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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

or

Commission File Number 1-7297

NICOR INC.

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

     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 [X] No [   ]

     The aggregate market value of common stock (based on the June 30, 2003 closing price of $37.11) held by non-affiliates of the registrant was approximately $1.6 billion. As of February 11, 2004, there were 44,039,432 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the company’s 2004 Annual Meeting Definitive Proxy Statement, to be filed on or about March 5, 2004, are incorporated by reference into Part III.

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Glossary

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PART I

Item 1. Business

Nicor Inc. (Nicor), incorporated in 1976, is a holding company. Its principal subsidiaries are Northern Illinois Gas Company (doing business as Nicor Gas Company (Nicor Gas)), one of the nation’s largest distributors of natural gas, and Tropical Shipping, a leading transporter of containerized freight in the Bahamas and the Caribbean region. Gas distribution is Nicor’s primary business, typically representing about 85 percent of consolidated operating income and about 90 percent of consolidated assets. Nicor also owns several energy-related ventures, including Nicor Services and Nicor Solutions, providing energy-related products and services for retail markets, and Nicor Enerchange, a wholesale natural gas marketing company. As a consolidated group, Nicor had approximately 3,500 employees at year-end 2003.

Summary financial information of Nicor’s major business segments is included in the Notes to the Consolidated Financial Statements - Note 13 Business Segment and Geographic Information. The following sections describe Nicor’s larger businesses. Certain terms used herein are defined in the glossary on page i.

GAS DISTRIBUTION

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 15 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.

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Item 1. Business (continued)

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.

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.

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Item 1. Business (continued)

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.

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 due to a partial financial offset within the consolidated Nicor group, as further described in Management’s Discussion and Analysis - Weather on page 22.

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 22.

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.

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Item 1. Business (continued)

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 27.

Properties

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 gas distribution properties are subject to the lien of the indenture securing Nicor Gas’ first mortgage bonds.

Additional information about Nicor Gas’ business is presented in Management’s Discussion and Analysis - Gas Distribution beginning on page 22.

SHIPPING

Tropical Shipping is one of the largest containerized cargo carriers in the Bahamas and Caribbean, a region characterized by modest market growth and intense competition. The company is a major carrier of exports from the east coast of the United States and Canada to the Caribbean region. The company’s shipments consist primarily of southbound cargo such as food, building materials and other necessities for developers, manufacturers and residents in the Caribbean, as well as tourist-related shipments intended for use in hotels and resorts, and on cruise ships. The balance of Tropical Shipping’s cargo consists of northbound shipments of apparel and agricultural products, and interisland shipments. The company also provides additional related services including inland transportation and cargo insurance. Tropical Shipping’s financial results can be significantly affected by general economic conditions in the United States, the Caribbean region and Canada.

At December 31, 2003, Tropical Shipping’s fleet consisted of 10 owned vessels and 5 chartered vessels with a container capacity totaling approximately 5,100 TEUs. In addition to the vessels, the company owns containers, container-handling equipment, chassis and other equipment. Real property, more than half of which is leased, includes office buildings, cargo handling facilities and warehouses located in the United States, Canada and some of the ports served.

Additional information about Tropical Shipping’s business is presented in Management’s Discussion and Analysis - Shipping beginning on page 24.

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Item 1. Business (concluded)

OTHER ENERGY VENTURES

Nicor owns several energy-related ventures, including two companies marketing energy-related products and services, and a wholesale natural gas marketing company. Nicor also has equity interests in several joint ventures including a FERC-regulated natural gas pipeline. In 2003, the company substantially liquidated its investment in a retail energy marketing joint venture.

Nicor Services and Nicor Solutions are wholly owned businesses that provide energy-related products and services for retail markets, including residential and small commercial users. Nicor Services offers products and services covering the sales, installation, maintenance, repair and improvement of heating, air conditioning and related equipment, including natural gas piping inside homes, ductwork and other equipment. Nicor Solutions offers its customers energy-related financial products, including utility-bill management plans as well as natural gas price protection plans.

Nicor Enerchange is a wholly owned business that engages in wholesale marketing of natural gas supply services primarily in the Midwest. Nicor Enerchange also administers the Nicor Gas Chicago Hub and manages Nicor Solutions’ product risks.

During 2002, Horizon Pipeline, a 50-percent-owned joint venture with NGPL, put into operation a 74-mile, 36-inch pipeline from Joliet, Illinois to near the Wisconsin/Illinois border. Nicor Gas has contracted for approximately 80 percent of Horizon Pipeline’s capacity under a 10-year agreement at rates that have been accepted by FERC.

