SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 1996 Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ________________ to ________________ Commission file number 1-9779 NIPSCO Industries, Inc. (Exact name of registrant as specified in its charter) Indiana 35-1719974 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5265 Hohman Avenue, Hammond, Indiana 46320-1775 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (219) 853-5200 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No -------- -------- As of July 31, 1996, 61,124,419 common shares were outstanding. NIPSCO INDUSTRIES, INC. Part I. FINANCIAL INFORMATION Item I. FINANCIAL STATEMENTS REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To The Board of Directors of NIPSCO Industries, Inc.: We have audited the accompanying consolidated balance sheet of NIPSCO Industries, Inc. (an Indiana corporation) and subsidiaries as of June 30, 1996, and December 31, 1995, and the related consolidated statements of income, common shareholders' equity and cash flows for the three, six, and twelve month periods ended June 30, 1996 and 1995. These consolidated financial statements are the responsibility of Industries' management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NIPSCO Industries, Inc. and subsidiaries as of June 30, 1996, and December 31, 1995, and the results of their operations and their cash flows for the three, six, and twelve month periods ended June 30, 1996 and 1995, in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP Chicago, Illinois July 26, 1996 CONSOLIDATED BALANCE SHEET June 30, December 31, ASSETS 1996 1995 ============ ============ (Dollars in thousands) UTILITY PLANT, AT ORIGINAL COST (INCLUDING CONSTRUCTION WORK IN PROGRESS OF $139,763 AND $145,129, RESPECTIVELY) (Note 2): Electric $ 3,980,907 $ 3,935,103 Gas 1,318,802 1,301,687 Common 351,104 350,168 ------------ ------------ 5,650,813 5,586,958 Less - Accumulated provision for depreciation and amortization 2,469,449 2,373,694 ------------ ------------ Total Utility Plant 3,181,364 3,213,264 ------------ ------------ OTHER PROPERTY AND INVESTMENTS: Other property, at cost, less accumulated provision for depreciation 140,026 136,006 Investments, at equity (Note 2) 51,890 47,565 Investments, at cost 25,071 22,899 Other investments 18,459 17,315 ------------ ------------ Total Other Property and Investments 235,446 223,785 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents 31,260 28,496 Accounts receivable, less reserve of $7,189 and $7,264,respectively (Note 2) 79,833 108,998 Fuel adjustment clause (Note 2) 11,623 10,301 Gas cost adjustment clause (Note 2) 48,946 1,423 Materials and supplies, at average cost 61,966 65,044 Electric production fuel, at average cost 30,897 14,258 Natural gas in storage, at last-in, first-out cost (Note 2) 29,530 60,884 Prepayments and other 67,998 27,177 ------------ ------------ Total Current Assets 362,053 316,581 ------------ ------------ OTHER ASSETS: Regulatory assets (Note 2) 212,933 212,491 Deferred charges and other noncurrent assets 63,707 33,399 ------------ ------------ Total Other Assets 276,640 245,890 ------------ ------------ $ 4,055,503 $ 3,999,520 ============ ============ <FN> The accompanying notes to consolidated financial statements are an integral part of this statement. CONSOLIDATED BALANCE SHEET June 30, December 31, CAPITALIZATION AND LIABILITIES 1996 1995 ============ ============ (Dollars in thousands) CAPITALIZATION: Common shareholders' equity (See accompanying statement) $ 1,116,228 $ 1,122,215 Cumulative preferred stocks (Note 10) - Northern Indiana Public Service Company: Series without mandatory redemption provisions (Note 11) 81,129 81,325 Series with mandatory redemption provisions (Note 12) 62,401 63,651 NIPSCO Industries Inc.: Series with mandatory redemption provisions (Note 12) 0 35,000 Long-term debt excluding amounts due within one year (Note 16) 1,254,936 1,175,728 ------------ ------------ Total Capitalization 2,514,694 2,477,919 ------------ ------------ CURRENT LIABILITIES: Current portion of long-term debt (Note 17) 90,584 96,855 Short-term borrowings (Note 18) 265,917 260,671 Accounts payable 156,379 151,691 Sinking funds due within one year (Notes 12 and 16) 2,621 2,621 Dividends declared on common and preferred stocks 26,976 28,179 Customer deposits 13,172 11,361 Taxes accrued 51,879 28,952 Interest accrued 9,439 8,439 Accrued employment costs 37,666 46,695 Other accruals 24,986 33,753 ------------ ------------ Total Current Liabilities 679,619 669,217 ------------ ------------ OTHER: Deferred income taxes (Note 7) 600,514 596,940 Deferred investment tax credits, being amortized over life of related property (Note 7) 112,328 115,666 Deferred credits 41,811 45,126 Accrued liability for postretirement benefits (Note 9) 91,647 75,012 Other noncurrent liabilities 14,890 19,640 ------------ ------------ Total Other 861,190 852,384 ------------ ------------ COMMITMENTS AND CONTINGENCIES: (Notes 3, 4, 5, 6, 19, and 20) $ 4,055,503 $ 3,999,520 ============ ============ <FN> The accompanying notes to consolidated financial statements are an integral part of this statement. CONSOLIDATED STATEMENT OF INCOME Three Months Six Months Ended June 30, Ended June 30, ---------------------- ---------------------- 1996 1995 1996 1995 ========== ========== ========== ========== (Dollars in thousands, except for per share amounts) Operating Revenues: (Notes 2, 5, and 22) Gas $ 120,738 $ 114,559 $ 448,342 $ 399,469 Electric 244,232 245,903 492,656 483,491 ---------- ---------- ---------- ---------- 364,970 360,462 940,998 882,960 ---------- ---------- ---------- ---------- Cost of Energy: (Note 2) Gas costs 67,438 65,059 266,696 237,358 Fuel for electric generation 53,184 55,912 110,386 109,697 Power purchased 14,322 11,169 26,283 22,133 ---------- ---------- ---------- ---------- 134,944 132,140 403,365 369,188 ---------- ---------- ---------- ---------- Operating Margin 230,026 228,322 537,633 513,772 ---------- ---------- ---------- ---------- Operating Expenses and Taxes (except income): Operation 72,127 70,876 151,275 141,677 Maintenance (Note 2) 19,695 18,597 37,491 40,050 Depreciation and amortization (Note 2) 54,247 49,748 107,703 98,865 Taxes (except income) 17,387 17,137 38,132 37,569 ---------- ---------- ---------- ---------- 163,456 156,358 334,601 318,161 ---------- ---------- ---------- ---------- Operating Income Before Utility Income Taxes 66,570 71,964 203,032 195,611 ---------- ---------- ---------- ---------- Utility Income Taxes (Note 7) 16,061 18,774 57,528 56,348 ---------- ---------- ---------- ---------- Operating Income 50,509 53,190 145,504 139,263 ---------- ---------- ---------- ---------- Other Income (Deductions) (Note 2) 1,492 (143) 1,953 (974) ---------- ---------- ---------- ---------- Income Before Interest and Other Charges 52,001 53,047 147,457 138,289 ---------- ---------- ---------- ---------- Interest and Other Charges: Interest on long-term debt 21,899 21,448 43,368 41,109 Other interest 3,544 2,680 6,918 6,500 Allowance for borrowed funds used during construction and carrying charges (Note 2) (216) (1,351) (447) (3,291) Amortization of premium, reacquisition premium, discount and expense on debt, net 1,167 1,057 2,326 2,102 Dividend requirements on preferred stocks of subsidiary 2,178 2,265 4,377 4,590 ---------- ---------- ---------- ---------- 28,572 26,099 56,542 51,010 ---------- ---------- ---------- ---------- Net Income 23,429 26,948 90,915 87,279 Dividend requirements on preferred shares 0 765 119 1,531 ---------- ---------- ---------- ---------- Balance available for common shareholders $ 23,429 $ 26,183 $ 90,796 $ 85,748 ========== ========== ========== ========== Average common shares outstanding 61,234,350 63,474,328 61,649,509 63,787,171 Earnings per average common share $ 0.38 $ 0.41 $ 1.47 $ 1.34 ========== ========== ========== ========== Dividends declared per common share $ 0.42 $ 0.39 $ 0.84 $ 0.78 ========== ========== ========== ========== Twelve Months Ended June 30, ---------------------- 1996 1995 ========== ========== (Dollars in thousands, except for per share amounts) Operating Revenues: (Notes 2, 5, and 22) Gas $ 740,275 $ 660,157 Electric 1,040,088 985,644 ---------- ---------- 1,780,363 1,645,801 ---------- ---------- Cost of Energy: (Note 2) Gas costs 428,451 386,230 Fuel for electric generation 243,026 234,033 Power purchased 47,831 35,794 ---------- ---------- 719,308 656,057 ---------- ---------- Operating Margin 1,061,055 989,744 ---------- ---------- Operating Expenses and Taxes (except income): Operation 300,549 280,184 Maintenance (Note 2) 75,734 79,061 Depreciation and amortization (Note 2) 209,975 196,935 Taxes (except income) 74,015 71,820 ---------- ---------- 660,273 628,000 ---------- ---------- Operating Income Before Utility Income Taxes 400,782 361,744 ---------- ---------- Utility Income Taxes (Note 7) 109,629 100,785 ---------- ---------- Operating Income 291,153 260,959 ---------- ---------- Other Income (Deductions) (Note 2) (1,314) 4,163 ---------- ---------- Income Before Interest and Other Charges 289,839 265,122 ---------- ---------- Interest and Other Charges: Interest on long-term debt 84,914 79,177 Other interest 13,199 13,579 Allowance for borrowed funds used during construction and carrying charges (Note 2) (834) (5,977) Amortization of premium, reacquisition premium, discount and expense on debt, net 4,626 4,189 Dividend requirements on preferred stocks of subsidiary 8,833 9,407 ---------- ---------- 110,738 100,375 ---------- ---------- Net Income 179,101 164,747 Dividend requirements on preferred shares 1,651 3,063 ---------- ---------- Balance available for common shareholders $ 177,450 $ 161,684 ========== ========== Average common shares outstanding 62,219,569 64,029,078 Earnings per average common share $ 2.85 $ 2.52 ========== ========== Dividends declared per common share $ 1.65 $ 1.53 ========== ========== <FN> The accompanying notes to consolidated financial statements are an integral part of this statement. CONSOLIDATED STATEMENT OF COMMON SHAREHOLDERS' EQUITY Dollars in Thousands -------------------------------------------------- Additional Common Paid-in Retained Three Months Ended Total Shares Capital Earnings ======================== =========== =========== =========== =========== Balance, April 1, 1995 $ 1,134,786 $ 870,930 $ 31,806 $ 481,176 Net income 26,948 26,948 Dividends: Preferred shares (765) (765) Common shares (24,511) (24,511) Treasury shares acquired (21,791) Issued: Employee stock purchase plan Long-term incentive plan 1,455 23 Amortization of unearned compensation 589 Other (503) 121 (25) ----------- ----------- ----------- ----------- Balance, June 30, 1995 $ 1,116,208 $ 870,930 $ 31,950 $ 482,823 =========== =========== =========== =========== Balance, April 1, 1996 $ 1,126,350 $ 870,930 $ 32,541 $ 560,401 Net income 23,429 23,429 Dividends: Preferred shares Common shares (25,684) (25,684) Treasury shares acquired (9,548) Issued: Employee stock purchase plan 146 84 Long-term incentive plan 675 30 Amortization of unearned compensation 574 Unrealized gain (loss) on available for sale securities 258 Other 28 19 (70) ----------- ----------- ----------- ----------- Balance, June 30, 1996 $ 1,116,228 $ 870,930 $ 32,674 $ 558,076 =========== =========== =========== =========== Dollars in Thousands Shares ------------------------------------- ----------- Currency Three Months Ended Treasury Translation Common (continued) Shares Adjustment Other Shares ======================== =========== =========== =========== =========== Balance, April 1, 1995 $ (240,222) $ (882) $ (8,022) 73,892,109 Net income Dividends: Preferred shares Common shares Treasury shares acquired (21,791) Issued: Employee stock purchase plan Long-term incentive plan 1,528 (96) Amortization of unearned compensation 589 Other (599) ----------- ----------- ----------- ----------- Balance, June 30, 1995 $ (260,485) $ (1,481) $ (7,529) 73,892,109 =========== =========== =========== =========== Balance, April 1, 1996 $ (330,942) $ (2,070) $ (4,510) 73,892,109 Net income Dividends: Preferred shares Common shares Treasury shares acquired (9,548) Issued: Employee stock purchase plan 62 Long-term incentive plan 755 (110) Amortization of unearned compensation 574 Unrealized gain (loss) on available for sale securities 258 Other 79 ----------- ----------- ----------- ----------- Balance, June 30, 1996 $ (339,673) $ (1,991) $ (3,788) 73,892,109 =========== =========== =========== =========== Shares ----------- Three Months Ended Treasury (continued) Shares ======================== =========== Balance, April 1, 1995 (10,020,238) Net income Dividends: Preferred shares Common shares Treasury shares acquired (669,335) Issued: Employee stock purchase plan Long-term incentive plan 62,000 Amortization of unearned compensation Other ----------- Balance, June 30, 1995 (10,627,573) =========== Balance, April 1, 1996 (12,503,363) Net income Dividends: Preferred shares Common shares Treasury shares acquired (266,067) Issued: Employee stock purchase plan 3,920 Long-term incentive plan 28,150 Amortization of unearned compensation Unrealized gain (loss) on available for sale securities Other ----------- Balance, June 30, 1996 (12,737,360) =========== Dollars in Thousands -------------------------------------------------- Additional Common Paid-in Retained Six Months Ended Total Shares Capital Earnings ======================== =========== =========== =========== =========== Balance, January 1, 1995 $ 1,107,848 $ 870,930 $ 29,657 $ 446,928 Net income 87,279 87,279 Dividends: Preferred shares (1,531) (1,531) Common shares (49,657) (49,657) Treasury shares acquired (32,239) Issued: Employee stock purchase plan 305 142 Long-term incentive plan 2,717 1,654 Amortization of unearned compensation 1,162 Other 324 497 (196) ----------- ----------- ----------- ----------- Balance, June 30, 1995 $ 1,116,208 $ 870,930 $ 31,950 $ 482,823 =========== =========== =========== =========== Balance, January 1, 1996 $ 1,122,215 $ 870,930 $ 32,210 $ 518,837 Net income 90,915 90,915 Dividends: Preferred shares (119) (119) Common shares (51,478) (51,478) Treasury shares acquired (48,036) Issued: Employee stock purchase plan 449 261 Long-term incentive plan 1,010 184 Amortization of unearned compensation 1,188 Unrealized gain (loss) on available for sale securities 205 Other (121) 19 (79) ----------- ----------- ----------- ----------- Balance, June 30, 1996 $ 1,116,228 $ 870,930 $ 32,674 $ 558,076 =========== =========== =========== =========== Dollars in Thousands Shares ------------------------------------- ----------- Currency Six Months Ended Treasury Translation Common (continued) Shares Adjustment Other Shares ======================== =========== =========== =========== =========== Balance, January 1, 1995 $ (237,193) $ (1,504) $ (970) 73,892,109 Net income Dividends: Preferred shares Common shares Treasury shares acquired (32,239) Issued: Employee stock purchase plan 163 Long-term incentive plan 8,784 (7,721) Amortization of unearned compensation 1,162 Other 23 ----------- ----------- ----------- ----------- Balance, June 30, 1995 $ (260,485) $ (1,481) $ (7,529) 73,892,109 =========== =========== =========== =========== Balance, January 1, 1996 $ (293,223) $ (1,930) $ (4,609) 73,892,109 Net income Dividends: Preferred shares Common shares Treasury shares acquired (48,036) Issued: Employee stock purchase plan 188 Long-term incentive plan 1,398 (572) Amortization of unearned 1,188 compensation Unrealized gain (loss) on available for sale securities 205 Other (61) ----------- ----------- ----------- ----------- Balance, June 30, 1996 $ (339,673) $ (1,991) $ (3,788) 73,892,109 =========== =========== =========== =========== Shares ----------- Six Months Ended Treasury (continued) Shares ======================== =========== Balance, January 1, 1995 (9,986,720) Net income Dividends: Preferred shares Common shares Treasury shares acquired (1,003,334) Issued: Employee