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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2003
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
I.R.S. Employer
Commission Registrant, State of Incorporation, Identification
File Number Address and Telephone Number Number
- -------------- ------------------------------------ ---------------
1-7296 Northern Illinois Gas Company 36-2863847
(Doing business as Nicor Gas Company)
(An Illinois Corporation)
1844 Ferry Road
Naperville, Illinois 60563-9600
(630) 983-8888
The registrant meets the conditions set forth in General Instruction H(1)(a) and
(b) of Form 10-Q and is therefore filing this Form with a reduced disclosure
format.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Shares of common stock, par value $5, outstanding at October 28, 2003 were
15,232,414, all of which are owned by Nicor Inc.
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Nicor Gas Company Page i
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Table of Contents
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Part I - Financial Information
Item 1. Financial Statements - (Unaudited) ..................... 1
Condensed Consolidated Statements of Operations:
Three and nine months ended
September 30, 2003 and 2002 .......................... 2
Condensed Consolidated Statements of Cash Flows:
Nine months ended
September 30, 2003 and 2002 .......................... 3
Condensed Consolidated Balance Sheets:
September 30, 2003 and 2002, and
December 31, 2002 .................................... 4
Notes to the Consolidated Financial Statements ......... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ....................14
Item 4. Controls and Procedures ................................22
Part II - Other Information
Item 1. Legal Proceedings ......................................25
Item 6. Exhibits and Reports on Form 8-K .......................25
Signature ..............................................26
Exhibit Index ..........................................27
Glossary
- --------
Degree day......The extent to which the daily average temperature falls below
65 degrees Fahrenheit. Normal weather for Nicor Gas' service
territory is about 6,000 degree days per year.
ICC.............Illinois Commerce Commission, the agency that regulates
investor-owned Illinois utilities.
FERC............Federal Energy Regulatory Commission, the agency that regulates
the interstate transportation of natural gas, oil and
electricity.
Mcf, MMcf, Bcf..Thousand cubic feet, million cubic feet, billion cubic feet.
PBR.............Performance-based rate, a regulatory plan that provided
economic incentives based on natural gas cost performance.
Nicor Gas Company Page 1
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
The following condensed unaudited consolidated financial statements of Nicor Gas
have been prepared by the company pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States have been
condensed or omitted pursuant to SEC rules and regulations. The condensed
financial statements should be read in conjunction with the financial statements
and the notes thereto included in the company's 2002 Annual Report on Form 10-K.
The information furnished reflects, in the opinion of the company, all
adjustments (consisting only of normal recurring adjustments) 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 Gas Company Page 2
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Condensed Consolidated Statements of Operations (Unaudited)
(millions)
Three months ended Nine months ended
September 30 September 30
----------------- ------------------
2003 2002 2003 2002
------- -------- --------- --------
Operating revenues (includes revenue
taxes of $11.4, $9.1, $98.3 and
$66.0, respectively) $ 223.4 $ 172.7 $ 1,699.6 $ 971.2
------- -------- --------- -------
Operating expenses
Cost of gas 117.6 65.4 1,221.5 527.3
Operating and maintenance 51.4 48.2 164.5 143.4
Depreciation 35.6 17.0 107.6 96.2
Taxes, other than income taxes 14.4 13.4 108.3 77.1
Mercury-related costs (recoveries) - (19.7) (17.8) (19.5)
Income taxes (1.8) 14.4 32.5 44.4
------- -------- --------- -------
217.2 138.7 1,616.6 868.9
------- -------- --------- -------
Operating income 6.2 34.0 83.0 102.3
------- -------- --------- -------
Other income (expense)
Other, net .3 1.1 1.4 5.8
Income taxes on other income (.1) (.4) (.5) (2.2)
------- -------- --------- -------
.2 .7 .9 3.6
------- -------- --------- -------
Interest expense
Interest on debt, net of amounts
capitalized 8.6 8.2 25.1 25.4
Other .6 .7 1.6 1.2
------- -------- --------- -------
9.2 8.9 26.7 26.6
------- -------- --------- -------
Net income (loss) (2.8) 25.8 57.2 79.3
Dividends on preferred stock - .1 .2 .2
------- -------- --------- -------
Earnings (loss) applicable to common
stock $ (2.8) $ 25.7 $ 57.0 $ 79.1
======= ======== ========= =======
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 3
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Condensed Consolidated Statements of Cash Flows (Unaudited)
(millions)
Nine months ended
September 30
------------------
2003 2002
-------- --------
Operating activities
Net income $ 57.2 $ 79.3
Adjustments to reconcile net income to net cash flow
provided from operating activities:
Depreciation 107.6 96.2
Deferred income tax expense 133.5 13.2
Gain on sale of property, plant and equipment (.4) (3.4)
Changes in:
Receivables, less allowances 194.2 147.8
Gas in storage (300.7) (27.7)
Deferred/accrued gas costs (48.7) (99.7)
Prepaid pension costs - (9.6)
Other assets (119.9) 4.5
Accounts payable (147.1) 23.7
Accrued mercury-related costs (recoveries) (1.2) (4.8)
Other liabilities (60.1) 16.1
Other .5 2.3
-------- --------
Net cash flow (used for) provided from
operating activities (185.1) 237.9
-------- --------
Investing activities
Capital expenditures (127.3) (118.2)
Net proceeds from the sale of property,
plant and equipment .4 3.5
-------- --------
Net cash flow used for investing activities (126.9) (114.7)
-------- --------
Financing activities
Net proceeds from issuing long-term debt - 49.9
Disbursements to retire long-term debt (100.0) -
Short-term borrowings (repayments), net 375.0 (77.0)
Dividends paid (54.2) (88.3)
Other (.6) (.4)
-------- --------
Net cash flow provided from (used for)
financing activities 220.2 (115.8)
-------- --------
Net (decrease) increase in cash and cash equivalents (91.8) 7.4
Cash and cash equivalents, beginning of period 182.2 137.7
-------- --------
Cash and cash equivalents, end of period $ 90.4 $ 145.1
======== ========
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 4
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Condensed Consolidated Balance Sheets (Unaudited)
(millions)
September 30 December 31 September 30
2003 2002 2002
----------- ----------- -----------
Assets
------
Gas distribution plant, at cost $ 3,662.3 $ 3,558.1 $ 3,525.4
Less accumulated depreciation 1,995.3 1,910.1 1,885.8
----------- ----------- -----------
1,667.0 1,648.0 1,639.6
----------- ----------- -----------
Current assets
Cash and cash equivalents - affiliates 83.1 115.3 139.3
Cash and cash equivalents - other 7.3 66.9 5.8
Receivables, less allowances of
$20.9, $14.4 and $10.5,
respectively 190.1 382.4 130.7
Receivables - affiliates 8.8 10.7 12.8
Gas in storage, at last-in, first-
out (LIFO) cost 319.3 18.6 59.7
Deferred income taxes 30.7 31.4 39.0
Other 150.7 12.2 8.3
----------- ----------- -----------
790.0 637.5 395.6
----------- ----------- -----------
Prepaid pension costs 177.1 177.1 173.9
Other assets 65.8 82.2 27.2
----------- ----------- -----------
$ 2,699.9 $ 2,544.8 $ 2,236.3
=========== =========== ===========
Capitalization and Liabilities
------------------------------
Capitalization
Long-term debt
Long-term bonds and notes $ 396.7 $ 396.2 $ 396.0
Mandatorily redeemable preferred
stock 5.0 - -
----------- ----------- -----------
401.7 396.2 396.0
----------- ----------- -----------
Preferred stock
Mandatorily redeemable preferred
stock - 5.6 5.6
Non-redeemable preferred stock 1.4 1.4 1.4
----------- ----------- -----------
1.4 7.0 7.0
----------- ----------- -----------
Common equity
Common stock 76.2 76.2 76.2
Paid-in capital 108.1 108.0 108.1
Retained earnings 431.5 424.5 415.8
Accumulated other comprehensive loss (1.1) (.9) (.6)
----------- ----------- -----------
614.7 607.8 599.5
----------- ----------- -----------
1,017.8 1,011.0 1,002.5
----------- ----------- -----------
Current liabilities
Long-term obligations due within one
year .5 100.5 100.5
Short-term borrowings - other 690.0 315.0 190.0
Accounts payable 314.6 461.7 421.4
Accrued gas costs 18.6 67.3 8.3
Accrued mercury-related costs 4.5 5.0 3.6
Accrued dividends payable 17.0 21.1 21.1
Other 14.6 46.4 33.0
----------- ----------- -----------
1,059.8 1,017.0 777.9
----------- ----------- -----------
Deferred credits and other liabilities
Deferred income taxes 387.8 253.5 240.7
Regulatory income tax liability 60.7 62.2 63.5
Unamortized investment tax credits 36.0 37.5 37.5
Accrued mercury-related costs 17.7 18.4 28.6
Other 120.1 145.2 85.6
----------- ----------- -----------
622.3 516.8 455.9
----------- ----------- -----------
$ 2,699.9 $ 2,544.8 $ 2,236.3
=========== =========== ===========
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 5
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Notes to the Consolidated Financial Statements (Unaudited)
The following notes should be read in conjunction with the financial statement
notes included in the Nicor Gas 2002 Annual Report on Form 10-K. Nicor Gas is a
wholly owned subsidiary of Nicor Inc. (Nicor).
