<PAGE>   1
 
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                       SECURITIES AND EXCHANGE COMMISSION
                          WASHINGTON, D.C. 20549-1004
 
                                   FORM 10-K
               ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
 
                         Commission File Number 1-7479
 
                            ------------------------
 
                             BAY STATE GAS COMPANY
             (Exact name of registrant as specified in its charter)
 
<TABLE>
<S>                                            <C>
                MASSACHUSETTS                                    04-2548120
       (State or other jurisdiction of              (I.R.S. Employer Identification No.)
        incorporation or organization)
</TABLE>
 
   300 FRIBERG PARKWAY, WESTBOROUGH, MASSACHUSETTS 01581-5039 (508/836-7000)
         (Address and telephone number of principal executive offices)
 
           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT
 
<TABLE>
<CAPTION>
             TITLE OF EACH CLASS                 NAME OF EACH EXCHANGE ON WHICH REGISTERED
             -------------------                 -----------------------------------------
<S>                                            <C>
      Common Stock, $3.33 1/3 par value                   New York Stock Exchange
                                                           Boston Stock Exchange
</TABLE>
 
       SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:  NONE
 
     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 __
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [X]
 
     Aggregate market value of registrant's voting stock held by non-affiliates
as of December 31, 1998 was $508,476,451*.
 
     On December 31, 1998 the Company had 13,571,844 shares of Common Stock
outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
<TABLE>
<CAPTION>
                  DOCUMENTS                                  PART OF FORM 10-K
                  ---------                                  -----------------
<S>                                            <C>
                     None
</TABLE>
 
                            ------------------------
 
* Calculated by excluding all shares held by directors and executive officers of
Registrant, without conceding that all such persons are "affiliates" of the
Registrant for purposes of the Federal securities laws.
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<PAGE>   2
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                               PAGE
                                                                               ----
<S>              <C>                                                           <C>
PART I
     Item 1.     Business:
                 The Company.................................................    3
                 Utility -- Markets and Competition..........................    3
                 Natural Gas Sales...........................................    5
                 Capacity Requirements.......................................    5
                 Regulation and Rates........................................    5
                 Franchises..................................................    6
                 Energy Products & Services..................................    6
                 Energy Ventures.............................................    6
                 Employees...................................................    6
                 Executive Officers of the Registrant........................    7
     Item 2.     Properties..................................................    7
     Item 3.     Legal Proceedings...........................................    8
     Item 4.     Submission of Matters to a Vote of Security Holders.........    8
 
PART II
     Item 5.     Market for the Registrant's Common Equity and Related
                   Stockholder Matters.......................................    8
     Item 6.     Selected Financial Data.....................................    8
     Item 7.     Management's Discussion and Analysis of Financial Condition
                   and Results of Operations.................................    9
     Item 8.     Financial Statements and Supplementary Data.................   17
     Item 9.     Changes in and Disagreements with Accountants on Accounting
                   and Financial Disclosure..................................   38
 
PART III
     Item 10.    Directors and Executive Officers of the Registrant..........   38
     Item 11.    Executive Compensation......................................   39
     Item 12.    Security Ownership of Certain Beneficial Owners and
                   Management................................................   48
     Item 13.    Certain Relationships and Related Transactions..............   49
 
PART IV
     Item 14.    Exhibits, Financial Statement Schedules and Reports on Form
                   8-K.......................................................   50
                 Signatures..................................................   52
                 Exhibit Index...............................................   53
</TABLE>
 
                                        2
<PAGE>   3
 
                                    PART I.
 
ITEM 1.  BUSINESS
 
THE COMPANY
 
     Bay State Gas Company ("Bay State" or the "Company") was incorporated in
1974 as a Massachusetts corporation. However, Bay State's predecessor companies'
operations began in 1847, and consecutive quarterly dividends have been paid by
these entities or Bay State since 1853. The Company is primarily a gas
distribution utility that provides local transportation service in the greater
Brockton, Lawrence, and Springfield, Massachusetts areas. Additionally, the
Company also offers additional energy products and services to its customers,
and invests in energy ventures. Approximately 89% of all revenues are generated
from providing local transportation and natural gas sales. Bay State has
thirteen subsidiaries within its corporate organization. Northern Utilities,
Inc. ("Northern") is a gas distribution utility operating in the Portland and
Lewiston areas in Maine and the Portsmouth area in New Hampshire. Granite State
Gas Transmission, Inc. ("Granite") is an interstate gas transmission and supply
company operating in the states of Maine, New Hampshire, Massachusetts, and
Vermont. Granite has four wholly owned subsidiaries, Natural Gas Development
Inc., a corporation established to invest in the Portland Natural Gas
Transmission System ("PNGTS"), a proposed natural gas transmission pipeline in
northern New England, Bay State Energy Enterprises, Inc., EnergyUSA, Inc., a
corporation established to provide non-regulated energy products and services,
and EnergyEXPRESS, Inc., which markets non-regulated energy commodities to
commercial and residential customers. EnergyUSA, Inc. wholly owns EnergySPE,
Inc. and SavageAlert, Inc., which in turn is the sole owner of 5 non-regulated
subsidiaries; Alert, Inc., Alert Scientific, Inc., Alert Air Systems, Inc.,
Alert Mechanical Services, Inc., and Savage Engineering, Inc.
 
     Natural gas sales in New England are seasonal, and results of operations
reflect this seasonality. Accordingly, results of operations are typically most
favorable in the second quarter of the fiscal year (three months ended March
31), with results of operations being next most favorable in the first quarter,
while losses are commonly incurred in the third and fourth quarters. The
quarterly operating results for 1998 and 1997 are described further in Note 10
of "Notes to Consolidated Financial Statements", Part II, Item 8, Financial
Statements and Supplementary Data.
 
     Customers are generally billed monthly on a cycle basis in therms. One
therm equals 100,000 British thermal units (1 Btu), the heat content of
approximately 100 cubic feet of gas. 1,000,000 Btu (1 MMBtu), or ten therms are
the energy equivalent of approximately 1,000 cubic feet of natural gas or 7.14
gallons of home heating oil.
 
UTILITY
 
     Almost all customers purchase bundled local transportation and natural gas,
with only 28,000 of 305,000 gas distribution customers electing to purchase
unbundled local transportation. In 1998, firm throughput increased 4.3% despite
warmer than normal weather due to the addition of 5,676 customers this year and
5,823 in 1997. Interruptible volumes declined 53.8% primarily due to a 63%
decrease in low-margin volumes sold to electric companies, which is reflected on
the Interruptible line of Table 2. Substantially all net margins from
interruptible sales are passed back to firm customers through cost of gas
adjustment clauses (see "Regulation and Rates").
 
                                        3
<PAGE>   4
 
     The tables below show the net change in transportation customers and
throughput volumes for the past three years.
 
                     TABLE 1 -- NET UTILITY CUSTOMER GROWTH
                     Yearly Increase in Number of Customers
 
<TABLE>
<CAPTION>
                                                  1998        1997       1996
                                                 ------      ------      -----
<S>                                              <C>         <C>         <C>
Residential....................................  (9,961)     (1,532)     5,342
Commercial/industrial..........................  (4,324)         54        748
Transportation only............................  19,961       7,301        374
                                                 ------      ------      -----
Net increase in number of Utility customers....   5,676       5,823      6,464
                                                 ======      ======      =====
</TABLE>
 
                    TABLE 2 -- CHANGE IN THROUGHPUT VOLUMES
               Yearly Increase (Decrease) -- Thousands of MMBtu*
 
<TABLE>
<CAPTION>
                                                 1998        1997        1996
                                                ------      ------      ------
<S>                                             <C>         <C>         <C>
Residential...................................  (1,239)       (592)      3,201
Commercial/industrial.........................  (3,934)     (1,374)      1,180
Transportation only...........................   8,357       7,132         931
                                                ------      ------      ------
Increase in firm throughput...................   3,184       5,166       5,312
Sales to other utilities......................       1         (56)      1,872
Interruptible.................................  (6,506)      3,092      (9,389)
                                                ------      ------      ------
Total increase (decrease) in throughput.......  (3,321)      8,202      (2,205)
                                                ======      ======      ======
</TABLE>
 
---------------
 
* Volumes have not been adjusted for weather variations.
 
COMPETITION
 
     The Company's principal competitors are fuel-oil retailers and electric
utilities. Increases in demand for natural gas are primarily driven by the rate
of economic growth and new construction within the Company's service
territories, and by the marketing and pricing of competing fuels.
 
     In the residential market, the Company should continue to benefit from the
New England region's market and growth potential. There are approximately
154,000 households and businesses along the Company's mains and additional homes
located short distances from existing gas mains that use no gas at all. In
addition, additional growth is anticipated from the estimated 42,000 existing
residential nonheating customers. These are attractive markets and represent an
opportunity to increase gas sales with little or no capital investment.
 
     As part of its efforts to unbundle transportation from gas sales service,
the Company sponsored one of the first residential pilot programs to allow
customers to purchase gas from among competing nonregulated natural gas
marketers. This program brought the benefits of competition and encouraged
increased system throughput.
 
     For commercial and industrial customers, environmental issues are important
in choosing an energy source. Since natural gas is the cleanest burning fossil
fuel, using natural gas can assist companies in complying with the Clean Air Act
and underground oil storage tank legislation.
 
     Finally, gas is marketed to large users on a seasonal or interruptible
basis. Approximately 46% of interruptible volumes in 1998 were sold to five
electric utilities for electric power generation, down from 66% the prior year.
The remainder were sold to approximately 100 industrial customers equipped to
burn either natural gas or fuel oil. Price is the key competitive factor in this
market, so the Company pursues interruptible sales through a flexible pricing
structure designed to remain competitive with other fuels. Substantially all net
 
                                        4
<PAGE>   5
 
margins from interruptible sales are passed back to firm customers through cost
of gas adjustment clauses (see "Regulation and Rates").
 
NATURAL GAS SALES
 
     The natural gas sales portion of bundled service does not provide a profit
margin. However, as almost all 305,000 utility customers purchase bundled
transportation and natural gas, minimizing gas costs to increase throughput is
an important part of the Company's business plan.
 
     A strategy of balancing gas purchase costs and security of supply is
achieved by optimizing the mix and terms of natural gas contracts with the use
of supplemental liquefied natural gas and propane to meet peak winter demand. A
diversified gas supply portfolio is maintained of domestic and Canadian gas
supply contracts with producers.
 
CAPACITY REQUIREMENTS
 
     Natural gas is currently imported from Canada through a converted oil
pipeline leased from the Portland Pipe Line Corporation ("PPLC"). The Portland
Natural Gas Transmission System ("PNGTS"), a long-term capacity addition, is
currently under construction by a consortium of energy investors, including an
affiliate of the Company, to provide a permanent pipeline link with Canadian gas
suppliers, and is expected to be in service in the spring of 1999. An option has
been exercised with PPLC to extend the lease until April 1999. For further
discussion see Note 9 of "Notes to Consolidated Financial Statements", Part II,
Item 8, Financial Statements and Supplementary Data.
 
REGULATION AND RATES
 
     The Company and its subsidiaries, are subject, where applicable, to
regulation by the Massachusetts Department of Telecommunications and Energy
("MADTE"), formerly the Massachusetts Department of Public Utilities ("MADPU"),
the New Hampshire Public Utilities Commission ("NHPUC"), the Maine Public
Utilities Commission ("MPUC") and the Federal Energy Regulatory Commission
("FERC") with respect to rates, adequacy of service, issuance of securities,
accounting, and other matters.
 
     The tariff schedules of the local distribution companies provide for
declining block rates which result in reductions in the unit price as usage
increases, and for seasonal rates that charge customers more per unit for gas
purchased during the high-demand winter heating season and less per unit during
summer months. These schedules also contain cost of gas adjustment ("CGA")
clauses that permit the distribution companies to pass on to firm customers
increases or decreases in recovered natural gas costs. Substantially all gas
supplier refunds and profits from interruptible sales are returned to firm
customers through the CGA clauses.
 
     As a result of a third party fuel inventory financing program instituted by
in 1982, fuel inventory and the related administrative and carrying costs are
also recovered through the CGA clauses. In addition, the MADTE allows recovery
of the following through the CGA: 1) the working capital costs associated with
purchased gas costs; 2) remediation costs associated with waste materials from
former gas manufacturing sites; 3) costs associated with MADTE-approved energy
conservation and load management programs; and 4) the gas cost portion of
customer accounts receivable balances that are written off.
 
                                        5
<PAGE>   6
 
     The following table provides the most recent rate activity of the Company
by state and federal jurisdictions:
 
                            TABLE 4 -- RATE ACTIVITY
 
<TABLE>
<CAPTION>
                                            REQUESTED INCREASES                GRANTED INCREASE
                                         -------------------------   -------------------------------------
                                                         RETURN ON                   RETURN ON
                                DATE        AMOUNT        COMMON        AMOUNT        COMMON       DATE
JURISDICTION                   FILED     (IN MILLIONS)    EQUITY     (IN MILLIONS)    EQUITY     EFFECTIVE
------------                  --------   -------------   ---------   -------------   ---------   ---------
<S>                           <C>        <C>             <C>         <C>             <C>         <C>
MADTE.......................    9/1/98       $ 1.8           (a)         $ 1.8           (a)      11/1/98
NHPUC.......................   9/17/98       $  .2           (b)         $  .1           (b)      11/1/98
FERC........................    5/1/98       $10.1         11.75%        $10.1         11.75%      5/1/98
MADTE.......................  10/24/97       $ 1.8           (a)         $ 1.8           (a)       1/1/98
FERC........................   10/1/96       $ 3.4         13.50%        $ 2.9         11.75%      4/1/97
NHPUC.......................   9/15/96       $  .2           (b)         $  .2           (b)      11/1/96
NHPUC.......................   9/15/95       $  .3           (b)         $  .3           (b)      11/1/95
MADPU.......................   4/14/95       $  .0           (c)            (c)          (c)       1/1/96
NHPUC.......................   9/14/94       $  .1           (b)         $  .1           (b)      11/1/94
FERC........................   4/29/94       $ 1.6         14.20%        $ 1.1         11.50%     11/1/94
</TABLE>
 
---------------
 
(a) The revenue increase was granted under a two-year Rate Plan allowing, among
    other things, recovery of certain costs under the terms of the Offer of
    Settlement effective 12/31/97; no return was requested or ordered.
 
(b) The revenue increase was granted under a step adjustment filing allowing
    recovery of certain costs under the terms of the Settlement Agreement
    effective 9/30/91; no return was requested or ordered.
 
(c) An overall revenue-neutral rate redesign was filed with the MADPU. The goal
    of the rate redesign was to implement rates that more closely reflect the
    actual costs associated with serving different customers.
 
FRANCHISES
 
     The utility franchise rights of the Company are non-exclusive. Competition
from other companies in the distribution of gas, however, is restricted without
prior approval of the applicable local and state governmental agencies.
 
     The laws of the Commonwealth of Massachusetts permit a municipality, by
appropriate vote of its residents, to enter the gas business and purchase the
facilities of the utility serving such municipality. If the utility is not
willing to sell, the municipality may construct a plant or acquire one from
another source. The Company is not aware of any municipality in its service
territories which intends to seek approval of such action.
 
ENERGY PRODUCTS & SERVICES
 
     For a discussion of Energy Products & Services see "Energy Products &
Services" in Part II, Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations.
 
ENERGY VENTURES
 
     For a discussion of Energy Ventures, see "Energy Ventures" in Part II, Item
7, Management's Discussion and Analysis of Financial Condition and Results of
Operations.
 
EMPLOYEES
 
     The Company employed 1,244 persons at September 30, 1998.
 
                                        6
<PAGE>   7
 
EXECUTIVE OFFICERS OF THE REGISTRANT
 
     The names, ages, and positions of the principal executive officers of the
Registrant as of December 31, 1998 are listed below along with their business
experience during the past five years. All principal executive officers are
elected annually by the Board of Directors at the Directors' first meeting
following the annual meeting of shareholders. There are no family relationships
among these officers, except as noted below, nor is there any arrangement or
understanding between any officer and any other person pursuant to which the
officer was selected.
 
<TABLE>
<CAPTION>
              NAME, AGE AND POSITION                     BUSINESS EXPERIENCE DURING PAST 5 YEARS
              ----------------------                     ---------------------------------------
<S>                                                  <C>
Roger A. Young, 52, Chairman of the Board of
  Directors (Chief Executive Officer) (a)..........  Chairman of the Board of Directors since 1996;
                                                     Chief Executive Officer; Director; President
                                                     until 1995.
 
Jeffrey W. Yundt, 53, President....................  President 1998; Executive Vice President, NIPSCO
                                                     Industries, Inc.
 
Thomas W. Sherman, 58, Executive Vice President
  (Chief Financial and Accounting Officer and
  Treasurer).......................................  Director; Executive Vice President; Chief
                                                     Financial Officer; Treasurer.
 
William L. Glascock, 53, Senior Vice President.....  Senior Vice President 1997; Senior Vice
                                                     President Nationsbank.
 
James D. Simpson, 48, Senior Vice President........  Senior Vice President 1998; Vice President.
 
Thomas J. Aruffo, 40, Vice President...............  Leader Information Services 1997; Vice President
                                                     Fidelity Investments 1996 to 1997; Director
                                                     Information Systems Prudential Insurance Company
                                                     of America.
 
Richard P. Cencini, 51, Vice President.............  Vice President 1997; Leader, Regulatory Pricing
                                                     1996 to 1997; Director Regulatory Affairs.
 
Carol A. Collins, 45, Vice President...............  Vice President 1997; Leader, Services Delivery
                                                     1996 to 1997; Manager Information Systems
                                                     Development.
 
Barbara S. McKay, 51, Vice President...............  Vice President 1997; Vice President Fleet
                                                     Financial Group.
 
John R. Snow, 57, Vice President...................  Vice President.
 
Stephen J. Curran, 52, Controller..................  Controller.
</TABLE>
 
---------------
 
(a) Charles H. Tenney II, Director, is the stepfather of Roger A. Young,
    Chairman of the Board of Directors.
 
ITEM 2.  PROPERTIES
 
     The Company holds franchise rights to lay gas mains in the streets and
public places of various service territories in Massachusetts, Maine, and New
Hampshire.
 
     As of September 30, 1998, the Company's system consisted of approximately
5,450 miles of distribution mains; 116 miles of transmission lines, with
requisite accessory pumping and regulating stations; LNG liquefaction,
vaporization and storage facilities; propane storage tanks; 268,022 services
(small pipes connecting mains with piping on the customers' premises) and
305,182 meters installed on customers' premises.
 
     The Company also leases a transmission line which is 166 miles in length
running from the Canadian border through Vermont and New Hampshire and
terminating in South Portland, Maine (see Item 1. Business, "Capacity
Requirements").
 
                                        7
<PAGE>   8
 
     The transmission and distribution system is for the most part located on or
under public streets, and other public places or on private property not owned
by the Company, with easements from or consent of the respective owners.
 
ITEM 3.  LEGAL PROCEEDINGS
 
     The Company is working with federal and state environmental agencies to
assess the extent and environmental impact of and appropriate remedial action
for waste materials from former gas manufacturing sites (see Note 9 of "Notes to
the Consolidated Financial Statements", Part II, Item 8, Financial Statements
and Supplementary Data).
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     There were no matters submitted during the fourth quarter of the fiscal
year covered by this report to a vote of security holders through solicitation
of proxies or otherwise.
 
