NiSource Inc (NI) 2006 Q2 法說會逐字稿

Good morning. My name is Michelle, and I will be your conference operator today. At this time I would like to welcome everyone to the NiSource second-quarter financial results and business update conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the call over to Mr. Glen Kettering, Senior Vice President of Corporate Affairs. Mr. Kettering, you may begin your conference.

Thank you, Michelle, and good morning to everyone. On behalf of NiSource, I would like to welcome you to our quarterly analyst call. We appreciate the opportunity to be with you today, and we thank you for taking the time to join us.

Joining me this morning are Bob Skaggs, President and Chief Executive Officer; Mike O'Donnell, Executive Vice President and Chief Financial Officer, and Randy Hullen, Director of Investor Relations.

As you know, the focus of today's call is to review our second-quarter 2006 financial performance and to provide an update on progress on our four-point business plan. We then will open the call to your questions.

I would like to remind you that some of the statements made on this conference call will be forward-looking statements within the meaning of the Safe Harbor provisions of the U.S. federal securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. Information concerning factors that could cause actual results to differ materially is included in the Management's Discussion and Analysis section of our Form 10-Q quarterly report for the first quarter, which was filed on May 5, 2006 with the SEC.

And now I will turn the call over to Bob Skaggs.

Thank you, Glen. Good morning. As you see in our just issued release, we are sharing difficult news with you about gas usage, customer attrition in our Gas Distribution segment and their likely impact on our earnings outlook. This news comes despite making solid progress on our four-point business plan and reporting higher net operating earnings for the second quarter and six-month period. The positive year-to-date performance has driven by our Gas Transmission and Storage business, which is delivering the revenue growth that began in the first quarter, and our Electric business that continues to deliver solid results.

We are providing this earnings alert to you today in an effort to be forthcoming and timely as possible in terms of what the usage attrition problem is, its dimensions and what we intend to do about it.

In a nutshell, our primary challenge is in our natural gas distribution business, which continues to be hit by reduced residential customer usage, as well as spiking customer attrition. As you know, both of these phenomena are affecting companies throughout the North American natural gas industry.

First, I will outline the broad financial dimensions of the usage issue, and then I will provide more detail and color. For NiSource we projected the combined impact of conservation and customer attrition will reduce our net revenues for 2006 by nearly $40 million or about $0.10 per share compared with the levels underlying our initial earnings guidance for the year. When we issued our guidance earlier this year, we noted that we expected the impact of net customer additions to more than offset the effect of customer usage reductions.

As I will discuss in a moment, it is now clear to us that those assumptions no longer hold. In addition to the usage issue, lower net interest savings are projected to increase interest expense and decrease other income compared with our initial 2006 earnings guidance. This impact is another $12 million or about $0.03 per share. Short-term interest rates are about 50 basis points higher than our original 2006 plan assumed.

Based primarily on these concerns, we're advising this morning that it is highly unlikely that we will achieve our original net operating earnings estimates of $1.45 to $1.55 per share. Also, we have decided not to provide new earnings guidance at this time because of the unpredictability of customer usage and attrition in the highly volatile market environment.

We're only halfway through the year, and we want to be prudent in providing as much insight as possible, but we are just not comfortable being more precise at this point. As issues surrounding these variables become more clear throughout the year, we will communicate any updates in a timely fashion. We have committed to you full transparency and straightforward communications, and I intend to continue to meet that pledge.

Now let me take a few minutes to elaborate on the primary reasons that we believe will cause us to fall short of our 2006 net operating earnings guidance.

The rate of decline in natural gas usage continues to be extraordinary. In many respects, this is, indeed, uncharted territory. Based on usage trends last winter and through the first half of the year, we now estimate a decline in normalized usage per residential customer of about 5%, which is on top of the 4% decline we saw in 2005. By contrast, as I pointed out earlier in the year when we announced our 2006 guidance, our initial plan assumed that in the wake of such a large 2005 usage drop, we would return in 2006 to historic levels of usage erosion of .5 to 1%.

Amplifying the usage impact is a significant softening of the rate of overall customer growth. New customer additions are give or take on track for the year, although we do expect to fall short of our original projections by about 2000 customers. An even more pronounced impact is from residential customer attrition that has significantly -- that has increased significantly from traditional levels coming out of last year when the market spiked to historically high gas price levels and shut-off levels increased.

Our original plan anticipated attrition of less than .5% in the number of residential gas consumers across our distribution company. Our present estimate is for more than double that rate, attrition of about 1.2% for the full year or approximately 36,000 customers. This increased attrition rate is the primary factor significantly reducing the projected Gas Distribution segment contribution from planned growth.