1. ACCOUNTING POLICIES
Regulatory assets and liabilities. Nicor Gas is regulated by the Illinois
Commerce Commission (ICC), which establishes the rules and regulations governing
utility rates and services in Illinois. The company applies accounting standards
that recognize the economic effects of rate regulation and, accordingly, has
recorded regulatory assets and liabilities. The company had regulatory assets
(liabilities) as follows (in millions):
September 30 December 31 September 30
2003 2002 2002
------------ ------------ ------------
Deferred (accrued) gas costs $ (18.6) $ (67.3) $ (8.3)
Regulatory income tax liability (60.7) (62.2) (63.5)
Unamortized loss on reacquired
debt 18.3 19.0 19.3
Deferred (accrued) environmental
costs 39.0 54.7 (7.5)
------------ ------------ ------------
$ (22.0) $ (55.8) $ (60.0)
============ ============ ============
The unamortized loss on reacquired debt is classified in other noncurrent
assets. Deferred (accrued) environmental costs are included in other noncurrent
assets and other noncurrent liabilities, respectively.
In addition, consistent with its regulatory treatment, Nicor Gas accrues
anticipated future removal costs over the useful lives of its property, plant
and equipment. The balance of removal costs in accumulated depreciation at
September 30, 2003, December 31, 2002 and September 30, 2002 was approximately
$660 million, $625 million and $615 million, respectively.
Revenue taxes. Nicor Gas classifies revenue taxes billed to customers as
operating revenues and related taxes due as operating expenses. Revenue taxes
included in operating expense for the three months and nine months ended
September 30, 2003 were $10.7 million and $96.0 million, respectively, and $8.7
million and $63.9 million, respectively, for the same periods ended September
30, 2002.
Depreciation. Property, plant and equipment are depreciated over estimated
useful lives on a straight-line basis. The annual composite depreciation rate is
4.1 percent, which includes estimated future removal costs.
Derivatives. The company generally classifies cash flows from derivatives in the
same category as cash flows from any related hedged item.
Nicor Gas Company Page 6
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
2. ACCOUNTING CHANGES
Depreciation. Effective January 1, 2003, Nicor Gas began using the straight-line
method for allocating annual depreciation to interim periods, the predominant
method used by other companies in its industry. Nicor Gas' 2002 results include
the company's depreciation allocated based upon the level of weather-normalized
gas deliveries. The following table provides a comparison of Nicor Gas' results
as reported for the three months and nine months ended September 30, 2002 to pro
forma results had depreciation been allocated on a straight-line basis (in
millions):
Three months ended Nine months ended
September 30, 2002 September 30, 2002
--------------------- --------------------
As As
Reported Pro Forma Reported Pro Forma
--------- ----------- ---------- ----------
Depreciation expense $ 17.0 $ 34.4 $ 96.2 $103.2
Operating income 34.0 23.5 102.3 98.1
Net income 25.8 15.4 79.3 75.1
Asset retirement obligations. In August 2001, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standards (FAS) No. 143,
Accounting for Asset Retirement Obligations. This standard requires entities to
record the fair value of a liability for an asset retirement obligation in the
period in which the obligation is incurred. When the liability is initially
recorded, the entity capitalizes the cost by increasing the carrying amount of
the related long-lived asset. Over time, the liability is accreted to its
present value, and the capitalized cost is depreciated over the useful life of
the related asset. This standard became effective on January 1, 2003.
The obligation of retiring gas distribution, transmission, storage and certain
general plant assets at Nicor Gas meets the definition of a legal obligation
within the meaning of FAS 143. However, the company, like most other gas
distribution utility companies, has determined that due to the indefinite life
of such assets a liability is generally not measurable. On January 1, 2003, a
$3.5 million asset retirement obligation for the expected replacement of inside
mercury regulators was recorded at Nicor Gas. Certain costs associated with the
retirement of other items at Nicor companies, including polychlorinated
biphenyls, underground storage tanks and asbestos abatement, are determined to
be immaterial or cannot be measured at this time.
Nicor Gas continues its practice of accruing for future retirement costs as
accumulated depreciation, subject to cost-of-service utility rate regulation,
even when an asset removal obligation does not exist under FAS 143. Through
September 30, 2003, the company has accrued and recovered about $660 million
associated with the future removal of these long-lived assets.
No cumulative effect gain or loss was required as a result of adopting this
standard due to the economic effect of Nicor Gas' cost-of-service utility rate
regulation. The application of this standard did not have a material effect on
the company's financial position and results of operations.
Nicor Gas Company Page 7
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
Derivative Instruments and Hedging Activities. In April 2003, the FASB issued
FAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. FAS 149 amends and addresses financial accounting and reporting for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities under FAS 133. The Statement is
generally effective prospectively for contracts entered into or modified after
June 30, 2003. The only impact of adoption on July 1, 2003, is that certain
natural gas commodity contracts at Nicor Gas no longer qualify for the normal
purchases and sales exception and must be recorded at fair value, with an
offsetting regulatory asset or liability. The application of this standard has
not had a material impact on the company's financial position or results of
operations.
Accounting for Certain Financial Instruments. In May 2003, the FASB issued FAS
150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. FAS 150 requires certain freestanding financial
instruments, such as mandatorily redeemable preferred stock, to be measured at
fair value and classified as liabilities. The provisions of FAS 150 are
effective for Nicor Gas beginning July 1, 2003. Upon adoption, Nicor Gas
reclassified approximately $6 million of redeemable preferred stock to a
liability, and related dividends are being prospectively classified as interest
expense. If Nicor Gas called the mandatorily redeemable preferred shares for
redemption at September 30, 2003, Nicor Gas would have to pay Nicor
approximately $6 million. The application of this standard did not have a
material impact on the company's financial position or results of operations.
3. NEW ACCOUNTING PRONOUNCEMENT
Consolidation of Variable Interest Entities. In January 2003, the FASB issued
Interpretation 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46
addresses the application of Accounting Research Bulletin 51, Consolidated
Financial Statements, to certain entities in which equity investors do not have
the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support. FIN 46 applied immediately to
variable interest entities created or interests obtained after January 31, 2003,
and it originally applied beginning July 1, 2003 to variable interests acquired
before February 1, 2003. However, a recent FASB Staff Position defers the
effective date of this Interpretation to December 31, 2003. The company has
determined that this standard has no impact on its financial position or results
of operations.
4. ACCRUED UNBILLED REVENUES
Receivables include accrued unbilled revenues of $55.0 million, $142.4 million
and $37.8 million at September 30, 2003, December 31, 2002, and September 30,
2002, respectively. Nicor Gas accrues revenues for estimated deliveries to
customers from the date of their last bill until the balance sheet date.