                                    PART II
 
ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
 
<TABLE>
<CAPTION>
                                                  QUARTER ENDED
                             --------------------------------------------------------
                             DECEMBER 31      MARCH 31      JUNE 30      SEPTEMBER 30
                             -----------      --------      -------      ------------
<S>                          <C>              <C>           <C>          <C>
FISCAL 1998
     High..................      $37 1/2        $38 1/2       $38 5/8        $39 3/16
     Low...................      $28 1/16       $36 15/16     $37 1/2        $37 7/8
FISCAL 1997
     High..................      $30 5/8        $28 1/4       $27 5/8        $30 3/8
     Low...................      $26 3/4        $25 1/8       $25 3/8        $26 1/4
</TABLE>
 
     The common stock of the Company is listed on both the New York Stock
Exchange and the Boston Stock Exchange. The ticker symbol is "BGC" and common
listings in the financial press include "BayStGas" and "BaySGs". As of December
31, 1998, there were approximately 8,669 shareholders of record. The number of
shareholders indicated does not reflect the number of persons or entities who
hold their common stock in nominee name through various brokerage firms or other
entities. Information regarding cash dividends declared on common stock is
included in Note 10 of "Notes to the Consolidated Financial Statements", Item 8,
Financial Statements and Supplementary Data.
 
ITEM 6.  SELECTED FINANCIAL DATA
 
     Listed below is the required selected financial data for the last five
fiscal years.
 
<TABLE>
<CAPTION>
                                          1998        1997        1996        1995        1994
IN THOUSANDS, EXCEPT PER SHARE AMOUNTS  --------    --------    --------    --------    --------
<S>                                     <C>         <C>         <C>         <C>         <C>
Total operating revenues.............   $450,032    $473,581    $428,843    $418,216    $463,280
Net income...........................   $  6,634    $ 26,062    $ 27,072    $ 23,128    $ 24,485
Diluted earnings per average common
  share..............................   $    .47    $   1.90    $   1.98    $   1.71    $   1.85
Total assets.........................   $772,251    $723,266    $684,253    $630,355    $614,798
Long-term obligations under capital
  leases.............................   $     --    $     --    $    694    $  1,611    $  2,719
Capitalization:
Common equity........................   $220,185    $234,378    $227,986    $219,873    $215,389
Preferred stock......................   $     --    $  4,917    $  5,009    $  5,149    $  5,293
Long-term debt.......................   $239,475    $229,500    $196,500    $199,000    $191,000
Cash dividends declared per common
  share..............................   $   1.60    $   1.56    $   1.52    $   1.48    $   1.44
</TABLE>
 
                                        8
<PAGE>   9
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
RESULT OF OPERATIONS
 
     Bay State Gas Company ("Bay State" or the "Company") operates in three
energy related business segments: Utility, Energy Products & Services, and
Energy Ventures. The Utility segment is in the local gas distribution and
transmission business. The nonregulated Energy Products & Services business
segment markets products and services under the brand names, "EnergyUSA(TM)" and
"EnergyEXPRESS(TM)". The Energy Ventures segment develops business opportunities
and projects which are closely related to the Company's core business.
 
YEAR IN REVIEW
 
     In 1998, net income was $6.6 million compared to $26.1 million in 1997
while diluted earnings per share were $.47 versus $1.90 one year ago. Net income
for 1998 decreased due to the effects of weather, the incurrence of merger and
merger-related costs, the write-off of certain assets whose recovery was no
longer probable, and operating losses in Energy Products & Services. Net income
was positively impacted by the receipt of environmental recovery cost insurance
settlements and by a change in a benefit plan accounting principle. The sale of
a subsidiary for a $7.8 million after-tax gain improved 1997 earnings. Weather
during 1998 was 9.1% warmer than normal and 7.8% warmer than 1997.
 
     Operating revenues and income before interest and taxes for the three
business segments for 1998 and 1997 were as follows:
 
                               OPERATING REVENUES
 
<TABLE>
<CAPTION>
                                                      1998          1997
IN MILLIONS                                          ------        ------
<S>                                                  <C>           <C>
Utility............................................  $405.5        $455.6
Energy Products & Services.........................    48.3          22.3
Eliminations.......................................    (3.8)         (4.3)
                                                     ------        ------
     Total operating revenues......................  $450.0        $473.6
                                                     ======        ======
</TABLE>
 
                    INCOME (LOSS) BEFORE INTEREST AND TAXES
 
<TABLE>
<CAPTION>
                                                      1998          1997
IN MILLIONS                                          ------        ------
<S>                                                  <C>           <C>
Utility............................................  $ 35.1        $ 47.9
Energy Products & Services.........................    (6.4)         (2.9)
Energy Ventures....................................     2.1          16.0
Corporate Costs....................................      --          (0.6)
                                                     ------        ------
     Total.........................................  $ 30.8        $ 60.4
                                                     ======        ======
</TABLE>
 
     Revenues are discussed below for each business segment.
 
INCOME (LOSS) BEFORE INTEREST AND TAXES OVERVIEW
 
     The $12.8 million decrease in Utility income before interest and taxes is
primarily the result of warmer than prior year weather, merger and merger
related costs of $8.4 million, including incentive compensation payments
triggered by the merger agreement (see "Merger"), the write-off of certain
assets totaling $9.9 million whose recovery was no longer considered probable,
offset by the receipt of $5.7 million in environmental recovery cost insurance
settlements. In 1997, $11.2 million of previously deferred corporate
restructuring costs were written off.
 
     Loss before interest and taxes for Energy Products & Services increased
$3.5 million in 1998, primarily due to losses in the Business Services and
EnergyEXPRESS units, losses associated with closing the HELP loan program unit
and merger and merger-related costs.
 
                                        9
<PAGE>   10
 
     Income before interest and taxes decreased $13.9 million in Energy Ventures
in 1998 primarily due to the sale of a subsidiary which held a 17.5% equity
investment in MASSPOWER for a $13.3 million pre-tax gain in 1997.
 
     Energy Ventures develops business opportunities and projects which are
closely related to the Company's core businesses. Currently this segment
participates in two major projects: the Portland Natural Gas Transmission System
("PNGTS"); and the Wells LNG facility ("Wells LNG"). Earnings from the PNGTS and
Wells LNG investments in the form of investment income and allowance for funds
used during construction ("AFUDC") totaled $2.4 million and $1.8 million in 1998
and 1997, respectively (see Note 9 of "Notes to Consolidated Financial
Statements", Part II, Item 8, Financial Statements and Supplemental Data).
 
     Common stock dividends declared in 1998 were $1.60 per share, 2.6% higher
than the prior year. This was the fifteenth consecutive year of increased common
stock dividends, and it completes the 145th year of consecutive quarterly
dividends. The current annualized dividend is equivalent to $1.62 per share.
 
MERGER
 
     On May 27, 1998, at a Special Meeting of Common Shareholders, an Agreement
and Plan of Merger dated December 18, 1997, as amended and restated as of March
4, 1998, and further amended as of November 16, 1998, by and between NIPSCO
Industries, Inc. ("Industries") and the Company was approved that provides for
the merger of Bay State with and into a corporation to be organized as a wholly
owned subsidiary of Industries. Consummation of the merger is subject to
satisfaction of certain conditions, including obtaining state regulatory
approvals, which have been received from the required regulatory agencies in
Massachusetts, New Hampshire, and Maine. Approvals of this type are customary
for utility mergers and are prerequisites for Securities and Exchange Commission
approval. All conditions, except receiving Securities and Exchange Commission
approval, have been met.
 
     On November 5, 1998, the MADTE approved the merger of the Company and
Industries, and adopted the Company's proposed five-year base rate freeze plan,
with modifications. The rate freeze is to be in place during the November 1,
1999 -- October 31, 2004 period, following the conclusion of the current
two-year regulatory plan. Increases for certain exogenous factors outside of the
Company's control are not precluded. The MADTE did not approve the Company's
proposed earnings sharing mechanism and directed the Company to continue the
current service quality index measures and penalties, as approved in the current
rate plan, pending filing of proposed changes for review and approval effective
November 1, 1999. The MADTE stated that the merged company could propose
recovery of the annual amortization of an acquisition premium in future rate
proceedings to the extent offset by merger-related savings and that amortization
of the premium is to begin immediately upon closure of the merger.
 
     Severance agreements with 14 officers and senior managers are in place
which become operative upon a change in control of Bay State and continue in
effect for up to three years. Potential severance expense under the agreements
could total $15.6 million if all covered individuals were terminated. Bay State
has no intention of taking any action which would result in payments being owed
under the severance agreements.
 
                                       10
<PAGE>   11
 
OPERATING REVENUES
 
UTILITY OPERATING REVENUES
 
     The following table details the components of Utility operating revenues
for the past three years:
 
<TABLE>
<CAPTION>
                                         1998          1997          1996
IN MILLIONS                             ------        ------        ------
<S>                                     <C>           <C>           <C>
Bundled transportation................  $155.8        $164.9        $167.9
Unbundled transportation..............    21.4          12.4           6.8
                                        ------        ------        ------
Transportation revenues...............   177.2         177.3         174.7
Natural gas sales.....................   212.2         262.6         226.8
                                        ------        ------        ------
Transportation and natural gas
  sales...............................   389.4         439.9         401.5
Other revenues........................    16.1          15.7          12.5
                                        ------        ------        ------
     Total Utility operating
       revenues.......................  $405.5        $455.6        $414.0
                                        ======        ======        ======
</TABLE>
 
TRANSPORTATION REVENUES
 
     Total transportation revenues in 1998 were consistent with 1997 at $177.2
million. The majority of customers purchase bundled transportation and natural
gas service. Traditionally some larger commercial, industrial, and interruptible
customers have elected to purchase unbundled transportation service allowing
them to manage their own gas purchasing, balancing, and storage functions.
 
     The Pioneer Valley Customer Choice pilot program was launched in November
1996 to give residential customers the opportunity to purchase their natural gas
from a supplier of their choice. Bay State continues to transport the gas to
customers' homes, maintain the local pipeline system, respond to emergencies,
and read customers' gas meters.
 
     The pilot program was expanded in July 1997 to include over 100,000
residential and small business customers. The expanded program -- Choice
Advantage from Bay State Gas -- was designed to foster competition within the
service territory and to enable the Company to continue to learn about gas
supplier and consumer behavior. To date, over 21,000 residential and 7,000 small
businesses have elected to become unbundled transportation customers.
 
     Earnings are unaffected by the shift from bundled to unbundled service as a
profit margin is only realized on the transportation portion of bundled
services.
 
     The number of customers grew 1.9% during 1998 with the addition of 5,700
customers, despite low competing fuel oil prices. Weather was 7.8% warmer in
1998 than in 1997. If 1998 weather had been normal, transportation revenues
would have been approximately $10.1 million higher. Normalized firm throughput,
adjusted for weather variances, which is a better indicator of our system
growth, increased by 4.5% to 58.2 Bcf in 1998.
 
     The following table displays degree days for the past three years:
 
<TABLE>
<CAPTION>
                                                                PERCENTAGE
                                                              COLDER/(WARMER)
                    YEAR                       DEGREE DAYS      THAN NORMAL
                    ----                       -----------    ---------------
<S>                                            <C>            <C>
1998.........................................     6,384            (9.1)%
1997.........................................     6,916            (2.1)%
1996.........................................     7,220             2.8%
</TABLE>
 
NATURAL GAS SALES
 
     The natural gas sales portion of bundled service does not provide a profit
margin. However, as 91% of Utility customers purchase bundled transportation and
natural gas commodity sales service, minimizing gas costs to increase throughput
is an important competitive strategy.
 
     Utility's goal is to balance gas purchase costs and security of supply by
optimizing the mix and terms of natural gas contracts with the use of
underground storage and supplemental liquefied natural gas and propane
 
                                       11
<PAGE>   12
 
to meet peak winter demand. Rates for natural gas sales include cost of gas
adjustment clauses ("CGA") pursuant to which gas purchase costs and other costs
are recovered from customers. The following table details Recovered Gas Costs:
 
<TABLE>
<CAPTION>
                                                 1998      1997      1996
IN MILLIONS                                     ------    ------    ------
<S>                                             <C>       <C>       <C>
Gas demand....................................  $ 22.7    $ 23.7    $ 25.2
Gas commodity.................................   120.5     167.2       120
                                                ------    ------    ------
Total purchase costs..........................   143.2     190.9     145.2
                                                ------    ------    ------
Transmission costs............................    47.6      44.2      49.8
Supplemental fuels............................    11.3      15.1      18.5
Other.........................................    10.1      12.4      13.3
                                                ------    ------    ------
          Total recovered gas costs...........  $212.2    $262.6    $226.8
                                                ======    ======    ======
</TABLE>
 
     Recovered gas costs decreased by 19%, or $50.4 million, in 1998. Lower gas
costs were the result of a decrease in gas commodity prices, lower volumes sold
due to warmer than normal weather lessening demand for gas for heating purposes,
and the increase in transportation only customers who purchase natural gas from
a third party and have it transported on Utility's system. The decrease in
supplemental fuel costs in 1998 is the result of the warmer weather, requiring
less supplemental supplies than in the previous year.
 
OTHER UTILITY REVENUES
 
     Other revenues, which consist primarily of customer service revenues,
merchandise sales, and equipment rentals, were consistent with 1997 results.
 
ENERGY PRODUCTS & SERVICES OPERATING REVENUES
 
     The following table details the components of Energy Products & Services
operating revenues for the past three years:
 
<TABLE>
<CAPTION>
                                                   1998     1997     1996
IN MILLIONS                                        -----    -----    -----
<S>                                                <C>      <C>      <C>
EnergyUSA(TM)
  Home Services(SM)..............................  $ 8.7    $ 7.7    $ 6.9
  Business Services(SM)..........................   24.2      2.4       --
EnergyEXPRESS(TM)................................   15.4     12.2     10.2
                                                   -----    -----    -----
          Total Energy Products & Services
            Operating Revenues...................  $48.3    $22.3    $17.1
                                                   =====    =====    =====
</TABLE>
 
     EnergyUSA Home Services(SM) offers rental of water heaters, insurance
programs for heating systems maintenance, and a variety of energy-related
products to residential customers. Water heater rentals provided $5.4 million in
revenue, a 6.2% increase from 1997, primarily due to an increase in the number
of water heater units rented. Insurance program revenues increased by 30% in
1998, due to an increase in rates. The energy-related financing unit, HELP, was
closed in 1998 after disappointing results in 1997 and 1998. A charge of
$427,000 was recorded associated with closing this business unit.
 
     Business Services(SM) manages the energy needs of commercial and industrial
customers, primarily through the operations of SavageAlert, Inc. and its
subsidiaries, which were acquired in November 1997. Business Services provides
strategic energy supply management, applied technology, engineering
design/build, and facilities management services. Since its acquisition
SavageAlert has contributed revenues of $18.6 million.
 
     EnergyEXPRESS(TM) markets energy commodities to the homes and businesses.
Retail propane revenues were $9.4 million, down from $11.5 million in 1997
primarily due to selling fewer gallons due to the warmer weather. Natural gas,
wholesale propane, electricity and other commodities contributed revenues of
$6.0 million, up $5.3 million from 1997 revenues of $700,000, when this unit was
a start-up operation.
 
                                       12
<PAGE>   13
 
OPERATING EXPENSES
 
     Other cost of goods sold consists of costs of products and services sold by
Energy Products & Services, primarily propane, natural gas, and professional
services, and the cost of merchandise products sold by Utility.
 
     Operations expenses increased by $26.1 million in 1998 primarily due to
increased pipeline rent expense ($3.4 million), rent payments on assets sold and
leased-back over the past two years ($3.1 million), increased compensation
expense, including compensation associated with the approval of the merger
agreement by shareholders ($4.6 million) and the write-off of previously
deferred Massachusetts postemployment benefit expenses ($4.8 million) whose
recovery was no longer considered probable. Offsetting these increases was a
decrease ($1.9 million) in bad debt expense caused by receiving MADTE approval
to allocate the portion of bad debt expense that relates to natural gas product
costs in Massachusetts to the CGA for collection from customers in future
periods. See "Liquidity and Capital Resources -- Cash flows from investing
activities" for a discussion of the Company's asset sales in recent years.
 
     Restructuring costs expensed in 1997 consisted of early retirement
benefits, consulting fees and other costs related to preparing for the
competitive environment of deregulation, primarily $11.2 million of costs in one
jurisdiction that were written-off to expense as part of a rate settlement
agreement (see Note 8 of "Notes to Consolidated Financial Statements", Part II,
Item 8, Financial Statements and Supplemental Data). Restructuring costs in 1998
consist of amortization of amounts deferred in other jurisdictions.
 
     Higher plant balances have resulted in continuing increases in depreciation
expense. Additionally, $5.1 million invested in software development was charged
to amortization expense in 1998 when the software project was terminated.
 
     Other taxes, principally property taxes, increased primarily due to higher
property taxes. Annual increases in property tax rates and assessments, combined
with the growth in plant, increased property taxes by $644,000 in 1998.
 
OTHER INCOME
 
     Other income decreased $8.5 million from 1997, primarily due to the $13.3
million pre-tax gain on the sale of a subsidiary which owned the Company's 17.5%
equity investment in MASSPOWER recorded in 1997, partially offset by $5.7
million in insurance receipts of environmental recovery costs in 1998. Income
from investments has decreased because 50% of the Company's ownership interest
in the PNGTS pipeline project was sold at book value in April 1998 to
Industries.
 
INTEREST EXPENSE
 
     Interest expense increased 3.9%, to $18.5 million in 1998 from $17.8
million in 1997, due to increases in the levels of short- and long-term debt,
offset by lower interest rates.
 
INTEREST RATE RISK
 
     The fair value of notes payable approximated carrying value due to its
short-term maturities. Market risk was estimated as the potential increase in
fair market value resulting from a hypothetical 10% decrease in the Company's
weighted-average long-term borrowing rate at September 30, 1998. The fair value
of long-term debt, including current maturities, was estimated to be $248.3
million at September 30, 1998, and exceeded the carrying value by $7.6 million.
Market risk was estimated as the potential increase in fair market value
resulting from a hypothetical 10% decrease in the Company's weighted average
long-term borrowing rate at September 30, 1998, or $22.6 million.
 
RESULTS OF OPERATIONS 1997 AND 1996
 
     Net income decreased $1.0 million in 1997 due to weather that was 4.9%
warmer than 1996, and the write-off of restructuring costs (see Note 8 of "Notes
to Consolidated Financial Statements", Part II, Item 8, Financial Statements and
Supplemental Data), offset by the sale of a subsidiary for an after-tax gain of
 
                                       13
<PAGE>   14
 
$7.8 million (see Note 9 of "Notes to Consolidated Financial Statements", Part
II, Item 8, Financial Statements and Supplemental Data). During 1996, net income
increased $3.9 million due to weather that was 2.8% colder than normal within
the service territories. In both years the customer base was growing. As a
result of higher natural gas product costs and increased throughput in fiscal
year 1997, operating revenues increased by $44.8 million after increasing $10.6
million in 1996 due to colder weather.
 
     Recovered gas costs increased 16% to $262.6 million in 1997. These higher
gas costs were the result of increases in gas commodity prices. In 1996,
recovered gas costs decreased 3.5% to $226.8 million. These lower gas costs were
the result of a decline in fixed purchase costs and pipeline refunds.
 
     Operation expenses increased by $4.9 million in 1997 after increasing by
$9.6 million in 1996. In 1997, the increase was primarily as a result of a $6.3
million increase in Energy Products & Services costs resulting from efforts to
develop that business segment, offset by a $2.0 million decrease in Utility
costs. In 1996, the increase was primarily the result of increases in payroll
and propane fuel purchases, due to the colder weather, and increases in outside
services.
 