stock purchase plan 10,231 Long-term incentive plan 352,250 Amortization of unearned compensation Other ----------- Balance, June 30, 1995 (10,627,573) =========== Balance, April 1, 1996 (11,512,513) Net income Dividends: Preferred shares Common shares Treasury shares acquired (1,289,744) Issued: Employee stock purchase plan 11,847 Long-term incentive plan 53,050 Amortization of unearned compensation Unrealized gain (loss) on available for sale securities Other ----------- Balance, June 30, 1996 (12,737,360) =========== Dollars in Thousands -------------------------------------------------- Additional Common Paid-in Retained Twelve Months Ended Total Shares Capital Earnings ======================== =========== =========== =========== =========== Balance, July 1, 1994 $ 1,102,698 $ 870,930 $ 27,825 $ 418,983 Net income 164,747 164,747 Dividends: Preferred shares (3,063) (3,063) Common shares (97,620) (97,620) Treasury shares acquired (58,326) Employee stock purchase plan 598 277 Long-term incentive plan 3,245 1,656 Amortization of unearned compensation 1,551 Other 2,378 2,192 (224) ----------- ----------- ----------- ----------- Balance, June 30, 1995 $ 1,116,208 $ 870,930 $ 31,950 $ 482,823 ----------- ----------- ----------- ----------- Net income 179,101 179,101 Dividends: Preferred shares (1,651) (1,651) Common shares Treasury shares acquired (102,053) (102,053) Issued: (84,980) Employee stock purchase plan 748 420 Long-term incentive plan 5,078 186 Amortization of unearned compensation 2,439 Unrealized gain (loss) on available for sale securities 1,874 Other (536) 118 (144) ----------- ----------- ----------- ----------- Balance, June 30, 1996 $ 1,116,228 $ 870,930 $ 32,674 $ 558,076 =========== =========== =========== =========== Dollars in Thousands Shares ------------------------------------- ----------- Currency Twelve Months Ended Treasury Translation Common (continued) Shares Adjustment Other Shares ======================== =========== =========== =========== =========== Balance, July 1, 1994 $ (211,790) $ (1,891) $ (1,359) 73,892,109 Net income Dividends: Preferred shares Common shares Treasury shares acquired (58,326) Issued: Employee stock purchase plan 321 Long-term incentive plan 9,310 (7,721) Amortization of unearned compensation 1,551 Other 410 ----------- ----------- ----------- ----------- Balance, June 30, 1995 $ (260,485) $ (1,481) $ (7,529) 73,892,109 ----------- ----------- ----------- ----------- Net income Dividends: Preferred shares Common shares Treasury shares acquired Issued: (84,980) Employee stock purchase plan 328 Long-term incentive plan 5,464 (572) Amortization of unearned compensation 2,439 Unrealized gain (loss) on available for sale securities 1,874 Other (510) ----------- ----------- ----------- ----------- Balance, June 30, 1996 $ (339,673) $ (1,991) $ (3,788) 73,892,109 =========== =========== =========== =========== Shares ----------- Twelve Months Ended Treasury (continued) Shares ======================== =========== Balance, July 1, 1994 (9,106,152) Net income Dividends: Preferred shares Common shares Treasury shares acquired (1,915,914) Issued: Employee stock purchase plan 20,193 Long-term incentive plan 374,300 Amortization of unearned compensation Other ----------- Balance, June 30, 1995 (10,627,573) ----------- Net income Dividends: Preferred shares Common shares Treasury shares acquired Issued: (2,344,075) Employee stock purchase plan 20,638 Long-term incentive plan 213,650 Amortization of unearned compensation Unrealized gain (loss) on available for sale securities Other ----------- Balance, June 30, 1996 (12,737,360) =========== <FN> The accompanying notes to consolidated financial statements are an integral part of this statement. CONSOLIDATED STATEMENT OF CASH FLOWS Three Months Ended June 30, ----------------------- 1996 1995 ========= ========= (Dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 23,429 $ 26,948 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH: Depreciation and amortization 54,247 49,748 Deferred federal and state operating income taxes, net (2,050) (4,897) Deferred investment tax credits, net (1,668) (1,868) Advanced contract payment 475 0 Change in certain assets and liabilities - Accounts receivable, net 62,940 52,847 Electric production fuel (10,951) 5,217 Materials and supplies 2,412 (129) Natural gas in storage (17,624) (16,302) Accounts payable (24,183) (31,170) Taxes accrued (38,276) (40,946) Fuel adjustment clause (3,156) (2,553) Gas cost adjustment clause 151 13,805 Accrued employment costs (236) 1,371 Other accruals (21,074) 6,399 Other, net (20,588) (6,941) --------- --------- Net cash provided by operating activities 3,848 51,529 --------- --------- CASH FLOWS USED IN INVESTING ACTIVITIES: Utility construction expenditures (45,129) (46,545) Construction expenditures related to Crossroads Pipeline Company (279) (718) Return of capital from equity investments 0 Other, net (652) (399) --------- --------- Net cash used in investing activities (46,060) (47,662) --------- --------- CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES: Issuance of long-term debt 1,153 169,623 Issuance of short-term debt 258,720 137,278 Net change in commercial paper 79,100 (70,000) Retirement of long-term debt (7,620) (25,092) Retirement of short-term debt (263,300) (155,192) Retirement of preferred shares (1,446) (1,761) Issuance of common shares 806 1,432 Acquisition of treasury shares (9,548) (21,791) Cash dividends paid on common shares (25,784) (24,876) Cash dividends paid on preferred shares 0 (765) Other, net 139 (210) --------- --------- Net cash provided by financing activities 32,220 8,646 --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (9,992) 12,513 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 41,252 36,157 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 31,260 $ 48,670 ========= ========= Six Months Ended June 30, ----------------------- 1996 1995 ========= ========= (Dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 90,915 $ 87,279 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH: Depreciation and amortization 107,703 98,865 Deferred federal and state operating income taxes, net 12,941 (21,954) Deferred investment tax credits, net (3,338) (3,736) Advanced contract payment (18,050) 0 Change in certain assets and liabilities - Accounts receivable, net 29,165 21,893 Electric production fuel (16,639) (1,371) Materials and supplies 3,078 (3,479) Natural gas in storage 31,354 39,464 Accounts payable 4,688 (43,921) Taxes accrued 6,180 29,969 Fuel adjustment clause (1,322) (1,306) Gas cost adjustment clause (47,523) 61,123 Accrued employment costs (9,029) (3,578) Other accruals (8,767) 28,993 Other, net (22,687) 6,106 ------- --------- Net cash provided by operating activities 158,669 294,347 --------- --------- CASH FLOWS USED IN INVESTING ACTIVITIES: Utility construction expenditures (80,158) (96,484) Construction expenditures related to Crossroads Pipeline Company (364) (932) Return of capital from equity investments 0 Other, net (14,569) (8,435) --------- --------- Net cash used in investing activities (95,091) (105,851) --------- --------- CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES: Issuance of long-term debt 77,450 173,974 Issuance of short-term debt 598,408 408,139 Net change in commercial paper 55,000 (163,000) Retirement of long-term debt (8,737) (25,956) Retirement of short-term debt (648,035) (487,592) Retirement of preferred shares (36,446) (5,331) Issuance of common shares 1,414 2,828 Acquisition of treasury shares (48,036) (32,239) Cash dividends paid on common shares (51,993) (50,022) Cash dividends paid on preferred shares (119) (1,531) Other, net 280 463 --------- --------- Net cash used in financing activities (60,814) (180,267) --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,764 8,229 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 28,496 40,441 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 31,260 $ 48,670 ========= ========= Twelve Months Ended June 30, ----------------------- 1996 1995 ========= ========= (Dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 179,101 $ 164,747 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH: Depreciation and amortization 209,975 196,935 Deferred federal and state operating income taxes, net 32,214 (18,015) Deferred investment tax credits, net (7,117) (7,418) Advanced contract payment (18,050) 0 Change in certain assets and liabilities - Accounts receivable, net (15,427) 13,706 Electric production fuel (11,179) 3,123 Materials and supplies 6,943 (2,654) Natural gas in storage 8,800 7,827 Accounts payable 41,588 (38,206) Taxes accrued (32,991) 33,174 Fuel adjustment clause (8,703) 4,413 Gas cost adjustment clause (84,097) 9,470 Accrued employment costs (2,567) 1,940 Other accruals (15,037) 22,818 Other, net (27,639) 15,999 --------- --------- Net cash provided by operating activities 255,814 407,859 --------- --------- CASH FLOWS USED IN INVESTING ACTIVITIES: Utility construction expenditures (173,428) (197,395) Construction expenditures related to Crossroads Pipeline Company (2,644) (1,511) Return of capital from equity investments 0 0 Other, net (57,883) (21,022) --------- --------- Net cash used in investing activities (233,955) (219,928) --------- --------- CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES: Issuance of long-term debt 83,031 369,910 Issuance of short-term debt 1,481,242 982,064 Net change in commercial paper 133,400 (100,800) Retirement of long-term debt (104,886) (53,983) Retirement of short-term debt (1,412,693) (1,205,081) Retirement of preferred shares (38,210) (14,367) Issuance of common shares 5,975 3,649 Acquisition of treasury shares (84,980) (58,326) Cash dividends paid on common shares (101,014) (96,398) Cash dividends paid on preferred shares (1,651) (3,063) Other, net 517 382 --------- --------- Net cash used in financing activities (39,269) (176,013) --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (17,410) 11,918 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 48,670 36,752 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 31,260 $ 48,670 ========= ========= <FN> The accompanying notes to consolidated financial statements are an integral part of this statement. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) HOLDING COMPANY STRUCTURE: NIPSCO Industries, Inc. (Industries) is an Indiana corporation serving as the holding company for a number of subsidiaries, including four regulated companies: Northern Indiana Public Service Company (Northern Indiana); Kokomo Gas and Fuel Company (Kokomo Gas); Northern Indiana Fuel and Light Company, Inc. (NIFL); and Crossroads Pipeline Company (Crossroads). Northern Indiana is a public utility operating company supplying natural gas and electric energy to the public. Kokomo Gas and NIFL are public utility operating companies supplying natural gas to the public, and Crossroads is an interstate natural gas transmission company. Industries' major non-utility subsidiaries include NIPSCO Development Company, Inc. (Development); NIPSCO Energy Services, Inc. (Services); Primary Energy, Inc. (Primary); and NIPSCO Capital Markets, Inc. (Capital Markets). Development makes various investments, including real estate and venture capital investments. Services coordinates the energy-related diversification ventures of Industries. Primary arranges energy-related projects with large industrial customers. Capital Markets handles financing for Industries and its subsidiaries, other than Northern Indiana. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: BASIS OF PRESENTATION. The consolidated financial statements include the accounts of Industries; its regulated subsidiaries Northern Indiana, Kokomo Gas, NIFL and Crossroads (Utilities); and all non-utility subsidiaries. Investments for which Industries has at least a 20% interest and certain joint ventures are accounted for under the equity method of accounting. Investments with less than a 20% interest are accounted for under the cost method of accounting. The operating results of the non-utility subsidiaries, as well as the non-operating results of the utilities, are included under the caption "Other Income (Deductions)" in the Consolidated Statement of Income. Interest on long-term debt, other interest, and amortization of debt discount and expense are reflected as a component of "Interest and Other Charges." All significant intercompany items have been eliminated in consolidation. Certain reclassifications were made to conform the prior years' financial statements to the current presentation. USE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. OPERATING REVENUES. Revenues are recorded based on estimated service rendered, but are billed to customers monthly on a cycle basis. DEPRECIATION AND MAINTENANCE. Northern Indiana provides depreciation on a straight-line method over the remaining service lives of the electric, gas, and common properties. The provisions, as a percentage of the cost of depreciable utility plant, were approximately 4.3%, 4.2%, and 4.1% for the three-month, six-month, and twelve-month periods ended June 30, 1996, respectively; and 4.0%, 4.0%, and 4.1% for the three-month, six-month, and twelve-month periods ended June 30, 1995. The depreciation rates for electric and gas properties were 3.55% and 4.92%, respectively. Kokomo Gas provides depreciation on the original cost of utility plant in service using straight-line rates that averaged approximately 3.1% for the three-month, six-month, and twelve-month periods ended June 30, 1996; and 3.2% for the three-month, six-month, and twelve-month periods ended June 30, 1995. NIFL provides depreciation on the original cost of utility plant in service using straight-line rates that averaged approximately 2.75% for the three-month, six-month, and twelve-month periods ended June 30, 1996 and June 30, 1995. Crossroads provides depreciation on the original cost of utility plant in service using straight-line rates that averaged approximately 2.5% for the three-month, six-month, and twelve-month periods ended June 30, 1996 and June 30, 1995. The Utilities follow the practice of charging maintenance and repairs, including the cost of renewals of minor items of property, to maintenance expense accounts, except for repairs of transportation and service equipment which are charged to clearing accounts and redistributed to operating expense and other accounts. When property which represents a retirement unit is replaced or removed, the cost of such property is credited to utility plant, and such cost, together with the cost of removal less salvage, is charged to the accumulated provision for depreciation. AMORTIZATION OF SOFTWARE COSTS. Northern Indiana amortizes capitalized software costs using the straight-line method based on estimated economic lives. PLANT ACQUISITION ADJUSTMENTS. Industries' costs in excess of the underlying book values of the acquired NIFL and Kokomo Gas subsidiaries have been recorded as plant acquisition adjustments which are being amortized over forty-year periods from their respective dates of acquisition. COAL RESERVES. Northern Indiana has a long-term mining contract to mine its coal reserves through the year 2001. The costs of these reserves are being recovered through the rate-making process as such coal reserves are used to produce electricity. OIL AND NATURAL GAS ACCOUNTING. NIPSCO Fuel Company, Inc., a wholly-owned subsidiary of Services, uses the full-cost method of accounting for its oil and natural gas production activities. Under this method, all costs incurred in the acquisition, exploration, and development of oil and natural gas properties are capitalized and amortized on the units-of-production basis. POWER PURCHASED. Power purchases and net interchange power with other electric utilities under interconnection agreements are included in Cost of Energy under the caption "Power purchased." ACCOUNTS RECEIVABLE. At June 30, 1996, Northern Indiana had sold $100 million of its