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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
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)
The registrant meets the conditions set forth in General Instruction
H(1)(a) and (b) of Form 10-Q and is therefore filing this Form with a reduced
disclosure format.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in rule 12b-2 of the Exchange Act). Yes [ ] No [X].
All shares of common stock are owned by Nicor Inc.
Nicor Gas Company Page i
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Table of Contents
Glossary ii
Part I - Financial Information
Item 1. Financial Statements - (Unaudited).................................1
Consolidated Statements of Operations:
Three months ended
March 31, 2005 and 2004...........................................2
Consolidated Statements of Cash Flows:
Three months ended
March 31, 2005 and 2004...........................................3
Consolidated Balance Sheets:
March 31, 2005 and 2004, and
December 31, 2004.................................................4
Notes to the Consolidated Financial Statements.....................5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..............................15
Item 4. Controls and Procedures...........................................23
Part II - Other Information
Item 1. Legal Proceedings.................................................24
Item 6. Exhibits..........................................................24
Signature.........................................................25
Nicor Gas Company page ii
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Glossary
Chicago Hub. A wholly owned venture of Nicor Gas which provides natural gas
storage and transmission-related services to marketers and other gas
distribution companies.
Degree day. The extent to which the daily average temperature falls below 65
degrees Fahrenheit. Normal weather for Nicor Gas' service territory, for
purposes of this report, is considered to be 5,830 degree days per year for
2005 and 6,000 degree days per year for 2004.
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 establishes the rules and
regulations governing utility rates and services in Illinois.
Mcf, MMcf, Bcf. Thousand cubic feet, million cubic feet, billion cubic feet.
PBR. Performance-based rate, a regulatory plan which ended on January 1, 2003,
that provided economic incentives based on natural gas cost performance.
Nicor Gas Company Page 1
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
The following condensed unaudited consolidated financial statements of
Northern Illinois Gas Company (doing business as Nicor Gas Company (Nicor
Gas)) have been prepared by the company pursuant to the rules and regulations
of the United States Securities and Exchange Commission (SEC). Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States have been condensed or omitted pursuant to SEC
rules and regulations. The condensed financial statements should be read in
conjunction with the financial statements and the notes thereto included in
the company's 2004 Annual Report on Form 10-K.
The information furnished reflects, in the opinion of the company, all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair statement of the results for the interim periods presented. Results for
the interim periods presented are not necessarily indicative of the results
to be expected for the full fiscal year due to seasonal and other factors.
Nicor Gas Company Page 2
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Consolidated Statements of Operations (Unaudited)
(millions)
Three months ended
March 31
--------------------
2005 2004
--------- ---------
Operating revenues (includes revenue taxes
of $72.1 and $70.9, respectively) $ 1,078.8 $ 1,035.1
--------- ---------
Operating expenses
Cost of gas 836.8 792.2
Operating and maintenance 68.3 63.3
Depreciation 38.6 37.3
Taxes, other than income taxes 76.1 74.6
Income tax expense 15.7 20.6
Mercury-related costs (recoveries), net .1 (.1)
--------- ---------
1,035.6 987.9
--------- ---------
Operating income 43.2 47.2
Other income (expense), net .1 -
Interest expense
Interest on debt, net of amounts capitalized 9.7 9.9
Other 1.1 .8
--------- ---------
10.8 10.7
--------- ---------
Net income 32.5 36.5
Dividends on preferred stock .1 -
--------- ---------
Earnings applicable to common stock $ 32.4 $ 36.5
========= =========
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 3
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Consolidated Statements of Cash Flows (Unaudited)
(millions)
Three months ended
March 31
------------------
2005 2004
-------- -------
Operating activities
Net income $ 32.5 $ 36.5
Adjustments to reconcile net income to net cash flow
provided from operating activities:
Depreciation 38.6 37.3
Deferred income tax (benefit)expense (2.5) 4.3
Changes in assets and liabilities:
Receivables, less allowances (35.1) (8.8)
Gas in storage 186.6 201.1
Deferred/accrued gas costs 1.9 38.0
Other assets 11.9 14.9
Accounts payable (118.4) (94.6)
Temporary last-in, first-out inventory liquidation 403.4 195.9
Other liabilities 4.9 5.1
Other noncash items .5 .4
-------- -------
Net cash flow provided from operating activities 524.3 430.1
-------- -------
Investing activities
Capital expenditures (36.8) (32.3)
-------- -------
Net cash flow used for investing activities (36.8) (32.3)
-------- -------
Financing activities
Short-term repayments, net (375.0) (519.0)
Dividends paid (10.0) (15.0)
-------- -------
Net cash flow used for financing activities (385.0) (534.0)
-------- -------
Net increase (decrease) in cash and cash equivalents 102.5 (136.2)
Cash and cash equivalents, beginning of period .1 141.0
-------- -------
Cash and cash equivalents, end of period $ 102.6 $ 4.8
======== =======
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 4
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Consolidated Balance Sheets (Unaudited)
(millions)
March 31 December 31 March 31
2005 2004 2004
---------- ----------- --------
Assets
------
Gas distribution plant, at cost $ 3,856.5 $ 3,831.5 $ 3,719.2
Less accumulated depreciation 1,430.9 1,415.1 1,368.2
-------- -------- --------
2,425.6 2,416.4 2,351.0
-------- -------- --------
Current assets
Cash and cash equivalents - affiliates 101.0 .1 -
