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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2003
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
I.R.S. Employer
Commission Registrant, State of Incorporation, Identification
File Number Address and Telephone Number Number
- -------------- ------------------------------------ --------------
1-7297 Nicor Inc. 36-2855175
(An Illinois Corporation)
1844 Ferry Road
Naperville, Illinois 60563-9600
(630) 305-9500
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 and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Shares of common stock, par value $2.50, outstanding at October 28, 2003, were
44,034,086.
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Nicor Inc. Page i
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Table of Contents
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Part I - Financial Information
Item 1. Financial Statements (Unaudited) ....................... 1
Condensed Consolidated Statements of Operations:
Three and nine months ended
September 30, 2003 and 2002 .......................... 2
Condensed Consolidated Statements of Cash Flows:
Nine months ended
September 30, 2003 and 2002 .......................... 3
Condensed Consolidated Balance Sheets:
September 30, 2003 and 2002, and
December 31, 2002 .................................... 4
Notes to the Consolidated Financial Statements ......... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ..................19
Item 3. Quantitative and Qualitative Disclosures
about Market Risk.....................................31
Item 4. Controls and Procedures ................................31
Part II - Other Information
Item 1. Legal Proceedings ......................................34
Item 6. Exhibits and Reports on Form 8-K .......................34
Signature ..............................................35
Exhibit Index ..........................................36
Glossary
- --------
Degree day......The extent to which the daily average temperature falls below
65 degrees Fahrenheit. Normal weather for Nicor Gas' service
territory is about 6,000 degree days per year.
ICC.............Illinois Commerce Commission, the agency that regulates
investor-owned Illinois utilities.
FERC............Federal Energy Regulatory Commission, the agency that regulates
the interstate transportation of natural gas, oil and
electricity.
Mcf, MMcf, Bcf..Thousand cubic feet, million cubic feet, billion cubic feet.
PBR.............Performance-based rate, a regulatory plan that
provided economic incentives based on natural gas
cost performance.
TEU.............Twenty-foot equivalent unit, a measure of volume in
containerized shipping equal to one 20-foot-long container.
Nicor Inc. Page 1
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
The following condensed unaudited consolidated financial statements of Nicor
Inc. (Nicor) have been prepared by the company pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC). Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to SEC rules and regulations. The
condensed financial statements should be read in conjunction with the financial
statements and the notes thereto included in the company's 2002 Annual Report on
Form 10-K.
The information furnished reflects, in the opinion of the company, all
adjustments (consisting only of normal recurring adjustments and adjustments to
reflect the change in accounting policy as described in the Notes to the
Consolidated Financial Statements - Note 2 Cumulative Effect of Change in
Accounting) necessary for a fair statement of the results for the interim
periods presented. Results for the interim periods presented are not necessarily
indicative of the results to be expected for the full fiscal year due to
seasonal and other factors.
Nicor Inc. Page 2
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Condensed Consolidated Statements of Operations (Unaudited)
(millions, except per share data)
Three months ended Nine months ended
September 30 September 30
----------------- ------------------
2003 2002 2003 2002
-------- -------- -------- --------
Operating revenues
Gas distribution (includes revenue
taxes of $11.4, $9.1, $98.3 and
$66.0, respectively) $ 223.4 $ 172.7 $1,699.6 $ 971.2
Shipping 63.8 66.6 197.4 191.6
Other 7.6 13.1 21.9 29.8
-------- -------- -------- --------
294.8 252.4 1,918.9 1,192.6
Operating expenses
Gas distribution
Cost of gas 117.6 65.4 1,221.5 527.3
Operating and maintenance 51.4 48.2 164.5 143.4
Depreciation 35.6 17.0 107.6 96.2
Taxes, other than income taxes 14.4 13.4 108.4 77.1
Mercury-related costs (recoveries) - (19.7) (17.8) (19.5)
Property sale (gains) losses - - (.4) (3.4)
Shipping 60.8 62.2 183.8 179.2
All other 10.8 12.3 26.9 30.0
-------- -------- -------- --------
290.6 198.8 1,794.5 1,030.3
-------- -------- -------- --------
Operating income 4.2 53.6 124.4 162.3
Equity investment income (loss), net 4.8 (2.6) 12.9 (7.5)
Other income (expense), net .4 .7 1.5 2.5
Interest expense, net of amounts
capitalized 8.8 9.7 27.8 28.4
-------- -------- -------- --------
Income before income taxes and cumulative
effect of accounting change .6 42.0 111.0 128.9
Income taxes .1 12.2 36.3 40.1
-------- -------- -------- --------
Income before cumulative effect of
accounting change .5 29.8 74.7 88.8
Cumulative effect of accounting change,
net of 3.0 income tax benefit - - (4.5) -
-------- -------- -------- --------
Net income .5 29.8 70.2 88.8
Dividends on preferred stock - .1 - .3
-------- -------- -------- --------
Earnings applicable to common stock $ .5 $ 29.7 $ 70.2 $ 88.5
======== ======== ======== ========
Average shares of common stock outstanding
Basic 44.0 44.0 44.0 44.2
Diluted 44.2 44.1 44.2 44.4
Earnings per average share of common stock
Basic
Before cumulative effect of
accounting change $ .01 $ .68 $ 1.69 $ 2.01
Cumulative effect of accounting
change, net of tax - - (.10) -
-------- -------- -------- --------
Basic earnings per share $ .01 $ .68 $ 1.59 $ 2.01
======== ======== ======== ========
Diluted
Before cumulative effect of
accounting change $ .01 $ .67 $ 1.69 $ 2.00
Cumulative effect of accounting
change, net of tax - - (.10) -
-------- -------- -------- --------
Diluted earnings per share $ .01 $ .67 $ 1.59 $ 2.00
======== ======== ======== ========
Dividends declared per share of
common stock $ .465 $ .46 $ 1.395 $ 1.38
The accompanying notes are an integral part of these statements.
Nicor Inc. Page 3
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Condensed Consolidated Statements of Cash Flows (Unaudited)
(millions)
Nine months ended
September 30
-------------------
2003 2002
-------- ---------
Operating activities
Net income $ 70.2 $ 88.8
Adjustments to reconcile net income to net cash flow
provided from operating activities:
Depreciation 121.0 109.2
Deferred income tax expense 129.8 33.6
Cumulative effect of accounting change 4.5 -
Gain on sale of property, plant and equipment (1.7) (4.6)
Changes in assets and liabilities:
Receivables, less allowances 215.9 153.6
Gas in storage (307.8) (61.6)
Deferred/accrued gas costs (48.7) (99.9)
Prepaid pension costs - (9.6)
Other assets (103.0) (12.9)
Accounts payable (163.2) 45.4
Accrued mercury-related costs (recoveries) (1.2) (4.8)
Other liabilities (32.5) 11.0
Other (16.1) 18.2
-------- ---------
Net cash flow (used for) provided from operating
activities (132.8) 266.4
-------- ---------
Investing activities
Capital expenditures (133.9) (137.7)
Net (increase) decrease in short-term investments (4.6) 12.1
Purchase of equity investments (7.8) (10.0)
Repayments from joint ventures 8.9 87.4
Loans to joint ventures - (64.4)
Investment in joint venture - (16.5)
Business acquisitions (.5) (10.2)
Net proceeds from sale of property, plant and
equipment 2.7 7.9
Other 1.2 1.1
-------- ---------
Net cash flow used for investing activities (134.0) (130.3)
-------- ---------
Financing activities
Net proceeds from issuing long-term debt - 49.9
Disbursements to retire long-term debt (100.1) -
Short-term borrowings (repayments), net 375.0 (87.0)
Dividends paid (61.3) (60.4)
Disbursements to reacquire stock (2.2) (26.5)
Other 1.1 2.1
-------- ---------
Net cash flow provided from (used for) financing
activities 212.5 (121.9)
-------- ---------
Net (decrease) increase in cash and cash equivalents (54.3) 14.2
Cash and cash equivalents, beginning of period 75.2 14.0
-------- ---------
Cash and cash equivalents, end of period $ 20.9 $ 28.2
======== =========
The accompanying notes are an integral part of these statements.
Nicor Inc. Page 4
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Condensed Consolidated Balance Sheets (Unaudited)
(millions)
September 30 December 31 September 30
2003 2002 2002
----------- ----------- -----------
Assets
-------
Current assets
Cash and cash equivalents $ 20.9 $ 75.2 $ 28.2
Short-term investments, at cost which
approximates market 30.3 25.7 22.1
Receivables, less allowances of $23.0,
$16.9 and $13.2, respectively 249.7 467.4 197.4
Gas in storage 348.2 52.3 105.0
Deferred income taxes 47.8 34.9 42.0
Other 172.9 52.2 36.4
----------- ----------- -----------
869.8 707.7 431.1
----------- ----------- -----------
Property, plant and equipment, at cost
Gas distribution 3,662.3 3,558.1 3,525.5
Shipping 304.5 309.1 309.5
Other 7.8 5.6 4.4
----------- ----------- -----------
3,974.6 3,872.8 3,839.4
Less accumulated depreciation 2,165.0 2,076.0 2,049.8
----------- ----------- -----------
1,809.6 1,796.8 1,789.6
----------- ----------- -----------
Prepaid pension costs 177.1 177.1 173.9
Other assets 214.1 217.8 162.1
----------- ----------- -----------
$ 3,070.6 $ 2,899.4 $ 2,556.7
=========== =========== ===========
Liabilities and Capitalization
------------------------------
Current liabilities
Long-term obligations due
within one year $ - $ 100.0 $ 100.0
Short-term borrowings 690.0 315.0 190.0
Accounts payable 386.8 556.3 500.5
Accrued gas costs 18.6 67.3 8.3
Accrued mercury-related costs 4.5 5.0 3.6
Accrued dividends payable 20.5 20.3 20.3
Other 29.4 34.7 29.6
----------- ---------- ----------
1,149.8 1,098.6 852.3
----------- ---------- ----------
Deferred credits and other liabilities
Deferred income taxes 529.9 386.1 357.1
Regulatory income tax liability 60.7 62.2 63.5
Unamortized investment tax credits 36.0 37.5 37.5
Accrued mercury-related costs 17.7 18.4 28.6
Other 141.9 167.7 107.1
----------- ---------- ----------
786.2 671.9 593.8
----------- ---------- ----------
Capitalization
Long-term debt
Long-term bonds and notes 396.7 396.2 396.0
Mandatorily redeemable preferred
stock 1.7 - -
----------- ---------- ----------
398.4 396.2 396.0
----------- ---------- ----------
Mandatorily redeemable preferred
stock - 4.3 6.0
Common equity
Common stock 110.1 110.0 110.0
Paid-in capital 2.4 1.2 3.0
Retained earnings 632.5 623.8 601.8
Unearned compensation (.2) (.3) (.3)
Accumulated other comprehensive loss (8.6) (6.3) (5.9)
----------- ---------- ----------
736.2 728.4 708.6
----------- ---------- ----------
1,134.6 1,128.9 1,110.6
----------- ---------- ----------
$ 3,070.6 $ 2,899.4 $ 2,556.7
=========== ========== ==========
The accompanying notes are an integral part of these statements.
Nicor Inc. Page 5
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Notes to the Consolidated Financial Statements (Unaudited)
The following notes should be read in conjunction with the consolidated
financial statement notes included in the Nicor Inc. (Nicor) 2002 Annual Report
on Form 10-K.