Several concluding observations on this point, our analysis shows that our usage experience is in line with that being experienced by other local distribution companies in the region and the country. And anecdotally we're also seeing higher attrition rates at other gas utilities.

Finally, I would note again, while it's possible customer attrition rates could turn around and usage levels could rebound to some extent, we are reluctant to predict that type of customer behavior in such a volatile energy environment.

Now what are we doing about this situation? At the outset I would say this can be fixed -- it will be fixed, but it will take time and a concerted effort. To that point the industry is fully mobilized and we are fully mobilized. Conservation among natural gas consumers is the major focus of our entire industry. The American Gas Association has comprehensive study under way in which we are participating that is designed to improve the understanding and increase the visibility of this issue. And we believe the study will add traction to the initiative that the AGA and the industry launched several years ago to reform rate design to more appropriately address conservation.

In more concrete terms, we believe that long-term mitigant is a more contemporary rate design that will have to be achieved through regulatory initiatives. Specifically in Indiana, we're currently working with regulatory stakeholders to adjust our gas rate structure to better reflect current conditions. This is a reference, and significant gas rates were set in 1988. We hope to reach agreement later this year on a proposal.

We now plan on making additional filings in other states during 2006 and 2007 either through broader rate proceedings or specific mechanisms. Our regulatory teams emissions in this regard could not be more clear or more urgent.

Turning now to a more full discussion of the second-quarter performance, despite the customer usage challenge, we are making steady progress on our four-point platform for long-term sustainable growth. To briefly reiterate, the areas in which we remain focused through the four-point platform for growth that we launched during 2005 are one, expansion and commercial growth in the Gas Transmission and Storage business. Two, commercial and regulatory initiatives at our utilities. Three, financial management. And four, process and expense management.

Let's now drill down into our second-quarter performance. On a non-GAAP basis, net operating earnings for the quarter ended June 30, 2006 were $39.1 million or $0.14 per share, an increase from $24.4 million or $0.09 per share for the second quarter of 2005. Operating earnings were 157.4 million for the second quarter of 2006, up from 137.8 million in 2005.

Just a reminder at this point that we focus on net operating earnings and operating earnings, both non-GAAP measures, because we feel these measures better represent the fundamental earnings strength and the performance of the Company. Net operating earnings does normalize for weather, as well as for other items such as restructuring charges related to the implementation of our outsourcing agreement with IBM and asset impairments. For a complete reconciliation of net operating earnings and operating earnings to GAAP, please see Schedules One and Two of the news release available at www.NiSource.com.

Primary drivers of the improvement in net operating earnings built upon the positives we reported in the first quarter, including successful sales of shorter term transportation and storage services, or so-called optimization initiatives, in our Gas Transmission and Storage business. Improved results in the electric business. Decreased losses of Whiting Clean Energy and as planned a decrease in interest expense, $8.2 million for the quarter, due to last year's refinancing of $2.4 billion in long-term debt at lower rates. These positive impacts were partially offset by the continuing decline in usage by natural gas utility customers and lower interest income that I have already discussed.

I'm now going to provide an overview of second-quarter operating earnings for each of our core business segments. In the Gas Distribution business, which I have already discussed at some length, we reported operating income earnings of $12.5 million, which was a decrease of about $2.1 million from the second quarter of 2005. The decrease was primarily due to the residential usage issue.

In distribution, all of our teams continue to be aggressive. Our gas supply team continued the efforts begun in the first quarter to capitalize on short-term market opportunities and use our distribution businesses extensive supply and storage portfolio to increase optimization revenues. These revenues also benefit our customers through regulatory sharing mechanisms.

In addition to the efforts to mitigate the usage impacts, we continue to work towards additional regulatory initiatives that will support profitable customer growth and ongoing infrastructure investments. An on the cost side, operating expenses were essentially flat with last year in this segment.

Moving to our Gas Transmission and Storage operations segment, operating earnings were $80.5 million, an increase of $9.9 million over the second quarter of last year. The improvement is a continuation of the success story we first told you about during our first-quarter conference call. Our commercial team is delivering on the revenue growth of more than $30 million that we projected for 2006. Almost $16 million of new revenue from shorter-term transportation services in storage optimization initiatives was recorded during the second quarter.

Meanwhile, the Gas Transmission and Storage segment continues to make real progress on asset expansion projects that are driven both by the market and producers. Construction of the Hardy Storage project in West Virginia is continuing, and the project remains on target to be in service in the second quarter of 2007.