Cash and cash equivalents - other 1.6 - 4.8
Receivables, less allowances of $29.3,
$19.7 and $27.3, respectively 526.1 473.8 410.4
Receivables - affiliates 9.6 26.8 7.7
Gas in storage, at last-in, first-out
(LIFO) cost 2.4 189.0 8.0
Deferred income taxes 43.8 41.5 40.5
Other 31.0 33.6 17.2
-------- -------- --------
715.5 764.8 488.6
-------- -------- --------
Prepaid pension costs 183.0 181.5 178.2
Other assets 57.1 67.3 60.3
-------- -------- --------
$ 3,381.2 $ 3,430.0 $ 3,078.1
======== ======== ========
Capitalization and Liabilities
------------------------------
Capitalization
Long-term obligations
Long-term bonds and notes $ 495.4 $ 495.3 $ 494.9
Mandatorily redeemable preferred stock 4.6 4.5 5.1
-------- -------- --------
500.0 499.8 500.0
-------- -------- --------
Preferred stock
Non-redeemable preferred stock 1.4 1.4 1.4
-------- -------- --------
Common equity
Common stock 76.2 76.2 76.2
Paid-in capital 108.1 108.1 108.1
Retained earnings 478.8 455.3 465.7
Accumulated other comprehensive
income (loss) (1.6) (1.5) (1.5)
-------- -------- --------
661.5 638.1 648.5
-------- -------- --------
1,162.9 1,139.3 1,149.9
-------- -------- --------
Current liabilities
Long-term obligations due within one year .5 .5 .5
Short-term borrowings - 375.0 56.0
Accounts payable 287.6 406.0 213.2
Temporary last-in, first-out
inventory liquidation 403.4 - 195.9
Accrued gas costs 70.1 68.2 85.0
Dividends payable 9.0 10.0 13.0
Other 52.8 47.3 40.2
-------- -------- --------
823.4 907.0 603.8
-------- -------- --------
Deferred credits and other liabilities
Accrued future removal costs 718.3 706.4 682.0
Deferred income taxes 437.6 437.0 417.5
Regulatory income tax liability 44.0 44.8 47.5
Unamortized investment tax credits 33.3 33.8 34.9
Other 161.7 161.7 142.5
-------- -------- --------
1,394.9 1,383.7 1,324.4
-------- -------- --------
$ 3,381.2 $ 3,430.0 $ 3,078.1
======== ======== ========
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 5
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Notes to the Consolidated Financial Statements (Unaudited)
The following notes should be read in conjunction with the financial
statement notes included in the Nicor Gas 2004 Annual Report on Form 10-K.
Nicor Gas is a wholly owned subsidiary of Nicor Inc. (Nicor). Results for
the interim periods presented are not necessarily indicative of the results
to be expected for the full fiscal year due to seasonal and other factors.
1. ACCOUNTING POLICIES
Cash and cash equivalents. The company considers investments purchased with
an initial maturity of three months or less, or amounts that are due on
demand from an affiliate (labeled "Cash and cash equivalents - affiliates" on
the Consolidated Balance Sheets), to be cash equivalents.
Gas in storage. Gas in storage inventory is carried at cost applying a
last-in, first-out (LIFO) method on a calendar-year basis. For interim
periods, the difference between estimated replacement cost and the LIFO cost
for quantities of gas temporarily withdrawn from storage is recorded in cost
of gas and in current liabilities as a temporary LIFO liquidation.
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 and liabilities as follows (in millions):
March 31 December 31 March 31
2005 2004 2004
----------- ----------- ----------
Regulatory assets
Deferred environmental costs $ 23.5 $ 35.4 $ 31.8
Unamortized losses on
reacquired debt 19.5 19.9 20.7
Deferred rate case costs 3.6 2.9 .2
----------- ----------- ----------
$ 46.6 $ 58.2 $ 52.7
=========== =========== ==========
Regulatory liabilities
Accrued future removal
costs - current $ 12.0 $ 11.6 $ -
Accrued future removal
costs - noncurrent 718.3 706.4 682.0
Accrued gas costs 70.1 68.2 85.0
Regulatory income tax
liability 44.0 44.8 47.5
Other noncurrent regulatory
liabilities 5.2 .7 -
----------- ----------- ----------
$ 849.6 $ 831.7 $ 814.5
=========== =========== ==========
All regulatory assets noted above are classified in noncurrent other assets.
The current portion of the accrued future removal costs obligation is
classified in other current liabilities.
Revenue taxes. Nicor Gas classifies revenue taxes billed to customers as
operating revenues and related taxes incurred as operating expenses. Revenue
taxes included in operating expense for the quarters ended March 31, 2005 and
2004 were $70.6 million and $69.5 million, respectively.
Nicor Gas Company Page 6
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Notes to the Consolidated Financial Statements (Unaudited) (continued)
Income and other taxes. The company's effective income tax rate was 32.6
percent for the quarter ended March 31, 2005 and 36.0 percent for the
corresponding prior-year period. The decrease in the effective income tax
rate in 2005 compared with 2004 was primarily a result of lower projected
2005 pretax income. Lower pretax income typically causes a lower effective
income tax rate since permanent differences and tax credits are a larger
share of pretax income.
The company accrues tax and interest related to tax uncertainties. Tax
uncertainties arise due to actual or potential disagreements about the tax
treatment of specific items between the company and the governmental agency
reviewing the company's tax returns. At March 31, 2005, December 31, 2004
and March 31, 2004, the company had accrued approximately $6.4 million, $4.4
million and $1.8 million, respectively, for such uncertainties.
Reclassifications. Certain reclassifications have been made to conform the
prior year's financial statements to the current year's presentation.
2. NEW ACCOUNTING PRONOUNCEMENT
In March 2005, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 47, Accounting for Conditional Asset Retirement
Obligations (FIN 47). FIN 47 indicates that an entity is required to
recognize the fair value of a liability for an asset retirement obligation in
the period in which the unconditional legal obligation is incurred, even if
the nature of the timing or method of settlement is conditional on some
future event that may or may not be within the control of the company. The
interpretation is effective for Nicor Gas no later than December 31, 2005 and
may be adopted either retrospectively or prospectively. The company is
evaluating the interpretation and has not yet determined the impact of
adopting its provisions.