1. ACCOUNTING POLICIES
Regulatory assets and liabilities. Northern Illinois Gas Company (Nicor Gas), a
wholly owned subsidiary of Nicor, is regulated by the Illinois Commerce
Commission (ICC), which establishes the rules and regulations governing utility
rates and services in Illinois. The company applies accounting standards that
recognize the economic effects of rate regulation and, accordingly, has recorded
regulatory assets and liabilities. The company had regulatory assets
(liabilities) as follows (in millions):
September 30 December 31 September 30
2003 2002 2002
------------ ------------ ------------
Deferred (accrued) gas costs $ (18.6) $ (67.3) $ (8.3)
Regulatory income tax liability (60.7) (62.2) (63.5)
Unamortized loss on reacquired
debt 18.3 19.0 19.3
Deferred (accrued) environmental
costs 39.0 54.7 (7.5)
------------ ------------ ------------
$ (22.0) $ (55.8) $ (60.0)
============ ============ ============
The unamortized loss on reacquired debt is classified in other noncurrent
assets. Deferred (accrued) environmental costs are included in other noncurrent
assets and other noncurrent liabilities, respectively.
In addition, consistent with its regulatory treatment, Nicor Gas accrues
anticipated future removal costs over the useful lives of its property, plant
and equipment. The balance of removal costs in accumulated depreciation at
September 30, 2003, December 31, 2002, and September 30, 2002 was approximately
$660 million, $625 million, and $615 million, respectively.
Revenue taxes. Nicor Gas classifies revenue taxes billed to customers as
operating revenues and related taxes due as operating expenses. Revenue taxes
included in operating expense for the three months and nine months ended
September 30, 2003 were $10.7 million and $96.0 million, respectively, and $8.7
million and $63.9 million, respectively, for the same periods ended September
30, 2002.
Depreciation. Property, plant and equipment are depreciated over estimated
useful lives on a straight-line basis. The annual gas distribution composite
depreciation rate is 4.1 percent, which includes estimated future removal costs.
The estimated useful lives of vessels range from 20 to 25 years.
Derivatives. The company generally classifies cash flows from derivatives in the
same category as cash flows from any related hedged item.
Nicor Inc. Page 6
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
Stock Options and Awards. Statement of Financial Accounting Standards (FAS) No.
123, Accounting for Stock-Based Compensation, encourages, but does not require,
entities to adopt the fair value method of accounting for stock-based
compensation plans. The fair value method would require the amortization of the
fair value of stock-based compensation at the date of grant over the related
vesting period. Nicor continues to apply the intrinsic value method of
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, for awards granted under its stock-based compensation plans. The
intrinsic value method does not require compensation expense to be recognized
based on Nicor's current option terms. As required by FAS 148, Accounting for
Stock-Based Compensation--Transition and Disclosure--an amendment of FASB
Statement No. 123, if compensation expense for the stock options had been
recognized based upon the fair value method, the impact on the company's net
income and earnings per share would have been as follows (in millions, except
per share data):
Three months ended Nine months ended
September 30 September 30
----------------- ------------------
2003 2002 2003 2002
------- ------- ------- --------
Net income
As reported $ .5 $ 29.8 $ 70.2 $ 88.8
Less: Total stock-based
employee compensation
expense determined
under the fair value
method for all awards,
net of tax .2 .1 .5 .4
------- ------- ------- --------
Pro forma $ .3 $ 29.7 $ 69.7 $ 88.4
======= ======= ======= ========
Earnings per share
Basic - As reported $ .01 $ .68 $ 1.59 $ 2.01
Basic - Pro forma .01 .67 1.58 2.00
Diluted - As reported .01 .67 1.59 2.00
Diluted - Pro forma .01 .67 1.58 1.99
2. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
Effective January 1, 2003, Nicor's wholesale natural gas marketing business,
Nicor Enerchange, began applying accrual accounting rather than fair value
accounting to gas in storage and certain energy-related contracts, such as
storage contracts. The change in accounting method relates to a rescission of
Emerging Issues Task Force Consensus No. 98-10, Accounting for Contracts
Involved in Energy Trading and Risk Management Activities, and a prohibition
against recording inventory at fair value. Effective with the change, Nicor
recorded a $4.5 million cumulative effect loss from the change in accounting
principle, which was net of $3.0 million in income tax benefits. Pro forma
results for the three months and nine months ended September 30, 2002 had the
new method been applied could not be reasonably determined and are therefore not
presented.
Annual and interim results will be more volatile under the new accounting
method. Also, the industry is working to resolve certain technical accounting
application questions that remain, which could lead to further changes.
Nicor Inc. Page 7
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
3. OTHER ACCOUNTING CHANGES
Depreciation. Effective January 1, 2003, Nicor Gas began using the straight-line
method for allocating annual depreciation to interim periods, the predominant
method used by other companies in its industry. Nicor's 2002 results include gas
distribution depreciation allocated based upon the level of weather-normalized
gas deliveries. The following table provides a comparison of Nicor's results as
reported for the three months and nine months ended September 30, 2002 to pro
forma results had gas distribution depreciation been allocated on a
straight-line basis (in millions, except per share data):
Three months ended Nine months ended
September 30, 2002 September 30, 2002
------------------- --------------------
As As
Reported Pro Forma Reported Pro Forma
------------------- --------------------
Gas distribution depreciation
expense $ 17.0 $ 34.4 $ 96.2 $ 103.2
Operating income 53.6 36.2 162.3 155.3
Income before income taxes 42.0 24.6 128.9 121.9
Net income 29.8 19.3 88.8 84.5
Earnings per average share of
common stock:
Basic $ .68 $ .44 $ 2.01 $ 1.91
Diluted .67 .44 2.00 1.90
Accounting for guarantees. In November 2002, the Financial Accounting Standards
Board (FASB) issued Interpretation No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. The interpretation expands the disclosure requirements for most
guarantees, including standby letters of credit. It also clarifies that at the
time a company issues a guarantee it must recognize an initial liability for the
fair value of the obligations it assumes under that guarantee, and it must
disclose that information in its financial statements. Nicor applied the
recognition provisions on a prospective basis, beginning January 1, 2003 and it
did not have a significant impact on the company's financial position or results
of operations.
Asset retirement obligations. In August 2001, the FASB issued FAS 143,
Accounting for Asset Retirement Obligations. This standard requires entities to
record the fair value of a liability for an asset retirement obligation in the
period in which the obligation is incurred. When the liability is initially
recorded, the entity capitalizes the cost by increasing the carrying amount of
the related long-lived asset. Over time, the liability is accreted to its
present value, and the capitalized cost is depreciated over the useful life of
the related asset. This standard became effective on January 1, 2003.
The obligation of retiring gas distribution, transmission, storage and certain
general plant assets at Nicor Gas meets the definition of a legal obligation
within the meaning of FAS 143. However, the company, like most other gas
distribution utility companies, has determined that due to the indefinite life
of such assets a liability is generally not measurable. On January 1, 2003, a
$3.5 million asset retirement obligation for the expected replacement of inside
mercury regulators was recorded at Nicor Gas. Certain costs associated with the
retirement of other items at Nicor companies, including polychlorinated
biphenyls, underground storage tanks and asbestos abatement, are determined to
be immaterial or cannot be measured at this time.
Nicor Inc. Page 8
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
Nicor Gas continues its practice of accruing for future retirement costs as
accumulated depreciation, subject to cost-of-service utility rate regulation,
even when an asset removal obligation does not exist under FAS 143. Through
September 30, 2003, the company had accrued and recovered about $660 million
associated with the future removal of these long-lived assets.
No cumulative effect gain or loss was required as a result of adopting this
standard due to the economic effect of Nicor Gas' cost-of-service utility rate
regulation. The application of this standard did not have a material effect on
the company's financial position or results of operations.
Derivative Instruments and Hedging Activities. In April 2003, the FASB issued
FAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. FAS 149 amends and addresses financial accounting and reporting for
derivative instruments under FAS 133. The Statement is generally effective
prospectively for contracts entered into or modified after June 30, 2003. The
only impact of adoption on July 1, 2003, is that certain natural gas commodity
contracts at Nicor Gas no longer qualify for the normal purchases and sales
exception and must be recorded at fair value, with an offsetting regulatory
asset or liability. The application of this standard has not had a material
impact on the company's financial position or results of operations.
Accounting for Certain Financial Instruments. In May 2003, the FASB issued FAS
150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. FAS 150 requires certain freestanding financial
instruments, such as mandatorily redeemable preferred stock, to be measured at
fair value and classified as liabilities. The provisions of FAS 150 were
effective for Nicor beginning July 1, 2003. Upon adoption, Nicor reclassified
approximately $2 million of redeemable preferred stock to a liability, and
related dividends are being prospectively classified as interest expense. If
Nicor called the mandatorily redeemable preferred shares for redemption at
September 30, 2003, Nicor would have to pay approximately $2 million. The
application of this standard did not have a material impact on the company's
financial position or results of operations.
4. NEW ACCOUNTING PRONOUNCEMENT
Consolidation of Variable Interest Entities. In January 2003, the FASB issued
Interpretation 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46
addresses the application of Accounting Research Bulletin 51, Consolidated
Financial Statements, to certain entities in which equity investors do not have
the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support. FIN 46 applied immediately to
variable interest entities created or interests obtained after January 31, 2003,
and it originally applied beginning July 1, 2003 to variable interests acquired
before February 1, 2003. However, a recent FASB Staff Position defers the
effective date of this Interpretation for Nicor to December 31, 2003.
The company does not currently believe it is reasonably possible that FIN 46
will require the consolidation of any significant entity. In the unlikely event
that consolidation of a significant entity is ultimately required, Nicor does
not anticipate that consolidation will have a material impact on its common
equity or net income; however, additional revenues, expenses, assets and
liabilities would be recorded on the company's income statement and balance
sheet.
Nicor Inc. Page 9
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
5. ACCRUED UNBILLED REVENUES
Receivables include accrued unbilled revenues of $55.1 million, $142.9 million
and $38.6 million at September 30, 2003, December 31, 2002, and September 30,
2002, respectively, related primarily to gas distribution operations. Nicor Gas
accrues revenues for estimated deliveries to customers from the date of their
last bill until the balance sheet date.
6. SHORT-TERM AND LONG-TERM DEBT
In April 2003, Nicor Gas refinanced $50 million of 3 percent unsecured notes due
in April 2003 with $50 million of 1.6 percent unsecured notes due and paid in
October 2003. In June 2003, Nicor Gas retired $50 million of 5.75% First
Mortgage Bonds due in 2003.
The company maintains short-term line of credit agreements with major domestic
and foreign banks. At September 30, 2003, these agreements, which serve as
backup for the issuance of commercial paper, allowed for borrowings of up to $1
billion through March 2004 and $500 million thereafter through September 2004.
Commitment fees paid in advance totaling $2.9 million will be amortized over the
respective term of the agreements as an adjustment to interest expense. The
company had $640 million of commercial paper borrowings outstanding at September
30, 2003.
Under the company's 2003/2004 short-term line of credit agreements, (1) if
Nicor's ratio of consolidated indebtedness to capitalization (including
short-term debt) exceeds 65% at the end of the first, second or third fiscal
quarter, or 70% at the end of the fourth fiscal quarter, and/or (2) if Nicor's
twelve-months-ended interest coverage ratio is less than 3 to 1 at the end of
any fiscal quarter during the term of the credit agreements, banks representing
66 2/3% of the commitments may declare any amounts due immediately payable
and/or terminate the commitments to make advances to the company. The company is
in compliance with this covenant at September 30, 2003. The company expects that
commercial paper funding will continue to be available in the foreseeable
future.
