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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-7296
NORTHERN ILLINOIS GAS COMPANY
(Doing Business as NICOR GAS COMPANY)
(Exact name of registrant as specified in its charter)
Illinois 36-2863847
(State of Incorporation) (I.R.S. Employer
Identification Number)
1844 Ferry Road
Naperville, Illinois 60563-9600 (630) 983-8888
(Address of principal executive offices) (Registrant's telephone number)
Securities registered pursuant to Section 12(b) or 12(g) of the Act: None
----
The registrant meets the conditions set forth in General Instruction
I(1)(a) and (b) of Form 10-K and is therefore filing this Form with the 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in rule 12b-2 of the Act). Yes [ ] No [X]
All shares of common stock 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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Item No. Description Page No.
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Part I
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1. Business .......... .............................................. 1
2. Properties ....................................................... 4
3. Legal Proceedings................................................. 4
4. Submission of Matters to a Vote of Security Holders................*
Part II
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5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.................4
6. Selected Financial Data ...........................................*
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 5
7A. Quantitative and Qualitative Disclosures about Market Risk........18
8. Financial Statements and Supplementary Data.......................19
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..............................41
9A. Controls and Procedures...........................................41
Part III
--------
10. Directors and Executive Officers of the Registrant.................*
11. Executive Compensation.............................................*
12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters........................*
13. Certain Relationships and Related Transactions.....................*
14. Principal Accountant Fees and Services............................44
Part IV
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15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K......................................................45
Signatures........................................................47
Supplemental Information..........................................48
Exhibit Index.....................................................49
* The Registrant meets the conditions set forth in General Instruction I(1)(a)
and (b) of Form 10-K and is therefore omitting the information called for by
the otherwise required item.
Glossary
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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.
FERC.............Federal Energy Regulatory Commission, the agency that regulates
the interstate transportation of natural gas, oil and
electricity.
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 provided
economic incentives based on natural gas cost performance.
Nicor Gas Company Page 1
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PART I
Item 1. Business
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Northern Illinois Gas Company (doing business as Nicor Gas Company (Nicor Gas)),
an Illinois corporation formed in 1954, is a wholly owned subsidiary of Nicor
Inc. (Nicor), a holding company. Certain terms used herein are defined in the
glossary on page i.
GENERAL
Nicor Gas, a regulated natural gas distribution utility, serves over two million
customers in a service territory that encompasses most of the northern third of
Illinois, excluding the city of Chicago. The company's service territory is
diverse and its customer base has grown steadily over the years, providing the
company with a well-balanced mix of residential, commercial and industrial
customers. Residential customers typically account for approximately 45 to 50
percent of natural gas deliveries, while commercial and industrial customers
each typically account for about 25 to 30 percent. See Gas Distribution
Statistics on page 8 for operating revenues, deliveries and number of customers
by customer classification. Nicor Gas had approximately 2,300 employees at
year-end 2003.
Nicor Gas maintains franchise agreements with most of the communities it serves,
allowing it to construct, operate and maintain distribution facilities in those
communities. Franchise agreement terms range up to 50 years. Currently, about 10
percent of the agreements will expire within five years.
Nicor Gas' gas costs are passed directly through to customers without markup,
subject to Illinois Commerce Commission (ICC) review. Accordingly, changes in
gas costs impact revenues but have no direct impact on operating income. Nicor
Gas' operating income is derived primarily from the delivery rather than the
sale of natural gas to customers.
Customers have the option of purchasing their own gas supplies, with delivery of
the gas by Nicor Gas. The larger of these transportation customers also have
options that include the use of Nicor Gas' storage system and the ability to
choose varying supply backup levels. The choice of transportation service as
compared to gas sales service results in less revenue for Nicor Gas but has no
impact on net operating results.
Nicor Gas also has nontraditional gas supply-related ventures, including the
Chicago Hub, which provides natural gas storage and transmission-related
services to marketers and other gas distribution companies.
SOURCES OF NATURAL GAS SUPPLY
Nicor Gas purchases natural gas supplies in the open market by contracting
directly with producers and marketers. Pipeline transportation and purchased
storage services are regulated by the Federal Energy Regulatory Commission
(FERC). When contracted services are temporarily not needed, Nicor Gas may
release the services in the secondary market under FERC-mandated capacity
release provisions, with proceeds reducing the company's cost of gas charged to
customers.
Peak-use requirements are met through utilization of company-owned storage
facilities, pipeline transportation capacity, purchased storage services and
other supply sources, arranged by either Nicor Gas or its transportation
customers. Nicor Gas has been able to obtain sufficient supplies of natural gas
to meet customer requirements. The company believes natural gas supply and
pipeline capacity will be sufficiently available to meet market demands in the
foreseeable future.
Nicor Gas Company Page 2
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Item 1. Business (continued)
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Natural gas supply. Nicor Gas maintains a diversified portfolio of natural gas
supply contracts. Supply contracts are diversified by supplier, producing
region, quantity and available transportation. Contract pricing is generally
tied to published price indices so as to approximate current market prices,
although at times the company may fix the price of a portion of its supply
portfolio. These supply contracts also generally provide for the payment of
fixed demand charges to ensure the availability of supplies on any given day and
are typically negotiated annually.
The company also purchases gas supplies on the spot market to fulfill its supply
requirements or to take advantage of favorable short-term pricing. Spot gas
purchases accounted for about one-half of the company's total gas purchases in
the last three years.
As noted previously, transportation customers purchase their own gas supplies.
About one-half of the gas that the company delivers is purchased by
transportation customers directly from producers and marketers rather than from
the company.
Pipeline transportation. Nicor Gas is directly connected to eight interstate
pipelines, providing access to most of the major natural gas producing regions
in North America. The company's primary transportation contracts are with
Natural Gas Pipeline Company of America (NGPL), Northern Natural Gas Company
(NNG), Tennessee Gas Pipeline Company (TGPL), Midwestern Gas Transmission
Company (MGT) and ANR Pipeline (ANR). In 2003, new transportation contracts with
NGPL, TGPL and MGT became effective, with terms generally into 2006. The
contract with NNG will expire in 2004 and Nicor Gas is negotiating a renewal of
this agreement. The contract with ANR will also expire in 2004 and Nicor Gas
expects to negotiate a renewal. In 2002, Nicor Gas also began receiving service
under a 10-year transportation agreement with Horizon Pipeline, a 50/50 joint
venture between Nicor and NGPL.
Storage. Nicor Gas owns and operates seven underground natural gas storage
facilities. This storage system is one of the largest in the gas distribution
industry. With about 140 Bcf of annual storage capacity, the system is designed
to meet about 55 percent of the company's estimated peak-day deliveries and
approximately 30 percent of its normal winter deliveries. In addition to
company-owned facilities, Nicor Gas has about 40 Bcf of purchased storage
services under contracts with NGPL that expire in 2006 and 2007. Storage
provides supply flexibility, improves the reliability of deliveries and can
mitigate the risk associated with seasonal price movements.
COMPETITION/DEMAND
Nicor Gas is the largest natural gas distributor in Illinois. Substantially all
single-family homes in Nicor Gas' service territory are heated with natural gas.
In the commercial and industrial markets, the company's natural gas services
compete with other forms of energy, such as electricity, coal, propane and oil,
based on such factors as price, service, reliability and environmental impact.
Other significant factors that impact demand for natural gas include weather and
economic conditions.
Natural gas deliveries are temperature-sensitive and seasonal since about
one-half of all deliveries are used for space heating. Typically, about 70
percent of deliveries and revenues occur from October through March.
Fluctuations in weather have the potential to significantly impact year-to-year
comparisons of operating income and cash flow.
Nicor Gas Company Page 3
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Item 1. Business (continued)
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In 2001, 2002 and the first quarter of 2003, Nicor Gas purchased earnings
protection against the impact of significantly warmer-than-normal or
colder-than-normal weather. No agreement is in effect for the 2003/2004 heating
season.
Nicor Gas' large residential customer base provides for a relatively stable
level of natural gas deliveries during weak economic conditions. The company's
industrial and commercial customer base is well diversified, lessening the
impact of industry-specific economic swings.
During periods of high natural gas prices, deliveries of natural gas can be
negatively affected by conservation and the use of alternative energy sources.
While natural gas prices have fluctuated greatly over the last several years,
natural gas has traditionally maintained a pricing advantage over electricity
and it is expected to maintain an advantage in the foreseeable future.
Additional information on competition and demand is presented in Management's
Discussion and Analysis - Factors That May Affect Business Performance beginning
on page 13.
REGULATION
Nicor Gas is regulated by the ICC, which establishes the rules and regulations
governing utility rates and services in Illinois. Certain rates are updated
monthly and designed to recover specific cost categories, such as gas supply and
environmental costs, subject to annual regulatory reviews. Base rates, on the
other hand, are designed to allow the company an opportunity to recover its
other costs and to earn a fair return for its investors. Nicor Gas has the
option to seek ICC approval for base rate increases. Once started, a rate relief
proceeding generally takes about one year. Significant changes in the
regulations applicable to Nicor Gas or its affiliates, or the regulatory
environment in general, could affect the performance of Nicor Gas.
The cost of gas the company purchases for customers is recovered through a
monthly gas supply charge, which accounted for approximately 80 percent of a
typical residential customer's annual bill in the last three years. As already
noted, the company's cost of gas is passed on to customers without markup,
subject to ICC review.
A performance-based rate (PBR) plan for natural gas costs was in effect from
2000 through 2002. 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
results of the PBR plan are currently under ICC review. Additional information
on the plan and the ICC review are presented in Management's Discussion and
Analysis - Contingencies - Performance-Based Rate Plan beginning on page 16.
Nicor Gas Company Page 4
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Item 1. Business (concluded)
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AVAILABLE INFORMATION
Nicor Gas files various reports with the Securities and Exchange Commission
(SEC). These reports include the annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K and amendments to those reports filed
or furnished pursuant to Section 15 (d) of the Securities Exchange Act of 1934.
Nicor Gas makes all of these reports available without charge to the public on
the investor relations section of Nicor's Web site at www.nicor.com as soon as
reasonably practicable after Nicor Gas files them with, or furnishes them to,
the SEC.
Additional information about Nicor Gas' business is presented in Management's
Discussion and Analysis of Financial Condition and Results of Operations.
Item 2. Properties
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The company's properties are located in the territory described under Item 1,
Business, and are suitable, adequate and utilized in its operations.
The gas distribution, transmission and storage system includes approximately
31,000 miles of steel, plastic and cast iron main; approximately 1.9 million
steel, plastic/aluminum composite, plastic and copper services connecting the
mains to customers' premises; and seven underground storage fields.
Other properties include buildings, land, motor vehicles, meters, regulators,
compressors, construction equipment, tools, communication and computer
equipment, software, and office equipment.
Most of the company's distribution and transmission property, and underground
storage fields are located on property owned by others and used by the company
through easements, permits or licenses. The company owns most of the buildings
housing its administrative offices and the land on which they sit.
Substantially all properties are subject to the lien of the indenture securing
the company's first mortgage bonds.
Item 3. Legal Proceedings
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See the Notes to the Consolidated Financial Statements - Note 15 Contingencies,
which are incorporated herein by reference.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
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Issuer Purchases of Equity Securities
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All of the outstanding common stock of Nicor Gas is owned by Nicor Inc. There is
no public trading market for the company's common stock. During 2003 and 2002,
the company declared dividends on its common stock totaling $65 million and $85
million, respectively.
Nicor Gas Company Page 5
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Item 7. Management's Discussion and Analysis of Financial Condition
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and Results of Operations
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The purpose of this financial review is to explain changes in Nicor Gas'
operating results and financial condition from 2001 to 2003 and to discuss
business trends and uncertainties that might affect Nicor Gas. Certain terms
used herein are defined in the glossary on page i. The discussion is organized
into five sections - Summary, Results of Operations, Financial Condition and
Liquidity, Critical Accounting Estimates, and Factors That May Affect Business
Performance.
SUMMARY
Nicor Gas, a wholly owned subsidiary of Nicor Inc., is one of the nation's
largest natural gas distribution companies and typically represents
approximately 85 percent of Nicor Inc.'s operating income.