5. SHORT-TERM AND LONG-TERM DEBT
In April 2003, Nicor Gas refinanced $50 million of 3 percent unsecured notes due
in April 2003 with $50 million of 1.6 percent unsecured notes due and paid in
October 2003. In June 2003, Nicor Gas retired $50 million of 5.75% First
Mortgage Bonds due in 2003.
The company maintains short-term line of credit agreements with major domestic
and foreign banks. At September 30, 2003, these agreements, which serve as
backup for the issuance of commercial paper,
Nicor Gas Company Page 8
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
allowed for borrowings of up to $1 billion through March 2004 and $500 million
thereafter through September 2004. Commitment fees paid in advance totaling $2.5
million will be amortized over the respective term of the agreements as an
adjustment to interest expense. The company had $640 million of commercial paper
borrowings outstanding at September 30, 2003.
Under the company's 2003/2004 short-term line of credit agreements, (1) if
Nicor's ratio of consolidated indebtedness to capitalization (including
short-term debt) exceeds 65% at the end of the first, second or third fiscal
quarter, or 70% at the end of the fourth fiscal quarter, and/or (2) if Nicor's
twelve-months-ended interest coverage ratio is less than 3 to 1 at the end of
any fiscal quarter during the term of the credit agreements, banks representing
66 2/3% of the commitments may declare any amounts due immediately payable
and/or terminate the commitments to make advances to the company. The company is
in compliance with this covenant at September 30, 2003. The company expects that
commercial paper funding will continue to be available in the foreseeable
future.
6. FAIR VALUE OF FINANCIAL INSTRUMENTS
The recorded amount of short-term investments and short-term borrowings
approximates fair value because of the short maturity of the instruments.
Long-term debt outstanding, including current maturities, is recorded at the
principal balance outstanding. The principal balance of Nicor Gas' First
Mortgage Bonds outstanding at September 30, 2003 was $400 million and at
December 31, 2002 and September 30, 2002, the principal balance outstanding was
$450 million. Based on quoted market interest rates, the fair value of the
company's First Mortgage Bonds outstanding, including current maturities, was
$437 million, $482 million and $486 million at September 30, 2003, December 31,
2002 and September 30, 2002, respectively.
7. OTHER INCOME (EXPENSE)
Other income (expense) - other, net consists of the following (in millions):
Three months ended Nine months ended
September 30 September 30
------------------ -------------------
2003 2002 2003 2002
-------- -------- -------- ---------
Gains on sale of property,
plant and equipment $ - $ - $ .4 $ 3.4
Interest income .3 .5 1.1 2.0
Other income .1 .6 .6 .6
Other expense (.1) - (.7) (.2)
-------- -------- -------- --------
$ .3 $ 1.1 $ 1.4 $ 5.8
======== ======== ======== ========
Nicor Gas Company Page 9
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
8. COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss), as defined by FAS 130, Reporting
Comprehensive Income, is equal to net income plus other comprehensive income and
is as follows (in millions):
Three months ended Nine months ended
September 30 September 30
------------------ -------------------
2003 2002 2003 2002
-------- -------- -------- ---------
Net income (loss) $ (2.8) $ 25.8 $ 57.2 $ 79.3
Other comprehensive income
(loss), net of tax - .4 (.2) .7
-------- -------- -------- ---------
$ (2.8) $ 26.2 $ 57.0 $ 80.0
======== ======== ======== =========
Other comprehensive income (loss) consists primarily of unrealized gains and
losses from derivative financial instruments accounted for as cash flow hedges.
9. GUARANTEES
Nicor Gas had outstanding letters of credit and surety bonds totaling
approximately $5 million at September 30, 2003. The letters of credit and surety
bonds typically act as a guarantee of payment or performance to certain third
parties in accordance with specified terms and conditions.
10. RELATED PARTY TRANSACTIONS
In the ordinary course of business, under the terms of an agreement approved by
the ICC, Nicor Gas enters into transactions with Nicor and its other wholly
owned subsidiaries for the use of facilities and services. The charges for these
transactions are cost-based, except where the charging party has a prevailing
price for which the facility or service is provided to the general public. In
addition, Nicor charges Nicor Gas and its other wholly owned subsidiaries for
the cost of corporate overheads. For the three months and nine months ended
September 30, 2003, Nicor Gas had net charges from (to) affiliates of $1.6
million and $(3.5) million, respectively. For the three months and nine months
ended September 30, 2002, Nicor Gas had net charges from (to) affiliates of $.4
million and $(3.8) million, respectively.
Under the terms of an ICC order, Nicor Gas routinely enters into transactions
with Nicor Enerchange, a wholesale natural gas marketing subsidiary of Nicor,
for the purchase and sale of natural gas, transportation and storage services.
For the three months ended September 30, 2003 and 2002, net charges from (to)
Nicor Enerchange were $.1 million and $(1.3) million, respectively, and for the
nine months ended September 30, 2003 and 2002, net charges (to) Nicor Enerchange
were $(2.2) million and $(11.4) million, respectively.
Horizon Pipeline, a 50/50 joint venture between Nicor and Natural Gas Pipeline
Company of America (NGPL), charged Nicor Gas $2.6 million and $7.7 million for
the three months and nine months ended September 30, 2003, respectively, for
natural gas transportation under rates that have been accepted by FERC. For the
three months and nine months ended September 30, 2002, Horizon Pipeline charged
Nicor Gas $2.6 million and $4.0 million, respectively, for this service.
Nicor Gas Company Page 10
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
Nicor Gas purchases engineering and corrosion services from Nicor Technologies,
a subsidiary of Nicor. Nicor Gas was charged $1.2 million and $1.1 million for
these services for the three months ended September 30, 2003 and 2002,
respectively, and $3.3 million for these services for the nine months ended
September 30, 2003 and 2002.
11. CONTINGENCIES
The following contingencies of Nicor Gas are in various stages of investigation
or disposition. Although in some cases the company is unable to estimate the
amount of loss reasonably possible in addition to any amounts already
recognized, it is possible that the resolution of these contingencies, either
individually or in aggregate, will require the company to take charges against,
or will result in reductions in, future earnings. It is the opinion of
management that the resolution of these contingencies, either individually or in
aggregate, could be material to earnings in a particular period, but is not
expected to have a material adverse impact on Nicor Gas' liquidity or financial
condition.
Performance-Based Rate (PBR) Plan. Nicor Gas' PBR plan for natural gas costs
went into effect in 2000 and was terminated by the company effective January 1,
2003. Under the PBR plan, Nicor Gas' total gas supply costs were compared to a
market-sensitive benchmark. Savings and losses relative to the benchmark were
determined annually and shared equally with sales customers. The PBR plan is
currently under Illinois Commerce Commission (ICC) review.
There are allegations that the company acted improperly in connection with the
PBR plan, and the ICC and others are reviewing these allegations. On June 27,
2002 the Citizens Utility Board (CUB) filed a motion to reopen the record in the
ICC's proceedings to review the PBR plan (the ICC Proceedings). As a result of
the motion to reopen, Nicor Gas, the Cook County State's Attorney's Office
(CCSAO), the staff of the ICC and CUB entered into a stipulation providing for
additional discovery. The Illinois Attorney General's Office has also intervened
in this matter. In addition, the Illinois Attorney General's Office issued Civil
Investigation Demands (CIDs) to CUB and the ICC staff. The CIDs ordered that CUB
and the ICC staff produce all documents relating to any claims that Nicor Gas
may have presented, or caused to be presented, false information related to its
PBR plan. Parties who were plaintiffs in a dismissed class action proceeding
against the company could potentially intervene in these proceedings. The
company has committed to cooperate fully in the reviews of the PBR plan.
Pursuant to the agreement of all parties, including the company, the ICC
re-opened the 1999 and 2000 purchased gas adjustment filings for review of
certain transactions related to the PBR plan and consolidated the reviews of the
1999-2002 purchased gas adjustment filings with the PBR plan review.
