owned subsidiary, Columbia, NiSource owns five local distribution companies (LDCs) that provide natural gas to approximately 2.1 million residential, commercial and industrial customers in Ohio, Pennsylvania, Virginia, Kentucky and Maryland (Columbia LDC's). NiSource also distributes natural gas to approximately 751,000 customers in northern Indiana through three subsidiaries: Northern Indiana Public Service Company (Northern Indiana), Kokomo Gas and Fuel Company and Northern Indiana Fuel and Light Company, Inc. Additionally, NiSource's subsidiary, Bay State Gas Company, and its subsidiary Northern Utilities, Inc., distribute natural gas to more than 320,000 customers in Massachusetts, Maine, and New Hampshire. Regulatory Matters At the Federal level, gas industry deregulation began in the mid-1980s when the Federal Energy Regulatory Commission (FERC) required interstate pipelines to provide nondiscriminatory transportation services pursuant to unbundled rates. This regulatory change permitted large industrial and commercial customers to purchase their gas supplies either from a LDC or directly from competing producers and marketers, which would then use the LDC's facilities to transport the gas. More recently, the focus of deregulation in the gas industry has shifted to retail customers at the state level. NiSource pursues initiatives that give retail customers the opportunity to purchase natural gas directly from marketers and to use Gas Distribution's facilities for transportation services. These opportunities are being pursued through regulatory initiatives in all of its jurisdictions. Once fully implemented, these programs would reduce Gas Distribution's commodity sales function and provide all customer classes with the opportunity to obtain gas supplies from alternative merchants. As these programs expand to all customers, regulations will have to be implemented to provide for the recovery of transition capacity costs and other costs incurred by a utility serving as the supplier of last resort if a marketing company cannot supply the gas. Transition capacity costs are created as customers enroll in these programs and purchase their gas from other suppliers, leaving the Gas Distribution subsidiaries with pipeline capacity it has contracted for, but no longer needs. The state commissions in jurisdictions served by Gas Distribution are at various stages in addressing these issues and other transition considerations. Gas Distribution is currently recovering, or has the opportunity to recover, the costs resulting from the unbundling of its services and believes that most of such future costs and costs resulting from being the supplier of last resort will be mitigated or recovered. Market Conditions Weather in Gas Distribution's markets for the second quarter of 2001, was on average 25% warmer than normal for the second quarter of 2001 and 8% warmer than normal for the six-month period. Throughput Total volumes sold and transported of 191.1 million dekatherms (MDth) for the second quarter of 2001 increased 110.5 MDth from the same period last year primarily due to the inclusion of Columbia's five distribution companies' throughput of 126.7 MDth. Volumes at Northern Indiana decreased due to weather 18% warmer than 2000, lower transportation volumes to industrial customers and decreased off-system sales. For the six month period ended June 30, 2001, total volumes sold and transported were 531.5 MDth, an increase of 306.9 MDth from the same period in 2000 primarily due to the inclusion of Columbia's five distribution companies' throughput of 342.1 MDth. Volumes at Northern Indiana decreased due to lower transportation volumes to industrial customers and decreased off-system sales, partially mitigated by weather that was 8% colder than in the first six months of 2000. Net Revenues Net revenues for the three months ended June 30, 2001 were $233.6 million, up $149.4 million over the same period in 2000, primarily due to the acquisition of Columbia, partially offset by warmer than normal weather. For the six month period ended June 30, 2001, net revenues were $810.9 million, a $534.6 million increase from the same period in 2000, primarily due to the acquisition of Columbia. Net revenues also increased due to weather in northern Indiana that was 8% colder than in the first six months of 2000. 23
24 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. Operating Income For the second quarter of 2001, gas distribution reported operating income of $1.1 million, an $8.6 million increase from the same period in 2000. Operating income increased due to the acquisition of Columbia's five distribution subsidiaries on November 1, 2000; however, this was partially offset by the amortization of goodwill associated with the acquisition. Operating income for the first six months of 2001 of $289.1 million increased $200.4 million over the same period in 2000 primarily due to the acquisition of Columbia, offset by six months of goodwill amortization. 24
25 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. TRANSMISSION AND STORAGE OPERATIONS <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, --------------------- ---------------------- ($ in millions) 2001 2000 2001 2000 =============================================================================================== <S> <C> <C> <C> <C> OPERATING REVENUES Transportation Revenues 167.7 13.8 400.4 27.7 Storage revenues 44.9 - 89.4 - Other revenues 3.8 - 20.4 - - ----------------------------------------------------------------------------------------------- Total Operating Revenues 216.4 13.8 510.2 27.7 Less: Cost of gas sold 18.6 11.7 53.7 23.2 - ----------------------------------------------------------------------------------------------- Net Revenues 197.8 2.1 456.5 4.5 - ----------------------------------------------------------------------------------------------- OPERATING EXPENSES Operation and maintenance 78.8 1.0 158.2 1.9 Depreciation and amortization 40.2 0.4 80.2 0.8 Other taxes 14.1 0.2 29.2 0.5 - ----------------------------------------------------------------------------------------------- Total Operating Expenses 133.1 1.6 267.6 3.2 - ----------------------------------------------------------------------------------------------- Operating