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, 2002
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Registrant, State of I.R.S. Employer
Commission 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 [ ]
Shares of common stock, par value $2.50, outstanding at November 5, 2002, were
44,014,697.
*The company's new independent public accountant, Deloitte & Touche LLP, did not
complete the review of the company's condensed unaudited 2002 financial
statements as required by Rule 10-01(d) of Regulation S-X promulgated under the
Securities Act of 1934, due to the pending financial statement restatements
discussed on page 5.
Nicor Inc. Page i
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Table of Contents
Part I - Financial Information
Item 1. Financial Statements (Unaudited) .......................... 1
Consolidated Statements of Operations:
Three and nine months ended
September 30, 2002 and 2001 ............................. 2
Consolidated Statements of Cash Flows:
Nine months ended
September 30, 2002 and 2001 ............................. 3
Consolidated Balance Sheets:
September 30, 2002 and 2001, and
December 31, 2001 ....................................... 4
Notes to the Consolidated Financial Statements ............ 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ..................... 20
Item 3. Quantitative and Qualitative Disclosures about Market
Risk.................................................. 32
Item 4. Controls and Procedures ................................... 32
Part II - Other Information
Item 1. Legal Proceedings ......................................... 32
Item 5. Other Information ......................................... 32
Item 6. Exhibits and Reports on Form 8-K........................... 32
Signature ................................................... 33
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.
Mcf, MMcf, Bcf...Thousand cubic feet, million cubic feet, billion
cubic feet.
PBR..............Performance-based rate, a regulatory plan that
provides 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
INTENTION TO RESTATE FINANCIAL STATEMENTS
The company is in the process of restating these financial statements, the
company's 1999 through 2001 financial statements and its first and second
quarter 2002 financial statements, for the reasons stated in the Pending
Financial Statement Restatements and Re-audits footnote on page 5. Accordingly,
existing financial statements for those periods should not be relied upon.
Furthermore, all the notes to the consolidated financial statements,
particularly the note referred to in the first sentence, should be read in their
entirety when reading these financial statements because they materially impact
the ability to understand the historical financial information presented
regarding the company.
The company's new independent public accountant, Deloitte & Touche LLP, did not
complete the review of the company's condensed unaudited 2002 financial
statements included herein, as required by Rule 10-01(d) of Regulation S-X
promulgated under the Securities Act of 1934, due to the pending financial
statement restatements. The company will file an amendment to this Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002, as soon as
practicable after the restatements are completed and audited or reviewed, as
appropriate.
Except as set forth above, the following condensed unaudited 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
latest Annual Report on Form 10-K, subject to the pending restatement of the
financial statements referred to above.
The information furnished (including the information on this page and in the
notes to the financial statements) reflects, in the opinion of the company, all
adjustments (consisting only of normal recurring adjustments) 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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Consolidated Statements of Operations (Unaudited) SUBJECT TO RESTATEMENT
(millions, except per share data)
Three months ended Nine months ended
September 30 September 30
------------------ ------------------
2002 2001 2002 2001
-------- -------- -------- --------
Operating revenues
Gas distribution (includes revenue
taxes of $9.1, $7.9, $66.0 and
$95.0, respectively) $ 172.6 $ 156.3 $ 969.4 $1,776.4
Shipping 66.6 52.7 191.6 165.7
Other 10.6 7.9 26.6 20.7
------- ------- -------- --------
249.8 216.9 1,187.6 1,962.8
Operating expenses
Gas distribution
Cost of gas 66.8 51.5 533.2 1,306.5
Operating and maintenance 46.8 39.1 137.5 122.5
Depreciation 17.0 15.5 96.2 91.8
Taxes, other than income taxes 13.4 11.0 78.0 104.9
Mercury-related costs (recoveries) (19.7) (9.2) (19.5) (11.4)
Shipping 62.3 48.5 180.4 154.6
All other 10.0 7.1 24.7 19.6
------- ------- ------- --------
196.6 163.5 1,030.5 1,788.5
------- ------- ------- --------
Operating income 53.2 53.4 157.1 174.3
Equity investment income (loss) (3.1) 1.2 (12.5) -
Other income (expense), net 1.2 6.7 6.9 12.2
Interest expense, net of amounts
capitalized 9.1 10.4 27.4 36.6
------- ------- ------- --------
Income before income taxes 42.2 50.9 124.1 149.9
Income taxes 12.2 17.9 38.3 51.4
------- ------- ------- --------
Net income 30.0 33.0 85.8 98.5
Dividends on preferred stock .1 .1 .2 .2
------- ------ ------- --------
Earnings applicable to common stock $ 29.9 $ 32.9 $ 85.6 $ 98.3
======= ====== ======= ========
Average shares of common stock
outstanding
Basic 44.0 45.0 44.2 45.2
Diluted 44.1 45.1 44.3 45.4
Earnings per average share of
common stock
Basic $ .68 $ .73 $ 1.94 $ 2.17
Diluted .68 .73 1.93 2.17
Dividends declared per share of
common stock $ .46 $ .44 $ 1.38 $ 1.32
The accompanying notes are an integral part of these statements. In particular,
see Cautionary Statement on page 5.
Nicor Inc. Page 3
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Consolidated Statements of Cash Flows (Unaudited) SUBJECT TO RESTATEMENT
(millions)
Nine months ended
September 30
-------------------
2002 2001
--------- --------
Operating activities
Net income $ 85.8 $ 98.5
Adjustments to reconcile net income to net cash flow
provided from operating activities:
Depreciation 109.2 104.0
Deferred income tax expense 32.4 22.1
Gain on sale of property, plant and equipment (4.5) (4.6)
Changes in assets and liabilities:
Receivables, less allowances 153.6 362.4
Gas in storage (29.7) 8.6
Deferred/accrued gas costs (85.1) 209.5
Prepaid pension costs (9.6) (25.5)
Other assets 7.0 1.1
Accounts payable (34.3) (339.4)
Temporary LIFO liquidation 41.0 5.9
Other liabilities 6.0 (25.2)
Other (5.6) (1.3)
--------- --------
Net cash flow provided from operating activities 266.2 416.1
--------- --------
Investing activities
Capital expenditures (137.7) (120.3)
Net decrease (increase) in short-term investments 12.1 (5.9)
Repayments from (loans to) joint ventures, net 23.0 (21.3)
Investment in joint ventures (26.5) (6.9)
Business acquisitions (11.3) -
Net proceeds from sale of property, plant and equipment 7.9 5.3
Other .8 (.6)
--------- --------
Net cash flow used for investing activities (131.7) (149.7)
--------- --------
Financing activities
Net proceeds from issuing long-term debt 49.9 197.6
Disbursements to retire long-term debt - (227.1)
Short-term borrowings (repayments), net (87.0) (166.0)
Dividends paid (60.4) (59.0)
Disbursements to reacquire stock (26.5) (28.4)
Other 6.0 -
-------- --------
Net cash flow used for financing activities (118.0) (282.9)
-------- --------
Net increase (decrease) in cash and cash equivalents 16.5 (16.5)
Cash and cash equivalents, beginning of period 10.7 55.8
-------- --------
Cash and cash equivalents, end of period $ 27.2 $ 39.3
======== ========
The accompanying notes are an integral part of these statements. In particular,
see Cautionary Statement on page 5.
Nicor Inc. Page 4
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Consolidated Balance Sheets (Unaudited) SUBJECT TO RESTATEMENT
(millions)
September 30 December 31 September 30
2002 2001 2001
------------ ----------- ------------
Assets
------
Current assets
Cash and cash equivalents $ 27.2 $ 10.7 $ 39.3
Short-term investments, at cost which
approximates market 22.1 34.2 48.9
Receivables, less allowances of $13.2,
$12.3 and $15.6, respectively 201.0 354.6 296.5
Notes receivable - joint ventures - 31.2 22.4
Gas in storage 58.3 28.6 23.2
Deferred income taxes 30.4 33.9 45.8
Other 28.6 24.7 23.8
---------- ----------- ------------
367.6 517.9 499.9
---------- ----------- ------------
Property, plant and equipment, at cost
Gas distribution 3,525.5 3,425.6 3,374.8
Shipping 309.5 304.6 294.6
Other 4.4 2.8 2.3
---------- ----------- ------------
3,839.4 3,733.0 3,671.7
Less accumulated depreciation 2,049.8 1,964.4 1,934.8
---------- ----------- ------------
1,789.6 1,768.6 1,736.9
---------- ----------- ------------
Prepaid pension costs 173.9 164.3 167.9
Other assets 162.1 124.0 106.5
---------- ----------- ------------
$ 2,493.2 $ 2,574.8 $ 2,511.2
========== =========== ============
Liabilities and Capitalization
------------------------------
Current liabilities
Long-term obligations due within
one year $ 100.0 $ - $ -
Short-term borrowings 190.0 277.0 276.0
Accounts payable 361.6 395.9 267.2
Accrued gas costs 15.7 100.8 160.4
Accrued mercury-related costs 3.6 7.0 41.5
Temporary LIFO liquidation 41.0 - 5.9
Other 50.0 45.7 60.4
---------- ----------- ------------
761.9 826.4 811.4
---------- ----------- ------------
Deferred credits and other liabilities
Deferred income taxes 360.5 328.8 315.9
Regulatory income tax liability 63.5 66.3 67.5
Unamortized investment tax credits 37.5 39.0 39.6
Accrued mercury-related costs 28.6 30.0 -
Other 113.0 104.2 107.6
---------- ----------- ------------
603.1 568.3 530.6
---------- ----------- ------------
Capitalization
Long-term debt 396.0 446.4 446.0
Preferred stock 6.0 6.1 6.1
Common equity
Common stock 110.0 111.0 112.0
Retained earnings 622.4 616.9 606.5
Unearned compensation (.3) - -
Accumulated other comprehensive
income (loss) (5.9) (.3) (1.4)
---------- ----------- ------------
1,128.2 1,180.1 1,169.2
---------- ----------- ------------
$ 2,493.2 $ 2,574.8 $ 2,511.2
========== =========== ============
The accompanying notes are an integral part of these statements. In particular,
see Cautionary Statement on page 5.