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The recorded amount of short-term investments and short-term borrowings
approximates fair value because of the short maturity of the instruments.
Long-term debt outstanding, including current maturities, is recorded at the
principal balance outstanding. The principal balance of Nicor's First Mortgage
Bonds outstanding at September 30, 2003 was $400 million and at December 31,
2002 and September 30, 2002, the principal balance outstanding was $450 million.
Based on quoted market interest rates, the fair value of the company's First
Mortgage Bonds outstanding, including current maturities, was $437 million, $482
million and $486 million at September 30, 2003, December 31, 2002 and September
30, 2002, respectively.
8. INCOME TAXES
The company's effective income tax rate increased for the year-to-date period
ended September 30, 2003, compared to the nine months ended September 30, 2002,
due to positive adjustments resulting from the completion of an income tax audit
in the first quarter of 2002.
Nicor Inc. Page 10
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
9. BUSINESS SEGMENT INFORMATION
Financial data by major business segment is presented below (in millions):
Three months ended Nine months ended
September 30 September 30
------------------ ------------------
2003 2002 2003 2002
-------- -------- -------- --------
Operating revenues
Gas distribution $ 223.4 $ 172.7 $1,699.6 $ 971.2
Shipping 63.8 66.6 197.4 191.6
Other energy ventures 15.1 13.1 53.7 37.5
Corporate and
eliminations (7.5) - (31.8) (7.7)
-------- -------- -------- --------
$ 294.8 $ 252.4 $1,918.9 $1,192.6
======== ======== ======== ========
Operating income (loss)
Gas distribution $ 4.4 $ 48.4 $ 115.8 $ 150.1
Shipping 3.0 4.4 13.6 12.4
Other energy ventures (.7) 2.8 2.3 4.9
Corporate and
eliminations (2.5) (2.0) (7.3) (5.1)
-------- -------- -------- --------
$ 4.2 $ 53.6 $ 124.4 $ 162.3
======== ======== ======== ========
Gas distribution operating revenues include customer charges paid, on behalf of
the customer, by a Nicor subsidiary offering a utility-bill management product.
These gas distribution revenues have been eliminated in the consolidated
financial statements.
10. EQUITY INVESTMENT INCOME (LOSS)
Equity investment income (loss) includes the following (in millions):
Three months ended Nine months ended
September 30 September 30
------------------ ------------------
2003 2002 2003 2002
-------- -------- -------- --------
Triton Container
Investments (Triton) $ 1.5 $ 1.1 $ 4.1 $ 3.0
Nicor Energy 3.3 (3.1) 8.9 (9.4)
All other - (.6) (.1) (1.1)
-------- -------- -------- --------
$ 4.8 $ (2.6) $ 12.9 $ (7.5)
======== ======== ======== ========
Nicor Inc. Page 11
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
11. OTHER INCOME (EXPENSE), NET
Other income (expense), net includes the following (in millions):
Three months ended Nine months ended
September 30 September 30
------------------ -------------------
2003 2002 2003 2002
-------- -------- -------- ---------
Interest income $ .4 $ .4 $ 1.5 $ 1.9
Other income .1 .5 .7 1.1
Other expense (.1) (.2) (.7) (.5)
-------- -------- -------- ---------
$ .4 $ .7 $ 1.5 $ 2.5
======== ======== ======== =========
12. COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss), as defined by FAS 130, Reporting
Comprehensive Income, is equal to net income plus other comprehensive income and
is as follows (in millions):
Three months ended Nine months ended
September 30 September 30
------------------ ------------------
2003 2002 2003 2002
-------- -------- -------- ---------
Net income $ .5 $ 29.8 $ 70.2 $ 88.8
Other comprehensive income
(loss), net of tax (2.6) (4.1) (2.3) (5.6)
-------- -------- -------- --------
$ (2.1) $ 25.7 $ 67.9 $ 83.2
======== ======== ======== ========
Other comprehensive income (loss) for Nicor consists primarily of unrealized
gains and losses from derivative financial instruments accounted for as cash
flow hedges, including Nicor's share of such amounts from joint ventures and
other equity method investees.
Most of the $8.6 million net loss in accumulated other comprehensive loss at
September 30, 2003, represents a net realized loss on financial derivatives
designated as hedges of interest payments on an anticipated fourth quarter
30-year bond issuance. This loss will be amortized to interest expense over the
life of the bonds.
Nicor Inc. Page 12
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
13. GUARANTEES AND INDEMNITIES
Nicor and certain subsidiaries enter into various financial and performance
guarantees and indemnities providing assurance to third parties.
Financial guarantees. The company has issued financial guarantees extending
through 2007 on behalf of its wholly owned subsidiaries and other affiliates,
guaranteeing payment by these affiliates under the terms of various contracts
and regulations. These contracts and regulations relate primarily to physical
and financial transactions in energy commodities and related services, and
operating lease obligations. As of September 30, 2003, the maximum potential
payment under these guarantees was approximately $170 million. Except for $3.1
million of guarantees on behalf of Nicor Energy, and $1.3 million of lease
guarantees, any related obligations underlying these guarantees are already
included in Nicor's consolidated balance sheet. Refer to the Nicor Energy
section in Note 15 - Contingencies for recent developments related to Nicor's
guarantees on behalf of Nicor Energy.
Tropic Equipment Leasing Inc. (TEL), a wholly owned subsidiary of Nicor, holds
the company's interests in Triton. TEL has a contingent liability to restore to
zero any deficit in its equity account for income tax purposes in the unlikely
event that Triton is liquidated and a deficit balance remains. This contingent
liability continues for the life of the Triton partnerships and any payment is
effectively limited to the assets of TEL, which were about $5 million at
September 30, 2003. Nicor believes the likelihood of any such payment by TEL is
remote.
Performance guarantees. Nicor Services markets separately priced product
warranty contracts that provide for the repair of heating, ventilation and air
conditioning (HVAC) equipment and natural gas lines within homes. Revenues from
these product warranty contracts are recognized ratably over the coverage
period, and repair costs are charged to expense as incurred. Repair expenses of
$.4 million and $1.2 million were incurred in the three-month and nine-month
periods ended September 30, 2003, respectively, and $.5 million and $1.4 million
for the corresponding prior-year periods. Prior to 2002, Nicor Services was not
the guarantor on these contracts.
Indemnities. In certain instances, Nicor has undertaken to indemnify current
property owners and others against costs associated with the effects and/or
remediation of contaminated sites for which the company may be responsible under
applicable federal or state environmental laws. Nicor has also indemnified, to
the fullest extent permitted under the laws of the State of Illinois and any
other applicable laws, its present and former directors, officers and employees
against expenses they may incur in connection with litigation they are a party
to by reason of their association with the company, subject to certain
limitations. It is not possible to estimate the maximum potential payment under
these indemnifications.
14. RELATED PARTY TRANSACTIONS
Horizon Pipeline is a 50/50 joint venture between Nicor and Natural Gas Pipeline
Company of America (NGPL) that operates a natural gas pipeline. In May 2002,
Horizon Pipeline repaid short-term loans outstanding from Nicor. For the three
months and nine months ended September 30, 2003, Horizon Pipeline charged Nicor
Gas $2.6 million and $7.7 million, respectively, for natural gas transportation
under rates that have been accepted by FERC. For the three months and nine
months ended September 30, 2002, Horizon Pipeline charged Nicor Gas $2.6 million
and $4.0 million, respectively, for this service.
Nicor Inc. Page 13
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
Nicor's investment in Nicor Energy, including an $8.3 million note receivable,
was written down to zero during the third quarter of 2002. During the
three-month and nine-month periods ended September 30, 2003, Nicor recovered
$3.3 million and $8.9 million, respectively, of its investment that was
previously written down. For additional important developments concerning this
investment, refer to Note 15 - Contingencies - Nicor Energy.
In 2002, Nicor Technologies, a wholly owned subsidiary of Nicor, began
purchasing engineering services from EN Engineering, a 50-percent-owned joint
venture. EN Engineering charged Nicor Technologies $1.2 million and $1.1 million
for these services for the three months ended September 30, 2003 and 2002,
respectively, and $3.3 million for these services for the nine months ended
September 30, 2003 and 2002.
15. CONTINGENCIES
The following contingencies of Nicor are in various stages of investigation or
disposition. Although in some cases the company is unable to estimate the amount
of loss reasonably possible in addition to any amounts already recognized, it is
possible that the resolution of these contingencies, either individually or in
aggregate, will require the company to take charges against, or will result in
reductions in, future earnings. It is the opinion of management that the
resolution of these contingencies, either individually or in aggregate, could be
material to earnings in a particular period, but is not expected to have a
material adverse impact on Nicor's liquidity or financial condition.
Performance-Based Rate (PBR) Plan. Nicor Gas' PBR plan for natural gas costs
went into effect in 2000 and was terminated by the company effective January 1,
2003. Under the PBR plan, Nicor Gas' total gas supply costs were compared to a
market-sensitive benchmark. Savings and losses relative to the benchmark were
determined annually and shared equally with sales customers. The PBR plan is
currently under Illinois Commerce Commission (ICC) review.
There are allegations that the company acted improperly in connection with the
PBR plan, and the ICC and others are reviewing these allegations. On June 27,
2002 the Citizens Utility Board (CUB) filed a motion to reopen the record in the
ICC's proceedings to review the PBR plan (the ICC Proceedings). As a result of
the motion to reopen, Nicor Gas, the Cook County State's Attorney's Office
(CCSAO), the staff of the ICC and CUB entered into a stipulation providing for
additional discovery. The Illinois Attorney General's Office has also intervened
in this matter. In addition, the Illinois Attorney General's Office issued Civil
Investigation Demands (CIDs) to CUB and the ICC staff. The CIDs ordered that CUB
and the ICC staff produce all documents relating to any claims that Nicor Gas
may have presented, or caused to be presented, false information related to its
PBR plan. Parties who were plaintiffs in a dismissed class action proceeding
against the company could potentially intervene in these proceedings. The
company has committed to cooperate fully in the reviews of the PBR plan.
Pursuant to the agreement of all parties, including the company, the ICC
re-opened the 1999 and 2000 purchased gas adjustment filings for review of
certain transactions related to the PBR plan and consolidated the reviews of the
1999-2002 purchased gas adjustment filings with the PBR plan review.
Nicor Inc. Page 14
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
Certain parties in the PBR plan review proceeding have indicated that they
believe substantial adjustments or penalties are warranted. In addition, on
February 5, 2003, the CCSAO and CUB filed a motion for $27 million in sanctions
against the company in the ICC Proceedings. In that motion, CCSAO and CUB
alleged that Nicor Gas' responses to certain CUB data requests were false. Also
on February 5, 2003, CUB stated in a press release that, in addition to $27
million in sanctions, it would seek additional refunds to consumers. On March 5,
2003, the ICC staff filed a response brief in support of CUB's motion for
sanctions. On May 1, 2003, the Administrative Law Judges issued a ruling denying
CUB and CCSAO's motion for sanctions. CUB has filed an appeal of the motion for
sanctions with the ICC, and the ICC has indicated that it will not rule on the
appeal until the final disposition of the ICC proceedings. It is not possible to
determine how the ICC will resolve the claims of CCSAO, CUB or other parties to
the ICC Proceedings.