Income 64.7 0.5 188.9 1.3 =============================================================================================== THROUGHPUT (BCF) Columbia Transmission Market Area 149.7 - 516.5 - Columbia Gulf Mainline 165.7 - 327.0 - Short-haul 47.8 - 84.8 - Intrasegment eliminations (164.7) - (322.0) - Columbia Pipeline Deep Water 0.9 - 1.7 - Crossroads Gas Pipeline 9.3 9.7 20.2 20.2 Granite State Pipeline 4.7 6.6 17.7 20.7 - ----------------------------------------------------------------------------------------------- Total 213.4 16.3 645.9 40.9 - ----------------------------------------------------------------------------------------------- </TABLE> NiSource's gas transmission and storage segment consists of the operations of Columbia Gas Transmission Corporation (Columbia Transmission), Columbia Gulf Transmission Company (Columbia Gulf), Columbia Pipeline Corporation, Crossroads Pipeline Company (Crossroads) and Granite State Transmission System (Granite). In total NiSource owns a pipeline network of approximately 16,500 miles extending from offshore in the Gulf of Mexico to Lake Erie, New York and the eastern seaboard. Together they serve customers in seventeen northeastern, mid-Atlantic, midwestern and southern states, as well as the District of Columbia. In addition, the NiSource gas transmission and storage segment operates one of the nation's largest underground natural gas storage systems. Proposed Millennium Pipeline Project The proposed Millennium Pipeline Project (Millennium Project), in which Columbia Transmission is participating and will serve as developer and operator, will transport western gas supplies to northeast and mid-Atlantic markets. The 442-mile pipeline will connect to TransCanada Pipe Lines Ltd. at a new Lake Erie export point and transport approximately 700,000 Dth per day to eastern markets. To date, nine shippers have signed agreements for a significant portion of the available capacity. Based on the current status of the regulatory approval process of the FERC, the Millennium Project anticipate an in-service date of November 1, 2003. The sponsors of the proposed Millennium Project are Columbia Transmission, Westcoast Energy, Inc., TransCanada Pipe Lines Ltd. and MCN Energy Group, Inc. 25
26 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. Mainline '99 Columbia Gulf filed an application with the FERC in June 1998, for authority to increase the maximum certificated capacity of its mainline facilities. Columbia Gulf's largest expansion of its mainline facilities, referred to as Mainline '99, was authorized by the FERC in February 1999. The Mainline '99 project has increased Columbia Gulf's certificated capacity to nearly 2.2 billion cubic feet per day (Bcf/day) by replacing certain compressor units and increasing the horsepower capacity of other compressor stations. Appeals challenging the FERC's authorization of the Mainline '99 facilities were dismissed by the United States Court of Appeals for the District of Columbia on May 14, 2001. Sale of Facilities Columbia Transmission continues to evaluate and dispose of non-core assets. Columbia Transmission is currently negotiating with third parties on the sale of approximately 180 miles of small diameter pipelines and other facilities in West Virginia, Pennsylvania, Maryland and New York. Supply Contracts to New Electric Generation Projects On May 16, 2001, the FERC approved planned facility enhancements allowing Columbia Gas Transmission to provide up to 140,000 dekatherms a day (Dth/d) to serve a new 425 MW electric generating facility in West Lorain, Ohio. This facility began service in June 2001. In June 2001, Columbia Gas Transmission began providing up to 60,000 Dth/d of transportation service for a new 552 MW electric generating facility in Pickaway County, Ohio. Columbia will also deliver up to 144,000 Dth/d of gas to the 500-MW Ceredo Generating Station in Wayne County, West Virginia, which began commercial operation in June 2001. Columbia Gas Transmission recently filed with the FERC for permission to construct facilities to provide 125,000 Dth/d of transportation service to serve a 750 MW electric generating facility that is under construction on the Delaware-Pennsylvania border. This facility has a scheduled in service date of June 2003. Storage Base Gas Sales Columbia Transmission sold 5.2 billion cubic feet (Bcf) of base gas volumes in the first quarter of 2001 resulting in a pre-tax gain of $11.4 million. Base gas represents storage volumes that are maintained to ensure that adequate pressure exists to deliver current inventory. As a result of ongoing improvements made in its storage operations, Columbia Transmission determined that a portion of these storage volumes were no longer necessary to maintain deliverability of current inventory. Throughput Columbia Transmission's throughput consists of transportation and storage services for local distribution companies and other customers within its market area, which covers portions of northeastern, mid-Atlantic, mid-western, and southern states and the District of Columbia. Throughput for Columbia Gulf reflects mainline transportation services from Rayne, Louisiana to Leach, Kentucky and short-haul transportation services from the Gulf of Mexico to Rayne, Louisiana. Crossroads serves customers in northern Indiana and Granite provides service in New Hampshire. Throughput for the Transmission and Storage segment totaled 213.4 Bcf for the second quarter of 2001, compared to 16.3 Bcf in 2000. Throughput in the six months ended June 30, 2001 was 645.9 Bcf, compared to 40.9 in the same period of 2000. The increase primarily reflects the addition of Columbia Transmission and Columbia Gulf Transmission from the acquisition of Columbia. Net Revenues Net revenues were $197.8 million for the second quarter of 2001, an increase of $195.7 due primarily to the inclusion of Columbia operations. Net revenues were $456.5 million for the six months ended June 30, 2001, an increase of $452.0 million from the same period in 2000. The increase is primarily due to the inclusion of Columbia. This also includes the effect of the sale of base gas discussed above. 26