Nicor Inc. Page 5
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement)
The following notes should be read in conjunction with the financial statement
notes included in the Nicor Inc. consolidated (Nicor) 2001 Annual Report on Form
10-K.
CAUTIONARY STATEMENT
The financial statements and information presented in this Report on Form 10-Q
do not include (1) adjustments that the company plans to make as a result of an
investigation by a special committee of independent directors (Special
Committee) of Nicor Gas' natural gas purchases, sales, transportation and
storage activities nor (2) any other adjustments that may be made when the
company restates its financial statements for prior periods and the third
quarter of 2002. For further information, see Pending Financial Statement
Restatements and Re-audits below, and Contingencies - Performance-Based Rate
Plan beginning on page 12.
PENDING FINANCIAL STATEMENT RESTATEMENTS AND RE-AUDITS
Based on the results of the special investigation of Nicor Gas' natural gas
purchases, sales, transportation, and storage activities, more fully described
under Contingencies - Performance-Based Rate Plan beginning on page 12, the
company is in the process of restating its financial statements for 1999, 2000,
2001 and interim periods in 2002. Accordingly, the financial statements for
those periods should not be relied upon.
The restatements will include accounting corrections and other adjustments
resulting from the Special Committee's investigation, other corrections not
related to the investigation that are more properly reflected in periods other
than the ones in which they were initially reported, and any additional issues
arising during the re-audits, or otherwise, but not presently known. In
addition, the restatements could include other adjustments that may be
identified as a result of Illinois Commerce Commission (ICC) review of the Nicor
Gas performance-based rate (PBR) plan.
The company has engaged Deloitte & Touche LLP to audit the restated 1999, 2000
and 2001 financial statements, to review the 2002 interim financial statements
and to audit the 2002 financial statements, and will file amended reports with
the Securities and Exchange Commission (SEC) as soon as it is practical after
Deloitte & Touche completes its work.
Although all of the issues related to the restatements have not been resolved,
the company estimates that cumulative net income for the 1999 through 2002
period will be $15 million to $35 million lower than previously reported. As a
result of the ICC review and independent audit, final amounts could be
materially different than these estimates. The company cannot predict with
certainty when the restatements, independent audits or ICC review will be
complete. Also, while there will likely be material changes to the amounts
reported in certain categories within the balance sheets and statements of cash
flows, these changes are not expected to have a material impact on the company's
financial condition or liquidity.
For additional information, see Contingencies beginning on page 12.
Nicor Inc. Page 6
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
ACCOUNTING POLICIES
Weather derivatives. Since 2000, Nicor Gas has held derivative contracts to
limit the earnings impact of weather fluctuations. These contracts settle as of
year-end, and the resulting benefit or loss is recorded in operating revenues.
For interim accounting periods, contract benefits and losses are measured by
applying the intrinsic value method, which compares actual weather during
interim periods to normal historical weather patterns.
Shipping revenues. In the shipping segment, revenues and related delivery costs
are recorded at the time vessels depart from port. While alternative methods of
recognizing shipping revenue and related costs exist, the difference between
those methods and the company's policy do not have a material impact on
financial results.
Gas in storage. The gas distribution segment's inventory is carried at cost on a
last-in, first-out (LIFO) method on a calendar-year basis. For interim periods,
the difference between current replacement cost and the LIFO cost for quantities
of gas temporarily withdrawn from storage is recorded in cost of gas and in
current liabilities as a temporary LIFO liquidation.
Repair and maintenance expense. Nicor expenses repair and maintenance costs as
incurred, with one exception. Tropical Shipping uses the accrue-in-advance
method for planned major maintenance related to dry-docking and major repairs
for its owned vessels. These costs are generally accrued over a three-year
period.
Depreciation. Depreciation for the gas distribution segment is
calculated using a straight-line method for the calendar year.
For interim periods, gas distribution segment depreciation is
allocated based on gas deliveries.
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- and nine-month periods ended
September 30, 2002, were $8.7 million and $63.9 million, respectively, and $7.1
million and $92.2 million, respectively, for the same periods in 2001.
NEW ACCOUNTING PRONOUNCEMENTS
Energy trading revenues. In June 2002, the Emerging Issues Task Force (EITF)
reached a consensus on one item under review in Issue 02-03 requiring all
mark-to-market gains and losses arising from energy trading contracts (whether
realized or unrealized) to be shown net in revenue with a corresponding
reclassification of prior years' financial statements. Although the EITF
reversed that conclusion in October 2002, the company implemented the change
this quarter in order to comply with recent Securities and Exchange Commission
guidance and to be consistent with industry trends. Nicor Enerchange, one of
Nicor's other energy ventures, previously displayed revenues and expenses
associated with realized gains and losses separately. The implementation of this
change affected the revenues and operating expenses of Nicor in equal and
offsetting amounts. It did not have any impact on the company's financial
condition or the overall results of operation. See Reclassification of Prior
Period Financial Statements footnote on page 8.
Nicor Inc. Page 7
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
Energy trading accounting methods. On October 25, 2002, the EITF voted to
rescind EITF 98-10, Accounting for Contracts Involved in Energy Trading and Risk
Management Activities, effective December 15, 2002. EITF 98-10 applies to
Nicor's wholesale natural gas marketing business, Nicor Enerchange. Nicor has
not yet determined the effect that this rescission will have on its financial
statements.
Exit activities. In June 2002, the Financial Accounting Standards Board (FASB)
issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal
Activities. The statement, which is effective for 2003, requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
The company has reviewed the requirements of this new standard and it is not
expected to have a material impact on the company's overall financial condition
or results of operations.
GOODWILL
On January 1, 2002 the company implemented FASB Statement No. 142, Goodwill and
Other Intangible Assets. The company has completed the initial impairment test
required by the statement and there was no impairment. At September 30, 2002 the
company had $17.5 million of goodwill included in its balance sheet related
primarily to acquisitions over the past twelve months. In 2001, the company
amortized $.7 million of goodwill.
FIRST QUARTER RESTATEMENT
The company has restated and reduced its first quarter 2002 results to correct
for $4.3 million of pretax charges related to Nicor's 50% investment in Nicor
Energy and to defer a previously recognized $2.3 million pretax gain related to
the termination of an interest rate hedging instrument. These restatements,
which are subject to further restatement, had the following effect on the first
quarter of 2002 (in millions):
As
Originally As
Reported Restated
--------- --------
Income before income taxes $ 58.9 $ 52.3
Net income 39.9 35.5
Earnings per average share of common stock:
Basic .90 .80
Diluted .90 .80
Nicor Inc. Page 8
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
RECLASSIFICATION OF PRIOR PERIOD FINANCIAL STATEMENTS
A consensus reached by the EITF regarding the accounting for contracts involved
in energy trading and risk management activities in Issue 02-03 requires Nicor
to reclassify amounts reported in prior period financial statements. The
following summarizes the reclassification to the accompanying financial
statements (in millions):
Three months ended Nine months ended
September 30, 2001 September 30, 2001
-------------------------- -------------------------
As As
Previously As Previously As
Reported Reclassified Reported Reclassified
------------ ------------- ------------ ------------
Revenues
Gas distribution $ 156.3 $ 156.3 $ 1,776.4 $ 1,776.4
Shipping 52.7 52.7 165.7 165.7
Other energy
ventures 39.2 7.9 181.0 20.7
Corporate and
eliminations (3.8) - (32.0) -
----------- ------------ ------------ -----------
Total revenues $ 244.4 $ 216.9 $ 2,091.1 $ 1,962.8
=========== ============ ============ ===========
Cost of gas $ 79.0 $ 51.5 $ 1,434.8 $ 1,306.5
In addition, certain other reclassifications have been made to conform the prior
years' financial statements to the current year's presentation.
ACCRUED UNBILLED REVENUE
Receivables includes accrued unbilled revenue of $38.6 million, $89.7 million
and $42.5 million at September 30, 2002, December 31, 2001, and September 30,
2001, respectively, related primarily to gas distribution operations.
REGULATORY ASSETS AND LIABILITIES
Nicor Gas is regulated by the 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
2002 2001 2001
------------ ----------- ------------
Unamortized loss on reacquired debt $ 19.3 $ 20.1 $ 17.4
Regulatory tax liability (63.5) (66.3) (67.5)
Deferred (accrued) gas cost (15.7) (100.8) (160.4)
Deferred (accrued)environmental costs (2.5) (5.8) (9.9)
------------ ----------- -----------
$(62.4) $(152.8) $(220.4)
============ =========== ===========
The unamortized loss on reacquired debt is included in other noncurrent assets.