Nicor Gas' net income was $83.0 million, $109.1 million and $98.8 million in
2003, 2002 and 2001, respectively.
Results for 2003 were lower as compared to 2002 due mainly to lower operating
income. Operating income decreased $25.2 million in 2003 due primarily to
increased operating and maintenance expenses ($20.5 million), lower Chicago Hub
results ($8.1 million), and higher depreciation ($5.9 million). Operating income
also reflects $17.8 million of mercury-related insurance recoveries in 2003 as
compared to $29 million of mercury-related insurance recoveries and reserve
reductions in 2002. The impact of weather colder than the prior year was an
increase in operating income of about $3 million. These factors are discussed in
more detail in the Results of Operations section which follows.
Net income was higher in 2002 compared with 2001 due primarily to mercury cost
recoveries, increased natural gas deliveries, lower losses related to the PBR
plan, and decreased interest expense. Overall results were negatively impacted
by higher operating costs, including lower pension credits, increased legal and
accounting costs in 2002, higher depreciation and higher health care costs.
RESULTS OF OPERATIONS
The following discussion summarizes the major items impacting Nicor Gas' results
of operations.
Operating revenues. Operating revenues increased nearly 50 percent to $2.4
billion in 2003 compared to $1.6 billion in 2002 due primarily to higher natural
gas costs, which are passed directly through to customers without markup,
subject to Illinois Commerce Commission (ICC) review. The revenue effect of
higher natural gas costs was approximately $680 million. Revenues also increased
in 2003 by about $40 million due to colder weather. While residential deliveries
rose on colder weather, industrial deliveries fell due largely to lower
power-generation load affected by mild summer weather.
Operating revenues decreased from $2.1 billion in 2001 to $1.6 billion in 2002
due primarily to significantly lower average natural gas costs. The revenue
effect of the lower average natural gas costs, estimated to be approximately
$575 million, was partially offset by the impact of colder weather on deliveries
($85 million) in 2002 compared to 2001.
Nicor Gas Company Page 6
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Item 7. Management's Discussion and Analysis of Financial Condition
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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, subject to ICC review, 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 excludes these items in
evaluating performance. A reconciliation of gas distribution revenues and margin
is as follows (in millions):
2003 2002 2001
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Revenues $ 2,351.6 $ 1,594.8 $ 2,105.6
Cost of gas (1,692.7) (970.1) (1,477.5)
Revenue tax expense (130.9) (92.4) (109.0)
---------- ----------- ----------
Margin $ 528.0 $ 532.3 $ 519.1
========== =========== ==========
Negatively impacting margin in 2003 was a smaller contribution from the Chicago
Hub and other nontraditional gas supply-related activities ($10.9 million) and
lower industrial deliveries, mainly for power generation ($2.9 million). The
company believes commercial and industrial deliveries were unfavorably impacted
by general economic conditions and higher natural gas prices. Positively
impacting margin were increased customer finance and late payment charges ($8
million) related to higher natural gas prices in 2003. Increased deliveries due
to colder weather than the prior year (about $7 million), partially offset by an
unfavorable variance from the company's weather hedge in 2003 compared to 2002
($3.5 million), also positively impacted margin.
Margin increased $13.2 million in 2002 from 2001. Contributing to the 2002
improvement were the positive effects of increased natural gas deliveries
unrelated to weather ($6.6 million) and colder weather (about $4 million), and
increased contributions from the Chicago Hub ($2.3 million). These positive
factors were partially offset by lower revenues from customer finance and late
payment charges ($4.8 million). The reduction of revenues from customer finance
and late payment charges was related to lower levels of customer receivables
arising from reduced natural gas prices in 2002.
Operating and maintenance. The increase in operating and maintenance expense for
2003 of $20.5 million was due primarily to higher pension costs ($9.7 million),
higher insurance expense ($4.2 million), increased bad debt expense ($4.1
million), increased natural gas costs to operate company equipment and
facilities ($3.2 million), and higher health care costs ($2.7 million). These
negative factors were partially offset by lower expenses related to the review
of the company's PBR plan ($6.2 million).
Operating and maintenance expense for 2002 and 2001 was $199.6 million and
$177.1 million, respectively. The $22.5 million increase reflects smaller
pension credits ($14.1 million), increased legal and accounting costs related
primarily to the PBR plan review ($8.7 million) and increased health care costs
($3.5 million). These increases were partially offset by lower natural gas costs
to operate company equipment and facilities ($4.2 million).
Operating and maintenance expense included pension credits of $9.2 million and
$23.3 million in 2002 and 2001, respectively. Pension expense for 2003 was $.5
million. For more details concerning fluctuations in pension credits, see the
Factors That May Affect Business Performance - Pension Investment Returns
section.
Nicor Gas Company Page 7
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Item 7. Management's Discussion and Analysis of Financial Condition
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and Results of Operations (continued)
-------------------------------------
Mercury-related costs (recoveries), net. Mercury-related costs (recoveries), net
reflects the estimated costs, credits and recoveries associated with the
company's mercury inspection and repair program. In 2003, 2002 and 2001, Nicor
Gas reached agreements with insurers and independent contractors whereby the
company recovered approximately $18 million, $20 million and $3 million,
respectively, of mercury-related costs. In addition, in each of 2002 and 2001, a
$9 million adjustment lowered the mercury-related reserve and reduced operating
expense. Additional information about the company's mercury inspection and
repair program is presented in the Notes to the Consolidated Financial
Statements - Note 15 Contingencies - Mercury Program.
Other income (expense). Pretax other income (expense) decreased $.7 million in
2003 compared to 2002 due to lower property sale gains ($3.7 million) and lower
interest income ($1.2 million), partially offset by the absence of PBR plan
losses compared to 2002 ($4.1 million). Pretax other income (expense) increased
$7.0 million in 2002. Contributing to the 2002 improvement were lower PBR plan
losses compared to 2001 ($10.7 million). Additional information related to the
PBR plan is described in the Contingencies - Performance-Based Rate Plan section
beginning on page 16. Other income (expense) for 2002 was negatively impacted by
lower interest income ($1.6 million) compared to 2001.
Property sale gains and losses vary from year-to-year depending upon property
sales activity. The company continues to assess its ownership of real estate
holdings and anticipates an increase in property sale activity in 2004.
Interest expense. Interest on debt remained essentially unchanged in 2003. The
impact of higher average borrowing levels was offset by the positive effect of
lower interest rates. Interest on debt decreased $10.3 million in 2002 due to
lower average borrowing levels and interest rates in 2002 compared to 2001.
Nicor Gas Company Page 8
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Item 7. Management's Discussion and Analysis of Financial Condition
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and Results of Operations (continued)
-------------------------------------
Operating Statistics
2003 2002 2001
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Operating revenues (millions)
Sales
Residential $ 1,611.9 $ 1,057.4 $ 1,486.4
Commercial 351.7 209.4 274.6
Industrial 51.2 32.5 41.5
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2,014.8 1,299.3 1,802.5
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Transportation
Residential 22.7 16.3 9.5
Commercial 71.6 75.6 75.0
Industrial 41.7 45.8 45.6
Other 12.0 7.6 7.5
--------- --------- ---------
148.0 145.3 137.6
--------- --------- ---------
Other revenues
Revenue taxes 134.0 95.3 112.3
Environmental cost recovery 31.3 24.6 15.6
Chicago Hub 7.3 15.4 13.0
Other 16.2 14.9 24.6
--------- --------- ---------
188.8 150.2 165.5
--------- --------- ---------
$ 2,351.6 $ 1,594.8 $ 2,105.6
========= ========= =========
Deliveries (Bcf)
Sales
Residential 214.9 212.9 201.5
Commercial 46.7 41.6 37.2
Industrial 7.0 6.9 5.9
--------- --------- ---------
268.6 261.4 244.6
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Transportation
Residential 16.6 11.0 6.1
Commercial 87.8 97.5 89.2
Industrial 121.2 149.2 135.3
--------- --------- ---------
225.6 257.7 230.6
--------- --------- ---------
494.2 519.1 475.2
========= ========= =========
Year-end customers (thousands)
Sales
Residential 1,745.2 1,733.6 1,766.5
Commercial 114.5 108.9 102.7
Industrial 7.3 7.0 6.7
--------- --------- ---------
1,867.0 1,849.5 1,875.9
--------- --------- ---------
Transportation
Residential 145.1 126.8 58.1
Commercial 58.3 62.4 66.0
Industrial 6.2 6.7 7.1
--------- --------- ---------
209.6 195.9 131.2
--------- --------- ---------
2,076.6 2,045.4 2,007.1
========= ========= =========
Other statistics
Degree days (normal 6000) 6,068 5,779 5,422
Colder (warmer) than normal 1% (4)% (10)%
Average gas cost per Mcf sold $ 6.24 $ 3.67 $ 6.00
Nicor Gas Company Page 9
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Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations (continued)
-------------------------------------
FINANCIAL CONDITION AND LIQUIDITY
The company believes it has access to adequate resources to meet its needs for
capital expenditures, debt redemptions, dividend payments and working capital.
These resources include net cash flow from operating activities, access to
capital markets, lines of credit and short-term investments.
Operating cash flows. The gas distribution business is highly seasonal and
operating cash flow may fluctuate significantly during the year and from
year-to-year due to factors such as weather, natural gas prices, the timing of
collections from customers, and natural gas purchasing and storage practices.
The company relies on short-term financing to meet seasonal increases in working
capital needs. Cash requirements generally increase during the third and fourth
quarters due to increases in natural gas purchases, gas in storage and accounts
receivable. During the first and second quarters, positive cash flow generally
occurs from the sale of gas in storage and the collection of accounts
receivable. This cash is typically used to reduce short-term debt to near zero
during the second quarter.
Net cash flow (used for) provided from operating activities was $(52.4) million,
$221.7 million and $437.5 million in 2003, 2002 and 2001, respectively.
Operating cash flow for 2003 was negative due primarily to changes in working
capital items. Two decisions in 2003 were the primary factors underlying the
working capital changes. First, the company significantly increased the quantity
of owned gas in storage at December 31, 2003 as compared to December 31, 2002.
In addition, to reduce associated costs, the company chose to fund a significant
portion of those purchases through short-term borrowings (which are shown
outside the operating segment, in the financing segment, of the Consolidated
Statements of Cash Flows) instead of accounts payable. As noted in the financing
activities section of Management's Discussion and Analysis, the company had
increased its short-term debt borrowing capacity in anticipation of these two
and other factors (including higher gas costs), accommodating the funding of
these decisions without impacting the level of long-term borrowing.
The company believes that operating cash flow will be positive in 2004, as
inventory and accounts payable balances at year-end 2004 should be comparable to
year-end 2003.
In the fourth quarter of 2003, Nicor Gas received an income tax refund of
approximately $100 million attributable to a tax loss carryback associated with
a change in tax accounting methods, subject to future Internal Revenue Service
review and approval. Decisions by taxing authorities may significantly impact
the company's cash flow.
Operating cash flow was significantly lower in 2002 compared to 2001 due
primarily to changes in accounts receivable, accrued/deferred gas costs and
accounts payable balances associated with natural gas price volatility.
Investing activities. Capital expenditures were $172.9 million in 2003 compared
with $169.5 million in 2002 and $149.8 million in 2001. Increased costs in 2003
for public main improvements of $8 million and higher capitalized pension costs
of $3 million were offset by a $6 million decrease in supply operations
expenditures compared with 2002. Supply operations expenditures in 2002 included
the acquisition of a compressor for a storage facility. Gas distribution capital
expenditures were higher in 2002 than in 2001 due primarily to the acquisition
of the compressor and $6 million of higher capitalized employee benefit costs.
Capital spending in 2004 is estimated to be about $170 million.
Nicor Gas Company Page 10
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Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations (continued)
-------------------------------------
Financing activities. Nicor Gas has long-term debt ratings that are among the
highest in the gas distribution industry. As of the filing date of this report,
the credit ratings as assigned by Standard and Poor's Ratings Services (S&P),
Moody's Investors Service (Moody's) and Fitch Ratings (Fitch) are as follows.