27 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. Operating Income Second quarter 2001 operating income of $64.7 million increased $64.2 million due primarily to the inclusion of Columbia's operations, partially offset by the amortization of goodwill for the Columbia acquisition. For the first six months of 2001, operating income of $188.9 million, an increase of $187.6 million from the 2000 period, was due primarily to the inclusion of Columbia's operations, partially offset by the amortization of goodwill. The $11.4 million of storage base gas sales in the first quarter of 2001 also contributed to the increase. 27
28 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. ELECTRIC OPERATIONS <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, ---------------------- ----------------------- ($ in millions) 2001 2000 2001 2000 =============================================================================================== <S> <C> <C> <C> <C> NET REVENUES Sales revenues 246.7 241.8 494.0 484.4 Less: Cost of sales 63.6 58.4 130.0 119.0 - ----------------------------------------------------------------------------------------------- Net Revenues 183.1 183.4 364.0 365.4 - ----------------------------------------------------------------------------------------------- OPERATING EXPENSES Operation and maintenance 54.1 56.1 106.1 109.8 Depreciation and amortization 41.8 40.2 83.3 80.2 Other taxes 13.4 7.8 27.1 21.2 - ----------------------------------------------------------------------------------------------- Total Operating Expenses 109.3 104.1 216.5 211.2 - ----------------------------------------------------------------------------------------------- Operating Income 73.8 79.3 147.5 154.2 =============================================================================================== REVENUES ($ IN MILLIONS) Residential 65.3 65.4 134.2 131.8 Commercial 73.3 69.3 141.3 136.6 Industrial 104.0 103.9 209.0 213.9 Other electric service 4.1 3.2 9.5 2.1 - ----------------------------------------------------------------------------------------------- Total 246.7 241.8 494.0 484.4 - ----------------------------------------------------------------------------------------------- SALES (GIGAWATT HOURS) Residential 640.7 655.8 1,338.3 1,323.6 Commercial 850.0 824.8 1,665.4 1,623.2 Industrial 2,309.0 2,390.8 4,632.1 4,926.8 Other electric service 26.7 32.6 60.1 64.0 - ----------------------------------------------------------------------------------------------- Total 3,826.4 3,904.0 7,695.9 7,937.6 - ----------------------------------------------------------------------------------------------- ELECTRIC CUSTOMERS Residential 379,059 377,474 Commercial 46,897 46,212 Industrial 2,663 2,671 Other electric service 804 812 - ----------------------------------------------------------------------------------------------- Total 429,423 427,169 - ----------------------------------------------------------------------------------------------- </TABLE> NiSource generates and distributes electricity, through its subsidiary Northern Indiana, to approximately 430,000 customers in 21 counties in the northern part of Indiana. Northern Indiana owns and operates four coal-fired electric generating stations with a net capability of 3,179 megawatts, four gas-fired combustion turbine generating units with a net capability of 203 megawatts and two hydroelectric generating plants with a net capability of 10 megawatts. These facilities provide for a total system net capability of 3,392 megawatts. Northern Indiana is interconnected with five neighboring electric utilities. Market Conditions The regulatory framework applicable to electric operations are undergoing fundamental changes. These changes have previously had, and will continue to have, an impact on NiSource's electric operations, structure and profitability. At the same time, competition within the industry will create opportunities to compete for new customers and revenues. Management has taken steps to become more competitive and profitable in this changing environment, including converting some of its generating units to allow use of lower cost, low sulfur coal and improving the transmission interconnections with neighboring electric utilities. 28
29 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. Regulatory Matters FERC issued Order No. 888-A in 1996 that required all public utilities owning, controlling or operating transmission lines to file non-discriminatory open-access tariffs and offer wholesale electricity suppliers and marketers the same transmission service they provide themselves. On June 30, 2000, the D.C. Circuit Court of Appeals upheld FERC's open access orders in all major respects, although the U.S. Supreme Court on February 26, 2001 agreed to review the case. In 1997, FERC accepted for filing Northern Indiana's open-access transmission tariff. On December 20, 1999, FERC issued Order 2000 addressing the formation and operation of Regional Transmission Organizations (RTOs). The rule is intended to eliminate pricing inequities in the provision of wholesale transmission service. On October 16, 2000, NiSource filed with the FERC indicating that it is committed to joining an RTO and on February 28, 2001 joined the Alliance RTO. The Alliance RTO expects to be fully operational by FERC's December 15, 2001 deadline. The Alliance RTO companies serve a population of 41 million within 178,800 square miles in 11 states and own 57,100 miles of transmission lines. During the course of a regularly scheduled review, referred to as a Level 1 review, the staff of the Indiana Utility Regulatory Commission (IURC) made a preliminary determination, based on unadjusted historical financial information filed by Northern Indiana, that Northern Indiana was earning returns that were in excess of its last rate order and generally established standards. Despite holding meetings with the IURC staff during 2000 to explain several adjustments that needed to be made to the filed information to make such an analysis meaningful, the staff has recommended that a formal investigation be performed. The IURC has ordered that an investigation begin. On June 18, Northern Indiana and several other parties filed their case-in-chief. Northern Indiana's