Accrued environmental costs are included in other current liabilities.
Nicor Inc. Page 9
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
EQUITY INVESTMENT INCOME (LOSS)
Other equity investment income (loss) includes the following (in millions):
Three months ended Nine months ended
September 30 September 30
------------------ ------------------
2002 2001 2002 2001
-------- -------- --------- -------
Equity investment income (loss):
Nicor Energy $ (3.5) $ .8 $ (14.4) $ (.8)
All other .4 .4 1.9 .8
-------- ------- --------- -------
$ (3.1) $ 1.2 $ (12.5) $ -
======== ======= ========= =======
OTHER INCOME (EXPENSE)
Other income (expense), net includes the following (in millions):
Three months ended Nine months ended
September 30 September 30
------------------ -------------------
2002 2001 2002 2001
-------- -------- --------- --------
Gains on sale of property,
plant and equipment $ - $ 3.9 $ 4.5 $ 4.6
Interest income .4 1.9 1.7 6.1
Other income .8 1.1 .9 1.9
Other expense - (.2) (.2) (.4)
-------- -------- --------- --------
$ 1.2 $ 6.7 $ 6.9 $12.2
======== ======== ========= ========
COMPREHENSIVE INCOME
Total comprehensive income, as defined by FASB Statement No. 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
------------------ ------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net income $ 30.0 $ 33.0 $ 85.8 $ 98.5
Other comprehensive income
(loss), net of tax (4.1) (1.3) (5.6) (1.3)
-------- -------- -------- --------
Total comprehensive income $ 25.9 $ 31.7 $ 80.2 $ 97.2
======== ======== ======== ========
Other comprehensive income (loss) for Nicor consists 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.
Most of the $5.9 million balance in accumulated other comprehensive income
(loss) at September 30, 2002, represents losses on financial derivatives
designated as hedges of interest payments on an
Nicor Inc. Page 10
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
anticipated first quarter 2003 issuance of 30-year bonds. The final settled
amount will be amortized over the life of the bond.
POSTRETIREMENT BENEFITS
Nicor Gas maintains noncontributory defined benefit pension plans covering
substantially all employees hired prior to 1998. About one-fourth of the net
periodic benefit cost or credit related to these plans is capitalized as a cost
of constructing gas distribution facilities and the remainder is included in gas
distribution operating and maintenance expense.
DEBT
In April 2002, Nicor Gas issued $50 million of 3 percent unsecured notes due in
April 2003 with proceeds to be used for general corporate purposes.
Under the company's short-term committed lines of credit agreements, if Nicor's
ratio of consolidated total indebtedness to capitalization (including short-term
debt) exceeds 65% during the term of the credit facility, each bank may at its
option declare any amounts due immediately payable and/or terminate its
commitment to make advances to the company.
RELATED PARTY TRANSACTIONS
During the second quarter of 2002 Horizon Pipeline, a 50% joint venture with
Natural Gas Pipeline Company of America (NGPL), put into operation a 74-mile,
36-inch pipeline from Joliet, Illinois to near the Wisconsin/Illinois border.
The project was initially financed through short-term loans from Nicor and
Kinder Morgan, Inc., the parent company of NGPL. In May 2002, Horizon Pipeline
financed the project with partnership equity and non-recourse third-party
long-term debt and repaid the short-term loans. Nicor's equity contribution was
$16.5 million. Horizon Pipeline's capacity is nearly fully subscribed under
10-year agreements, with Nicor Gas having contracted for approximately 80
percent of the 380 MMcf per day initial capacity. This transportation agreement
has been approved by the ICC. For the three and nine months ended September 30,
2002, Horizon Pipeline charged Nicor Gas $2.6 million and $4.0 million,
respectively, for natural gas transportation under rates that have been accepted
by FERC.
In 2002, Nicor Technologies, a wholly owned subsidiary of Nicor, began
purchasing gas distribution engineering and corrosion services from EN
Engineering, a 50-percent owned joint venture. EN Engineering charged Nicor
Technologies $1.1 million and $3.3 million for these services for the three- and
nine-month periods ended September 30, 2002, respectively.
In addition, Nicor has entered into transactions with Nicor Energy described
within the Nicor Energy section of Contingencies beginning on page 12.
Nicor Inc. Page 11
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
BUSINESS SEGMENT INFORMATION
Financial data by major business segment is presented below (in millions):
Three months ended Nine months ended
September 30 September 30
------------------ -------------------
2002 2001 2002 2001
-------- -------- -------- ---------
Operating revenues
Gas distribution $ 172.6 $ 156.3 $ 969.4 $1,776.4
Shipping 66.6 52.7 191.6 165.7
Other energy ventures 11.2 7.9 32.8 20.7
Corporate and eliminations (.6) - (6.2) -
-------- -------- -------- --------
$ 249.8 $ 216.9 $1,187.6 $1,962.8
======== ======== ======== ========
Operating income (loss)
Gas distribution $ 48.3 $ 48.4 $ 144.0 $ 162.1
Shipping 4.3 4.2 11.2 11.1
Other energy ventures 2.4 1.2 4.7 3.1
Corporate and eliminations (1.8) (.4) (2.8) (2.0)
-------- -------- -------- --------
$ 53.2 $ 53.4 $ 157.1 $ 174.3
======== ======== ======== ========
Gas distribution operating revenues include customer charges paid, on behalf of
the customer, by a Nicor affiliate offering a fixed bill service. These gas
distribution revenues have been eliminated in the consolidated financial
statements.
COMMON AND PREFERRED STOCK
Each share of common and preferred stock, regardless of class, entitles the
holder to one vote as to matters considered at the company's annual meeting of
stockholders.
DIVIDEND RESTRICTIONS
Nicor has no contractual or regulatory restrictions on the payment of dividends.
Nicor Gas is restricted by regulation in the amount it can dividend or loan to
affiliates. Dividends are allowed only to the extent of Nicor Gas' retained
earnings balance. The balance of cash advances from Nicor Gas to an affiliate at
any time shall not exceed the unused balance of funds actually available to that
affiliate under its existing bank credit agreements or its commercial paper
facilities with an unaffiliated third party.
Nicor Inc. Page 12
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
EARNINGS PER SHARE
The computation of diluted earnings per share includes the potentially dilutive
effect of additional shares due to employees exercising stock options. However,
when option exercise prices are above the stock prices, those options are not
considered in the earnings per share computation, as to do so would be
anti-dilutive. As a result, Nicor's earnings per share computation excludes the
incremental effect related to the following number of stock options:
Three months ended Nine months ended
September 30 September 30
------------------ ----------------
2002 2001 2002 2001
-------- ------- ------- -------
Number of options (in thousands) 634 197 302 184
INCOME TAXES
The company's effective income tax rate decreased for the three- and nine-month
periods ended September 30, 2002 due to positive adjustments resulting from the
completion of an income tax audit in the first quarter of 2002. In addition,
lower pretax income has caused a somewhat lower effective income tax rate since
permanent tax differences and tax credits are now a larger share of pretax
income.
CONTINGENCIES
The following contingencies of Nicor are in various stages of investigation or
disposition. Although the company is unable to estimate the amount of loss
reasonably possible in addition to the amount already recognized, if any, it is
possible that the resolution of these contingencies, either individually or in
aggregate, will materially affect the restated financial statements that the
company is planning to issue or require the company to take charges against or
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. It is the opinion of management
that the resolution of these contingencies, either individually or in aggregate,
is not expected to have a material adverse impact on Nicor's liquidity or
financial condition.
Performance-Based Rate Plan. On January 1, 2000, Nicor Gas' performance-based
rate (PBR) plan for natural gas costs went into effect. Under the PBR plan,
Nicor Gas' total gas supply costs are compared to a market-sensitive benchmark.
Savings and losses relative to the benchmark are determined annually and are
shared equally with sales customers. Pursuant to the requirements of Illinois
law, the plan is currently under ICC review.
There are allegations that the company acted improperly in connection with the
PBR plan, and the ICC is 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. 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
Nicor Inc. Page 13
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
in this matter. In addition, the Illinois Attorney General's Office issued Civil
Investigation Demands (CIDs) to the 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. Other governmental agencies may be reviewing these allegations.
The company has committed to cooperate fully in the review of the PBR plan.
Nicor Gas has responded to approximately three hundred data requests that have
been propounded by the ICC Staff, CUB, CCSAO and the Illinois Attorney General's
Office to date.
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. To conduct the
inquiry, the Special Committee retained Scott Lassar of the law firm of Sidley
Austin Brown & Wood (Sidley), and Sidley hired the accounting firm of KPMG LLP.
Mr. Lassar is the former United States Attorney for the Northern District of
Illinois.
The Special Committee presented the report of its counsel (Report) to Nicor's
Board of Directors on October 28, 2002. The transmittal letter from the Special
Committee to Nicor's Board of Directors and Mr. Lassar's Report were filed with
the SEC on a Form 8-K on October 31, 2002, and are hereby incorporated by
reference. The findings of the independent counsel's 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 addition, the Nicor Board of Directors has directed the
company's management to:
o make appropriate adjustments to account for, and fully
address the adverse consequences to ratepayers of, the items
noted in the Report,
o undertake a re-audit of 1999 to 2001 and a review of the
first two quarters of 2002,
o amend any filings with the ICC, the SEC or other regulatory
agencies, as necessary,
o conduct a full audit of management fees paid by the company
to third parties during 2000 and 2001,
o conduct a detailed study of management bonus issues, and
o conduct a detailed study of the adequacy of internal
accounting and regulatory controls.