3. SHORT-TERM DEBT
During 2004, Nicor Inc. and Nicor Gas established two revolving credit
facilities totaling $900 million with major domestic and foreign banks.
These facilities consist of a $500 million, 3-year revolver, expiring
September 2007, available to Nicor Inc. and Nicor Gas, and a $400 million,
210-day seasonal revolver available to Nicor Gas which expired in April
2005. The company had no commercial paper borrowings outstanding at March
31, 2005, and $375 million and $56 million of commercial paper borrowings
outstanding at December 31, 2004 and March 31, 2004, respectively. The
company is in compliance with the covenants relating to its credit facilities
at March 31, 2005.
4. ACCRUED UNBILLED REVENUES
Receivables included accrued unbilled revenues of $126.6 million, $204.4
million and $95.5 million at March 31, 2005, December 31, 2004 and March 31,
2004, respectively. Nicor Gas accrues revenues for estimated deliveries to
customers from the date of their last bill until the balance sheet date.
Nicor Gas Company Page 7
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Notes to the Consolidated Financial Statements (Unaudited) (continued)
5. 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, net of unamortized discount and issuance
costs. The principal balance of Nicor Gas' First Mortgage Bonds outstanding
at March 31, 2005, December 31, 2004 and March 31, 2004 was $500 million.
Based on quoted market interest rates, the fair value of the company's First
Mortgage Bonds outstanding, including current maturities, was approximately
$528 million, $530 million and $546 million at March 31, 2005, December 31,
2004 and March 31, 2004, respectively.
Derivative financial instruments are recorded at fair value as determined
primarily from actively quoted prices. These instruments had gross asset
(liability) fair values of $17.1 million and zero, respectively, at March 31,
2005, $4.7 million and $(1.1) million, respectively, at December 31, 2004 and
$2.7 million and zero, respectively, at March 31, 2004. These financial
instruments relate to hedging of natural gas purchases, and their settlement
is passed directly through to customers without markup, subject to ICC review.
6. 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 employees hired
after 1982. The company's postretirement benefit costs have historically
been considered in rate proceedings in the period they are accrued.
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):
Health care and
Pension benefits other benefits
------------------ -----------------
2005 2004 2005 2004
-------- -------- -------- -------
Three months ended March 31
Service cost $ 2.3 $ 2.2 $ .7 $ .6
Interest cost 3.9 4.0 2.6 2.5
Expected return on plan assets (8.3) (8.0) (.2) (.2)
Recognized net actuarial loss .4 .5 1.1 1.2
Amortization of prior service
cost .2 .2 - -
-------- -------- -------- -------
Net periodic benefit cost
(credit) $ (1.5) $ (1.1) $ 4.2 $ 4.1
======== ======== ======== =======
Nicor Gas Company Page 8
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Notes to the Consolidated Financial Statements (Unaudited) (continued)
The company reflected its best estimate of the potential subsidy it may
receive under the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 in its October 1, 2004 measurement of the postretirement health
care obligation. The potential subsidy reduced the benefit obligation by
$19.4 million. Beginning in 2005, the company has also reflected its best
estimate of the potential subsidy in its measurement of net periodic
postretirement health care costs. The estimated subsidy reduced such costs
by $0.6 million for the three months ended March 31, 2005. This reduction
was offset by general cost increases.
7. COMPREHENSIVE INCOME
Total comprehensive income, as defined by SFAS 130, Reporting Comprehensive
Income, was equal to net income for the three months ended March 31, 2005 and
2004.
8. RELATED PARTY TRANSACTIONS
In the ordinary course of business, under the terms of an agreement approved
by the ICC, Nicor Gas enters into transactions with Nicor and its other
wholly owned subsidiaries for the use of facilities and services. The
charges for these transactions are cost-based, except where the charging
party has a prevailing price for which the facility or service is provided to
the general public. In addition, Nicor charges Nicor Gas and its other
wholly owned subsidiaries for the cost of corporate overheads. For the three
months ended March 31, 2005 and 2004, Nicor Gas had net charges to affiliates
of $4.3 million and $4.1 million, respectively.
At March 31, 2005, Nicor Gas had outstanding cash advances, due on demand
from Nicor, of $101 million. No such advances were outstanding as of
December 31, 2004 or March 31, 2004. For the quarter ended March 31, 2005
and 2004, interest income from Nicor was negligible. Nicor Gas is restricted
by regulation in the amount it can loan to affiliates. 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. In addition, Nicor Gas may not extend cash
advances to an affiliate if Nicor Gas has any outstanding short-term
borrowings.
Nicor Solutions, a subsidiary of Nicor, offers utility-bill management
products to customers of Nicor Gas. Under these products, Nicor Solutions
pays Nicor Gas for the utility bills issued to the utility-bill
management customers. For the three months ended March 31, 2005 and 2004,
Nicor Gas recorded revenues of $30.9 million and $35.1 million, respectively,
associated with the payments Nicor Solutions makes to Nicor Gas on behalf of
its customers.
Under the terms of an ICC order, Nicor Gas routinely enters into transactions
with Nicor Enerchange, a wholesale natural gas marketing subsidiary of Nicor,
for the purchase and sale of natural gas, transportation and storage
services. For the three months ended March 31, 2005 and 2004, net
charges from Nicor Enerchange were $8.4 million and $8.3 million,
respectively.
In the first quarter of 2005 and 2004, Horizon Pipeline, a 50-percent-owned
joint venture of Nicor, charged Nicor Gas $2.6 million and $2.7 million,
respectively, for natural gas transportation under rates that have been
accepted by the Federal Energy Regulatory Commission.