testimony indicated that if rates are to be changed, they should be increased. Other parties indicated that rates should be reduced. Management is unable at this time to determine if a broader analysis, which would be performed through a formal investigation, could result in a rate adjustment that would be higher or lower than currently allowed rates. Management intends to vigorously oppose any efforts to reduce rates that may result from this investigation. Environmental Matters AIR. During 1998, the United States Environmental Protection Agency (EPA) issued a final rule, the nitrogen oxides (NOx) State Implementation Plan (SIP) call, requiring certain states, including Indiana to reduce NOx levels from several sources, including industrial and utility boilers. At a June 6, 2001 meeting, the Air Pollution Control Board of Indiana adopted as final the Indiana NOx control rule to meet the requirements of the EPA NOx SIP call. Before it will become Indiana regulation the rule must be signed by the Attorney General and Governor. Preliminary estimates of Northern Indiana's NOx control compliance costs range from $200 to $300 million. Actual compliance costs may be more than preliminary estimates due to a number of factors including: market demand/resource constraints, uncertainty of future equipment and construction costs, and the potential need for additional control technology. The EPA has initiated enforcement actions against several electric utilities alleging violations of the new source review provisions of the Clean Air Act. Northern Indiana has received and is in the process of responding to information requests from the EPA on this subject. It is impossible at this time to predict the result of EPA's review of Northern Indiana's information responses. The EPA is in the process of developing a program to address regional haze. The new administration announced that the EPA would move forward with rules that mandate the states to require power plants built between 1962 and 1977 to install the "best available retrofit technology" or BART. The BART program will target for control by 2013 those pollutants that limit visibility - particulate, sulfur dioxide and/or nitrogen oxides. Until the program is developed, Northern Indiana cannot predict the cost of complying with these rules. WATER. The Great Lakes Water Quality Initiative ("GLI") program is expected to add new water quality standards for facilities that discharge into the Great Lakes watershed, including Northern Indiana's three electric generating stations located on Lake Michigan. The State of Indiana has promulgated its regulations for this water discharge permit program and has received final EPA approval. As promulgated, the regulations would provide the Indiana Department of Environmental Management (IDEM) with the authority to grant water quality criteria variances and exemptions for non-contact cooling water. However, the EPA revised the variance language and other minor provisions of IDEM's GLI rule. The EPA by and large left the non-contact cooling water exemption intact; however, a separate agreement between the EPA and IDEM on interpretation of this exemption still leaves 29
30 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. uncertainty as to its impact. The EPA change to the variance rule has prompted litigation by the affected industrial parties and the EPA/IDEM agreement on the non-contact cooling water exemption may be subject to future litigation. Northern Indiana expects that IDEM will issue a proposed permit renewal for each of its lakeside stations. Pending the outcome of litigation and the proposed permit renewal requirements, the costs of complying with these requirements cannot be predicted at this time. Sales Electric sales for the second three months of 2001 were 3,826.4 million kilowatt-hours (kwh), a decrease of 77.6 million kwh, compared to the 2000 period, primarily reflecting decreased industrial sales due to a decline in production in the steel industry offset by increased commercial sales. Electric sales for the first six months of 2001 were 7,695.9 kwh, a decrease of 241.7 million kwh, compared to the 2000 period, primarily reflecting decreased industrial sales due to a decline in production in the steel industry. Net Revenues In the second quarter of 2001, electric net revenues of $183.1 million decreased by $0.3 million over the 2000 period. This decrease reflects decreased industrial sales due to decreased production in the steel industry offset by an increase in commercial sales. In the first six months of 2001, electric net revenues of $364.0 million decreased by $1.4 million over the 2000 period. This decrease reflects decreased industrial sales due to decreased production in the steel industry offset by an increase in commercial sales. Operating Income Operating income for the second quarter of 2001 was $73.8 million, a decrease of $ 5.5 million over the same period in 2000. The 2000 period had been favorably impacted as a result of an adjustment of property tax accruals of $5.8 million. Operating income for the first six months of 2001 was $147.5 million, a decrease of $6.7 million over the same period in 2000. The 2000 period had been favorably impacted as a result of an adjustment of property tax accruals of $5.8 million. 30