IMPACT OF INFLATION
 
     Inflation did not have a significant impact on operations in 1998, 1997 or
1996.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Natural gas sales in New England are seasonal, and cash flows reflect this
seasonality. Approximately 74% of annual revenues are generated during the
heating season, which results in a high level of cash flow from operations from
late winter through early summer. Short-term borrowings are typically highest in
the fall and early winter as a result of completion of the annual construction
program and seasonal working capital requirements. Access to financial markets
has been sufficient to meet capital requirements and a change in its access to,
or the availability of, capital in the coming year is not anticipated.
 
CASH FLOWS FROM OPERATING ACTIVITIES
 
<TABLE>
<CAPTION>
                                                    1998     1997     1996
IN MILLIONS                                         -----    -----    ----
<S>                                                 <C>      <C>      <C>
Net cash provided by operating activities.........  $25.6    $44.5    $7.1
</TABLE>
 
     Cash flows from operations decreased by $18.9 million in 1998 primarily as
the result of the decrease in net income coupled with an overall increase in net
operating assets. Cash flows from operations increased $37.4 million in 1997,
primarily as the result of increases in accounts payable and deferred gas costs
and refunds due customers.
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
<TABLE>
<CAPTION>
                                                 1998      1997      1996
IN MILLIONS                                     ------    ------    ------
<S>                                             <C>       <C>       <C>
Net cash used in investing activities.........  $(31.9)   $(32.7)   $(34.7)
</TABLE>
 
     Investments are made in utility property, plant, and equipment to improve
and protect the distribution system, and to expand the system to meet customer
demand. Capital expenditures for property, plant, and equipment were $57.4
million compared with $57.6 million in 1997 and $50.7 million in 1996. The
increase from 1996 to 1997 was primarily attributable to increased spending on
automated meter reading devices of $6.5 million. Capital expenditures for
property, plant, and equipment for 1999 are estimated to be approximately $60
million.
 
     The sale of automated meter reading devices and rental assets provided
$23.8 million and the sale of 50% of the Company's equity interest in the PNGTS
pipeline project provided $12.4 million in cash in 1998. The sale of a
subsidiary which owned an equity investment in MASSPOWER and the sale/leaseback
of Bay State's Westborough headquarters building and ten acres of land provided
additional cash of $17.0 million and $10.1 million, respectively, in 1997. The
sale of rental assets provided $20.7 million in additional cash during 1996.
 
                                       14
<PAGE>   15
 
     Cash used for other investments include expenditures primarily for PNGTS
and Wells LNG, which were $10.6 million, $2.5 million, and $5.7 million in 1998,
1997, and 1996, respectively (see Note 9 of "Notes to Consolidated Financial
Statements", Part II, Item 8, Financial Statements and Supplemental Data). Now
that the PNGTS project is under construction and it is receiving project
financing from financial institutions, it is expected that further cash
contributions for this project will be minimal.
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
<TABLE>
<CAPTION>
                                                   1998     1997     1996
IN MILLIONS                                        ----    ------    -----
<S>                                                <C>     <C>       <C>
Net cash provided by (used in) financing
  activities.....................................  $7.0    $(12.8)   $29.6
</TABLE>
 
     Cash flows from financing activities increased in 1998 primarily due to the
Company borrowing $31 million of short-term debt as compared with paying down
$13 million of short-term debt in 1997 and borrowing $33 million in 1996.
 
     $30 million of 6.26% long-term notes were issued and an additional $2
million was borrowed against a long-term revolving credit agreement. The
proceeds from these borrowings were used primarily to retire $25 million of
9.45% notes, $5 million of 6.3% notes, and redeem $4.9 million of preferred
stock. The Company has access to $95.0 million in bank lines of credit at
September 30, 1998.
 
ENVIRONMENTAL ISSUES
 
     The Company continues to work with federal and state environmental agencies
to assess the extent and environmental impact of waste materials that exist at
or near former gas manufacturing sites. The costs of such assessments and any
related remediation determined to be necessary will be funded from traditional
sources of capital and recovered from customers (see Note 9 of "Notes to
Consolidated Financial Statements", Part II, Item 8, Financial Statements and
Supplemental Data).
 
NEW ACCOUNTING STANDARDS
 
     The Financial Accounting Standards Board has issued four new accounting
standards effective for fiscal year 1999. Statement of Financial Accounting
Standards No. 130 ("SFAS 130"), Reporting Comprehensive Income, requires
reporting comprehensive income and its components. Statement of Financial
Accounting Standards No. 131 ("SFAS 131"), Disclosures about Segments of an
Enterprise and Related Information, requires reporting financial and descriptive
information about reportable operating segments. Statement of Financial
Accounting Standards No. 132 ("SFAS 132"), Employers' Disclosures about Pensions
and Other Postretirement Benefits, revises employers' pension and other
postretirement benefit plan disclosures, but does not change the measurement or
accounting for those plans. Statement of Financial Accounting Standards No. 133
("SFAS 133"), Accounting for Derivative Instruments and Hedging Activities,
establishes accounting and reporting standards for derivative instruments and
hedging activities. It is expected that the adoption of these standards will not
have a material impact on cash flows, financial condition, or the results of
operations.
 
YEAR 2000
 
     A program is underway to prepare computer systems and other applications
for proper functioning in the Year 2000. The program consists of four phases:
assessment, remediation, testing, and certification. The assessment phase, which
involved determining the full scope of potential problems with respect to
hardware, software and embedded chips, assisting in the development of a
framework and timetable for addressing all potential Year 2000 problems and
providing an estimate of the cost of remediating and/or replacing computer
systems and other applications, has been completed. Based on this assessment, it
has been determined that all computer systems and other applications will be
replaced/upgraded with the exception of one computer system which will be
remediated.
 
     Currently, the program is in the remediation and testing phases. It is
anticipated that replacements/upgrades and remediations will be completed by
July 1999. Testing plans are being developed to ensure
 
                                       15
<PAGE>   16
 
that computer systems and other applications potentially affected by the Year
2000 are compliant. It is anticipated that the testing and certification phases
will be completed by September 1999.
 
     A vendor management program has been undertaken to determine the readiness
of important vendors, with the goal of obtaining reasonable assurances that
there will not be any interruptions in the supply of goods and services due to
Year 2000 issues. Additionally, electronic data interchanges with other
companies are being reviewed to identify potential Year 2000 issues.
 
     Approximately $1.5 million was expensed in 1998 for Year 2000 related work.
The assessment phase analysis indicated that total program expense will exceed
$4.0 million (including the $1.5 million spent in 1998.) Where the replacement
of certain systems was the recommended course of action, the cost of those
replacement systems will be recorded as assets and depreciated or amortized. All
other costs associated with Year 2000 issues will be expensed and funded through
operating cash flows.
 
     Due to the complexity of the problem and the reliance on certain important
vendors and suppliers, there can be no guarantee that Year 2000 compliance for
all computer systems and other applications will be achieved or that critical
and important vendors and suppliers will achieve compliance. As a result, the
development of contingency plans are included as part of the program in an
effort to mitigate the risks of non-compliance. It is anticipated that
contingency plans will be completed by September 1999. As an additional measure,
independent parties are being utilized to verify the reliability of risk and
cost estimates for the program.
 
     Despite adequate program efforts, contingency planning, and independent
reviews, a Year 2000 computer system or application failure, either by the
Company's systems or a critical vendor or supplier, could be encountered.
Management believes the worst case scenario would include service interruptions
to some communities and customers which would be expected to be restored in a
reasonably short time frame. With respect to other interruptions to operations,
such as customer service, business operations, supplies and emergency response
capabilities, such scenarios would likely cause minor disruptions of services
and processes followed by rapid recovery and that essential information or data
would not be impaired.
 
FORWARD LOOKING INFORMATION
 
     This report and other Company reports contain forward looking statements.
The Company cautions that, while it believes such statements to be reasonable
and makes them in good faith, they almost always vary from actual results, and
the differences between assumed facts or basis and actual results can be
material, depending upon the circumstances. Investors should be aware of
important factors that could have a material impact on future results. These
factors include, but are not limited to, the regulatory environment, and other
uncertainties, which are difficult to predict, and are beyond the control of the
Company.
 
                                       16
<PAGE>   17
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                             BAY STATE GAS COMPANY
 
                      CONSOLIDATED STATEMENTS OF EARNINGS
                 YEARS ENDED SEPTEMBER 30, 1998, 1997, AND 1996
 
<TABLE>
<CAPTION>
                                                               1998        1997        1996
IN THOUSANDS, EXCEPT PER SHARE AMOUNTS                       --------    --------    --------
<S>                                                          <C>         <C>         <C>
Operating revenues.........................................  $450,032    $473,581    $428,843
                                                             --------    --------    --------
Operating expenses:
     Recovered natural gas costs...........................   212,250     262,571     226,836
     Other cost of goods sold..............................    31,201      10,328       5,805
     Operations (note 9)...................................   121,347      95,264      90,509
     Restructuring costs (note 8)..........................       626      11,404          --
     Merger costs..........................................     4,385          --          --
     Maintenance...........................................    10,425      10,573      10,426
     Depreciation and amortization.........................    34,870      28,486      26,311
     Other taxes, principally property taxes...............    14,263      13,251      12,741
                                                             --------    --------    --------
Total operating expenses...................................   429,367     431,877     372,628
                                                             --------    --------    --------
Operating income...........................................    20,665      41,704      56,215
                                                             --------    --------    --------
Other income:
     Income from sale of subsidiary (note 9)...............        --      13,344          --
     Income from investments...............................     1,639       2,667       2,502
     AFUDC equity and other................................     8,529       2,653       1,594
                                                             --------    --------    --------
Income before interest and income taxes....................    30,833      60,368      60,311
                                                             --------    --------    --------
Interest income............................................      (220)       (515)       (477)
Interest expense...........................................    18,513      17,842      16,763
Federal and state taxes on income (note 2).................     8,165      16,979      16,953
                                                             --------    --------    --------
Net income before change in accounting principle...........     4,375      26,062      27,072
Change in accounting principle (net of taxes) (note 1).....     2,259          --          --
                                                             --------    --------    --------
Net income.................................................     6,634      26,062      27,072
Dividend requirements on preferred stock...................       118         288         293
                                                             --------    --------    --------
Earnings applicable to common stock........................  $  6,516    $ 25,774    $ 26,779
                                                             ========    ========    ========
Average number of shares outstanding -- basic..............    13,523      13,455      13,397
                                                             ========    ========    ========
Basic earnings per share...................................  $   0.48    $   1.92    $   2.00
                                                             ========    ========    ========
Average number of common shares outstanding -- diluted.....    13,749      13,584      13,544
                                                             ========    ========    ========
Diluted earnings per share.................................  $   0.47    $   1.90    $   1.98
                                                             ========    ========    ========
Dividends declared per common share........................  $   1.60    $   1.56    $   1.52
                                                             ========    ========    ========
</TABLE>
 
        The accompanying notes are an integral part of these statements.
                                       17
<PAGE>   18
 
                             BAY STATE GAS COMPANY
                          CONSOLIDATED BALANCE SHEETS
                          SEPTEMBER 30, 1998 AND 1997
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                1998            1997
                        IN THOUSANDS                          --------        --------
<S>                                                           <C>             <C>
Plant, at cost..............................................  $760,799        $740,266
Accumulated depreciation and amortization...................   236,791         216,965
                                                              --------        --------
Net plant...................................................   524,008         523,301
                                                              --------        --------
Investments (note 9)........................................    20,001          19,382
Prepaid benefit plans (note 7)..............................    27,057          21,941
Other long-term assets......................................    21,966           8,064
Current assets:
     Cash and temporary cash investments....................     4,425           3,672
     Accounts receivable, less allowances of $4,413 and
      $4,138................................................    41,080          32,713
     Unbilled revenues......................................     3,138           3,708
     Deferred gas costs.....................................    58,406          39,764
     Inventories, at average cost (note 6)..................    43,131          30,473
     Prepaid taxes..........................................     4,508           1,147
     Other..................................................     5,194           4,828
                                                              --------        --------
Total current assets........................................   159,882         116,305
                                                              --------        --------
Regulatory assets:
     Income taxes...........................................    12,978          11,045
     Other (note 9).........................................     6,359          23,228
                                                              --------        --------
                                                              $772,251        $723,266
                                                              ========        ========
 
                            CAPITALIZATION AND LIABILITIES
Capitalization (see accompanying statements and note 3):
     Common stock equity....................................  $220,185        $234,378
     Preferred stock equity.................................        --           4,917
     Long-term debt.........................................   239,475         229,500
                                                              --------        --------
Total capitalization........................................   459,660         468,795
                                                              --------        --------
Long-term liabilities:
     Deferred taxes (note 2)................................    91,061          81,770
     Other long-term liabilities............................    17,332          13,583
                                                              --------        --------
Total long-term liabilities.................................   108,393          95,353
                                                              --------        --------
Commitments and contingencies (note 9)
Current liabilities:
     Short-term debt (note 5)...............................    82,700          51,625
     Current maturities of long-term debt (note 3)..........     1,247           5,000
     Accounts payable.......................................    45,772          41,404
     Fuel purchase commitments (note 6).....................    29,769          22,817
     Refunds due customers..................................    38,074          25,802
     Deferred and accrued taxes (note 2)....................        --           4,473
     Other..................................................     6,636           7,997
                                                              --------        --------
Total current liabilities...................................   204,198         159,118
                                                              --------        --------
                                                              $772,251        $723,266
                                                              ========        ========
</TABLE>
 
        The accompanying notes are an integral part of these statements.
                                       18
<PAGE>   19
 
                             BAY STATE GAS COMPANY
 
                   CONSOLIDATED STATEMENTS OF CAPITALIZATION
                          SEPTEMBER 30, 1998 AND 1997
 
<TABLE>
<CAPTION>
                                                             1998                  1997
                                                      -------------------   -------------------
                                                       AMOUNT     PERCENT    AMOUNT     PERCENT
                    IN THOUSANDS                       ------     -------    ------     -------
<S>                                                   <C>         <C>       <C>         <C>
Common stock equity:
Common stock, $3.33 1/3 par value, authorized
  36,000,000 shares; 13,543,344, and 13,506,594
  shares outstanding................................  $  45,144             $  45,025
Paid-in-capital.....................................    103,933               103,126
Retained earnings...................................     71,108                86,227
                                                      ---------   ------    ---------   ------
Total common stock equity...........................    220,185    47.9%      234,378    50.0%
                                                      ---------   ------    ---------   ------
Cumulative preferred stock:
Redeemable cumulative preferred stock...............         --                 4,917
                                                      ---------   ------    ---------   ------
Total cumulative preferred stock....................         --     0.0%        4,917     1.0%
                                                      ---------   ------    ---------   ------
Long-term debt:
Revolving Credit Agreement..........................     20,000                18,000
Notes...............................................    220,722               216,500
                                                      ---------   ------    ---------   ------
Total long-term debt................................    240,722               234,500
Less current maturities of long-term debt...........      1,247                 5,000
                                                      ---------   ------    ---------   ------
Long-term debt, net.................................    239,475    52.1%      229,500    49.0%
                                                      ---------   ------    ---------   ------
Total capitalization................................  $ 459,660   100.0%    $ 468,795   100.0%
                                                      =========   ======    =========   ======
</TABLE>
 
        The accompanying notes are an integral part of these statements.


                                       19
<PAGE>   20
 
                             BAY STATE GAS COMPANY
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                 YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
 
<TABLE>
<CAPTION>
                                                                                       CUMULATIVE
                                                      COMMON STOCK                   PREFERRED STOCK
                                      --------------------------------------------   ---------------
                                                               PAID-IN    RETAINED
                                        SHARES     PAR VALUE   CAPITAL    EARNINGS
 IN THOUSANDS, EXCEPT SHARE AMOUNTS   ----------   ---------   --------   --------
<S>                                   <C>          <C>         <C>        <C>        <C>
BALANCE AT SEPTEMBER 30, 1995         13,353,394    $44,511    $100,339   $ 75,023       $ 5,149
Net income..........................                                        27,072
Dividends declared:
     Preferred stock................                                          (293)
     Common stock...................                                       (20,361)
Common stock issued:
     Key Employee Stock Option
       Plan.........................      74,850        250       1,467
Redemption of preferred stock.......                                (22)                    (140)
                                      ----------    -------    --------   --------       -------
BALANCE AT SEPTEMBER 30, 1996         13,428,244     44,761     101,784     81,441         5,009
Net income..........................                                        26,062
Dividends declared:
     Preferred stock................                                          (288)
     Common stock...................                                       (20,988)
Common stock issued:
     Key Employee Stock Option
       Plan.........................      78,350        264       1,354
Redemption of preferred stock.......                                (12)                     (92)
                                      ----------    -------    --------   --------       -------
BALANCE AT SEPTEMBER 30, 1997         13,506,594     45,025     103,126     86,227         4,917
Net income..........................                                         6,634
Dividends declared:
     Preferred stock................                                          (118)
     Common stock...................                                       (21,635)
Common stock issued:
     Key Employee Stock Option
       Plan.........................      36,750        119       1,041
Redemption of preferred stock.......                               (234)                  (4,917)
                                      ----------    -------    --------   --------       -------
BALANCE AT SEPTEMBER 30, 1998         13,543,344    $45,144    $103,933   $ 71,108       $     0
                                      ==========    =======    ========   ========       =======
</TABLE>
 
        The accompanying notes are an integral part of these statements.


                                       20
<PAGE>   21
 
                             BAY STATE GAS COMPANY
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
             FOR THE YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
 
<TABLE>
<CAPTION>
                                                                1998       1997       1996
                        IN THOUSANDS                          --------   --------   --------
<S>                                                           <C>        <C>        <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income..................................................  $  6,634   $ 26,062   $ 27,072
Adjustments to reconcile net income to net cash provided by
  operating activities:
     Depreciation and amortization..........................    34,870     28,486     26,311
     Deferred income taxes..................................     4,269      1,603      6,743
     Gain from sale of subsidiary...........................        --    (13,344)        --
     Change in accounting principle (net of taxes)..........    (2,259)        --         --
     Investment income and AFUDC............................    (3,572)    (3,568)    (3,981)
Changes in operating assets and liabilities:
     Accounts receivable....................................    (5,646)    (5,570)    (4,899)
     Accounts payable.......................................     2,400      9,546      2,693
     Taxes..................................................    (6,233)       525     (2,390)
     Deferred gas costs and refunds due customers...........    (6,370)     3,058    (32,758)
     Other..................................................     1,497     (2,258)   (11,653)
                                                              --------   --------   --------
Net cash provided by operating activities...................    25,590     44,540      7,138
                                                              --------   --------   --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to plant..........................................   (57,425)   (57,638)   (50,731)
Proceeds from sale of subsidiary............................        --     17,000         --
Proceeds from sale of assets and investments................    36,195     10,145     20,667
Other investments...........................................   (10,632)    (2,171)    (4,623)
                                                              --------   --------   --------
Net cash used in investing activities.......................   (31,862)   (32,664)   (34,687)
                                                              --------   --------   --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock....................................     1,160      1,618      1,717
Dividends on common stock...................................   (21,635)   (20,988)   (20,361)
Dividends on preferred stock................................      (118)      (288)      (293)
Issuance of long-term debt..................................    32,000     20,000     22,000
Retirements of preferred stock and long-term debt...........   (35,457)      (104)    (6,662)
Short-term debt.............................................    31,075    (13,025)    33,150
                                                              --------   --------   --------
Net cash provided by (used in) financing activities.........     7,025    (12,787)    29,551
                                                              --------   --------   --------
Net increase (decrease) in cash and temporary cash
  investments...............................................       753       (911)     2,002
Cash and temporary cash investments at beginning of
  period....................................................     3,672      4,583      2,581
                                                              --------   --------   --------
Cash and temporary cash investments at end of period........  $  4,425   $  3,672   $  4,583
                                                              ========   ========   ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
     Interest (net of amounts capitalized)..................  $ 20,884   $ 19,229   $ 18,134
                                                              ========   ========   ========
     Income taxes...........................................  $  9,629   $ 14,711   $ 11,935
                                                              ========   ========   ========
</TABLE>
 
Supplementary non-cash information:
In November 1997, all the common stock of SavageAlert, Inc. was acquired through
a combination of cash and long-term notes. The non-cash portion of this
transaction amounted to $3.9 million in note issuances (see note 1.)
 