Nicor Energy is a 50-percent-owned retail energy marketing joint venture with Dynegy Marketing and Trade. During 2003, Nicor Energy disposed of its customer contracts and ceased operations. For information about Nicor Energy see the Notes to the Consolidated Financial Statements - Note 19 Contingencies - Nicor Energy.

AVAILABLE INFORMATION

Nicor 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 13 (a) of the Securities Exchange Act of 1934. Nicor makes all of these reports available without charge to the public on the investor relations section of its corporate Web site at www.nicor.com as soon as reasonably practicable after Nicor files them with, or furnishes them to, the SEC.

Item 2. Properties

Information concerning Nicor and its major subsidiaries’ properties is included in Item 1, Business, beginning on page 1, and is incorporated herein by reference. These properties are suitable, adequate and utilized in the company’s operations.

Item 3. Legal Proceedings

See the Notes to the Consolidated Financial Statements - Note 19 Contingencies, which are incorporated herein by reference.

Item 4. Submission of Matters to a Vote of Security Holders

None.

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Executive Officers of the Registrant

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Executive Officers of the Registrant (concluded)

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Nicor common stock is listed on the New York and Chicago Stock Exchanges. At February 11, 2004, there were approximately 25,000 common stockholders of record.

Under a common stock repurchase program, Nicor may purchase its common stock as market conditions permit through open market transactions and to the extent cash flow is available after other cash needs and investment opportunities. There were no purchases in 2003, and at December 31, 2003, approximately $22 million remained authorized for the repurchase of common stock. However, Nicor did have the following common stock repurchases in the fourth quarter of 2003, primarily related to its Automatic Dividend Reinvestment and Stock Purchase Plans: 3,978 shares at an average price of $35.32 in October 2003; 53,164 shares at an average price of $34.46 in November 2003; and 6,304 shares at an average price of $33.34 in December 2003.

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Item 6. Selected Financial Data
(in millions, except per share data)

As of December 31, 2003, property, plant and equipment, net and total assets reflect the change in classification of accrued future removal costs. See Notes to the Consolidated Financial Statements Note 3 - Other Accounting Changes - Asset Retirement Obligations for further information.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The purpose of this financial review is to explain changes in operating results and financial condition from 2001 to 2003 and to discuss business trends and uncertainties that might affect Nicor Inc. (Nicor). 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 Inc. (Nicor) is a holding company with two principal subsidiaries - Nicor Gas and Tropical Shipping. Nicor Gas is one of the nation’s largest natural gas distribution companies and typically represents approximately 85 percent of Nicor’s operating income. Tropical Shipping is a containerized shipping business serving the Bahamas and the Caribbean region that typically represents approximately 10 percent of Nicor’s operating income. Nicor also owns or has equity interests in several energy-related businesses which have begun to provide a small but growing amount of income.

Net income and diluted earnings per common share are presented below (in millions, except per share data):

Net income was lower in 2003 compared with 2002 due primarily to lower operating income from the gas distribution segment, the cumulative effect of a change in accounting methods and an increase in the effective income tax rate. These factors were partially offset by improved equity investment results due primarily to cash received from a previously written off investment.

Net income was higher in 2002 compared with 2001 due primarily to increased insurance recoveries at the company’s gas distribution segment related to its mercury inspection and repair program, partially offset by other operating income reductions in the gas distribution segment. Lower net interest expense, and operating income improvements in the shipping segment, also contributed to the 2002 improvement.

Nicor’s net income and earnings per share were positively impacted for all periods presented by the recognition of partial recoveries from insurers and contractors and/or reserve reductions for Nicor Gas’ mercury inspection and repair program. The recognition of partial recoveries from insurers and contractors and/or reserve reductions lowered pretax operating expenses by $17.8 million, $29.0 million and $12.2 million in 2003, 2002 and 2001, respectively. For details of Nicor Gas’ mercury inspection and repair program, see the Notes to the Consolidated Financial Statements - Note 19 Contingencies - - Mercury Program.

Details of various financial and operating information by segment can be found on the pages that follow.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Operating income. Operating income (loss) by major business segment is presented below (in millions):

The following summarizes operating income comparisons by business segment:

•

Gas distribution operating income decreased $40.8 million in 2003 as compared to 2002 due primarily to increased operating and maintenance expenses ($20.5 million), lower Chicago Hub results ($8.1 million), higher depreciation ($5.9 million), and lower property sale gains ($3.7 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.