31 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. EXPLORATION AND PRODUCTION OPERATIONS <TABLE> <CAPTION> THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ($ in millions) 2001 2001 =============================================================================================== <S> <C> <C> OPERATING REVENUES Gas revenues 43.2 92.4 Gathering revenues 2.4 5.0 Other revenues 1.3 3.2 - ----------------------------------------------------------------------------------------------- Total Operating Revenues 46.9 100.6 - ----------------------------------------------------------------------------------------------- Operating Expenses Operation and maintenance 14.4 31.0 Depreciation and depletion 12.6 22.8 Other taxes 4.2 9.9 - ----------------------------------------------------------------------------------------------- Total Operating Expenses 31.2 63.7 - ----------------------------------------------------------------------------------------------- Operating Income 15.7 36.9 =============================================================================================== AVERAGE PRICE OF GAS PRODUCTION ($ PER MCf) U.S. 4.06 3.67 Canada 5.00 6.69 GAS PRODUCTION (BCf): U.S. 11.6 26.1 Canada 0.1 0.1 - ----------------------------------------------------------------------------------------------- Total 11.7 26.2 - ----------------------------------------------------------------------------------------------- OIL AND LIQUIDS PRODUCTION STATISTICS Production (000 Bbls) U.S. 41 100 Canada 2 4 - ----------------------------------------------------------------------------------------------- Total 43 104 =============================================================================================== Average Price ($ per Bbl) U.S. 22.75 24.59 Canada 28.92 30.15 - ----------------------------------------------------------------------------------------------- </TABLE> NiSource's exploration and production subsidiary, Columbia Energy Resources, Inc. (Columbia Resources), is one of the largest independent natural gas and oil producers in the Appalachian Basin and also has production operations in Canada. NiSource acquired Columbia Resources as part of the Columbia acquisition on November 1, 2000. Columbia Resources produced nearly 11.7 Bcf equivalents (Bcfe) and 26.2 Bcf of natural gas and oil in the second quarter and the first six months of 2001, respectively, has financial interests in over 8,000 wells, and has net proven gas and oil reserve holdings of 1.1 trillion cubic feet equivalent at June 30, 2001. Columbia Resources also owns and operates approximately 6,200 miles of gathering pipelines. Columbia Resources seeks to achieve asset and profit growth primarily through expanded drilling activities. For the second quarter of 2001, Columbia Resource's drilling activity resulted in the discovery of 11.2 net Bcfe of gas and oil reserves. For the six months ended June 30, 2001, Columbia Resource discovered 23.6 net Bcfe of gas and oil reserves. During the second quarter of 2001, Columbia Resources has participated in 37 gross (35 net) wells with a success rate of 88 percent. For the six months ended June 30, 2001, Columbia Resources participated in 61 gross (57.4 net) wells with a success rate of 93 percent. 31
32 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. Forward Sale of Natural Gas On March 30, 2001, Columbia Resources restructured its existing forward gas sales agreements with Mahonia II Limited (Mahonia). Physical deliveries of 19.9 Bcf of natural gas to Mahonia, required under the previous agreements for the period April 2001 through March 2002, have been postponed. These deliveries have been scheduled to resume in January 2003 and continue through February 2006, with 31.7 Bcf of gas to be delivered in addition to the previous requirements of the forward gas sales agreements. Volumes Gas production was 11.7 Bcf and 26.2 Bcf in the second quarter and first six months of 2001, respectively. The second quarter results were negatively impacted by shut-in production in coal mining territory and compressor outages. Oil and liquids production was 43,000 barrels and 104,000 barrels in the second quarter and first six months of 2001, respectively. Operating Revenues Operating revenues for the second quarter of 2001 were $46.9 million. Columbia Resources' natural gas production was fully hedged at an average price of $4.15 per million cubic feet (Mcf). Operating revenues for the first half of 2001 were $100.6 million. Approximately 86% of Columbia Resource's natural gas production was hedged at an average price of $4.12 per Mcf. Operating Income Operating income for the second quarter of 2001 was $15.7 million. Depletion expense included an impairment write-down of $1.9 million for the Canadian oil and gas properties. Operating income for the six months ended June 30, 2001 was $36.9 million. Depletion expense included an impairment write-down of $3.5 million for the Canadian oil and gas properties. 32
33 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. MERCHANT OPERATIONS <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, -------------------- ------------------------ ($ in millions) 2001 2000 2001 2000 =============================================================================================== <S> <C> <C> <C> <C> NET REVENUES Gas 428.7 370.2 1,573.1 656.5 Electric 251.9 123.4 375.2 198.8 Other 19.0 16.2 33.2 32.3 - ----------------------------------------------------------------------------------------------- Total Revenues 699.6 509.8 1,981.5 887.6 Less: Cost of products purchased 662.7 474.5 1,928.6 816.8 - ----------------------------------------------------------------------------------------------- Net Revenues 36.9 35.3 52.9 70.8 - ----------------------------------------------------------------------------------------------- OPERATING EXPENSES Operation and maintenance 15.6 15.5 30.7 31.1 Depreciation and amortization 0.6 0.5 1.1 1.0 Other taxes 0.9 0.5 1.7 1.1 - ----------------------------------------------------------------------------------------------- Total Operating Expenses 17.1 16.5 33.5 33.2 - ----------------------------------------------------------------------------------------------- Operating Income 19.8 18.8 19.4 37.6 =============================================================================================== VOLUMES Gas sales (MDth) 88.0 98.9 251.2 196.5 Electric sales (Gigawatt Hours) 5,146.6 2,414.2 7,722.5 5,167.0 - ----------------------------------------------------------------------------------------------- </TABLE> NiSource provides non-regulated merchant energy through its wholly-owned subsidiary EnergyUSA, Inc., Primary Energy and Northern Indiana. Energy USA, Inc., through its subsidiary EnergyUSA-TPC Corp. (TPC), provides energy related asset management and asset portfolio replacement opportunities for LDCs and fuel requirement services for electric utilities, independent power producers and cogeneration facilities. TPC also provides natural gas sales and management services to industrial and commercial customers, engages in natural gas marketing activities and provides gas supply. Primary Energy