        The accompanying notes are an integral part of these statements.
                                       21
<PAGE>   22
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1
 
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
     NATURE OF OPERATIONS.  Bay State Gas Company ("Bay State" or the "Company")
operates in three related energy segments: Utility, Energy Products & Services,
and Energy Ventures. The Utility serves about 305,000 natural gas customers in
the states of Massachusetts, New Hampshire, and Maine. The non-regulated Energy
Products & Services segment serves about 94,000 residential, commercial, and
industrial customers throughout New England, and markets products and services
under the brand names, "EnergyUSA(TM)" and "EnergyEXPRESS(TM)". Energy Ventures
develops business opportunities and projects which are closely related to the
Company's core businesses.
 
     MERGER.  On May 27, 1998, Common Shareholders' approved a merger with
NIPSCO Industries, Inc. ("Industries") (see discussion in Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations.)
 
     BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION.  The preparation of
consolidated 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. Actual
results may differ from those estimates. The consolidated financial statements
include the accounts of Bay State Gas Company and its wholly owned subsidiaries.
All significant intercompany transactions and accounts have been eliminated.
Certain information in the prior period financial statements has been
reclassified to conform with the current period's presentation.
 
     REGULATION.  The Company is subject to regulation with respect to rates,
accounting, and other matters, where applicable, by the Massachusetts Department
of Telecommunications and Energy ("MADTE"), the New Hampshire Public Utilities
Commission, the Maine Public Utilities Commission, and the Federal Energy
Regulatory Commission ("FERC"). Accounting policies conform to generally
accepted accounting principles and reflect the effects of the ratemaking process
in accordance with Statement of Financial Accounting Standards No. 71,
Accounting for the Effects of Certain Types of Regulation.
 
     ACQUISITION.  On November 18, 1997, EnergyUSA(TM), a nonregulated
subsidiary, purchased 100% of the outstanding stock of SavageAlert, Inc.
("Savage") for cash of $55,000 and $3.9 million in long-term notes. In
accordance with Accounting Principles Board Opinion No. 16, the acquisition was
accounted for using the purchase method of accounting. The results of this
acquisition are not material to the consolidated financial statements.
 
     PLANT.  Plant is stated at original cost and consists of utility plant and
Energy Products & Services plant assets. The original cost of depreciable units
of utility plant retired, together with the cost of removal, net of salvage, is
charged to accumulated depreciation. The costs of maintenance, repairs, and
replacements of minor items are charged to expense as incurred.
 
     Depreciation is provided for all classes of utility plant on a group
straight-line basis in amounts equivalent to overall composite rates of 3.63%
for 1998 and 1997, and 3.66% for 1996. Depreciation for assets used by Energy
Products & Services is provided for on a straight-line basis over the estimated
useful lives of the assets.
 
     ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC).  AFUDC is the
estimated cost of funds used for construction purposes. Such allowances are
charged to plant and reported as other income (cost of equity funds) or a
reduction of interest expense (cost of borrowed funds). AFUDC was $1.2 million,
$901,000, and $1.4 million for 1998, 1997, and 1996, respectively.
 
     INVESTMENTS.  Partnership investments are accounted for by the equity
method.
 
     CASH AND TEMPORARY CASH INVESTMENTS.  All highly liquid debt instruments
purchased with an original maturity of three months or less are considered to be
cash equivalents.
 
                                       22
<PAGE>   23
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     TRANSPORTATION, NATURAL GAS SALES, AND DEFERRED GAS COSTS. Transportation
revenues and natural gas sales are based on the volume of gas transported or
sold at billing rates authorized by regulatory authorities and include unbilled
revenues for transportation services and gas delivered, but not billed. Rates
include cost of gas adjustment ("CGA") clauses pursuant to which gas and certain
other costs are recovered from customers. Any differences between gas costs
incurred and amounts collected are deferred for recovery from or refund to
customers in future periods. Also included in natural gas sales are sales to
interruptible customers and spot sales for resale. Substantially all profit
margins from these types of sales are used to reduce gas costs to customers
through CGA clauses.
 
     BAD DEBT EXPENSE.  In January 1998, the Company received regulatory
approval in Massachusetts to allocate the portion of bad debt expense that
relates to natural gas product costs to the CGA for collection from customers in
future periods. Bad debt expense related to natural gas transportation in
Massachusetts and all bad debt expense for subsidiary companies continue to be
recorded as operations expense. The change in procedure added approximately $1.9
million to pre-tax earnings in 1998.
 
     ENVIRONMENTAL COSTS.  In accordance with orders of regulatory authorities,
costs incurred to remediate environmental damage are deferred. Deferred
environmental costs in Massachusetts, Maine, and New Hampshire are amortized to
expense over periods of five to ten years as they are recovered from customers.
 
     INTEREST RATE SWAP.  An interest rate swap (a "derivative") was entered
into to exchange a variable rate interest payment obligation for a fixed rate
obligation in order to reduce the impact of interest rate fluctuations. This
derivative qualifies for hedge accounting. To qualify for hedge accounting,
derivatives must meet the following criteria: 1) the item to be hedged exposes
the enterprise to interest rate risk; and 2) the derivative reduces that
exposure and is designated as a hedge. The interest-rate swap agreement is used
to measure interest to be paid or received and does not represent the amount of
exposure to credit loss. In the unlikely event that the counterparty fails to
meet the terms of the interest rate swap agreement, the original floating
interest rate would be paid rather than the fixed rate anticipated by the
agreement. Non-performance by the counterparty is not anticipated. Net interest
differentials to be paid or received related to the interest swap agreement are
accrued and ultimately recognized as an adjustment to interest expense over the
life of the agreement. The fair value of the interest rate swap agreement is the
estimated amount that would be received or paid to terminate the agreement at
the reporting date, taking into account current interest rates and the current
creditworthiness of the counterparty.
 
     INCOME TAXES.  Deferred taxes are provided for using the asset and
liability method for temporary differences between financial and tax reporting.
Deferred income taxes are recognized for the expected tax consequences of
temporary differences by applying enacted statutory tax rates, applicable to
future years, to differences between the financial reporting basis and tax basis
of assets and liabilities (see note 2).
 
     PENSION AND OTHER EMPLOYEE BENEFIT PLANS.  Noncontributory defined benefit
pension plans cover substantially all employees. Benefits under the plans are
generally based on years of service and the level of compensation during the
final years of employment. Other postretirement benefits consist of certain
health and life insurance benefits for retired and active employees hired before
September 30, 1990. Postemployment benefits consist of workers compensation
claims, long-term disability payments, and medical coverage continuation
payments. These costs are generally recognized on the accrual method of
accounting over the expected periods of employee service based on actuarial
assumptions (see note 7).
 
     The method of recognizing actuarial gains and losses for postretirement
benefit plans was changed during 1998. The previous policy amortized all
actuarial gains and losses over average future service of the covered
population. The new policy amortizes actuarial gains and losses which are less
than 40% of plan liability over the average future service of the covered
population. Actuarial gains and losses in excess of 40% of plan liability are
recognized as incurred.
 
     In developing its amortization policy, the Financial Accounting Standards
Board ("FASB") recognized that if assumptions were carefully made, actuarial
gains in one year would be offset by losses in subsequent
 
                                       23
<PAGE>   24
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
years. Since entry into the postretirement plans has terminated, offsetting
actuarial losses are considered by management to be extremely unlikely. Due to
lower than expected health care costs, actuarial gains of approximately 70% of
plan liability built up. Management believes that allowing these excess
actuarial gains to accumulate on an unlimited basis is inconsistent with the
intent of Statement of Financial Accounting Standards No. 106, Employer's
Accounting for Postretirement Benefits Other Than Pensions, ("SFAS 106".) This
change was adopted because the new amortization method allows for a timely
recognition of economic events that have occurred and represents an improvement
in the financial reporting of the accrued postretirement benefit calculation. As
a result of adopting this change, $2.2 million, net of income taxes, was
recognized in net income in the fourth quarter of 1998.
 
     For the defined benefit pension plans and postemployment benefit plans,
unrecognized gains and losses will continue to be amortized over the average
remaining service life of plan participants as this period approximates the
benefit period.
 
     EARNINGS PER SHARE.  On December 31, 1997, Statement of Financial
Accounting Standards No. 128 ("SFAS 128"), Earnings per Share, was adopted,
which requires the presentation of basic earnings per common share and diluted
earnings per common share in place of primary and fully diluted earnings per
common share. Basic earnings per common share are computed by dividing earnings
applicable to common stock by the weighted average number of shares of common
stock outstanding during each year. The diluted earnings per share calculation
assumes conversion of dilutive stock options into common shares. See Note 3 for
the calculation of basic and diluted earnings per share.
 
     ACCOUNTING FOR LONG-LIVED ASSETS.  Long-lived assets are reviewed for
impairment whenever events change or circumstances indicate that the carrying
amount of an asset may not be recoverable. $5.1 million of software development
costs were written off in 1998 in accordance with Statement of Financial
Accounting Standards No. 121, Accounting for Long-Lived Assets, after the
cancellation of a software project indicated that the carrying amount of the
asset was not going to be recoverable.
 
     STOCK-BASED COMPENSATION.  Statement of Financial Accounting Standards No.
123 ("SFAS 123"), Accounting for Stock-based Compensation, established a
fair-value based method of accounting for stock-based compensation plans. Prior
to the Company's adoption of SFAS 123, employee stock options were accounted for
under APB Opinion No. 25, Accounting for Stock Issued to Employees, which
required the use of an intrinsic-value method of accounting for stock options.
SFAS 123 allows the continued use of the intrinsic-value method of accounting as
long as pro-forma disclosures of net income and net income per share, as if the
fair-value method of accounting for stock options were applied, are presented.
 
     SFAS 123 was adopted and stock options have continued to be accounted for
using the methodology prescribed by APB Opinion No. 25. Accordingly, pro forma
disclosures of net income and net income per share as if the fair-value method
of accounting for stock options were applied are presented in note 3.
 
     NEW ACCOUNTING STANDARDS.  The FASB has issued four accounting standards
effective for fiscal year 1999. SFAS 130, Reporting Comprehensive Income,
requires reporting comprehensive income and its components, SFAS 131,
Disclosures about Segments of an Enterprise and Related Information, requires
reporting financial and descriptive information about reportable operating
segments, SFAS 132, Employers' Disclosures about Pensions and Other
Postretirement Benefits, revises employers' pension and other postretirement
benefit plan disclosures, but does not change the measurement or accounting for
those plans, and SFAS 133, Accounting for Derivative Instruments and Hedging
Activities, establishes accounting and reporting standards for derivative
instruments and hedging activities. It is expected that the adoption of these
standards will not have a material impact on cash flows, financial condition, or
the results of operations.
 
                                       24
<PAGE>   25
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 2
 
INCOME TAXES
 
     Income tax expense consists of the following:
 
<TABLE>
<CAPTION>
                                           1998        1997         1996
              IN THOUSANDS                ------      -------      -------
<S>                                       <C>         <C>          <C>
Current:
     Federal............................  $3,446      $12,891      $ 8,785
     State..............................     850        2,885        1,824
                                          ------      -------      -------
          Total current.................   4,296       15,776       10,609
                                          ------      -------      -------
Deferred:
     Federal............................   3,965        1,292        5,551
     State..............................     304          311        1,192
                                          ------      -------      -------
          Total deferred................   4,269        1,603        6,743
                                          ------      -------      -------
Deferred investment tax credits, net....    (400)        (400)        (399)
                                          ------      -------      -------
                                          $8,165      $16,979      $16,953
                                          ======      =======      =======
</TABLE>
 
     Total income tax expense is as follows:
 
<TABLE>
<CAPTION>
                                           1998        1997         1996
              IN THOUSANDS                ------      -------      -------
<S>                                       <C>         <C>          <C>
Income from operations..................  $8,165      $16,979      $16,953
Change in accounting principle..........   1,445           --           --
                                          ------      -------      -------
Total income tax expense................  $9,610      $16,979      $16,953
                                          ======      =======      =======
</TABLE>
 
     The annual provision for deferred income taxes is comprised of the
following:
 
<TABLE>
<CAPTION>
                                               1998       1997       1996
                IN THOUSANDS                  -------    -------    ------
<S>                                           <C>        <C>        <C>
Accelerated tax depreciation................  $ 3,256    $ 5,557    $3,858
Capitalized overheads.......................     (666)      (827)     (418)
Pension.....................................   (3,502)       342       771
Premium on retirement of long-term debt.....    1,888         --        --
Demand side management costs................      368       (709)      545
Restructuring costs.........................    2,289     (2,543)       --
Postretirement benefits.....................      763        348      (537)
Investment in MASSPOWER.....................      (60)    (2,212)      494
Other.......................................      (67)     1,647     2,030
                                              -------    -------    ------
Total deferred tax expense..................  $ 4,269    $ 1,603    $6,743
                                              =======    =======    ======
</TABLE>
 
     A reconciliation of statutory federal income tax rates to the effective
income tax rate is as follows:
 
<TABLE>
<CAPTION>
                                                    1998    1997    1996
                                                    ----    ----    ----
<S>                                                 <C>     <C>     <C>
Federal income tax rate...........................   35%    35%      35%
State income taxes, net of federal benefit........     4      4        4
Non-deductible merger related costs...............     8     --       --
Other non-deductible costs........................    12     --       --
                                                    ----    ---     ----
                                                     59%    39%      39%
                                                    ====    ===     ====
</TABLE>
 
                                       25
<PAGE>   26
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Temporary differences that resulted in deferred income tax assets and
liabilities as of September 30, 1998 and 1997 are as follows:
 
<TABLE>
<CAPTION>
                                                    1998           1997
                  IN THOUSANDS                    --------        -------
<S>                                               <C>             <C>
Deferred income tax assets:
Allowance for doubtful accounts.................  $  2,123        $ 1,828
Restructuring costs.............................       422          2,543
Inventory and overhead costs....................     2,721          2,943
Unamortized investment tax credits..............     2,975          3,235
Other...........................................     5,377          2,636
                                                  --------        -------
     Total deferred income tax assets...........    13,618         13,185
                                                  --------        -------
Deferred income tax liabilities:
Prepaid pension and other benefits..............    11,992         13,746
Plant related...................................    83,228         78,533
Other...........................................     9,346          5,724
                                                  --------        -------
     Total deferred income tax liabilities......   104,566         98,003
                                                  --------        -------
Net deferred income tax liability...............  $ 90,948        $84,818
                                                  ========        =======
</TABLE>
 
     At September 30, 1998 and 1997, unamortized deferred investment tax credits
included in long-term deferred taxes amounted to $4.6 million and $5.0 million,
respectively.
 
NOTE 3
 
CAPITALIZATION
 
     COMMON STOCK.  A Stock Performance Sharing Plan (formerly Key Employee
Long-Term Incentive Plan) awarded performance shares to certain employees. All
of the performance shares became fully vested upon shareholder approval of the
Industries merger during 1998, (see discussion in Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations), and
$4.1 million was paid, and charged to expense in 1998, to redeem all the
outstanding performance shares. No compensation expense was recorded in 1997 or
1996. As of September 30, 1998, there are no outstanding performance shares.
 
     A Key Employee Stock Option Plan provides for the granting of options to
key employees to purchase an aggregate of 1,050,000 shares of common stock.
Options issued before 1998 are exercisable upon grant and expire within 10 years
from the date of grant. Options issued in 1998 are 1/3 exercisable upon grant,
with 1/3 vesting in December 1998 and the remaining options vesting in December
1999. Outstanding options are exercisable through 2007. Option activity is as
follows:
 
<TABLE>
<CAPTION>
                                                                WEIGHTED AVERAGE
                                                     SHARES      EXERCISE PRICE
                OPTIONS OUTSTANDING                  -------    ----------------
<S>                                                  <C>        <C>
September 30, 1995.................................  655,700         $20.28
Options exercised..................................  (74,850)        $19.56
                                                     -------         ------
September 30, 1996.................................  580,850         $20.37
Options exercised..................................  (78,350)        $20.73
                                                     -------         ------
September 30, 1997.................................  502,500         $20.31
Options issued.....................................  107,915         $28.50
Options exercised..................................  (36,750)        $20.89
                                                     -------         ------
September 30, 1998.................................  573,665         $21.82
                                                     =======         ======
</TABLE>
 
                                       26
<PAGE>   27
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Outstanding options by exercise price are as follows:
 
<TABLE>
<CAPTION>
                            OPTIONS OUTSTANDING AT       REMAINING       OPTIONS EXERCISABLE AT
      EXERCISE PRICE          SEPTEMBER 30, 1998      CONTRACTUAL LIFE     SEPTEMBER 30, 1998
      --------------        ----------------------    ----------------   ----------------------
<S>                         <C>                       <C>                <C>
$17.75....................          73,250                   1                   73,250
$19.625...................         114,250                   2                  114,250
$20.375...................         137,500                   3                  137,500
$22.00....................         140,750                   4                  140,750
$28.50....................         107,915                   9                   72,303
                                   -------                                      -------
                                   573,665                                      538,053
                                   =======                                      =======
</TABLE>
 
     APB 25 is applied in accounting for stock option plans. Accordingly, no
compensation cost has been recognized in connection with these plans. Since APB
25 is applied, certain pro forma information regarding net income and net income
per share is required by SFAS 123, as if the stock option plans were accounted
for under the fair value approach of SFAS 123. For purposes of pro forma
disclosures, the estimated fair value of the stock plans is amortized to expense
over the related vesting period of the options. The pro forma information is as
follows:
 
<TABLE>
<CAPTION>
                                                  1998      1997       1996
            NET INCOME IN THOUSANDS              ------    -------    -------
<S>                                              <C>       <C>        <C>
Net income as reported.........................  $6,634    $26,062    $27,072
Pro forma net income...........................  $6,383    $26,062    $27,072
Basic net income per share as reported.........  $  .48    $  1.92    $  2.00
Pro forma basic net income per share...........  $  .47    $  1.92    $  2.00
Diluted net income per share as reported.......  $  .47    $  1.90    $  1.98
Pro forma diluted net income per share.........  $  .46    $  1.90    $  1.98
</TABLE>
 
     The effect of applying SFAS 123 as shown above in the pro forma disclosures
is not representative of the pro forma effect on net income in future years
because it does not take into consideration pro forma compensation expenses
related to stock options granted prior to 1996.
 
     The fair value of options granted in 1998 was estimated on the date of
grant using the Black-Scholes option pricing model with the following weighted
average assumptions used: dividend yield for the year, 5.60%; expected
volatility of 15%; risk-free interest rate, 6%; and expected life of 8 years.
The weighted average fair value of options granted during 1998 was $3.49.
 
     On January 1, 1997 the Stock Accumulation Plan for outside Directors was
adopted. Its intent was to align the interests of the outside Directors with the
interests of shareholders by paying a portion of their annual retainer in common
stock. During 1998 and 1997, respectively, 1,460 and 1,620 shares were
reacquired by the Company for reissuance under this plan. All of the Stock
Accumulation Plan shares became fully vested upon shareholder approval of the
Industries merger during 1998 and were issued to the outside Directors.
 