As a result of the Special Committee's review, Nicor and Nicor Gas believe that
the company's financial statements should reflect, and prior period financial
statements may require restatement for, the following items:
o The $15 million of transactions noted above. Examples of the transactions
identified in the report include a late 1999 wholesale transfer of natural
gas from Nicor Gas' storage inventory which increased customers' gas costs by
approximately $6.75 million. The Report also found that operational transfers
of natural gas between Nicor Gas' storage fields were not consistently
accounted for under the PBR plan. If accounted for on a consistent basis, the
Report concluded, the most appropriate result would be a $3.5 million refund
to customers. The Report found additional issues totaling about $5 million
related to interest costs and the purchase of weather insurance for 2001.
Nicor Inc. Page 14
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
o Changes in the timing of certain sales and purchases of natural gas inventory
between Nicor Gas and independent third-parties during the period December
1999 to the present. Nicor Gas had previously recorded these transactions
based upon when it held title to the natural gas, but there are additional
criteria that were not applied in determining the accounting treatment,
including those set forth in FASB Statement No. 49, Accounting for Product
Financing Arrangements and Staff Accounting Bulletin No. 101, Revenue
Recognition in Financial Statements. For example, the level of economic
interest in or control over the asset must be considered, which changes the
timing of recognizing gas purchases and inventory in some of the third-party
storage arrangements. Nicor and Nicor Gas believe that these restatements
will change assets and liabilities in nearly equal amounts, but the impact
will likely vary from quarter to quarter.
o PBR plan results. Since the calendar-year PBR plan calculations consider the
cost of gas charged to customers and volumes withdrawn from inventory, which
will both be restated, PBR plan results will also change.
The impact of the items listed above is estimated to result in an aggregate
reduction in Nicor and Nicor Gas net income for 1999 through 2002 of $15 million
to $35 million. This reduction has not been reflected in the preliminary third
quarter 2002 results reported in this filing. Furthermore, because the
restatements have not been completed and are subject to independent audit and
ICC review, it is possible that the final reduction could be materially
different, and possibly greater, than these estimates. Certain parties in the
PBR review proceeding have publicly indicated disagreement with the findings in
the Report.
Nicor is unable to predict the outcome of the review of the PBR plan or the
company's potential exposure thereunder, and has not recorded a liability
associated with this contingency.
Nicor's earnings included pretax income of $14.9 million in 2001 and $12.2
million in 2000 related to the PBR plan. Due to uncertainties surrounding the
PBR plan, Nicor Gas has not recorded estimated year-to-date results related to
the 2002 PBR plan year, which would have been immaterial. However, a negative
$1.3 million correction of 2001 PBR plan results is included in the year-to-date
period ended September 30, 2002.
In a letter dated October 28, 2002, Nicor Gas informed the ICC that it is
terminating its PBR plan effective January 1, 2003.
On July 22, 2002, a purported class action was filed against Nicor Gas and Nicor
in the Circuit Court of Cook County, Illinois, on behalf of all customers of
Nicor Gas who at any time from January 2000 through the present were subject to
Nicor Gas's PBR plan. The plaintiff alleges breach of contract, unjust
enrichment and violation of the Illinois Consumer Fraud and Deceptive Practices
Act, and that the class sustained damages as a result of Nicor Gas manipulating
the benchmark under the PBR plan. The class is seeking compensatory damages,
prejudgment and postjudgment interest, disgorgement of all profits, and
restitution to plaintiff and the purported class. Nicor filed a Motion to
Dismiss this action on September 24, 2002. 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 potential outcome of this
contingency.
Nicor Energy. In 2002, equity investment income (loss) included pretax losses of
$3.5 million and $14.4 million for the quarter and nine-month periods,
respectively, related to the company's 50-percent share of operating results at
Nicor Energy, a retail energy marketing joint venture with Dynegy Marketing and
Nicor Inc. Page 15
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
Trade (Dynegy). These amounts include negative pretax adjustments of $5.6
million in the year-to-date period related to a year-end 2001 independent audit
of Nicor Energy completed in May 2002. In the second quarter, as a result of the
audit findings, the owners of the venture and new Nicor Energy management
commenced a review of Nicor Energy's business strategy, accounting practices,
controls and financial results. The review process identified irregularities in
accounting and additional accounting errors and adjustments at Nicor Energy that
were also part of the reason for the losses referred to above. The adjustments,
irregularities and errors at Nicor Energy related primarily to estimates of
unbilled revenues and unrecorded liabilities. The review process has continued
and no additional material corrections were identified and recorded in the third
quarter. Year-to-date losses from Nicor Energy include some error corrections
related to 2001 that the company does not consider material, but they may be
moved to the 2001 financial statements as a result of the restatements.
Nicor's maximum exposure under its current guarantee commitments on behalf of
Nicor Energy is currently about $25 million related to payables and other
commitments, although Nicor may, at its discretion, provide additional
guarantees. At September 30, 2002 there was $5.6 million of outstanding accounts
payable under these guarantees. While it is possible that Nicor will be required
to make payments under the guarantees, Nicor does not believe it is probable and
cannot estimate the amount of any such payment. Accordingly, no liability has
been recorded. In the third quarter of 2002, Nicor's investment in Nicor Energy
was written down to zero due to the likelihood that Nicor ultimately will not
recover its investment balance.
In April 2002, Nicor and Dynegy renegotiated their joint venture agreement,
extending the original agreement, which would have expired in mid-2002, by five
years. Nicor Energy is dependent on the financial support of both equity
investors, and Dynegy is the joint venture's primary energy supplier. In October
2002, Dynegy announced it is exiting the marketing and trading business. If
either equity investor fails to continue its support of the joint venture, the
effect on Nicor Energy could cause Nicor to make payments under the guarantees
noted above.
As a result of the adjustments, review process and other matters referred to
above, Nicor is taking steps to withdraw, as soon as practicable, from its
continued involvement with Nicor Energy.
SEC and U.S. Attorney Inquiries. The staff of the Securities and Exchange
Commission has informed Nicor that the SEC is conducting a formal inquiry
regarding the PBR plan and Nicor Energy. 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.
Securities Class Actions. Following Nicor's July 18, 2002 issuance of the 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) on
behalf of all persons or entities who purchased Nicor common stock in the open
market during a specified period ending in July 2002. The actions were brought
in the United States District Court for the Northern District of Illinois,
Eastern Division, and are being consolidated. The plaintiffs allege that the
defendants violated sec. 10(b) and sec. 20(a) of the Securities Exchange Act of
1934 and Rule 10b-5 thereunder. Plaintiffs allege that during the class period
defendants misrepresented Nicor's historical financial condition and results of
operations and its future prospects. The class is seeking compensatory damages,
prejudgment interest, attorneys' fees and costs and other equitable relief.
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.
Nicor Inc. Page 16
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
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 members of
Nicor's Board of Directors. Nicor was named as a nominal defendant in all three
suits, and Arthur Andersen LLP was named as a defendant in one of the suits. The
actions were brought in the Circuit Court of Cook County, Illinois, Chancery
Division. The plaintiffs allege that Fisher, Halloran and the directors breached
their fiduciary duties to Nicor, knowingly participated in each others' breaches
of fiduciary duties, committed constructive fraud, and abused their control of
Nicor. The plaintiffs seek on behalf of Nicor compensatory damages, punitive
damages, attorneys' fees and costs, and other relief against the individual
defendants but do not seek any damages against the company. Nicor has insurance
that the company reasonably expects will cover these claims in whole, or in
part. Nicor 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 has refunded, or expects to refund, service fees plus
potential interest of approximately $1 million. The company is investigating to
determine whether any additional refunds or other charges are appropriate. At
this time, Nicor Gas cannot estimate whether additional refunds will be required
with respect to either FERC or ICC-regulated services, and it has not recorded
any additional liability associated with this contingency.
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 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. The Fixed Bill
Service is offered to Nicor Gas residential customers and allows customers to
pay twelve equal monthly amounts for their annual gas service based upon the
gas-use profile of their home. The class 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. 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 (U.S. EPA) 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 (PSD) Permit. An
application for the PSD permit had been previously submitted to the IEPA. The
disclosure to U.S. EPA was made pursuant to the U.S. EPA's Self -Disclosure
Policy. Nicor's investigation of this matter is continuing. The potential
maximum civil penalties under the Federal and State Environmental Acts are
$27,500 to $50,000, respectively, for the initial day of violation. For each
additional day of continued violation, the potential maximum civil penalties are
$27,500 and $10,000, respectively. Nicor has not yet identified the number of
potential violations. At this early stage, Nicor is unable to predict the
outcome of this matter or to reasonably estimate its exposure related thereto
and has not recorded a liability associated with this contingency.
Nicor Inc. Page 17
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
Mercury Program. Nicor Gas has incurred, and expects to continue to incur,
significant costs related to its historical use of mercury in various kinds of
company equipment. Prior to 1961, gas regulators containing small quantities of
mercury were installed in homes. These gas regulators reduce the pressure of
natural gas flow from the service line to the inside of the home. During the
third quarter of 2000, the company learned that in certain instances some
mercury was spilled or left in residences.