Nicor is unable to predict the outcome of any of the foregoing reviews or the
company's potential exposure thereunder. Due to the uncertainties surrounding
the PBR plan, Nicor Gas has not recognized a $26.9 million pretax gain from the
2002 PBR plan year. Because the PBR plan and historical utility gas costs are
still under ICC review, it is possible that the final outcome could be
materially different than the amounts reflected in the company's financial
statements as of September 30, 2003.
Nicor Energy. Nicor is a 50-percent owner of Nicor Energy, a retail energy
marketing joint venture with Dynegy Marketing and Trade.
As a result of an audit and review process in 2002, accounting irregularities
were identified at Nicor Energy. Appropriate accounting adjustments were made in
restated financial statements previously filed with the Securities and Exchange
Commission (SEC).
Nicor Energy has disposed of all of its customer accounts and is in the process
of liquidating its remaining assets and resolving remaining contingent
liabilities. Nicor's investment in Nicor Energy was written down to zero in the
third quarter of 2002 due to the likelihood at that time that Nicor ultimately
would not recover its investment balance. During the second and third quarters
of 2003, Nicor recovered $5.6 million and $3.3 million, respectively, of its
investment that was previously written down, and other modest recoveries are
possible. Nicor's maximum exposure under guarantee commitments on behalf of
Nicor Energy as of September 30, 2003 was about $3.1 million. Nicor believes it
is unlikely that payments will be required under the guarantees.
SEC and U.S. Attorney Inquiries. In 2002, the staff of the SEC informed Nicor
and Nicor Energy that the SEC is conducting a formal inquiry regarding the PBR
plan and Nicor Energy. On January 28, 2003, Nicor Energy was advised by the SEC
Division of Enforcement that it intended to recommend to the SEC that it bring a
civil injunctive action against Nicor Energy, alleging that it violated Sections
10(b) and 13(b)(5) of the Securities Exchange Act of 1934. A representative of
the Office of the United States Attorney for the Northern District of Illinois
has notified Nicor that that office is conducting an inquiry on the same matters
that the SEC is investigating, and a grand jury is also reviewing these matters.
Nicor Inc. Page 15
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
Securities Class Actions. Following a July 18, 2002 Nicor press release
concerning Nicor Energy and the PBR plan, several purported class actions were
brought against Nicor, Thomas Fisher (Chairman and CEO) and Kathleen Halloran
(Executive Vice President Finance and Administration). The actions were brought
in the United States District Court for the Northern District of Illinois,
Eastern Division, and have been consolidated. On February 14, 2003, plaintiffs
filed an amended complaint adding as defendants George Behrens (Vice President
of Administration and Treasurer), Philip Cali (former Executive Vice President
of Operations) and Arthur Andersen LLP, the company's former independent
auditor. The plaintiffs seek to represent a class consisting of all persons or
entities who purchased Nicor common stock on the open market during the period
from November 24, 1999 through and including July 19, 2002. They allege that the
defendants violated Section 10(b) and Section 20(a) of the Securities Exchange
Act of 1934 and Rule 10b-5 thereunder. Plaintiffs allege that during the class
period defendants misrepresented the PBR plan, Nicor's historical financial
condition and results of operations, and its future prospects. The class is
seeking compensatory damages, prejudgment interest, and attorneys' fees and
costs. On March 31, 2003, Nicor filed a Motion to Dismiss. Nicor is unable to
predict the outcome of this litigation or Nicor's potential exposure related
thereto and has not recorded a liability associated with the outcome of this
contingency.
Shareholder Derivative Lawsuits. Also following Nicor's issuance of the press
release concerning Nicor Energy and the PBR plan, three purported derivative
lawsuits were brought against Thomas Fisher (Chairman and CEO), Kathleen
Halloran (Executive Vice President Finance and Administration) and all members
of Nicor's Board of Directors (the "individual defendants"). Nicor was named as
a nominal defendant in all three suits, which have since been consolidated in an
amended complaint. The actions were brought in the Circuit Court of Cook County,
Illinois, Chancery Division. The plaintiffs allege that the individual
defendants breached their fiduciary duties to Nicor by allegedly causing or
allowing Nicor to disseminate to the market materially misleading and inaccurate
information, and failing to establish and maintain adequate accounting controls.
Plaintiffs also contend that two of the defendants (Mr. Fisher and Mr. Birdsall)
engaged in improper insider selling of Nicor stock at inflated prices. The
plaintiffs seek compensatory and punitive damages, attorneys' fees and costs,
and other relief against the individual defendants on behalf of Nicor but do not
seek any damages against the company. On May 8, 2003, Nicor filed a Motion to
Dismiss. On October 7, 2003, the Court granted Nicor's Motion to Dismiss.
Plaintiffs have been provided leave to file a Consolidated Third Amended
Complaint by November 7, 2003. Nicor is unable to predict the outcome of this
litigation or Nicor's potential exposure related thereto and has not recorded a
liability associated with the outcome of this contingency.
Hub Services. Nicor Gas offers interstate transportation and storage services,
which are regulated by the Federal Energy Regulatory Commission (FERC), as well
as certain intrastate interruptible transportation and storage services which
are regulated by the ICC. During a periodic rate case that was filed with FERC,
Nicor Gas determined that refunds were due to certain customers of these
services. Nicor Gas accrued customer refunds and other costs totaling $1.4
million in the years 2000 to 2002. On March 14, 2003, FERC issued an order
approving a settlement with Nicor Gas. The resolution of this matter did not
have a material adverse impact on the company's financial condition or results
of operations.
Other FERC Matters. In 2002, Nicor Gas determined that it may not have complied
with regulations of FERC governing the release of certain transportation and
storage capacity that it contracts for with interstate pipelines, and the
company brought these matters to the attention of FERC. The company accrued a
$.4 million liability associated with these matters in the fourth quarter of
2002. On March 14, 2003, FERC issued an order approving a settlement with Nicor
Gas. The resolution of this matter did not have a material adverse impact on the
company's financial condition or results of operations.
Nicor Inc. Page 16
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
Fixed Bill Service. On July 17, 2002, a purported class action was filed in the
Circuit Court of Cook County, Illinois against Nicor Energy Services Company
(Nicor Services) and Nicor Gas alleging violation of the Illinois Consumer Fraud
and Deceptive Practices Act (ICFA) by Nicor Services and Nicor Gas relating to
the fixed bill service offered by Nicor Services and a conspiracy claim against
Nicor Gas arising out of marketing efforts by Nicor Services. Nicor Services
offered a fixed bill product under which it paid the annual gas service portion
of a customer's Nicor Gas utility bill in exchange for twelve equal monthly
payments by the customer to Nicor Services, regardless of changes in the price
of natural gas or weather. The plaintiff is seeking compensatory damages,
prejudgment and postjudgment interest, punitive damages, attorneys' fees and
injunctive relief. On September 6, 2002, Nicor Gas and Nicor Services filed a
Motion to Dismiss this action. On November 26, 2002, the court dismissed the
complaint without prejudice, but allowed the plaintiff to file an amended
complaint. The plaintiff filed an amended complaint on December 10, 2002, which
names only Nicor Services as a defendant, and which purports to state claims
under the ICFA and for breach of contract. The plaintiff filed a second amended
complaint on April 29, 2003. Nicor filed a Motion to Dismiss the second amended
complaint on May 15, 2003. On August 5, 2003 the Court granted Nicor's Motion to
Dismiss on the breach of contract claims but denied Nicor's Motion on the ICFA
claims. Nicor is unable to predict the outcome of this litigation or to
reasonably estimate its potential exposure related thereto and has not recorded
a liability associated with this contingency.
Troy Grove Facility. On October 15, 2002, Nicor Gas voluntarily disclosed a
potential violation of certain air pollution regulations and statutes to both
the United States Environmental Protection Agency and the Illinois Environmental
Protection Agency (IEPA) related to commencement of construction of certain
compressor equipment at its Troy Grove storage field prior to the issuance of a
Prevention of Significant Deterioration Permit. On June 26, 2003, Nicor Gas
completed the installation of an alternate fuel refueling station at Nicor's
Ottawa, Illinois facility pursuant to the terms of a Compliance Commitment
Agreement proposed by Nicor Gas and approved by IEPA to resolve the matter. The
resolution of this matter did not have a material adverse impact on the
company's financial condition or results of operations.
Horizon Pipeline Lien. The general contractor on the construction of the Horizon
Pipeline (Horizon) filed a $5.7 million Notice of Claim for Lien against
Horizon. On May 23, 2003, Horizon filed a Declaratory Judgment Complaint in the
United States District Court for the District of Colorado seeking resolution of
this dispute. On June 23, 2003, the general contractor filed an answer and
counterclaim to Horizon's complaint seeking in excess of $11 million in damages
from Horizon. While Nicor is unable to predict the outcome of this matter, its
resolution is not expected to have a material adverse impact on the company's
financial condition or results of operations.
Mercury. Nicor Gas has incurred, and expects to continue to incur, costs related
to its historical use of mercury in various kinds of company equipment.
Nicor Gas is a defendant in several private lawsuits, all in the Circuit Courts
of Cook and DuPage Counties, Illinois, claiming a variety of unquantified
damages (including bodily injury, property and punitive damages) allegedly
caused by mercury-containing regulators. Under the terms of a class action
settlement agreement, Nicor Gas will continue, until 2006, to provide medical
screening to persons exposed to mercury from its equipment, and will use its
best efforts to replace any remaining inside residential mercury regulators by
2005. The class action settlement permitted class members to "opt out" of the
settlement and pursue their claims individually. Nicor is currently defending
claims brought by 28 households.
Nicor Inc. Page 17
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
As of September 30, 2003, Nicor Gas had remaining an estimated liability of
$22.2 million, representing management's best estimate of future costs,
including potential liabilities relating to remaining lawsuits, based on an
evaluation of currently available information. Actual costs may vary from this
estimate. The company will continue to reassess its estimated obligation and
will record any necessary adjustment, which could be material to operating
results in the period recorded.
Nicor Gas continues to pursue recovery from insurers and independent contractors
that had performed work for the company, but believes that it has now collected
the majority of such recoveries. When received, these recoveries are recorded as
a reduction to gas distribution operating expense. Nicor Gas recovered
approximately $17.8 million of pretax mercury-related costs, net of legal fees,
from insurers and independent contractors year-to-date through September 30,
2003, including approximately $17.4 million recovered in the second quarter of
2003.
The final disposition of these mercury-related matters is not expected to have a
material adverse impact on the company's financial condition.
Manufactured Gas Plant Sites. Manufactured gas plants were used in the 1800's
and early to mid 1900's to produce manufactured gas from coal, creating a coal
tar byproduct. Current environmental laws may require the cleanup of coal tar at
certain former manufactured gas plant sites.
To date, Nicor Gas has identified about 40 properties for which it may, in part,
be responsible. Most of these properties are not presently owned by the company.
Information regarding preliminary site reviews has been presented to the IEPA
for certain properties. More detailed investigations and remedial activities are
complete, in progress or planned at many of these sites. The results of the
detailed site-by-site investigations determine the extent additional remediation
is necessary and provide a basis for estimating additional future costs which,
based on industry experience, could be significant. In accordance with ICC
authorization, the company is and has been recovering these costs from its
customers, subject to annual prudence reviews.
In December 2001, a purported class action lawsuit was filed against Exelon
Corporation, Commonwealth Edison Company and Nicor Gas in the Circuit Court of
Cook County alleging, among other things, that the ongoing cleanup of a former
manufactured gas plant site in Oak Park, Illinois is inadequate. Since then,
additional lawsuits have been filed related to this same former manufactured gas
plant site. These lawsuits seek, in part, unspecified damages for property
damage, nuisance, various personal injuries and one death that allegedly
resulted from exposure to contaminants allegedly emanating from the site, and
punitive damages. Management cannot predict the outcome of this litigation or
the company's potential exposure thereto and has not recorded a liability
associated with this contingency.