S&P Moody's Fitch
-------- -------- --------
Commercial Paper A-1+ P-1 F1+
First Mortgage Bonds AA Aa3 AA
Unsecured Credit Facility AA- n/a n/a
Senior Unsecured Debt AA A1 AA-
In 2003, Moody's downgraded Nicor Gas' First Mortgage Bonds from Aa1 to Aa3, and
Nicor Gas' senior unsecured debt from Aa2 to A1. In 2002, Fitch downgraded Nicor
Gas' First Mortgage Bonds from AA+ to AA, and Nicor Gas' senior unsecured debt
from AA to AA-. As of December 31, 2003, S&P's ratings outlook for the company
was Stable while Moody's and Fitch's ratings outlooks were Negative.
Nicor Gas' debt-related financial statistics at December 31 include:
2003 2002 2001
-------- -------- --------
Long-term debt, net of current maturities,
as a percent of capitalization 44.4% 39.2% 43.0%
Times interest earned, before income taxes 4.5 5.7 5.4
Long-term debt. The company typically uses the net proceeds from long-term debt
for refinancing outstanding debt, construction programs to the extent not
provided by internally generated funds, and general corporate purposes. At
December 31, 2003, the company had the capacity to issue about another
$350 million of First Mortgage Bonds under the terms of its indenture,
of which $75 million was available for immediate issuance under a July 2001
shelf registration filing. Nicor Gas is in compliance with its debt covenants
and believes it will continue to remain so. Nicor Gas' long-term debt agreements
do not include ratings triggers or material adverse change provisions.
In 2003, Nicor Gas issued the following First Mortgage Bonds: $50 million due in
2023 at 5.80%, $50 million due in 2032 at 5.90%, and $50 million due in 2033 at
5.90%. Retirements of First Mortgage Bonds in 2003 were as follows: $50 million
due in 2003 at 5.75% and $50 million due in 2027 at 7.375%.
In April 2003, Nicor Gas refinanced $50 million of 3% unsecured notes due in
April 2003 with $50 million of 1.6% unsecured notes due and paid in October
2003.
In 2001, Nicor Gas issued the following First Mortgage Bonds: $50 million due in
2006 at 5.55%, $75 million due in 2008 at 5.875%, $75 million due in 2011 at
6.625%, and $50 million due in 2016 at 7.2%. Retirements of First Mortgage Bonds
in 2001 were as follows: $75 million due in 2001 at 6.45%, $50 million due in
2002 at 6.75%, $50 million due in 2021 at 8.875%, and $50 million due in 2025 at
7.26%. During 2001, Nicor Gas also retired $50 million of variable-rate
unsecured notes.
Nicor Gas Company Page 11
- ------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations (continued)
-------------------------------------
Short-term debt. The company relies on short-term financing to meet temporary
operating cash flow needs resulting from seasonal changes in working capital.
Nicor Gas maintains short-term line of credit agreements with major domestic and
foreign banks. These agreements, which serve as backup for the issuance of
commercial paper, allow 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 are being amortized over the respective terms
of the agreements as interest expense. The company had $575 million and $315
million of commercial paper borrowings outstanding at December 31, 2003 and
2002, respectively.
Under the company's 2003/2004 short-term line of credit agreements, if (1)
Nicor's or Nicor Gas' 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 December 31, 2003, or (2) Nicor's or Nicor Gas'
twelve-months-ended interest rate coverage ratio is less than 3 to 1 at the end
of any fiscal quarter during the term of the credit agreements, banks
representing two-thirds 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 these covenants at December 31, 2003.
The company expects that commercial paper and the related backup line of credit
agreements funding will continue to be available in the foreseeable future.
Common stock. The company paid dividends of $71 million, $109 million and $72
million in 2003, 2002 and 2001, respectively.
Contractual obligations. As of December 31, 2003, Nicor Gas had contractual
obligations with payments due as follows (in millions):
Payments due by period
--------------------------------------------
Less More
Than 1 1-3 3-5 than 5
Total Year years years years
-------- ------- ------- ------- -------
Purchase obligations $1,181.4 $ 602.6 $ 372.4 $ 162.2 $ 44.2
Long-term debt 500.0 - 50.0 75.0 375.0
Operating leases 2.4 .7 .9 .7 .1
Other long-term
obligations 5.6 .5 1.0 1.0 3.1
-------- ------- ------- ------- -------
$1,689.4 $ 603.8 $ 424.3 $ 238.9 $ 422.4
======== ======= ======= ======= =======
Purchase obligations consist primarily of natural gas transportation and storage
contracts, and natural gas purchase agreements. Purchase obligations also
include obligations to purchase natural gas at future market prices, calculated
using December 31, 2003 NYMEX futures prices.
Operating leases are primarily for office space and equipment. Rental expense
under operating leases was $1.3 million, $2.3 million and $1.5 million in 2003,
2002 and 2001, respectively. Other long-term obligations consist primarily of
redeemable preferred stock.
Nicor Gas Company Page 12
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Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations (continued)
-------------------------------------
CRITICAL ACCOUNTING ESTIMATES
Nicor Gas prepares its consolidated financial statements in accordance with
accounting principles generally accepted in the United States, which regularly
require Nicor Gas' 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.
The use of estimates and the selection of accounting policies affect Nicor Gas'
reported results and financial condition. The company has adopted several
significant accounting policies and is required to make significant accounting
estimates that are important to understanding its financial statements and are
described throughout the Notes to the Consolidated Financial Statements.
Although there are numerous areas in which Nicor Gas' management makes
significant accounting estimates, it believes its critical estimates are those
that require management's most difficult and subjective or complex judgments.
Nicor Gas management has a practice of reviewing its critical accounting
estimates and policy decisions with the audit committee of its board of
directors. Its critical estimates typically involve loss contingencies,
derivative instruments, credit risk and unbilled revenues because they are
estimates which could materially impact Nicor Gas' financial statements.
Loss contingencies. In accordance with Statement of Financial Accounting
Standards No. 5, Nicor Gas records contingent losses as liabilities when a loss
is both probable and the amount or range of loss, including related legal
defense costs, is reasonably estimable. When only a range of potential loss is
estimable, the company records a liability for the minimum anticipated loss.
Nicor Gas is involved in various legal and regulatory proceedings and is exposed
to various loss contingencies. These loss contingencies are in some cases
resolved in stages over time, estimates may change significantly from period to
period, and the company's ultimate obligations may differ materially from its
estimates. Of particular note is the PBR plan contingency described in the Notes
to the Consolidated Financial Statements - Note 15 Contingencies.
Derivative instruments. The rules for determining whether a contract meets the
definition of a derivative instrument or 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, changes in
management's assessment of the likelihood of future hedged transactions or new
interpretations of accounting rules. 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, and
changes in hedge effectiveness may impact the accounting treatment. These
determinations and changes in estimates may have a material impact on reported
results.
Credit risk. Nicor Gas is required to estimate credit risk in establishing
allowances for doubtful accounts. Actual credit losses could vary materially
from Nicor Gas' estimates. Nicor Gas' estimated allowance for doubtful accounts
at December 31, 2003, 2002 and 2001 was $19.4 million, $14.4 million and $9.6
million, respectively, as presented on Schedule II on page 46.
Nicor Gas Company Page 13
- ------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations (continued)
-------------------------------------
Unbilled revenues. Nicor Gas estimates revenues for gas deliveries not yet
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 costs, weather and customer
usage. These estimates are adjusted when actual billings occur, and changes in
estimates can be material. Estimated unbilled revenues at December 31, 2003,
2002 and 2001 were $139 million, $142.4 million and $88.1 million, respectively.
FACTORS THAT MAY AFFECT BUSINESS PERFORMANCE
The following factors can impact year-to-year comparisons and may affect the
future performance of Nicor Gas.
General. Nicor Gas, a regulated natural gas distribution utility, serves over
two million customers in a service territory that encompasses most of the
northern third of Illinois, excluding the city of Chicago. The region's economy
is diverse and its customer base has grown steadily over the years, providing
Nicor Gas with a well-balanced mix of residential, commercial and industrial
customers. In 2003, residential, commercial and industrial customers accounted
for approximately 45 percent, 30 percent and 25 percent of natural gas
deliveries, respectively.
Weather. Natural gas deliveries are temperature-sensitive and seasonal since
about one-half of all deliveries are used for space heating. Typically, about 70
percent of deliveries and revenues occur from October through March.
Fluctuations in weather have the potential to significantly impact year-to-year
comparisons of operating income and cash flow.
In 2001, 2002 and the first quarter of 2003, Nicor Gas purchased earnings
protection against the impact of significantly warmer-than-normal or
colder-than-normal weather. No agreement is in effect for the 2003/2004 heating
season. It is estimated that in 2004 a 100-degree-day variation from normal
weather (about 6,000 degree days per year) may affect Nicor Gas' net income by
about $1 million. The company will continue to evaluate its coverage options to
determine whether any weather protection should be purchased.
Demand and natural gas prices. In addition to the impact of weather, significant
changes in economic conditions or natural gas prices can impact customer gas
usage. However, Nicor Gas' large residential customer base provides relative
stability during weak economic periods, and the industrial and commercial
customer base is well diversified, lessening the impact of industry-specific
economic swings.
Nicor Gas' growth in natural gas deliveries has traditionally come from customer
additions and increased usage by commercial and industrial customers. In 2003
commercial and industrial deliveries were unfavorably impacted by general
economic conditions. The company is uncertain as to the long-term impact of this
factor.
Changes in the price of natural gas have no direct impact on gas distribution
margin since gas costs are passed directly through to customers without markup,
subject to ICC review. However, high natural gas prices can have an adverse
effect on accounts receivable collections, customer demand, company-use gas
expenses, financing costs and customer service expenses.
Nicor Gas Company Page 14
- ------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations (continued)
-------------------------------------
Competition. Nicor Gas competes with other energy suppliers based on such
factors as price, service and reliability. The company believes that it is well
positioned to deal with the possibility of fuel switching by customers because
it has rates and services designed to compete against alternative fuels. In
addition, the company has a rate that allows negotiation with potential bypass
customers, and no customer has bypassed the Nicor Gas system since the rate
became effective in 1987. Nicor Gas also offers commercial and industrial
customers alternatives in rates and service, increasing its ability to compete
in these markets.
Storage and supply. Nicor Gas has a direct connection to eight interstate
pipelines and extensive underground storage capacity that provides the company
and its transportation customers with flexibility and alternatives for natural
gas supply procurement and storage services. In addition, in an effort to ensure
supply reliability, the company purchases gas from several different producing
regions under varied contract terms.
Customer choice of commodity supplier. Since March 2002, all Nicor Gas customers
have had a choice of natural gas suppliers. Previously, supplier choice was
available to all industrial and commercial customers and about 15 percent of
residential customers. The choice of another natural gas commodity supplier has
no direct impact on gas distribution margin because natural gas costs are passed
directly through to customers without markup, subject to ICC review. Nicor Gas
continues to deliver the natural gas, maintain its distribution system and
respond to emergencies.
Customer credit risk. Nicor Gas has a diversified customer base, which limits
its exposure to concentrations of credit risk in any one industry or income
class. The company believes that it maintains prudent credit policies, subject
to ICC regulations. Customers also have options to help them manage their bills,
such as energy assistance programs for low-income customers and a budget payment
plan that spreads gas bills more evenly throughout the year. However, high
natural gas prices can increase the risk of customer nonpayment. Nicor Gas
experienced increasing bad debt expense in the past three years due in part to
high natural gas prices and increasingly adverse credit experience consistent
with general market conditions. It is expected that high natural gas prices will
continue in 2004. See also the Credit Risk section on page 16.
Pension investment returns. Nicor Gas maintains a noncontributory defined
benefit pension plan covering substantially all employees hired prior to 1998.
For actuarial valuation purposes, Nicor Gas utilizes an October 1 measurement
date to determine the company's pension expense or credit for the subsequent
calendar year. During the 12 months ended September 30, 2002, the pension plans
experienced poor investment returns consistent with general market conditions,
negatively impacting the company's 2003 operating income. The company's pension
credit (expense) included in operating income was $(.5) million, $9.2 million
and $23.3 million in 2003, 2002 and 2001, respectively. Pension credits
represented 5 percent and 14 percent of Nicor Gas' net income in 2002 and 2001,
respectively.