Nicor Gas has been named 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. One of the lawsuits in the
Circuit Court of Cook County involves five previous class actions that were
consolidated before a single judge. On October 10, 2001, Nicor Gas entered into
an agreement to settle the class action litigation. Under the terms of that
agreement, Nicor Gas has paid a total of approximately $1.85 million, will
continue for a period of five years 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 within four years. The class
action settlement permitted class members to "opt out" of the settlement and
pursue their claims individually. On February 7, 2002, the Circuit Court of Cook
County entered a final order approving the class action settlement. The "opt
out" period has ended and approximately 160 households have opted out of the
class. Of those, 42 households had traces of mercury, and Nicor Gas has settled
with five households.
Nicor Gas charged $148 million to operating expense in the third quarter of 2000
for estimated obligations related to the mercury-related inspection and cleanup
work and for legal defense costs. A $9 million adjustment lowered the
mercury-related reserve and reduced operating expense in the third quarter of
2001, reflecting a lower number of homes expected to be found with traces of
mercury requiring cleanup, a lower average cleanup and repair cost and estimated
costs of litigation. Through September 30, 2002, the company has incurred $106.8
million in associated costs, leaving a $32.2 million estimated liability. The
remaining $32.2 million liability at September 30, 2002, represented
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.
The company has certain insurance policies, has notified its insurers, and is
vigorously pursuing recovery of mercury-related costs pursuant to its insurance
coverage. In January 2001, the company filed suit in the Circuit Court of Cook
County against certain of its insurance carriers for a declaration that the
company's mercury-related losses are covered, and for the recovery of those
losses. Nicor Gas is also pursuing certain insurance recoveries through
arbitration. In addition, some of the removals of mercury-containing regulators
were conducted by independent contractors working for the company. In November
2000, the company filed suit in the Circuit Court of Cook County seeking
indemnification and contribution from these contractors and their insurance
carriers. Through September 30, 2002, Nicor Gas has recovered, net of related
expenses, $22.6 million from certain insurance carriers of the company and its
independent contractors, including approximately $20 million recovered in the
third quarter of 2002. These recoveries have been recorded as a reduction to gas
distribution operating expense.
Nicor Inc. Page 18
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (continued)
Subsequent to September 30, 2002, Nicor Gas reached an agreement with a
subcontractor's insurer wherein Nicor Gas will receive $.7 million for past
defense costs, which will be included in the company's results of operations for
the fourth quarter of 2002. In addition, this subcontractor's insurer has agreed
to assume certain future defense costs related to claims against this
subcontractor and to pay all judgments and settlements related to such claims up
to $50 million. The impact of this agreement will be reflected in the company's
evaluation of its mercury reserve for the fourth quarter. At this stage, it is
not possible to estimate the likelihood of additional recoveries from insurance
carriers or other third parties related to the mercury spills, and Nicor Gas has
not recorded any such recoveries in its financial statements.
Nicor Gas will not seek recovery of the costs associated with these mercury
spills from its customers, and any proceeds from insurance carriers or third
parties will be retained by the company to offset costs incurred.
Manufactured Gas Plant Sites. Manufactured gas plants were used in the 1800's
and early to mid 1900's to produce natural 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
Illinois Environmental Protection Agency for certain properties. More detailed
investigations and remedial activities are either in progress or planned at many
of these sites. The results of continued testing and analysis should determine
to what extent additional remediation is necessary and may provide a basis for
estimating any 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 1995, Nicor Gas filed suit in the Circuit Court of Cook County
against certain insurance carriers seeking recovery of environmental cleanup
costs of certain former manufactured gas plant sites. Nicor Gas reached a
settlement with one of the insurance carriers, and in February 2000, the court
dismissed the company's case on summary judgment motions by certain other
defendants. The company filed an appeal in March 2000. In May 2001, Nicor Gas
reached a recovery settlement with certain insurance carriers who were involved
in this appeal. In September 2002, the Illinois Appellate Court upheld the
ruling of the trial court. Nicor Gas has filed a petition for leave to appeal to
the Illinois Supreme Court. Management cannot predict the outcome of the lawsuit
against the remaining insurance carriers. All such recoveries are refunded to
the company's customers.
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 plans for the proposed cleanup of
a manufactured gas plant site in Oak Park, Illinois are inadequate. The lawsuit
claims that houses might have to be razed or removed and asks that residents be
compensated for the alleged loss in the value of their homes and other monetary
damages. An amended complaint adding additional plaintiffs and, as defendants,
the Village of Oak Park and the Oak Park Park District, was filed in April 2002.
In October 2002, two lawsuits were filed against Nicor Gas in the Circuit Court
of Cook County seeking unspecified damages for various injuries and one death
that allegedly resulted from exposure to contaminants allegedly emanating from
the manufactured gas plant site in Oak Park, Illinois. The plaintiffs lived in
homes adjoining the site. 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 19
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Notes to the Consolidated Financial Statements (Unaudited;
Subject to Restatement) (concluded)
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 MWRD) under the 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 MWRD.
The suit was filed in federal court in Chicago and the company has filed
responsive pleadings. 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.
Since costs and recoveries relating to the cleanup of these 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
these 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 20
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement)
The following discussion should be read in conjunction with the Management's
Discussion and Analysis section of the Nicor Inc. consolidated (Nicor) 2001
Annual Report on Form 10-K.
CAUTIONARY STATEMENT
The company intends to restate its financial statements for 1999, 2000, 2001 and
interim periods in 2002, including the financial statements included in this
Report on Form 10-Q. The financial statements and information presented in this
Form 10-Q do not include (1) adjustments that the company plans to make as a
result of an investigation by a special committee of independent directors of
Nicor Gas' natural gas purchases, sales, transportation and storage activities
nor (2) any other adjustments that may be made when the company restates its
financial statements for prior periods and the third quarter of 2002. For
further information, see Pending Financial Statement Restatements and Re-audits
on page 5, and Contingencies - Performance-Based Rate Plan beginning on page 12,
which are hereby incorporated by reference. Accordingly, all of the notes to the
consolidated financial statements, particularly the notes referred to in the
previous sentence, should be read in their entirety when reading the financial
statements in this Form 10-Q and the following discussion because they
materially impact the ability to understand the historical financial information
presented regarding the company. All information in the following discussion is
subject to restatement.
SUMMARY
Nicor's diluted earnings per share for the three- and nine-month periods ended
September 30, 2002, were $.68 and $1.93, respectively, compared to diluted
earnings per share of $.73 and $2.17, respectively, for the same periods in
2001. Third quarter net income was $30.0 million in 2002 compared to $33.0
million in 2001. Net income for the nine-month period decreased to $85.8 million
from $98.5 million a year ago.
Gas distribution segment operating income was favorably affected in both years
by mercury-related credits. These positive impacts were $19.7 million and $9.2
million for the 2002 and 2001 third quarter periods, respectively, and $19.5
million and $11.4 million for the corresponding year-to-date periods. Excluding
the positive effects of the mercury-related credits, more fully described
beginning on page 17, gas distribution operating income would have decreased in
both the 2002 quarter and year-to-date periods. Reduced pension credits and
poorer performance-based rate (PBR) plan results were the primary reasons for
those decreases. Lower equity investment results from Nicor Energy, LLC (Nicor
Energy), the company's 50-percent-owned retail energy marketing joint venture,
are also reflected in Nicor's lower results in the 2002 three- and nine-month
periods. Both 2002 periods were positively affected by lower interest expense
compared to the prior-year periods, and per share results in both periods were
favorably affected by the company's common stock repurchase program.
Nicor Inc. Page 21
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement)(continued)
Operating income. Operating income (loss) by major business segment was (in
millions):
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
-------- ------ ------- -------
Gas distribution $ 48.3 $ 48.4 $ 144.0 $ 162.1
Shipping 4.3 4.2 11.2 11.1
Other energy ventures 2.4 1.2 4.7 3.1
Corporate and eliminations (1.8) (.4) (2.8) (2.0)
------- ------ ------- -------
$ 53.2 $ 53.4 $ 157.1 $ 174.3
======= ====== ======= =======
The following summarizes operating income comparisons for major business
segments:
o Gas distribution operating income decreased in the third quarter to $48.3
million from $48.4 million a year ago. For the nine months ended September
30, 2002, operating income decreased to $144.0 million, from $162.1 million
in 2001. Excluding the mercury-related credits discussed previously, gas
distribution operating income declined $10.5 million and $26.2 million in the
2002 quarter and year-to-date periods, respectively, compared to the prior
year periods.
Third quarter 2002 gas distribution operating results were negatively
affected by decreased pension credits ($3.8 million) and lower PBR plan
results ($3.3 million). Year-to-date results for 2002 were positively
affected by increased customer demand unrelated to weather ($4.1 million) and
lower natural gas costs to operate company equipment and facilities ($3.8
million). These positive factors were more than offset by smaller pension
credits ($11.4 million), lower PBR plan results ($8.8 million), and lower
customer financing charges ($6.3 million) in the 2002 year-to-date period.
o Containerized shipping operating income was essentially flat for the three-
and nine-month periods compared to a year ago. Increased volume-related
revenues ($15.0 million) in the third quarter of 2002 compared to the same
period in 2001 were offset by increased volume-related expenses ($13.8
million) and lower average rates ($1.1 million). In the 2002 year-to-date
period, higher volume-related revenues ($32.7 million) and a lower average
cost per TEU shipped ($4.6 million) were offset by higher volume-related
expenses ($30.5 million) and the impact of lower average rates ($6.7
million). The higher volume-related revenues and expenses in both periods
were primarily attributable to recent acquisitions.
o Other energy ventures operating income rose for the quarter and year-to-date
periods due primarily to increased operating income at Nicor Services,
Nicor's retail energy-related products and services business. Nicor Services'
third quarter operating income rose from $.8 million in 2001 to $2.5 million
in 2002 and increased in the year-to-date period from $2.3 million in 2001 to
$4.1 million in 2002.