The partners, part Columbia Gas Transmission and the unit of Piedmont Natural Gas, closed on financing for the Hardy Storage project in late June. Prefiling activities continued for Columbia Gas Transmission's Eastern market expansion. Another combined storage and transportation project designed to meet core market growth in the mid Atlantic region. As we previously reported to you, this project is supported by binding customer agreements.

The Electric Operation segment had another strong quarter as well, reporting operating earnings of $67 million, an increase of 6.8 million from the year ago period. We are seeing lower administrative costs from the Midwest Independent System Operator, MISO, and received a favorable regulatory ruling on the recoverability of certain MISO charges.

Other positive impacts driving the increase in operating earnings in this segment are the timing of revenue credits and customer growth.

As we previously reported, the moratorium under the NIPSCO electric rate review settlement expired on August 1, and NIPSCO has now begun deferring MISO administrative costs for future recovery. Operating expenses in the Electric segment, excluding those subject to the environmental trackers, were up by $1.2 million due primarily to higher electric generation and maintenance expenses and higher gross receipts tax accruals. Partially offset by lower employee and administrative expenses.

Notably electric sales volumes to industrial customers increased by 9%. We're seeing increased demand by the strong steel market, as well as by other industrial customers that support the steel industry.

Moving to the segment we refer to as other operations, we report an operating earning loss of $3.1 million for the second quarter compared with an operating earnings loss of 8.3 million for the year ago period. The $5.2 million improvement was primarily due to decreased losses from Whiting Clean Energy, increased net revenues from commercial and industrial marketing activities and lower property tax accruals.

To briefly touch on a few additional factors that affect our consolidated net earnings, interest expense for the second quarter of 2006 decreased by $8.2 million compared to the second quarter of 2005 due to the refinancing of $2.4 billion in long-term debt at lower rates than we completed in 2005.

Net other expense was $2.7 million this quarter compared to net other income of 3.6 million in the previous year. The change was due primarily to lower interest income and increased costs related to the sale of Accounts Receivable.

Focusing now on liquidity, net cash from operating activities for the six months ended June 30 was over $1 billion, an increase of $83 million for the first six months of 2005. This increase was primarily due to a significant reduction in outstanding Accounts Receivable and the collection of underrecovered gas costs, partially offset by the impact in 2006 of reduced Accounts Payable balances. We closed the quarter with short-term debt of $420 million and total debt of $6 billion. That equates to a 55.3% debt to capitalization ratio.

In early July, we secured an amendment to our revolving line of credit. The amendment extended the existing agreement for an additional year, increased the size of the line of credit from $1.25 billion to $1.5 billion and reduced the cost of short-term borrowing. The amendment will save us an additional $4.5 million in interest costs over the five-year term of the facility.

To wrap up, overall our performance for the second quarter, as well as through the first six months of the year, was solid. Having said that, consistent with our commitment to transparency and timely communication with the investment community, we feel it is best at this time to alert the markets that we are unlikely to attain our original net operating earnings estimate for 2006 based on our uncertain outlook for customer usage and customer attrition, as well as the difficulty in predicting the timing and the outcome of regulatory solutions to the usage issue. Higher interest rates affecting our expected interest expense savings and reducing interest income were also key factors in this decision.

Briefly in closing, I would like to also update you on the efforts we launched earlier this year to unlock the underlying value of our asset base. We forged ahead aggressively on a number of fronts. We're in discussions with BP, the host customer of the Whiting Clean Energy facility, on ways to decouple whiting steam obligation to BP from the operations at the Whiting clean energy plant. These constructive discussions are in fairly advanced stages and are focusing on ways to deal with the short-term and long-term needs for steam at the BP refinery.

We also have been busy on the so-called financial and strategic study initiative. We have concluded the analytic phase of our comprehensive review and are continuing the process. We expect to be in a position to report on our conclusions and directions by the end of the year.

As I stated earlier, we remain committed to communicating with our investors and all other stakeholders in a transparent and timely manner when decisions are made on these efforts, as well as on addressing the usage and customer attrition issues we outlined today. We look forward to keeping investors and all interested stakeholders updated on our progress throughout the year. As always, these updates will be provided through our quarterly analyst calls and through press releases that will be posted promptly on www.NiSource.com.

Thank you for participating today and for your continued interest and support in NiSource. At this time Glen would like to open the call for questions.

(OPERATOR INSTRUCTIONS). Sam Brothwell, Wachovia Securities.