     A Shareholder Rights Plan provides one right ("Right") to buy one share of
common stock at a purchase price of $70 for each share of common stock issued
and to be issued. The Rights expire on November 30, 1999 and only become
exercisable, or separately transferable, 10 days after a person or group
acquires, or announces an intention to acquire, beneficial ownership of 20% or
more of the Company's common stock. The Rights are redeemable by the Board at a
price of $.01 per Right, at any time prior to the acquisition by a person or a
group of beneficial ownership of 20% or more of the Company's common stock. Once
a person or group acquires more than 20% of the Company's common stock, however,
the Rights may not be redeemed.
 
     At September 30, 1998, there were 385,000 authorized but unissued shares of
common stock reserved for the Dividend Reinvestment Plan ("DRP"). On December 1,
1994, the DRP was converted to a market based plan. It is anticipated that no
further shares will be issued under this plan.
 
                                       27
<PAGE>   28
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     EARNINGS PER SHARE.  Basic earnings per share is based upon the weighted
average common shares outstanding during each period. Diluted earnings per share
is based upon the weighted average common shares and dilutive common stock
equivalent shares during each period. The weighted average number of shares used
to compute diluted earnings per share consisted of the following:
 
<TABLE>
<CAPTION>
                                                    1998      1997      1996
                  IN THOUSANDS                     ------    ------    ------
<S>                                                <C>       <C>       <C>
Average common shares outstanding during the
  year -- basic..................................  13,523    13,455    13,397
Average common equivalent shares due to stock
  options........................................     226       129       147
                                                   ------    ------    ------
Average common shares outstanding during the
  year -- diluted................................  13,749    13,584    13,544
                                                   ======    ======    ======
</TABLE>
 
     Basic and diluted earnings per share are comprised of the following
components:
 
<TABLE>
<CAPTION>
                                                       1998    1997     1996
                                                       ----    -----    -----
<S>                                                    <C>     <C>      <C>
Basic earnings per share
Income before change in accounting principle.........  $.31    $1.92    $2.00
Change in accounting principle.......................   .17       --       --
                                                       ----    -----    -----
Net income...........................................  $.48    $1.92    $2.00
                                                       ====    =====    =====
Diluted earnings per share
Income before change in accounting principle.........  $.31    $1.90    $1.98
Change in accounting principle.......................   .16       --       --
                                                       ----    -----    -----
Net income...........................................  $.47    $1.90    $1.98
                                                       ====    =====    =====
</TABLE>
 
     CUMULATIVE PREFERRED STOCK.  On January 23, 1998, notice of redemption was
provided to holders of record of preferred shares, and effective March 1, 1998,
all preferred shares were redeemed and are no longer outstanding.
 
     LONG-TERM DEBT.  On February 11, 1998, $30 million of 6.26% notes to mature
in 2028 were issued. $25 million of the proceeds were used to pay down an
outstanding $25 million, 9.45% note and $4.9 million were used to retire
outstanding preferred stock.
 
     SINKING FUND REQUIREMENTS AND MATURITIES.  Annual sinking fund requirements
and maturities of long-term debt for the next five years and thereafter are as
follows:
 
<TABLE>
<CAPTION>
                                                              LONG-TERM
                                                                DEBT
IN THOUSANDS                                                  ---------
<S>                                                           <C>
1999........................................................  $  1,247
2000........................................................    11,190
2001........................................................    36,257
2002........................................................    26,375
2003........................................................    29,333
Thereafter..................................................   136,320
                                                              --------
Total.......................................................  $240,722
                                                              ========
</TABLE>
 
     As of September 30, 1998, long-term debt agreements contain no provisions
restricting the payment of dividends on common stock. The merger agreement
restricts dividend payments to typical quarterly payments. All debt is
unsecured.
 
     As of September 30, 1998 and 1997, $240.7 and $234.5 million, respectively,
of long-term debt was outstanding at weighted average interest rates of 7.02%
and 7.34%, respectively. Long-term debt is payable through 2031.
 
                                       28
<PAGE>   29
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     An interest rate hedging agreement was entered into with respect to $18
million of long-term debt under a revolving credit agreement to fix the interest
rate for this debt at 5.75% through March 2000. During the year ended September
30, 1998, payments under the instrument were $9,600. There were no receipts
pursuant to the instrument.
 
     FAIR VALUES OF FINANCIAL INSTRUMENTS.  The estimated fair values of
financial instruments are summarized below:
 
<TABLE>
<CAPTION>
                                                     CARRYING/
                                                     NOTIONAL     ESTIMATED
                                                      AMOUNT      FAIR VALUE
IN THOUSANDS                                         ---------    ----------
<S>                                                  <C>          <C>
September 30, 1998
Long-term debt.....................................  $240,722      $248,329
Interest rate swap.................................  $ 18,000      $    250
 
September 30, 1997
Capital lease obligations..........................  $    694      $    697
Long-term debt.....................................  $234,500      $245,619
</TABLE>
 
     The fair values of capital lease obligations were estimated using the
present value of the minimum lease payments discounted at market rates. The fair
values of long-term debt are estimated based on current rates offered for debt
of the same remaining maturities. The carrying amounts for cash and temporary
cash investments, accounts receivable, accounts payable, accrued liabilities,
and short-term debt approximate their fair values, due to the short-term nature
of these instruments.
 
     At September 30, 1998, an outstanding off-balance sheet interest swap
agreement ("instrument") with total notional principal amount of $18 million
fixed the interest rate at 5.75%. The notional principal amount for the
instrument provides one measure of the transaction volume outstanding as of
September 30, 1998 and does not represent the amount of exposure to credit risk
or market loss. The notional principal and fair value of the instrument do not
reflect the gains or losses associated with the exposures and transactions that
the instrument is intended to hedge. The amount ultimately realized upon
settlement of this instrument, together with the gains and losses on the
underlying exposures, will depend on actual market conditions during the
remaining life of the instrument.
 
NOTE 4
 
LEASES
 
     Noncancelable operating leases have been entered into for the use of
certain facilities and equipment. Operating lease agreements generally contain
renewal options and certain leases contain renewal and purchase options and
escalation clauses. There are no capital leases at September 30, 1998. Future
annual minimum rental payments under long-term noncancelable operating leases at
September 30, 1998, are as follows:
 
<TABLE>
<CAPTION>
IN THOUSANDS:
<S>                                                           <C>
1999........................................................  $13,174
2000........................................................    8,766
2001........................................................    8,519
2002........................................................    8,470
2003........................................................    8,567
Thereafter..................................................   34,947
                                                              -------
Future minimum lease payments...............................  $82,443
                                                              =======
</TABLE>
 
                                       29
<PAGE>   30
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The following rentals were charged to operating expenses:
 
<TABLE>
<CAPTION>
                                                        CAPITAL    OPERATING
                                                        LEASES      LEASES
IN THOUSANDS                                            -------    ---------
<S>                                                     <C>        <C>
1998..................................................  $  726      $17,592
1997..................................................  $1,096      $10,258
1996..................................................  $1,281      $ 8,007
</TABLE>
 
     A series of sale/leasebacks of automatic meter reading devices and water
heaters were executed during 1998 with no gain or loss to the Company. $23.8
million, representing the carrying value of the assets sold, was received, which
was used to reduce short-term debt and pay general corporate expenses. In
conformity with its regulatory accounting requirements, rent expense is recorded
as if all leases were operating leases.
 
     Interest included in capital lease payments was $32,000, $119,000, and
$173,000 in 1998, 1997, and 1996, respectively.
 
NOTE 5
 
SHORT-TERM DEBT AND LINES OF CREDIT
 
<TABLE>
<CAPTION>
                                                        1998       1997
IN THOUSANDS                                           -------    -------
<S>                                                    <C>        <C>
Unsecured bank lines of credit
     Principal outstanding (thousands)...............  $12,700    $26,625
     Weighted average interest rate..................    6.22%      6.72%
Commercial paper
     Principal outstanding (thousands)...............  $70,000    $25,000
     Weighted average interest rate..................    5.62%      5.62%
Total short-term debt
     Principal outstanding (thousands)...............  $82,700    $51,625
     Weighted average interest rate..................    5.71%      6.19%
</TABLE>
 
     Unsecured bank lines of credit aggregating $95.0 million are available, for
which commitment fees are paid, in addition to $30.0 million under the Fuel
Purchase Agreements as described in note 6, of which $12.7 million was
outstanding at September 30, 1998.
 
NOTE 6
 
FUEL PURCHASE AGREEMENTS
 
     Up to $30.0 million can be raised through credit agreements (the
"Agreements") underlying the Fuel Purchase Agreements with a corporation
established to provide financing, through borrowing on a demand basis or selling
supplemental gas inventories. Any inventories sold must be repurchased and any
associated carrying costs paid when the gas is withdrawn from storage. All gas
costs, carrying costs, and administrative charges are fully recoverable through
the CGA approved in each state regulatory jurisdiction. The Agreements contain
an expiration date of September 2000.
 
                                       30
<PAGE>   31
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 7
 
PENSION AND EMPLOYEE BENEFIT PLANS
 
     PENSION PLANS.  The funded status of pension plans as of September 30, 1998
and 1997, is as follows:
 
<TABLE>
<CAPTION>
                                                        1998       1997
IN THOUSANDS                                           -------    -------
<S>                                                    <C>        <C>
Vested benefits......................................  $73,136    $61,060
Nonvested benefits...................................      477        978
                                                       -------    -------
Accumulated benefit obligation.......................   73,613     62,038
Additional benefits related to future compensation
  levels.............................................   11,133      9,138
                                                       -------    -------
Projected benefit obligation.........................   84,746     71,176
Plan assets at fair value............................   90,577     86,907
                                                       -------    -------
Plan assets in excess of plan benefit obligations....  $ 5,831    $15,731
                                                       =======    =======
</TABLE>
 
     Plan assets are primarily invested in marketable pooled funds holding
equity and corporate debt securities and cash equivalents. Certain changes in
items shown above are not recognized as they occur, but are systematically
amortized over subsequent periods. Unrecognized amounts as of September 30, 1998
and 1997, are as follows:
 
<TABLE>
<CAPTION>
                                                        1998       1997
IN THOUSANDS                                           -------    -------
<S>                                                    <C>        <C>
Unrecognized net gain (loss).........................  $    (4)   $ 9,634
Unrecognized prior service cost......................   (3,872)    (4,311)
Unrecognized net transition obligation...............   (1,768)    (2,683)
Prepaid pension costs included in the Consolidated
  Balance Sheets.....................................   11,475     13,091
                                                       -------    -------
Plan assets in excess of plan benefit obligations....  $ 5,831    $15,731
                                                       =======    =======
</TABLE>
 
     The discount rate used in determining the actuarial present value of the
projected benefit obligation was 7.0% for 1998 and 8.0% for 1997 and 1996. The
expected long-term rate of return on plan assets and the rate of increase in
future compensation levels used were 9.0% and 4.5%, respectively, for 1998, 1997
and 1996. Net pension cost for 1998, 1997, and 1996 included the following
components:
 
<TABLE>
<CAPTION>
                                             1998        1997       1996
IN THOUSANDS                                -------    --------    -------
<S>                                         <C>        <C>         <C>
Service cost-benefits earned..............  $ 1,811    $  1,883    $ 2,052
Interest cost on benefit obligations......    5,740       5,731      6,292
Actual return on plan assets..............   (7,646)    (14,753)    (8,210)
Net amortization and deferral.............    1,466       9,242      2,309
Restructuring -- early retirement.........      155       4,923         --
                                            -------    --------    -------
Net pension cost..........................  $ 1,526    $  7,026    $ 2,443
                                            =======    ========    =======
</TABLE>
 
     POSTRETIREMENT BENEFITS OTHER THAN PENSIONS.  The present value of the
accumulated benefit obligation for postretirement benefits other than pensions
was $23.2 million and $23.5 million, at September 30, 1998 and 1997,
respectively. The components of expense are as follows:
 
<TABLE>
<CAPTION>
                                              1998       1997       1996
IN THOUSANDS                                 -------    -------    -------
<S>                                          <C>        <C>        <C>
Interest cost..............................  $ 1,616    $ 1,775    $ 1,880
Service cost...............................      234        307        453
Actual return on assets....................   (2,012)    (3,649)    (2,355)
Net amortization...........................   (5,460)     2,352      1,656
Deferred assets............................    3,976      1,815        967
Restructuring -- early retirement..........       --      3,995         --
                                             -------    -------    -------
Other postretirement benefit (income)
  expense..................................  $(1,646)   $ 6,595    $ 2,601
                                             =======    =======    =======
</TABLE>
 
                                       31
<PAGE>   32
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The method of recognizing actuarial gains and losses for the postretirement
benefit plans was changed in 1998 (see note 1.) Without the change in accounting
principle, 1998 postretirement benefit expense would have been $2.1 million.
 
     The funded status of the Company's other postretirement benefit plans as of
September 30, 1998 and 1997 is as follows:
 
<TABLE>
<CAPTION>
                                                       1998        1997
IN THOUSANDS                                         --------    --------
<S>                                                  <C>         <C>
Retirees...........................................  $ 15,819    $ 12,324
Fully eligible active employees....................     2,553       3,768
Other active employees.............................     4,788       7,405
                                                     --------    --------
Accumulated other postretirement benefit
  obligation.......................................    23,160      23,497
Fair value of plan assets..........................   (26,180)    (25,772)
Unrecognized net transition obligation.............   (15,961)    (17,025)
Unrecognized net gain..............................     5,607      11,548
                                                     --------    --------
Prepaid other postretirement benefits recorded in
  the Consolidated Balance Sheets..................  $ 13,374    $  7,752
                                                     ========    ========
</TABLE>
 
     Plan assets are held in voluntary employee benefit association ("VEBA")
trusts and medical funds in the pension plans. VEBA assets are invested in
common stocks, bonds, and cash equivalents. The accumulated other postretirement
benefit obligation was determined using assumed discount rates of 7.0% for 1998
and 8.0% for 1997 and 1996, expected long-term pre-tax rate of return on plan
assets of 9.0% for 1998, 1997 and 1996, and health care cost trend rates of
5.0%, in 1998 and 1997 and 8.0% for 1996. An annual 1% increase in the health
care cost trend rate would increase the accumulated postretirement benefit
obligation by $953,000 and the cost for 1998 by $150,000.
 
     RETURN ON PREPAYMENTS OF POSTRETIREMENT BENEFITS.  As permitted by
regulatory authorities, noncash returns of $1.5 million, $1.7 million and $1.5
million for 1998, 1997, and 1996, respectively, have been recorded on amounts of
prepayments associated with employee postretirement benefit plans other than
pensions. Regulators permitted the accrual of returns on these prepayments
because the plan funding will significantly reduce the future costs of the
plans.
 
     POSTEMPLOYMENT BENEFITS OTHER THAN PENSIONS.  The present value of the
accumulated benefit obligation for postemployment benefits other than pensions
was $5.0 million and $5.2 million at September 30, 1998 and 1997.
 
     EMPLOYEE SAVINGS PLANS.  Employee Savings Plans ("ESP") provide eligible
employees with an incentive to save and invest regularly. The ESP are defined
contribution plans, which allow eligible employees to defer a portion of their
salaries to employee-funded pretax retirement savings accounts. Matching
contributions to certain employee deferrals were $1.2 million, $1.2 million, and
$1.3 million in 1998, 1997, and 1996, respectively.
 
NOTE 8
 
RESTRUCTURING COSTS
 
     During 1997, the Company was restructured in response to deregulation
within the natural gas industry. A total of $13.1 million was spent on
restructuring which consisted primarily of early retirement programs for certain
employees, consulting fees, and other related costs. Eighty-six employees
(approximately 8.5% of the workforce) accepted an offer of enhanced retirement
benefits which resulted in $4.9 million in additional pension benefits and $4.0
million in additional medical benefits to be funded by the pension and VEBA
plans. At September 30, 1997, all restructuring costs incurred in the
Massachusetts jurisdiction were expensed, resulting in an $11.2 million charge
to income. These costs had been initially deferred pending regulatory approval
of a petition to amortize these costs over future periods. During the fourth
quarter, the petition was withdrawn as part of a negotiated settlement in the
Performance-based Rate filing. At September 30, 1998
 
                                       32
<PAGE>   33
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
and 1997, $1.1 million and $1.7 million, respectively were deferred for
amortization in future periods in other jurisdictions. The amortization of those
deferrals was $626,000 and $191,000, in 1998 and 1997, respectively.
 
NOTE 9
 
COMMITMENTS AND CONTINGENCIES
 
     LONG-TERM OBLIGATIONS.  Long-term contracts provide for the purchase,
storage, and transportation of approximately half of projected gas supplies.
Certain of these contracts contain minimum purchase provisions, which in the
opinion of management, are not in excess of requirements.
 
     Natural gas is imported from Canada through a converted oil pipeline leased
from the Portland Pipe Line Corporation ("PPLC"). The Portland Natural Gas
Transmission System ("PNGTS"), a long-term capacity addition, is currently under
construction by a consortium of energy investors, including an affiliate of the
Company, to provide a permanent pipeline link with Canadian gas suppliers and is
planned to be in service in the spring of 1999. An option has been exercised
with PPLC to extend the lease until April 1999.
 
     PURCHASE OF LNG PLANT.  Bay State has agreed to purchase a liquefied
natural gas plant on February 1, 1999 for $12.5 million.
 
     INVESTMENTS.  The following table summarizes investments:
 
<TABLE>
<CAPTION>
                                                          1998      1997
IN THOUSANDS                                             -------   -------
<S>                                                      <C>       <C>
PNGTS..................................................  $10,597   $11,470
Wells LNG..............................................    9,370     7,878
Other..................................................       34        34
                                                         -------   -------
Total..................................................  $20,001   $19,382
                                                         =======   =======
</TABLE>
 
     PNGTS is an interstate pipeline that will extend 292 miles from the
US-Canadian border to the New Hampshire-Massachusetts border. The project has
secured contracts for service to the New England market and has received all the
necessary regulatory approvals. Construction is under way and the project is
planned to be in service in the spring of 1999.
 
     On March 31, 1998, an additional 1.3% ownership interest in PNGTS was
acquired when one of the partners left the project and sold its interest at book
value to the partnership. On April 3, 1998, 50% of the Company's 19.06%
ownership interest was sold to Industries at book value.
 
     Wells LNG is a proposed two million MMBtu liquefied natural gas storage
facility in Wells, Maine. Final approval for construction was received from the
FERC May 27, 1998. The decision regarding the construction schedule for this
project is still being developed.
 
     Amounts invested in PNGTS and Wells LNG consist principally of the costs of
developing each project and the carrying costs on these expenditures. Full
recovery of these investments is dependent upon the receipt of satisfactory
regulatory treatment.
 
     On June 30, 1997, a subsidiary which owned a 17.5% equity investment in the
MASSPOWER electric cogeneration facility was sold for $17.0 million.
 
     ENVIRONMENTAL ISSUES.  Like other companies in the natural gas industry,
the Company is party to governmental actions associated with former gas
manufacturing sites. Management estimates that, exclusive of insurance
recoveries, expenditures to remediate and monitor known environmental sites will
likely be $5 million at a minimum. Accordingly, the Company has accrued $5
million with an offsetting charge to a regulatory asset (see note 1). Accrued
environmental regulatory assets do not earn a return and are not collected from
customers until cash is expended. Environmental expenditures for 1998, 1997, and
1996 were $3.1 million, $1.2 million, and $2.5 million, respectively. Exclusive
of amounts accrued for future expenditures, at September 30, 1998 and 1997,
approximately $0.3 million and $4.9 million, respectively, of environmental
expenditures had been deferred for future recovery from customers. The reduction
in deferred environmental expenditures during 1998 was caused by the receipt of
insurance recoveries. In the fourth quarter of 1998, $15 million in insurance
recoveries were received relating to environmental costs associated
 
                                       33
<PAGE>   34
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
with the former gas manufacturing sites. The recoveries, net of recovery costs,
were shared by customers and shareholders, with the shareholders' portion having
a pre-tax impact on 1998 net income of approximately $5.7 million, included in
other income on the Consolidated Statement of Earnings.
 