develops, builds, owns, operates and manages industrial based energy projects. The focus of the company is to develop on-site, industrial-based energy solutions for large complexes having multiple energy flows, such as electricity, steam, by-product fuels or heated water. Northern Indiana provides non-regulated electric power generation marketing, electric wheeling and bulk power sales. Primary Energy Through its subsidiaries, Primary Energy has entered into agreements with several of NiSource's largest industrial customers, principally steel mills and a refinery, to service a portion of their energy needs. In order to serve its customers under the agreements, and to have electricity available for the wholesale market, Primary Energy, through its subsidiaries, has entered into certain operating lease commitments to lease these energy-related projects, which have a combined capacity of 393 megawatts in operation and 575 megawatts under construction. NiSource, through subsidiaries, guarantees certain of Primary Energy's obligations under each lease. LTV Bankruptcy The LTV Corporation, parent of LTV Steel Company, Inc. (LTV), filed for protection under Chapter 11 of the Federal Bankruptcy Code on December 29, 2000. Primary Energy is constructing a cogeneration plant on the site of LTV's East Chicago mill. While the bankruptcy affords LTV an opportunity to reject the current 15-year contract for use of the facility, Primary Energy is working closely with LTV to obtain contract affirmation. LTV's decision is expected during 2001. Work on the project is continuing with commercial operation scheduled for October 2001. Net Revenues Total sales revenues of $699.6 million for the second quarter of 2001 increased $189.8 million over the 2000 second quarter. The increase in sales revenues primarily reflected an increase in trading activity and higher energy prices. Net revenues for the second quarter of 2001 were $36.9 million, an increase of $1.6 million over the same period last year. The improvement is due primarily to increased opportunities in electric trading, offset by TPC's mark-to-market adjustments, which reflect a decline in the value of basis positions related to structured transactions in Northeast markets. 33
34 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) NISOURCE INC. Total sales revenues of $1,981.5 million for the first six months of 2001 increased $1,093.9 million over the 2000 period. The increase in sales revenues primarily reflected an increase in trading activity. Net revenues for the first six months of 2001 were $52.9 million, compared to $70.8 million in the same period last year. The decline is due primarily to mark-to-market adjustments resulting from a decline in the value of basis positions related to structured transactions in Northeast markets. Operating Income Merchant Operations had operating income of $19.8 million for the second quarter of 2001 compared to operating income of $18.8 million for the same period last year. The increase is primarily due to the increased net revenues discussed above. For the six months ended June 30, 2001, Merchant Operations had operating income of $19.4 million compared to operating income of $37.6 for the same period in 2000. The decrease is primarily due to the decline in net revenues discussed above. 34
35 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OPERATIONS (continued) NISOURCE INC. OTHER (INCLUDES ASSETS HELD FOR SALE) <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, ----------------- ----------------- ($ in millions) 2001 2000 2001 2000 =============================================================================================== <S> <C> <C> <C> <C> NET REVENUES Products and services revenue 41.4 67.2 78.4 124.9 Less: Cost of products purchased 29.7 43.1 58.4 83.3 - ----------------------------------------------------------------------------------------------- Net Revenues 11.7 24.1 20.0 41.6 - ----------------------------------------------------------------------------------------------- OPERATING EXPENSES Operation and maintenance 14.3 16.6 33.0 32.0 Lawsuit settlement charges - - 15.5 - Depreciation and amortization 2.0 6.2 4.1 12.5 Other taxes 2.2 1.2 3.3 2.4 Impairment of telecommunication assets 9.2 - 9.2 - - ----------------------------------------------------------------------------------------------- Total Operating Expenses 27.7 24.0 65.1 46.9 - ----------------------------------------------------------------------------------------------- Operating Income (Loss) (16.0) 0.1 (45.1) (5.3) - ----------------------------------------------------------------------------------------------- </TABLE> NiSource has invested in a number of distributed generation technologies including fuel cells and microturbine ventures. NiSource is also building a dark-fiber optics telecommunications network primarily along its pipeline rights-of-way between New York and Washington D.C. NiSource is pursuing strategic alternatives for its telecommunications network, has recently exited the pipeline construction business and is in the process of selling the line locating and marking business. Telecommunications Network As a result of project delays, cost overruns, and the economics of the fiber optics market that have occurred since the acquisition of Columbia, NiSource recorded a charge of $9.2 million to operating income in the second quarter of 2001, related to Columbia Transmission Communications Corporation (Transcom), a fiber optics telecommunications network. In September and October 2000, management held discussions with investment banking firms seeking strategic options for the Transcom assets. Although significant uncertainties existed surrounding the estimated costs to complete the fiber optic network, time to market in a competitive environment, and delays due to construction deficiencies and environmental issues, the decision was made to complete the Transcom network and sell the assets. The Company has received subsequent information pertaining to the estimated construction costs and delays. Consequently, management has concluded that the carrying value of the telecommunication assets exceeds the realizable value by approximately $89.2 million. Given the resolution of certain