Date: Thu, 18 Dec 1997 21:26:14 GMT Server: Apache/1.2.0 Last-Modified: Fri, 03 Oct 1997 21:01:10 GMT ETag: "2d1c60-63e3-34355d16" Content-Length: 25571 Accept-Ranges: bytes Connection: close Content-Type: text/html Indiana Energy Annual Report
President's Letter
Investment Qualities/Profile
Management's Discussion and Analysis
Financial Statements
Notes to Consolidated Financial Statements
11-Year Operations and Financial Review

Making Sense of It All
Competition
Customers
Cost Effectiveness
Culture





Dear Shareholders:
I am very pleased to tell you about fiscal year 1996 - one of the most outstanding years in Indiana Energy's 51-year history. Benefiting from the coldest weather in a decade and by growing and managing our core gas distribution business and related gas marketing business, we realized superior financial results. We also made progress in dealing with the future of the evolving energy industry. While we are proud of our past and current accomplishments, it is the future upon which we all must focus. This led us to the theme of this annual report - "The Future: Making Sense of It All." Before we look to the future, though, let's take a look at fiscal 1996 financial and operating highlights.
In fiscal 1996, we realized record net income and record earnings per share (EPS). Net income was $42 million, compared to nearly $33 million in fiscal 1995. EPS were $1.87 versus $1.46 last year. The previous record for EPS was $1.62 in 1993. Our return on equity of 14.6 percent significantly exceeds last year's ROE of 11.9 percent. To establish and measure performance, we compare ourselves to a group of nearly 30 peer companies - local distribution companies selected by an independent investment banking firm. In fiscal 1996, the estimated average ROE achieved by our peers was 11.8 percent.
Because of the current and future outlook for company earnings, Indiana Energy's board of directors increased the quarterly dividend in July 1996 from 27 1/2 cents per common share to 28 1/2 cents per share. This 3.6-percent increase brought the year's dividend paid to a record $1.11, or $1.14 annualized. This is the 24th consecutive year that we increased dividends paid.
Several factors contributed to our ability to achieve these outstanding results:
  • Weather that was 8 percent colder than normal. This is a marked contrast to fiscal 1995, when weather was 13 percent warmer than normal;
  • The continued strength of our service area economy, which netted more than 10,000 new residential and commercial customers and a 6.3-percent increase in industrial gas throughput;
  • A continued strong focus on managing Indiana Gas' core business; and
  • Gas marketing affiliates that contributed 8 percent to consolidated net income.
We believe that our incentive compensation plans were also a key in our ability to achieve these outstanding results. Bargaining and non-bargaining employees companywide received maximum payout through our Performance Incentive Plan because of their dedication and hard work in the areas of customer service, safety, cost control and achieving the above-average ROE. Likewise, our management incentive compensation program is linked to achieving corporate goals, including return on equity and increased shareholder value.
The increased margin resulting from the very cold weather allowed us to accelerate some projects that will help us maintain and strengthen our distribution system. It also means we increased our operation and maintenance (O & M) expenditures from last year's levels. You may recall that last year's operating expenses were held well below budgeted levels to offset margins lost due to the extremely warm weather. Despite the 11.3-percent increase in O & M this year, we remain committed to controlling these costs. While weather may cause year-to-year fluctuations, long-term, we plan to limit annual expense growth to an average annual rate below the Consumer Price Index.
Our total return for fiscal year 1996 was about 18 percent, and for the five-year period ending in 1996 it was about 75 percent. Although these returns are good, relative weakness in our stock price at fiscal year end brought our returns to less than the averages for our peer group of nearly 30 companies. Over the last 10 years, the total return earned for our shareholders ranks us fourth out of the nearly 30 companies. As I will discuss in the remainder of my letter, I believe our strategy should help return our performance to the outstanding level we have achieved in the past.
We believe we are positioned to exceed the industry average for dividend growth. Some analysts are projecting 2 1/2 - to 3-percent average dividend growth this coming year. We're optimistic about our performance for several reasons: our growing and diverse service area; a supportive regulatory climate; competitive prices; our proven ability to control costs over time; and an historically conservative dividend payout ratio that has enabled the company to increase dividends paid year after year.
The continuously changing energy industry requires us to be thughtful and creative about how we will grow the company, differentiate ourselves from other utility investments and increase investor value. So now, let me share with you what we have been doing and here we are heading.