Nicor Gas Company Page 9
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Notes to the Consolidated Financial Statements (Unaudited) (continued)
In the first quarter of 2005 and 2004, Nicor Technologies, a subsidiary of
Nicor, charged Nicor Gas $1.2 million and $0.9 million, respectively, for
engineering and corrosion services.
In addition, certain related parties may acquire regulated utility services
at rates approved by the ICC.
9. RATE PROCEEDING
On November 4, 2004, Nicor Gas filed with the ICC for an overall increase in
rates of approximately $83 million (or about 16.5 percent of base rates
revenue). The company's filing provided for a rate of return on
original-cost rate base of 9.34 percent, which reflects an 11.37 percent cost
of common equity. The requested rate increase is needed to recover higher
operating costs and increased capital investments. Nicor Gas has not raised
base rates since 1996.
As part of the requested rate increase, Nicor Gas has proposed that all
Chicago Hub revenues and approximately two-thirds of all bad debt expenses be
passed directly through to customers, reducing the earnings variability of
both items. In addition, the company has proposed setting rates assuming
normal weather of 5,830 degree days beginning in 2005 versus the 6,000 degree
days previously considered by the company as normal.
The proposed rate increase has been suspended pending the completion of the
ICC's review. The ICC normally has 11 months to complete its review of the
rate filing and to issue an order.
On April 5, 2005, Nicor Gas filed rebuttal testimony with the ICC, in
response to the direct testimony of the ICC staff and intervenors in the
proceeding, and revised its proposed rate increase of approximately $83
million to approximately $78 million. The revised proposal reflects a 10.82
percent cost of common equity resulting in a rate of return on original-cost
rate base of 9.03 percent.
10. COMMITMENTS
At March 31, 2005, purchase obligations for property, plant and equipment
totaled $27.8 million which was relatively flat compared with year-end 2004.
These commitments are mostly related to computer system upgrades and a
storage compressor.
11. GUARANTEES
In certain instances, Nicor Gas has undertaken to indemnify current property
owners and others against costs associated with the effects and/or
remediation of contaminated sites for which the company may be responsible
under applicable federal or state environmental laws, generally with no
limitation as to the amount. Aside from liabilities recorded in connection
with coal tar cleanup, as discussed in Note 12 Contingencies - Manufactured
Gas Plant Sites, Nicor Gas believes that the likelihood of payment under
these indemnifications is either remote or that the amount would be
immaterial and no liability has been recorded for these indemnifications.
Nicor Gas has also indemnified, to the fullest extent permitted under the
laws of the State of Illinois and any other applicable laws, its present and
former directors, officers and employees against expenses they may incur in
connection with litigation they are a party to by reason of their association
with the company. There is generally no limitation as to the amount. The
company does not expect to incur significant costs under these
indemnifications.
Nicor Gas Company Page 10
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Notes to the Consolidated Financial Statements (Unaudited) (continued)
12. 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 ICC review.
There are allegations that the company acted improperly in connection with
the PBR plan, and the ICC and others are reviewing these allegations. On
June 27, 2002 the Citizens Utility Board (CUB) filed a motion to reopen the
record in the ICC's proceedings to review the PBR plan (the ICC
Proceedings). As a result of the motion to reopen, Nicor Gas, the Cook
County State's Attorney Office (CCSAO), the staff of the ICC and CUB entered
into a stipulation providing for additional discovery. The Illinois Attorney
General's Office has also intervened in this matter. In addition, the Illinois
Attorney General's Office issued Civil Investigation Demands (CIDs) to CUB and
the ICC staff. The CIDs ordered that CUB and the ICC staff produce all
documents relating to any claims that Nicor Gas may have presented, or caused
to be presented, false information related to its PBR plan. Parties who were
plaintiffs in a dismissed class action proceeding against the company could
potentially intervene in these proceedings. The company has committed to
cooperate fully in the reviews of the PBR plan.
In response to these allegations, on July 18, 2002, the Nicor Board of
Directors appointed a special committee of independent, non-management
directors to conduct an inquiry into issues surrounding natural gas
purchases, sales, transportation, storage and such other matters as may come
to the attention of the special committee in the course of its investigation.
The special committee presented the report of its counsel (Report) to Nicor's
Board of Directors on October 28, 2002.
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 prior
years' financial statements resulting in a $24.8 million liability. Included
in such $24.8 million liability is a $4.1 million loss contingency. A $1.8
million adjustment to the previously recorded liability, which is discussed
below, was made in the third quarter of 2004 increasing the recorded liability
to $26.6 million. 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 and interest income on certain components results in a $1.0
million reimbursement the company is seeking as of March 31, 2005, pending
resolution of the proceedings discussed below. By the end of 2003 the company
completed steps to correct the weaknesses and deficiencies identified in the
detailed study of the adequacy of internal controls.
Nicor Gas Company Page 11
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Notes to the Consolidated Financial Statements (Unaudited) (continued)
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 were 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. On February 27, 2004 the above referenced intervenors filed their
rebuttal testimony in the ICC Proceedings. In such rebuttal testimony, CUB
and CCSAO amended the alleged amount to be refunded to customers from
approximately $143 million to $190 million. Nicor Gas filed rebuttal
testimony in January 2004, which is consistent with the findings of the
special committee Report. Nicor Gas seeks a reimbursement of approximately
$1.0 million as referenced above. The parties to the ICC Proceedings have
agreed to a stay of the evidentiary hearings on this matter in order to
undertake additional third party discovery from Entergy-Koch Trading, LP
(EKT), a natural gas, storage and transportation trader and consultant with
whom Nicor Gas did business under the PBR plan.