uncertainties related to Transcom that existed when NiSource acquired Columbia, the purchase price allocation relating to the Transcom assets is now essentially complete and goodwill resulting from the acquisition of Columbia has been increased by the after-tax impact of the excess carrying amount of $52.0 million. Net Operating Revenues Net operating revenues of $11.7 million for the second quarter of 2001 decreased by $12.4 million from the second quarter of 2000. This decrease is due to the absence of revenues from the non-core businesses that have been sold, partially offset by higher revenues in the line locating business. Net operating revenues of $20.0 million for the first half of 2001 decreased by $21.6 million from the same period in 2000. This decrease is due to the absence of revenues from non-core businesses, partially offset by higher revenues in the line locating business. Operating Income (Loss) Other reported an operating loss of $16.0 million versus operating income of $0.1 million in the second quarter of 2000, reflecting the impairment of telecommunication assets and non-core businesses included in the prior year that were subsequently sold. For the first six months of 2001, Other reported an operating loss of $45.1 million versus an operating loss of $5.3 million in the first half of 2000. The decrease reflects the impairment of telecommunication assets, the settlement of litigation related to Market Hub Partners, LLP., and the absence of non-core businesses as discussed above. These items were partially offset by increased operating income in the line locating business. 35
36 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK NISOURCE INC. For a discussion regarding quantitative and qualitative disclosures about market risk see page 19 of the Management's Discussion and Analysis of Financial Condition and Results of Operations under "Market Risk Sensitive Instruments and Positions." 36
37 PART II ITEM 1. LEGAL PROCEEDINGS NISOURCE INC. 1. UNITED STATES OF AMERICA EX REL. JACK J. GRYNBERG V. COLUMBIA GAS TRANSMISSION CORP. ET. AL. The plaintiff filed a complaint under the False Claims Act, on behalf of the United States of America, against approximately seventy pipelines, including Columbia Gulf. The plaintiff claimed that the defendants had submitted false royalty reports to the government (or caused others to do so) by mismeasuring the volume and heating content of natural gas produced on Federal land and Indian lands. Plaintiff's original complaint was dismissed without prejudice for misjoinder of parties and for failing to plead fraud with specificity. In 1997, the plaintiff then filed over sixty-five new False Claims Act complaints against over 330 defendants in numerous Federal courts. One of those complaints was filed in the Federal District Court for the Eastern District of Louisiana against Columbia and thirteen affiliated entities. Plaintiff's second complaint repeats the mismeasurement claims previously made and adds valuation claims alleging that the defendants have undervalued natural gas for royalty purposes in various ways, including by making sales to affiliated entities at artificially low prices. Most of the Grynberg cases were transferred to Federal court in Wyoming in 1999. In December 1999, the Columbia defendants filed a motion to dismiss plaintiff's second complaint primarily based on a failure to plead fraud with specificity. In May 2001, the Court denied the Columbia defendants' motion to dismiss. The Columbia defendants have joined together with numerous other defendants and have filed a motion requesting the district court to amend its order to include a certification so that the defendant could request permission from the United States Court of Appeals for the Tenth Circuit to appeal a controlling question of law. That motion was denied on July 2, 2001. 2. QUINQUE OPERATING CO. ET AL V. GAS PIPELINES ET AL. Plaintiff filed an amended complaint in Stevens County, Kansas state court on September 23, 1999, against over 200 natural gas measurers, mostly natural gas pipelines, including Columbia and fourteen affiliated entities. The allegations in Quinque are similar to those made in Grynberg; however, Quinque broadens the claims to cover all oil and gas leases (other than the Federal and Indian leases that are the subject of Grynberg). Quinque asserts a breach of contract claim, negligent or intentional misrepresentation, civil conspiracy, common carrier liability, conversion, violation of a variety of Kansas statutes and other common law causes of action. Quinque purports to be a nationwide class action filed on behalf of all similarly situated gas producers, royalty owners, overriding royalty owners, working interest owners and certain state taxing authorities. The defendants had previously moved the case to Federal court. On January 12, 2001, the Federal court remanded the case to state court. In June 2001, the plaintiff voluntarily dismissed ten of the fourteen Columbia entities. Discovery relating to personal jurisdiction has begun. 3. VIVIAN K. KERSHAW ET AL. V. COLUMBIA NATURAL RESOURCES, INC., ET AL. In February 2000, plaintiff filed a complaint in New York state court against Columbia Resources and Columbia Transmission. The complaint alleges that Kershaw owns an interest in an oil and gas lease in New York and that the defendants have underpaid royalties on those leases by, among other things, failing to base royalties on the price at which natural gas is sold to the end user and by improperly deducting post-production costs. The complaint also seeks class action status on behalf of all royalty owners in oil and gas leases operated by Columbia Resources. Plaintiff seeks the alleged royalty underpayments and punitive damages. Columbia Resources and Columbia Transmission removed the case to Federal court in March 2000. The Federal court has now remanded Kershaw back to New York state court. The New York state court judge has heard the Columbia defendants' motion to dismiss the case and has taken the matter under advisement. 4. ANTHONY GONZALEZ, ET AL. V. NATIONAL PROPANE CORPORATION, ET AL. On December 11, 1997, plaintiffs Anthony Gonzalez, Helen Pieczynski, as Special Administrator of the Estate of Edmund Pieczynski, deceased, Michael Brown and Stephen Pieczynski filed a multiple-count complaint for personal injuries in the Circuit Court of Cook County, Illinois against National Propane Corporation and the Estate of Edmund Pieczynski sounding in strict tort liability and negligence. Plaintiff's complaint arises from an explosion and fire which occurred in a Wisconsin vacation cottage in 1997. National Propane, L.P. filed a third-party complaint for contribution against Natural Gas Odorizing and Phillips Petroleum Company. Written discovery has been completed and the parties are conducting oral discovery of the fact witnesses. There has been no trial date set in the matter, and the next court date is October 16, 2001, at which time further scheduling of discovery will occur. 37