Nicor Inc. Page 22
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement)(continued)
Equity investment income (loss). Equity investment income (loss) declined to
$(3.1) million in the third quarter of 2002 from $1.2 million in the third
quarter of 2001 due primarily to lower contributions from Nicor Energy ($4.3
million). For the year-to-date period, equity investment income (loss) was
$(12.5) million compared to no income or loss a year ago. The decline in the
year-to-date period was also due to poorer results at Nicor Energy ($13.6
million), including the negative adjustments described in the Nicor Energy
section beginning on page 14.
Other income (expense). Other income (expense) decreased in the third quarter of
2002 to $1.2 million compared to $6.7 million in the third quarter a year ago.
Lower property sale gains ($3.9 million) and decreased interest income ($1.5
million) were the primary reasons for lower results for the 2002 quarter. Other
income (expense) decreased to $6.9 million in the 2002 year-to-date period from
$12.2 million a year ago. The decline in the year-to-date period was largely due
to lower interest income ($4.4 million) in 2002. Interest income declined in
both periods due to lower average investment levels in 2002.
Interest expense. Interest expense for the quarter decreased from $10.4 million
in 2001 to $9.1 million in 2002. For the year-to-date period, interest expense
decreased from $36.6 million in 2001 to $27.4 million in 2002. The decline in
the quarter was primarily due to lower average borrowing levels. The decline in
the nine-month period was primarily due to lower average borrowing levels ($5.6
million) and interest rates ($4.0 million). Reduced natural gas costs in the
first quarter of 2002 compared to 2001 contributed to the lower borrowing
levels.
Income taxes. The company's effective income tax rate decreased for the three-
and nine-month periods due to positive adjustments resulting from the completion
of an income tax audit in the first quarter of 2002. In addition, lower pretax
income has caused a somewhat lower effective income tax rate since permanent tax
differences and tax credits are now a larger share of pretax income.
RESULTS OF OPERATIONS
Details of various financial and operating information by segment can be found
in the tables on pages 30 and 31. The following discussion summarizes the major
items impacting Nicor's earnings.
Operating revenues. Operating revenues by major business segment were (in
millions):
Three months ended Nine months ended
September 30 September 30
------------------ --------------------
2002 2001 2002 2001
-------- ------- --------- ---------
Gas distribution $ 172.6 $ 156.3 $ 969.4 $ 1,776.4
Shipping 66.6 52.7 191.6 165.7
Other energy ventures 11.2 7.9 32.8 20.7
Corporate and eliminations (.6) - (6.2) -
------- ------- --------- ---------
$ 249.8 $ 216.9 $ 1,187.6 $ 1,962.8
======= ======= ========= =========
Nicor Inc. Page 23
- -------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement)(continued)
Gas distribution revenues decreased for the nine-month period due primarily to
significantly lower average natural gas prices, which are passed directly
through to customers without markup. The revenue effect of the lower average
natural gas prices is estimated to be approximately $770 million. Gas
distribution revenues increased in the third quarter of 2002 due primarily to
higher natural gas prices in the period compared to the same period of 2001. The
estimated revenue effect of higher natural gas prices in the third quarter of
2002 compared to 2001 is about $20 million.
Shipping segment results include higher volume-related revenues ($15.0 million)
in the third quarter of 2002 compared to the same period in 2001. Year-to-date
results include higher volume-related revenues ($32.7 million) partially offset
by lower average rates ($6.7 million). The increases in volume-related revenue
in both periods relate primarily to acquisitions. The slow economy in the
Caribbean region continues to put pressure on shipping segment average rates.
The increase in revenues for other energy ventures was due primarily to
increased business activity at Nicor Services. Nicor Services 2002 revenues
increased $6.9 million in the third quarter to $10.5 million and $13.3 million
in the year-to-date period to $22.5 million compared to the same periods in
2001.
Gas distribution margin. Gas distribution margin, defined as operating revenues
less cost of gas and revenue taxes, which are both passed directly through to
customers, was nearly unchanged at $97.1 million in the third quarter of 2002
compared to $97.7 million for the same period a year ago. For the quarter, gas
distribution margin was negatively affected by the lack of income from the PBR
plan ($3.3 million) partially offset by the impact of higher average rates.
For the 2002 nine-month period, gas distribution margin decreased slightly to
$372.3 million compared to $377.7 million in 2001. For the year-to-date period,
the positive effects of higher customer demand unrelated to weather ($4.1
million) and a lower cost of gas used to operate company equipment and
facilities ($3.8 million) were more than offset by lower revenue from customer
finance charges ($6.3 million) and reduced PBR plan results ($8.8 million)
compared to a year ago. The reduction in company-use gas costs and customer
finance charges is related to lower natural gas prices in the first quarter of
2002.
Nicor Gas recorded no PBR plan results in the third quarter of 2002 compared to
$3.3 million in the third quarter of 2001. For the year-to-date period, Nicor
Gas recorded a $1.3 million PBR plan loss in 2002 compared with a $7.5 million
gain for the same 2001 period. The year-to-date 2002 period excludes estimated
PBR plan results related to the 2002 plan year, which would have been
immaterial, due to the developments described in the performance-based rate plan
section beginning on page 12. The year-to-date period also includes negative
pretax corrections of 2001 PBR plan results of $1.3 million recorded in the
nine-month period ended September 30, 2002.
Gas distribution operating and maintenance expense. Gas distribution operating
expense for the three- and nine-month periods ended September 30, 2002, was
$46.8 million and $137.5 million, respectively, compared to $39.1 million and
$122.5 million, respectively, for the same periods in 2001. The quarterly
increase was related to the negative effects of reduced pension credits ($3.8
million), increased liabilities for legal settlements ($3.6 million) and costs
related to the PBR plan and other investigations in 2002 ($2.8 million). The
year-to-date increase reflects smaller pension credits ($11.4 million),
increased liabilities for legal settlements ($3.5 million), the investigation
costs ($2.8 million) and increased retiree health care costs ($2.4 million).
Nicor Inc. Page 24
- -------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement)(continued)
Mercury-related costs (recoveries). In the third quarter, Nicor Gas reached an
agreement with an insurer wherein the company recovered approximately $20
million of mercury-related costs. A $9 million adjustment lowered the
mercury-related reserve and reduced operating expense in the third quarter of
2001, reflecting a lower number of homes expected to be found with traces of
mercury requiring cleanup, a lower average cleanup and repair cost and estimated
costs of litigation. Year-to-date operating income for 2001 also reflected $2.4
million in mercury-related recoveries.
Shipping operating expenses. Shipping segment operating expenses rose for the
2002 quarter and year-to-date periods compared to a year ago due primarily to
higher operating and maintenance expenses related to increased volumes shipped
as a result of recent acquisitions. For the quarter, increased costs related to
the higher volumes included higher transportation expenses ($4.1 million),
increased wage and benefit costs ($2.5 million) and greater leased equipment
costs ($1.7 million). Increased costs in the year-to-date period included higher
transportation costs ($8.2 million), greater leased equipment costs ($4.3
million), increased vessel charter expenses ($2.8 million) and higher wage and
benefit costs ($2.7 million).
All other operating expenses. The increase in all other operating expenses was
associated largely with the addition of new customers and products at Nicor
Services.
FINANCIAL CONDITION AND LIQUIDITY
Operating cash flows. Net cash flow from operating activities decreased $149.9
million to $266.2 million for the nine months ended September 30, 2002, due
primarily to changes in working capital items in the gas distribution segment.
Working capital can increase or decrease significantly due to certain gas
distribution factors including weather, the price of 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.
Investing activities. 2002 capital expenditures are estimated at $200 million, a
$20 million increase from the projection included in Nicor's latest Annual
Report on Form 10-K. The increase is due primarily to storage field improvements
in the gas distribution segment.
During the second quarter of 2002, Horizon Pipeline, a 50/50 joint venture
between Nicor and Natural Gas Pipeline Company of America (NGPL), put into
operation a 74-mile, 36-inch pipeline from Joliet, Illinois to near the
Wisconsin/Illinois border. The project was initially financed through short-term
loans from Nicor and Kinder Morgan, Inc., the parent company of NGPL. In May
2002, Horizon Pipeline financed the project with partnership equity and
non-recourse third party long-term debt and repaid the short-term loans. Nicor's
equity contribution was $16.5 million.
In April 2002, Tropical Shipping, a subsidiary of Nicor, purchased certain
assets of Tecmarine Lines Inc. and TMX Logistics Inc. for cash, thereby
expanding its network of Caribbean and South American destinations. The
acquisition is expected to increase Tropical Shipping's annual volumes by
approximately 10 to 15 percent.
Financing activities. Nicor and its gas distribution subsidiary maintain
short-term line of credit agreements with major domestic and foreign banks. The
company had line of credit agreements with four banks at September 30, 2002.