accounts receivable under a sales agreement which expires May 31, 1997. STATEMENT OF CASH FLOWS. For the purposes of the Consolidated Statement of Cash Flows, Industries considers temporary cash investments with an original maturity of three months or less to be cash equivalents. Cash paid during the periods reported for income taxes and interest was as follows: Three Months Six Months Twelve Months Ended June 30, Ended June 30, Ended June 30, ------------------ ------------------ ------------------ 1996 1995 1996 1995 1996 1995 ======== ======== ======== ======== ======== ======== (Dollars in thousands) Income taxes $ 55,748 $ 49,600 $ 55,748 $ 49,600 $124,088 $ 95,009 Interest, net of amounts capitalized $ 30,544 $ 25,023 $ 40,948 $ 40,932 $ 89,337 $ 78,911 FUEL ADJUSTMENT CLAUSE. All metered electric rates contain a provision for adjustment in charges for electric energy to reflect increases and decreases in the cost of fuel and the fuel cost of purchased power through operation of a fuel adjustment clause. As prescribed by order of the Indiana Utility Regulatory Commission (Commission) applicable to metered retail rates, the adjustment factor has been calculated based on the estimated cost of fuel and the fuel cost of purchased power in a future three-month period. If two statutory requirements relating to expense and return levels are satisfied, any under-recovery or over-recovery caused by variances between estimated and actual cost in a given three-month period will be included in a future filing. Northern Indiana records any under-recovery or over-recovery as a current asset or current liability until such time as it is billed or refunded to its customers. The fuel adjustment factor is subject to a quarterly hearing by the Commission and remains in effect for a three-month period. GAS COST ADJUSTMENT CLAUSE. All metered gas rates contain an adjustment factor which reflects the cost of purchased gas, contracted gas storage, and storage transportation charges. The Utilities record any under-recovery or over-recovery as a current asset or current liability until such time as it is billed or refunded to their customers. The gas cost adjustment factor for Northern Indiana is subject to a quarterly hearing by the Commission and remains in effect for a three-month period. The gas cost adjustment factors for Kokomo Gas and NIFL are subject to semi-annual hearings by the Commission and remain in effect for a six-month period. If the statutory requirement relating to the level of return is satisfied, any under-recovery or over- recovery caused by variances between estimated and actual cost in a given three-month or six-month period will be included in a future filing. See Note 5, FERC Order No. 636 for a discussion of gas transition cost charges. NATURAL GAS IN STORAGE. Northern Indiana's natural gas in storage is valued using the last-in, first-out (LIFO) inventory methodology. Based on the average cost of gas purchased in June 1996 and December 1995 the estimated replacement cost of gas in storage (current and non-current) at June 30, 1996 and December 31, 1995 exceeded the stated LIFO cost by approximately $36 million and $30 million, respectively. Certain other subsidiaries of Industries have natural gas in storage valued at average cost. HEDGING ACTIVITIES. Industries' non-regulated gas subsidiaries use commodity futures contracts and swaps to hedge the impact of natural gas price fluctuations related to its business activities. Gains and losses on futures contracts are deferred and recognized in income concurrent with the related purchases and sales of natural gas. As of June 30, 1996, Industries had open futures contracts representing hedges of natural gas purchases of 0.3 million British thermal units (MMBtu) and natural gas sales of 2.4 MMBtu. The deferred loss on these open contracts totalled $0.6 million. This loss will be offset by the margin on the related natural gas transactions. REGULATORY ASSETS. The Utilities' operations are subject to the regulation of the Commission and the Federal Energy Regulatory Commission (FERC). Accordingly, the Utilities' accounting policies are subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." The Utilities monitor changes in market and regulatory conditions and the resulting impact of such changes in order to continue to apply the provisions of SFAS No. 71 to some or all of its operations. The regulatory assets identified below represent probable future revenue to the Utilities associated with certain incurred costs as these costs are recovered through the rate-making process. If a portion of the Utilities' operations becomes no longer subject to the provisions of SFAS No. 71, a write-off of certain of the regulatory assets identified below might be required. Regulatory assets were comprised of the following items and were reflected in the Consolidated Balance Sheet as follows: June 30, December 31, 1996 1995 ============ ============ (Dollars in thousands) Unamortized reacquisition premium on debt (Note 16) $ 52,019 $ 53,776 Unamortized R.M. Schahfer Unit 17 and Unit 18 carrying charges and deferred depreciation (See below) 72,872 74,981 Bailly scrubber carrying charges and deferred depreciation (See below) 11,284 11,517 Deferral of SFAS No. 106 expense not recovered (Note 9) 76,612 64,834 FERC Order No. 636 transition costs (Note 5) 28,162 25,038 ------------ ------------ 240,949 230,146 Less: Current portion of regulatory assets 28,016 17,655 ------------ ------------ $ 212,933 $ 212,491 ============ ============ In March 1995, the Financial Accounting Standards Board issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This statement imposes stricter criteria for retention of regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. The Utilities adopted this standard on January 1, 1996, and adoption did not impact their financial position or results of operations. CARRYING CHARGES AND DEFERRED DEPRECIATION. Upon completion of R. M. Schahfer Units 17 and 18, Northern Indiana capitalized the carrying charges and deferred depreciation in accordance with orders of the Commission until the cost of each unit was allowed in rates. Such carrying charges and deferred depreciation are being amortized over the remaining life of each unit. Northern Indiana has capitalized carrying charges and deferred depreciation and certain operating expenses relating to its scrubber service agreement for its Bailly Generating Station in accordance with an order of the Commission. Pursuant to such order, capitalization of carrying charges and deferral of depreciation and certain operating expenses ceased on December 31, 1995. The accumulated balance of the deferred costs and related carrying charges is being amortized over the remaining life of the scrubber service agreement. ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION. Allowance for funds used during construction (AFUDC) is charged to construction work in progress during the period of construction and represents the net cost of borrowed funds used for construction purposes and a reasonable rate upon other (equity) funds. Under established regulatory rate practices, after the construction project is placed in service, Northern Indiana is permitted to include in the rates charged for utility services (a) a fair return on and (b) depreciation of such AFUDC included in plant in service. At January 1, 1994, a pre-tax rate of 5.0% for all construction was being used; effective January 1, 1995 the rate increased to 6.0%; and for 1996 the rate remained at 6.0%. FOREIGN CURRENCY TRANSLATION. Translation gains or losses are based upon the end-of-period exchange rate and are recorded as a separate component of shareholders' equity. INVESTMENTS IN REAL ESTATE. Development has invested in a series of affordable housing projects in the Utilities' service territory. These investments include certain tax benefits, including low-income housing tax credits and tax deductions for operating losses of the housing projects. Development accounts for these investments using the equity method. Investments, at equity, include $24.3 million and $21.9 million relating to affordable housing projects at June 30, 1996 and December 31, 1995, respectively. INCOME TAXES. Deferred income taxes are recognized as costs in the rate-making process by the commissions having jurisdiction over the rates charged by the Utilities. Deferred income taxes are provided as a result of provisions in the income tax law that either require or permit certain items to be reported on the income tax return in a different period than they are reported in the financial statements. These taxes are reversed by a debit or credit to deferred income tax expense as the temporary differences reverse. Investment tax credits have been deferred and are being amortized to income over the life of the related property. (3) PENDING TAX MATTER: On August 1, 1991, the Internal Revenue Service (IRS) issued a notice of deficiency for Northern Indiana's taxes for the years 1982 through 1985 ($3,785,250 per year plus interest) relating to interest payments on $70 million of 17-1/4% Notes issued in 1981 by Northern Indiana's former foreign subsidiary, Northern Indiana Public Service Finance N.V. (Finance). The IRS believes that interest paid on the Notes should have been subject to United States tax withholding. The Notes were redeemed in 1985 and Finance was subsequently liquidated. On October 25, 1991, Northern Indiana challenged the assessment in the United States Tax Court (Tax Court) and the matter was tried in 1994. On November 6, 1995, the Tax Court ruled in favor of Northern Indiana, finding that the interest paid on the Notes was not subject to United States tax withholding. On March 13, 1996, the IRS appealed the Tax Court's decision to the U. S. Court of Appeals for the Seventh Circuit, and on March 25, 1996 Northern Indiana filed its cross appeal. Northern Indiana's management and general counsel believe the ruling of the Tax Court will prevail. (4) ELM ENERGY AND RECYCLING (UK) LTD.: Development, a wholly-owned subsidiary of Industries, is a 95% shareholder in Elm Energy and Recycling (UK) Ltd. (Elm), which owns and operates a tire-fueled electric generating plant in Wolverhampton, England (Project), that began operating in late 1993. In 1992, Elm entered into a contract with TBV Power Limited (TBV), a company jointly owned by affiliates of the Tarmac PLC Group and Black & Veatch, for the design, construction, and commissioning of the Project. Pursuant to that contract and other agreements between Elm and TBV, TBV committed to complete certain work and pass certain performance and reliability tests for the Project no later than June 30, 1995, which would have allowed the independent Project engineer to issue an Acceptance and Completion Certificate by that date. On July 3, 1995, the Project engineer notified TBV that an Acceptance and Completion Certificate had not been issued as of June 30, 1995. Elm then notified TBV that it was rejecting the Project in accordance with the terms of the contract between it and TBV. As a result, on July 3, 1995 Barclays Bank, as agent for the banks which had provided financing for the Project, issued a notice of an event of default to Elm. On July 4, 1995, the Project engineer notified TBV that, in accordance with the contract between Elm and TBV all monies previously paid by Elm to TBV (Pounds 29.6 million) were to be reimbursed by TBV to Elm. The certificate issued by the Project engineer was adjudicated under a procedure provided in the construction contract, and the adjudicator confirmed the full (Pounds) 29.6 million as owing to Elm. TBV has filed suit in the English courts to enjoin enforcement of the adjudicator's decision, to challenge again the Project engineer's decision and to allege breaches of the underlying construction contract and misrepresentations by Elm. Elm has counterclaimed and is aggressively pursuing its remedies. Elm and Development are also seeking additional remedies at law, in both the United States and the United Kingdom, for further damages and/or sanctions against TBV and/or Tarmac PLC Group and Black & Veatch. In response to the claims brought by Elm and Development in the United States, Black & Veatch has brought a counterclaim against Elm and Development alleging breach of contract, negligence, misrepresentation and promissory estoppel. Development believes that the claims made against it and Elm are meritless and that its remedies, in conjunction with Elm's rights under the construction contract, will be sufficient to mitigate any losses which Elm and/or Development may otherwise incur as a result of TBV's failure to complete the Project in accordance with the contract. Development believes that it and Elm have sustainable and adequate remedies under the construction contract such that rejection will not have a material adverse effect on Industries. Elm is continuing to operate the plant. The banks which provided the financing for the plant are continuing to support its operations and to provide working capital under an uncommitted loan facility which is repayable on demand or, in any event, May 31, 1997, (unless extended). However, because of the ongoing defaults under the Project financing and the demand nature of the uncommitted working loan facility, the banks have the right to ask that the operation of the plant be terminated and the assets sold. In that event, some or all of Industries' investments in Elm may be at risk. Industries' investments in Elm were approximately $14 million at June 30, 1996. (5) FERC ORDER NO. 636. Pursuant to FERC Order No. 636, interstate pipeline sales services have been "unbundled" such that gas supplies are being sold separately from interstate transportation services. The Utilities have contracted for a mix of transportation and storage services from their pipeline suppliers which allows them to meet the needs of their customers. Pipelines are recovering, from their customers, certain transition costs associated with restructuring under the Order No. 636 regulation. Any such recovery is subject to established review procedures at the FERC. The Utilities expect that the total transition costs from all suppliers will approximate $139 million; however, the ultimate level of costs will depend on future events, including the market price of natural gas. Approximately $91 million of such costs have been recorded, a portion of which has been paid to the pipeline suppliers, subject to refund. The Commission has approved the recovery of these FERC-allowed transition costs on a volumetric basis from sales and transportation customers. Regulatory assets, in amounts corresponding to the costs recorded but not yet collected, have been recorded to reflect the ultimate recovery of these costs. (6) ENVIRONMENTAL MATTERS: The Utilities have an ongoing program to remain aware of laws and regulations involved with hazardous waste and other environmental matters. It is the Utilities' intent to continue to evaluate their facilities and properties with respect to these rules and identify any sites that would require corrective action. The Utilities have recorded a reserve of $7.2 million to cover probable corrective actions as of June 30, 1996; however, environmental regulations and remediation techniques are subject to future change. The ultimate cost could be significant, depending on the extent of corrective actions required. Based upon investigations and management's understanding of current laws and regulations, the Utilities believe that any corrective actions required, after consideration of insurance coverages and contributions from other potentially responsible parties, will not have a significant impact on the financial position or results of operations of Industries. Because of major investments made in modern environmental control facilities and the use of low-sulfur coal, all of Northern Indiana's electric production facilities now comply with the sulfur dioxide limitations contained in the