In April 2002, Nicor Gas was named as a defendant, together with Commonwealth
Edison Company, in a lawsuit brought by the Metropolitan Water Reclamation
District of Greater Chicago (the MWRDGC) under the Federal Comprehensive
Environmental Response, Compensation and Liability Act seeking recovery of past
and future remediation costs and a declaration of the level of appropriate
cleanup for a former manufactured gas plant site in Skokie, Illinois now owned
by the MWRDGC. In January 2003, the suit was amended to include a claim under
the Federal Resource Conservation and Recovery Act. The suit was filed in the
United States District Court for the Northern District of Illinois. Management
cannot predict the outcome of this litigation or the company's potential
exposure thereto and has not recorded a liability associated with this
contingency.
Nicor Inc. Page 18
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Notes to the Consolidated Financial Statements (Unaudited)(concluded)
Since costs and recoveries relating to the cleanup of manufactured gas plant
sites are passed directly through to customers in accordance with ICC
regulations, subject to an annual ICC prudence review, the final disposition of
manufactured gas plant matters is not expected to have a material impact on the
company's financial condition or results of operations.
Other. In addition to the matters set forth above, the company is involved in
legal or administrative proceedings before various courts and agencies with
respect to rates, taxes and other matters. Although unable to determine the
outcome of these other contingencies, management believes that appropriate
accruals for them have been recorded.
Nicor Inc. Page 19
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion should be read in conjunction with the Management's
Discussion and Analysis section of the Nicor Inc. (Nicor) 2002 Annual Report on
Form 10-K.
SUMMARY
Nicor's 2003 quarterly and year-to-date earnings were significantly impacted by
a change in the method of allocating annual depreciation to interim periods in
the gas distribution segment. Effective January 1, 2003, the gas distribution
segment began using a straight-line method to allocate annual depreciation to
interim periods, a predominant method used by others in the industry. While this
change has a significant impact on quarterly and year-to-date results as noted
in the table below, it has no impact on depreciation for the full year. Nicor's
2002 interim period results include gas distribution depreciation allocated
based upon the level of weather-normalized gas deliveries. The following table
provides a comparison of Nicor's results as reported for the third-quarter and
year-to-date periods of 2003 and 2002, and the pro forma results for 2002 had
gas distribution depreciation been allocated on a straight-line basis (in
millions, except per share data):
Three months ended
September 30
-------------------------------
2002 2002
2003 As Reported Pro Forma
-------- ----------- ---------
Net income $ .5 $ 29.8 $ 19.3
Diluted earnings per average share
of common stock .01 .67 .44
Nine months ended
September 30
-------------------------------
2002 2002
2003 As Reported Pro Forma
-------- ----------- ---------
Income before cumulative effect of
accounting change $ 74.7 $ 88.8 $ 84.5
Net income 70.2 88.8 84.5
Earnings per average share of
common stock:
Diluted - before cumulative effect
of accounting change 1.69 2.00 1.90
Diluted 1.59 2.00 1.90
Third quarter results for 2003 were lower as compared to the reported 2002
amounts due primarily to the absence of significant recoveries from third
parties related to the mercury inspection and repair program, as occurred in the
third quarter of 2002, and the 2003 change in interim depreciation allocation
method in the gas distribution segment. Another contributing factor to the
quarterly decline was lower operating results for each of Nicor's major business
segments, partially offset by higher equity investment income relating to cash
recoveries of a previously written off investment in Nicor Energy, a
50-percent-owned retail energy marketing joint venture.
Net income and diluted earnings per share for the 2003 year-to-date period were
lower as compared to the reported 2002 amounts due primarily to higher operating
expenses in the gas distribution segment and the 2003 change in interim
depreciation method. These factors were partially offset by more positive
results from equity investments due primarily to $8.9 million of cash recoveries
from Nicor Energy as compared to a loss of $9.4 million for the same period a
year ago.
Nicor Inc. Page 20
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Net income for the 2003 year-to-date period included a $4.5 million cumulative
effect loss from a required accounting change at Nicor Enerchange, Nicor's
wholesale natural gas marketing company. With the change, Nicor Enerchange now
applies accrual accounting rather than fair value accounting to gas in storage
and certain energy-related contracts.
Operating income. Operating income (loss) by major business segment is presented
below (in millions):
Three months Nine months
ended ended
September 30 September 30
---------------- -----------------
2003 2002 2003 2002
-------- ------- ------- --------
Gas distribution $ 4.4 $ 48.4 $ 115.8 $ 150.1
Shipping 3.0 4.4 13.6 12.4
Other energy ventures (.7) 2.8 2.3 4.9
Corporate and
eliminations (2.5) (2.0) (7.3) (5.1)
-------- ------- ------- --------
$ 4.2 $ 53.6 $ 124.4 $ 162.3
======== ======= ======= ========
The following summarizes operating income comparisons for major business
segments:
- -- Gas distribution operating income decreased $44.0 million in the 2003 quarter
due primarily to the absence of net mercury-related recoveries ($19.7
million), increased depreciation ($18.6 million), lower margin ($3.5 million)
and higher operating and maintenance expenses ($3.2 million). The $34.3
million decrease in operating income for the year-to-date period was due
primarily to increased operating and maintenance expenses in 2003 ($21.1
million), higher depreciation ($11.4 million), and lower property sale gains
($3.0 million), partially offset by slightly higher margin ($2.0 million).
The year-to-year fluctuation in depreciation expense for both periods was due
primarily to the change in the interim depreciation accounting method. These
factors are discussed in more detail in the Results of Operations section
beginning on the following page.
- -- Shipping segment operating income decreased in the 2003 three-month period
compared to the corresponding 2002 period due to lower volumes shipped ($2.1
million), due in part from a decline in tourism, and reduced average rates
($1.3 million). Lower operating expenses ($1.4 million) and increased charter
income from company-owned vessels ($.6 million) partially offset these
negative factors. The nine-month period remained higher than the same period
a year ago due to higher revenues from higher average rates ($2.9 million),
higher volumes shipped ($1.1 million) and increased charter income ($1.8
million). These improvements were largely offset by higher fuel costs ($2.4
million) as well as other operating expenses ($2.2 million) in 2003.
- -- Operating income at Nicor's other energy ventures decreased in the third
quarter of 2003 compared to the 2002 quarter by $3.5 million due to lower
results from Nicor's wholesale natural gas marketing business, Nicor
Enerchange ($2.4 million) and Nicor's energy-related products and services
businesses ($1.4 million). Operating income for the year-to-date period
decreased by $2.6 million also due primarily to lower operating results at
Nicor Enerchange ($2.0 million) and Nicor's energy-related products and
services businesses ($1.5 million), partially offset by the absence of 2002
project losses on former energy system development activities ($1.4 million).
Operating income from Nicor's energy-related products and services businesses
was lower in 2003 due primarily to higher up-front marketing costs ($1.4
million) associated with the utility-bill management product.
Nicor Inc. Page 21
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Equity investment income (loss). Equity investment results were positively
affected for the quarter and year-to-date periods in 2003 by cash received from
the company's previously written-off investment in Nicor Energy of $3.3 million
and $8.9 million, respectively. Equity investment results were negatively
affected for the same periods in 2002 by Nicor Energy losses of $3.1 million and
$9.4 million, respectively. Developments related to this investment are more
fully described in the Notes to the Consolidated Financial Statements - Note 15
Contingencies - Nicor Energy.
Interest expense. Interest expense was positively affected for the quarter and
year-to-date periods in 2003 by an interest benefit on tax-related matters ($.6
million). Excluding this benefit, interest expense for the three months and nine
months ended September 30, 2003 remained essentially unchanged compared to the
same prior-year periods. The impact of higher average borrowing levels was
offset by the positive effect of lower interest rates.
Cumulative effect of accounting change. Represents the cumulative effect of a
January 1, 2003 accounting change related to the application of accrual
accounting, rather than fair value accounting, to gas in storage and certain
energy-related contracts, such as storage and transportation contracts, at Nicor
Enerchange. Annual and interim results are subject to greater volatility under
the new accounting method.
Income taxes. The company's effective income tax rate increased for the
year-to-date period ended September 30, 2003, compared to the nine months ended
September 30, 2002, due to positive adjustments resulting from the completion of
an income tax audit in the first quarter of 2002.
RESULTS OF OPERATIONS
The following discussion provides additional information about the major items
impacting Nicor's results of operations.
Operating revenues. Operating revenues by major business segment are presented
below (in millions):
Three months Nine months
ended ended
September 30 September 30
---------------- ------------------
2003 2002 2003 2002
-------- ------- --------- --------
Gas distribution $ 223.4 $ 172.7 $1,699.6 $ 971.2
Shipping 63.8 66.6 197.4 191.6
Other energy ventures 15.1 13.1 53.7 37.5
Corporate and
eliminations (7.5) - (31.8) (7.7)
------- ------ -------- --------
$ 294.8 $ 252.4 $1,918.9 $ 1,192.6
======= ======= ======== =========
Gas distribution revenues increased significantly in the quarter and
year-to-date periods of 2003 compared with a year ago due primarily to higher
natural gas costs, which are passed directly through to customers without
markup. The revenue effect of higher natural gas costs was approximately $40
million and $580 million for the three-month and nine-month periods,
respectively. For the year-to-date period, revenues also increased by about $90
million due to colder weather, of which $80 million related to
Nicor Inc. Page 22
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
colder weather experienced in the first quarter of 2003. Industrial deliveries
fell in the third quarter and year-to-date periods, despite colder weather in
the year-to-date period, due largely to lower power-generation load.
Third quarter revenues for the shipping segment decreased $2.8 million as a
result of lower volumes shipped ($2.1 million) and reduced average rates ($1.3
million), partially offset by increased charter income from company-owned
vessels ($.6 million). The $5.8 million increase for the nine-month period
related primarily to higher average rates ($2.9 million), increased charter
activity ($1.8 million) and increased volumes shipped ($1.1 million) reflecting
increased activity from an acquisition that occurred in April 2002.
The increase in third quarter and year-to-date revenues for other energy
ventures is due primarily to a new utility-bill management product introduced in
early 2002 at Nicor's energy-related products and services businesses. For the
third quarter, revenues increased for the new product ($3.4 million) as well as
for Nicor's other energy-related products and services ($1.3 million), partially
offset by decreased revenue from Nicor's wholesale natural gas marketing
business ($1.9 million). Also negatively affecting the quarter were Nicor's
former energy system development activities and its technology business ($1.0
million). For the year-to-date period, increased revenues from the new product
($21.3 million) and Nicor's other energy-related products and services ($4.9
million) were partially offset by decreased revenue from Nicor's former energy
system development activities ($9.2 million).
Corporate and eliminations reflects primarily the elimination of gas
distribution revenues against other energy venture expenses for customers
purchasing the new utility-bill management product.
Gas distribution margin. Nicor utilizes a measure it refers to as "gas
distribution margin" to evaluate the operating income impact of gas distribution
revenues. Gas distribution revenues include gas costs, which are passed directly
through to customers without markup, and revenue taxes, for which Nicor Gas
earns only a small administrative fee. These items often cause significant
fluctuations in gas distribution revenues, and yet they have virtually no direct
impact on gas distribution operating income. Therefore, Nicor Gas and many other
natural gas distribution companies exclude these items in evaluating
performance.