Certain parties in the PBR plan review proceeding have indicated that they
believe substantial adjustments or penalties are warranted. In addition, on
February 5, 2003, the CCSAO and CUB filed a motion for $27 million in sanctions
against the company in the ICC Proceedings. In that motion, CCSAO and CUB
alleged that Nicor Gas' responses to certain CUB data requests were false. Also
on February 5, 2003, CUB stated in a press release that, in addition to $27
million in sanctions, it would seek additional refunds to consumers. On March 5,
2003, the ICC staff filed a response brief in support of CUB's motion for
sanctions. On May 1, 2003, the Administrative Law Judges issued a ruling denying
CUB and CCSAO's motion for sanctions. CUB has filed an appeal of the motion for
sanctions with the ICC, and the ICC has indicated that it will not rule on the
appeal until the final disposition of the ICC proceedings. It is not possible to
determine how the ICC will resolve the claims of CCSAO, CUB or other parties to
the ICC Proceedings.
Nicor Gas Company Page 11
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
Nicor Gas is unable to predict the outcome of any of the foregoing reviews or
the company's potential exposure thereunder. Due to the uncertainties
surrounding the PBR plan, Nicor Gas has not recognized a $26.9 million pretax
gain from the 2002 PBR plan year. Because the PBR plan and historical utility
gas costs are still under ICC review, it is possible that the final outcome
could be materially different than the amounts reflected in the company's
financial statements as of September 30, 2003.
SEC and U.S. Attorney Inquiries. In 2002, the staff of the Securities and
Exchange Commission (SEC) informed the company that the SEC is conducting a
formal inquiry regarding the PBR plan. A representative of the Office of the
United States Attorney for the Northern District of Illinois has notified the
company that that office is conducting an inquiry on the same matter that the
SEC is investigating, and a grand jury is also reviewing this matter.
Hub Services. Nicor Gas offers interstate transportation and storage services,
which are regulated by the Federal Energy Regulatory Commission (FERC), as well
as certain intrastate interruptible transportation and storage services which
are regulated by the ICC. During a periodic rate case that was filed with FERC,
Nicor Gas determined that refunds were due to certain customers of these
services. Nicor Gas accrued customer refunds and other costs totaling $1.4
million in the years 2000 to 2002. On March 14, 2003, FERC issued an order
approving a settlement with Nicor Gas. The resolution of this matter did not
have a material adverse impact on the company's financial condition or results
of operations.
Other FERC Matters. In 2002, Nicor Gas determined that it may not have complied
with regulations of FERC governing the release of certain transportation and
storage capacity that it contracts for with interstate pipelines, and the
company brought these matters to the attention of FERC. The company accrued a
$.4 million liability associated with these matters in the fourth quarter of
2002. On March 14, 2003, FERC issued an order approving a settlement with Nicor
Gas. The resolution of this matter did not have a material adverse impact on the
company's financial condition or results of operations.
Troy Grove Facility. On October 15, 2002, Nicor Gas voluntarily disclosed a
potential violation of certain air pollution regulations and statutes to both
the United States Environmental Protection Agency and the Illinois Environmental
Protection Agency (IEPA) related to commencement of construction of certain
compressor equipment at its Troy Grove storage field prior to the issuance of a
Prevention of Significant Deterioration Permit. On June 26, 2003, Nicor Gas
completed the installation of an alternate fuel refueling station at Nicor's
Ottawa, Illinois facility pursuant to the terms of a Compliance Commitment
Agreement proposed by Nicor Gas and approved by IEPA to resolve this matter. The
resolution of this matter did not have a material adverse impact on the
company's financial condition or results of operations.
Mercury. Nicor Gas has incurred, and expects to continue to incur, costs related
to its historical use of mercury in various kinds of company equipment.
Nicor Gas is a defendant in several private lawsuits, all in the Circuit Courts
of Cook and DuPage Counties, Illinois, claiming a variety of unquantified
damages (including bodily injury, property and punitive damages) allegedly
caused by mercury-containing regulators. Under the terms of a class action
settlement agreement, Nicor Gas will continue, until 2006, to provide medical
screening to persons exposed to mercury from its equipment, and will use its
best efforts to replace any remaining inside residential mercury regulators by
2005. The class action settlement permitted class members to "opt out" of the
settlement and pursue their claims individually. Nicor is currently defending
claims brought by 28 households.
Nicor Gas Company Page 12
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Notes to the Consolidated Financial Statements (Unaudited)(continued)
As of September 30, 2003, Nicor Gas had remaining an estimated liability of
$22.2 million, representing management's best estimate of future costs,
including potential liabilities relating to remaining lawsuits, based on an
evaluation of currently available information. Actual costs may vary from this
estimate. The company will continue to reassess its estimated obligation and
will record any necessary adjustment, which could be material to operating
results in the period recorded.
Nicor Gas continues to pursue recovery from insurers and independent contractors
that had performed work for the company, but believes that it has now collected
the majority of such recoveries. When received, these recoveries are recorded as
a reduction to gas distribution operating expense. Nicor Gas recovered
approximately $17.8 million of pretax mercury-related costs, net of legal fees,
from insurers and independent contractors year-to-date through September 30,
2003, including approximately $17.4 million recovered in the second quarter of
2003.
The final disposition of these mercury-related matters is not expected to have a
material adverse impact on the company's financial condition.
Manufactured Gas Plant Sites. Manufactured gas plants were used in the 1800's
and early to mid 1900's to produce manufactured gas from coal, creating a coal
tar byproduct. Current environmental laws may require the cleanup of coal tar at
certain former manufactured gas plant sites.
To date, Nicor Gas has identified about 40 properties for which it may, in part,
be responsible. Most of these properties are not presently owned by the company.
Information regarding preliminary site reviews has been presented to the IEPA
for certain properties. More detailed investigations and remedial activities are
complete, in progress or planned at many of these sites. The results of the
detailed site-by-site investigations determine the extent additional remediation
is necessary and provide a basis for estimating additional future costs which,
based on industry experience, could be significant. In accordance with ICC
authorization, the company is and has been recovering these costs from its
customers, subject to annual prudence reviews.
In December 2001, a purported class action lawsuit was filed against Exelon
Corporation, Commonwealth Edison Company and Nicor Gas in the Circuit Court of
Cook County alleging, among other things, that the ongoing cleanup of a former
manufactured gas plant site in Oak Park, Illinois is inadequate. Since then,
additional lawsuits have been filed related to this same former manufactured gas
plant site. These lawsuits seek, in part, unspecified damages for property
damage, nuisance, various personal injuries and one death that allegedly
resulted from exposure to contaminants allegedly emanating from the site, and
punitive damages. Management cannot predict the outcome of this litigation or
the company's potential exposure thereto and has not recorded a liability
associated with this contingency.
In April 2002, Nicor Gas was named as a defendant, together with Commonwealth
Edison Company, in a lawsuit brought by the Metropolitan Water Reclamation
District of Greater Chicago (the MWRDGC) under the Federal Comprehensive
Environmental Response, Compensation and Liability Act seeking recovery of past
and future remediation costs and a declaration of the level of appropriate
cleanup for a former manufactured gas plant site in Skokie, Illinois now owned
by the MWRDGC. In January 2003, the suit was amended to include a claim under
the Federal Resource Conservation and Recovery Act. The suit was filed in the
United States District Court for the Northern District of Illinois. Management
cannot predict the outcome of this litigation or the company's potential
exposure thereto and has not recorded a liability associated with this
contingency.
Nicor Gas Company Page 13
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Notes to the Consolidated Financial Statements (Unaudited)(concluded)
Since costs and recoveries relating to the cleanup of manufactured gas plant
sites are passed directly through to customers in accordance with ICC
regulations, subject to an annual ICC prudence review, the final disposition of
manufactured gas plant matters is not expected to have a material impact on the
company's financial condition or results of operations.