During the course of the SEC investigation discussed below, the company
became aware of additional information relating to the activities of
individuals affecting the PBR plan for the period from 1999 through 2002,
including information consisting of third party documents and recordings of
telephone conversations from EKT. The company continues to obtain access to
and review this information. Review of additional information completed in
the third quarter of 2004 resulted in the $1.8 million adjustment to the
previously recorded liability referenced above.
Although the Report of the special committee's counsel did not find that
there was criminal activity or fraud, a review of this additional information
(which was not available to the independent counsel who prepared the Report)
and re-interviews of certain Nicor Gas personnel indicates that certain
former Nicor Gas personnel may have engaged in potentially fraudulent conduct
regarding the PBR plan in violation of company policy, and in possible violation
of SEC rules and applicable law. Further, certain former Nicor Gas personnel
also may have attempted to conceal their conduct in connection with an ICC
review of the PBR plan. The company continues to cooperate with the SEC, the
U.S. Attorney's office and the ICC on this matter and to review and produce
additional documents as requested by these agencies. The company has reviewed
all third party information it has obtained and will continue to review any
additional third party information the company may obtain. The company
terminated four employees in connection with this matter in the third quarter
of 2004.
Nicor Gas Company Page 12
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Notes to the Consolidated Financial Statements (Unaudited) (continued)
Nicor Gas is unable to predict the outcome of any of the foregoing reviews or
the company's potential exposure thereunder. 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 March 31, 2005.
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. In April 2004, Nicor was advised by the SEC Division of
Enforcement that it intended to recommend to the SEC that it bring a civil
injunctive action against Nicor, alleging that Nicor violated Sections 17(a) of
the Securities Act of 1933 and Sections 10(b) and 13(a) of the Securities
Exchange Act of 1934 and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder.
The SEC may also seek injunctive relief, disgorgement and civil penalties.
The SEC staff invited Nicor to make a formal response (known as a Wells
Submission) with respect to the proposed recommendation. In June 2004, Nicor
filed its Wells Submission with the SEC. In addition, in connection with
the SEC's invitation to the company to make a Wells Submission, the SEC
informed the company of additional sources of information relating to activities
affecting the PBR plan, the status of which is addressed in detail in the
Performance-Based Rate (PBR) Plan section set forth above. In August 2004,
Nicor withdrew its Wells Submission in light of its continuing review of the
newly available additional sources of information referenced above. Nicor
continues in its efforts to resolve this matter with the SEC and has requested
that the SEC allow Nicor to file an updated Wells Submission if necessary.
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
Court of Cook County, Illinois, seeking 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 Gas is currently defending claims
brought by 28 households.
As of March 31, 2005, Nicor Gas had remaining an estimated liability of $19.7
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 Company Page 13
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Notes to the Consolidated Financial Statements (Unaudited) (continued)
Nicor Gas continues to pursue recovery from insurers and independent
contractors that had performed work for the company. 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. Amounts recovered
during 2004 were immaterial. On October 25, 2004 the Circuit Court of Cook
County, Illinois entered judgment in favor of Nicor and against various
insurers in the amount of $10.2 million with respect to one of Nicor's
mercury-related insurance claims. The judgment is subject to appeal, and the
insurers have indicated their intention to appeal the judgment. Accordingly,
the company has not reflected the $10.2 million in its financial statements.
The final disposition of these mercury-related matters is not expected to
have a material adverse impact on the company's financial condition.
Manufactured Gas Plant Sites. Manufactured gas plants were used in the
1800's and early to mid 1900's to produce manufactured gas from coal, creating
a coal tar byproduct. Current environmental laws may require the cleanup of
coal tar at certain former manufactured gas plant sites.
To date, Nicor Gas has identified about 40 properties for which it may, in
part, be responsible. Most of these properties are not presently owned by
the company. Information regarding preliminary site reviews has been
presented to the 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. As of
March 31, 2005 the company had recorded a liability of $32.8 million. 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.
Nicor Gas Company Page 14
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Notes to the Consolidated Financial Statements (Unaudited) (concluded)
Since costs and recoveries relating to the cleanup of manufactured gas plant
sites are passed directly through to customers in accordance with ICC
regulations, subject to an annual ICC prudence review, the final disposition
of manufactured gas plant matters is not expected to have a material impact
on the company's financial condition or results of operations.
Other. In an Illinois Supreme Court decision, the court affirmed the
appellate court's decision to permit proceedings to move forward against
Nicor Gas relating to a home explosion, which resulted in a fatality,
allegedly caused by a faulty gas appliance connector installed by the
homeowner. Although unable to determine the ultimate outcome of the above
referenced proceeding, the resolution is not expected to have a material
adverse impact on the company's financial condition or results of operations.
The company is unable to predict any potential operational impact of the
Illinois Supreme Court decision.
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, gas costs prudence reviews
and other matters. Although unable to determine the ultimate outcome of
these other contingencies, management believes that these amounts are
appropriately reflected in the financial statements, including the recording
of appropriate liabilities when reasonably estimable.
Nicor Gas Company Page 15
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion should be read in conjunction with the Management's
Discussion and Analysis section of the Nicor Gas 2004 Annual Report on Form
10-K. Results for the interim periods presented are not necessarily
indicative of the results to be expected for the full fiscal year due to
seasonal and other factors.
RESULTS OF OPERATIONS
The following table provides a comparison of Nicor Gas' results as reported
for the first quarter of 2005 and 2004 (in millions):
Three months ended
March 31
------------------
2005 2004
-------- --------
Operating income $ 43.2 $ 47.2
Net income 32.5 36.5
Net income for the first quarter of 2005 decreased to $32.5 million from
$36.5 million in the first quarter of 2004 due mainly to lower operating
income. Operating income decreased $4.0 million in 2005 due primarily to
higher operating and maintenance expenses, lower distribution margin and
higher depreciation expense.