I want to just drill down into this customer usage thing a little bit and a couple of questions that come to mind. Is this specific to one region? Is it more Indiana versus Bay State? And I guess on the attrition issue, what are these customers going to do to heat their homes? Are they going to burn the kitchen table? Where are they going? You have a need in the areas that you serve for heat, so I am a little puzzled by that.

On the first question, we see consistent usage erosion across the entire service territory. One state or community is not any notable than the other. We may see a little variation, but by and enlarge it is not material. Consistent behavior.

On the attrition issue, frankly, we are puzzled on what customers are going to do. To your point, heat and hot water is essential, but having said this, we have seen this rate increase. We have a team focused on what is going on with customers that elect not to return, but for the moment we just don't have a definitive answer on that particular point. It is disturbing, and as you pointed out, you would have to conclude that they are going somewhere.

Now maybe the mild weather that we experienced last year stunted a return, but as we have suggested, we just cannot count on that right now. Just as a footnote, our working of disconnect alerts are at all-time record highs.

Are these fourth disconnects due to nonpayment, or is these customers that are actually electing?

Typically no. Virtually all of this are disconnects for non-pay. Now we have seen what we call (inaudible) accounts, customers that have gone off typically for non-pay or customers that had vacated a housing unit not return. But by and large, disconnect, non-pay.

Okay. Well, thanks very much.

Ashar Khan, SAC Capital.

I just wanted to go over a couple of things in and out you probably heard the call and missed it a little bit. I guess the two things you said this morning, which are below expectations and I was going back to the waterfall chart that you had provided at the beginning of the year, if I'm right, the two things that we are below is usage and customers, correct? (multiple speakers). You had $0.02 up on it, and I guess you're saying that this could be a negative number this year. Is that what I'm hearing from your comments this morning?

That is precisely what I'm saying.

Okay. The second number you said was interest expense savings was $0.10. I guess it is coming what, half that level this year? Is that a more appropriate way to look at it?

No, it is about the total of interest expense savings and other income right next to it. The total reduction for both of them is $0.02.

Total reduction for both of them is $0.02 in the aggregate?

That is right.

And about 2 of that is interest expense savings, so instead of 10, that is going to be about 8.

And then can you just mention to us, you mentioned a little bit in the call but the regulatory and commercial initiatives of 9 to 14 pickup, where you are specifically in that category?

Yes, that is a positive story as we suggested. The Gas Transmission and Storage segment is leading the way because of their gas capacity optimization activities, and I mentioned that we are seeing about $30 million from that new line of business that rejuvenated line of business. We're also seeing a bit of a lift out of our Gas Distribution gas supply activities that are also optimization in nature. We have achieved a couple of other notable wins across the states that we believe keep us within that $0.09 to $0.14 range on regulatory initiatives at this point.

Okay. So then the big miss is going to be in the usage and customer category. Is that correct? As I look at this chart, is that a fair thing, or is it something else in electric generational O&M or pipeline O&M? I'm just trying to go through the deltas that you have provided?

Yes, I think just in the simplest terms we're saying the fundamental issue is usage and attrition. We have had progress on virtually every other plank of the four-point plan and virtually every other bar on the chart that you see on the waterfall.

Okay. So what are you -- what are your new numbers? Could you just explain to us what you had, if you could just repeat what you had when you put this in terms of usage and customer versus what you have seen in the first six months?

Well, as I mentioned in my comments, the plan was built on the assumption that customer additions in the gas business would offset customer usage loss and attrition in the gas business. So they would offset.

And what was that percentage?

It was give or take about .5% to 1% residential gas usage reduction. What I have mentioned was that reflects a historical relationship, and we felt that that made sense given that we saw losses of about 5% in 2004. And as Sam suggested, we are hard pressed to see another year of 5% (multiple speakers). The best -- that is the basic underlying assumption.

I would add we assume that customer attrition would be about .5%, and in reality we are now seeing more like 1.2, 1.3, 1.4% customer attrition. Now for the full year as opposed to that estimate that is reflected in the waterfall, we now think residential customer usage erosion will approximate about 5%. I have already given you the attrition.

Okay. So it is a like a 5% usage versus kind of like 1% and then an attrition of a 1% higher on the residential side, which is coming out actual versus forecasted approximately?

Yes, approximately. Just on attrition, let me be clear. The underlying assumption in the outlook was about .5%.

.5, and now it is 1.4 you said, right?

1.2.

1.2?

1.2. Those are all full-year numbers (multiple speakers) and they are compared to the outlook that we provided the investment community.