38 ITEM 1. LEGAL PROCEEDINGS (continued) NISOURCE INC. 5. COLUMBIA GAS TRANSMISSION CORP. V. CONSOLIDATION COAL CO., ET AL. On December 21, 1999, Columbia Transmission filed a complaint in Federal court in Pittsburgh, Pennsylvania against Consolidation Coal Co. and McElroy Coal Co. (collectively, Consol), seeking declaratory and permanent injunctive relief enjoining Consol from pursuing its current plan to conduct longwall mining through Columbia Transmission's Victory Storage Field (Victory) in northern West Virginia. The complaint was served on April 10, 2000. Consol's current plans to longwall mine through Victory would destroy certain infrastructure of Victory, including all of Columbia Transmission's storage wells in the path of the mining. The parties are holding discussions concerning resolution of this matter. On December 8, 2000, the court denied Consol's motion to dismiss. On March 5, 2001, the court denied Consol's motion to transfer this action to Federal court in West Virginia (see McElroy Coal Company v. Columbia Gas Transmission Corporation below). On March 27, 2001, the court also granted Columbia's motion to enjoin Consol from further prosecuting the West Virginia action and from initiating any further actions in any other court raising compulsory counterclaims to this action. On April 2, 2001, Consol filed an appeal of the March 27, 2001 order to the United States Court of Appeals for the Third Circuit. The appeal has been fully briefed and is awaiting disposition by the United States Court of Appeals for the Third Circuit. Consol also filed a Motion for Leave to File a Counterclaim on April 10, 2001, including a claim for inverse condemnation. The court accepted Consol's Motion for Leave on April 12, 2001. Columbia Transmission filed its response to Consol's counterclaim on May 3, 2001. Meanwhile, discovery is proceeding. 6. McELROY COAL COMPANY V. COLUMBIA GAS TRANSMISSION CORPORATION On February 12, 2001, McElroy Coal Company (McElroy), an affiliate of Consolidation Coal Co., filed a complaint against Columbia Transmission in Federal court in Wheeling, West Virginia. The West Virginia complaint seeks declaratory and injunctive relief as to McElroy's alleged right to mine coal within Victory, and Columbia Transmission's obligation to take all necessary measures to permit McElroy to longwall mine. The complaint also seeks compensation for the inverse condemnation of any coal that cannot be mined due to Columbia Transmission's Victory operations. Except for the claim of inverse condemnation, McElroy's West Virginia complaint appears to be virtually identical to Consol's original counterclaim to Columbia Transmission's Federal court action in Pennsylvania. As discussed in Columbia Gas Transmission Corp. v. Consolidation Coal Co., et al, above, the federal court in Pittsburgh has granted Columbia's motion to enjoin McElroy from further prosecution of this action and this order is on appeal to the United States Court of Appeals for the Third Circuit. Meanwhile, on April 10, 2001, the West Virginia case was dismissed without prejudice. 38
39 NISOURCE INC. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On April 11, 2001, NiSource held its Annual Meeting of Stockholders. On the February 26, 2001 record date, NiSource had 206,394,868 shares of common stock outstanding, each of which was entitled to one vote at the meeting. Voted upon and approved by the requisite number of shares present in person or by proxy at the meeting was: the election of four directors each to serve a term of three years. <TABLE> <CAPTION> Name of Director Votes For Votes Withheld ---------------------------------------------------------------------- <S> <C> <C> Steven C. Beering 175,654,620 2,172,334 Dennis E. Foster 176,093,951 1,733,003 James T. Morris 166,917,014 10,909,940 Carolyn Y. Woo 170,718,750 7,108,204 </TABLE> ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits (10.34) Form of Agreement between NiSource Inc. and certain officers of Columbia Energy Group and schedule of parties to such Agreements. (10.35) NiSource Inc. Directors' Charitable Gift Program effective January 1, 2001 (superceding the NIPSCO Industries, Inc. Directors' Charitable Gift Program effective September 27, 1994 (filed as Exhibit 10.9 to the NiSource Annual Report on Form 10-K for the year ended December 31, 2000)). Pursuant to Item 601(b)(4)(iii) of Regulation S-K, NiSource hereby agrees to furnish the SEC, upon request, any instrument defining the rights of holders of long-term debt of NiSource not filed as an exhibit herein. No such instrument authorizes long-term debt securities in excess of 10% of the total assets of NiSource and its subsidiaries on a consolidated basis. (b) Reports on Form 8-K The following reports on Form 8-K were filed during the second quarter of 2001: <TABLE> <CAPTION> Financial Item Statements Reported Included Date of Event Date Filed ----------------------------------------------------------------- <S> <C> <C> <C> 9 No June 12, 2001 June 12, 2001 5 No May 21, 2001 May 21, 2001 7 Yes April 2, 2001 April 2, 2001 </TABLE> 39
40 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. <TABLE> <S> <C> NiSource Inc. ------------------------------- (Registrant) Date: August 7, 2001 By: /s/ Jeffrey W. Grossman ------------------------------- Jeffrey W. Grossman Vice President and Controller (Principal Accounting Officer and Duly Authorized Officer) </TABLE> 40