Other. In addition to the matters set forth above, the company is involved in
legal or administrative proceedings before various courts and agencies with
respect to rates, taxes and other matters. Although unable to determine the
outcome of these other contingencies, management believes that appropriate
accruals for them have been recorded.
Nicor Gas Company Page 14
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion should be read in conjunction with the Management's
Discussion and Analysis section of the Nicor Gas 2002 Annual Report on Form
10-K.
RESULTS OF OPERATIONS
Nicor Gas' 2003 quarterly and year-to-date results of operations were
significantly impacted by a change in the method of allocating annual
depreciation to interim periods. Effective January 1, 2003, the company began
using a straight-line method to allocate annual depreciation to interim periods,
a predominant method used by others in the industry. While this change has a
significant impact on quarterly and year-to-date results as noted in the table
below, it has no impact on depreciation for the full year. Nicor Gas' 2002
interim period results include depreciation allocated based upon the level of
weather-normalized gas deliveries. The following table provides a comparison of
Nicor Gas' results as reported for the third-quarter and year-to-date periods of
2003 and 2002, and the pro forma results for 2002 had the company's depreciation
been allocated on a straight-line basis (in millions):
Three months ended
September 30
-------------------------------
2002 2002
2003 As Reported Pro Forma
-------- ----------- ---------
Operating income $ 6.2 $ 34.0 $ 23.5
Net income (loss) (2.8) 25.8 15.4
Nine months ended
September 30
-------------------------------
2002 2002
2003 As Reported Pro Forma
-------- ----------- ---------
Operating income $ 83.0 $ 102.3 $ 98.1
Net income 57.2 79.3 75.1
Third quarter results for 2003 were lower as compared to the reported 2002
amounts due primarily to the absence of significant recoveries from third
parties related to the mercury inspection and repair program, as occurred in the
third quarter of 2002, and the 2003 change in interim depreciation allocation
method. Operating income and net income for the 2003 year-to-date period were
lower as compared to the reported 2002 amounts due primarily to higher operating
expenses and the 2003 change in interim depreciation method. Both year-to-date
periods reflect comparable favorable impacts of significant recoveries from
third parties related to the mercury inspection and repair program.
Operating revenues. Operating revenues increased significantly in the quarter
and year-to-date periods of 2003 compared with the prior-year periods due
primarily to higher natural gas costs, which are passed directly through to
customers without markup. The revenue effect of higher natural gas costs was
approximately $40 million and $580 million for the three-month and nine-month
periods, respectively. For the year-to-date period, revenues increased by about
$90 million due to colder weather, of which $80 million related to colder
weather experienced in the first quarter of 2003. Industrial deliveries fell in
the third quarter and year-to-date periods, despite colder weather in the
year-to-date period, due largely to lower power-generation load.
Nicor Gas Company Page 15
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Margin. Nicor Gas utilizes a measure it refers to as "margin" to evaluate the
operating income impact of gas distribution revenues. Gas distribution revenues
include gas costs, which are passed directly through to customers without
markup, and revenue taxes, for which Nicor Gas earns only a small administrative
fee. These items often cause significant fluctuations in gas distribution
revenues, and yet they have virtually no direct impact on gas distribution
operating income. Therefore, Nicor Gas and many other natural gas distribution
companies exclude these items in evaluating performance. A reconciliation of gas
distribution revenues and margin is as follows (in millions):
Three months Nine months
ended ended
September 30 September 30
---------------- ------------------
2003 2002 2003 2002
-------- ------- -------- ---------
Revenues $ 223.4 $ 172.7 $ 1,699.6 $ 971.2
Cost of gas (117.6) (65.4) (1,221.5) (527.3)
Revenue tax expense (10.7) (8.7) (96.0) (63.8)
-------- ------- --------- -------
Gas distribution margin $ 95.1 $ 98.6 $ 382.1 $ 380.1
======== ======= ========= ========
For the three-month period, margin decreased slightly due primarily to a smaller
contribution from nontraditional gas supply-related services ($3.7 million),
such as the Chicago Hub, and reduced deliveries for power generation ($1.7
million). The favorable impact of increased deliveries due to weather ($2.0
million) was offset by unfavorable weather hedge results ($.7 million) and lower
average rates charged during the period ($1.7 million). Positively impacting
margin were increased customer finance charges ($2.0 million).
For the nine-month period, margin was positively impacted by increased customer
deliveries due to colder weather than the prior year ($12.2 million), partially
offset by an unfavorable variance from the company's weather hedge in 2003
compared to 2002 ($4.8 million). Increased customer finance charges ($6.7
million) related to larger 2003 customer bills also contributed to the slight
increase. Negatively impacting margin was a smaller contribution from
nontraditional gas supply-related services ($7.7 million) and lower deliveries
for power generation ($2.8 million).
Operating and maintenance expense. Operating and maintenance expense increased
$3.2 million and $21.1 million in the three-month and nine-month periods ended
September 30, 2003, respectively, compared to the same periods of 2002. The
quarterly increase was due to a number of factors including lower pension
credits ($2.5 million), increased bad debt expense related to higher customer
bills ($1.7 million), and higher insurance and health care costs ($1.6 million).
An offsetting factor for 2003 was a charge in the third quarter of 2002 to
increase liabilities for costs related to the performance-based rate (PBR) plan
and other investigations ($3.8 million).
The $21.1 million increase in the nine-month period was due primarily to lower
pension credits ($7.3 million), higher health care and insurance costs ($4.9
million), increased natural gas costs to operate company equipment and
facilities ($2.8 million) and increased bad debt expense ($1.7 million). The
higher company-use gas expenses are related to higher average natural gas costs
in 2003 compared to 2002. These negative factors were partially offset by lower
costs related to the review of the company's PBR plan ($2.5 million).
Nicor Gas Company Page 16
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Operating and maintenance expense included $.4 million and $1.0 million of
pension expense in the 2003 three-month and nine-month periods, respectively,
compared with $2.1 million and $6.3 million of pension credits in the same 2002
periods.
Depreciation. Both the quarter and year-to-date results were significantly
affected by the change to a straight-line interim depreciation allocation
method. Previously, Nicor Gas allocated depreciation to interim periods based
upon the level of weather-normalized gas deliveries each quarter. If a
straight-line allocation method had been used in 2002, depreciation in both 2003
periods would have increased slightly compared to the 2002 periods as a result
of property additions.
Mercury-related costs (recoveries). In the second quarter of 2003, Nicor Gas
recovered approximately $17 million of mercury-related costs, net of legal fees,
from insurers and independent contractors. In the third quarter of 2002, Nicor
Gas reached an agreement with an insurer wherein the company recovered
approximately $20 million of mercury-related costs.
Other income (expense). Other income (expense) before taxes declined $4.4
million in the nine-month period ended September 30, 2003 compared to the same
period in 2002 due primarily to lower property sale gains ($3.0 million).
Interest expense. Interest expense for the three months and nine months ended
September 30, 2003 remained essentially unchanged compared to the same
prior-year periods. The impact of higher average borrowing levels was offset by
the positive effect of lower interest rates.
Nicor Gas Company Page 17
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
OPERATING STATISTICS
Operating revenues, deliveries, customers and other statistics are presented
below.