Making Sense of It All
Competition...Customers...Cost Effectiveness...Culture.
These four words, dubbed the "4 Cs," represent the key areas upon which Indiana Energy and its primary subsidiary, Indiana Gas, must focus in order to excel in the evolving utility industry. While we have been working to understand industry changes the past couple of years, this year has brought an increased sense of urgency. It has also led us to these four key areas. One thing the accelerating industry change has not done is change the company's mission or its basic business of providing natural gas and related services to customers. We are still committed to maximizing return Brian Azman and Stephanie Dalton, of ProLiance Energy,
	are helping position Indiana Energy for the new business environment. to investors, commensurate with business risks, by providing long-term value to our customers through safe, reliable, low-cost products and services. We will accomplish this through our employees and by supporting the communities where we live and work.
While the basic mission hasn't really changed, we have had to change the ways we look at and operate our core gas distribution business as the industry becomes increasingly deregulated and, as a result, more competitive.
In order to be competitive and successful, Indiana Gas can't rely on simply being able to deliver natural gas to its residential, commercial and industrial customers, bill them and then collect from them. Indeed, we have continued to introduce expanded service options to more customers. Our larger-volume industrial and commercial customers, for example, now choose which services they receive and from whom they receive them. This is what's known as unbundled service or customer choice.
But being successful in the future entails more than developing unbundled services. It requires a recognition of where the industry is heading and a willingness to change thinking and approaches to business. It also requires that the company be proactive, rather than reactive. And that's exactly what we're doing.



Competition
Competition in the utility industry is real and is here to stay. It seems that every week there's word of another utility merger or strategic alliance. Independent energy marketing companies have become an important part of the landscape. For Indiana Energy, competition is one of the primary drivers in the company's decision-making process.
Competition in the gas business exists in several forms. There's competition for gas transportation load, and competition for the sale of the commodity to local distribution companies, like Indiana Gas, and to end-use customers. Competition continues to exist between natural gas and other energy sources such as electricity and oil. We expect competitive pressures will build as the electric industry continues to restructure.
About half of Indiana Gas' throughput is already open to transportation service. We believe that even the smallest of our customers would like to be able to choose their gas supplier (much like they choose their long distance phone service provider), and take advantage of competition just as many of our larger customers already do. However, we also believe that the transition to full customer choice needs to be managed so that it is offered in an easily understood manner, with benefits that are clearly identifiable and readily achievable.
Our efforts to be successful in the short- and long-term include several different initiatives. The formation of a strategic alliance with Citizens Gas and Coke Utility of Indianapolis this year is one example of Indiana Energy positioning itself for this new business environment. This new entity, ProLiance Energy, LLC, was formed to optimize the gas acquisition and supply resources of both companies. Its goal is to provide reliable energy solutions at more competitive prices than Indiana Gas is able to offer on its own in a niche market that includes Indiana and surrounding states.
However, the formation and operations of ProLiance have been challenged in hearings before the Indiana Utility Regulatory Commission (IURC). Details on the challenge can be found on page 12. We believe that ProLiance is a reasonable response to the changing utility marketplace, and that it accomplishes several important objectives, including:
  • Indiana Gas and its customers are shielded from the risk of paying above-market prices;
  • Indiana Gas and its customers have experienced immediately reduced gas costs and, over the next few years, have the potential for further substantial reductions;
  • ProLiance ensures the presence of an Indiana-based provider of service that can compete with marketers for gas sales to end users, and that will be a long-term gas supply option available to customers, of all sizes, at a competitive cost; and
  • ProLiance provides an opportunity for Indiana Energy to be financially rewarded for the assumption of risks associated with the provision of gas supply.
We hope to have a decision from the IURC during the first half of calendar 1997.
How the IURC addresses the issues related to ProLiance and to the competitive utility environment is very important to us, all of our customers and stakeholders and many others in the industry. We strongly believe that to be competitive in the future, we'll need to replace the traditional cost-of-service regulation with performance-based regulation. We need ratemaking that encourages and rewards rigorous cost management and risk-taking, while ensuring quality customer service. Indiana has a state law that allows for innovative approaches to regulation for gas and electric utilities.
We expect to move toward performance-based regulation, or PBR, in the future. We believe that incentives work in a competitive marketplace. And through PBR, we would seek to create a balance between customer service and the financial objectives embodied in many cost control measures.