A reconciliation of gas distribution revenues and margin follows (in millions):
Three months Nine months
ended ended
September 30 September 30
---------------- ------------------
2003 2002 2003 2002
-------- ------- -------- ---------
Gas distribution revenues $ 223.4 $ 172.7 $ 1,699.6 $ 971.2
Cost of gas (117.6) (65.4) (1,221.5) (527.3)
Revenue tax expense (10.7) (8.7) (96.0) (63.8)
-------- ------- --------- -------
Gas distribution margin $ 95.1 $ 98.6 $ 382.1 $ 380.1
======== ======= ========= ========
For the three-month period, gas distribution margin decreased slightly due
primarily to a smaller contribution from nontraditional gas supply-related
services ($3.7 million), such as the Chicago Hub, and reduced deliveries for
power generation ($1.7 million). The favorable impact of increased deliveries
due to weather ($2.0 million) was offset by unfavorable weather hedge results
($.7 million) and lower average
Nicor Inc. Page 23
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
rates charged during the period ($1.7 million). Positively impacting margin were
increased customer finance charges ($2.0 million).
For the nine-month period, gas distribution margin was positively impacted by
increased customer deliveries due to colder weather than the prior year ($12.2
million), partially offset by an unfavorable variance from the company's weather
hedge in 2003 compared to 2002 ($4.8 million). Increased customer finance
charges ($6.7 million) related to larger 2003 customer bills also contributed to
the slight increase. Negatively impacting margin was a smaller contribution from
nontraditional gas supply-related services ($7.7 million) and lower deliveries
for power generation ($2.8 million).
Gas distribution operating and maintenance expense. Gas distribution operating
and maintenance expense increased $3.2 million and $21.1 million in the
three-month and nine-month periods ended September 30, 2003, respectively,
compared to the same periods of 2002. The quarterly increase was due to a number
of factors including lower pension credits ($2.5 million), increased bad debt
expense related to higher customer bills and increasingly adverse credit
experience ($1.7 million), and higher insurance and health care costs ($1.6
million). An offsetting factor for 2003 was a charge in the third quarter of
2002 to increase liabilities for costs related to the performance-based rate
(PBR) plan and other investigations ($3.8 million).
The $21.1 million increase in the nine-month period was due primarily to lower
pension credits ($7.3 million), higher health care and insurance costs ($4.9
million), increased natural gas costs to operate company equipment and
facilities ($2.8 million) and increased bad debt expense ($1.7 million). The
higher company-use gas expenses are related to higher average natural gas costs
in 2003 compared to 2002. These negative factors were partially offset by lower
costs related to the review of the company's PBR plan ($2.5 million).
Gas distribution operating and maintenance expense included $.4 million and $1.0
million of pension expense in the 2003 three-month and nine-month periods,
respectively, compared with $2.1 million and $6.3 million of pension credits in
the same 2002 periods.
Gas distribution depreciation. Both the quarter and year-to-date results for the
gas distribution segment were significantly affected by the change to a
straight-line interim depreciation allocation method. Previously, Nicor Gas
allocated depreciation to interim periods based upon the level of
weather-normalized gas deliveries each quarter. If a straight-line allocation
method had been used in 2002, depreciation in both 2003 periods would have
increased slightly compared to the 2002 periods as a result of property
additions.
Mercury-related costs (recoveries). In the second quarter of 2003, Nicor Gas
recovered approximately $17 million of mercury-related costs, net of legal fees,
from insurers and independent contractors. In the third quarter of 2002, Nicor
Gas reached an agreement with an insurer wherein the company recovered
approximately $20 million of mercury-related costs.
Gas distribution property sale (gains) losses. Property sale gains and losses
vary from year-to-year depending upon property sales activity. The company
continues to assess its ownership of real estate holdings.
Nicor Inc. Page 24
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Shipping operating expenses. Shipping segment operating expenses decreased by
$1.4 million in the third quarter of 2003 compared to 2002 due primarily to
lower operating expenses ($3.1 million), related to decreased volumes, partially
offset by increased corporate overhead ($.7 million) and increased fuel costs
($.5 million). For the 2003 nine-month period, shipping operating expenses
increased $4.6 million due primarily to increased fuel costs ($2.4 million),
increased corporate overhead ($1.1 million) and higher wage and benefit costs
($.5 million). Increased fuel costs for both periods reflect the impact of
higher fuel prices in 2003.
All other operating expenses. The $1.5 million decrease in the 2003 third
quarter all other operating expenses as compared to 2002 was due primarily to
lower operating expenses from the company's former energy system and design
activities ($3.7 million), partially offset by higher operating expenses at
Nicor's energy-related products and services businesses ($2.2 million).
The $3.1 million decrease in the 2003 year-to-date operating expenses compared
to 2002 was due primarily to lower operating expenses from the company's former
energy system and design activities ($10.5 million). This decrease was partially
offset by higher operating expenses at Nicor's energy-related products and
services businesses ($3.0 million) and Nicor's corporate operating costs ($3.9
million). The increase in corporate operating expenses in the year-to-date
period related primarily to increased legal costs.
The increase in operating costs for Nicor's energy-related products and services
businesses in both periods was due mainly to an increased number of customers
and a new utility-bill management product introduced in early 2002.
Nicor Inc. Page 25
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
GAS DISTRIBUTION STATISTICS
Operating revenues, deliveries, customers and other statistics are presented
below.
Three months ended Nine months ended
September 30 September 30
------------------ -------------------
2003 2002 2003 2002
-------- -------- --------- --------
Operating revenues (millions):
Sales
Residential $ 142.0 $ 100.8 $ 1,158.2 $ 620.1
Commercial 31.2 20.3 256.2 120.1
Industrial 4.3 2.1 37.7 19.7
-------- -------- --------- --------
177.5 123.2 1,452.1 759.9
-------- -------- --------- --------
Transportation
Residential 3.9 4.0 15.7 10.0
Commercial 11.0 12.2 51.5 53.9
Industrial 11.1 13.7 32.5 35.8
Other 1.3 1.0 10.4 5.5
-------- -------- --------- --------
27.3 30.9 110.1 105.2
-------- -------- --------- --------
Other revenues
Revenue taxes 11.4 9.1 98.3 66.0
Environmental cost recovery 2.4 1.7 22.1 17.1
Chicago Hub 1.1 3.6 4.6 10.1
Weather hedge results - .7 (3.5) 1.3
Other 3.7 3.5 15.9 11.6
-------- -------- --------- --------
18.6 18.6 137.4 106.1
-------- -------- --------- --------
$ 223.4 $ 172.7 $ 1,699.6 $ 971.2
======== ======== ========= ========
Deliveries (Bcf):
Sales
Residential 14.3 13.2 150.3 139.0
Commercial 3.5 3.0 33.2 26.7
Industrial .5 .3 5.1 4.8
-------- -------- --------- --------
18.3 16.5 188.6 170.5
-------- -------- --------- --------
Transportation
Residential 1.0 1.1 11.2 5.6
Commercial 8.7 14.1 61.8 68.4
Industrial 27.8 42.6 89.8 116.6
-------- -------- --------- --------
37.5 57.8 162.8 190.6
-------- -------- --------- --------
55.8 74.3 351.4 361.1
======== ======== ========= ========
Customers at end of period (thousands):
Sales
Residential 1,726.9 1,701.5
Commercial 111.4 105.0
Industrial 7.0 6.7
------- -------
1,845.3 1,813.2
------- -------
Transportation
Residential 138.9 135.2
Commercial 58.3 63.6
Industrial 6.3 6.8
------- -------
203.5 205.6
------- -------
2,048.8 2,018.8
======== =======
Other statistics:
Degree days 97 33 4,094 3,530
Percent colder (warmer)
than normal 37% (54)% 7% (8)%
Average gas cost per Mcf sold $ 6.31 $ 3.84 $ 6.41 $ 3.04
Nicor Inc. Page 26
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
SHIPPING STATISTICS
Three months Nine months
ended ended
September 30 September 30
-------------- -----------------
2003 2002 2003 2002
------- --------- -------- --------
TEUs shipped (thousands) 42.5 43.9 127.4 126.7
Revenue per TEU $ 1,484 $ 1,515 $ 1,534 $ 1,511
Ports served 24 24
Vessels operated 16 17
FINANCIAL CONDITION AND LIQUIDITY
Operating cash flows. Net cash flow provided from operating activities decreased
$399.2 million in the 2003 nine-month period from $266.4 million in the
prior-year period. Year-to-year changes in operating cash flow result largely
from fluctuations in working capital items occurring mainly in the gas
distribution segment due to factors such as weather, the price of natural gas,
the timing of collections from customers and gas purchasing practices. The
company generally relies on short-term financing to meet temporary increases in
working capital needs. In the fourth quarter of 2003, Nicor received an income
tax refund of approximately $100 million attributed to a tax loss carryback
associated with a change in tax accounting methods, subject to Internal Revenue
Service review and approval.
Investing activities. In September 2003, Nicor invested an additional $6.3
million in Triton Container Investments. Nicor estimates capital expenditures in
property, plant and equipment of about $180 million in 2003. The $5 million
increase over prior projections is related to the gas distribution segment.
Financing activities. Nicor Inc. and Nicor Gas maintain short-term line of
credit agreements with major domestic and foreign banks. At September 30, 2003,
these agreements, which serve as backup for the issuance of commercial paper,
allowed for borrowings of up to $1 billion through March 2004 and $500 million
thereafter through September 2004. Commitment fees paid in advance totaled $2.9
million and will be amortized over the respective term of the agreements as an
adjustment to interest expense. As of September 30, 2003, the company had $640
million of commercial paper borrowings outstanding.
Under the company's 2003/2004 short-term line of credit agreements, (1) if
Nicor's ratio of consolidated indebtedness to capitalization (including
short-term debt) exceeds 65% at the end of the first, second or third fiscal
quarter, or 70% at the end of the fourth fiscal quarter, and/or (2) if Nicor's
twelve-months-ended interest coverage ratio is less than 3 to 1 at the end of
any fiscal quarter during the term of the credit agreements, banks representing
66 2/3% of the commitments may declare any amounts due immediately payable
and/or terminate the commitments to make advances to the company. The company is
in compliance with this covenant at September 30, 2003. The company expects that
commercial paper funding will continue to be available in the foreseeable
future.
In April 2003, Nicor Gas refinanced $50 million of 3 percent unsecured notes due
in April 2003 with $50 million of 1.6 percent unsecured notes due and paid in
October 2003. In June 2003, Nicor Gas retired $50 million of First Mortgage
Bonds due June 1, 2003 at 5.75% through the issuance of commercial paper.
Nicor Inc. Page 27
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
In April 2003, Moody's Investors Service downgraded the long-term debt ratings
of Nicor Gas from Aa1 to Aa3, while affirming their short-term ratings. Standard
and Poor's Ratings Services and Fitch Ratings affirmed Nicor and Nicor Gas'
short-term and long-term debt ratings. All three rating agencies removed the
debt ratings from negative ratings watch. As of the filing date of this report,
these ratings are among the highest in the gas distribution industry.
In September 2003, Standard and Poor's Ratings Services assigned a AA- rating to
the two new short-term line of credit agreements.
On April 30, 2003, Nicor announced a quarterly dividend on common stock of 46.5
cents per share payable August 1, 2003. On July 17, 2003, Nicor announced a
quarterly dividend on common stock of 46.5 cents per share payable November 1,
2003.