These agreements, which serve as backup for the issuance of commercial paper,
allow for borrowings of up to $334 million through March 31, 2003 and $259
million through
Nicor Inc. Page 25
- -------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement)(continued)
September 30, 2003. At September 30, 2002 the company had $190 million of
commercial paper borrowings outstanding. The company expects to enter into an
additional line of credit agreement in the next few weeks which will allow for
an additional $75 million of borrowings.
Because of uncertainties pertaining to the energy industry in general and to the
company, as described in Contingencies beginning on page 12, the rating agencies
have put Nicor and Nicor Gas' long-term debt ratings under review for possible
downgrade or on credit watch with negative implications. Moody's Investors
Service has also put the company's commercial paper on credit watch. On November
5, 2002, Fitch Ratings lowered its rating on Nicor Gas' long-term debt to AA
from AA+ and lowered its rating on Nicor Inc.'s short-term debt to F-1 from
F-1+. Nicor Gas' F-1+ short-term debt rating was unchanged. While ratings on the
company's debt remain among the highest in the utility industry, lower ratings
could cause higher interest costs.
Under the company's short-term committed lines of credit agreements, if Nicor's
ratio of consolidated total indebtedness to capitalization (including short-term
debt) exceeds 65% during the term of the credit facility, each bank may at its
option declare any amounts due immediately payable and/or terminate its
commitment to make advances to the company.
Nicor Gas is currently unable to issue First Mortgage Bonds under its July 2001
shelf registration filing. However, Nicor believes it will continue to be able
to access sufficient capital resources to fund its capital expenditures and
other cash requirements through other sources of financing available to the
company, should it be required. Nicor is in compliance with its debt covenants
and believes it will remain so even if its debt ratings are lowered. Nicor's
debt agreements do not include ratings triggers or material adverse change
provisions.
In April 2002, Nicor Gas issued $50 million of 3 percent unsecured notes due in
April 2003 with the proceeds to be used for general corporate purposes.
Under an existing common stock repurchase program, Nicor purchased and retired
24,500 common shares during the third quarter of 2002 at an aggregate cost of
$1.1 million. For the nine-month period, Nicor purchased 413,500 common shares
at an aggregate cost of $18.0 million. Purchases may be made from time to time
through open market transactions and to the extent cash flow is available after
other investment opportunities.
Nicor Inc. currently has no contractual or regulatory
restrictions on the payment of dividends. On May 1, August 1,
and November 1, 2002, Nicor paid quarterly dividends on common
stock of 46 cents per share.
FACTORS AFFECTING BUSINESS
Contingencies. Future operating results could be materially impacted by
contingencies discussed under the heading Contingencies beginning on page 12,
which is hereby incorporated by reference.
Critical accounting policies and estimates. Nicor prepares its consolidated
financial statements in accordance with accounting principles generally accepted
in the United States, which regularly requires Nicor management to exercise
judgment in the selection and application of accounting methods. The application
of accounting methods includes making estimates using subjective assumptions and
judgments about matters that are inherently uncertain.
Nicor Inc. Page 26
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement)(continued)
The selection of accounting methods and the use of estimates affects Nicor's
reported results and financial condition. The company has adopted several
significant accounting policies that are important to understanding its
financial statements and are described in the Accounting Policies footnote
beginning on page 30 of Nicor's 2001 Annual Report on Form 10-K and on page 6 of
this report. Management is also required to make significant estimates which are
similarly described in the footnotes of both reports.
Although there are numerous areas in which Nicor management selects methods and
makes estimates, it believes that those requiring among the most critical
judgments involve derivative instruments, unbilled revenues, credit risk and
loss contingencies, because those judgments are susceptible to material change
and could materially impact Nicor's financial statements.
The rules for determining whether a contract meets the criteria for a derivative
instrument, or whether a derivative qualifies for hedge accounting treatment,
are numerous and complex. The treatment of a single contract may vary from
period to period depending upon accounting elections and changes in management's
assessment of the likelihood of future hedged transactions. As a result,
management judgment is required in the determination of the appropriate
accounting treatment. In addition, the estimated fair value of derivative
instruments may change significantly from period to period depending upon market
projections. These determinations and changes in estimates may have a material
impact on reported results.
Certain Nicor subsidiaries and affiliates estimate revenues for gas and electric
deliveries not billed to customers from the last billing date to month-end
(unbilled revenues). Unbilled revenue estimates are dependent upon a number of
factors which require management judgment, including projections of gas and
electric costs, weather, and customer usage. These estimates are adjusted when
actual billings occur, and changes in estimates can be material.
Nicor's subsidiaries and affiliates are required to estimate credit risk in
establishing allowances for doubtful accounts and in estimating the fair values
of certain derivative instruments and energy-related trading contracts, with
counterparty credit risk being an especially difficult and critical judgment.
Actual credit losses could vary materially from Nicor's estimates.
Nicor records loss contingencies as liabilities when it is probable that a
liability has been incurred and the amount of loss is reasonably estimable.
Nicor and its subsidiaries and affiliates are involved in various legal
proceedings and exposed to various loss contingencies. (See discussion of
Contingencies, beginning on page 12). These loss contingencies are often
resolved in stages over long time periods, estimates may change significantly
from period to period, and the company's ultimate obligations may differ
materially from its estimates.
Net periodic benefit credit related to pension benefits. Nicor Gas maintains
noncontributory defined benefit pension plans covering substantially all
employees hired prior to 1998. Five percent of Nicor's quarterly and
year-to-date 2002 net income was related to net periodic benefit credits
compared to 11 percent in 2001. For valuation purposes, Nicor Gas utilizes an
October 1 measurement date to determine the company's annual pension expense or
credit. Since October 1, 2001, the pension plan has experienced negative
investment returns, consistent with market conditions. The current actuarial
valuation is in progress and Nicor Gas expects that the October 1, 2002 asset
values, along with changes in actuarial assumptions, will lead to a materially
lower pension credit, reducing operating income (after capitalization) in 2003
by at least $8 million. As of the date of this filing, the company believes its
Nicor Inc. Page 27
- -------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement)(continued)
pension plans are adequately funded. Market performance could impact future
company contributions but should not impact participant benefits.
Other operating expenses. Health care costs have been rising and Nicor expects
significant additional increases in 2003. In addition, Nicor Gas now expects bad
debt expense to be higher in 2002 than in 2001 due to a number of factors
including current economic conditions. Nicor is also experiencing, and expects
to continue to experience in the near future, higher insurance costs due to a
tightening insurance market and company loss experience. These cost increases,
either collectively or individually, could materially reduce Nicor's future
results of operations.
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, electricity and fuel commodity prices and interest rates. It is
Nicor's practice to manage these risks utilizing derivative instruments and
other methods, as deemed appropriate. This section updates the Commodity Price
Risk and Counterparty Credit Risk sections of the market risk disclosure in
Nicor's latest Annual Report on Form 10-K.
Commodity price risk. With regard to commodity price risk, the company has
established policies and procedures governing the management of such risks and
the use of derivative commodity instruments to hedge its exposure to such risks.
A risk management committee oversees compliance with such policies and
procedures. The company utilizes various techniques to limit, measure and
monitor market risk, including limits based on volume, dollar amounts, and
duration, and in some cases value at risk (VaR). VaR is the potential loss for
an instrument or portfolio from adverse changes in market factors, for a
specified time period and at a specified confidence level. The company's risk
management committee has established exposure limits at such a level that
adverse results are not expected to have a material adverse effect on the
results of operations or the financial condition of the company. The company's
policies and procedures continue to evolve with its businesses and are subject
to ongoing review and modification.
In accordance with SEC disclosure requirements, Nicor performs sensitivity
analyses to assess the potential loss in earnings based upon a hypothetical 10
percent adverse change in market prices. Management does not believe that
sensitivity analyses alone provide an accurate or reliable method for monitoring
and controlling risks and therefore also relies on the experience and judgment
of its management to revise strategies and adjust positions as deemed necessary.
Losses in excess of the amounts determined in sensitivity analyses could occur
if market prices exceed the 10 percent shift used for the analyses. Based on the
company's unhedged positions at September 30, 2002, a 10 percent decrease in
natural gas prices at September 30, 2002 would have decreased Nicor's earnings
by about $.4 million. In addition, substantial increases in natural gas prices
may indirectly impact Nicor Gas' earnings by increasing the cost of gas used by
the company, bad debt expense and other operating expenses. Higher natural gas
prices may also lead to lower customer gas consumption and margin.
Nicor's regulated utility, Nicor Gas, is generally not exposed to market risk
caused by changes in commodity prices because of Illinois rate regulation
allowing for the recovery of prudently incurred natural gas supply costs from
customers. However, Nicor Gas' PBR plan for natural gas costs creates some
exposure to commodity price risk. The company's exposure to this market risk is
partially mitigated because the PBR plan compares actual gas costs to a
market-sensitive benchmark as opposed to a fixed benchmark. On October 28, 2002,
Nicor Gas informed the ICC that it is terminating its PBR plan effective January
1, 2003. Other risks related to the PBR plan are described in the Contingencies
- - Performance-Based Rate Plan section beginning on page 12.
Nicor Inc. Page 28
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement)(continued)
In 2002, Nicor Services began offering Nicor Gas customers a 12-month
fixed-price alternative to payment of their monthly utility bills regardless of
natural gas prices or weather. The commodity risk of this product is partially
hedged using swap agreements. Management also believes it has taken appropriate
steps to manage other risks of loss associated with this product.