The October 1, 2003 actuarial valuation reflected higher asset values which,
absent any plan or accounting rule changes, will lead to a pension credit for
2004, increasing operating income by about $3 million. Actuarial assumptions
affecting 2004 include an expected rate of return on plan assets of 8.50% and a
discount rate of 6.00%, reduced from 8.75% and 6.75%, respectively, for 2003.
Anticipated impacts of the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 have not yet been estimated by Nicor Gas.
Nicor Gas Company Page 15
- ------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations (continued)
-------------------------------------
The pension plans are adequately funded, and recent market performance is not
expected to impact participant benefits or future company contributions.
However, substantial declines in market performance or changes to actuarial
assumptions could require future company contributions.
Nontraditional activities. Nicor Gas continues to pursue nontraditional
activities, including the Chicago Hub, which provides natural gas transportation
and storage services. The Chicago area is a major market hub for natural gas,
and demand exists for storage and transmission-related services by marketers,
other gas distribution companies and electric power-generation facilities.
During 2003, 2002 and 2001, the Chicago Hub contributed to operating income $7.3
million, $15.4 million and $13 million, respectively. The 2003 decline reflects
primarily unfavorable general market conditions, including less liquidity in the
market.
Regulation. Nicor Gas is regulated by the ICC, which establishes the rules and
regulations governing utility rates and services in Illinois. Certain rates are
updated monthly and designed to recover specific past costs, such as gas supply
and environmental costs, subject to an annual prudence review. Base rates, on
the other hand, are designed to allow the company an opportunity to recover its
costs and to earn a fair return for its investors. Nicor Gas has the option to
seek ICC approval for a base rate increase. Once started, a rate relief
proceeding generally takes about one year. The company's last rate increase was
in 1996. Significant changes in the regulations applicable to Nicor Gas or its
affiliates, or the regulatory environment in general, could affect the
performance of Nicor Gas. Information regarding certain ICC proceedings is
presented within the Notes to the Consolidated Financial Statements - Note 15
Contingencies - Performance-Based Rate Plan.
Labor negotiations. The current labor contract between Nicor Gas and the
International Brotherhood of Electrical Workers (IBEW) Local 19 expires on
February 29, 2004. The current agreement covers approximately 1,500 physical and
clerical employees of Nicor Gas. As of the filing date of this report,
negotiations between IBEW representatives and the company continue. Nicor Gas
believes that there are adequate contingency plans in the event of a work
stoppage, which the company currently does not expect.
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, credit conditions and interest rates. It is Nicor
Gas' practice to manage these risks utilizing derivative instruments and other
methods, as deemed appropriate.
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 instruments to hedge its exposure to such risks. A risk
management committee oversees compliance with such policies and procedures.
Nicor Gas is not directly 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, 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. The company is mitigating these risks through the
use of fixed-price purchase agreements, futures contracts and swap agreements.
Nicor Gas Company Page 16
- ------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations (continued)
-------------------------------------
Credit risk. The company is also 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. In some instances, Nicor Gas enters into
netting arrangements to mitigate counterparty credit risk.
Interest rate risk. Nicor Gas is exposed to changes in interest rates. The
company manages its interest rate risk by issuing long-term fixed-rate debt with
varying maturities, refinancing certain debt and periodically hedging the
interest rate on anticipated borrowings. For further information about debt
securities, interest rates and fair values, see the Financial Statements -
Consolidated Statements of Capitalization and the Notes to the Consolidated
Financial Statements - Note 7 Fair Value of Financial Instruments and the Notes
to the Consolidated Financial Statements - Note 6 Short-Term and Long-Term Debt.
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
Nicor Gas Company Page 17
- ------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations (continued)
-------------------------------------
counsel (Report) to Nicor's Board of Directors on October 28, 2002. The
findings of the Report include:
o Certain transactions increased customer costs in the aggregate amount of
approximately $15 million.
o No improper Nicor affiliated-party transactions or improper hedging
activities were identified.
o Inadvertent accounting errors occurred, sometimes to the benefit of customers
and sometimes to the benefit of Nicor Gas.
o No criminal activity or fraud was identified.
In response, the Nicor Board of Directors directed the company's management to,
among other things, make appropriate adjustments to account for, and fully
address, the adverse consequences to ratepayers of the items noted in the
Report, and conduct a detailed study of the adequacy of internal accounting and
regulatory controls. The adjustments were made in financial statements resulting
in a $24.1 million liability at December 31, 2003. Included in such $24.1
million adjustments is a $4.1 million loss contingency. In addition, Nicor Gas
estimates that there is $26.9 million due to the company from the 2002 PBR plan
year, which has not been recognized in the financial statements due to
uncertainties surrounding the PBR plan. The net of these items results in a $2.8
million reimbursement the company is seeking as of December 31, 2003, pending
resolution of the proceedings discussed below. The company has taken steps
throughout 2003 to correct the weaknesses and deficiencies identified in the
detailed study of the adequacy 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.
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.
In November 2003, the ICC staff, CUB, CCSAO and the Illinois Attorney General's
Office (IAGO) filed their respective direct testimony in the ICC Proceedings.
The ICC staff is seeking refunds to customers of approximately $108 million and
CUB and CCSAO are jointly seeking refunds to customers of approximately $143
million. The IAGO direct testimony alleges adjustments in a range from $145
million to $190 million. The IAGO testimony as filed is presently unclear as to
the amount which IAGO seeks to have refunded to customers. Nicor Gas filed
rebuttal testimony in January 2004, which is consistent with the findings of the
special committee Report and, as noted above, seeks a reimbursement to Nicor Gas
of approximately $2.8 million.
Nicor is unable to predict the outcome of any of the foregoing reviews or the
company's potential exposure thereunder. Because the PBR plan and historical gas
costs are still under ICC review, the final outcome could be materially
different than the amounts reflected in the company's financial statements as of
December 31, 2003.
Nicor Gas Company Page 18
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Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations (concluded)
-------------------------------------
SEC and U.S. Attorney Inquiries. In 2002, the staff of the United States
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. Nicor Gas is unable to predict the outcome of these inquiries or Nicor
Gas' potential exposure related thereto and has not recorded a liability
associated with the outcome of this contingency.
Mercury. Future operating results may be impacted by adjustments to the
company's estimated mercury liability or by related recoveries. Additional
information about mercury contingencies is presented in the Notes to the
Consolidated Financial Statements - Note 15 Contingencies - Mercury.
Manufactured gas plant sites. The company is conducting environmental
investigations and remedial activities at former manufactured gas plant sites.
Additional information about these sites is presented in the Notes to the
Consolidated Financial Statements - Note 15 Contingencies - Manufactured Gas
Plant Sites.
Other contingencies. The company is involved in legal or administrative
proceedings before various courts and agencies with respect to general claims,
rates, taxes, environmental and other matters. See the Notes to the Consolidated
Financial Statements - Note 15 Contingencies.
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," "project,"
"estimate," 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 legal contingencies (including litigation) and the
resolution of those issues, including the effects of an ICC review, and undue
reliance should not be placed on such statements. Other factors that could cause
materially different results include, but are not limited to, weather
conditions; natural gas prices; health care costs; insurance costs; legal costs;
borrowing needs; interest rates; credit conditions; economic and market
conditions; energy conservation; legislative and regulatory actions; tax rulings
or audit results; asset sales; significant unplanned capital needs; future
mercury-related charges or credits; changes in accounting principles, methods,
judgments or estimates; performance of major suppliers and contractors; labor
relations; 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.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
- -------- ----------------------------------------------------------
For disclosures about market risk, see the Market Risk section on page 15, which
is incorporated herein by reference.
Nicor Gas Company Page 19
- ------------------------------------------------------------------------------
Item 8. Financial Statements and Supplementary Data
- ------- -------------------------------------------
Page
----
Independent Auditors' Report.....................................20
Financial Statements:
Consolidated Statements of Operations.........................21
Consolidated Statements of Cash Flows.........................22
Consolidated Balance Sheets...................................23
Consolidated Statements of Capitalization.....................24
Consolidated Statements of Retained Earnings..................25
Consolidated Statements of Comprehensive Income...............25
Notes to the Consolidated Financial Statements................26
Nicor Gas Company Page 20
- ------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
To the Shareholder and Board of Directors of Northern Illinois Gas Company
We have audited the accompanying consolidated balance sheets and statements of
capitalization of Northern Illinois Gas Company and subsidiary (the Company) as
of December 31, 2003 and 2002, and the related consolidated statements of
operations, retained earnings, comprehensive income, and cash flows for each of
the three years in the period ended December 31, 2003. Our audits also included
the financial statement schedule listed in the Index at Item 15(a)(2). These
financial statements and the financial statement schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and the financial statement schedule based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Northern Illinois Gas Company and
subsidiary as of December 31, 2003 and 2002, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2003 in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 2003, the
Company changed its method of classifying future removal costs of utility
property, plant and equipment.