     In one jurisdiction, the insurance recoveries shared with ratepayers will
reduce the amount of deferred environmental costs to be recovered from
customers. In all other jurisdictions, recoveries shared with ratepayers will be
passed back to customers over approximately one year.
 
     REGULATORY ASSETS.  Significant regulatory assets arising from the
rate-making process associated with income taxes, employee benefits, and
environmental response costs have been recorded. Based on its assessments of
decisions by regulatory authorities, management believes that all regulatory
assets will be settled at recorded amounts.
 
     The following table summarizes the principal regulatory assets as of
September 30, 1998 and 1997:
 
<TABLE>
<CAPTION>
                                                            1998     1997
IN THOUSANDS                                               ------   ------
<S>                                                        <C>      <C>
Postemployment benefit costs.............................  $  290   $4,850
Accrued environmental costs..............................  $5,000   $4,900
</TABLE>
 
     Postemployment benefit costs are theoretically similar to pension and
postretirement costs for which full recovery of costs had been approved and were
therefore expected to be recoverable without carrying costs. While reviewing
long-lived assets for possible impairment, management determined that the
probability of recovering Massachusetts postemployment benefit costs within a
reasonable timeframe was remote. Therefore, the Massachusetts postemployment
benefit costs regulatory assets of $4.8 million was expensed in the fourth
quarter of 1998.
 
     Accrued environmental costs are a regulatory asset offsetting the accrual
of the lower end of the range of costs anticipated to be incurred in future
periods. When environmental costs are actually incurred, they will be recovered
through existing mechanisms in all jurisdictions without carrying costs.
 
     REGULATORY MATTERS.  In the first quarter of 1998 approval was received
from the MADTE for new rates associated with a "two-year rate plan," which is a
form of price-cap incentive rate mechanism. As a result of this settlement,
beginning January 1, 1998 rates increased $1.8 million on an annual basis in
order to recover safety-related and compliance-related costs associated with
maintenance of its natural gas distribution system.
 
     In addition, as part of the settlement, earnings above an 11.4% return on
equity will be shared on a 50/50 basis between customers and shareholders. Due
to 1997 performance, rates were reduced by $206,000 from January 1, 1998 to
September 30, 1998. No reduction of rates based on 1998 results will be
required. See discussion in Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations for additional information on the
earnings sharing mechanism.
 
     SEVERANCE AGREEMENTS.  The Company has severance agreements with 14
officers and senior managers which become operative upon a change in control of
Bay State and continue in effect for up to three years. Potential severance
expense under the agreements could total $15.6 million if all covered
individuals were terminated.
 
     LITIGATION.  Various legal actions and claims arise in the normal course of
business. Based on its current assessment of the facts of law, and consultations
with outside counsel, management does not believe that the outcome of any action
or claim will have a material effect upon consolidated financial position,
results of operations, or liquidity.
 
                                       34
<PAGE>   35
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 10
 
QUARTERLY FINANCIAL DATA (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                                    QUARTER ENDED
                                                   ------------------------------------------------
                                                   DECEMBER 31   MARCH 31   JUNE 30    SEPTEMBER 30
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)            -----------   --------   --------   ------------
<S>                                                <C>           <C>        <C>        <C>
1998
Operating revenues...............................   $153,356     $173,557   $ 71,723     $ 51,396
Operating income (loss)..........................   $ 23,614     $ 37,182   $(10,310)    $(29,821)
Net income (loss)................................   $ 11,719     $ 20,066   $ (8,548)    $(16,603)
Per average common share:
     Diluted income (loss).......................   $   0.85     $   1.45   $   (.62)    $  (1.23)(C)
     Dividend declared and paid..................   $   .395     $   .395   $   .405     $   .405
</TABLE>
 
<TABLE>
<CAPTION>
                                                   DECEMBER 31   MARCH 31   JUNE 30    SEPTEMBER 30
                                                   -----------   --------   --------   ------------
<S>                                                <C>           <C>        <C>        <C>
1997
Operating revenues...............................   $137,006     $199,879   $ 84,624     $ 52,072
Operating income (loss)..........................   $ 24,768     $ 41,212   $   (526)    $(23,750)
Net income (loss)................................   $ 13,204     $ 22,934   $  6,098     $(16,174)
Per average common share:
     Diluted income (loss).......................   $    .97     $   1.68   $    .44(A)  $  (1.21)(B)
     Dividend declared and paid..................   $   .385     $   .385   $   .395     $   .395
</TABLE>
 
     In the opinion of management, quarterly financial data includes all
adjustments, consisting only of normal recurring accruals, necessary for a fair
representation of such information. Revenue and income amounts vary
significantly due to seasonal weather conditions.
---------------
A -- In the third quarter of fiscal year 1997, Bay State sold a subsidiary which
     held a 17.5% equity investment in MASSPOWER resulting in a $0.58 per share
     gain.
 
B -- In the fourth quarter of fiscal year 1997, Bay State wrote-off previously
     deferred restructuring costs resulting in a $0.50 per share loss.
 
C -- In the fourth quarter of fiscal year 1998, Bay State changed its accounting
     method for accounting for actuarial gains and losses related to the
     postretirement benefit plans (see note 1), which added $.16 per share to
     net income, recorded insurance recoveries resulting in $.25 per share in
     additional net income, and wrote-off certain assets whose recovery was no
     longer probable, which resulted in a reduction of net income of $.44 per
     share.
 
                                       35
<PAGE>   36
 
                              REPORT OF MANAGEMENT
 
     The management of Bay State Gas Company and its subsidiaries has the
responsibility for preparing the accompanying financial statements. We believe
the financial statements were prepared in conformity with generally accepted
accounting principles. Management also prepared the other information in the
annual report and is responsible for its accuracy and consistency with the
financial statements.
 
     To fulfill its responsibility, management maintains a system of internal
control that has been designed to provide reasonable assurance as to the
integrity and reliability of the financial statements and the safeguarding of
Company assets.
 
     The Company has established statements of corporate policy relating to
conflict of interest and conduct of business and annually receives from
appropriate employees confirmation of compliance with these policies.
 
     The Company's financial statements have been audited by KPMG Peat Marwick
LLP, independent certified public accountants. The independent accountants are
elected by the Company's Directors and report any recommendations concerning the
Company's system of internal control to the Audit Committee of the Board of
Directors. The Audit Committee meets periodically with Management, internal
auditors, and KPMG Peat Marwick LLP, to review and monitor the Company's
financial reporting, accounting practices, and business conduct.
 
     Although these are inherent limitations in any system of internal control,
management believes that as of September 30, 1998, the Company's system of
internal control was adequate to accomplish the objectives discussed herein.
 
<TABLE>
<S>                                            <C>
Roger A. Young                                 Thomas W. Sherman
Chairman of the Board and                      Chief Financial Officer
Chief Executive Officer
</TABLE>
 
                                       36
<PAGE>   37
 
                          INDEPENDENT AUDITORS' REPORT
 
The Board of Directors and Shareholders of
Bay State Gas Company
 
     We have audited the accompanying consolidated balance sheets and statements
of capitalization of Bay State Gas Company and subsidiaries as of September 30,
1998 and 1997, and the related consolidated statements of earnings,
shareholders' equity and cash flows for each of the years in the three-year
period ended September 30, 1998. These consolidated financial statements are the
responsibility of the Company's 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 audits 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 financial statements referred to above present fairly,
in all material respects, the financial position of Bay State Gas Company and
subsidiaries at September 30, 1998 and 1997, and the results of their operations
and their cash flows for each of the years in the three-year period ended
September 30, 1998 in conformity with generally accepted accounting principles.
 
     As discussed in Note 1 to the consolidated financial statements, the
Company changed its method of recognizing actuarial gains and losses for
postretirement benefit plans during 1998.
 
                                            /s/ KPMG PEAT MARWICK LLP
 
Boston, Massachusetts
October 27, 1998
 
                                       37
<PAGE>   38
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
 
     None.
 
                                    PART III
 
ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
<TABLE>
<CAPTION>
                    NAME AND AGE                              BUSINESS EXPERIENCE DURING PAST 5 YEARS
                    ------------                              ---------------------------------------
<S>                                                    <C>
Lawrence J. Finnegan, Age 67; Director since 1982;
  Term expires in 1999; Chairman of the Audit
  Committee and serves on the Corporate Governance
  Committee..........................................  Chairman of the Board of Directors, President and
                                                       Chief Executive Officer of Boston Mutual Life
                                                       Insurance Company, Canton, MA.
Douglas W. Hawes, Age 66; Director since 1992; Term
  expires in 1999; Northern Capacity ad hoc
  Committee..........................................  Lawyer; senior partner in the law firm of LeBoeuf,
                                                       Lamb, Greene & MacRae, L.L.P., New York, NY.;
                                                       Director of United Water Resources Inc., Harrington
                                                       Park, NJ.
John H. Larson, Age 68; Director since 1991; Term
  expires in 2000; Chairman of the Corporate
  Governance Committee and serves on the Compensation
  Committee and the Northern Capacity ad hoc
  Committee..........................................  Retired since 1989; President and Chief Executive
                                                       Officer of Connecticut Energy Corp., Bridgeport, CT,
                                                       prior thereto.; Director of Bolt Technology Corp.,
                                                       Norwalk, CT.
Jack E. McGregor, Age 64; Director since 1995; Term
  expires in 2001; Chairman of the Northern Capacity
  ad hoc Committee and Serves on the Audit Committee
  and Corporate Governance Committee.................  Since 1995, of Counsel to Cohen and Wolf, P.C., and
                                                       partner of Bridgeport Waterfront Investors, LLC.;
                                                       retired in 1996 as Chairman of the Board of Directors
                                                       of Aquarion Company, Bridgeport, CT, a water and
                                                       water-related services company; President and Chief
                                                       Executive Officer of Aquarion Company prior thereto;
                                                       Director of Aquarion Company; Director of People's
                                                       Bank, Bridgeport, CT.
Daniel J. Murphy III, Age 56; Director since 1986;
  Term expires in 1999; Chairman of the Compensation
  Committee and serves on the Audit Committee........  Chairman of the Board of Directors of Northmark Bank,
                                                       North Andover, MA.; Director of Watts Industries,
                                                       Inc., North Andover, MA.
</TABLE>
 
                                       38
<PAGE>   39
 
<TABLE>
<CAPTION>
                    NAME AND AGE                              BUSINESS EXPERIENCE DURING PAST 5 YEARS
                    ------------                              ---------------------------------------
<S>                                                    <C>
George W. Sarney, Age 59; Director since 1992; Term
  expires in 2000; Compensation Committee and the
  Corporate Governance Committee.....................  President of The Foxboro Company, Foxboro, MA, a
                                                       manufacturer of instruments and systems for
                                                       industrial process automation; President and Chief
                                                       Operating Officer of Siebe Control Systems, a
                                                       Division of Siebe PLC, Windsor, U.K., of which The
                                                       Foxboro Company is a part; Director of Siebe PLC and
                                                       Bowthorpe PLC; Senior Vice President of Raytheon
                                                       Company, Lexington, MA prior thereto.
Thomas W. Sherman, Age 58; Director since 1975; Term
  expires in 2000....................................  Executive Vice President, Chief Financial Officer and
                                                       Treasurer of the Company.
Charles H. Tenney II (a), Age 80; Director since
  1974; Term expires in 2000; Corporate Governance
  Committee..........................................  Retired since 1996 as Chairman of the Board of
                                                       Directors; Chief Executive Officer of the Company
                                                       1974-1990; Retired Chairman of the Board of Directors
                                                       and Chief Executive Officer of Fitchburg Gas and
                                                       Electric Light Company, Fitchburg, MA and UNITIL
                                                       Corporation, Hampton, NH.; Director of UNITIL
                                                       Corporation.
Roger A. Young (a), Age 52; Chairman of the Board of
  Directors since 1996; Director since 1975; Term
  expires in 1999....................................  Chief Executive Officer of the Company. President
                                                       until 1995.
</TABLE>
 
---------------
(a) Charles H Tenney II, Director, is the stepfather of Roger A. Young, Chairman
    of the Board of Directors.
 
     Information relating to the Executive Officers of the Registrant is
contained in Part 1, Item 1, Business.
 
SECTION 16(a)  BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
 
     Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors and executive officers to file reports with the Securities and
Exchange Commission (the "SEC") reflecting their ownership and changes in
ownership of the Company's Common Stock.
 
     Based on its review of reports of beneficial ownership and changes in
beneficial ownership required under Section 16(a), the Company believes that
during fiscal 1998 all of its directors and executive officers filed all reports
of beneficial ownership and changes in beneficial ownership required under
Section 16(a) on a timely basis.
 
ITEM 11.  EXECUTIVE COMPENSATION
 
COMPENSATION OF DIRECTORS
 
     Members of the Board of Directors who are not employees of the Company (the
"Outside Directors") currently receive an annual retainer fee of $11,000 and a
fee of $800 for attendance at each meeting of the Board. Effective January 1,
1997, the Company adopted the Bay State Gas Company Stock Accumulation Plan for
Outside Directors ("Stock Accumulation Plan") as a means to align the interests
of the Outside Directors of the Company or its subsidiaries more closely with
the interests of the Company's shareholders by paying a portion of their annual
retainer in Common Stock of the Company. Under terms of the Stock Accumulation
Plan, Outside Directors who do not have beneficial ownership of the Company's
Common Stock having a value at least equal to six times the annual retainer then
in effect (currently $66,000) will receive their annual retainer in shares of
Common Stock of equivalent value that will be credited to a stock
 
                                       39
<PAGE>   40
 
account for the benefit of such Directors and will vest, except for certain
automatic vesting provisions under the plan, upon completion of two (2) years of
service from the annual retainer payment date (the date of the Company's Annual
Meeting of Common Shareholders).
 
     According to the provisions of the plan, in fiscal 1998 Messrs. Hawes,
Larson, McGregor, Murphy and Sarney all had 292 shares of Bay State Gas Company
Common Stock credited to their respective stock accounts subject to the above
referenced two-year vesting period. All other Outside Directors received their
annual retainer in cash.
 
     Under the terms of the Plan, upon the occurrence of a "Change in Control"
of Bay State. including approval of a merger agreement by the Company's
shareholders, shares of common stock credited to each participant's Stock
Account immediately vest. On May 27, 1998, the Company's shareholders approved
the Merger Agreement with Industries. Subsequently, each Director in the plan
was paid the number of shares credited to his or her stock account together with
cash in an amount equal to all dividends which would have been paid or such
shares during the vesting period. Accordingly, Messrs. Larson, McGregor, Murphy,
and Sarney each received 697 shares of Company common stock and $1,193.45 in
cash equivalent of accumulated dividends, and Mr. Hawes received 292 shares of
common stock and cash of $233.60.
 
     Members of the various Board Committees currently receive an annual
Committee fee of $1,000 and a fee of $800 for attendance at each meeting of said
Committees. Members of any ad hoc Committee just receive a fee of $800 for
attendance at each meeting of said Committees. Directors who are employees of
the Company receive no fees as members of the Board or any Committee thereof.
All Directors are entitled to reimbursement of expenses incurred in connection
with attendance at meetings of the Board and any Committee on which they serve.
 
     Mr. Tenney is a former executive officer of the Company and served as such
until his resignation as an employee of the Company in 1992, at which time he
became a consultant to the Company pursuant to a Senior Advisory Agreement
between himself and the Company. The Senior Advisory Agreement between Mr.
Tenney and the Company was last extended on January 22, 1998 and has a two-year
term, subject to extension as provided therein. Under the terms of the current
Senior Advisory Agreement, Mr. Tenney received $72,500 plus reasonable and
normal business related expenses in fiscal 1998.
 
     Until January 22, 1998, the Company had a directors' advisory council
composed of retired members of the Company's Board of Directors known as a
Director Emeritus. Directors Emeriti have no right to vote on any action that
may come before the Board, nor is their presence counted for purposes of
determining a quorum. Directors Emeriti receive as compensation for such
advisory services an annual retainer of $11,000 and a fee of $800 for each Board
meeting attended, as well as reimbursement for any expenses incurred in
connection with attendance at any meeting. Retired Board members Endicott Smith
and Richard L. Brickley served as Directors Emeriti during the fiscal year.
 
DIRECTORS RETIREMENT PLAN
 
     In 1994, the Company adopted the Bay State Gas Company Directors'
Retirement Plan for the purpose of providing retirement income to Directors of
the Company who are not officers of the Company. The plan provides for (a) a
minimum of five years of service as a Director to qualify, (b) an annual benefit
equaling ten percent of final year's retainer times the number of years of
service up to a maximum benefit equaling one hundred percent of final year's
retainer, (c) the benefit to be paid for the remainder of the life of said
Director but in no event for a period of time longer than the number of years of
service as a Director and (d) payments to begin at the later of retirement as a
Director, end of service as Director Emeritus, or age 65. Effective January 22,
1998, Endicott Smith, Richard L. Brickley and Walter C. Ivancevic qualified for
this plan. They each received benefits of $8,250 under this plan in fiscal 1998.
 
                                       40
<PAGE>   41
 
                             EXECUTIVE COMPENSATION
 
REPORT OF THE COMPENSATION COMMITTEE
 
     This report outlines the framework used for making compensation decisions,
the Company's management compensation philosophy, and the criteria used for
making compensation decisions in fiscal 1998 regarding the Chief Executive
Officer (CEO) and the other executive officers named in the Summary Compensation
Table below (the "Named Officers").
 
  Framework for Compensation Decisions
 
     The Board of Directors (the "Board") has overall responsibility for the
Company's compensation and benefit programs. The Board has appointed the
Compensation Committee (the "Committee"), consisting entirely of non-employee
Directors, to facilitate its fulfillment of this responsibility. The Committee
administers the Company's salary program, Profit Sharing Plan, and the Stock
Performance Sharing Plan, and reviews and recommends for Board approval all
decisions relating to the compensation of the CEO and all other officers.
Decisions relating to all other officers' compensation are based on
recommendations of the CEO, as reviewed and approved by the Committee.
 
  Philosophy of Management Compensation
 
     The Company manages its compensation philosophy and programs to accurately
reflect its competitive business environment and growth-oriented culture. The
pay philosophy and programs strengthen the linkage between executive pay and
Company performance.
 
     The Company has an aggressive goal to significantly improve shareholder
value by being an industry growth leader under deregulation. To assist in
accomplishing this goal the Company has compensation programs that link
executive pay to Company performance relative to: 1) its financial targets, and
2) the performance of a selected peer group of companies who are aggressively
managing issues under deregulation. When Company performance exceeds or falls
below: 1) its financial targets or 2) that of the selected peer group companies,
by design of the Company's compensation programs, the executives' overall
compensation levels will exceed or fall below competitive levels respectively.
 
  Criteria Used for Making Compensation Decisions in Fiscal 1998
 
     On January 22, 1998, the Board of Directors established the Office of the
Chief Executive and appointed Roger A. Young, Chairman of the Board of
Directors, and Joel L. Singer, President, to serve as Co-Chief Executive
Officers ("Co-CEOs".) Mr. Singer served in this capacity until his resignation
on September 18, 1998. Mr. Young was subsequently reappointed CEO.
 