Now I forget now I have to go back to my notes, you had provided a delta that the 1% usage would have on your revenues. Could you remind us of those numbers?

Roughly speaking just on the usage issue, it is about $5 to $6 million pretax.

For 1%?

Yes.

Okay, and for attrition?

I don't have a rule of thumb number at hand. I would say that in our current outlook $40 million that I have cited, attrition is about $7 to $8, $9 million. And again that is an estimate based on where we stand in the middle of year on attrition.

Okay. So just going back to what you said, when do you get a clearer view regarding your guidance? Is it after the third quarter because results? I mean you don't earn that much in the third quarter. The big quarter is the fourth quarter. So I'm just trying to understand when does clarity come in in terms of the way you look to earnings are coming or the new basis?

Yes, I apologize. I just cannot be definitive right now. What I'm committing to you is as soon as we get a better read on usage and attrition and related issues, we will certainly get back you as soon as we possibly can. But that is a footnote.

One of the key elements just in our business is light-up season, and that is when we see customers reapply to get back on the system. They may have been shutoff for collection issues, and that hits as soon as cold weather. As soon as the temperature drops, we begin seeing customers come back, and we think that is going to be a barometer. It may not move the numbers this year, but it is going to be a barometer of where this fundamental issue is shaking out.

But that won't occur until later in the year, right? That is what I was implying.

It is going to be the October/November timeframe.

That is what I was implying. That won't happen until the fourth quarter, correct. So that is when you get a better feed of what the numbers are.

I think it is certainly going to be closer to that than it is in the middle of the third quarter. Again, we are just reluctant to give you information that is misleading or unreliable.

Can I just go on to BP? You guys started off with the BP initiative if I am right three years ago, and then we did not get anything substantial out of it. What makes you feel that this time the negotiations do lead to something more substantial than the previous round?

Well, maybe just a different point of view on what we did earlier. We entered into a fairly significant amendment of that steam supply agreement that did give us relief on what I would call the must run provisions of that agreement. So BP worked with us. We felt like they did give us a notable concession, and we feel like it was a reasonably good accommodation at that time.

So throughout that discussion, discussions that have occurred since, BP has been constructive. They certainly understand that we have a significant business and commercial problem, and so they have been forthcoming, and they have been very constructive in their discussions. I can only say to you they are reasonable business people. They have a need for reliable steam, and they understand that we are going to press and push hard on obtaining relief and accommodation.

And could you repeat, you said an outcome is towards the end of this quarter? Is that would you are forecasting?

We're focusing on an outcome as soon as we possibly can. But we have indicated that we hope to give you more definitive information on this initiative and our financial and strategic initiative by the end of the year.

Okay. So it is at the end of the year. So the way to look at is it is any savings that might come in would help in '07 rather than '06. Is that a fair assumption?

Well, certainly the assumption that we are going to see any material impact on our financials in 2006, that is not going to occur. That is unlikely (multiple speakers) because of Whiting. Beyond that, I would prefer not to (indiscernible).

Paul Debbas, Value Line.

Do you have any discretionary O&M expenses that you can cut to offset the decline in usage?

At this point in the year, we don't have adequate latitude or latitude around discretionary expenses to rise to that magnitude. I don't think we can make a material dent in $40 million of the usage yet through O&M at this point in the year.

Can you do anything that would be reflected next year?

We have a series of measures to continue to aggressively address O&M, and our agreement with IBM is one. We also have a number of other just blocking and tackling initiatives in place to hold the line on O&M, and we are going to continue to pursue those aggressively. Again, I would be remiss if I suggest to you that we can cut O&M to the extent of $40 million to give relief to the problem. What I will commit is we will continue to work like heck on O&M to hold the line and reduce it where appropriate.

Paul Ridzon, KeyBanc.

I am a little bit confused about the fact that rising interest rates are hurting both interest expense, which I understand, and interest income. Can you reconcile that?

Yes, I'm going to ask Mike to handle that one.

Last year on interest income -- we will start with that. Last year you will recall that we did some prefinancing for the basically 2.5 billion that we refinanced last year. So we had for us an unusual amount of interest income last year.

The other thing that is in that component in other income is a negative entry for the Accounts Receivable program. And what is happening this year and what the change is, is that the Accounts Receivables program is somewhat higher than it was last year because the receivables balances are a little higher, and in effect the borrowing cost on that program is higher as well because of the higher short-term interest rates.

So you are basically floating the customer some money with a higher cost to yield?

No, actually what we're doing is we're selling the receivables to a conduit, basically a commercial paper conduit, and using that conduit's borrowing rate as our borrowing rate to get the cash for the receivables about 60 days sooner than we would otherwise. And there's an interest component built into that process.