Operating revenues. Gas distribution revenues are impacted by changes in
natural gas costs, which are passed directly through to customers without
markup, subject to Illinois Commerce Commission (ICC) review. Operating
revenues increased to $1,078.8 million in the first quarter of 2005 from
$1,035.1 million in 2004 due primarily to higher natural gas costs ($71.7
million), partially offset by the impact of warmer weather (approximately $30
million) and lower demand unrelated to weather (approximately $10 million).
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 natural gas costs, which are passed directly through to
customers without markup, subject to ICC review, and revenue taxes, for which
Nicor Gas earns 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.
A reconciliation of gas distribution revenues and margin follows (in
millions):
Three months ended
March 31
--------------------
2005 2004
--------- ---------
Revenues $ 1,078.8 $ 1,035.1
Cost of gas (836.8) (792.2)
Revenue tax expense (70.6) (69.5)
--------- ---------
Margin $ 171.4 $ 173.4
========= =========
Nicor Gas Company Page 16
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Gas distribution margin decreased $2.0 million in the first quarter of 2005
compared with the corresponding prior-year period due primarily to the
impacts of warmer weather (approximately $2 million) and lower demand
unrelated to weather (approximately $1 million), partially offset by higher
average rates realized during the period ($0.9 million).
Operating and maintenance expense. Operating and maintenance expense
increased $5.0 million to $68.3 million in the first quarter of 2005 from
$63.3 million in the 2004 first quarter due primarily to higher general claims
($2.2 million), bad debt expense ($1.7 million), payroll costs ($1.0
million), employee benefit costs ($0.7 million) and municipal franchise costs
($0.4 million). These negative factors were partially offset by lower legal
expenses related to the Performance Based Rate (PBR) plan ($2.5 million).
For information about the PBR plan, see the notes to the Consolidated
Financial Statements - Note 12 Contingencies.
Income taxes. The company's effective income tax rate was 32.6 percent for
the quarter ended March 31, 2005 and 36.0 percent for the corresponding
prior-year period. The decrease in the effective income tax rate in 2005
compared with 2004 was primarily a result of lower projected 2005 pretax
income. Lower pretax income typically causes a lower effective income tax
rate since permanent differences and tax credits are a larger share of pretax
income.
Interest expense. Interest expense for the three-month period ended March
31, 2005 remained relatively flat as compared with the corresponding 2004
period. This was the result of the offsetting impacts of higher effective
interest rates on debt ($1.4 million) and lower average borrowing levels
($1.5 million).
Nicor Gas Company Page 17
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Operating Statistics
Three months ended
March 31
-------------------
2005 2004
-------- --------
Operating revenues (millions)
Sales
Residential $ 748.6 $ 720.0
Commercial 166.1 158.0
Industrial 23.9 22.7
-------- --------
938.6 900.7
-------- --------
Transportation
Residential 8.2 8.1
Commercial 24.7 25.2
Industrial 10.3 10.9
Other 5.1 5.1
-------- --------
48.3 49.3
-------- --------
Other revenues
Revenue taxes 72.1 70.9
Environmental cost recovery 11.9 6.6
Chicago Hub 1.9 1.4
Other 6.0 6.2
-------- --------
91.9 85.1
-------- --------
$ 1,078.8 $ 1,035.1
======== ========
Deliveries (Bcf)
Sales
Residential 96.3 99.9
Commercial 21.1 21.6
Industrial 3.1 3.2
-------- --------
120.5 124.7
-------- --------
Transportation
Residential 8.6 8.8
Commercial 38.9 37.4
Industrial 33.8 36.9
-------- --------
81.3 83.1
-------- --------
201.8 207.8
======== ========
Customers at end of period (thousands)
Sales
Residential 1,781.2 1,759.0
Commercial 118.1 115.8
Industrial 7.4 7.4
-------- --------
1,906.7 1,882.2
-------- --------
Transportation
Residential 154.6 144.4
Commercial 59.1 58.6
Industrial 6.0 6.2
-------- --------
219.7 209.2
-------- --------
2,126.4 2,091.4
======== ========
Other statistics
Degree days 2,966 3,030
Colder (warmer) than normal* (1)% (2)%
Average gas cost per Mcf sold $ 6.90 $ 6.30
*Normal weather for Nicor Gas' service territory, for purposes of this report,
is considered to be about 5,830 degree days per year for 2005 and 6,000 degree
days per year for 2004. On a 6,000 degree day basis, the first quarter of 2005
is 4% warmer than normal.
Nicor Gas Company Page 18
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
FINANCIAL CONDITION AND LIQUIDITY
Operating cash flows. 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, storage and
hedging practices. The company relies on short-term financing to meet
seasonal increases in working capital needs. Cash requirements generally
increase over the third and fourth quarters due to increases in natural gas
purchases, gas in storage and accounts receivable. Over the first and second
quarters, positive cash flow generally results from the sale of gas in
storage and the collection of accounts receivable. This cash is typically
used to reduce short-term debt during the first half of the year. Net cash
flow provided from operating activities increased $94.2 million to $524.3
million in the 2005 first quarter from $430.1 million in the year-earlier
period.
Investing activities. Net cash flow used for investing activities increased
$4.5 million to $36.8 million in the 2005 first quarter from $32.3 million in
the prior-year period due to higher capital spending.