Three months ended Nine months ended
September 30 September 30
------------------ -------------------
2003 2002 2003 2002
-------- -------- --------- --------
Operating revenues (millions):
Sales
Residential $ 142.0 $ 100.8 $ 1,158.2 $ 620.1
Commercial 31.2 20.3 256.2 120.1
Industrial 4.3 2.1 37.7 19.7
------- ------- --------- --------
177.5 123.2 1,452.1 759.9
------- ------- --------- --------
Transportation
Residential 3.9 4.0 15.7 10.0
Commercial 11.0 12.2 51.5 53.9
Industrial 11.1 13.7 32.5 35.8
Other 1.3 1.0 10.4 5.5
------- ------- --------- --------
27.3 30.9 110.1 105.2
------- ------- --------- --------
Other revenues
Revenue taxes 11.4 9.1 98.3 66.0
Environmental cost recovery 2.4 1.7 22.1 17.1
Chicago Hub 1.1 3.6 4.6 10.1
Weather hedge results - .7 (3.5) 1.3
Other 3.7 3.5 15.9 11.6
------- ------- --------- --------
18.6 18.6 137.4 106.1
------- ------- --------- --------
$ 223.4 $ 172.7 $ 1,699.6 $ 971.2
======= ======= ========= ========
Deliveries (Bcf):
Sales
Residential 14.3 13.2 150.3 139.0
Commercial 3.5 3.0 33.2 26.7
Industrial .5 .3 5.1 4.8
------- ------- --------- --------
18.3 16.5 188.6 170.5
------- ------- --------- --------
Transportation
Residential 1.0 1.1 11.2 5.6
Commercial 8.7 14.1 61.8 68.4
Industrial 27.8 42.6 89.8 116.6
------- ------- --------- --------
37.5 57.8 162.8 190.6
------- ------- --------- --------
55.8 74.3 351.4 361.1
======= ======== ========= ========
Customers at end of period (thousands):
Sales
Residential 1,726.9 1,701.5
Commercial 111.4 105.0
Industrial 7.0 6.7
-------- --------
1,845.3 1,813.2
-------- --------
Transportation
Residential 138.9 135.2
Commercial 58.3 63.6
Industrial 6.3 6.8
-------- --------
203.5 205.6
-------- --------
2,048.8 2,018.8
======== ========
Other statistics:
Degree days 97 33 4,094 3,530
Percent colder (warmer)
than normal 37% (54)% 7% (8)%
Average gas cost per Mcf
sold $ 6.31 $ 3.84 $ 6.41 $ 3.04
Nicor Gas Company Page 18
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
FINANCIAL CONDITION AND LIQUIDITY
Operating cash flows. Net cash flow provided from operating activities decreased
$423 million in the 2003 nine-month period from $237.9 million in the prior-year
period. Year-to-year changes in operating cash flow result largely from
fluctuations in working capital items due to such factors as weather, the price
of natural gas, the timing of collections from customers and gas purchasing
practices. The company generally relies on short-term financing to meet
temporary increases in working capital needs. In the fourth quarter of 2003,
Nicor received an income tax refund of approximately $100 million attributed to
a tax loss carryback associated with a change in tax accounting methods, subject
to Internal Revenue Service review and approval.
Investing activities. The current forecast for 2003 capital expenditures is $165
million.
Financing. Nicor Gas maintains short-term line of credit agreements with major
domestic and foreign banks. At September 30, 2003, these agreements, which serve
as backup for the issuance of commercial paper, allowed for borrowings of up to
$1 billion through March 2004 and $500 million thereafter through September
2004. Commitment fees paid in advance totaled $2.5 million and will be amortized
over the respective term of the agreements as an adjustment to interest expense.
As of September 30, 2003, the company had $640 million of commercial paper
borrowings outstanding.
Under the company's 2003/2004 short-term line of credit agreements, (1) if
Nicor's ratio of consolidated indebtedness to capitalization (including
short-term debt) exceeds 65% at the end of the first, second or third fiscal
quarter, or 70% at the end of the fourth fiscal quarter, and/or (2) if Nicor's
twelve-months-ended interest coverage ratio is less than 3 to 1 at the end of
any fiscal quarter during the term of the credit agreements, banks representing
66 2/3% of the commitments may declare any amounts due immediately payable
and/or terminate the commitments to make advances to the company. The company is
in compliance with this covenant at September 30, 2003. The company expects that
commercial paper funding will continue to be available in the foreseeable
future.
In April 2003, Nicor Gas refinanced $50 million of 3 percent unsecured notes due
in April 2003 with $50 million of 1.6 percent unsecured notes due and paid in
October 2003. In June 2003, Nicor Gas retired $50 million of First Mortgage
Bonds due June 1, 2003 at 5.75% through the issuance of commercial paper.
In April 2003, Moody's Investors Service downgraded the long-term debt ratings
of Nicor Gas from Aa1 to Aa3, while affirming their short-term ratings. Standard
and Poor's Ratings Services and Fitch Ratings affirmed Nicor Gas' short-term and
long-term debt ratings. All three rating agencies removed the debt ratings from
negative ratings watch. As of the filing date of this report, these ratings are
among the highest in the gas distribution industry.
In September 2003, Standard and Poor's Ratings Services assigned a AA- rating to
the two new short-term line of credit agreements.
FACTORS AFFECTING BUSINESS PERFORMANCE
Critical accounting policies. Nicor Gas made a change to an accounting policy in
the first quarter of 2003 related to the method of allocating annual
depreciation to interim periods. This creates a significant favorable impact on
first-quarter and fourth-quarter results and an adverse impact on second-quarter
and
Nicor Gas Company Page 19
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
third-quarter results as compared to 2002. As a result, depreciation is expected
to be about $5 million lower in the fourth quarter of 2003, respectively, than
for the same quarter of 2002. It will have no impact on full-year results. For
further information about the changes in accounting methods, see the Notes to
the Consolidated Financial Statements - Note 2 Accounting Changes, which
explains all material changes to the company's critical accounting policies
since December 31, 2002.
Weather protection. The company is no longer carrying weather hedges at Nicor
Gas because there is a natural internal financial offset between traditional
utility sales and the fixed bill product marketed by Nicor's energy-related
products and services businesses. The natural offset reduces Nicor's historical
earnings variability due to weather, of about 2 1/2 cents per share per 100
degree days, by about a third. The company will continue to evaluate its
coverage options to determine whether any additional coverage should be
purchased.
Contingencies. The following contingencies of Nicor Gas are in various stages of
investigation or disposition. Although in some cases the company is unable to
estimate the amount of loss reasonably possible in addition to any amounts
already recognized, it is possible that the resolution of these contingencies,
either individually or in aggregate, will require the company to take charges
against, or will result in reductions in, future earnings. It is the opinion of
management that the resolution of these contingencies, either individually or in
aggregate, could be material to earnings in a particular period, but is not
expected to have a material adverse impact on Nicor Gas' liquidity or financial
condition.
Performance-based rate plan. Nicor Gas' PBR plan for natural gas costs went into
effect in 2000 and was terminated by the company effective January 1, 2003.
Under the PBR plan, Nicor Gas' total gas supply costs were compared to a
market-sensitive benchmark. Savings and losses relative to the benchmark were
determined annually and shared equally with sales customers. The PBR is
currently under Illinois Commerce Commission (ICC) review.
There are allegations that the company acted improperly in connection with the
PBR plan, and the ICC and others are reviewing these allegations. On June 27,
2002 the Citizens Utility Board (CUB) filed a motion to reopen the record in the
ICC's proceedings to review the PBR plan (the ICC Proceedings). As a result of
the motion to reopen, Nicor Gas, the Cook County State's Attorney Office
(CCSAO), the staff of the ICC and CUB entered into a stipulation providing for
additional discovery. The Illinois Attorney General's Office has also intervened
in this matter. In addition, the Illinois Attorney General's Office issued Civil
Investigation Demands (CIDs) to CUB and the ICC staff. The CIDs ordered that CUB
and the ICC staff produce all documents relating to any claims that Nicor Gas
may have presented, or caused to be presented, false information related to its
PBR plan. Parties who were plaintiffs in a dismissed class action proceeding
against the company could potentially intervene in these proceedings. The
company has committed to cooperate fully in the reviews of the PBR plan.
In response to these allegations, on July 18, 2002, the Nicor Board of Directors
appointed a special committee of independent, non-management directors to
conduct an inquiry into issues surrounding natural gas purchases, sales,
transportation, storage and such other matters as may come to the attention of
the special committee in the course of its investigation. The special committee
presented the report of its counsel (Report) to Nicor's Board of Directors on
October 28, 2002. The findings of the Report include:
o Certain transactions increased customer costs in the aggregate amount of
approximately $15 million.
o No improper Nicor affiliated-party transactions or improper hedging
activities were identified.