Gas distribution operating income increased $12.6 million in 2002 compared to 2001. The improvement reflects $29.0 million of pretax mercury-related insurance recoveries and reserve reductions in 2002 compared to $12.2 million in the prior year. Annual results were also impacted favorably by lower losses related to a performance-based rate (PBR) plan ($10.7 million), increased natural gas deliveries unrelated to weather ($6.6 million) and colder weather (about $4 million). Results were negatively impacted by higher operating costs, including lower pension credits ($14.1 million), increased legal and accounting costs related primarily to the PBR plan review ($8.7 million), higher depreciation ($5.2 million) and higher health care costs ($3.5 million).

•

Shipping operating income for 2003 rose $1.5 million compared to 2002 due to increased revenues from higher volumes shipped ($3.1 million), higher average rates ($1.4 million) and increased charter income ($1.8 million). These improvements were largely offset by higher fuel costs ($3.1 million) as well as higher other operating expenses ($2 million) in 2003.

Shipping operating income for 2002 increased $2.1 million compared to 2001 due to increased revenues from higher volumes shipped ($46.3 million) attributable primarily to acquisitions in 2002 and 2001, partially offset by the impact of higher operating expenses ($33.6 million) due primarily to increased volumes shipped as a result of the acquisitions and lower average rates ($10.9 million) due mainly to unfavorable economic conditions throughout the Caribbean region.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

•

Other energy ventures operating income for 2003 increased $1.5 million compared to 2002. Operating results were higher in Nicor’s energy-related products and services businesses ($.7 million). Also favorably impacting the year was the absence of project losses, as occurred in 2002, on former energy system development activities ($2.7 million).

Other energy ventures operating income for 2002 decreased $.4 million compared to 2001. Higher operating results in the company’s energy-related products and services businesses ($4.2 million) were more than offset by increased losses from the company’s former energy system development activities ($4.7 million).

RESULTS OF OPERATIONS

Details of various financial and operating information by segment can be found in the tables throughout this review. The following discussion summarizes the major items impacting Nicor’s results of operations.

Operating revenues. Operating revenues by major business segment are presented below (in millions):

Gas distribution revenues increased nearly 50 percent in 2003 compared to 2002 due primarily to higher natural gas costs, which are passed directly through to customers without markup, subject to 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.

The decrease in 2002 gas distribution revenues compared to 2001 was due primarily to much 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 (about $85 million) in 2002 compared to 2001.

In 2003, shipping segment operating revenues increased due primarily to higher volumes shipped ($3.1 million), higher average rates ($1.4 million) and increased charter income ($1.8 million). Higher volumes reflect increased activity from an acquisition that occurred in April 2002.

In 2002, shipping segment results included higher volume-related revenues ($46.3 million) partially offset by lower average rates ($10.9 million). The increases in volume-related revenues resulted primarily from acquisitions. The slow economy in the Caribbean region in 2002 put pressure on rates.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

The 2003 increase in revenues for other energy ventures was due primarily to the company’s energy-related products and services businesses ($49.4 million), largely reflecting new customers and products, such as utility-bill management products introduced in 2002. Negatively impacting 2003 were decreased revenues from Nicor’s former energy system development activities ($10.1 million).

The 2002 increase in revenues for other energy ventures was due primarily to higher revenue at the company’s energy-related products and services businesses, which increased $27.0 million to $40.0 million. Partially offsetting this increase were decreased revenues from former energy system development activities ($10.1 million).

Corporate and eliminations reflects primarily the elimination of gas distribution revenues against expenses for customers purchasing the utility-bill management products.

Gas distribution margin. Nicor utilizes a measure it refers to as “gas distribution margin” to evaluate the operating income impact of gas distribution revenues. Gas distribution revenues include gas costs, which are passed directly through to customers without markup, 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 follows (in millions):

Although 2003 and 2002 were essentially equal, a number of factors impacted margin. 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. The absence of PBR plan losses as occurred in 2002 ($4.1 million) and 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.

Gas distribution margin increased $23.9 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 included in the Notes to the Consolidated Financial Statements - Note 19 Contingencies - Performance-Based Rate Plan. Other factors affecting margin in 2002 were the positive effects of increased natural gas deliveries unrelated to weather ($6.6 million) and colder weather (about $4 million), and the negative effect of 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.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Gas distribution operating and maintenance expense. The increase in gas distribution 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).

Gas distribution 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).

Gas distribution 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 - Gas Distribution - Pension Investment Returns section.

Other gas distribution operating expenses. 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 19 Contingencies - Mercury Program.

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.

Shipping operating expenses. Shipping segment operating expenses rose $4.7 million in 2003 versus 2002 due primarily to higher fuel costs ($3.1 million) and increased vessel charter expenses ($.6 million). Increased fuel costs reflect the impact of higher fuel prices in 2003.