Financing activities. Nicor Inc. and Nicor Gas established two revolving
credit facilities totaling $900 million with major domestic and foreign banks
in 2004. These facilities, which serve as backup for the issuance of
commercial paper, consist of a $500 million, 3-year revolver, expiring
September 2007, available to Nicor Inc. and Nicor Gas, and a $400 million,
210-day seasonal revolver available to Nicor Gas, which expired in April
2005. The company had no commercial paper borrowings outstanding at March
31, 2005, and $375 million and $56 million of commercial paper borrowings
outstanding at December 31, 2004 and March 31, 2004, respectively. The
company is in compliance with the covenants relating to its credit facilities
at March 31, 2005. The company expects that funding from commercial paper
and related backup credit facilities will continue to be available in the
foreseeable future and sufficient to meet estimated cash requirements.
Nicor Gas maintains margin accounts related to financial derivative
transactions. These margin accounts may cause large fluctuations in cash
needs or sources in a relatively short period of time due to daily
settlements resulting from changes in natural gas futures prices. The
company manages these fluctuations with short-term borrowings.
Other. At March 31, 2005, Nicor Gas had outstanding cash advances due on
demand from Nicor, of $101 million. No such advances were outstanding as of
December 31, 2004 or March 31, 2004. For the quarter ended March 31, 2005
and 2004, interest income from Nicor was negligible. The company considers
investments purchased with an initial maturity of three months or less, or
amounts that are due on demand from an affiliate (labeled "Cash and cash
equivalents - affiliates" on the Consolidated Balance Sheets), to be cash
equivalents.
Contractual obligations. See Management's Discussion and Analysis of
Financial Condition and Results of Operations - Contractual obligations in
Nicor Gas' 2004 Annual Report on Form 10-K for a discussion of Nicor Gas'
contractual obligations.
Nicor Gas Company Page 19
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
OTHER FACTORS THAT MAY AFFECT BUSINESS PERFORMANCE
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. 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 12 Contingencies -
Performance-Based Rate Plan.
Rate Proceeding. On November 4, 2004, Nicor Gas filed with the ICC for an
overall increase in rates of approximately $83 million (or about 16.5 percent
of base rates revenue). The company's filing provided for a rate of return
on original-cost rate base of 9.34 percent, which reflects an 11.37 percent
cost of common equity. The requested rate increase is needed to recover
higher operating costs and increased capital investments. Nicor Gas has not
raised base rates since 1996.
As part of the requested rate increase, Nicor Gas has proposed that all
Chicago Hub revenues and approximately two-thirds of all bad debt expenses be
passed directly through to customers, reducing the earnings variability of
both items. In addition, the company has proposed setting rates assuming
normal weather of 5,830 degree days beginning in 2005 versus the 6,000 degree
days previously considered by the company as normal.
The proposed rate increase has been suspended pending the completion of the
ICC's review. The ICC normally has 11 months to complete its review of the
rate filing and to issue an order.
On April 5, 2005, Nicor Gas filed rebuttal testimony with the ICC, in
response to the direct testimony of the ICC staff and intervenors in the
proceeding, and revised its proposed rate increase of approximately $83
million to approximately $78 million. The revised proposal reflects a 10.82
percent cost of common equity resulting in a rate of return on original-cost
rate base of 9.03 percent.
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.
It is estimated that a 100-degree day variation from normal weather would
affect Nicor gas' net income by approximately $1 million. Since the first
quarter of 2003, external weather protection has not been purchased by the
company.
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.
Nicor Gas Company Page 20
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
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 ICC review.
There are allegations that the company acted improperly in connection with
the PBR plan, and the ICC and others are reviewing these allegations. On
June 27, 2002 the Citizens Utility Board (CUB) filed a motion to reopen the
record in the ICC's proceedings to review the PBR plan (the ICC Proceedings).
As a result of the motion to reopen, Nicor Gas, the Cook County State's Attorney
Office (CCSAO), the staff of the ICC and CUB entered into a stipulation
providing for additional discovery. The Illinois Attorney General's Office has
also intervened in this matter. In addition, the Illinois Attorney General's
Office issued Civil Investigation Demands (CIDs) to CUB and the ICC staff. The
CIDs ordered that CUB and the ICC staff produce all documents relating to any
claims that Nicor Gas may have presented, or caused to be presented, false
information related to its PBR plan. Parties who were plaintiffs in a dismissed
class action proceeding against the company could potentially intervene in these
proceedings. The company has committed to cooperate fully in the reviews of the
PBR plan.
In response to these allegations, on July 18, 2002, the Nicor Board of
Directors appointed a special committee of independent, non-management
directors to conduct an inquiry into issues surrounding natural gas purchases,
sales, transportation, storage and such other matters as may come to the
attention of the special committee in the course of its investigation. The
special committee presented the report of its counsel (Report) to Nicor's Board
of Directors on October 28, 2002. A copy of the report is available at the
Nicor website and has been previously produced to all parties in the ICC
Proceedings.
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 prior
years' financial statements resulting in a $24.8 million liability. Included
in such $24.8 million liability is a $4.1 million loss contingency. A $1.8
million adjustment to the previously recorded liability, which is discussed
below, was made in the third quarter of 2004 increasing the recorded
liability to $26.6 million. 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 and interest income on certain components
results in a $1.0 million reimbursement the company is seeking as of March 31,
2005, pending resolution of the proceedings discussed below. By the end of 2003
the company completed steps 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
Nicor Gas Company Page 21
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
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 were 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. On February 27, 2004 the above referenced intervenors filed their
rebuttal testimony in the ICC Proceedings. In such rebuttal testimony, CUB and
CCSAO amended the alleged amount to be refunded to customers from approximately
$143 million to $190 million. Nicor Gas filed rebuttal testimony in January
2004, which is consistent with the findings of the special committee Report.