acid deposition provisions of the Clean Air Act Amendments of 1990 (CAAA). Northern Indiana estimates that total costs of compliance with the CAAA sulfur dioxide regulations will impact electric rates by less than 5% in the future. The CAAA contain provisions that could lead to limitations on emissions of nitrogen oxides and hazardous air pollutants which may require significant capital expenditures for control of these emissions. Northern Indiana is pursuing a nitrogen oxide control program to meet future requirements. Northern Indiana cannot predict the costs of complying with CAAA requirements, but Northern Indiana believes that any such mandated costs would be recoverable through the rate-making process. The Environmental Protection Agency (EPA) has notified Northern Indiana that it is a "potentially responsible party" (PRP) under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) and may be required to share in the cost of cleanup of several waste disposal sites identified by the EPA. The sites are in various stages of investigation, analysis and remediation. At each of the sites, Northern Indiana is one of several PRPs, and it is expected that remedial costs, as provided under CERCLA, will be shared among them. At some sites Northern Indiana and/or the other named PRPs are presently working with the EPA to clean up the sites and avoid the imposition of fines or added costs. The Utilities have instituted a program to investigate former manufactured-gas plants where one of them is the current or former owner. The Utilities have identified twenty-seven of these sites and made visual inspections of these sites. Initial samplings have been conducted at seventeen sites. Follow-up investigations have been conducted at five sites and potential remedial measures are being evaluated. The Utilities will continue their program to assess sites. During the follow-up investigation of the former manufactured-gas plant in Elkhart, Indiana, Northern Indiana noted the presence of hydrocarbons in the Elkhart River. Northern Indiana reported this finding to the Indiana Department of Environmental Management (IDEM) and the EPA. Northern Indiana has placed the Elkhart site in the IDEM Voluntary Remediation Program (VRP). The goal of placing the site in the VRP is to obtain IDEM approval of the determination and subsequent implementation of what remedial measures, if any, may be needed. Northern Indiana was notified by the IDEM of the release of a petroleum substance into the St. Mary's River in Fort Wayne, Indiana, from the site of a former manufactured-gas plant formerly owned by Northern Indiana. In cooperation with IDEM, Northern Indiana has taken steps to investigate and contain the substance. Northern Indiana has remediated parts of the Fort Wayne site. The remainder of the site is being evaluated to determine what further remedial measures, if any, may be needed. Northern Indiana and Indiana Gas Company, Inc. (Indiana Gas) have entered into an agreement covering cost sharing and management of investigation and remediation programs at five former manufactured-gas plant sites at which both companies or their predecessors were former operators or owners. One of these sites is the Lafayette site which Indiana Gas had previously notified Northern Indiana is being investigated and remediated pursuant to an administrative order with IDEM. Northern Indiana also notified PSI Energy, Inc. that it was a former owner or operator of seven former manufactured-gas plants at which Northern Indiana had conducted or was planning investigation or remediation activities. The Utilities have met with various companies that provided insurance coverage which the Utilities believe covers costs related to actions taken at former manufactured-gas plants. In September 1995, certain insurance companies initiated a suit in Indiana state court against Northern Indiana to deny coverage. Later in September 1995, Northern Indiana filed a more comprehensive suit in Federal Court in Indiana against those insurers and several other insurance companies, seeking coverage for costs associated with several former manufactured-gas plant sites. The state court action is stayed pending resolution of the Northern Indiana suit in Federal Court. The possibility that exposure to electric and magnetic fields emanating from power lines, household appliances, and other electric sources may result in adverse health effects has been the subject of public, governmental, and media attention. A considerable amount of scientific research has been conducted on this topic without definitive results. Research is continuing to resolve scientific uncertainties. (7) INCOME TAXES: Industries uses the liability method of accounting for income taxes under which deferred income taxes are recognized, at currently enacted income tax rates, to reflect the tax effect of temporary differences between the financial statement and tax bases of assets and liabilities. To the extent certain deferred income taxes are recoverable or payable through future rates, regulatory assets and liabilities have been established. Regulatory assets are primarily attributable to undepreciated AFUDC-equity and the cumulative net amount of other income tax timing differences for which deferred taxes had not been provided in the past, when regulators did not recognize such taxes as costs in the rate-making process. Regulatory liabilities are primarily attributable to the Utilities' obligation to credit to ratepayers deferred income taxes provided at rates higher than the current federal tax rate currently being credited to ratepayers using the average rate assumption method and unamortized deferred investment tax credits. The components of the net deferred income tax liability at June 30, 1996 and December 31, 1995 are as follows: June 30, December 31, 1996 1995 ============ ============ (Dollars in thousands) Deferred tax liabilities - Accelerated depreciation and other property differences $ 714,037 $ 706,715 AFUDC-equity 38,954 40,083 Adjustment clauses 22,595 4,613 Take-or-pay gas costs 1,001 1,550 Other regulatory assets 30,824 28,930 Reacquisition premium on debt 19,731 20,397 Deferred tax assets - Deferred investment tax credits (42,587) (43,854) Removal costs (124,059) (118,064) FERC Order No. 636 transition costs (3,458) (4,400) Other postretirement/postemployment benefits (38,026) (32,512) Other, net (7,808) (12,575) ------------ ------------ 611,204 590,883 Less: Deferred income taxes related to current assets and liabilities 10,690 (6,057) ------------ ------------ Deferred income taxes - noncurrent $ 600,514 $ 596,940 ============ ============ Federal and state income taxes as set forth in the Consolidated Statement of Income are comprised of the following: Three Months Six Months Ended June 30, Ended June 30, -------------------- -------------------- 1996 1995 1996 1995 ========= ========= ========= ========= (Dollars in thousands) Current income taxes - Federal $ 17,031 $ 22,197 $ 41,405 $ 71,575 State 2,748 3,342 6,520 10,463 --------- --------- --------- --------- 19,779 25,539 47,925 82,038 --------- --------- --------- --------- Deferred income taxes, net - Federal (1,970) (4,568) 11,790 (20,358) State (80) (329) 1,151 (1,596) --------- --------- --------- --------- (2,050) (4,897) 12,941 (21,954) --------- --------- --------- --------- Deferred investment tax credits, net (1,668) (1,868) (3,338) (3,736) --------- --------- --------- --------- Total utility operating income taxes 16,061 18,774 57,528 56,348 Income tax applicable to non- operating activities and income of non-utility subsidaries (451) (2,957) (2,076) (5,013) --------- --------- --------- --------- Total income taxes $ 15,610 $ 15,817 $ 55,452 $ 51,335 ========= ========= ========= ========= Twelve Months Ended June 30, -------------------- 1996 1995 ========= ========= (Dollars in thousands) Current income taxes - Federal $ 73,054 $ 109,737 State 11,478 16,481 --------- --------- 84,532 126,218 --------- --------- Deferred income taxes, net - Federal 29,504 (16,793) State 2,710 (1,222) --------- --------- 32,214 (18,015) --------- --------- Deferred investment tax credits, net (7,117) (7,418) --------- --------- Total utility operating income taxes 109,629 100,785 Income tax applicable to non- operating activities and income of non-utility subsidiaries (6,313) (18,169) --------- --------- Total income taxes $ 103,316 $ 82,616 ========= ========= A reconciliation of total tax expense to an amount computed by applying the statutory federal income tax rate to pre-tax income is as follows: Three Months Six Months Ended June 30, Ended June 30, -------------------- -------------------- 1996 1995 1996 1995 ========= ========= ========= ========= (Dollars in thousands) Net income $ 23,429 $ 26,948 $ 90,915 $ 87,279 Add-Income taxes 15,610 15,817 55,452 51,335 Dividend requirements on preferred stocks of subsidiary 2,178 2,265 4,377 4,590 --------- --------- --------- --------- Income before preferred dividend requirements of subsidiary and income taxes $ 41,217 $ 45,030 $ 150,744 $ 143,204 ========= ========= ========= ========= Amount derived by multiplying pre-tax income by the statutory rate $ 14,426 $ 15,760 $ 52,760 $ 50,121 Reconciling items multiplied by the statutory rate: Book depreciation over related tax depreciation 1,030 1,005 2,013 2,009 Amortization of deferred investment tax credits (1,668) (1,868) (3,338) (3,736) State income taxes, net of federal income tax benefit 1,706 1,764 5,391 4,949 Fair market value of property donated in excess of book value 0 0 0 0 Reversal of deferred taxes provided at rates in excess of the current federal income tax rate (1,145) (1,359) (2,819) (2,719) Other, net 1,261 515 1,445 711 --------- --------- --------- --------- Total income taxes $ 15,610 $ 15,817 $ 55,452 $ 51,335 ========= ========= ========= ========= Twelve Months Ended June 30, -------------------- 1996 1995 ========= ========= (Dollars in thousands) Net income $ 179,101 $ 164,747 Add-Income taxes 103,316 82,616 Dividend requirements on preferred stocks of subsidiary 8,833 9,407 --------- --------- Income before preferred dividend requirements of subsidiary and income taxes $ 291,250 $ 256,770 ========= ========= Amount derived by multiplying pre-tax income by the statutory rate $ 101,938 $ 89,869 Reconciling items multiplied by the statutory rate: Book depreciation over related tax depreciation 4,022 4,118 Amortization of deferred investment tax credits (7,117) (7,419) State income taxes, net of federal income tax benefit 10,171 8,979 Fair market value of property donated in excess of book value 0 (7,753) Reversal of deferred taxes provided at rates in excess of the current federal income tax rate (5,765) (5,929) Other, net 67 751 --------- --------- Total income taxes $ 103,316 $ 82,616 ========= ========= (8) PENSION PLANS: Industries and its subsidiaries have three noncontributory, defined benefit retirement plans covering substantially all employees. Benefits under the plans reflect the employees' compensation, years of service, and age at retirement. The plans' funded status as of January 1, 1996 and 1995 are as follows: 1996 1995 ========= ========= (Dollars in thousands) Vested benefit obligation $ 549,234 $ 449,043 Nonvested benefit 104,814 97,138 --------- --------- Accumulated benefit obligation $ 654,048 $ 546,181 ========= ========= Projected benefit obligation for service rendered to date $ 759,681 $ 613,094 Plan assets at fair market value 706,320 571,624 --------- --------- Projected benefit obligation in excess of plan assets 53,361 41,470 Unrecognized transition obligation at January 1, being recognized over seventeen years (43,484) (48,906) Unrecognized prior service cost (27,242) (29,847) Unrecognized gains 4,217 47,788 --------- --------- Accrued (prepaid) pension costs $ (13,148) $ 10,505 ========= ========= The accumulated benefit obligation is the present value of future pension benefit payments and is based on a plan benefit formula without considering expected future salary increases. The projected benefit obligation considers estimated future salary increases. Discount rates of 7.25% and 8.75% and rates of increase in compensation levels of 5.5% were used to determine the accumulated benefit obligation and projected benefit obligation at January 1, 1996 and 1995, respectively. The increase in the accumulated benefit obligation as of January 1, 1996 is mainly caused by the decrease in the discount rate from 8.75% to 7.25%. The following items are the components of provisions for pensions for the three-month, six-month, and twelve-month periods ended June 30, 1996 and June 30, 1995: Three Months Six Months Twelve Months Ended Ended Ended June 30, June 30, June 30, ------------------ ------------------ ------------------ 1996 1995 1996 1995 1996 1995 ======== ======== ======== ======== ======== ======== (Dollars in thousands) Service costs $ 4,321 $ 3,298 $ 10,588 $ 6,597 $ 16,222 $ 13,442 Interest costs 13,078 13,338 32,129 26,676 57,964 50,634 Estimated return on plan assets (15,499) (12,864) (38,103) (25,728) (147,618) 13,211 Amortization of transition obligation 1,321 1,356 3,263 2,711 5,974 5,439 Other net amortization and deferral 636 659 1,550 1,318 86,397 (61,346) -------- -------- -------- -------- -------- -------- $ 3,857 $ 5,787 $ 9,427 $ 11,574 $ 18,939 $ 21,380 ======== ======== ======== ======== ======== ======== Assumptions used in the valuation and determination of 1996 and 1995 pension expenses were as follows: 1996 1995 ===== ===== Discount rate 7.25% 8.75% Rate of increase in compensation levels 5.50% 5.50% Expected long-term rate of return on assets 9.00% 9.00% The plans' assets are invested primarily in common stocks, bonds, and notes. (9) POSTRETIREMENT BENEFITS: Industries provides certain health care and life insurance benefits for retired employees. Substantially all of Industries' employees may become eligible for those benefits if they reach retirement age while working for Industries. The expected cost of such benefits is accrued during the employees' years of service. Northern Indiana's current rate-making includes the cost of providing these benefits based on the related insurance premiums. On December 30, 1992, the Commission authorized the accrual method of accounting for postretirement benefits for rate-making purposes consistent with SFAS No. 106 "Employers' Accounting for Postretirement Benefits Other Than Pensions," and authorized the deferral of the differences between the net periodic postretirement benefits costs and the insurance premiums paid for such benefits as a regulatory asset until such time as the accrual cost method may be reflected in the rate-making process. The Commission stated that a deferral period of four years or less would be rebuttably presumed to be reasonable and also indicated each utility would have to demonstrate its postretirement benefit costs were prudent and reasonably incurred at the time such costs were proposed to be recovered in the rate-making process. Northern Indiana will request the recovery of such costs within that period and, accordingly, is deferring as a regulatory asset the difference between the amount that would have been charged to expense under pay-as-you-go accounting and the amount accrued in accordance with the standard. This conclusion could change as competitive factors influence pricing decisions. The following table sets forth the plans' accumulated postretirement benefit obligation as of January 1, 1996 and 1995: January 1, January 1, 1996 1995 ========== ========== (Dollars in thousands) Retirees $ 99,453 $ 96,676 Fully eligible active plan participants 23,084 20,008 Other active plan participants 136,322 105,991 ---------- ---------- Accumulated postretirement benefit obligation 258,859 222,675 Unrecognized transition obligation at January 1, being recognized over twenty years (197,088) (208,681) Unrecognized actuarial gain 23,439 45,496 ---------- ---------- Accrued liability for postretirement benefits $ 