DELOITTE & TOUCHE LLP
Chicago, Illinois
February 19, 2004
Nicor Gas Company Page 21
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Consolidated Statements of Operations
(millions)
Year ended December 31
-----------------------------
2003 2002 2001
--------- --------- ---------
Operating revenues (includes revenue taxes of
$134.0, $95.3, and $112.3, respectively) $ 2,351.6 $ 1,594.8 $ 2,105.6
--------- --------- ---------
Operating expenses
Cost of gas 1,692.7 970.1 1,477.5
Operating and maintenance 220.1 199.6 177.1
Depreciation 143.5 137.6 132.4
Taxes, other than income taxes 147.3 109.5 125.5
Mercury-related costs (recoveries), net (17.8) (29.0) (12.2)
Income taxes 47.4 63.4 58.9
--------- --------- ---------
2,233.2 1,451.2 1,959.2
--------- --------- ---------
Operating income 118.4 143.6 146.4
--------- --------- ---------
Other income (expense)
Other, net 2.0 2.7 (4.3)
Income taxes on other income (.6) (.9) 1.9
--------- --------- ---------
1.4 1.8 (2.4)
--------- --------- ---------
Interest expense
Interest on debt, net of amounts capitalized 35.2 34.3 44.6
Other 1.6 2.0 .6
--------- --------- ---------
36.8 36.3 45.2
--------- --------- ---------
Net income 83.0 109.1 98.8
Dividends on preferred stock .2 .3 .4
--------- --------- ---------
Earnings applicable to common stock $ 82.8 $ 108.8 $ 98.4
========= ========= =========
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 22
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Consolidated Statements of Cash Flows
(millions)
December 31
---------------------------
2003 2002 2001
-------- -------- -------
Operating activities
Net income $ 83.0 $ 109.1 $ 98.8
Adjustments to reconcile net income to
net cash flow provided from
operating activities:
Depreciation 143.5 137.6 132.4
Deferred income tax expense 136.7 32.3 16.0
Gain on sale of property, plant and equipment (.4) (4.1) (3.9)
Changes in assets and liabilities:
Receivables, less allowances (16.2) (101.8) 279.6
Gas in storage (190.5) 13.4 (10.4)
Deferred/accrued gas costs (20.3) (40.7) 183.5
Prepaid pension costs - (12.8) (32.0)
Other assets 6.2 (52.9) 20.4
Accounts payable (153.9) 64.0 (194.0)
Accrued mercury-related costs (1.5) (13.6) (41.0)
Other liabilities (39.9) 89.0 (11.5)
Other .9 2.2 (.4)
-------- -------- -------
Net cash flow (used for) provided from
operating activities (52.4) 221.7 437.5
-------- -------- -------
Investing activities
Capital expenditures (172.9) (169.5) (149.8)
Net proceeds from the sale of property,
plant and equipment .4 4.2 4.0
-------- -------- -------
Net cash flow used for investing activities (172.5) (165.3) (145.8)
-------- -------- -------
Financing activities
Net proceeds from issuing long-term debt 147.8 49.9 247.2
Disbursements to retire long-term debt (152.4) - (279.5)
Short-term borrowings (repayments), net 260.0 48.0 (88.6)
Dividends paid (71.3) (109.4) (72.3)
Other (.4) (.4) (.5)
-------- -------- -------
Net cash flow provided from (used for)
financing activities 183.7 (11.9) (193.7)
-------- -------- -------
Net (decrease) increase in cash and cash equivalents (41.2) 44.5 98.0
Cash and cash equivalents, beginning of year 182.2 137.7 39.7
-------- -------- -------
Cash and cash equivalents, end of year $ 141.0 $ 182.2 $ 137.7
======== ======== =======
Supplemental information
Income taxes paid (refunded), net $ (59.5) $ 17.5 $ 30.1
Interest paid, net of amounts capitalized 39.1 32.2 44.9
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 23
- -------------------------------------------------------------------------------
Consolidated Balance Sheets
(millions)
December 31
--------------------
2003 2002
--------- ---------
Assets
------
Gas distribution plant, at cost $ 3,694.8 $ 3,558.1
Less accumulated depreciation 1,349.6 1,910.1
--------- ---------
2,345.2 1,648.0
--------- ---------
Current assets
Cash and cash equivalents - affiliates 97.5 115.3
Cash and cash equivalents - other 43.5 66.9
Receivables, less allowances of $19.4 and
$14.4, respectively 384.9 382.4
Receivables - affiliates 24.4 10.7
Gas in storage, at last-in, first-out cost 209.1 18.6
Deferred income taxes 41.9 31.4
Other 27.5 12.2
--------- ---------
828.8 637.5
--------- ---------
Prepaid pension costs 177.1 177.1
Other assets 66.6 82.2
--------- ---------
$ 3,417.7 $ 2,544.8
========= =========
Capitalization and Liabilities
------------------------------
Capitalization
Long-term obligations
Long-term bonds and notes $ 495.1 $ 396.2
Mandatorily redeemable preferred stock 5.1 -
--------- ---------
500.2 396.2
--------- ---------
Preferred stock
Mandatorily redeemable preferred stock - 5.6
Non-redeemable preferred stock 1.4 1.4
--------- ---------
1.4 7.0
--------- ---------
Common equity
Common stock 76.2 76.2
Paid-in capital 108.1 108.0
Retained earnings 442.3 424.5
Accumulated other comprehensive loss (1.5) (.9)
--------- ---------
625.1 607.8
--------- ---------
1,126.7 1,011.0
--------- ---------
Current liabilities
Long-term obligations due within one year .5 100.5
Short-term borrowings 575.0 315.0
Accounts payable 307.8 461.7
Accrued gas costs 47.0 67.3
Accrued dividends payable 15.0 21.1
Other 31.5 51.4
--------- ---------
976.8 1,017.0
--------- ---------
Deferred credits and other liabilities
Accrued removal costs 670.0 -
Deferred income taxes 414.5 253.5
Regulatory income tax liability 48.4 62.2
Unamortized investment tax credits 35.6 37.5
Other 145.7 163.6
--------- ---------
1,314.2 516.8
--------- ---------
$ 3,417.7 $ 2,544.8
========= =========
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 24
- -----------------------------------------------------------------------------
Consolidated Statements of Capitalization
(millions, except share data)
December 31
--------------------------------------
2003 2002
----------------- -------------------
First Mortgage Bonds
5.75% Series due 2003 $ - $ 50.0
5.55% Series due 2006 50.0 50.0
5.875% Series due 2008 75.0 75.0
5.37% Series due 2009 50.0 50.0
6.625% Series due 2011 75.0 75.0
7.20% Series due 2016 50.0 50.0
5.80% Series due 2023 50.0 -
7.375% Series due 2027 - 50.0
6.58% Series due 2028 50.0 50.0
5.90% Series due 2032 50.0 -
5.90% Series due 2033 50.0 -
------- -------
500.0 450.0
Less: Amount due within one year - 50.0
Unamortized debt discount,
net of premium 4.9 3.8
------- -------
495.1 43.9% 396.2 39.2%
------- -------
Long-term notes
Note payable due 2003 at
variable interest rate - 50.0
Less amount due within one year - 50.0
------- -------
- - - -
------- -------
Preferred stock, cumulative, $100 par
value, 800,000 shares authorized
Mandatorily redeemable preferred
stock, 4.48% and 5.00% series,
56,000 shares outstanding in 2003
and 61,000 shares outstanding in
2002. 5.6 6.1
Less amount due within one year .5 .5
------- -------
5.1 .5 5.6 .6
------- -------
Nonredeemable preferred stock,
4.60% and 5.00% convertible
series, 14,008 shares
outstanding 1.4 .1 1.4 .1
------- -------
Common equity
Common stock, $5 par value,
25,000,000 shares authorized,
32,365 shares reserved for
conversion and 15,232,414
shares outstanding 76.2 76.2
Paid-in capital 108.1 108.0
Retained earnings 442.3 424.5
Accumulated other comprehensive
income (loss)
Cash flow hedges - .5
Minimum pension liability (1.5) (1.4)
------- -------
(1.5) (.9)
------- -------
625.1 55.5 607.8 60.1
-------- ------ -------- ------
$1,126.7 100.0% $1,011.0 100.0%
======== ====== ======== ======
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 25
- ------------------------------------------------------------------------------
Consolidated Statements of Retained Earnings
(millions)
Year ended December 31
---------------------------
2003 2002 2001
-------- ------- --------
Balance at beginning of year $ 424.5 $ 400.7 $ 392.3
Net income 83.0 109.1 98.8
Dividends declared on common stock (65.0) (85.0) (90.0)
Dividends declared on preferred stock (.2) (.3) (.4)
-------- ------- --------
Balance at end of year $ 442.3 $ 424.5 $ 400.7
======== ======= ========
Consolidated Statements of Comprehensive Income
(millions)
Year ended December 31
---------------------------
2003 2002 2001
-------- ------- --------
Net income $ 83.0 $ 109.1 $ 98.8
Other comprehensive income (loss), before tax
Gain (loss) on cash flow hedges, net (2.8) 2.0 (.6)
Reclassifications to net income 1.9 (.7) -
Decrease (increase) to minimum pension
liability (.1) (.6) (.3)
-------- ------- --------
(1.0) .7 (.9)
Related income tax expense .4 (.3) .4
-------- ------- --------
Other comprehensive income, net of tax (.6) .4 (.5)
-------- ------- --------
Comprehensive income $ 82.4 $ 109.5 $ 98.3
======== ======= ========
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 26
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements
- ----------------------------------------------
Nicor Gas is one of the nation's largest distributors of natural gas, serving
over two million customers in a service territory that encompasses most of the
northern third of Illinois, excluding the city of Chicago.
1. ACCOUNTING POLICIES
General. Nicor Gas is a wholly owned subsidiary of Nicor Inc. Nicor Gas and its
affiliates reimburse each other for transactions between the companies.
Consolidation. The consolidated financial statements include the accounts of
Nicor Gas and its subsidiary. All significant intercompany balances and
transactions have been eliminated.
Use of estimates. The preparation of the financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates that affect reported amounts. Actual results could
differ from those estimates, and such differences could be material. Accounting
estimates requiring significant management judgment involve accruals for legal,
regulatory, environmental, and tax loss contingencies, the identification and
valuation of derivative instruments, unbilled revenues, postretirement benefits,
income taxes, and the allowance for doubtful accounts.
Reclassifications. Certain reclassifications have been made to conform the prior
years' financial statements to the current year presentation.
Cash and cash equivalents. The company considers investments purchased with an
initial maturity of three months or less, or that are due on demand from an
affiliate (labeled "Cash and cash equivalents - affiliates" on the Consolidated
Balance Sheets), to be cash equivalents.
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) at December 31 as follows (in millions):
2003 2002
---------- ----------
Accrued removal costs $ (670.0) $ (625.0)
Accrued gas costs (47.0) (67.3)
Regulatory income tax liability (48.4) (62.2)
Unamortized loss on reacquired debt 20.9 19.0
Deferred environmental costs 37.0 54.7
---------- ----------
$ (707.5) $ (680.8)
========== ==========
Estimated accrued removal costs were classified in accumulated depreciation at
December 31, 2002 and as a noncurrent liability at December 31, 2003. The
unamortized loss on reacquired debt and deferred environmental costs are
classified in other noncurrent assets.
Nicor Gas Company Page 27
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
Derivative instruments. At Nicor Gas, derivative instruments are utilized
primarily in the procurement of natural gas for customers. Realized gains or
losses on such derivatives are included in the cost of gas delivered and are
passed directly through to customers, subject to ICC review, having no direct
impact on earnings. Unrealized changes in the fair value of these derivative
instruments are deferred as regulatory assets or liabilities and classified as
deferred or accrued gas costs, respectively.
At times, Nicor Gas enters into futures contracts, options and swap agreements
to reduce the earnings impact of certain forecasted operating costs arising from
fluctuations in natural gas prices. To the extent that hedge accounting is
elected, unrealized changes in the fair market value of these derivative
instruments are reported as a component of accumulated other comprehensive
income or loss. When the forecasted expenses are incurred, the accumulated other
comprehensive income or loss component is reclassified to operating and
maintenance expense.
Through the first quarter of 2003, Nicor Gas held weather-related swap
agreements to limit the earnings impact of weather fluctuations. The benefits or
losses on these agreements were recorded in operating revenues.
The company generally classifies cash flows from derivatives in the same
category as cash flows from the related hedged item.
Credit risk. Nicor Gas has a diversified customer base and prudent credit
policies which mitigate customer receivable and derivative counterparty credit
risk.
Operating revenues and gas costs. Operating revenues are recorded when gas is
delivered to customers. In accordance with ICC regulations, the cost of gas
delivered is charged to customers without markup, although the timing of cost
recovery can vary, and is subject to ICC review. Temporary undercollections and
overcollections of gas costs are deferred or accrued as a regulatory asset or
liability with a corresponding decrease or increase to cost of gas,
respectively.
Legal defense costs. Nicor Gas accrues future legal defense costs associated
with loss contingencies in the period in which it is determined that such costs
are probable of being incurred and are reasonably estimable.
Depreciation. Property, plant and equipment are depreciated over estimated
useful lives on a straight-line basis. The composite depreciation rate is 4.1
percent, which includes estimated future removal costs.
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 2003, 2002 and 2001 were $130.9 million, $92.5
million and $108.9 million, respectively.
Income taxes. Nicor Gas files a consolidated federal income tax return with
Nicor Inc. Income taxes are allocated to Nicor Gas based upon the tax liability
which would have been incurred on a separate company basis. Deferred income
taxes are provided for temporary differences between the tax basis of an asset
or liability and its reported amount in the financial statements. Nicor Gas
amortizes prior investment tax credits and regulatory income tax liabilities to
income over the lives of the related properties.
Nicor Gas Company Page 28
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
2. OTHER ACCOUNTING CHANGES
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 each period, 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
under FAS 143. However, the company has determined that due to the indefinite
life of such assets a fair value 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 removal costs through
depreciation, subject to cost-of-service utility rate regulation, even when a
legal asset retirement obligation does not exist under FAS 143 or its fair value
cannot be measured. Through December 31, 2003, the company had accrued and
recovered about $670 million associated with the future removal of these
long-lived assets. During 2003, in conjunction with the adoption of FAS 143,
Nicor Gas reclassified accrued removal costs from accumulated depreciation to
other noncurrent liabilities.
Derivative Instruments and Hedging Activities. In April 2003, the FASB issued
FAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. FAS 149 amends and addresses financial accounting and reporting for
derivative instruments under FAS 133. The Statement was generally effective
prospectively for contracts entered into or modified after June 30, 2003. The
only impact of adoption on July 1, 2003, was 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 classified as deferred or accrued gas costs. 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 initially
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
prospectively reclassified approximately $6 million of redeemable preferred
stock to a liability and related dividends to interest expense. If Nicor Gas
called the mandatorily redeemable preferred shares for redemption at December
31, 2003, Nicor Gas would have to pay Nicor, the holder, approximately $6
million. The application of this standard did not have a material impact on the
company's financial position or results of operations.
Nicor Gas Company Page 29
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
3. NEW ACCOUNTING PRONOUNCEMENT
In December 2003, the FASB issued Interpretation 46(R), Consolidation of
Variable Interest Entities (FIN 46R). FIN 46R 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. The company believes that FIN 46R will have no impact on its
financial position or results of operations.
4. ACCRUED UNBILLED REVENUES
Receivables include accrued unbilled revenues of $139 million and $142.4 million
at December 31, 2003 and 2002, respectively. Nicor Gas accrues revenues for
estimated deliveries to customers from the date of their last bill until the
balance sheet date.