Customers
Consumers are the spark driving the fierce competition. As we have seen in other industries that are now deregulated, such as telecommunications, banking, railroads and airlines, competition creates the power of customer choice. We believe that energy customers will expect unmatched value and more for less (much like buying food, clothing and long distance phone service) in this new competitive environment. This means the company must continue providing safe, reliable, low-cost products and services. However, while low cost has been, and will likely continue to be, important, we believe that value and service are also extremely important.
In 1996, we know that customers in all classes are pleased with the products and services they receive from Indiana Gas. In fact, our annual customer opinion survey shows steady increases in residential customer satisfaction the past three years. Surveys of other customer groups mirror that positive result. We feel so strongly about customer service that it's one of the three components of our companywide incentive compensation plan.
Indiana Gas continues to realize strong customer and load growth in the residential, commercial and industrial sectors. Customer additions continue at about 21/2 percent annually. Industry growth averages about 2 percent. We are confident that our market will provide the opportunities to realize solid future growth.
One of the reasons we remain optimistic is the ongoing economic expansion and strength of our existing service area. Indiana Gas serves an area that includes 281 communities in 48 of Indiana's 92 counties, with a population of about 2 million. We reach from the Ohio to Illinois borders. We serve communities along the Ohio River in southern Indiana and communities through north central Indiana. A unique distribution center with 60 percent of the U.S. population within a day's drive, Indiana Gas' market is truly at the "crossroads of America."
Overall, the Indiana economy, as well as that of the Midwest, continues to outperform the national economy. Various economic indicators for a recent 12-month period show continued growth in the industrial sector, total construction, housing starts and retail sales. Seasonally adjusted unemployment rates average in the range of 4.1 to 4.3 percent.
In addition to our outstanding location and strong economy, our customer base is diverse and growing. It includes agriculture, automotive and steel production, pharmaceutical, glass and food producers, among other industries.
While customers are satisfied with Indiana Gas products and services, we can't rest on our laurels. To achieve outstanding financial performance, we are focused on profitable customer growth and customer needs. We want to know and understand even more about our customers' needs even though in Indiana, there are no regulatory mandates to offer choices or unbundled service.
Indiana Gas has chosen to be proactive in this regard. Indiana Gas currently offers unbundled service to customers using as little as 5,000 dekatherms a year. Customers representing about half of our load can purchase gas from Indiana Gas or a third party.
During the first half of fiscal 1997, the company plans to file a request with the IURC for a new pilot program to further test the market and gain additional experience at providing unbundled service to smaller-sized customers. During the pilot, aggregated load transportation would be offered to a group of small commercial customers.
In addition, we see this time as an outstanding opportunity to develop new energy-related products and services. A management team is creating a process for identifying and evaluating new business opportunities. It will also search for earnings growth opportunities we might pursue. We will have results from this effort to incorporate into our fiscal 1998 planning cycle.
Strong communities result in a good business environment for us. Recognizing this, we actively support the cities and towns where we live, work or provide service. In fiscal 1996, we formed the Indiana Energy Foundation to assist in these efforts. Through the foundation we provide financial support to organizations and activities that meet certain criteria.
We also encourage employees to volunteer their time and energy to community activities and needs. Our "Partners in Community Business Retention and Expansion" program continues to assist local communities with economic development-related issues.
Cost Effectiveness
Cost effectiveness is not a new idea at Indiana Energy. Its importance is well known, and it's integrated into the company's ongoing business strategy. Employees are encouraged to look for opportunities to operate more efficiently and cost effectively in their daily routines and responsibilities.
To provide customers with more for less, the company uses process improvement and activity-based management techniques to better understand the costs of processes and services, to identify room for improvement and to generate savings. These also will help determine what it takes to be competitive in the marketplace and in which areas we can and cannot be successful. Performance-based regulation would also provide incentives for the company to continue to generate cost savings to share with customers and shareholders.
Information technology plays an increasingly important role in our ability to be competitive and operate cost effectively. Indiana Gas has a comprehensive information technology plan to update its existing infrastructure and to implement several major new systems. We're making a significant investment to adapt and implement an integrated customer information and work management system. This new system, which will be on line the summer of 1998, will allow employees to collect, better manage and study important customer information, to track and manage customer choice programs and to improve customer service. We're also continuing to test mobile data dispatching technology, which allows service specialists to receive and send customer information via personal computers in their trucks. This makes us more efficient and helps us deliver better service to customers.
Information technology also will give us the ability to expand our customer base cost effectively with the same number or fewer employees. It also allows for more timely communication with various audiences. Both Indiana Energy and Indiana Gas have World Wide Web sites on the Internet. Indiana Energy's site, located at http://www.indiana-energy.com, features information of particular interest to shareholders and financial analysts. Indiana Gas' site at http://www.indiana-gas.com contains more general company, product and educational information. An internal Web site, or Intranet, is currently being tested within Indiana Gas.

Culture

Culture is the way we think and act. To be competitive, Indiana Gas is adapting its culture to the changing environment. The company is working with all employees to become more team-based and to stimulate a performance-driven environment focusing on improving processes and lowering costs.
We are making every effort to see that all employees work together to accomplish our corporate goals and objectives. I believe our incentive plans, training programs and increased employee participation in decision-making efforts have helped us begin to achieve the intense, focused teamwork we need and want. In addition, we are increasing the amount and frequency, as well as improving the quality, of communication across all boundaries. The open, candid exchange of ideas and information is a must. We need to begin thinking that communication is the responsibility of everyone in the organization.
Knowing where to focus efforts is important in business today. However, companies need their employees all moving in the same direction. As a team, we need to think safe, reliable, low-cost service in everything we do. We need to think prudently and creatively to see if there are better, more cost-effective ways we can do our jobs and meet our commitments to customers and the communities where we live and work. We are working hard to do these things. If we can accomplish these, we will keep intact our outstanding operational and financial performance records and continue to build the same shareholder value in the future that we have successfully done in the past.
As always, thank you for your continued support and confidence in our management team and employees.
© 1996 Indiana Energy, Inc.
www.indiana-energy.com