85,210 $ 59,490 ========== ========== A discount rate of 7.25% and a pre-Medicare medical trend rate of 10% declining to a long-term rate of 6% and a discount rate of 8.75%, and a pre-Medicare medical trend rate of 11% declining to a long-term rate of 7% were used to determine the accumulated postretirement benefit obligation at January 1, 1996 and 1995, respectively. Net periodic postretirement benefits costs for the three-month, six- month, and twelve-month periods ended June 30, 1996 and June 30, 1995 include the following components: Three Months Six Months Twelve Months Ended Ended Ended June 30, June 30, June 30, ------------------ ------------------ ------------------ 1996 1995 1996 1995 1996 1995 ======== ======== ======== ======== ======== ======== (Dollars in thousands) Service costs $ 1,620 $ 1,526 $ 3,240 $ 3,052 $ 6,264 $ 7,234 Interest costs 5,079 4,745 10,159 9,490 19,700 19,511 Amortization of transition obligation over twenty years 3,095 2,899 6,190 5,798 11,985 11,627 Amortization of unrecognized actuarial (gain) (582) (541) (1,165) (1,082) (2,262) (1,082) -------- -------- -------- -------- -------- -------- $ 9,212 $ 8,629 $ 18,424 $ 17,258 $ 35,687 $ 37,290 ======== ======== ======== ======== ======== ======== The net periodic postretirement benefit costs for 1996 were determined assuming a 7.25% discount rate, a 5% rate of compensation increase, and a pre-Medicare medical trend rate of 10% declining to a long-term rate of 6%. The effect of a 1% increase in the assumed health care cost trend rates for each future year would increase the accumulated postretirement benefit obligation at January 1, 1996 by approximately $40.9 million, and increase the aggregate of the service and interest cost components of plan costs by approximately $1.3 million and $2.6 million for the three-month and six-month period ended June 30, 1996. Amounts disclosed above could be changed significantly in the future by changes in health care costs, work force demographics, interest rates, or plan changes. (10) AUTHORIZED CLASSES OF CUMULATIVE PREFERRED AND PREFERENCE STOCKS: INDUSTRIES - 20,000,000 shares - Preferred - without par value Effective March 2, 1990, 2,000,000 shares of the Industries' Series A Junior Participating Preferred Shares were reserved for issuance pursuant to the Share Purchase Rights Plan described in Note 14, Common Shares. NORTHERN INDIANA - 2,400,000 shares - Cumulative Preferred - $100 par value 3,000,000 shares - Cumulative Preferred - no par value 2,000,000 shares - Cumulative Preference - $50 par value (none outstanding) 3,000,000 shares - Cumulative Preference - no par value (none issued) Note 11 sets forth the preferred stocks which are redeemable solely at the option of the issuer, and Note 12 sets forth the preferred stocks which are subject to mandatory redemption requirements or whose redemption is outside the control of the issuer. The Preferred shareholders of Industries and Northern Indiana have no voting rights, except in the event of default on the payment of four consecutive quarterly dividends, or as required by Indiana law to authorize additional preferred shares, or by the Articles of Incorporation in the event of certain merger transactions. (11) PREFERRED STOCKS, REDEEMABLE SOLELY AT THE OPTION OF THE ISSUER, OUTSTANDING AT JUNE 30, 1996 AND DECEMBER 31, 1995 (SEE NOTE 10): Redemption Price at June 30, December 31, June 30, 1996 1995 1996 ============ ============ ============ (Dollars in thousands) NORTHERN INDIANA PUBLIC SERVICE COMPANY: Cumulative preferred stock - $100 par value - 4-1/4% series - 209,176 and 209,190 shares outstanding, respectively $ 20,918 $ 20,919 $101.20 4-1/2% series - 79,996 shares outstanding 8,000 8,000 $100.00 4.22% series - 106,198 shares outstanding 10,620 10,620 $101.60 4.88% series - 100,000 shares outstanding 10,000 10,000 $102.00 7.44% series - 41,890 shares outstanding 4,189 4,189 $101.00 7.50% series - 34,842 shares outstanding 3,484 3,484 $101.00 Premium on preferred stock 254 254 Cumulative preferred stock - no par value - Adjustable rate (6.00% at June 30, 1996), Series A (stated value $50 per share) 473,285 and 477,185 shares outstanding, respectively 23,664 23,859 $50.00 ------------ ------------ $ 81,129 $ 81,325 ============ ============ During the period July 1, 1994 to June 30, 1996, there were no additional issuances of the above preferred stocks. The foregoing preferred stocks are redeemable in whole or in part at any time upon thirty days' notice at the option of Northern Indiana at the redemption prices shown. (12) REDEEMABLE PREFERRED STOCKS OUTSTANDING AT JUNE 30, 1996 AND DECEMBER 31, 1995 (SEE NOTE 10): June 30, December 31, 1996 1995 ============ ============ (Dollars in thousands) Preferred stocks subject to mandatory redemption requirements or whose redemption is outside the control of issuer: NORTHERN INDIANA PUBLIC SERVICE COMPANY: Cumulative preferred stock - $100 par value - 8.85% series - 75,000 and 87,500 shares outstanding, respectively, excluding sinking fund payments due within one year $ 7,500 $ 8,750 7-3/4% series - 50,014 shares outstanding, excluding sinking fund payments due within one year 5,001 5,001 8.35% series - 69,000 shares outstanding, excluding sinking fund payments due within one year 6,900 6,900 Cumulative preferred stock - no par value - 6.50% series - 430,000 shares outstanding 43,000 43,000 ------------ ------------ 62,401 63,651 ------------ ------------ NIPSCO INDUSTRIES, INC.: Cumulative preferred shares - without par value - 8.75% series (stated value - $100 per share), 0 and 350,000 shares outstanding, respectively 0 35,000 ------------ ------------ $ 62,401 $ 98,651 ============ ============ Pursuant to mandatory redemption provisions, 350,000 shares of 8.75% Series Cumulative Preferred Shares were redeemed in whole by Industries on January 12, 1996 for $100 per share plus accrued dividends. The redemption prices at June 30, 1996, as well as sinking fund provisions for the cumulative preferred stock subject to mandatory redemption requirements, or whose redemption is outside the control of Northern Indiana, are as follows: Sinking Fund Or Mandatory Redemption Series Redemption Price Per Share Provisions ====== ========================== =========================== NORTHERN INDIANA PUBLIC SERVICE COMPANY: Cumulative preferred stock - $100 par value - 8.85% $101.85, reduced periodically 12,500 shares on or before April 1. 8.35% $104.18, reduced periodically 3,000 shares on or before July 1; increasing to 6,000 shares beginning in 2004; noncumulative option to double amount each year. 7-3/4% $104.58, reduced periodically 2,777 shares on or before December 1; noncumulative option to double amount each year. Cumulative preferred stock - no par value - 6.50% $100.00 on October 14, 2002 430,000 shares on October 14, 2002. Sinking fund requirements with respect to redeemable preferred stocks outstanding at June 30, 1996 for each of the twelve-month periods subsequent to June 30, 1997 are as follows: Twelve Months Ended June 30,* ============================== 1998 $ 1,827,700 1999 $ 1,827,700 2000 $ 1,827,700 2001 $ 1,827,700 <FN> * Table does not reflect redemptions made after June 30, 1996. (13) COMMON SHARE DIVIDEND: During the next few years, Industries expects that the great majority of earnings available for distribution of dividends will depend upon dividends paid to Industries by Northern Indiana. Northern Indiana's Indenture provides that it will not declare or pay any dividends on any class of capital stock (other than preferred or preference stock) except out of earned surplus or net profits of Northern Indiana. At June 30, 1996, Northern Indiana had approximately $149.6 million of retained earnings (earned surplus) available for the payment of dividends. Future dividends will depend upon adequate retained earnings, adequate future earnings, and the absence of adverse developments. (14) COMMON SHARES: Industries has 200,000,000 common shares authorized without par value. SHARE PURCHASE RIGHTS PLAN. On February 27, 1990, the Board of Directors of Industries (Board) declared a dividend distribution of one Right for each outstanding common share of Industries to shareholders of record on March 12, 1990. The Rights are not currently exercisable. Each Right, when exercisable, would initially entitle the holder to purchase from Industries one one-hundredth of a Series A Junior Participating Preferred Share, without par value, of Industries at a price of $60 per one one-hundredth of a share. In certain circumstances, if an acquirer obtained 25% of Industries' outstanding shares, or merged into Industries or merged Industries into the acquirer, the Rights would entitle the holders to purchase Industries' or the acquirer's common shares for one-half of the market price. The Rights will not dilute Industries' common shares nor affect earnings per share unless they become exercisable for common shares. The Plan was not adopted in response to any specific attempt to acquire control of Industries. COMMON SHARE REPURCHASES. The Board has authorized the repurchase of common shares. At June 30, 1996, Industries had purchased approximately 17.2 million shares at an average price of $25.14 per share. Including 3.5 million shares authorized on March 26, 1996, approximately 3.8 million additional common shares may be repurchased under the Board's authorization. (15) LONG-TERM INCENTIVE PLAN: Industries has two Long-Term Incentive Plans for key management employees that were approved by shareholders on April 13, 1988 (1988 Plan) and April 13, 1994 (1994 Plan), each of which provides for the issuance of up to 2.5 million of Industries' common shares to key employees through 1998 and 2004, respectively. At June 30, 1996, there were 140,461 shares and 2,338,550 shares reserved for future awards under the 1988 Plan and 1994 Plan, respectively. The 1988 Plan and 1994 Plan permit the following types of grants, separately or in combination: nonqualified stock options, incentive stock options, restricted stock awards, stock appreciation rights, and performance units. No incentive stock options or performance units were outstanding at June 30, 1996. Under both Plans, the exercise price of each option equals the market price of Industries' stock on the date of grant. Each option's maximum term is ten years and vests one year from the date of grant. The stock appreciation rights (SARs) may be exercised only in tandem with stock options on a one-for-one basis and are payable in cash, Industries stock, or a combination thereof. Restricted stock awards are restricted as to transfer and are subject to forfeiture for specific periods from the date of grant. Restrictions on the shares awarded during 1991 lapse five years from date of grant and vest subject to specific share price appreciation conditions. Restrictions on shares awarded in 1995 lapse five years from date of grant and vesting is variable from 0% to 200% of the number awarded and are subject to specific earnings per share and stock appreciation goals. Restrictions on shares awarded in 1996 lapse two years from date of grant and are variable from 0% to 100% of the number awarded and are subject to specific performance goals. If a participant's employment is terminated other than by reason of death, disability or retirement, restricted shares are forfeited. There were 342,500 and 330,500 restricted shares outstanding at June 30, 1996 and December 31, 1995, respectively. The Industries Nonemployee Director Stock Incentive Plan, which was approved by shareholders, provides for the issuance of up to 100,000 of Industries' common shares to nonemployee directors of Industries. The Plan provides for awards of common shares which vest in 20% per year increments, with full vesting after five years. The Plan also allows the award of nonqualified stock options in the future. If a director's service on the Board is terminated for any reason other than death or disability, any common shares not vested as of the date of termination are forfeited. As of June 30, 1996, 30,750 shares were issued under the Plan. Industries accounts for these plans under Accounting Principles Board Opinion No. 25, under which no compensation cost has been recognized for non- qualified stock options. The compensation cost that has been charged against income for restricted stock awards was $0.5, $1.1, and $2.8 million for the three-month, six-month, and twelve-month periods ending June 30, 1996. Had compensation cost for stock options been determined consistent with SFAS No. 123 "Accounting for Stock-Based Compensation," Industries' net income and earnings per share would have been reduced to the following pro forma amounts: Three Months Six Months Twelve Months Ended Ended Ended June 30, June 30, June 30, 1996 1996 1996 ============= ============= ============= Net Income: (Dollars in thousands) As reported $ 23,429 $ 90,915 $ 179,101 Pro forma $ 23,267 $ 90,590 $ 178,532 Earnings Per Share: As reported $ 0.38 $ 1.47 $ 2.85 Pro forma $ 0.38 $ 1.47 $ 2.84 Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation costs may not be representative of that to be expected in future years. The fair value of each option granted used to determine pro forma net income is estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in the three-month, six-month, and twelve-month periods ended June 30, 1996: risk-free interest rate of 6.24%, expected dividend yield of $1.56 per share, expected option term of five years, and expected volatility of 13%. Changes in outstanding shares under option and SARs for the three- month, six-month, and twelve-month periods ended June 30, 1996 and 1995 are as follows: NONQUALIFIED STOCK OPTIONS ------------------------------------------- Weighted Weighted Average Average Three Months Ended Option Option June 30, 1996 Price 1995 Price =========================== ========= ======== ========= ======== Balance beginning of period 1,093,850 $ 28.54 1,059,700 $ 26.86 Granted 0 0 $ 0 Exercised (25,150) $ 24.36 (63,300) $ 23.58 Canceled (6,000) $ 32.44 (500) $ 28.75 --------- --------- Balance end of period 1,062,700 $ 28.62 995,900 $ 27.07 ========= ========= Shares exercisable 797,250 $ 27.35 702,600 $ 26.36 ========= ========= Weighted average fair value of options granted N/A N/A ========= ========= NONQUALIFIED STOCK OPTIONS ------------------------------------------- Six Months Ended Option Option June 30, 1996 Price 1995 Price =========================== ========= ======== ========= ======== Balance beginning of period 1,107,750 $ 28.55 1,097,550 $ 26.59 Granted 0 5,000 $ 30.31 Exercised (38,050) $ 25.92 (103,550) $ 22.09 Canceled (7,000) $ 32.44 (3,100) $ 30.18 --------- --------- Balance end of period 1,062,700 $ 28.62 995,900 $ 27.07 ========= ========= Shares exercisable 797,250 $ 27.35 702,600 $ 26.36 ========= ========= Weighted average fair value of options granted N/A $ 4.74 ========= ========= NONQUALIFIED STOCK OPTIONS ------------------------------------------- Weighted Weighted Average Average Twelve Months Ended Option Option June 30, 1996 Price 1995 Price =========================== ========= ======== ========= ======== Balance beginning of period 995,900 $ 27.07 829,200 $ 25.73 Granted 277,450 $ 32.44 299,650 $ 28.78 Exercised (198,650) $ 25.96 (125,600) $ 22.18 Canceled (12,000) $ 32.44 (7,350) $ 29.35 --------- --------- Balance end of period 1,062,700 $ 28.62 995,900 $ 27.07 ========= ========= Shares exercisable 797,250 $ 27.35 702,600 $ 26.36 ========= ========= Weighted average fair value of options granted $3.87 * ========= ========= NONQUALIFIED STOCK OPTIONS WITH SARs ------------------------------------------- Three Months Ended Option Option June 30, 1996 Price 1995 Price =========================== ========= ======== ========= ======== Balance beginning of period 5,600 $ 10.94 9,900 $ 10.94 Granted 0 0 Exercised 0 (4,300) $ 10.94 Canceled 0 0 --------- --------- Balance end of period 5,600 $ 10.94 5,600 $ 10.94 ========= ========= Shares exercisable 