Nicor Gas Company Page 20
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
o Inadvertent accounting errors occurred, sometimes to the benefit of customers
and sometimes to the benefit of Nicor Gas.
o No criminal activity or fraud was identified.
In response, the Nicor Board of Directors directed the company's management to,
among other things, make appropriate adjustments to account for, and fully
address, the adverse consequences to ratepayers of the items noted in the
Report, and conduct a detailed study of the adequacy of internal accounting and
regulatory controls. The adjustments were made in restated financial statements
previously filed with the SEC, and substantial progress has been made in the
ongoing study of internal controls.
Pursuant to the agreement of all parties, including the company, the ICC
re-opened the 1999 and 2000 purchased gas adjustment filings for review of
certain transactions related to the PBR plan and consolidated the reviews of the
1999-2002 purchased gas adjustment filings with the PBR plan review.
Certain parties in the PBR plan review proceeding have indicated disagreement
with the findings in the Report or have indicated that they believe
substantially greater adjustments or penalties are warranted. In addition, on
February 5, 2003, the CCSAO and CUB filed a motion for $27 million in sanctions
against the company in the ICC Proceedings. In that motion, CCSAO and CUB
alleged that Nicor Gas' responses to certain CUB data requests were false. Also
on February 5, 2003, CUB stated in a press release that, in addition to $27
million in sanctions, it would seek refunds to consumers in an amount much
greater than the $15 million of adjustments identified in the Report. On March
5, 2003, the ICC staff filed a response brief in support of CUB's motion for
sanctions. On May 1, 2003, the Administrative Law Judges issued a ruling denying
CUB and CCSAO's motion for sanctions. CUB has filed an appeal of the motion for
sanctions with the ICC, and the ICC has indicated that it will not rule on the
appeal until the final disposition of the ICC proceedings. It is not possible to
determine how the ICC will resolve the claims of CCSAO, CUB or other parties to
the ICC Proceedings.
Nicor Gas is unable to predict the outcome of any of the foregoing reviews or
the company's potential exposure thereunder. Due to the uncertainties
surrounding the PBR plan, Nicor Gas has not recognized a $26.9 million pretax
gain from the 2002 PBR plan year. Because the PBR plan and historical utility
gas costs are still under ICC review, it is possible that the final outcome
could be materially different than the amounts reflected in the company's
financial statements as of September 30, 2003.
SEC and U.S. Attorney Inquiries. In 2002, the staff of the Securities and
Exchange Commission (SEC) informed the company that the SEC is conducting a
formal inquiry regarding the PBR plan. A representative of the Office of the
United States Attorney for the Northern District of Illinois has notified the
company that that office is conducting an inquiry on the same matter that the
SEC is investigating, and a grand jury is also reviewing this matter.
Mercury. Future operating results may be impacted by adjustments to the
company's estimated mercury liability or by related recoveries. Additional
information about mercury contingencies is presented in the Notes to the
Consolidated Financial Statements - Note 11 Contingencies - Mercury.
Manufactured gas plant sites. The company is conducting environmental
investigations and remedial activities at former manufactured gas plant sites.
Additional information about these sites is presented in the Notes to the
Consolidated Financial Statements - Note 11 Contingencies - Manufactured Gas
Plant Sites.
Nicor Gas Company Page 21
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (concluded)
Other contingencies. The company is involved in legal or administrative
proceedings before various courts and agencies with respect to rates, taxes and
other matters. See the Notes to the Consolidated Financial Statements - Note 11
Contingencies.
Market risk. The company 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 commodity prices and interest rates. There has been no material
change in the company's exposure to market risk since the filing of the 2002
Annual Report on Form 10-K, except as noted below.
Credit risk. The company is exposed to credit risk in the event a counterparty,
customer or supplier defaults on a contract to pay for or deliver product at
agreed-upon terms and conditions. To manage this risk, the company has
established procedures to determine and monitor the creditworthiness of
counterparties, to require guarantees or collateral back-up, and to limit its
exposure to any one counterparty. Nicor Gas, in some instances, enters into
netting agreements to mitigate counterparty credit risk.
On December 2, 2001 Enron North America Corporation (Enron) filed a voluntary
petition for relief under Chapter 11 of Title XI of the United States Bankruptcy
Code in the United States Bankruptcy Court for the Southern District of New
York. At the date of Enron's bankruptcy filing, the net amount due to Enron from
Nicor Gas was $2.8 million. In May of 2003 Enron and Nicor Gas entered into a
settlement and mutual release whereby Nicor Gas agreed to pay Enron an amount of
$2.8 million in full settlement and release of all amounts due Enron. This
settlement agreement was approved on May 30, 2003 by the U.S Bankruptcy Court
and the settlement payment by Nicor Gas has been made.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
This document includes certain forward-looking statements about the expectations
of Nicor Gas. Although Nicor Gas believes these statements are based on
reasonable assumptions, actual results may vary materially from stated
expectations. Such forward-looking statements may be identified by the use of
forward-looking words or phrases such as "anticipate," "believe," "expect,"
"intend," "may," "planned," "potential," "should," "will," "would," or similar
phrases. Actual results may differ materially from those indicated in the
company's forward-looking statements due to the direct or indirect effects of
the results of legal contingencies (including litigation) and the resolution of
those issues, including the effects of an Illinois Commerce Commission review,
and undue reliance should not be placed on such statements. Other factors that
could cause materially different results include, but are not limited to,
weather conditions; natural gas prices; health care costs; insurance costs;
borrowing needs; interest rates; credit conditions; economic and market
conditions; energy conservation; legislative and regulatory actions, results, or
adjustments; asset sales; significant unplanned capital needs; future
mercury-related charges or credits; changes in accounting principles;
performance of major suppliers and contractors; and acts of terrorism. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date of this filing. Nicor Gas undertakes no
obligation to publicly release any revision to these forward-looking statements
to reflect events or circumstances after the date of this filing.
Nicor Gas Company Page 22
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Item 4. Controls and Procedures
Attached as exhibits 31.1 and 31.2 to this Quarterly Report are certifications
of the company's CEO and the CFO required in accord with Section 302 of the
Sarbanes-Oxley Act of 2002 (the "Section 302 Certifications"). This portion of
our Quarterly Report on Form 10-Q is our disclosure of the results of our
controls evaluation referred to in paragraphs (4) and (5) of the Section 302
Certification and should be read in conjunction with the Section 302
Certifications for a more complete understanding of the topics presented.
In July 2002, in response to allegations that Nicor Gas acted improperly in
connection with its performance-based rate plan for natural gas costs, the Nicor
Board of Directors appointed a special committee of independent, non-management
directors to conduct an inquiry into issues surrounding natural gas purchases,
sales, transportation and storage, and certain other matters. In addition,
following up on the work of the committee, the Nicor Board of Directors later
directed Nicor's management to, among other things, (a) undertake a reaudit of
the Nicor and Nicor Gas financial statements for the years 1999 through 2001 and
a review of subsequent quarterly periods, (b) amend any filings with the SEC as
necessary, and (c) conduct a detailed study of the adequacy of internal
accounting and regulatory controls. See Notes to Consolidated Financial
Statements - Contingencies.
To assist management in assessing the control environment and related issues
associated with Nicor's natural gas supply, transport, storage and marketing
activities, including Nicor Gas Hub administration and Nicor Enerchange trading
("gas supply activities"), Nicor retained a consulting firm in the fourth
quarter of 2002 with experience in internal controls and the energy industry
that is not and has not been the company's external auditor.
Through this review of gas supply activities ("gas supply review"), it was
observed that:
o Although key controls have been designed to facilitate the complete and
accurate capture and processing of gas supply activities, many control
activities are not standardized. As such, the reliability and effectiveness
of these control processes are dependent on interpretation and execution by
business unit personnel.
o Existing processes provide limited oversight and monitoring to ensure that
transaction activities and control procedures are performed reliably and
consistent with management expectations.
o As a result, gas supply activities are not adequately documented, are overly
dependent on people, and are not supported by formal training or
communication of controls.