FACTORS AFFECTING BUSINESS PERFORMANCE
Critical accounting policies. Nicor made several changes to its accounting
policies in 2003, including a change to the method of allocating annual
depreciation to interim periods. This creates a significant favorable impact on
first-quarter and fourth-quarter results and an adverse impact on second-quarter
and third-quarter results as compared to 2002. As a result, depreciation is
expected to be about $5 million lower in the fourth quarter of 2003 than for the
same quarter of 2002. For further information about Nicor's accounting changes,
see the Notes to the Consolidated Financial Statements - Note 2 Cumulative
Effect of Change in Accounting and - Note 3 Other Accounting Changes, which
explain all material changes to the company's critical accounting policies since
December 31, 2002.
Weather protection. The company is no longer carrying weather hedges at Nicor
Gas because there is a natural internal financial offset between traditional
utility sales and the fixed bill product marketed by Nicor's energy-related
products and services businesses. The natural offset reduces Nicor's historical
earnings variability due to weather, of about 2 1/2 cents per share per 100
degree days, by about a third. The company will continue to evaluate its
coverage options to determine whether any additional coverage should be
purchased.
Contingencies. The following contingencies of Nicor are in various stages of
investigation or disposition. Although in some cases the company is unable to
estimate the amount of loss reasonably possible in addition to any amounts
already recognized, it is possible that the resolution of these contingencies,
either individually or in aggregate, will require the company to take charges
against, or will result in reductions in, future earnings. It is the opinion of
management that the resolution of these contingencies, either individually or in
aggregate, could be material to earnings in a particular period, but is not
expected to have a material adverse impact on Nicor's liquidity or financial
condition.
Performance-based rate plan. Nicor Gas' PBR plan for natural gas costs went into
effect in 2000 and was terminated by the company effective January 1, 2003.
Under the PBR plan, Nicor Gas' total gas supply costs were compared to a
market-sensitive benchmark. Savings and losses relative to the benchmark were
determined annually and shared equally with sales customers. The PBR is
currently under Illinois Commerce Commission (ICC) review.
Nicor Inc. Page 28
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
There are allegations that the company acted improperly in connection with the
PBR plan, and the ICC and others are reviewing these allegations. On June 27,
2002 the Citizens Utility Board (CUB) filed a motion to reopen the record in the
ICC's proceedings to review the PBR plan (the ICC Proceedings). As a result of
the motion to reopen, Nicor Gas, the Cook County State's Attorney Office
(CCSAO), the staff of the ICC and CUB entered into a stipulation providing for
additional discovery. The Illinois Attorney General's Office has also intervened
in this matter. In addition, the Illinois Attorney General's Office issued Civil
Investigation Demands (CIDs) to CUB and the ICC staff. The CIDs ordered that CUB
and the ICC staff produce all documents relating to any claims that Nicor Gas
may have presented, or caused to be presented, false information related to its
PBR plan. Parties who were plaintiffs in a dismissed class action proceeding
against the company could potentially intervene in these proceedings. The
company has committed to cooperate fully in the reviews of the PBR plan.
In response to these allegations, on July 18, 2002, the Nicor Board of Directors
appointed a special committee of independent, non-management directors to
conduct an inquiry into issues surrounding natural gas purchases, sales,
transportation, storage and such other matters as may come to the attention of
the special committee in the course of its investigation. The special committee
presented the report of its counsel (Report) to Nicor's Board of Directors on
October 28, 2002. The findings of the Report include:
o Certain transactions increased customer costs in the aggregate amount of
approximately $15 million.
o No improper Nicor affiliated-party transactions or improper hedging
activities were identified.
o Inadvertent accounting errors occurred, sometimes to the benefit of customers
and sometimes to the benefit of Nicor Gas.
o No criminal activity or fraud was identified.
In response, the Nicor Board of Directors directed the company's management to,
among other things, make appropriate adjustments to account for, and fully
address, the adverse consequences to ratepayers of the items noted in the
Report, and conduct a detailed study of the adequacy of internal accounting and
regulatory controls. The adjustments were made in restated financial statements
previously filed with the SEC, and substantial progress has been made in the
ongoing study of internal controls.
Pursuant to the agreement of all parties, including the company, the ICC
re-opened the 1999 and 2000 purchased gas adjustment filings for review of
certain transactions related to the PBR plan and consolidated the reviews of the
1999-2002 purchased gas adjustment filings with the PBR plan review.
Certain parties in the PBR plan review proceeding have indicated disagreement
with the findings in the Report or have indicated that they believe
substantially greater adjustments or penalties are warranted. In addition, on
February 5, 2003, the CCSAO and CUB filed a motion for $27 million in sanctions
against the company in the ICC Proceedings. In that motion, CCSAO and CUB
alleged that Nicor Gas' responses to certain CUB data requests were false. Also
on February 5, 2003, CUB stated in a press release that, in addition to $27
million in sanctions, it would seek refunds to consumers in an amount much
greater than the $15 million of adjustments identified in the Report. On March
5, 2003, the ICC staff filed a response brief in support of CUB's motion for
sanctions. On May 1, 2003, the Administrative Law Judges issued a ruling denying
CUB and CCSAO's motion for sanctions. CUB has filed an appeal of the motion for
sanctions with the ICC, and the ICC has indicated that it will not rule on the
appeal until the final disposition of the ICC proceedings. It is not possible to
determine how the ICC will resolve the claims of CCSAO, CUB or other parties to
the ICC Proceedings.
Nicor Inc. Page 29
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Nicor is unable to predict the outcome of any of the foregoing reviews or the
company's potential exposure thereunder. Due to the uncertainties surrounding
the PBR plan, Nicor Gas has not recognized a $26.9 million pretax gain from the
2002 PBR plan year. Because the PBR plan and historical utility gas costs are
still under ICC review, it is possible that the final outcome could be
materially different than the amounts reflected in the company's financial
statements as of September 30, 2003.
Nicor Energy. Significant developments have occurred relating to Nicor's
50-percent interest in Nicor Energy. Accounting irregularities at Nicor Energy
were identified in 2002. Information about these developments is presented
within the Notes to the Consolidated Financial Statements - Note 15
Contingencies - Nicor Energy.
SEC and U.S. Attorney Inquiries. In 2002, the staff of the Securities and
Exchange Commission (SEC) informed Nicor and Nicor Energy that the SEC is
conducting a formal inquiry regarding the PBR plan and Nicor Energy. On January
28, 2003, Nicor Energy was advised by the SEC Division of Enforcement that it
intended to recommend to the SEC that it bring a civil injunctive action against
Nicor Energy, alleging that it violated Sections 10(b) and 13(b)(5) of the
Securities Exchange Act of 1934. A representative of the Office of the United
States Attorney for the Northern District of Illinois has notified Nicor that
that office is conducting an inquiry on the same matters that the SEC is
investigating, and a grand jury is also reviewing these matters.
Securities Class Actions. Nicor and certain of its executives are defendants in
a consolidated class action lawsuit. Information about this action is presented
within the Notes to the Consolidated Financial Statements - Note 15
Contingencies - Securities Class Actions.
Shareholder Derivative Lawsuits. Certain Nicor executives and all members of its
Board of Directors are defendants in a consolidated derivative lawsuit. Further
information about this lawsuit is presented within the Notes to the Consolidated
Financial Statements - Note 15 Contingencies - Shareholder Derivative Lawsuits.
Mercury. Future operating results may be impacted by adjustments to the
company's estimated mercury liability or by related recoveries. Additional
information about mercury contingencies is presented in the Notes to the
Consolidated Financial Statements - Note 15 Contingencies - Mercury.
Manufactured gas plant sites. The company is conducting environmental
investigations and remedial activities at former manufactured gas plant sites.
Additional information about these sites is presented in the Notes to the
Consolidated Financial Statements - Note 15 Contingencies - Manufactured Gas
Plant Sites.
Other contingencies. The company is involved in legal or administrative
proceedings before various courts and agencies with respect to rates, taxes and
other matters. See the Notes to the Consolidated Financial Statements - Note 15
Contingencies.
Market risk. Nicor is exposed to market risk in the normal course of its
business operations, including the risk of loss arising from adverse changes in
natural gas and fuel commodity prices, and interest rates. There has been no
material change in the company's exposure to market risk since the filing of the
2002 Annual Report on Form 10-K, except as noted below.
Nicor Inc. Page 30
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (concluded)
Energy trading activities. At September 30, 2003, Nicor Enerchange, Nicor's
wholesale natural gas marketing business, held financial derivative contracts
with the following fair values (in millions):
Maturity
--------------------------------
Total Less than 1 to 3 3 to 5
Source of Fair Value Fair Value 1 Year Years Years
- ----------------------------- --------- --------- ------- ---------
Prices actively quoted $ (1.2) $ (.7) $ (.5) $ -
Prices based on pricing
models - - - -
--------- --------- --------- --------
$ (1.2) $ (.7) $ (.5) $ -
========= ========= ========= ========
Credit risk. The company is exposed to credit risk in the event a counterparty,
customer or supplier defaults on a contract to pay for or deliver product at
agreed-upon terms and conditions. To manage this risk, the company has
established procedures to determine and monitor the creditworthiness of
counterparties, to require guarantees or collateral back-up, and to limit its
exposure to any one counterparty. Nicor, in some instances, enters into netting
agreements to mitigate counterparty credit risk.
On December 2, 2001 Enron North America Corporation (Enron) filed a voluntary
petition for relief under Chapter 11 of Title XI of the United States Bankruptcy
Code in the United States Bankruptcy Court for the Southern District of New
York. At the date of Enron's bankruptcy filing, the net amounts due to Enron
were $2.8 million from Nicor Gas, and $.9 million from Nicor Enerchange. Payment
has been made under settlement and mutual release agreements approved by the U.S
Bankruptcy Court during the second quarter of 2003.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
This document includes certain forward-looking statements about the expectations
of Nicor, and its subsidiaries and affiliates. Although Nicor believes these
statements are based on reasonable assumptions, actual results may vary
materially from stated expectations. Such forward-looking statements may be
identified by the use of forward-looking words or phrases such as "anticipate,"
"believe," "expect," "intend," "may," "planned," "potential," "should," "will,"
"would," or similar phrases. Actual results may differ materially from those
indicated in the company's forward-looking statements due to the direct or
indirect effects of the results of legal contingencies (including litigation)
and the resolution of those issues, including the effects of an ICC review, and
undue reliance should not be placed on such statements. Other factors that could
cause materially different results include, but are not limited to, weather
conditions; natural gas and other fuel prices; fair value accounting
adjustments; health care costs; insurance costs; legal costs; borrowing needs;
interest rates; credit conditions; economic and market conditions; Caribbean
tourism; energy conservation; legislative and regulatory actions, results, or
adjustments; additional adjustments related to Nicor's retail energy marketing
joint venture; asset sales; significant unplanned capital needs; future
mercury-related charges or credits; changes in accounting principles;
performance of major suppliers and contractors; and acts of terrorism. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date of this filing. Nicor undertakes no obligation
to publicly release any revision to these forward-looking statements to reflect
events or circumstances after the date of this filing.
Nicor Inc. Page 31
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
For disclosures about market risk, see Management's Discussion and Analysis -
Market Risk beginning on page 29 which is incorporated herein by reference.