  Base Salary
 
     Each year the Company, with the assistance of an outside consulting firm,
reviews various salary surveys to confirm that compensation levels for executive
officers are consistent with competitive practices in: 1) general industry; 2)
the gas utility industry; and 3) other companies in the Company's geographic
area. Salary increases are based on an individual's performance and his or her
current compensation compared to competitive market compensation.
 
     The Committee recommended and the Board approved, effective January 1,
1998, merit increases in base salaries for each of the Named Officers based on
successful achievement of specific quantitative and qualitative measures
including: growth in earnings per share and net gas sales; reduced operating,
maintenance, and capital expenses; regulated community leadership; and
achievement of major change initiatives.
 
     In evaluating the performance of the Co-CEOs, the Committee noted that
quantifiable objectives were met or exceeded in the areas listed above. The
Committee further noted accomplishment in the areas of: financial results
realized through the sale of MASSPOWER cogeneration facility; growing of new
products
 
                                       41
<PAGE>   42
 
and services through the acquisition of SavageAlert, Inc.; and the building of a
significant new business partnership.
 
     Based on the above results, the Committee recommended and the Board
approved a $25,000 increase in Mr. Young's base salary and a $22,500 increase in
Mr. Singer's base salary, effective January 1, 1998. With the appointment of
Joel L. Singer as President and Co-Chief Executive Officer on January 22, 1998,
the Committee recommended and the Board approved an additional increase of
$46,500 in Mr. Singer's base salary.
 
  Profit Sharing Plan
 
     Bonuses paid under the Profit Sharing Plan are recommended by the Committee
and approved by the Board based on a specified formula. Target awards for the
CEO and Named Officers range from 30% to 50% of base salary. Actual awards have
the potential of ranging from 0% to 200% of target (300% of target for
EnergyUSA), based on corporate and business unit performance.
 
     The Committee established corporate performance targets in three different
areas for the CEO and the Named Officers. These measures included: financial
(earnings per share) and non-financial performance (customer satisfaction and
safety) against predetermined targeted levels, and major change initiatives.
 
     Mr. Young's Profit Sharing Award of $180,000, which was 100% of the target,
was based on the achievement of targeted earnings and the building of a
significant new business partnership. In accordance with the Profit Sharing Plan
document, Mr. Singer did not receive an award because he was not employed by the
Company at the time of the actual payment.
 
  Stock Performance Sharing Plan
 
     The Committee recommends and the Board approves annual awards of
performance shares granted to all executive officers and certain exempt
employees. The performance shares granted to the Co-CEOs and the other Named
Officers were awarded as part of the officers' total compensation based on
competitive analysis and the recommendations of an outside consulting firm. The
number of performance shares granted to each of the Co-CEOs in fiscal 1998 was
14,000.
 
     In accordance with the Stock Performance Sharing Plan's "Change of Control"
provision, upon shareholder approval of the Merger Agreement with NIPSCO
Industries, Inc. on May 27, 1998, Messrs. Young and Singer's outstanding
performance shares vested and they received payments of $767,956 and $566,422,
respectively, representing the cash equivalent of 50% of their outstanding
performance shares under this Plan. (See "Long-Term Compensation -- Stock
Performance Sharing Plan".)
 
COMPENSATION COMMITTEE
Daniel J. Murphy III, Chairman
John H. Larson
George W. Sarney
 
                                       42
<PAGE>   43
 
PERFORMANCE GRAPH
 
     The following table shows a line graph comparing the yearly percentage
change in the cumulative total return assuming price appreciation and
reinvestment of dividends for the Company's Common Stock, the S&P 500 Index,
which is a broad equity market index, and the Edward Jones Gas Distribution
Index, a published industry index consisting of natural gas distribution
companies weighted by market capitalization which includes the Company.
 
                COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN
      BAY STATE GAS, S&P 500 INDEX AND EDWARD JONES GAS DISTRIBUTION INDEX

                                  [LINE GRAPH]
 
<TABLE>
<CAPTION>
                                      BAY STATE GAS                          EDWARD JONES GAS
                                         COMPANY         S & P 500 INDEX    DISTRIBUTION INDEX
<S>                                 <C>                 <C>                 <C>
SEP-93                                     100                 100                 100
SEP-94                                      92                 104                  87
SEP-95                                      95                 135                  98
SEP-96                                     111                 162                 117
SEP-97                                     128                 227                 137
SEP-98                                     179                 248                 154
</TABLE>
 
     E. D. Jones & Co. Gas Distribution Index includes the following companies:
AGL Resources, Atmos Energy, Bay State Gas, Berkshire Gas, Cascade Natural Gas,
Colonial Gas, Connecticut Energy, Corning Natural Gas, CTG Resources, Delta
Natural Gas, Energy West, Energynorth, Energysouth, Essex County Gas, Fall River
Gas, Indiana Energy, Laclede Gas, New Jersey Resources, North Carolina Natural
Gas, Northwest Natural Gas, NUI, Pennsylvania Enterprises, Peoples Energy,
Piedmont Natural Gas, Providence Energy, Public Service of NC, Roanoke Gas,
South Jersey Industrials, Southern Union, Washington Gas Light, and Yankee
Energy System.
 
                                       43
<PAGE>   44
 
COMPENSATION OF OFFICERS
 
     The following table shows all compensation awarded to, earned by or paid to
the Chief Executive Officer of the Company and each of the other four most
highly compensated executive officers of the Company for services rendered in
all capacities to the Company and its subsidiaries for each of the past three
fiscal years ended September 30, 1996, 1997 and 1998.
 
                           SUMMARY COMPENSATION TABLE
 
<TABLE>
<CAPTION>
                                                                           LONG-TERM
                                            ANNUAL COMPENSATION           COMPENSATION
                                     ---------------------------------    ------------
                                                             OTHER
                                                             ANNUAL           LTIP        ALL OTHER
                                     SALARY      BONUS    COMPENSATION      PAYOUTS      COMPENSATION
NAME AND PRINCIPAL POSITION  YEAR      ($)      ($)(A)       ($)(B)          ($)(C)         ($)(D)
---------------------------  ----    -------    -------   ------------    ------------   ------------
<S>                          <C>     <C>        <C>       <C>             <C>            <C>
Roger A. Young.............  1998    353,750    180,000       5,788         767,956          36,305(e)
  Chairman of the Board &    1997    332,500    238,855       1,196              --          21,595
  Chief Executive Officer    1996    307,733     98,293       2,259              --          17,854
Joel L. Singer.............  1998    287,146         --         420         566,422       1,948,540(f)
  President & Chief          1997    236,250    171,120         137              --           7,584
  Operating Officer          1996    217,500     73,560          19              --           1,237
Thomas W. Sherman..........  1998    188,875     57,600       1,972         236,226          16,257(g)
  Executive Vice             1997    177,000     76,790         463              --          12,356
  President, Treasurer &     1996    167,875     32,884       1,004              --          10,716
  Chief Financial Officer
William L. Glascock........  1998    177,625     36,100       1,039         158,900           7,134(h)
  Senior Vice President      1997    135,783     78,512      39,327              --           1,404
                             1996         --         --          --              --              --
James D. Simpson...........  1998    140,925     58,850          --         187,477           6,602(i)
  Senior Vice President      1997    132,550     50,000          --              --           7,751
                             1996    119,350     24,605          --              --           4,281
Thomas J. Aruffo...........  1998    133,090     66,496          --          33,103             495(j)
  Vice President             1997         --         --          --              --              --
                             1996         --         --          --              --              --
</TABLE>
 
---------------
 
NOTES:
 (a) Includes awards pursuant to the Profit Sharing Plan which are shown for the
     fiscal year upon which performance was measured (see "Report of the
     Compensation Committee -- Profit Sharing Plan") and any other special or
     extraordinary bonus earned during the fiscal year.
 
(b) Unless otherwise indicated, "Other Annual Compensation" includes interest in
    excess of 120% of the applicable Federal long-term rate ("above-market
    interest") on compensation paid or payable during the fiscal year but
    deferred at the officer's election pursuant to the Key Employee Deferred
    Compensation Plan ("KEDCP").
 
 (c) The indicated payments were made upon a "change of control" as defined in
     the Company's Stock Performance Sharing Plan for long-term incentive plan
     awards made in fiscal 1996, 1997, and 1998 (see "Long-Term
     Compensation-Stock Performance Sharing Plan".)
 
(d) "All Other Compensation" includes the following: (i) employer matching
    contributions under the Company's Employee Savings Plan ("ESP"), (ii)
    above-market interest earned during the fiscal year on compensation deferred
    prior to the fiscal year pursuant to the KEDCP and (iii) term life insurance
    premiums paid by the employer for the benefit of the Named Officers.
 
 (e) Included for Mr. Young is an employer contribution of $5,000 under the ESP
     and above-market interest of $30,250 and a term life insurance premium of
     $1,055.
 
                                       44
<PAGE>   45
 
 (f) Included for Mr. Singer is a severance payment of $1,940,440 paid in fiscal
     1998 upon his resignation as President and Co-Chief Executive Officer of
     the Company (see "Severance Agreements".) Also included for Mr. Singer is
     an employer contribution of $6,577 under the ESP, above market interest of
     $496 and a term life insurance premium $1,027.
 
 (g) Included for Mr. Sherman is an employer contribution of $4,199 under the
     ESP, above-market interest of $11,283 and a term life insurance premium of
     $775.
 
(h) Included for Mr. Glascock is an employer contribution of $6,203 under the
    ESP, above market interest of $203 and a term life insurance premium of
    $728.
 
 (i) Included for Mr. Simpson is an employer contribution of $5,998 under the
     ESP and a term life insurance premium of $604.
 
 (j) Included for Mr. Aruffo is a term life insurance premium of $495.
 
                        OTHER COMPENSATION ARRANGEMENTS
 
STOCK OPTIONS
 
  Key Employee Stock Option Plan
 
     The Company has in effect a Key Employee Stock Option Plan ("KESOP") to
provide for grants of options to key employees to purchase Common Stock of the
Company. In fiscal 1998 the Board approved the granting of options under the
KESOP to new employees of the Company and its subsidiaries. No stock options
were granted to any named executive officer in the Summary Compensation Table in
fiscal 1998 pursuant to the KESOP.
 
     Options granted under the KESOP have been entirely non-qualified stock
options. The maximum exercise period for any option is ten years. The option
price per share for options granted under the KESOP was determined at 100% of
the fair market value of the closing price for the Common Stock on the New York
Stock Exchange as of the date preceding the date the option was granted. All
options granted to named executive officers in the Summary Compensation Table
under the KESOP are presently exercisable.
 
     The following table provides information with respect to options to
purchase shares of the Company's Common Stock exercised in fiscal 1998 and the
value of unexercised options granted in prior years under the KESOP to the named
executive officers in the Summary Compensation Table and held by them as of
September 30, 1998. The Company has no compensation plan under which SARs are
granted.
 
              AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
                         FISCAL YEAR-END OPTION VALUES
 
<TABLE>
<CAPTION>
                                                      NUMBER OF SECURITIES          VALUE OF UNEXERCISED
                                                     UNDERLYING UNEXERCISED        IN-THE-MONEY OPTIONS AT
                            SHARES                 OPTIONS AT FISCAL YEAR-END          FISCAL YEAR-END
                          ACQUIRED ON    VALUE                 (#)                         ($)(b)
                           EXERCISE     REALIZED   ---------------------------   ---------------------------
          NAME                (#)        ($)(a)    EXERCISABLE   UNEXERCISABLE   EXERCISABLE   UNEXERCISABLE
          ----            -----------   --------   -----------   -------------   -----------   -------------
<S>                       <C>           <C>        <C>           <C>             <C>           <C>
Roger A. Young..........       0           $0        108,000        0            $2,025,750         $0
Joel L. Singer..........       0            0              0        0                     0          0
Thomas W. Sherman.......       0            0         53,000        0            $  978,563          0
William L. Glascock.....       0            0              0        0                     0          0
James D. Simpson........       0            0          4,500        0            $   76,219          0
Thomas J. Aruffo........       0            0              0        0                     0          0
</TABLE>
 
---------------
 
NOTES:
(a) Fair market value of the shares acquired on the date of exercise minus the
    exercise price of the options.
 
(b) Represents the difference between the exercise prices of the options and the
    closing price of $38.9375 for the Company's Common Stock as quoted by the
    New York Stock Exchange ("NYSE") on September 30, 1998 times the number of
    options held.
 
                                       45
<PAGE>   46
 
LONG-TERM COMPENSATION
 
  Stock Performance Sharing Plan
 
     The Company has in effect a Stock Performance Sharing Plan, Amended and
Restated effective October 1, 1997, and further amended on March 4, 1998. The
Stock Performance Sharing Plan provides for the award of performance shares,
exchangeable for shares of the Company's Common Stock in accordance with the
terms of the Stock Performance Sharing Plan, to eligible employees. The Stock
Performance Sharing Plan is intended to promote the interests of the Company by
providing long-term performance incentives to certain employees and by
increasing the opportunity for ownership in the Company by those employees who
are directly responsible for the management, growth and success of the Company's
business.
 
     Performance shares are awarded under the Stock Performance Sharing Plan
upon the recommendation of the Compensation Committee and approval by the Board
of Directors. Awards may be granted as of October 1 of each year from 1994
through 2003. An employee to whom an award has been made becomes vested and
entitled to payment of all or a portion of the performance shares subject to the
award at the end of the three-year period beginning on the date the award is
granted (the "Performance Period") depending on the Company's total return to
shareholders for the Performance Period. The percentage of the award to which
the employee becomes entitled is determined by the Company's performance in
relation to companies listed in the Edward Jones Gas Distribution Index.
Performance shares will, upon vesting, be exchangeable for (i) a cash payment of
equivalent value and (ii) a cash payment equal to the dividends that would have
been paid on such Stock during the Performance Period.
 
     Under the terms of the Plan, as amended, if a "Change of Control" of the
Company occurs, including approval of a merger agreement by the Company's
Shareholders, during a Performance Period, an employee to whom an award has been
made for that Performance Period becomes vested and entitled to immediate
payment of the cash equivalent of 50% of the performance shares subject to the
award. On May 27, 1998, the Company's Shareholders approved the Merger Agreement
with Industries.
 
     The following table provides information with respect to the share payouts
under the Stock Performance Sharing Plan for awards of performance shares
granted in fiscal 1998 to the named executive officers in the Summary
Compensation Table.
 
                      LONG-TERM INCENTIVE PLANS -- AWARDS
                              IN LAST FISCAL YEAR
 
<TABLE>
<CAPTION>
                                                                                  PAYOUTS UNDER
                                                               PERFORMANCE          NON-STOCK
                                                NUMBER OF     PERIOD UNTIL      PRICED-BASED PLANS
                                                 SHARES       MATURATION OR           TARGET
                     NAME                          (#)           PAYOUT               ($)(A)
                     ----                       ---------    ---------------    ------------------
<S>                                             <C>          <C>                <C>
Roger A. Young................................   14,000      10/1/97-5/27/98         $264,250
Joel L. Singer................................   14,000      10/1/97-5/27/98         $264,250
Thomas W. Sherman.............................    4,000      10/1/97-5/27/98         $ 75,500
William L. Glascock...........................    4,000      10/1/97-5/27/98         $ 75,500
James D. Simpson..............................    4,000      10/1/97-5/27/98         $ 75,500
Thomas J. Aruffo..............................    1,700      10/1/97-5/27/98         $ 32,088
</TABLE>
 
---------------
NOTES:
 
(a) Target refers to the amount payable if the specified performance target is
    reached. Pursuant to the Plan, the specified performance share target is the
    50th percentile. The indicated cash payout was determined by multiplying 50%
    of the number of performance shares by the closing price of $37.75 for the
    Company's common stock as quoted by the NYSE on May 26, 1998, the day before
    shareholder approval of the Merger Agreement with Industries.
 
                                       46
<PAGE>   47
 
RETIREMENT PLANS
 
     The Company has in effect a funded, qualified Pension Plan and related
Trust Agreement, which Plan provides retirement benefits for all non-union
employees, including all officers. No amounts were set aside or allocated for
the benefit of any of the named executive officers in the Summary Compensation
Table under any pension or retirement plan except for unidentified amounts paid
into the Trust pursuant to the Plan. Directors who are not, or have not been,
officers of the Company or Northern do not participate in the Plan.
 
     The formula for determining annual benefits under the life annuity option
of the Plan is (a) 1.4% of average annual earnings (average annual earnings
during the three consecutive years of employment that are the highest average
earnings) up to the Covered Compensation (thirty-five year average of the Social
Security taxable wage bases ending with the last day of the calendar year in
which the employee attains or will attain Social Security retirement age) amount
for each of the first twenty-five years of benefit service, plus (b) 1.875% of
average annual earnings in excess of the Covered Compensation amount for each of
the first twenty-five years of benefit service, plus (c) .5% of average annual
earnings for benefit service greater than twenty-five years, minus (d) any
affiliated plan benefit. Average annual earnings includes incentive compensation
and overtime pay up to certain limits and 100% of sales commissions. All salary
and Profit Sharing Plan bonuses listed in the Summary Compensation Table are
included in the calculation of average annual earnings for the named executive
officers. The average annual earnings used for computing qualified pensions are
subject to a $160,000 limitation on earnings in 1998. Messrs. Young, Singer,
Sherman, Glascock, Simpson and Aruffo have 30, 3, 32, 2, 17 and 1 credited
year(s) of benefit service, respectively, under the Plan.
 
     In 1986 the Company adopted a Supplemental Executive Retirement Plan
("SERP"), a non-qualified defined benefit plan which provides for supplemental
retirement benefits to certain officers. The Chairman of the Board of Directors,
the President, and Vice Presidents of the Company who are approved for
participation in the SERP by the Compensation Committee are designated as
eligible for benefits under the SERP. The formula for determining annual
benefits under the life annuity option of the SERP is 4% of average annual
earnings (average annual earnings during the three consecutive years of
employment that are the highest average earnings) for each of the first fifteen
years of benefit service minus the benefit payable under any qualified Pension
Plan covering such persons.
 
     The following table sets forth, for various years of service and average
compensation levels, estimated combined annual amounts payable upon retirement
to those executive officers who are participants in both the applicable Pension
Plan and the SERP, assuming continued active service until retirement at age 65
and that the present Pension Plan and the SERP are in effect at such time.
 
                               PENSION PLAN TABLE
 
<TABLE>
<CAPTION>
    AVERAGE       15 YEARS OF   20 YEARS OF   25 YEARS OF   30 YEARS OF   35 YEARS OF
ANNUAL EARNINGS     SERVICE       SERVICE       SERVICE       SERVICE       SERVICE
---------------   -----------   -----------   -----------   -----------   -----------
<S>               <C>           <C>           <C>           <C>           <C>
   $125,000        $ 75,000      $ 75,000      $ 75,000      $ 75,000      $ 75,000
    150,000          90,000        90,000        90,000        90,000        90,000
    175,000         105,000       105,000       105,000       105,000       105,000
    200,000         120,000       120,000       120,000       120,000       120,000
    225,000         135,000       135,000       135,000       135,000       135,000
    250,000         150,000       150,000       150,000       150,000       150,000
    300,000         180,000       180,000       180,000       180,000       180,000
    400,000         240,000       240,000       240,000       240,000       240,000
    450,000         270,000       270,000       270,000       270,000       270,000
    500,000         300,000       300,000       300,000       300,000       300,000
</TABLE>
 
SEVERANCE AGREEMENTS
 
     The Company has entered into severance agreements with various key
employees, including each of the executive officers of the Company named in the
Summary Compensation Table. The intent of the severance
 
                                       47
<PAGE>   48
 
agreements is to assure continuity in the Company's administration and
operations in the event of a Change in Control (as hereinafter described).
 