5,600 $ 10.94 5,600 $ 10.94 ========= ========= NONQUALIFIED STOCK OPTIONS WITH SARs ------------------------------------------- Six Months Ended Option Option June 30, 1996 Price 1995 Price =========================== ========= ======== ========= ======== Balance beginning of period 5,600 $ 10.94 9,900 $ 10.94 Granted 0 0 Exercised 0 (4,300) $ 10.94 Canceled 0 0 --------- --------- Balance end of period 5,600 $ 10.94 5,600 $ 10.94 ========= ========= Shares exercisable 5,600 $ 10.94 5,600 $ 10.94 ========= ========= NONQUALIFIED STOCK OPTIONS WITH SARs ------------------------------------------- Twelve Months Ended Option Option June 30, 1996 Price 1995 Price =========================== ========= ======== ========= ======== Balance beginning of period 5,600 $ 10.94 9,900 $ 10.94 Granted 0 0 Exercised 0 (4,300) $ 10.94 Canceled 0 0 --------- --------- Balance end of period 5,600 $ 10.94 5,600 $ 10.94 ========= ========= Shares exercisable 5,600 $ 10.94 5,600 $ 10.94 ========= ========= <FN> * The weighted average option price of nonqualified stock options granted in January 1995 is $4.74. The following table summarizes information about non-qualified stock options at June 30, 1996: OPTIONS OUTSTANDING - -------------------------------------------------------------------------- Number Weighted Average Range of Outstanding at Remaining Weighted Average Option Price June 30, 1996 Contractual Life Option Price ================ ============== ================== ================= $10.94 to $17.73 97,400 3.60 years $16.74 $22.94 to $28.75 456,050 6.82 years $26.53 $30.31 to $33.19 509,250 8.20 years $32.77 - ---------------- --------- ---------- ------ $10.94 to $33.19 1,062,700 7.19 years $28.62 ========= OPTIONS EXERCISABLE - -------------------------------------------------------------------------- Number Range of Exercisable at Weighted Average Option Price June 30, 1996 Option Price ================ =============== ================= $10.94 to $17.73 97,400 $16.74 $22.94 to $28.75 456,050 $26.53 $30.31 to $33.19 243,800 $33.13 - ---------------- ------- ------ $10.94 to $33.19 797,250 $27.35 ======= (16) LONG-TERM DEBT: At June 30, 1996 and December 31, 1995, Industries' long-term debt, excluding amounts due within one year, issued and not retired or canceled was as follows: AMOUNT OUTSTANDING --------------------------- June 30, December 31, 1996 1995 ============ ============ (Dollars in thousands) NORTHERN INDIANA PUBLIC SERVICE COMPANY First mortgage bonds - Series O, 6-3/8%, due September 1, 1997 $ 25,747 $ 25,747 Series P, 6-7/8%, due October 1, 1998 14,509 14,509 Series T, 7-1/2%, due April 1, 2002 40,500 40,500 Series NN, 7.10%, due July 1, 2017 55,000 55,000 ------------ ------------ Total 135,756 135,756 ------------ ------------ Pollution control notes and bonds - Series A Note - City of Michigan City, 5.70% due October 1, 2003 20,000 20,000 Series 1988 Bonds - Jasper County - Series A, B, and C - 3.51% weighted average at June 30, 1996, due November 1, 2016 130,000 130,000 Series 1988 Bonds - Jasper County - Series D - 3.37% weighted average at June 30 1996, due November 1, 2007 24,000 24,000 Series 1994 Bonds - Jasper County - Series A - 3.80% at June 30, 1996, due August 1, 2010 10,000 10,000 Series 1994 Bonds - Jasper County - Series B - 3.80% at June 30, 1996, due June 1, 2013 18,000 18,000 Series 1994 Bonds - Jasper County - Series C - 3.80% at June 30, 1996, due April 1, 2019 41,000 41,000 ------------ ------------ Total 243,000 243,000 ------------ ------------ Medium-term notes - Interest rates between 5.81% and 7.64% with a weighted average interest rate of 6.79% and various maturities between July 25, 1997 and January 19, 2024 684,025 684,025 ------------ ------------ Unamortized premium and discount on long-term debt, net (3,761) (4,040) ------------ ------------ Total long-term debt of Northern Indiana Public Service Company 1,059,020 1,058,741 ------------ ------------ NIPSCO CAPITAL MARKETS, INC. Subordinated Debentures - Series A, 7-3/4%, due March 31, 2026 75,000 0 Zero Coupon Notes - 7.57%, $72,500 at maturity, due December 1, 1997 65,259 62,875 ------------ ------------ Total long-term debt of NIPSCO Capital Markets, Inc. 140,259 62,875 ------------ ------------ NIPSCO DEVELOPMENT COMPANY, INC. LAKE ERIE LAND COMPANY - Notes payable - 8.25% - due June 30, 1998 100 389 ELM ENERGY AND RECYCLING (UK), LTD. Term Loan Facility-weighted average interest rate of 7.40% at June 30, 1996, due December 31, 2004 35,354 34,516 NDC DOUGLAS PROPERTIES, INC. Notes Payable - Interest rates between 6.72% and 8.15% with a weighted average interest rate of 7.77% and maturities through April 1, 2006 20,203 19,207 ------------ ------------ Total long-term debt of NIPSCO Development Company,Inc. 55,657 54,112 ------------ ------------ Total long-term debt, excluding amounts due in one year $ 1,254,936 $ 1,175,728 ============ ============ The sinking fund requirements of long-term debt outstanding at June 30, 1996 (including the maturity of Northern Indiana's first mortgage bonds: Series O, 6-3/8%, due September 1, 1997; Series P, 6-7/8%, due October 1, 1998; Northern Indiana's medium-term notes due from April 6, 1998 to June 1, 2000; Capital Markets' Zero Coupon Notes due December 1, 1997; Lake Erie Land Company's notes payable due June 30, 1998; and NDC Douglas Properties, Inc. notes payable due December 22, 1999), for each of the twelve-month periods subsequent to June 30, 1997 are as follows: Twelve Months Ended June 30, ============================= 1998 $ 184,545,787 1999 $ 25,458,139 2000 $ 166,126,818 2001 $ 11,600,068 Unamortized debt expense, premium and discount on long-term debt applicable to outstanding bonds are being amortized over the lives of such bonds. Reacquisition premiums are being deferred and amortized. Northern Indiana's Indenture dated August 1, 1939, as amended and supplemented, securing the first mortgage bonds issued by Northern Indiana, constitutes a direct first mortgage lien upon substantially all property and franchises, other than expressly excepted property, owned by Northern Indiana. On March 4, 1994, the Commission authorized Northern Indiana to issue up to $289,275,000 of its Medium-Term Notes, Series D, due from one year to thirty years, for purposes of refinancing certain first mortgage bonds and paying short-term debt used to pay at maturity medium-term notes due in January and April 1994. On May 23, 1994, Northern Indiana exercised its option to redeem all the outstanding First Mortgage Bonds, Series S, Y, and AA aggregating $125.5 million, through the use of working capital and the proceeds of short-term debt. During 1994, $120.0 million of the Medium-Term Notes, Series D, were issued to complete the permanent refinancing of those first mortgage bonds. On June 12, 1995, the remaining $169,275,000 of Medium- Term Notes, Series D, were issued and part of the proceeds were used to redeem all of the outstanding First Mortgage Bonds, Series U and Z aggregating $94.8 million on July 3, 1995. On February 13, 1996, Capital Markets issued $75 million of 7-3/4% Junior Subordinated Deferrable Interest Debentures, Series A, due March 31, 2026 (Debentures) pursuant to an underwritten public offering. Proceeds from the sale of the Debentures were used to pay short-term debt incurred to redeem on January 12, 1996 Industries' $35 million of 8.75% Preferred Shares, pursuant to mandatory redemption, and to pay other short-term debt of Capital Markets. The obligations of Capital Markets are subject to a Support Agreement between Industries and Capital Markets, under which Industries has committed to make payments of interest and principal on Capital Markets' securities in the event of a failure to pay by Capital Markets. Restrictions in the Support Agreement prohibit recourse on the part of Capital Markets' investors against the stock and assets of Northern Indiana. Under the terms of the Support Agreement, in addition to the cash flow of cash dividends paid to Industries by any of its consolidated subsidiaries, the assets of Industries, other than the stock and assets of Northern Indiana, are available as recourse to holders of Capital Markets' securities. The carrying value of those assets (other than Northern Indiana), reflected in the consolidated financial statements of Industries, is approximately $451.4 million at June 30, 1996. (17) CURRENT PORTION OF LONG-TERM DEBT: At June 30, 1996 and December 31, 1995, Industries' current portion of long-term debt due within one year was as follows: June 30, December 31, 1996 1995 ============ ============ (Dollars in thousands) NORTHERN INDIANA PUBLIC SERVICE COMPANY: Medium-term notes - Interest rates of 5.77% and 5.80% with a weighted average interest rate of 5.78% and maturities of July 25, 1996 and July 26, 1996 $ 80,000 $ 80,000 NIPSCO CAPITAL MARKETS, INC.: Medium-term notes - 9.95% - due June 10, 1996 0 7,500 LAKE ERIE LAND COMPANY: Notes payable 3,106 2,961 ELM ENERGY AND RECYCLING (UK), LTD.: Term loan facility 5,277 4,554 NDC DOUGLAS PROPERTIES, INC.: Notes payable 2,201 1,840 ------------ ------------ Total current portion of long-term debt $ 90,584 $ 96,855 ============ ============ (18) SHORT-TERM BORROWINGS: Northern Indiana has a $250 million revolving Credit Agreement with several banks which terminates August 19, 1998 unless extended by its terms. As of June 30, 1996, there were no borrowings outstanding under this agreement. In addition, Northern Indiana has $14.2 million in lines of credit which run to May 31, 1997. The credit pricing of each of the lines varies from either the lending banks' commercial prime or market rates. Northern Indiana has agreed to compensate the participating banks with arrangements that vary from no commitment fees to a combination of fees which are mutually satisfactory to both parties. As of June 30, 1996, there were no borrowings under these lines of credit. The Credit Agreement and lines of credit are also available to support the issuance of commercial paper. Northern Indiana also has $268.5 million of money market lines of credit. As of June 30, 1996 and December 31, 1995, there were $64.2 million and $118.8 million of borrowings, respectively, outstanding under these lines of credit. Northern Indiana has a $50 million uncommitted finance facility. At June 30, 1996, there were no borrowings outstanding under this facility. Northern Indiana and Capital Markets make use of commercial paper to fund short-term working capital requirements. Capital Markets has a $150 million revolving Credit Agreement which will terminate August 19, 1998, unless extended by its terms. This facility provides short-term financing flexibility to Industries and also serves as the backup instrument for a commercial paper program. As of June 30, 1996, there were no borrowings outstanding under this agreement. Capital Markets also has $105 million of money market lines of credit. As of June 30, 1996 and December 31, 1995, $22.1 million and $17.4 million, respectively, of borrowings were outstanding under these lines of credit. At June 30, 1996 and December 31, 1995, Industries' short-term borrowings were as follows: June 30, December 31, 1996 1995 ============ ============ (Dollars in thousands) NORTHERN INDIANA PUBLIC SERVICE COMPANY: Commercial paper - Weighted average interest rate of 5.39% at June 30, 1996 $ 88,400 $ 44,800 Notes payable - Issued at interest rates between 5.39% and 5.5% with a weighted average interest rate of 5.45% and various maturities between July 3, 1996 and July 29, 1996 64,200 118,800 NIPSCO CAPITAL MARKETS, INC.: Commercial paper - Weighted average interest rate of 5.63% at June 30, 1996 88,100 76,700 Notes payable - Issued at interest rates of 5.63% and 5.65% with a weighted average interest rate of 5.63% and maturities of July 5, 1996 and July 26, 1996 22,100 17,400 LAKE ERIE LAND COMPANY: Notes payable - 0 1,239 ELM ENERGY AND RECYCLING (UK), LTD.: Standby loan facility 3,117 1,732 ------------ ------------ Total short-term borrowings $ 265,917 $ 260,671 ============ ============ (19) OPERATING LEASES: On April 1, 1990, Northern Indiana entered into a twenty-year agreement for the rental of office facilities from Development at a current annual rental payment of approximately $3.3 million. The following is a schedule, by years, of future minimum rental payments, excluding those to associated companies, required under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of June 30, 1996: Twelve Months Ended June 30, =============================== (Dollars in thousands) 1997 $ 11,529 1998 8,984 1999 7,268 2000 5,642 2001 5,557 Later years 79,610 -------- Total minimum payments required $118,590 ======== The consolidated financial statements include rental expense for all operating leases as follows: June 30, June 30, 1996 1995 ============ ============ (Dollars in thousands) Three months ended $ 1,693 $ 2,159 Six months ended $ 3,724 $ 3,987 Twelve months ended $ 8,187 $ 7,653 (20) COMMITMENTS: Northern Indiana estimates that approximately $764 million will be expended for construction purposes for the period from January 1, 1996 to December 31, 2000. Substantial commitments have been made by Northern Indiana in connection with this program. Northern Indiana has entered into a service agreement with Pure Air, a general partnership between Air Products and Chemicals, Inc. and Mitsubishi Heavy Industries America, Inc., under which Pure Air provides scrubber services to reduce sulfur dioxide emissions for Units 7 and 8 at Bailly Generating Station. Services under this contract commenced on June 15, 1992 with annual charges approximating $20 million. The agreement provides that, assuming various performance standards are met by Pure Air, a termination payment would be due if Northern Indiana terminates the agreement prior to the end of the twenty-year contract period. Northern Indiana has entered into an agreement with Integrated Systems Solutions Corporation (ISSC), a wholly-owned subsidiary of IBM, for ISSC to perform all data center, application development and maintenance, and desktop management of Northern Indiana. Primary is the parent of subsidiaries including Harbor Coal Company (Harbor Coal), North Lake Energy Corporation (North Lake), Lakeside Energy Corporation (LEC) and Portside Energy Corporation (Portside). Primary arranges energy-related projects with large industrial customers and has entered into certain commitments in connection with these projects. Harbor Coal has invested in a partnership to finance, construct, own, and operate a $65 million pulverized coal injection facility which began commercial operation in August, 1993. The facility receives raw coal, pulverizes it and delivers it to Inland Steel Company for use in the operation of its blast furnaces. Harbor Coal is a 50% partner in the project with an Inland Steel affiliate. Industries has guaranteed the payment and performance of the partnership's obligations under a sale and leaseback of a 50% undivided interest in the facility. North Lake has entered into a lease for the use of a 75-megawatt energy facility to be located at Inland Steel Company. The facility uses steam generated by Inland Steel to produce electricity which is delivered to Inland Steel. The facility began commercial operation in May 1996. Industries has guaranteed North Lake's obligations relative to the lease and certain obligations to Inland Steel relative to the project. LEC has entered into an agreement with USX Corporation - US Steel Group to utilize a new 161 megawatt energy facility at USS Gary Works to process high-pressure steam into electricity and low-pressure process steam for a fifteen-year period. LEC will lease this facility, once constructed, from a third party. Additionally, LEC has entered into an interim agreement, which expires when the lease is established with the third-party lessor, under which LEC is acting as the agent for the lessor to design, construct, and start up the energy facility. Industries has guaranteed certain