Item 4. Controls and Procedures
Attached as exhibits 31.1 and 31.2 to this Quarterly Report are certifications
of the company's CEO and the CFO required in accord with Section 302 of the
Sarbanes-Oxley Act of 2002 (the "Section 302 Certifications"). This portion of
our Quarterly Report on Form 10-Q is our disclosure of the results of our
controls evaluation referred to in paragraphs (4) and (5) of the Section 302
Certification and should be read in conjunction with the Section 302
Certifications for a more complete understanding of the topics presented.
In July 2002, in response to allegations that Nicor Gas acted improperly in
connection with its performance-based rate plan for natural gas costs, the Nicor
Board of Directors appointed a special committee of independent, non-management
directors to conduct an inquiry into issues surrounding natural gas purchases,
sales, transportation and storage, and certain other matters. In addition,
following up on the work of the committee, the Nicor Board of Directors later
directed Nicor's management to, among other things, (a) undertake a reaudit of
the Nicor and Nicor Gas financial statements for the years 1999 through 2001 and
a review of subsequent quarterly periods, (b) amend any filings with the SEC as
necessary, and (c) conduct a detailed study of the adequacy of internal
accounting and regulatory controls. See Notes to Consolidated Financial
Statements - Contingencies.
To assist management in assessing the control environment and related issues
associated with Nicor's natural gas supply, transport, storage and marketing
activities, including Nicor Gas Hub administration and Nicor Enerchange trading
("gas supply activities"), Nicor retained a consulting firm in the fourth
quarter of 2002 with experience in internal controls and the energy industry
that is not and has not been the company's external auditor.
Through this review of gas supply activities ("gas supply review"), it was
observed that:
o Although key controls have been designed to facilitate the complete and
accurate capture and processing of gas supply activities, many control
activities are not standardized. As such, the reliability and effectiveness
of these control processes are dependent on interpretation and execution by
business unit personnel.
o Existing processes provide limited oversight and monitoring to ensure that
transaction activities and control procedures are performed reliably and
consistent with management expectations.
o As a result, gas supply activities are not adequately documented, are overly
dependent on people, and are not supported by formal training or
communication of controls.
In light of the foregoing, and reflecting the consultant's work related to gas
supply activities, management concluded that the following steps related to gas
supply activities should be undertaken:
o Enhance the effectiveness of corporate governance and independent oversight
of gas supply activities by creating a formal risk management function and
expanding senior management oversight through the company's risk management
committee.
o Enhance senior management monitoring and oversight of gas supply activities
by creating formal reporting frameworks designed to effectively communicate
performance, existing risk profile/position, and compliance with
policies/procedures.
Nicor Inc. Page 32
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Item 4. Controls and Procedures (continued)
o Enhance the communication of senior management's expectations regarding
objectives, risk tolerances, and business practices in connection with gas
supply activities by creating codified and standardized policies and
procedures for these activities.
o Given the high degree of regulatory oversight and review over gas supply
activities, develop formal documentation and retention standards for key
decision-making and transaction activities that are subject to regulatory
review.
o For each business unit responsible for gas supply contract negotiation and
execution, establish a dedicated contract administration function as well as
a contract compliance program.
o Develop formal contracting standards, including practices and procedures
surrounding contract execution, contract review and approval and contract
modification.
In May 2002, the company engaged new accountants, Deloitte & Touche LLP ("D&T"),
who were asked in October 2002 to audit the company's 1999, 2000 and 2001
restated financial statements in addition to its audit of the company's 2002
financial statements. In connection with the completion of its audit of, and the
issuance of an unqualified report on Nicor's and Nicor Gas' restated financial
statements for the years ended December 31, 1999, 2000 and 2001, D&T issued a
letter dated February 28, 2003 (the "D&T Letter"), in which it identified to
management and the Audit Committee of the Board of Directors certain
deficiencies that existed in the design or operation of Nicor Gas' internal
accounting controls which, considered collectively, constituted a material
weakness in Nicor Gas' internal controls pursuant to standards established by
the American Institute of Certified Public Accountants. Such deficiencies at
Nicor Gas' regulated gas purchasing operations included significant weaknesses
in the design of controls surrounding execution, monitoring and accounting for
gas commodity, transportation, storage and related contracts due, in part, to
the lack of a centralized independent back office for these activities. D&T also
concluded that these weaknesses had resulted in errors that affected gas
purchase costs, inventory, regulatory assets and liabilities, and results of the
performance-based rate plan, and led to a restatement of Nicor's and Nicor Gas'
financial statements. D&T made the following recommendations to Nicor and Nicor
Gas with respect to these deficiencies:
o Establish a centralized, independent back office function for gas supply
activities, staffed with an adequate number of appropriately skilled
individuals.
o Charge the gas supply back office function with responsibility for, among
other matters, contract analysis to determine correct accounting treatment,
ensuring that contract terms are followed, overseeing the contract approval
process and contract administration.
The company carried out an evaluation under the supervision and with the
participation of the company's management, including its principal executive
officer and principal financial officer, of the effectiveness of the design and
operation of the company's disclosure controls and procedures as of the end of
the period covered by this Quarterly Report on Form 10-Q (the "Evaluation").
During the course of the Evaluation, the company's principal executive officer
and principal financial officer took note of, and considered as part of the
company's disclosure controls and procedures (as defined in Rule 13a-15 under
the Securities Exchange Act of 1934), additional procedures performed and
controls instituted by the company subsequent to the receipt of the D&T Letter
(the "Additional Procedures") to supplement its internal controls in order to
mitigate the effect of the weaknesses and deficiencies identified in the gas
supply review and the D&T Letter and to prevent misstatements or omissions in
its consolidated financial statements resulting from such factors. In designing
and evaluating the disclosure controls and procedures, management recognizes
that any controls and
Nicor Inc. Page 33
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Item 4. Controls and Procedures (concluded)
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
is required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Based on the Evaluation, the company's Chief
Executive Officer and Chief Financial Officer concluded that the company's
disclosure controls and procedures, as of the end of the period covered by this
Quarterly Report on Form 10-Q, including the Additional Procedures, were
effective at the reasonable assurance level to ensure that information required
to be disclosed by the company in reports that it files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms.
Management has considered the matters referred to above, D&T's recommendations
with respect thereto and the gas supply review in connection with management's
general evaluation of the company's internal controls in particular and its
disclosure controls and procedures generally. The company has accepted the
recommendations identified in the D&T Letter and in the gas supply review. The
company's management assigned a high priority to the short-term and long-term
correction of the internal control weaknesses and deficiencies identified by D&T
and in the gas supply review, and has implemented changes to the company's
policies, procedures, systems and personnel to address these issues. The
company's management has implemented the following changes based upon the D&T
Letter and the gas supply review:
o The company has dedicated additional internal audit and external resources to
the assessment of the internal controls of the company.
o New policies with respect to the approval and authorization of all
transactions related to gas supply activities and affiliated transactions
have been developed and implemented.
o Gas supply purchasing testing is being regularly performed to verify that
prices are consistent with market rates.
o Personnel in gas supply accounting now report directly to the company's
Controller.
o The company's Risk Management Committee has increased its oversight level,
and a new Chief Risk Officer position has been established.
o Substantial effort has been put forth on documentation and implementation of
appropriate processes, procedures and controls.
o The company has implemented, and will continue to implement, controls
designed to ensure compliance with regulatory rules and mandates.
o New contract administration processes have been implemented to provide a more
effective method of contract administration.
The company will continue to evaluate and implement corrective actions to
improve the effectiveness of its disclosure controls and procedures and will
take further actions as dictated by such continuing reviews. These actions will
include additional procedures to supplement its internal controls. The steps
taken and to be taken to correct the weaknesses and deficiencies identified in
the gas supply review and the D&T Letter constitute significant changes in
internal controls over financial reporting in the period covered by this
Quarterly Report on Form 10-Q.
Nicor Inc. Page 34
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
For information concerning legal proceedings, see the Notes to the Consolidated
Financial Statements - Note 15 Contingencies and Management's Discussion and
Analysis - Contingencies beginning on page 27, which are incorporated herein by
reference.
Item 6. Exhibits and Reports on Form 8-K
(a) See Exhibit Index filed herewith.
(b) On July 3, 2003, Nicor filed a Form 8-K, under Item 9, regarding a press
release dated July 3, 2003 announcing additional mercury-related cost
recoveries.
On August 1, 2003, Nicor filed a Form 8-K, under Item 12, regarding a
press release dated July 31, 2003 announcing earnings for the quarter
ended June 30, 2003.
On August 6, 2003, Nicor filed a Form 8-K, under Item 9, regarding an
analyst presentation of August 6, 2003.
On September 10, 2003, Nicor filed a Form 8-K, under Item 5, regarding a
press release dated September 9, 2003 announcing $1 billion syndicated
revolving credit facilities.
On September 25, 2003, Nicor filed a Form 8-K, under Item 9, regarding
analyst presentations of September 25 and 26, 2003.
Nicor Inc. Page 35
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Signature
- ---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Nicor Inc.
Date November 4, 2003 /s/ KATHLEEN L. HALLORAN
------------------ ----------------------------------
Kathleen L. Halloran
Executive Vice President
Finance and Administration
Nicor Inc. Page 36
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Exhibit Index
- -------------
Exhibit
Number Description of Document
- --------- -------------------------------------------------------------------
3.01 * Articles of Incorporation of the company. (File No.
2-55451, Form S-14, Nicor Inc., Exhibit 1-03 and
Exhibit B of Amendment No. 1 thereto.)
3.02 * Amendment to Articles of Incorporation of the company.
(Proxy Statement dated April 20, 1979, Nicor Inc., Item
3 thereto.)
3.03 * Amendment to Articles of Incorporation of the company.
(File No. 2-68777, Form S-16, Nicor Inc., Exhibit 2-01.)
3.04 * Amendment to Articles of Incorporation of the company.
(File No. 1-7297, Form 10-K for 1985, Nicor Inc.,
Exhibit 3-03.)
3.05 * Amendment to Articles of Incorporation of the
company. (Proxy Statement dated March 12, 1987, Nicor
Inc., Exhibit A and Exhibit B thereto.)
3.06 * Amendment to Articles of Incorporation of the company.
(File No. 1-7297, Form 10-K for 1992, Nicor Inc.,
Exhibit 3-06.)
3.07 * Amendments to Articles of Incorporation of the
company. (Proxy Statement dated March 9, 1994, Nicor
Inc., Exhibit A-1 and Exhibit B thereto.)
3.08 * Amendment to Articles of Incorporation of the company.
(Proxy Statement dated March 6, 1998, Nicor Inc., Item
2 thereto.)
3.09 * By-Laws of the company as amended by the company's
Board of Directors on May 3, 1995. (File No. 1-7297,
Form 10-Q for March 1995, Nicor Inc., Exhibit 3(ii).01.)
10.1 180-Day Credit Agreement dated as of September 9, 2003.
10.2 364-Day Credit Agreement dated as of September 9, 2003.
31.1 Rule 13a-14(a)/15d-14(a) Certification.
31.2 Rule 13a-14(a)/15d-14(a) Certification.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* These exhibits have been previously filed with the Securities and Exchange
Commission as exhibits to registration statements or to other filings with
the Commission and are incorporated herein as exhibits by reference. The
file number and exhibit number of each such exhibit, where applicable, are
stated in parentheses in the description of such exhibit.
Nicor Inc. Page 37
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Exhibit Index (concluded)
- -------------------------
Exhibit
Number Description of Document
- --------- -----------------------------------------------------------------
Upon written request, the company will furnish free of charge a copy of any
exhibit. Requests should be sent to Investor Relations at the corporate
headquarters.