     Each severance agreement provides that the employee's stipulated
compensation, benefits, position, responsibilities and other conditions of
employment will not be reduced during the term of the agreement. The term of
each agreement is for either 12, 24 or 36 months, effective upon the date on
which a Change in Control of the Company occurs. Each of the executive officers
named in the Summary Compensation Table is party to a severance agreement having
a term of 36 months. A Change in Control is defined as occurring when (i) any
person, group, corporation, or other entity is the beneficial owner, directly or
indirectly, of 25% or more of the Common Stock of the Company; (ii) any person
other than the Company purchases shares pursuant to a tender offer or exchange
offer to acquire any Common Stock of the Company (or securities convertible into
Common Stock) for cash, securities or any other consideration, provided that
after consummation of the offer, the Person in question is the beneficial owner
(as such term is defined in Rule 13d-3 under the Exchange Act), directly or
indirectly, of 25% or more of the outstanding Common Stock; (iii) the
shareholders of the Company approve any consolidation or merger of the Company
in which the Company is not the continuing or surviving corporation or pursuant
to which the shares of Common Stock would be converted into cash, securities or
other property or any sale, lease, exchange or other transfer of all or
substantially all of the Company's assets; or the Company is the continuing or
surviving corporation but in which the common shareholders of the Company
immediately prior to the consolidation or merger do not hold at least a majority
of the outstanding Common Stock of the corporation which owns all of the Common
Stock of the Company; or where, after the merger or consolidation, one Person
owns 100% of the shares of stock of the Company (except where the common holders
of the Company's stock immediately prior to such merger or consolidation own at
least 90% of the outstanding stock of such Person immediately after such merger
or consolidation) or (iv) there is a change in a majority of the members of the
Company's Board of Directors within a 25-month period unless approved by
two-thirds of the Directors then still in office who were in office at the
beginning of the 25-month period. Each agreement further provides that in the
event (i) the employee's employment is terminated by the Company, except for the
employee's acceptance of a position with another company or for cause; or (ii)
the employee terminated employment due to (a) a material change in the
employee's responsibilities, (b) assignment to a location more than 50 miles
from the current place of employment, (c) liquidation, merger, or sale of all or
substantially all of the assets of the Company, unless the successor corporation
has a net worth at least equal to that of the Company, (d) reduction in total
compensation, or (e) any other material breach of the agreement by the Company,
the employee is entitled to a severance benefit. The amount payable to the
employee upon the occurrence of any of the foregoing events is a lump sum cash
amount equal to (i) the present value of either one, two or three years' base
salary and bonus; (ii) the present value of the additional amount the employee
would have received under the Pension Plan, and the SERP if applicable, if the
employee had continued to be employed for such 12, 24 or 36 month period; and
(iii) the present value of contributions that would have been made by the
Company under the ESP and Deferred Compensation Plan if the employee had been
employed for such 12, 24 or 36 month period. Each agreement also provides for
the continuation of all employee benefits for a period of 12, 24 or 36 months.
In addition, for those employees covered by a 36 month agreement, the Company is
required to make an additional payment to the employee sufficient on an
after-tax basis to satisfy any tax liability incurred under the "parachute" tax
rules of the Internal Revenue Code. Subsequent to Mr. Singer's resignation,
effective September 18, 1998, as President and Co-Chief Executive Officer of the
Company, Mr. Singer was paid a severance payment of $1,940,440.
 
     On May 27, 1998, the Company's Shareholders approved the Merger Agreement
with Industries which constitutes a change of control as defined above. The
Company has no intention of taking any action which would result in payments
being owed under the severance agreements.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
SECURITY OWNERSHIP OF MANAGEMENT
 
     The following table shows, as of December 31, 1998, the number of equity
securities beneficially owned by each Director, by each of the named executive
officers in the Summary Compensation Table and by all
 
                                       48
<PAGE>   49
 
directors and executive officers of the Company as a group, together with the
percentage of the outstanding shares of the applicable class of equity
securities.
 
<TABLE>
<CAPTION>
                                                              AMOUNT AND NATURE OF
                                                              BENEFICIAL OWNERSHIP
                                                              --------------------      PERCENT OF
                      BENEFICIAL OWNER                          COMMON STOCK(a)           CLASS
                      ----------------                        --------------------      ----------
<S>                                                           <C>                       <C>
Thomas J. Aruffo............................................              0                0.00%
Lawrence J. Finnegan........................................          6,141                0.05%
William L. Glascock.........................................            401(d)             0.00%
Doug1as W. Hawes............................................          1,292                0.01%
John H. Larson..............................................          2,141(c)             0.02%
Jack E. McGregor............................................          2,116                0.02%
Daniel J. Murphy III........................................          3,148                0.02%
George W. Sarney............................................          1,697                0.01%
Thomas W. Sherman...........................................         56,277(b)(d)(e)       0.41%
James D. Simpson............................................          4,549(b)(d)          0.03%
Joel L. Singer..............................................              0                0.00%
Charles H. Tenney II........................................        557,132(b)(d)(f)       4.08%
Roger A. Young..............................................        108,631(b)(d)          0.80%
Directors and executive officers of the Company as a group
  (19 persons)..............................................        800,065                5.78%
</TABLE>
 
---------------
NOTES:
(a) Based on information furnished to the Company by the nominees and continuing
    Directors and executive officers of the Company. The calculation of
    percentages shown herein is based on the total outstanding shares of the
    applicable class of equity securities, except for Messrs. Young, Sherman,
    Simpson, and Tenney, and all Directors and executive officers of the Company
    as a group, where the percentage is based on the total outstanding shares of
    such Stock plus shares which such individuals have the right to acquire
    pursuant to the Company's Key Employee Stock Option Plan ("KESOP"). There
    are a total of 273,250 shares (1.97%) reflected in beneficial ownership
    which various officers have the right to acquire pursuant to the KESOP.
    Except as noted, each of said Directors and executive officers has voting
    and investment power with respect to shares beneficially owned.
 
(b) Included are 90,000, 49,500, 4,500 and 90,000 shares which Messrs. Young,
    Sherman, Simpson and Tenney, respectively, have the right to purchase
    pursuant to the exercise of options under the KESOP (see "Stock
    Options -- Key Employee Stock Option Plan"); they have no voting power with
    respect to these shares until the shares are purchased.
 
(c) Included are 1,444 shares which are owned by Mr. Larson's wife. He has no
    voting or investment power with respect to these shares.
 
(d) Included are 13,616; 4,320; 401; 49; and 18,692 shares which are held in
    trust for Messrs. Young, Sherman, Glascock, Simpson and Tenney,
    respectively, under the terms of the Employee Savings Plan; they have voting
    power only with respect to the shares credited to their accounts.
 
(e) Included are 600 shares held by Mr. Sherman as trustee for his parents.
 
(f) Included are 294,369 shares (2.15%) owned by two trusts in which Mr. Tenney
    has a 1/6 beneficial interest and of which he is Co-Trustee with shared
    voting and investment power, which shares are voted pro rata in accordance
    with the wishes of each of the beneficiaries thereof. Mr. Tenney disclaims
    beneficial ownership of such shares other than such 1/6 beneficial interests
    in both trusts. Also included are 60 shares which are owned by Mr. Tenney's
    wife. He has no voting or investment power with respect to, and no
    beneficial interest in, these shares.
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     In fiscal 1998 the Company, Northern and Granite retained the legal
services of the firm of LeBoeuf, Lamb, Greene & MacRae, L.L.P., of which Douglas
W. Hawes, a Director of the Company, is a senior
 
                                       49
<PAGE>   50
 
partner. The firm of LeBoeuf, Lamb, Greene & MacRae, L.L.P., has acted as legal
counsel for the Company on various matters for many years and is expected to be
retained by the Company in this capacity in the future.
 
     The Company believes that the transactions described herein have been on
terms representing competitive market prices which are as favorable to the
Company and its subsidiaries as those available from third party entities.
 
                                    PART IV
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
(a) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THE REPORT:
 
     (1) The following financial statements are included herein under Part II,
         Item 8, Financial Statements and Supplementary Data
 
     Consolidated Statements of Earnings for the Years ended September 30, 1998,
     1997, and 1996
     Consolidated Balance Sheets as of September 30, 1998 and 1997
     Consolidated Statements of Capitalization as of September 30, 1998 and 1997
     Consolidated Statements of Shareholders' Equity for the Years ended
     September 30, 1998, 1997, and 1996
     Consolidated Statements of Cash Flows for the Years ended September 30,
     1998, 1997, and 1996 Independent Auditors' Report
 
     (2) The following additional data should be read in conjunction with the
         financial statements included in Part II, Item 8, Financial Statements
         and Supplementary Data. Schedules not included herein have been omitted
         because they are not required or are not applicable, or the required
         information is shown in such financial statements or notes thereto.
 
<TABLE>
<CAPTION>
                                                              PAGES IN
                                                              FORM 10-K
                                                              ---------
<S>                                                           <C>
VIII  Consolidated Valuation and Qualifying
  Accounts -- 1998, 1997, and 1996
</TABLE>
 
     (3) Exhibits -- See Exhibit index on page 53.
 
(b) REPORTS ON FORM 8-K:
 
     The Company did not file a report on Form 8-K during the fourth quarter of
fiscal 1998.
 
     Subsequent to September 30, 1998, a report on Form 8-K was filed November
16, 1998. See Exhibit 10.09.
 
                                       50
<PAGE>   51
 
                                                                   SCHEDULE VIII
 
                             BAY STATE GAS COMPANY
 
                 CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
                 YEARS ENDED SEPTEMBER 30, 1998, 1997, AND 1996
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                              ADDITIONS
                                               BALANCE AT     CHARGED TO                     BALANCE AT
                                              BEGINNING OF    COSTS AND                        END OF
                DESCRIPTION                      PERIOD        EXPENSE      DEDUCTIONS(a)      PERIOD
                -----------                   ------------    ----------    -------------    ----------
<S>                                           <C>             <C>           <C>              <C>
YEAR ENDED SEPTEMBER 30, 1998
  Allowance for doubtful accounts...........     $4,138         $5,577         $5,302          $4,413
                                                 ======         ======         ======          ======
YEAR ENDED SEPTEMBER 30, 1997
  Allowance for doubtful accounts...........     $3,557         $6,429         $5,848          $4,138
                                                 ======         ======         ======          ======
YEAR ENDED SEPTEMBER 30, 1996
  Allowance for doubtful accounts...........     $4,232         $5,444         $6,119          $3,557
                                                 ======         ======         ======          ======
</TABLE>
 
---------------
(a) Write-off of uncollectible accounts, net of recoveries.
 
                                       51
<PAGE>   52
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) 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.
 
                                            BAY STATE GAS COMPANY
 
                                            By    /s/ THOMAS W. SHERMAN
 
                                             -----------------------------------
                                                      THOMAS W. SHERMAN
                                                  EXECUTIVE VICE PRESIDENT
 
Date:  January 12, 1999
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
                     SIGNATURE                                  CAPACITY                    DATE
                     ---------                                  --------                    ----
<S>                                                  <C>                              <C>
 
/s/ ROGER A. YOUNG                                   Chairman of the Board; Chief     January 12, 1999
---------------------------------------------------  Executive Officer; Director
ROGER A. YOUNG
(CHAIRMAN OF THE BOARD)
 
/s/ THOMAS W. SHERMAN                                Chief Financial and Accounting   January 12, 1999
---------------------------------------------------  Officer; Director
THOMAS W. SHERMAN
(EXECUTIVE VICE PRESIDENT)
 
/s/ LAWRENCE J. FINNEGAN                             Director                         January 12, 1999
---------------------------------------------------
LAWRENCE J. FINNEGAN
 
/s/ DOUGLAS W. HAWES                                 Director                         January 12, 1999
---------------------------------------------------
DOUGLAS W. HAWES
 
/s/ JOHN H. LARSON                                   Director                         January 12, 1999
---------------------------------------------------
JOHN H. LARSON
 
/s/ JACK E. MCGREGOR                                 Director                         January 12, 1999
---------------------------------------------------
JACK E. MCGREGOR
 
/s/ DANIEL J. MURPHY III                             Director                         January 12, 1999
---------------------------------------------------
DANIEL J. MURPHY III
 
/s/ GEORGE W. SARNEY                                 Director                         January 12, 1999
---------------------------------------------------
GEORGE W. SARNEY
 
/s/ CHARLES H. TENNEY II                             Director                         January 12, 1999
---------------------------------------------------
CHARLES H. TENNEY II
</TABLE>
 
                                       52
<PAGE>   53
 
                                 EXHIBIT INDEX
 
(3) Articles of incorporation and by-laws:
 
<TABLE>
<CAPTION>
  EXHIBIT
    NO.                      DESCRIPTION                                REFERENCE
  -------                    -----------                                ---------
<S>            <C>                                       <C>
*3.1           Articles of Incorporation                 Exhibit 3.1 to Form 10-Q
                                                         dated February 9, 1995
                                                         (File No. 1-7479)
*3.2           By-Laws, as amended                       Exhibit 3.2 to Form 10-Q
                                                         dated May 2, 1996
                                                         (File No. 1-7479)
</TABLE>
 
---------------
 
* Incorporated by reference to the indicated filing.
 
(4) Instruments defining the rights of security holders, including indentures:
 
     The following is a listing of debt instruments defining the rights of
security holders, including indentures and/or note agreements for Bay State,
Northern, and Granite. None of these instruments represent any securities in an
amount authorized or outstanding which exceeds 10 % of the total assets of the
Company as of September 30, 1998. The Company will furnish the Securities and
Exchange Commission with copies of any of the instruments listed below upon
request.
 
     Revolving Credit Agreement between Northern and The First National Bank of
Boston, to borrow up to $20,000,000, dated as of March 17, 1997, due March 17,
2001.
 
     Indenture between Bay State and The First National Bank of Boston, Trustee,
dated as of April 1, 1991, for Senior Unsecured Debt Securities under which the
following Notes have been issued under a Prospectus dated April 18, 1991:
 
<TABLE>
<S>  <C>
-    $8,500,000 Principal Amount of 9.20% Notes due June 6, 2011
     $12,000,000 Principal Amount of 8.15% Notes due August 26,
-    2022
     $4,000,000 Principal Amount of 7.55% Notes due November 1,
-    2002
     $1,000,000 Principal Amount of 7.55% Notes due October 2,
-    2002
     $5,000,000 Principal Amount of 7.45% Notes due December 16,
-    2002
     $5,000,000 Principal Amount of 7.38% Notes due December 31,
-    2002
     $7,000,000 Principal Amount of 7.375% Notes due November 1,
-    2002
     $1,000,000 Principal Amount of 7.375% Notes due December 31,
-    2002
     $5,000,000 Principal Amount of 7.37% Notes due December 31,
-    2002
     $20,000,000 Principal Amount of 7.25% Notes due August 5,
-    2002
</TABLE>
 
     Indenture between Bay State and The First National Bank of Boston, Trustee,
dated as of April 1, 1991, for Senior Unsecured Debt Securities under which the
following Notes have been issued under a Prospectus dated April 7, 1993:
 
<TABLE>
<S>  <C>
     $10,000,000 Principal Amount of 7.42% Notes due September
-    10, 2001
     $10,000,000 Principal Amount of 7.625% Notes due June 19,
-    2023
-    $10,000,000 Principal Amount of 6.0% Notes due July 6, 2000
     $15,000,000 Principal Amount of 6.0% Notes due September 29,
-    2003
     $10,000,000 Principal Amount of 6.58% Notes due June 21,
-    2005
     $5,000,000 Principal Amount of 6.0% Notes due January 30,
-    2001
     $5,000,000 Principal Amount of 6.625% Notes due June 28,
-    2002
     $10,000,000 Principal Amount of 6.43% Notes due December 15,
-    2025
     $20,000,000 Principal Amount of 6.375% Notes due December
-    15, 2006
     $30,000,000 Principal Amount of 6.26% Notes due February 15,
-    2028
</TABLE>
 
     Note Purchase Agreement between Northern and First Colony Life Insurance
for the purchase and sale of $13,000,000 principal amount of 9.70% Notes dated
as of January 1, 1992, due September 1, 2031.
 
                                       53
<PAGE>   54
 
     Note Purchase Agreement between Northern and the Mutual Life Insurance
Company of New York for the purchase and sale of $10,000,000 principal amount of
6.93% Notes dated as of September 29, 1996, due September 27, 2010.
 
     Promissory Note between EnergyUSA, Inc. and Harlow D. Savage dated November
18, 1997, due November 18, 2001, in the amount of $1,174,694.
 
     Promissory Note between EnergyUSA, Inc. and John J. McGuire dated November
18, 1997, due November 18, 2001, in the amount of $1,098,749.
 
     Promissory Note between EnergyUSA, Inc. and Duane A. Fox dated November 18,
1997, due November 18, 2001, in the amount of $1,019,554.
 
     Promissory Note between EnergyUSA, Inc. and Philip J. Fine dated November
18, 1997, due November 18, 2001, in the amount of $488,454.
 
     Promissory Note between EnergyUSA, Inc. and Gary S. Solomon dated November
18, 1997, due November 18, 2001, in the amount of $163,912
 
(10) Material contracts:
 
<TABLE>
<CAPTION>
EXHIBIT
  NO.                          DESCRIPTION                                     REFERENCE
-------                        -----------                                     ---------
<C>       <S>                                                    <C>
*10.01    Key Employee Stock Option Plan covering key employees
          of the Company.......................................  Exhibit 10.16 to Form 10-K for 1989
                                                                 (File No. 1-7479)
*10.02    Key Employee Deferred Compensation Plan covering the
          Chairman of the Board of Directors, the President,
          and Vice Presidents of the Company...................  Exhibit 10.21 to Form 10-K for 1992
                                                                 (File No. 1-7479)
*10.03    Supplemental Executive Retirement Plan covering the
          Chairman of the Board of Directors, the President,
          and Vice Presidents of the Company...................  Exhibit 10.22 to Form 10-K for 1992
                                                                 (File No. 1-7479)
*10.04    Senior Advisory Agreement between Bay State and
          Charles H. Tenney II, dated January 27, 1995.........  Exhibit 10.05 to Form 10-K for 1996
                                                                 (File No. 1-7479)
*10.05    Severance agreement between Bay State and each of the
          executive officers of the Company....................  Exhibit 10.05 to Form 10-K for 1997
                                                                 (File No. 1-7479)
*10.06    Directors' Retirement Plan...........................  Exhibit 10.07 to Form 10-K for 1996
                                                                 (File No. 1-7479)
*10.07    Stock Performance Sharing Plan.......................  Exhibit 10.07 to Form 10-K for 1997
                                                                 (File No. 1-7479)
*10.08    Stock Accumulation Plan for Outside Directors........  Exhibit 10.08 Form 10-K for 1997
                                                                 (File No. 1-7479)
*10.09    First amendment dated as of November 16, 1998 to the
          Amended and Restated Agreement and Plan of Merger
          among NIPSCO Industries, Inc., Bay State Gas Company
          and Acquisition Gas Company..........................  Form 8-K filed November 16, 1998
                                                                 (File No. 1-7479)
</TABLE>
 
(12) Statement re: computation of ratio of earnings to fixed charges, filed
herewith.
 
(21) Subsidiaries of the Registrant, filed herewith.
 
(23) Consent of Independent Auditors, filed herewith.
 
(27) Financial Data Schedule, filed herewith.
---------------
 
* Incorporated by reference to the indicated filing.
 
                                       54