LEC obligations to the interim lessor. Capital Markets anticipates guaranteeing LEC's security deposit obligations relative to the anticipated lease and certain LEC obligations to the lessor during construction. Construction of the project began in January 1996. The facility is scheduled to be operational in May 1997. Portside has entered into an agreement with National Steel Corporation (National) to utilize a new 63-megawatt energy facility at National's Midwest Division to process natural gas into electricity, process steam and heated water for a fifteen-year period. Portside will lease this facility, once constructed, from a third party. Additionally, Portside has entered into an interim agreement, which expires when the lease is established with the third- party lessor, under which Portside is acting as agent for the lessor to design, construct, and start up the energy facility. Industries has guaranteed certain Portside obligations to the lessor during construction. Capital Markets anticipates guaranteeing certain Portside obligations relative to the anticipated lease. Construction of the project began in June 1996. The facility is scheduled to be operational in August 1997. Primary has advanced approximately $45 million and $11 million, at June 30, 1996 and December 31, 1995, respectively, to the lessors of the energy related projects discussed above. These advances are included in "Prepayments and other" in the Consolidated Balance Sheet. (21) FAIR VALUE OF FINANCIAL INSTRUMENTS: The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and cash equivalents: The carrying amount approximates fair value because of the short maturity of those instruments. Investments: The fair value of some investments is estimated based on market prices for those or similar investments. Long-term debt/Preferred stock: The fair value of long-term debt and preferred stock is estimated based on the quoted market prices for the same or similar issues or on the rates offered to Industries for securities of the same remaining maturities. Certain premium costs associated with the early settlement of long-term debt are not taken into consideration in determining fair value. The carrying values and estimated fair values of Industries' financial instruments are as follows: June 30, 1996 December 31, 1995 ---------------------- ---------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ========== ========== ========== ========== (Dollars in thousands) Cash and cash equivalents $ 31,260 $ 31,260 $ 28,496 $ 28,496 Investments $ 26,853 $ 28,726 $ 25,893 $ 27,045 Long-term debt (including current portion) $1,346,313 $1,173,301 $1,273,376 $1,274,079 Preferred stock $ 145,358 $ 123,059 $ 181,804 $ 164,306 The majority of the long-term debt relates to utility operations. The Utilities are subject to regulation, and gains or losses may be included in rates over a prescribed amortization period, if in fact settled at amounts approximating those above. (22) CUSTOMER CONCENTRATIONS: Industries' public utility subsidiaries supply natural gas and electrical energy in the northern third of Indiana. Although these public utilities have a diversified base of residential and commercial customers, a substantial portion of their electric and gas industrial deliveries are dependent upon the basic steel industry. The basic steel industry accounted for 3% of gas revenue (including transportation services) and 22% of electric revenue for the twelve months ended June 30, 1996 as compared to 4% and 24%, respectively, for the twelve months ended June 30, 1995. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS HOLDING COMPANY - NIPSCO Industries, Inc. (Industries) is an Indiana corporation serving as the holding company for a number of subsidiaries, including four regulated companies: Northern Indiana Public Service Company (Northern Indiana); Kokomo Gas and Fuel Company (Kokomo Gas); Northern Indiana Fuel and Light Company, Inc. (NIFL); and Crossroads Pipeline Company (Crossroads). Northern Indiana is a public utility operating company supplying natural gas and electric energy to the public. Kokomo Gas and NIFL are public utility operating companies supplying natural gas to the public, and Crossroads is an interstate natural gas transmission company. Industries' major non-utility subsidiaries include NIPSCO Development Company, Inc. (Development); NIPSCO Energy Services, Inc. (Services); Primary Energy, Inc. (Primary); and NIPSCO Capital Markets, Inc. (Capital Markets). Development makes various investments, including real estate and venture capital investments. Services coordinates the energy-related diversification ventures of Industries. Primary arranges energy-related projects with large industrial customers. Capital Markets handles financing for Industries and its subsidiaries, other than Northern Indiana. The following discussion, except where noted, is attributable to the operations of Northern Indiana, Kokomo Gas, NIFL, and Crossroads (Utilities). REVENUES - Total operating revenues for the twelve months ended June 30, 1996 increased $134.6 million as compared to the twelve months ended June 30, 1995. Gas revenues increased $80.1 million and electric revenues increased $54.5 million. The increase in gas revenues for the twelve months ended June 30, 1996 was largely attributable to increased sales to residential and commercial customers due to colder weather, increased sales to industrial and wholesale customers, increased deliveries of gas transported for others, and increased gas transition costs, which were partially offset by decreased gas costs per dekatherm (dth). The increase in electric revenues for the twelve months ended June 30, 1996 was mainly due to increased sales to residential and commercial customers as a result of warmer weather in the third quarter of 1995, increased sales to wholesale customers, and increased fuel cost per kilowatt-hour (kwh), partially offset by decreased sales to industrial customers. Total operating revenue for the six months ended June 30, 1996 increased $58.0 million as compared to the six months ended June 30, 1995. Gas revenues increased $48.9 million and electric revenues increased $9.1 million as compared to the same period in 1995. The increase in gas revenues was mainly due to increased sales to residential and commercial customers as a result of colder weather, increased sales to industrial customers, and increased gas costs per dth, which were partially offset by decreased gas transition costs. The increase in electric revenues for the six months ended June 30, 1996 was mainly due to increased sales to residential and commercial customers, and increased fuel costs per kwh, and was partially offset by decreased sales to industrial customers. Total operating revenue for the three months ended June 30, 1996 increased $4.5 million as compared to the three months ended June 30, 1995. Gas revenues increased $6.2 million and electric revenues decreased $1.7 million as compared to the same period in 1995. The increase in gas revenues was mainly due to increased sales to residential and commercial customers, and increased gas costs per dth, which were partially offset by decreased gas transition costs. The decrease in electric revenues was primarily caused by several major industrial customers with plant operating equipment problems during the period. The basic steel industry accounted for 30% of natural gas delivered (including volumes transported) and 35% of electric sales during the twelve months ended June 30, 1996. The components of the variations in gas and electric revenues are shown in the following table: Variations from Prior Periods --------------------------------- June 30, 1996 Compared to June 30, 1995 Three Six Twelve Months Months Months ========= ========= ========= (Dollars in thousands ) Gas Revenue - Pass through of net changes in purchased gas costs, gas storage, and storage transportation costs $ 4,321 $ 12,646 $ (64,130) Gas transition costs (8,649) (23,632) 40,037 Changes in sales levels 10,856 59,744 105,480 Gas transport levels (349) 115 (1,269) --------- --------- --------- Gas Revenue Change 6,179 48,873 80,118 --------- --------- --------- Electric Revenue - Pass through of net changes in fuel 2,750 4,222 4,512 Changes in sales levels (4,421) 4,943 49,932 --------- --------- --------- Electric Revenue Change (1,671) 9,165 54,444 --------- --------- --------- Total Revenue Change $ 4,508 $ 58,038 $ 134,562 ========= ========= ========= See Note 5 to Notes to Consolidated Financial Statements regarding FERC Order No. 636 transition costs. GAS COSTS - The Utilities' gas costs increased $2.4, $29.3, and $42.2 million for the three-month, six-month, and twelve-month periods ended June 30, 1996, respectively. Gas costs increased for the three-month and six-month periods due to increased purchases and increased gas costs per dth, and were partially offset by decreased gas transition costs. Gas costs increased for the twelve- month period due to increased purchases and were partially offset by decreased gas costs per dth. The average cost for the Utilities' purchased gas for the three-month, six-month, and twelve-month periods ended June 30, 1996, after adjustment for gas transition costs billed to transport customers, was $2.85, $2.94, and $2.73 per dth, respectively, as compared to $2.76, $2.87, and $2.85 per dth for the same periods in 1995. FUEL AND PURCHASED POWER - The cost of fuel for electric generation increased for the six-month and twelve-month periods ended June 30, 1996, compared to 1995 periods, mainly as a result of increased production of electricity. The cost of fuel for electric generation decreased for the three-month period ended June 30, 1996, compared to 1995 period, mainly as a result of decreased production of electricity. Power purchased increased $12.0 million for the twelve-month period ended June 30, 1996 as a result of increased bulk power purchases with other utilities due to increased sales. Purchased power costs increased $3.2 and $4.2 million for the three-month and six-month periods ended June 30, 1996, respectively, as a result of increased costs per megawatt-hour purchased. OPERATING MARGINS - Operating margins increased $71.3 million for the twelve months ended June 30, 1996 from the same period a year ago. The operating margin from gas deliveries increased $37.9 million due to increased sales to residential and commercial customers reflecting colder weather, increased sales to industrial and wholesale customers, and increased deliveries of gas transported for others, compared to the twelve-month period ended June 30, 1995. The operating margin from electric sales increased $33.4 million reflecting increased sales to residential and commercial customers due to warmer weather in the third quarter of 1995 and increased sales to wholesale customers, partially offset by decreased sales to industrial customers. Operating margins increased $23.9 million for the six months ended June 30, 1996 from the same period a year ago. Gas operating margin increased $19.6 million due to increased sales to residential and commercial customers reflecting colder weather during the period, increased sales to industrial and wholesale customers, and increased deliveries of gas transported for others. Operating margins on electric sales increased $4.3 million due to increased sales to residential, commercial, and wholesale customers, partially offset by decreased sales to industrial customers. Operating margins increased $1.7 million for the three months ended June 30, 1996 over the same period a year ago. The operating margin from gas deliveries increased $3.8 million due to increased sales to residential and commercial customers reflecting colder weather and increased deliveries of gas transported for others. Operating margin on electric sales decreased $2.1 million primarily caused by several major industrial customers with plant operating equipment problems during the period. OPERATING EXPENSES AND TAXES - Operation expenses increased $1.3, $9.6, and $20.4 million for the three-month, six-month, and twelve-month periods ended June 30, 1996, respectively. Operation expenses increased for the six-month period reflecting increased electric production costs of $3.6 million resulting from increased pollution control facility costs, increased environmental cleanup costs of $3.9 million, and other various increased operating costs. Operation expenses increased for the twelve-month period reflecting a December 1995 Indiana Utility Regulatory Commission (Commission) order to refund $3.4 million to electric customers related to a 1992 insurance settlement previously credited to operation and maintenance expenses, increased electric production costs of $7.6 million mainly resulting from pollution control facilities costs, increased employee-related costs of $4.6 million, increased environmental cleanup costs of $3.2 million, and various other increased operation expenses. Maintenance expenses decreased $2.6 and $3.3 million for the six-month and twelve-month periods ended June 30, 1996, respectively, mainly reflecting decreased maintenance activity at the electric production facilities. Depreciation and amortization expense increased $4.5, $8.8, and $13.0 million for the three-month, six-month, and twelve-month periods ended June 30, 1996, respectively, resulting from plant additions, increased amortization of computer software, and the amortization of previously deferred costs related to scrubber services provided by Pure Air at the Bailly Generating Station. Utility income taxes increased for the six-month and twelve-month periods ended June 30, 1996 as a result of increased pre-tax income. Utility income taxes decreased for the three-month period ended June 30, 1996 as a result of decreased pre-tax income. OTHER INCOME (DEDUCTIONS) - Other Income (Deductions) decreased $5.5 million for the twelve-month period ended June 30, 1996 as the result of the inclusion in the prior period of a $5.6 million after-tax benefit for the Northern Indiana land donation to the Shafer and Freeman Lakes Environmental Conservation Corporation. The operating results of all non-utility subsidiaries are included in "Other Income (Deductions)." INTEREST AND OTHER CHARGES - Interest and other charges increased for the three-month, six-month, and twelve-month periods ended June 30, 1996 reflecting the issuance of $169,275,000 of Northern Indiana's Medium-Term Notes, Series D; and $75 million of Capital Markets' Junior Subordinated Deferrable Interest Debentures, Series A; and the discontinuance of carrying charges on deferred charges related to the Bailly Generating Station scrubber service agreement. See Note 2 to Notes to Consolidated Financial Statements (Summary of Significant Accounting Policies) for a discussion of Regulatory Assets, Carrying Charges and Deferred Depreciation, and Allowance for Funds Used During Construction. Also see Notes 5, 7, and 9 for a discussion of FERC Order No. 636, Income Taxes and Postretirement Benefits. NET INCOME- Industries' net income for the twelve-month period ended June 30, 1996 was $179.1 million compared to $164.7 million for the twelve-month period ended June 30, 1995. Net income for the six months ended June 30, 1996 was $90.9 million compared to $87.3 million for the six months ended June 30, 1995. Net income for the three months ended June 30, 1996 was $23.4 million compared to $26.9 million for the three months ended June 30, 1995. ENVIRONMENTAL MATTERS - The Utilities have an ongoing program to remain aware of laws and regulations involved with hazardous waste and other environmental matters. It is the Utilities' intent to continue to evaluate their facilities and properties with respect to these rules and identify any sites that would require corrective action. The Utilities have recorded a reserve of $7.2 million to cover probable corrective actions as of June 30, 1996; however, environmental regulations and remediation techniques are subject to future