5. GAS IN STORAGE
Based on the average cost of gas purchased in December 2003 and 2002, the
estimated replacement cost of inventory at December 31, 2003 and 2002, exceeded
the last-in, first-out cost by $341.6 million and $311.2 million, respectively.
During 2002, Nicor Gas liquidated LIFO layers at an average cost of $1.32 per
Mcf. The company's average purchase price in 2002 was $2.01 per Mcf higher than
the average LIFO liquidation rate. Applying LIFO cost in valuing the
liquidation, as opposed to using the average gas purchase rate, decreased 2002
cost of gas by $20.3 million. As the cost of gas including inventory costs is
charged to customers without markup, the amount had no impact on net income.
6. SHORT-TERM AND LONG-TERM DEBT
In December 2003, Nicor Gas issued the following First Mortgage Bonds: $50
million due in 2023 at 5.80%, $50 million due in 2032 at 5.90%, and $50 million
due in 2033 at 5.90%. Additionally, in December 2003, Nicor Gas redeemed $50
million of 7.375% First Mortgage Bonds due in 2027. In June 2003, Nicor Gas
retired $50 million of 5.75% First Mortgage Bonds due in 2003.
In April 2003, Nicor Gas refinanced $50 million of 3% unsecured notes due in
April 2003 with $50 million of 1.6% unsecured notes due and paid in October
2003.
The company maintains short-term line of credit agreements with major domestic
and foreign banks. At December 31, 2003, these agreements, which serve as backup
for the issuance of commercial paper, allowed for borrowings of up to $1 billion
through March 2004 and $500 million thereafter through September 2004.
Commitment fees paid in advance totaling $2.5 million are being amortized over
the respective term of the agreements as interest expense.
The company had $575 million and $315 million of commercial paper outstanding
with a weighted average interest rate of 1.1% and 1.6% at December 31, 2003 and
2002, respectively.
Nicor Gas Company Page 30
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
Under the company's 2003/2004 short-term line of credit agreements, if (1)
Nicor's or Nicor Gas' 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 December 31, 2003, or (2) Nicor's or Nicor Gas'
twelve-months-ended interest rate coverage ratio is less than 3 to 1 at the end
of any fiscal quarter during the term of the credit agreements, banks
representing two-thirds 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 these covenants at December 31, 2003.
Bank cash balances averaged about $2 million during 2003, which partially
compensated for the cost of maintaining accounts and other banking services.
Such demand balances may be withdrawn at any time.
First Mortgage Bonds are secured by liens on substantially all property.
Interest expense is reported net of amounts capitalized. The interest expense
capitalized for the years ended December 31, 2003, 2002 and 2001 was $.2
million, $.4 million and $.2 million, respectively.
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The recorded amount of short-term investments and short-term borrowings
approximates fair value because of the short maturity of the instruments.
Long-term debt outstanding, including current maturities, is recorded at the
principal balance outstanding. The principal balance of Nicor's First Mortgage
Bonds outstanding at December 31, 2003 and 2002 was $500 million and $450
million, respectively. Based on quoted market interest rates, the fair value of
the company's First Mortgage Bonds outstanding, including current maturities,
was approximately $530 million and $480 million at December 31, 2003 and 2002,
respectively.
8. INCOME TAXES
The components of income tax expense (benefit) are presented below (in
millions):
2003 2002 2001
-------- --------- ---------
Current
Federal $ (73.0) $ 27.3 $ 33.0
State (13.7) 6.1 10.1
-------- --------- ---------
(86.7) 33.4 43.1
-------- --------- ---------
Deferred
Federal 113.5 26.8 15.7
State 23.2 5.5 .3
-------- --------- ---------
136.7 32.3 16.0
-------- --------- ---------
Amortization of investment tax
credits, net (2.0) (1.4) (2.1)
-------- --------- ---------
Income tax expense (benefit), net $ 48.0 $ 64.3 $ 57.0
======== ========= =========
Nicor Gas Company Page 31
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
The temporary differences which gave rise to the net deferred tax liability at
December 31, 2003 and 2002, were as follows (in millions):
2003 2002
-------- --------
Deferred tax liabilities
Property, plant and equipment $ 399.0 $ 236.0
Employee benefits 32.6 37.6
Other 24.3 20.1
-------- ---------
455.9 293.7
-------- ---------
Deferred tax assets
Unamortized investment tax credits 22.8 24.0
Regulatory income tax liability 10.2 15.2
Accrued mercury-related costs 8.7 9.0
Alternative minimum tax credits 17.7 -
Other 23.9 23.4
-------- ---------
83.3 71.6
-------- ---------
Net deferred tax liability $ 372.6 $ 222.1
======== =========
The effective combined federal and state income tax rate was 37 percent in 2003,
2002 and 2001. Differences between federal income taxes computed using the
statutory rate and reported income tax expense are shown below (in millions):
2003 2002 2001
--------- --------- ---------
Federal income taxes using statutory rate $ 45.9 $ 60.7 $ 54.5
State income taxes, net 6.6 8.3 6.8
Tax credits (2.3) (2.3) (2.3)
Regulatory income tax liability (2.1) (2.0) (2.1)
Other, net (.1) (.4) .1
-------- --------- ---------
Income tax expense (benefit), net $ 48.0 $ 64.3 $ 57.0
======== ========= =========
In the fourth quarter of 2003, Nicor Gas received an income tax refund of
approximately $100 million attributable to a tax loss carryback associated with
a change in tax accounting methods, subject to future Internal Revenue Service
review and approval.
9. POSTRETIREMENT BENEFITS
Nicor Gas maintains a noncontributory defined benefit pension plan covering
substantially all employees hired prior to 1998. Pension benefits are based on
years of service and highest average salary for management employees and job
level for unionized employees. The benefit obligation related to collectively
bargained benefits considers the company's past practice of regular benefit
increases to reflect current wages. Nicor Gas also provides health care and life
insurance benefits to eligible retired employees under a plan that includes a
limit on the company's share of cost for most future retirees. The company's
accrued postretirement benefit costs have historically been considered in rate
proceedings.
Nicor Gas Company Page 32
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
The following tables set forth the changes in the plans' benefit obligations and
assets, and reconciles the October 1 funded status of the plans to the prepaid
(accrued) benefit cost recorded on the balance sheet at December 31 (in
millions):
Pension benefits Other benefits
--------------------- ------------------
2003 2002 2003 2002
---------- ---------- --------- --------
Change in benefit obligation
Benefit obligation at
beginning of period $ 252.0 $ 237.5 $ 169.3 $ 141.9
Service cost 7.4 7.2 2.0 1.5
Interest cost 16.3 16.5 11.1 9.9
Actuarial loss 21.3 14.0 27.7 29.2
Participant contributions - - .7 1.3
Plan amendments - .3 (26.7) -
Benefits paid (23.9) (23.5) (10.5) (14.5)
---------- ---------- --------- --------
Benefit obligation at end of period 273.1 252.0 173.6 169.3
---------- ---------- --------- --------
Change in plan assets
Fair value of plan assets at
beginning of period 337.9 399.7 13.1 19.7
Actual gain (loss) on plan assets 69.6 (38.3) 2.2 (1.3)
Employer contributions - - 6.2 7.9
Participant contributions - - .7 1.3
Benefits paid (23.9) (23.5) (10.5) (14.5)
---------- ---------- --------- --------
Fair value of plan assets at
end of period 383.6 337.9 11.7 13.1
---------- ---------- --------- --------
Funded status 110.5 85.9 (161.9) (156.2)
Unrecognized net actuarial loss 62.3 86.3 84.4 60.7
Unrecognized prior service cost 4.3 4.9 - -
Unrecognized transition obligation - - 1.2 30.9
Other - - (1.5) (3.3)
---------- ---------- --------- --------
Recognized prepaid (accrued)
benefit cost $ 177.1 $ 177.1 $ (77.8) $ (67.9)
========== ========== ========= ========
The accumulated benefit obligation for pension benefits, a measure which
excludes the effect of salary and wage increases, was $233.1 million and $213
million at October 1, 2003 and 2002, respectively. The accrued benefit cost for
health care and life insurance benefits is classified as an other noncurrent
liability. In 2003, the company amended the retiree health care benefit plan to
improve consistency of benefits among participant groups and reduce the
company's share of plan costs effective January 1, 2004.
Nicor Gas Company Page 33
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
About one-fourth of the net periodic benefit cost or credit related to these
plans has been capitalized as a cost of constructing gas distribution facilities
and the remainder is included in gas distribution operating and maintenance
expense. Net periodic benefit cost (credit) included the following components
(in millions):
Pension benefits Other benefits
---------------------- ---------------------
2003 2002 2001 2003 2002 2001
------- ------ ------- ------- ------ ------
Service cost $ 7.4 $ 7.2 $ 6.5 $ 2.0 $ 1.5 $ 1.2
Interest cost 16.3 16.5 16.4 11.1 9.9 8.4
Expected return on plan
assets (28.7) (36.0) (44.3) (1.2) (1.8) (2.1)
Recognized net actuarial
(gain) loss 4.3 - (7.4) 2.9 1.0 -
Amortization of unrecognized
transition (asset) obligation - (1.0) (3.8) 3.1 3.1 3.1
Amortization of prior
service cost .7 .5 .6 - - -
------ ------ ------- ------- ------ ------
Net periodic benefit
cost (credit) $ - $(12.8) $(32.0) $ 17.9 $ 13.7 $ 10.6
====== ======= ======= ======= ====== ======
Assumptions used to determine benefit obligations at October 1 included the
following:
Pension benefits Other benefits
------------------- -------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Discount rate 6.00% 6.75% 6.00% 6.75%
Rate of compensation increase 4.00 4.00 4.00 4.00
Assumptions used to determine net periodic benefit cost for the years ended
December 31 included the following:
Pension benefits Other benefits
---------------------- ---------------------
2003 2002 2001 2003 2002 2001
------- ------ ------- ------- ------ ------
Discount rate 6.75% 7.25% 7.75% 6.75% 7.25% 7.75%
Expected return on assets 8.75 9.25 9.25 8.75 9.25 9.25
Rate of compensation increase 4.00 4.00 4.00 4.00 4.00 4.00
Nicor Gas establishes its expected return-on-asset assumption by considering
projected 20-year returns for each investment asset category. Projected returns
are calculated by an independent firm via a probability-based model. The company
has elected to apply this assumption to the fair value of plan assets, rather
than to a rolling-average fair value, in calculating the expected return on plan
assets component of net periodic benefit cost.
Assumptions used to determine other benefit obligations at October 1 were as
follows:
2003 2002
-------- --------
Health care cost trend rate 9.5% 11.0%
Rate to which the cost trend rate is assumed
to decline (the ultimate rate) 5.0% 5.0%
Years to reach ultimate rate 4 4
Nicor Gas Company Page 34
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
Assumptions used to determine other net benefit cost for the years ended
December 31 were as follows:
2003 2002 2001
-------- -------- --------
Health care cost trend rate - Pre-65 11.0% 10.0% 6.5%
Health care cost trend rate - Post-65 11.0% 7.5% 5.0%
Rate to which the cost trend rate is
assumed to decline (the ultimate rate) 5.0% 5.0% 5.0%
Years to reach ultimate rate 4 4 3
Assumed health care cost trend rates can have a significant effect on the
amounts reported for the health care plans. A one-percentage-point change in the
assumed health care cost trend rates would have the following effects (in
millions):
One-percent
-----------------------
Increase Decrease
----------- -----------
Effect on total of service and interest cost
components $ 1.4 $ (1.2)
Effect on benefit obligation 18.8 (15.8)
The recently enacted Medicare Prescription Drug, Improvement and Modernization
Act of 2003 (the Act) provides a prescription drug benefit as well as a federal
subsidy to sponsors of certain retiree health care benefit plans. As allowed by
FASB Staff Position No. 106-1, Nicor Gas has elected to defer reflecting the
effects of the Act on the accumulated benefit obligation and net periodic
postretirement benefit cost in these financial statements and accompanying
notes. The company's deferral election expires upon the occurrence of any event
that triggers a required remeasurement of plan assets or obligations, or upon
the issuance of specific authoritative guidance on the accounting for the
federal subsidy. Such guidance is pending and when issued could require the
company to adjust previously reported information.