In light of the foregoing, and reflecting the consultant's work related to gas
supply activities, management concluded that the following steps related to gas
supply activities should be undertaken:
o Enhance the effectiveness of corporate governance and independent oversight
of gas supply activities by creating a formal risk management function and
expanding senior management oversight through the company's risk management
committee.
o Enhance senior management monitoring and oversight of gas supply activities
by creating formal reporting frameworks designed to effectively communicate
performance, existing risk profile/position, and compliance with
policies/procedures.
o Enhance the communication of senior management's expectations regarding
objectives, risk tolerances, and business practices in connection with gas
supply activities by creating codified and standardized policies and
procedures for these activities.
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Item 4. Controls and Procedures (continued)
o Given the high degree of regulatory oversight and review over gas supply
activities, develop formal documentation and retention standards for key
decision-making and transaction activities that are subject to regulatory
review.
o For each business unit responsible for gas supply contract negotiation and
execution, establish a dedicated contract administration function as well as
a contract compliance program.
o Develop formal contracting standards, including practices and procedures
surrounding contract execution, contract review and approval and contract
modification.
In May 2002, the company engaged new accountants, Deloitte & Touche LLP ("D&T"),
who were asked in October 2002 to audit the company's 1999, 2000 and 2001
restated financial statements in addition to its audit of the company's 2002
financial statements. In connection with the completion of its audit of, and the
issuance of an unqualified report on Nicor's and Nicor Gas' restated financial
statements for the years ended December 31, 1999, 2000 and 2001, D&T issued a
letter dated February 28, 2003 (the "D&T Letter"), in which it identified to
management and the Audit Committee of the Board of Directors certain
deficiencies that existed in the design or operation of Nicor Gas' internal
accounting controls which, considered collectively, constituted a material
weakness in Nicor Gas' internal controls pursuant to standards established by
the American Institute of Certified Public Accountants. Such deficiencies at
Nicor Gas' regulated gas purchasing operations included significant weaknesses
in the design of controls surrounding execution, monitoring and accounting for
gas commodity, transportation, storage and related contracts due, in part, to
the lack of a centralized independent back office for these activities. D&T also
concluded that these weaknesses had resulted in errors that affected gas
purchase costs, inventory, regulatory assets and liabilities, and results of the
performance-based rate plan, and led to a restatement of Nicor's and Nicor Gas'
financial statements. D&T made the following recommendations to Nicor and Nicor
Gas with respect to these deficiencies:
o Establish a centralized, independent back office function for gas supply
activities, staffed with an adequate number of appropriately skilled
individuals.
o Charge the gas supply back office function with responsibility for, among
other matters, contract analysis to determine correct accounting treatment,
ensuring that contract terms are followed, overseeing the contract approval
process and contract administration.
The company carried out an evaluation under the supervision and with the
participation of the company's management, including its principal executive
officer and principal financial officer, of the effectiveness of the design and
operation of the company's disclosure controls and procedures as of the end of
the period covered by this Quarterly Report on Form 10-Q (the "Evaluation").
During the course of the Evaluation, the company's principal executive officer
and principal financial officer took note of, and considered as part of the
company's disclosure controls and procedures (as defined in Rule 13a-15 under
the Securities Exchange Act of 1934), additional procedures performed and
controls instituted by the company subsequent to the receipt of the D&T Letter
(the "Additional Procedures") to supplement its internal controls in order to
mitigate the effect of the weaknesses and deficiencies identified in the gas
supply review and the D&T Letter and to prevent misstatements or omissions in
its consolidated financial statements resulting from such factors. In designing
and evaluating the disclosure controls and procedures, management recognizes
that any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management is required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures. Based on the Evaluation, the
company's
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Item 4. Controls and Procedures (concluded)
Chief Executive Officer and Chief Financial Officer concluded that the company's
disclosure controls and procedures, as of the end of the period covered by this
Quarterly Report on Form 10-Q, including the Additional Procedures, were
effective at the reasonable assurance level to ensure that information required
to be disclosed by the company in reports that it files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms.
Management has considered the matters referred to above, D&T's recommendations
with respect thereto and the gas supply review in connection with management's
general evaluation of the company's internal controls in particular and its
disclosure controls and procedures generally. The company has accepted the
recommendations identified in the D&T Letter and in the gas supply review. The
company's management assigned a high priority to the short-term and long-term
correction of the internal control weaknesses and deficiencies identified by D&T
and in the gas supply review, and has implemented changes to the company's
policies, procedures, systems and personnel to address these issues. The
company's management has implemented the following changes based upon the D&T
Letter and the gas supply review:
o The company has dedicated additional internal audit and external resources to
the assessment of the internal controls of the company.
o New policies with respect to the approval and authorization of all
transactions related to gas supply activities and affiliated transactions
have been developed and implemented.
o Gas supply purchasing testing is being regularly performed to verify that
prices are consistent with market rates.
o Personnel in gas supply accounting now report directly to the company's
Controller.
o The company's Risk Management Committee has increased its oversight level,
and a new Chief Risk Officer position has been established.
o Substantial effort has been put forth on documentation and implementation of
appropriate processes, procedures and controls.
o The company has implemented, and will continue to implement, controls
designed to ensure compliance with regulatory rules and mandates.
o New contract administration processes have been implemented to provide a more
effective method of contract administration.
The company will continue to evaluate and implement corrective actions to
improve the effectiveness of its disclosure controls and procedures, and will
take further actions as dictated by such continuing reviews. These actions will
include additional procedures to supplement its internal controls. The steps
taken and to be taken to correct the weaknesses and deficiencies identified in
the gas supply review and the D&T Letter constitute significant changes in
internal controls over financial reporting in the period covered by this
Quarterly Report on Form 10-Q.
Nicor Gas Company Page 25
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
For information concerning legal proceedings, see the Notes to the Consolidated
Financial Statements - Note 11 Contingencies and Management's Discussion and
Analysis - Contingencies beginning on page 19, which are incorporated herein by
reference.
Item 6. Exhibits and Reports on Form 8-K
(a) See Exhibit Index filed herewith.
(b) The company did not file a report on Form 8-K during the third quarter of
2003.
Nicor Gas Company Page 26
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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 Gas Company
Date November 4, 2003 /s/ KATHLEEN L. HALLORAN
---------------- -----------------------------
Kathleen L. Halloran
Executive Vice President
Finance and Administration
Nicor Gas Company Page 27
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Exhibit Index
- -------------
Exhibit
Number Description of Document
- --------- -----------------------------------------------------------------
3.01 * Articles of Incorporation of the company. (File No. 1-7296,
Form 10-K for 1980, Exhibit 3-01.)
3.02 * Amendment to Articles of Incorporation of the company.
(File No. 1-7296, Form 10-Q for June 1994, Exhibit 3.01.)
3.03 * By-Laws of the company as amended by the company's
Board of Directors on May 3, 1995. (File No. 1-7296,
Form 10-Q for March 1995, Exhibit 3(ii).01.)
10.1 180-Day Credit Agreement dated as of September 9, 2003.
10.2 364-Day Credit Agreement dated as of September 9, 2003.
12.01 Computation of Consolidated Ratio of Earnings to Fixed Charges.
31.1 Rule 13a-14(a)/15d-14(a) Certification.
31.2 Rule 13a-14(a)/15d-14(a) Certification.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* These exhibits have been previously filed with the Securities and Exchange
Commission as exhibits to registration statements or to other filings with
the Commission and are incorporated herein as exhibits by reference. The file
number and exhibit number of each such exhibit, where applicable, are stated
in parentheses in the description of such exhibit.
Upon written request, the company will furnish free of charge a copy of any
exhibit. Requests should be sent to Investor Relations at the corporate
headquarters.