change. The ultimate cost could be significant, depending on the extent of corrective actions required. Based upon investigations and management's understanding of current laws and regulations, the Utilities believe that any corrective actions required, after consideration of insurance coverages and contributions from other potentially responsible parties, will not have a significant impact on the financial position or results of operations of Industries. Because of major investments made in modern environmental control facilities and the use of low-sulfur coal, all of Northern Indiana's electric production facilities now comply with the sulfur dioxide limitations contained in the acid deposition provisions of the Clean Air Act Amendments of 1990 (CAAA). Northern Indiana estimates that total costs of compliance with the CAAA sulfur dioxide regulations will impact electric rates by less than 5% in the future. The CAAA contain provisions that could lead to limitations on emissions of nitrogen oxides and hazardous air pollutants which may require significant capital expenditures for control of these emissions. Northern Indiana is pursuing a nitrogen oxide control program to meet future requirements. Northern Indiana cannot predict the costs of complying with CAAA requirements, but Northern Indiana believes that any such mandated costs would be recoverable through the rate-making process. The Environmental Protection Agency (EPA) has notified Northern Indiana that it is a "potentially responsible party" (PRP) under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) and may be required to share in the cost of cleanup of several waste disposal sites identified by the EPA. The sites are in various stages of investigation, analysis, and remediation. At each of the sites, Northern Indiana is one of several PRPs, and it is expected that remedial costs, as provided under CERCLA, will be shared among them. At some sites, Northern Indiana and/or the other named PRPs are presently working with the EPA to clean up the sites and avoid the imposition of fines or added costs. The Utilities have instituted a program to investigate former manufactured-gas plants where one of them is the current or former owner. The Utilities have identified twenty-seven of these sites and made visual inspections of these sites. Initial samplings have been conducted at seventeen sites. Follow-up investigations have been conducted at five sites and potential remedial measures are being evaluated. The Utilities will continue their program to assess sites. During the follow-up investigation of the former manufactured-gas plant in Elkhart, Indiana, Northern Indiana noted the presence of hydrocarbons in the Elkhart River. Northern Indiana reported this finding to the Indiana Department of Environmental Management (IDEM) and the EPA. Northern Indiana has placed the Elkhart site in the IDEM Voluntary Remediation Program (VRP). The goal of placing the site in the VRP is to obtain IDEM approval of the determination and subsequent implementation of what remedial measures, if any, may be needed. Northern Indiana was notified by IDEM of the release of a petroleum substance into the St. Mary's River in Fort Wayne, Indiana, from the site of a former manufactured-gas plant formerly owned by Northern Indiana. In cooperation with IDEM, Northern Indiana has taken steps to investigate and contain the substance. Northern Indiana has remediated parts of the Fort Wayne site. The remainder of the site is being evaluated to determine what further remedial measures, if any, may be needed. Northern Indiana and Indiana Gas Company, Inc. (Indiana Gas) have entered into an agreement covering cost sharing and management of investigation and remediation programs at five former manufactured-gas plant sites at which both companies or their predecessors were former operators or owners. One of these sites is the Lafayette site which Indiana Gas had previously notified Northern Indiana is being investigated and remediated pursuant to an administrative order with IDEM. Northern Indiana also notified PSI Energy, Inc. that it was a former owner or operator of seven former manufactured-gas plants at which Northern Indiana had conducted or was planning investigation or remediation activities. The Utilities have met with various companies that provided insurance coverage which the Utilities believe covers costs related to actions taken at former manufactured-gas plants. In September 1995, certain insurance companies initiated a suit in Indiana state court against Northern Indiana to deny coverage. Later, in September 1995, Northern Indiana filed a more comprehensive suit in Federal Court in Indiana against those insurers and several other insurance companies, seeking coverage for costs associated with several former manufactured-gas plant sites. The state court action is stayed pending resolution of the Northern Indiana suit in Federal court. The possibility that exposure to electric and magnetic fields emanating from power lines, household appliances, and other electric sources may result in adverse health effects has been the subject of public, governmental, and media attention. A considerable amount of scientific research has been conducted on this topic without definitive results. Research is continuing to resolve scientific uncertainties. LIQUIDITY AND CAPITAL RESOURCES - During the next few years, it is anticipated that the great majority of earnings available for distribution of dividends will depend upon dividends paid to Industries by Northern Indiana. See Note 13 to Notes to Consolidated Financial Statements for a discussion of the Common Share dividend. On March 4, 1994, the Commission authorized Northern Indiana to issue up to $289,275,000 of its Medium-Term Notes, Series D, due from one year to thirty years, for purposes of refinancing certain first mortgage bonds and paying short-term debt used to pay at maturity medium-term notes due in January and April 1994. On May 23, 1994, Northern Indiana exercised its option to redeem all the outstanding First Mortgage Bonds, Series S, Y, and AA aggregating $125.5 million, through the use of working capital and the proceeds of short-term debt. During 1994, $120.0 million of the Medium-Term Notes, Series D, were issued to complete the permanent refinancing of those first mortgage bonds. On June 12, 1995, the remaining $169,275,000 of Medium-Term Notes, Series D, were issued and part of the proceeds were used to redeem all of the outstanding First Mortgage Bonds, Series U and Z, aggregating $94.8 million on July 3, 1995. On February 13, 1996, Capital Markets issued $75 million of 7-3/4% Junior Subordinated Deferrable Interest Debentures, Series A, due March 31, 2026 (Debentures), pursuant to an underwritten public offering. Proceeds from the sale of the Debentures were used to pay short-term debt incurred to redeem on January 12, 1996 Industries' $35 million of 8.75% Preferred Shares, pursuant to mandatory redemption, and to pay other short-term debt of Capital Markets. Capital Markets has a $150 million revolving Credit Agreement which will terminate August 19, 1998, unless extended by its terms. This facility provides short-term financing flexibility to Industries and also serves as the backup instrument for a commercial paper program. As of June 30, 1996, there were no borrowings outstanding under this agreement. Capital Markets also has $105 million of money market lines of credit. As of June 30, 1996, $22.1 million of borrowings were outstanding under these lines of credit. As of June 30, 1996, Capital Markets had $88.1 million in commercial paper outstanding, having a weighted average interest rate of 5.63%. The obligations of Capital Markets are subject to a Support Agreement between Industries and Capital Markets, under which Industries has committed to make payments of interest and principal on Capital Markets' securities in the event of a failure to pay by Capital Markets. Restrictions in the Support Agreement prohibit recourse on the part of Capital Markets' investors against the stock and assets of Northern Indiana. Under the terms of the Support Agreement, in addition to the cash flow of cash dividends paid to Industries by any of its consolidated subsidiaries, the assets of Industries, other than the stock and assets of Northern Indiana, are available as recourse to holders of Capital Markets' securities. The carrying value of those assets (other than Northern Indiana), reflected in the consolidated financial statements of Industries, is approximately $451.4 million at June 30, 1996. Cash flow from operations has provided sufficient liquidity to meet current operating requirements. Because of the seasonal nature of the utility business and the construction program, Northern Indiana makes use of commercial paper to fund short-term working capital requirements. As of June 30, 1996, Northern Indiana had $88.4 million in commercial paper outstanding, having a weighted average interest rate of 5.39%. Northern Indiana has a $250 million revolving Credit Agreement with several banks which terminates August 19, 1998 unless extended by its terms. As of June 30, 1996, there were no borrowings outstanding under this agreement. In addition, Northern Indiana has $14.2 million in lines of credit which run to May 31, 1997. The credit pricing of each of the lines varies from either the lending banks' commercial prime or market rates. Northern Indiana has agreed to compensate the participating banks with arrangements that vary from no commitment fees to a combination of fees which are mutually satisfactory to both parties. As of June 30, 1996, there were no borrowings under these lines of credit. The Credit Agreement and lines of credit are also available to support the issuance of commercial paper. Northern Indiana also has $268.5 million of money market lines of credit. As of June 30, 1996, there were $64.2 million of borrowings outstanding under these lines of credit. Northern Indiana has a $50 million uncommitted finance facility. At June 30, 1996, there were no borrowings outstanding under this facility. During recent years, Northern Indiana has been able to finance its construction program with internally generated funds and expects to be able to meet future commitments through such funds. The Utilities do not expect the effects of inflation at current levels to have a significant impact on their results of operations, ability to contain cost increases, or need to seek timely and adequate rate relief. The Utilities do not anticipate the need to file for gas and electric base rate increases in the near future. COMPETITION The Energy Policy Act of 1992 (Energy Act) allowed FERC to order electric utilities to grant access to transmission systems by third-party power producers. The Energy Act specifically prohibits federally mandated wheeling of power for retail customers. On April 24, 1996, the FERC issued its Order No. 888 which opens wholesale power sales to competition and requires public utilities owning, controlling, or operating transmission lines to file non-discriminatory open access tariffs that offer others the same transmission service they provide themselves. Order No. 888 also provides for the full recovery of stranded costs - that is, costs that were prudently incurred to serve power customers and that could go unrecovered if these customers use open access to move to another supplier. FERC expects this rule will accelerate competition and bring lower prices and more choices to wholesale energy customers. This competition will create opportunities to compete for new customers and revenues, as well as increase the risk of the loss of customers. Although wholesale customers represent a relatively small portion of Northern Indiana's sales, Northern Indiana will continue its efforts to retain and add customers by offering competitive rates. Operating in a competitive environment will place added pressures on utility profit margins and credit quality. Increasing competition in the electric utility industry has already led the credit rating agencies to apply more stringent guidelines in making credit rating determinations. Industries' management has taken steps to make the company more competitive and profitable in the changing utility environment, including partnering on energy projects with major industrial customers and conversions of some of its generating units to allow use of lower cost, low-sulfur coal. FERC Order No. 636 shifted primary responsibility for gas acquisition, transportation, and peak days' supply from pipelines to local gas distribution companies such as the Utilities. Although pipelines continue to transport gas, they no longer provide sale service. The Utilities believe they have taken appropriate steps to ensure the continued acquisition of adequate gas supplies at reasonable prices. The mix of gas revenues from retail sales, interruptible retail sales, firm transportation service, and interruptible transportation services has changed significantly over the past several years. The deregulation of the gas industry, since the mid-1980's, allows large industrial and commercial customers to purchase their gas supplies directly from producers and use the Utilities' facilities to transport the gas. Transportation customers pay the Utilities only for transporting their gas from the pipeline to the customers' premises. Northern Indiana filed an Alternative Regulatory Plan (ARP) with the Commission on November 29, 1995. The purpose of the ARP is to create a business and regulatory environment and structure which will permit increased choice for gas customers, competition among suppliers, and improved natural gas service. In its petition, Northern Indiana stated it would propose to implement new rates and services that would include, but not be limited to, further unbundling of services for additional customer classes which would include increased customer choice for sources of natural gas supply, negotiated services and prices, and incentive gas and storage cost mechanisms. To date, the Utilities' system has not been materially affected by competition, and management does not foresee substantial adverse effects in the near future, unless the current regulatory structure is substantially altered. The Utilities believe the steps they are taking to deal with increased competition will have significant, positive effects in the next few years. Part II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS. Industries and Northern Indiana are parties to various pending proceedings, including suits and claims against them for personal injury, death and property damage, but, in the opinion of their counsel, the nature of such proceedings and suits, and the amounts involved, do not depart from the ordinary routine litigation and proceedings incidental to the kind of business conducted by Industries and Northern Indiana, except as described under Note 3 Pending Tax Matter, Note 4 Elm Energy and Recycling (UK) Ltd., and Note 6 Environmental Matters in the Notes to Consolidated Financial Statements under Part I, Item 1 of this report on Form 10-Q. To the knowledge of Industries no other material legal proceedings against Industries, Northern Indiana or their subsidiaries are contemplated by governmental authorities and other parties. Item 2. CHANGES IN SECURITIES. None Item 3. DEFAULTS UPON SENIOR SECURITIES. None Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None Item 5. OTHER INFORMATION. None Item 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. Exhibit 11.1 - Computation of Per Share Earnings Three-Month, Six-Month, and Twelve-Month Periods Ended June 30, 1996. Exhibit 11.2 - Computation of Per Share Earnings Three-Month, Six-Month, and Twelve-Month Periods Ended June 30, 1995. Exhibit 23-Consent of Arthur Andersen LLP (b) Reports on Form 8-K. None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NIPSCO Industries, Inc. (Registrant) /s/ Jerry M. Springer, Controller and Chief Accounting Officer Date August 13, 1996