The company's investment objective relating to pension plan assets is to have a
high probability of meeting its obligations without additional cash
contributions. The company's investment strategy is to maintain an asset mix
near its target asset allocation and to rebalance the portfolio monthly if the
actual allocation deviates from the target by two or more percentage points. The
following table sets forth the target allocation and actual percentage of plan
assets by asset category:
Target Percentage of Plan
Allocation Assets at October 1
------------- -----------------------
Asset Category 2004 2003 2002
- ------------------- ------------- ----------- -----------
Equity securities 70% 70% 69%
Debt securities 30 29 31
Real estate and other - 1 -
------------- ----------- -----------
Total 100% 100% 100%
============= =========== ===========
The company does not expect to contribute to its pension plan in 2004 and
expects to contribute about $10 million to its other postretirement benefit plan
in 2004.
Nicor Gas Company Page 35
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
Nicor Gas also has a separate unfunded supplemental retirement plan. The
supplemental retirement plan is noncontributory with defined benefits and plan
costs of $.8 million, $.9 million and $.8 million in 2003, 2002 and 2001,
respectively. The benefit obligation of the plan was $6.6 million and $6.2
million at December 31, 2003 and 2002, respectively.
The company also sponsors defined contribution plans covering substantially all
domestic employees. These plans provide for employer matching contributions. The
total cost of these plans was $4.4 million, $4.5 million and $3.9 million in
2003, 2002 and 2001, respectively.
10. DIVIDEND AND OTHER RESTRICTIONS
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 unaffiliated third parties.
11. OTHER INCOME (EXPENSE), NET
Other income (expense), net included the following (in millions):
2003 2002 2001
-------- --------- --------
Performance-based rate plan $ - $ (4.1) $ (14.8)
Interest income 1.5 2.7 4.3
Gains on sale of property, plant and
equipment .4 4.1 3.9
Other income .9 .5 2.7
Other expense (.8) (.5) (.4)
-------- --------- --------
$ 2.0 $ 2.7 $ (4.3)
======== ========= ========
12. 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 years ended December 31, 2003, 2002 and
2001 Nicor Gas had net charges to affiliates of $4.7 million, $2.1 million and
$6.4 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 years ended December 31, 2003, 2002 and 2001, net charges to (from)
Nicor Enerchange were $.1 million, $12.5 million and $(6.8) million,
respectively.
Horizon Pipeline is a 50/50 joint venture between Nicor and Natural Gas Pipeline
Company of America (NGPL) that operates, since mid-2002, a FERC regulated
natural gas pipeline in northern Illinois. Horizon Pipeline charged Nicor Gas
$10.4 million and $6.6 million for the years ended December 31, 2003 and 2002,
respectively, for natural gas transportation under rates that have been accepted
by FERC.
Nicor Gas Company Page 36
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
Nicor Gas purchases engineering and corrosion services from Nicor Technologies,
a subsidiary of Nicor. Nicor Gas was charged $4.4 million and $4.6 million for
these services for the years ended December 31, 2003 and 2002, respectively.
13. GUARANTEES
Nicor Gas had outstanding letters of credit and surety bonds totaling
approximately $5 million at December 31, 2003 and 2002. 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.
14. CONTRACTUAL OBLIGATIONS
As of December 31, 2003, Nicor Gas had contractual obligations with payments due
as follows (in millions):
Payments due by year
----------------------------------------------------
After
2004 2005 2006 2007 2008 2008 Total
------ ------ ------ ------ ------ ------ ---------
Purchase obligations $602.6 $257.6 $114.8 $ 83.0 $ 79.2 $ 44.2 $ 1,181.4
Long-term debt - - 50.0 - 75.0 375.0 500.0
Operating leases .7 .5 .4 .4 .3 .1 2.4
Other long-term
obligations .5 .5 .5 .5 .5 3.1 5.6
------ ------ ------ ------ ------ ------ ---------
$603.8 $258.6 $165.7 $ 83.9 $155.0 $422.4 $ 1,689.4
====== ====== ====== ====== ====== ====== =========
Purchase obligations consist primarily of natural gas transportation and storage
contracts, and natural gas purchase agreements. Purchase obligations also
include obligations to purchase natural gas at future market prices, calculated
using December 31, 2003 NYMEX futures prices.
Operating leases are primarily for office space and equipment. Rental expense
under operating leases was $1.3 million, $2.3 million and $1.5 million in 2003,
2002 and 2001, respectively. Other long-term obligations consist primarily of
redeemable preferred stock.
15. 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.
Nicor Gas Company Page 37
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
There are allegations that the company acted improperly in connection with the
PBR plan, and the ICC and others are reviewing these allegations. On June 27,
2002 the Citizens Utility Board (CUB) filed a motion to reopen the record in the
ICC's proceedings to review the PBR plan (the ICC Proceedings). As a result of
the motion to reopen, Nicor Gas, the Cook County State's Attorney Office
(CCSAO), the staff of the ICC and CUB entered into a stipulation providing for
additional discovery. The Illinois Attorney General's Office has also intervened
in this matter. In addition, the Illinois Attorney General's Office issued Civil
Investigation Demands (CIDs) to CUB and the ICC staff. The CIDs ordered that CUB
and the ICC staff produce all documents relating to any claims that Nicor Gas
may have presented, or caused to be presented, false information related to its
PBR plan. Parties who were plaintiffs in a dismissed class action proceeding
against the company could potentially intervene in these proceedings. The
company has committed to cooperate fully in the reviews of the PBR plan.
In response to these allegations, on July 18, 2002, the Nicor Board of Directors
appointed a special committee of independent, non-management directors to
conduct an inquiry into issues surrounding natural gas purchases, sales,
transportation, storage and such other matters as may come to the attention of
the special committee in the course of its investigation. The special committee
presented the report of its counsel (Report) to Nicor's Board of Directors on
October 28, 2002.
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 financial statements resulting
in a $24.1 million liability at December 31, 2003. Included in such $24.1
million adjustments is a $4.1 million loss contingency. In addition, Nicor Gas
estimates that there is $26.9 million due to the company from the 2002 PBR plan
year, which has not been recognized in the financial statements due to
uncertainties surrounding the PBR plan. The net of these items results in a $2.8
million reimbursement the company is seeking as of December 31, 2003, pending
resolution of the proceedings discussed below. The company has taken steps
throughout 2003 to correct the weaknesses and deficiencies identified in the
detailed study of the adequacy 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.
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 38
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
In November 2003, the ICC staff, CUB, CCSAO and the Illinois Attorney General's
Office (IAGO) filed their respective direct testimony in the ICC Proceedings.
The ICC staff is seeking refunds to customers of approximately $108 million and
CUB and CCSAO are jointly seeking refunds to customers of approximately $143
million. The IAGO direct testimony alleges adjustments in a range from $145
million to $190 million. The IAGO testimony as filed is presently unclear as to
the amount which IAGO seeks to have refunded to customers. Nicor Gas filed
rebuttal testimony in January 2004, which is consistent with the findings of the
special committee Report and, as noted above, seeks a reimbursement to Nicor Gas
of approximately $2.8 million.
Nicor Gas is unable to predict the outcome of any of the foregoing reviews or
the company's potential exposure thereunder. Because the PBR plan and historical
gas costs are still under ICC review, the final outcome could be materially
different than the amounts reflected in the company's financial statements as of
December 31, 2003.
SEC and U.S. Attorney Inquiries. In 2002, the staff of the United States
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. Nicor Gas is unable to predict the outcome of these inquiries or Nicor
Gas' potential exposure related thereto and has not recorded a liability
associated with the outcome of this contingency.
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.
As of December 31, 2003, Nicor Gas had remaining an estimated liability of $21.9
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 $18 million and $20 million of pretax mercury-related costs, net
of legal fees, from insurers and independent contractors in 2003 and 2002,
respectively.
The final disposition of these mercury-related matters is not expected to have a
material adverse impact on the company's financial condition.
Nicor Gas Company Page 39
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (continued)
- ----------------------------------------------------------
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
Illinois Environmental Protection Agency (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, and various personal injuries 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.
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 general claims, rates, taxes, environmental, and other matters.
Although unable to determine the ultimate outcome of these other contingencies,
management believes that it has recorded appropriate liabilities when reasonably
estimable.
Nicor Gas Company Page 40
- ------------------------------------------------------------------------------
Notes to the Consolidated Financial Statements (concluded)
- ----------------------------------------------------------
16. QUARTERLY RESULTS (UNAUDITED)
Summarized quarterly financial data is presented below (in millions).
Quarter ended
----------------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31
--------- --------- ---------- ---------
2003
- ----
Operating revenues $ 1,096.7 $ 379.5 $ 223.4 $ 652.0
Operating income 50.4 26.4 6.2 35.5
Net income (loss) 41.5 18.5 (2.8) 25.8
2002
- ----
Operating revenues $ 516.5 $ 282.0 $ 172.7 $ 623.6
Operating income 38.2 30.1 34.0 41.3
Net income 32.6 20.9 25.8 29.8
Effective January 1, 2003, Nicor Gas began using the straight-line method for
allocating annual depreciation to interim periods. Nicor Gas' 2002 results
include depreciation allocated based upon the level of weather-normalized gas
deliveries. While this change had a significant impact on quarterly results, it
has no impact on depreciation for the full year. Had 2002 depreciation been
allocated on a straight-line basis, it is estimated that depreciation expense
would have been lower by approximately $22 million and $7 million in the first
and fourth quarters of 2002, respectively, and higher by approximately $12
million and $17 million in the second and third quarters of 2002, respectively.
The fourth quarter of 2002 included the positive impact of a $9 million pretax
mercury reserve adjustment and the negative impact of establishing a $4.1
million pretax loss contingency reserve related to the PBR plan review.
Nicor Gas Company Page 41
- ------------------------------------------------------------------------------
Item 9. Changes in and Disagreements with Accountants on Accounting and
- ------- ---------------------------------------------------------------
Financial Disclosure
--------------------
On May 3, 2002, Nicor Gas filed a Form 8-K announcing that its Board of
Directors dismissed Arthur Andersen LLP and engaged Deloitte & Touche LLP
as its new independent auditors. This disclosure has been previously reported.
Item 9A. Controls and Procedures
- -------- -----------------------
Attached as exhibits 31.1 and 31.2 to this Annual 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 Annual Report on Form 10-K discloses the results of our evaluation of our
disclosure controls and procedures as of December 31, 2003 referred to in
paragraphs (4) and (5) of the Section 302 Certification and should be read in
conjunction with the Section 302 Certifications for a more complete
understanding of the topics presented.
In July 2002, in response to allegations that Nicor Gas acted improperly in
connection with its performance-based rate plan for natural gas costs, the Nicor
Board of Directors appointed a special committee of independent, non-management
directors to conduct an inquiry into issues surrounding natural gas purchases,
sales, transportation and storage, and certain other matters. In addition,
following up on the work of the committee, the Nicor Board of Directors later
directed Nicor's management to, among other things, (a) undertake a reaudit of
the Nicor and Nicor Gas financial statements for the years 1999 through 2001 and
a review of subsequent quarterly periods, (b) amend any filings with the SEC as
necessary, and (c) conduct a detailed study of the adequacy of internal
accounting and regulatory controls. See Notes to Consolidated Financial
Statements - Contingencies.
To assist management in assessing the control environment and related issues
associated with Nicor's natural gas supply, transport, storage and marketing
activities, including Nicor Gas Hub administration and Nicor Enerchange trading
("gas supply activities"), Nicor retained a consulting firm in the fourth
quarter of 2002 with experience in internal controls and the energy industry
that is not and has not been the company's external auditor.
Through this review of gas supply activities ("gas supply review"), it was
observed that:
o Although key controls have been designed to facilitate the complete and
accurate capture and processing of gas supply activities, many control
activities are not standardized. As such, the reliability and effectiveness
of these control processes are dependent on interpretation and execution by
business unit personnel.
o Existing processes provide limited oversight and monitoring to ensure that
transaction activities and control procedures are performed reliably and
consistent with management expectations.
o As a result, gas supply activities are not adequately documented, are overly
dependent on people, and are not supported by formal training or
communication of controls.