Got you. And I know you touched on this a little bit, but what is the timing on some of these regulatory fixes, and is -- in Indiana can you isolate the gas business without opening up the Pandora's box at the Electrical business?

Starting with Indiana first, we believe we can -- typically the regulatory commission has addressed gas and electric separately. We have structured our regulatory arrangements separately, and the proposal that we are dealing with in Indiana is, in fact, discrete and specific to the gas business.

So the answer to that one is, yes, we don't believe that triggers any regulatory activity on the Electric side. And beyond Indiana, assuming we have to use rate cases as the primary means to secure relief on usage or to address usage, those cases typically will consume a year and in some cases maybe a year and a half. (multiple speakers) -- excuse me?

And when would you file?

As I suggested in my comments, we are looking at filing ASAP. The major filings would occur in 2006. Sorry, 2007. I misspoke. 2007. Right now we're seriously considering cases in Kentucky and in Pennsylvania the first half or so in 2007.

Ohio and Massachusetts are okay?

Well, as you recall, in Ohio we are working under a fairly complex regulatory settlement that is set to expire in 2008, like November of 2008. That will be -- we will have our discussion and our efforts centered around that arrangement and how we intend to deal with an arrangement on a long-term basis.

We're working internally at this point on that case as we speak. In Massachusetts, as you may recall, we had a rate case that was decided last December, late November, early December 2005. So we are in a bit of a stay out in Massachusetts for a period of time.

Did that Massachusetts rate case have any potential to address -- did that case address some of these issues you are facing now?

It did not address customer usage per se. We do have a mechanism in Massachusetts that will allow us to periodically adjust rates to reflect the impacts due to conservation and conservation programs. It is not what one might consider a true decoupling mechanism or a true conservation tracker, but it does provide a certain level of relief to conservation.

And the other thing I would mention about Bay State, we do have a PBR in place at Bay State, and while that is not directly on point with conservation, we think it is a pretty effective mechanism across the entire rate structure.

Have you discussed this development with the rating agencies on top of this, the headwind of weather thus far in the year, probably -- obviously their interest is more cash flow than earnings. How have they reacted?

We have not had a specific discussion about this. Certainly the rating agencies are aware -- keenly aware that the gas utility industry, all companies have dealt with weather. All companies are dealing to some extent with this usage issue. We will be talking with the rating agencies during the fourth quarter. Certainly it will be the topic of conversation at that point, but we have not had specific conversations on this point issue.

Faisel Khan, Citigroup.

I just wanted to follow up on the last question there about potential rate relief. You say that you could file for rate relief in Kentucky and Pennsylvania next year?

2007, that is right.

Okay. So that is not just decoupling; that is actually like kind of a base rate increase?

That is right. Again, we would consider those as vehicles for any number of initiatives.

Okay. Then, is there resolution yet on -- isn't there a Virginia filing that you guys made recently?

Well, yes and no. We're in the midst of a rate investigation in Virginia, and you may recall or I think you're recalling that we also filed for a PBR mechanism for Virginia. So we're in process in Virginia on both of those. Currently there's a hearing slated in Virginia for late November, early December. We will see whether we hold that procedural schedule. The resolution of that proceeding is aways off.

Okay. I think there has been talk in Pennsylvania about decoupling volumes from revenue. Is that true? Are you hearing the same thing?

Well, National Fuel is actually pushing proposals in Pennsylvania.

Okay. I did not hear anything on the quarter about the IBM outsourcing contract. What have the benefits been so far? Is that coming along as you guys expected?

That effort is more or less on track. I will state the obvious that this is a day to day execution challenge and issues, and as you would expect of something of that magnitude, you do encounter what we think are temporary bumps and dislocations. But by and large, we are, indeed, on track on the savings that we project from that arrangement.

In fact, as we speak, we're in the midst of a wave of implementing new financial systems and new procure to pay systems, so we're proceeding both with the day to day outsourcing work, as well as transforming our suite of underlying IP systems and again on track.

And do you think that as you go in for rate relief that the commissions will let you keep these savings you are generating from that outsourcing contract?

I would just say at this point, as you would expect in a rate case, all the issues are open to discussion and debate. Now we certainly feel like we can demonstrate benefits, demonstrate what this arrangement brings to the table, and certainly, as we get into the cases that will be discussed, I will just give you one data point, and that is at Bay State.