Nicor's other energy businesses are subject to natural gas and electricity
commodity price risk, arising primarily from fixed-price purchase and sale
agreements and natural gas inventories. Derivative commodity instruments such as
futures, options, forwards and swaps may be used to hedge this risk.
Counterparty credit risk. The company is also exposed to credit risk in the
event a hedging transaction counterparty 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 uses,
and is entering into additional, master netting arrangements to mitigate
counterparty credit risk.
In late 2001, Enron North America Corporation (Enron), an energy trading
company, filed for bankruptcy protection. At the date of Enron's bankruptcy,
Nicor's receivable from Enron was about $5 million and its payable to Enron was
about $9 million. Nicor has filed its appropriate Proof of Claims with the U.S.
Bankruptcy Court. There have not been any subsequent settlements related to the
amounts outstanding with Enron at the time of the bankruptcy filing. Nicor
believes that it has the right to set off receivables against amounts owed to
the Enron companies.
Energy trading activities. At September 30, 2002, Nicor Enerchange, Nicor's
wholesale natural gas marketing business, had contracts outstanding 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 $ .5 $ .5 $ - $ -
Prices based on pricing models 5.5 .9 3.8 .8
---------- -------- ------- ------
Total $ 6.0 $ 1.4 $ 3.8 $ .8
========== ======== ======= ======
The above fair values exclude $40.0 million attributable to natural gas
inventory (net of borrowed gas) which is valued at quoted spot market prices.
OTHER
The company sponsors defined contribution plans covering essentially all
domestic employees. Under the plans, employees may elect to make contributions
that are partially matched by the company. In addition, substantially all Nicor
Gas employees hired after 1997 receive a separate company contribution to this
plan. These plans involve risk for the participants, who direct their
contributions and company contributions into various investment options,
including numerous mutual funds, a stable value fund and a Nicor stock fund.
Nicor Inc. Page 29
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement)(continued)
OUTLOOK
Management currently estimates 2002 diluted earnings per common share to be in
the range of $2.65 to $2.80. These estimates do not consider any pending
adjustments or restatements and assume normal weather for the rest of the year,
no further mercury-related charges or credits, no income or negative charges
related to the PBR plan and no additional negative charges related to Nicor
Energy. See also Forward-Looking Information disclaimer below.
FORWARD-LOOKING INFORMATION
Although management believes its statements about the earnings expectations of
Nicor, the expected results of financial restatements and other adjustments, and
other forwarding-looking statements are based on reasonable assumptions, actual
results may vary materially from stated expectations. 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 accounting reviews and the
resolution of those issues, including the direct or indirect effects of a
restatement and re-audit of financial statements and ICC review of the Nicor Gas
PBR plan. Other factors that could cause materially different results include,
but are not limited to, PBR plan review, the legal contingencies and other
matters referred to in the Contingencies section beginning on page 12, weather
conditions, natural gas and electricity prices, interest rates, borrowing needs,
credit conditions, economic and market conditions, health care costs, insurance
costs, energy conservation, legislative and regulatory actions, asset sales, any
future mercury-related charges or credits, and any additional adjustments
related to Nicor Energy. These forward-looking statements speak only as of the
date of this filing, and the company assumes no obligation to update any
forward-looking statements.
Nicor Inc. Page 30
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement) (continued)
GAS DISTRIBUTION STATISTICS
Operating revenues, deliveries, customers and other statistics are presented
below.
Three months ended Nine months ended
September 30 September 30
------------------ --------------------
2002 2001 2002 2001
-------- -------- --------- ---------
Operating revenues (millions):
Sales
Residential $ 100.8 $ 93.5 $ 620.1 $ 1,258.0
Commercial 20.3 13.7 120.1 235.6
Industrial 2.1 1.8 19.7 35.8
-------- -------- --------- ---------
123.2 109.0 759.9 1,529.4
-------- -------- --------- ---------
Transportation
Residential 4.0 1.8 10.0 6.7
Commercial 12.2 12.1 53.9 54.5
Industrial 13.7 12.8 35.8 35.8
Other 1.0 .7 5.5 6.7
-------- -------- --------- ---------
30.9 27.4 105.2 103.7
-------- -------- --------- ---------
Other revenues
Revenue taxes 9.1 7.9 66.0 95.0
Environmental cost recovery 1.7 1.2 17.1 14.3
Performance-based rate plan - 3.3 (1.3) 7.5
Chicago Hub 3.5 3.4 9.6 9.0
Weather protection .7 - 1.3 -
Other 3.5 4.1 11.6 17.5
-------- -------- --------- ---------
18.5 19.9 104.3 143.3
-------- -------- --------- ---------
$ 172.6 $ 156.3 $ 969.4 $ 1,776.4
======== ======== ========= =========
Deliveries (Bcf):
Sales
Residential 13.2 14.8 139.0 140.6
Commercial 3.0 2.6 26.7 26.9
Industrial .3 .4 4.8 4.3
-------- -------- --------- ---------
16.5 17.8 170.5 171.8
-------- -------- --------- ---------
Transportation
Residential 1.1 .5 5.6 4.2
Commercial 8.9 8.6 68.4 61.3
Industrial 42.6 32.3 116.6 103.5
-------- -------- --------- ---------
52.6 41.4 190.6 169.0
-------- -------- --------- ---------
69.1 59.2 361.1 340.8
======== ======== ========= =========
Customers at end of period (thousands):
Sales
Residential 1,701.5 1,748.0
Commercial 105.0 98.2
Industrial 6.7 6.4
-------- --------
1,813.2 1,852.6
-------- --------
Transportation
Residential 135.2 59.7
Commercial 63.6 67.5
Industrial 6.8 7.2
-------- --------
205.6 134.4
-------- --------
2,018.8 1,987.0
======== ========
Other statistics:
Degree days 33 85 3,530 3,724
Average gas cost per
Mcf sold $ 3.93 $ 2.83 $ 3.08 $ 7.56
Nicor Inc. Page 31
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Subject to Restatement) (concluded)
SHIPPING STATISTICS
Three months ended Nine months ended
September 30 September 30
------------------ -------------------
2002 2001 2002 2001
-------- -------- --------- --------
TEUs shipped (thousands):
Southbound 33.6 27.9 98.9 87.4
Northbound 4.5 4.7 13.9 13.8
Interisland 5.8 1.6 13.9 4.6
-------- -------- --------- --------
43.9 34.2 126.7 105.8
======== ======== ========= ========
Other statistics:
Revenue per TEU $ 1,515 $ 1,539 $ 1,511 $ 1,564
Ports served 24 22
Vessels operated 17 16
Nicor Inc. Page 32
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
For disclosures about market risk, see Market Risk beginning on page 27, which
is incorporated herein by reference.
Item 4. Control and Procedures
Within the 90 days prior to the date of filing this Quarterly Report on Form
10-Q, Nicor completed its evaluation, under the supervision and with the
participation of the company's management, including the principal executive
officer and the principal financial officer, of the effectiveness of the design
and operation of the company's disclosure controls and procedures pursuant to
Securities and Exchange Commission Rules 13a-14(c) and 15d-14(c). Based upon
that evaluation, the principal executive officer and the principal financial
officer concluded that the company's disclosure controls and procedures are
effective in timely alerting them to material information relating to the
company (including its consolidated subsidiaries) required to be included in the
company's periodic SEC filings. Subsequent to the date of that evaluation, there
have been no significant changes in the company's internal controls or in other
factors that could significantly affect internal controls, nor were any
corrective actions required with regard to significant deficiencies and material
weaknesses.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
For information concerning legal proceedings, see Contingencies beginning on
page 12, which is incorporated herein by reference.
Item 5. Other Information
Because of the inability of the company's independent public accountant to
complete its review of the condensed unaudited 2002 financial statements
included herein, as required by Rule 10-01(d) of Regulation S-X (see Item 1),
the company's Chief Executive Officer and Chief Financial Officer are unable to
complete the statement required under 18 U.S.C. sec. 1350 (Section 906 of the
Sarbanes-Oxley Act of 2002).
Item 6. Exhibits and Reports on Form 8-K
(a) See Exhibit Index on page 36 filed herewith.
(b) On August 14, 2002, the company filed a Form 8-K including
CEO/CFO certifications(SEC 4-460).
Nicor Inc. Page 33
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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 11, 2002 By /s/ KATHLEEN L. HALLORAN
-------------------- ------------------------
Kathleen L. Halloran
Executive Vice President
Finance and Administration
Nicor Inc. Page 34
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Certification
I, Thomas L. Fisher, Chairman and Chief Executive Officer of
Nicor Inc., certify that:
1) I have reviewed this quarterly report on Form 10-Q of Nicor Inc.;
2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5) The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date November 11, 2002 /s/ THOMAS L.FISHER
----------------- -------------------
Thomas L. Fisher
Chairman and Chief Executive Officer
Nicor Inc. Page 35
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Certification
I, Kathleen L. Halloran, Executive Vice President Finance and
Administration of Nicor Inc., certify that:
1) I have reviewed this quarterly report on Form 10-Q of Nicor Inc.;
2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5) The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date November 11, 2002 /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
------- ----------------------------------------------------
10.01 Second Amendment and Restatement to Nicor Salary
Deferral Plan.