Nicor Gas seeks a reimbursement of approximately $1.0 million as referenced
above. The parties to the ICC Proceedings have agreed to a stay of the
evidentiary hearings on this matter in order to undertake additional third
party discovery from Entergy-Koch Trading, LP (EKT), a natural gas, storage
and transportation trader and consultant with whom Nicor Gas did business under
the PBR plan.
During the course of the Securities and Exchange Commission (SEC)
investigation discussed below, the company became aware of additional
information relating to the activities of individuals affecting the PBR plan
for the period from 1999 through 2002, including information consisting of
third party documents and recordings of telephone conversations from EKT.
The company continues to obtain access to and review this information.
Review of additional information completed in the third quarter of 2004
resulted in the $1.8 million adjustment to the previously recorded liability
referenced above.
Although the Report of the special committee's counsel did not find that
there was criminal activity or fraud, a review of this additional information
(which was not available to the independent counsel who prepared the Report)
and re-interviews of certain Nicor Gas personnel indicates that certain
former Nicor Gas personnel may have engaged in potentially fraudulent conduct
regarding the PBR plan in violation of company policy, and in possible
violation of SEC rules and applicable law. Further, certain former Nicor Gas
personnel also may have attempted to conceal their conduct in connection with
an ICC review of the PBR plan. The company continues to cooperate with the SEC,
the U.S. Attorney's office and the ICC on this matter and to review and produce
additional documents as requested by these agencies. The company has reviewed
all third party information it has obtained and will continue to review any
additional third party information the company may obtain. The company
terminated four employees in connection with this matter in the third quarter
of 2004.
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 March 31, 2005.
SEC and U.S. Attorney Inquiries. In 2002, the staff of the 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
Nicor Gas Company Page 22
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
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. In April
2004, Nicor was advised by the SEC Division of Enforcement that it intended
to recommend to the SEC that it bring a civil injunctive action against
Nicor, alleging that Nicor violated Sections 17(a) of the Securities Act of
1933 and Sections 10(b) and 13(a) of the Securities Exchange Act of 1934 and
Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. The SEC may also seek
injunctive relief, disgorgement and civil penalties. The SEC staff invited
Nicor to make a formal response (known as a Wells Submission) with respect to
the proposed recommendation. In June 2004, Nicor filed its Wells Submission
with the SEC. In addition, in connection with the SEC's invitation to the
company to make a Wells Submission, the SEC informed the company of additional
sources of information relating to activities affecting the PBR plan, the
status of which is addressed in detail in the Performance-Based Rate (PBR) Plan
section set forth above. In August 2004, Nicor withdrew its Wells Submission
in light of its continuing review of the additional sources of newly available
information referenced above. Nicor continues in its efforts to resolve this
matter with the SEC and has requested that the SEC allow Nicor to file an
updated Wells Submission if necessary. 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 12 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 12 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, gas costs prudence reviews and other
matters. See the Notes to the Consolidated Financial Statements - Note 12
Contingencies.
Market risk. The company is exposed to market risk in the normal course of
its business operations, including the risk of loss arising from adverse
changes in natural gas commodity prices and interest rates. There has been
no material change in the company's exposure to market risk since the filing
of the 2004 Annual Report on Form 10-K.
See Management's Discussion and Analysis of Financial Condition and Results
of Operations - Other Factors That May Affect Business Performance in Nicor
Gas' 2004 Annual Report on Form 10-K for a detailed discussion of additional
factors that may affect the company's business performance.
CRITICAL ACCOUNTING ESTIMATES
See Management's Discussion and Analysis of Financial Condition and Results
of Operations - Critical Accounting Estimates in Nicor Gas' 2004 Annual
Report on Form 10-K for a discussion of the company's critical accounting
estimates.
Nicor Gas Company Page 23
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (concluded)
NEW ACCOUNTING PRONOUNCEMENT
Accounting for Conditional Asset Retirement Obligations. In March 2005, the
Financial Accounting Standards Board (FASB) issued Interpretation No. 47,
Accounting for Conditional Asset Retirement Obligations (FIN 47). For more
information, see the Notes to the Consolidated Financial Statements - Note 2
New Accounting Pronouncements.
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 SEC
and U.S. Attorney inquiries, 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 or recoveries; 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, interpretations, 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 4. Controls and Procedures
The company carried out an evaluation under the supervision and with the
participation of the company's management, including its Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of the company's disclosure controls and procedures as of the end
of the period covered by this Quarterly Report on Form 10-Q (the
"Evaluation").
In designing and evaluating the disclosure controls and procedures,
management recognizes that any disclosure 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
disclosure controls and procedures. Based on the Evaluation, the company's
Chief Executive Officer and Chief Financial Officer concluded that the
company's disclosure controls and procedures, as of the end of the period
covered by this Quarterly Report on Form 10-Q, 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 United States Securities and Exchange Commission
rules and forms.
Nicor Gas Company Page 24
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Item 4. Controls and Procedures (concluded)
There has been no change in the company's internal controls over financial
reporting during the company's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the company's
internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
See Management's Discussion and Analysis of Financial Condition and Results
of Operations - Contingencies and the Notes to the Consolidated Financial
Statements - Note 9 Rate Proceeding and Note 12 Contingencies, which are
incorporated herein by reference.
Item 6. Exhibits
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. (File No. 1-7296, Form 10-K for
2003, Exhibit 3.03.)
12.01 Computation of Consolidated Ratio of Earnings to Fixed Charges.
31.1 Rule 13a-14(a)/15d-14(a) Certification.
31.2 Rule 13a-14(a)/15d-14(a) Certification.
32.1 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.
Nicor Gas Company Page 25
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Signature
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Nicor Gas Company
May 3, 2005 /s/ RICHARD L. HAWLEY
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(Date) Richard L. Hawley
Executive Vice President and
Chief Financial Officer