We litigated that case, I'm forgetting exactly when in 2005, but actually during the announcement and the beginning of the implementation of the IBM agreement. By and large, we got through that proceeding in good shape. Commission and other stakeholders are looking at that arrangement as we speak, but we feel like our team did a good job of handling that arrangement and coming through with a good outcome in Massachusetts.

Okay. And then I believe in your press release you talked about how you concluded your analytical phase of unlocking value. Is this something that you go to the board now with and you guys discuss what the certain issues are and then you come out towards the year-end with a result?

The board has been engaged in this effort. Discussions and considerations are ongoing. I think you're accurate to say that by year's end we hope to give you more definitive conclusions and directions.

Okay. Then I was wondering in terms if your debt to total capitalization, do you think that you're properly capitalized vis-a-vis your other competitors in the gas utility space?

I think we are, yes.

Okay. So you are comfortable with your kind of debt to total cap ratio stance right now?

As it currently stands, yes.

Carl Kirst, Credit Suisse.

Most of my questions have been asked and answered, but if I could just, maybe a few clarifications. First, the $40 million impact on the usage and the conservation attrition, is this effectively just a mirror extrapolation second half or first half?

One of the things I'm trying to better understand, kind of off of Sam's question in the beginning about this effectively not being a voluntary attrition cutoff, are we to a point now where pretty much everyone who is not paid their winter bills, you know has passed the 90-day point, and they are already cut off. Or are we going to continue to see kind of this 5% level continue through the rest of the year? I'm just trying to get a sense if that is just kind of homogenous or if we have spikes to the year?

Well, I may not fully understand your question. If I'm non-responsive, just jump in.

Well, maybe I can rephrase it. Are you still seeing the rate of customer attrition today that you were seeing perhaps in March and April?

What we began to see in March and April would suggest by year-end the attrition rate will be about 1.2%. So at the end of the year, we would have lost give or take 35,000 customers. Again, we are basing that on beginning to work shutoff much earlier because of warm weather, an aggressive collections program and just higher shutoff orders, and that is what we are seeing. In fact, shutoffs are about 10% higher than they were in 2005 as we stand here today.

Now the big variable that I mentioned on the attrition issue is, what will the returns look like as we enter into the light-up season? And that is where the predictability of human behavior and the economics and the energy dynamics, right now we just don't have that answer, quite frankly.

I understand.

I would just say we have never seen anything like this attrition rate.

Switching to the conservation side, obviously second quarter has got April heating demand but is typically not looked at as a very big heating quarter. I guess how firm are we on this trend? I mean do we have a lot of statistical leeway here, or you guys being pretty firm with what you are seeing?

Well, we are relatively firm on what we are seeing. Again, we are in an area where we have got consumer behavior in play, and hopefully the AGA is going to give us some help on consumer behavior in these sorts of conditions. But what we have seen we feel is a pretty firm indication of conservation. We certainly have not seen any numbers that would suggest that we are off the mark in a material way.

I would add, I thought this was where you were going maybe initially, of the roughly $40 million, we think we have seen between 25 and 30 million of that already occur. (multiple speakers). The remaining year to your point and maybe to Asher's point, certainly the third quarter we're not going to see a lot. The fourth quarter we will see additional usage that we think.

Great. Two other quick questions. Looking at the LDC customer class relative to what I have got in my model, it looks like maybe there was a reclassification taking the transportation customers and reallocating them. Does that change -- if that reallocation did not happen, did that change any of the residential decline, etc.? I'm just trying to make sure -- I'm having a little time reconciling with my source model.

This is Mike. No, that does not change anything, but what we did, frankly, to clear up some confusion was we added the transportation and sales customers together by customer class. Because we found that a lot of people were missing the fact that a lot of residential heating customers were in transportation. So we thought it best to go back to the old way and add sales and transportation together.

Great. And then last question Bob of Chris, there has been a little bit in the trade press about Columbia and FERC, and again I don't want to make anything out of it. Is this just kind of more pipeline noise or is something brewing?

Yes, I hope that there is nothing more to this. I don't think there's anything more to this, but what you're referring to I assume is the indication that FERC is referring one of our cases or proceedings to enforce -- is that correct?

It is.

Yes, we believe -- we thought we were in full compliance with FERC's order. Clearly they felt otherwise. We certainly would never intentionally not comply. In fact, on this particular issue, we were negotiating an interconnection agreement with Tennessee, and that is pursuant to our policies and practices.