In light of the foregoing, and reflecting the consultant's work related to gas
supply activities, management concluded that the following steps related to gas
supply activities should be undertaken:
o Enhance the effectiveness of corporate governance and independent oversight
of gas supply activities by creating a formal risk management function and
expanding senior management oversight through the company's risk management
committee.
o Enhance senior management monitoring and oversight of gas supply activities
by creating formal reporting frameworks designed to effectively communicate
performance, existing risk profile/position, and compliance with
policies/procedures.
Nicor Gas Company Page 42
- ------------------------------------------------------------------------------
Item 9A. Controls and Procedures (continued)
- -------- -----------------------------------
o Enhance the communication of senior management's expectations regarding
objectives, risk tolerances, and business practices in connection with gas
supply activities by creating codified and standardized policies and
procedures for these activities.
o Given the high degree of regulatory oversight and review over gas supply
activities, develop formal documentation and retention standards for key
decision-making and transaction activities that are subject to regulatory
review.
o For each business unit responsible for gas supply contract negotiation and
execution, establish a dedicated contract administration function as well as
a contract compliance program.
o Develop formal contracting standards, including practices and procedures
surrounding contract execution, contract review and approval and contract
modification.
In May 2002, the company engaged new accountants, Deloitte & Touche LLP ("D&T"),
who were asked in October 2002 to audit the company's 1999, 2000 and 2001
restated financial statements in addition to its audit of the company's 2002
financial statements. In connection with the completion of its audit of, and the
issuance of an unqualified report on Nicor's and Nicor Gas' restated financial
statements for the years ended December 31, 1999, 2000 and 2001, D&T issued a
letter dated February 28, 2003 (the "D&T Letter"), in which it identified to
management and the Audit Committee of the Board of Directors certain
deficiencies that existed in the design or operation of Nicor Gas' internal
accounting controls which, considered collectively, constituted a material
weakness in Nicor Gas' internal controls pursuant to standards established by
the American Institute of Certified Public Accountants. Such deficiencies at
Nicor Gas' regulated gas purchasing operations included significant weaknesses
in the design of controls surrounding execution, monitoring and accounting for
gas commodity, transportation, storage and related contracts due, in part, to
the lack of a centralized independent back office for these activities. D&T also
concluded that these weaknesses had resulted in errors that affected gas
purchase costs, inventory, regulatory assets and liabilities, and results of the
performance-based rate plan, and led to a restatement of Nicor's and Nicor Gas'
financial statements. D&T made the following recommendations to Nicor and Nicor
Gas with respect to these deficiencies:
o Establish a centralized, independent back office function for gas supply
activities, staffed with an adequate number of appropriately skilled
individuals.
o Charge the gas supply back office function with responsibility for, among
other matters, contract analysis to determine correct accounting treatment,
ensuring that contract terms are followed, overseeing the contract approval
process and contract administration.
The company carried out an evaluation under the supervision and with the
participation of the company's management, including its principal executive
officer and principal financial officer, of the effectiveness of the design and
operation of the company's disclosure controls and procedures as of the end of
the period covered by this Annual Report on Form 10-K (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
Nicor Gas Company Page 43
- ------------------------------------------------------------------------------
Item 9A. 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
Annual Report on Form 10-K, 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 steps taken throughout 2003 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 fourth quarter of
2003. The company will continue to review and implement enhancements to improve
the effectiveness of its disclosure controls and procedures and will take
further actions as dictated by such continuing reviews.
Nicor Gas Company Page 44
- ------------------------------------------------------------------------------
PART III
Item 14. Principal Accountant Fees and Services
- -------- --------------------------------------
The following is a summary of the fees billed to Nicor Gas by Deloitte & Touche
LLP for professional services rendered for the years ended December 31, 2003 and
2002 (in millions):
Fee Category 2003 Fees 2002 Fees
---------------- --------- ---------
Audit Fees $ .5 $ 1.4
Audit-Related Fees .1 -
Tax Fees - -
All Other Fees - -
--------- --------
Total Fees $ .6 $ 1.4
Audit Fees. Consists of fees for professional services rendered for the audit of
Nicor Gas' financial statements, review of the interim financial statements
included in quarterly reports, and services in connection with statutory and
regulatory filings and preparation of comfort letters for debt issues.
Audit-Related Fees. Consists of fees for assurance and related services that are
reasonably related to the performance of the audit of Nicor Gas' financial
statements and are not reported under "Audit Fees." These services include
employee benefit plan audits and consultations concerning financial accounting
and reporting standards.
Tax Fees. None.
All Other Fees. None.
Audit Committee Pre-Approval Policies and Procedures
In accordance with the Sarbanes-Oxley Act of 2002, the Audit Committee's policy
is to pre-approve all audit and non-audit services provided by Deloitte & Touche
LLP. On an ongoing basis, management of Nicor Gas defines and communicates
specific projects and categories of service for which the advance approval of
the Audit Committee is requested. The Audit Committee reviews these requests and
advises management if the Committee approves the engagement of Deloitte & Touche
LLP. On a periodic basis, Nicor Gas' management reports to the Audit Committee
the actual spending for such projects and services compared to the approved
amounts. In 2003, all services provided by Deloitte & Touche LLP were approved
in advance by the Committee.
Nicor Gas Company Page 45
- ------------------------------------------------------------------------------
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- -------- ----------------------------------------------------------------
(a) 1) Financial Statements:
See Item 8, Financial Statements and Supplementary Data, on page 19
filed herewith, for a list of financial statements.
2) Financial Statement Schedules:
Schedule
Number Page
-------- ----
Independent Auditors' Report 20
II Valuation and Qualifying Accounts 46
Schedules other than those listed are omitted because they are not
applicable.
3) Exhibits Filed:
See Exhibit Index beginning on page 49 filed herewith.
(b) On November 21, 2003, Nicor Gas filed a Form 8-K, under Item 5,
regarding a press release dated November 21, 2003 announcing key
executive appointments.
On December 2, 2003, Nicor Gas filed a Form 8-K, under Item 5,
regarding the company's Registration Statement on Form S-3
(Registration No.333-65486).
On December 5, 2003, Nicor Gas filed a Form 8-K, under Items 5 and 7,
regarding a Prospectus Supplement dated December 4, 2003.
On December 9, 2003, Nicor Gas filed a Form 8-K, under Item 7,
regarding the company's Registration Statement on Form S-3
(Registration No.333-65486).
Nicor Gas Company Page 46
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Schedule II
VALUATION AND QUALIFYING ACCOUNTS
(millions)
Additions
-----------------------
Balance at Charged to Charged to Balance
beginning costs and other at end
Description of period expenses accounts Deductions of period
- ---------------------- ---------- ---------- ---------- ---------- ---------
2003
----
Allowance for
uncollectible
accounts receivable $ 14.4 $ 29.8 $ - $ 24.8 (a) $ 19.4
Accrued mercury-related
costs 23.4 - - 1.5 (b) 21.9
2002
----
Allowance for
uncollectible
accounts receivable $ 9.6 $ 25.7 $ - $ 20.9 (a) $ 14.4
Accrued mercury-related
costs 37.0 - - 13.6 (c) 23.4
2001
----
Allowance for
uncollectible
accounts receivable $ 13.4 $ 23.3 $ - $ 27.1 (a) $ 9.6
Accrued mercury-related
costs 78.0 - - 41.0 (c) 37.0
(a) Accounts receivable written off, net of recoveries.
(b) Expenditures.
(c) Expenditures and reserve reduction to reflect new estimate.
Nicor Gas Company Page 47
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Signatures
- ----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Nicor Gas Company
Date February 19, 2004 /s/ RICHARD L. HAWLEY
----------------- ---------------------
Richard L. Hawley
Executive Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on February 19, 2004.
Signature Title
- -------------------------------- -------------------------------
/s/ RUSS M. STROBEL
-------------------
Russ M. Strobel President and Chief Executive Officer
(Principal Executive Officer)
/s/ RICHARD L. HAWLEY
---------------------
Richard L. Hawley Executive Vice President and
(Principal Financial Officer) Chief Financial Officer
/s/ JEFFREY L. METZ
-------------------
Jeffrey L. Metz Vice President and Controller
(Principal Accounting Officer)
ROBERT M. BEAVERS, JR.* Director
BRUCE P. BICKNER* Director
JOHN H. BIRDSALL, III* Director
THOMAS A. DONAHOE* Director
THOMAS L. FISHER* Director
JOHN E. JONES* Director
DENNIS J. KELLER* Director
WILLIAM A. OSBORN* Director
JOHN RAU* Director
JOHN F. RIORDAN* Director
PATRICIA A. WIER* Director
* By /s/ JEFFREY L. METZ
-------------------
Jeffrey L. Metz
(Attorney-in-fact)
Nicor Gas Company Page 48
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Supplemental Information
- ------------------------
Supplemental Information to be Furnished With Reports Filed Pursuant to Section
15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to
Section 12 of the Act:
No annual report or proxy material has been sent to security holders as Nicor
Gas is a wholly owned subsidiary of Nicor Inc.
Nicor Gas Company Page 49
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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 January 15, 2004.
4.01 * Indenture of Commonwealth Edison Company to
Continental Illinois National Bank and Trust Company of
Chicago, Trustee, dated as of January 1, 1954. (File
No. 1-7296, Form 10-K for 1995, Exhibit 4.01.)
4.02 * Indenture of Adoption of the company to
Continental Illinois National Bank and Trust Company of
Chicago, Trustee, dated February 9, 1954. (File No.
1-7296, Form 10-K for 1995, Exhibit 4.02.)
4.03 * Supplemental Indenture, dated February 15, 1998,
of the company to Harris Trust and Savings Bank,
Trustee, under Indenture dated as of January 1, 1954.
(File No. 1-7296, Form 10-K for 1997, Exhibit 4.19.)
4.04 * Supplemental Indenture, dated February 1, 1999, of
the company to Harris Trust and Savings Bank, Trustee,
under Indenture dated as of January 1, 1954. (File No.
1-7296, Form 10-K for 1998, Exhibit 4.19.)
4.05 * Supplemental Indenture, dated February 1, 2001, of
the company to BNY Midwest Trust Company, Trustee,
under Indenture dated as of January 1, 1954. (File No.
1-7296, Form 10-K for 2000, Exhibit 4.17.)
4.06 * Supplemental Indenture, dated May 15, 2001, of the
company to BNY Midwest Trust Company, Trustee, under
Indenture dated as of January 1, 1954. (File No.
1-7296, Form 10-Q for June 2001, Exhibit 4.01.)
4.07 * Supplemental Indenture, dated August 15, 2001, of
the company to BNY Midwest Trust Company, Trustee,
under Indenture dated as of January 1, 1954. (File No.
1-7296, Form 10-Q for September 2001, Exhibit 4.01.)
4.08 * Supplemental Indenture, dated December 15, 2001,
of the company to BNY Midwest Trust Company, Trustee,
under Indenture dated as of January 1, 1954. (File No.
1-7296, Form 10-K for 2001, Exhibit 4.20.)
4.09 Supplemental Indenture, dated December 1, 2003, of the company to
BNY Midwest Trust Company, Trustee, under Indenture dated as of
January 1, 1954.
Nicor Gas Company Page 50
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Exhibit Index (concluded)
- -------------------------
Exhibit
Number Description of Document
- ------- -----------------------------------------------------------------
4.10 Supplemental Indenture, dated December 1, 2003, of the company to
BNY Midwest Trust Company, Trustee, under Indenture dated as of
January 1, 1954.
4.11 Supplemental Indenture, dated December 1, 2003, of the company to
BNY Midwest Trust Company, Trustee, under Indenture dated as of
January 1, 1954.
12.01 Computation of Consolidated Ratio of Earnings to Fixed Charges.
18.01 * Preferability Letter regarding Change in Accounting of Interim
Depreciation. (File No. 1-7296, Form 10-Q for March 2003,
Exhibit 18.01.)
23.01 Independent Auditors' Consent.
24.01 Powers of Attorney.
31.1 Rule 13a-14(a)/15d-14(a) Certification.
31.2 Rule 13a-14(a)/15d-14(a) Certification.
32.1 Section 1350 Certification.
32.2 Section 1350 Certification.
* 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.