The FERC found you don't need that agreement. An agreement exists under another set of operating agreements that you have with Tennessee. So they said, go on and build the interconnect. Frankly, we just did not understand that, and again we felt we were in compliance. It was never our intent to thumb our nose at anyone and in particular not to FERC. And so we are going to proceed to deal with the interconnect, go on and construct it, and we are certainly going to work with the commission to sort out what we think is a misunderstanding.

Great. I appreciate the color and best of luck.

Raymond Leung, Bear Stearns.

A couple of questions. Can you elaborate a little bit more about your strategic plans that you probably don't want to talk about and maybe how ties into your balance sheet and your rating aspirations?

Yes, again generally what we have been doing is taking a clean sheet of paper look at literally everything -- structural, financial form, financial policies -- and again trying to do it in a very methodical, comprehensive and disciplined way across the entire company and enterprise. We have been doing this on a very measured basis because obviously we have a lot of concern with tax, regulatory and other issues that we don't want to inadvertently destroy value or take a wrong step. I cannot really comment on specific techniques or specific approaches at this point other than to say we are looking literally at everything. As I mentioned earlier, the board is engaged, and we're going to keep the process moving. We hope to give you more definition as we get towards the end of the year.

Okay. How would that tie into -- historically you guys have been very supportive of your investment-grade ratings. How does that tie into that?

Well, we certainly intend for our investment-grade rating.

And just one final thing, financial plans. I know there are some maturities later this year. Can you talk a little bit about what you need to do for the balance of the year?

We're still working on that, but we do have about 400 million of maturities coming up the balance of this year, and we're pondering now whether to package all that together and do a financing later in the year or even delay that and carry it into next year. That is kind of on the drawing board right now.

[Stephen Lessons], Luminous Management.

You may have addressed this already, so I apologize if I missed it. It looks like you are on track for Hardy project. But I was just wondering where do things stand as far as Millennium concerned?

Yes, Millennium is we announced recently pushing out our projections and in-service stay to November of 2008, and what we have been saying and suggesting is that with multiple companion pipelines in this project, it is a complex undertaking. You will recall that we have an upstream link in power, and we have Algonquin, [Iraquay], Islander East. So literally just the work dealing with those interrelated applications has pushed the timing of this.

We are still optimistic and hopeful to receive certification later this year, begin construction in 2007 and really be a two-year construction effort and then hit an in-service date of 2008.

One encouraging sign that I can point you to, a tangible example is National's in power link, the upstream link, received a preliminary determination, gosh, a week, 10 days ago. So that is I think a positive tangible indication that FERC is supported and is processing these applications as quickly as possible. I think you're aware that FERC's processing track record of doing things with dispatch has been good, so again we are hopeful.

The total cost of that I think for the whole project was around 550 million. As has that figure changed?

We're still looking at those numbers. Like everyone in the industry, we are certainly going to be encountering upward pressure on prices. So the partnership is looking at budgets, working on budgets. Certainly we want to bring that in as economically as we possibly can. It is an issue we are going to have to grapple with as we approach construction.

Terran Miller, UBS.

Just as a follow-up maybe from a slightly different point of view from some of the questions previously, when we look at your desire to solve this issue, the fundamental issue, as well as enhanced shareholder value and balance it with reference to your credit quality, how are you waiting the three of those and what seems to be the driving force?

I'm not sure I can specifically answer your underlying point of premise. Our approach at looking at all of our alternatives and all of the options is, indeed, comprehensive. So we are looking at an array of options, techniques, structures, approaches, and we are measuring, calibrating all of those against our financial plan, and that financial plan, as you would expect, includes the outlook on usage, the outlook on regulatory activity, the outlook on fundamental growth. So by definition that exercise certainly considers that at the distribution companies at the moment strong growth is a challenging issue.

So that is embedded by definition in those exercises. As you would expect, the focus on growth is the fundamental point throughout those exercises. So that is embedded.

The other point on credit, again one of the underlying assumptions, premise, objectives is that for the utilities we are going to need investment-grade. We want investment-grade quality to support those businesses. So it may not have been responsive, but those are the points and premises underlying this methodical approach.

Okay and just a point of clarification. In your last comment, you just said for the utilities what do you consider the requirement for the holding company? Would that still be investment-grade, or are you willing to go below investment-grade at NiSource finance?

Right now we're committed to investment-grade at the holding company.

Josh Golden, JPMorgan Asset Management.

Thank you. My question has been answered.

At this time, there are no further questions.

Well, again, we want to thank everyone for participating in this morning's phone call. We thank you for your ongoing support, and we look forward to communicating with you in the not too distant future. Good morning.

Ladies and gentlemen, we thank you for your participation in today's conference call. You may now disconnect.