Shipping segment operating expenses rose $33.6 million in 2002 versus 2001 due primarily to increased volumes shipped as a result of acquisitions. Increased costs included higher transportation and voyage costs ($10.6 million), greater leased equipment costs ($5.1 million), higher wage and benefit costs ($4.1 million), and increased vessel charter expenses ($2.6 million).

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Other energy ventures operating expenses. The $38.1 million increase in the 2003 operating expenses compared to 2002 was due primarily to increased expenses at Nicor’s energy-related products and services businesses ($48.6 million) associated largely with the addition of new customers and products. This increase was partially offset by lower operating expenses from the company’s former energy system and design activities ($12.9 million).

The $13.6 million increase in other energy ventures operating expenses for 2002 compared to 2001 was due primarily to increased expenses at Nicor’s energy-related products and services businesses ($22.8 million) associated largely with the addition of new customers and products. The increase was partially offset by lower operating expenses from Nicor’s former energy system development activities ($5.4 million) and its gas distribution technology business ($4.3 million).

Corporate operating expenses and eliminations. Corporate operating expenses of $8.2 million, $6.3 million and $2.6 million in 2003, 2002 and 2001, respectively, include primarily legal and business development costs. These costs were more than offset by intercompany eliminations, related primarily to utility-bill management products offered by one of Nicor’s energy-related products and services businesses.

Equity investment income (loss). Equity investment results were positively affected in 2003 by cash receipts of $9.6 million from the company’s previously written-off investment in Nicor Energy. Lower results in 2002 reflect a $9.2 million investment loss from Nicor Energy, including the impairment writedown, compared with a loss of $.9 million in 2001. Equity investment results also include $5.5 million, $4.1 million and $3.6 million for 2003, 2002 and 2001, respectively, for Nicor’s share of Triton Container Investments LLC results.

Other income (expense). Other income (expense), net was $2.0 million in 2003, $3.4 million in 2002, and $7.6 million in 2001. The fluctuation from year to year was due primarily to reduced short-term investment levels and the resultant effect on interest income.

Interest expense. Interest expense decreased $1.2 million in 2003 and was down $7.5 million in 2002 compared to 2001 due to lower average borrowing levels and interest rates.

Income taxes. The company’s effective income tax rate rose to 35 percent in 2003 as compared to 31 percent in 2002 due principally to the effects of an increase in tax expense in 2003 relating to adjustments of deferred tax accounts and a reduction in tax expense in 2002 resulting from the completion of an income tax audit.

Cumulative effect of accounting change. The cumulative effect of a January 1, 2003 required accounting change relates to the application of accrual accounting, rather than fair value accounting, to gas in storage and certain energy-related contracts, such as storage and transportation contracts, at Nicor Enerchange, Nicor’s wholesale natural gas marketing business.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Gas Distribution Statistics

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Shipping Statistics

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 $(12.6) million, $268.3 million and $491.3 million in 2003, 2002 and 2001, respectively. Operating cash flow for 2003 was negative due primarily to changes in working capital items in the gas distribution segment. 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 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.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Capital expenditures. Capital expenditures by business segment are presented below (in millions):

Capital expenditures in the gas distribution segment for 2003 versus 2002 remained relatively level. 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.

Shipping segment capital expenditures were higher than normal in 2001 due primarily to the construction of two vessels. Expenditures were lower in 2002 and were further reduced in 2003 because vessel construction was completed in early 2002. Shipping segment capital expenditures are expected to rise in 2004 due to facilities renovations, the purchase of freight handling equipment and systems upgrades that were postponed from 2003.

Capital expenditures are expected to be higher at our other energy ventures in 2004 as computer systems are upgraded and facilities expanded at our retail energy-related products and services businesses.

Other investing activities. Nicor invested $10 million in each of 2003, 2002 and 2001 in a cargo container leasing business and may invest a similar amount in 2004. Nicor’s equity investment in this business at December 31, 2003 was $83.2 million.

In 2002, Nicor invested $16.5 million for a 50-percent share of equity in Horizon Pipeline. Nicor’s equity investment in this business at December 31, 2003 was $19.9 million. Additional information about Horizon Pipeline is presented on page 25.

Nicor’s equity investment in Nicor Energy was written off during the third quarter of 2002. During 2003, Nicor recorded gains of $9.6 million upon the receipt of cash from Nicor Energy. Any future gains or losses are expected to be minimal. Additional information about transactions with Nicor Energy is provided within the Nicor Energy section of the Notes to the Consolidated Financial Statements - Note 19 Contingencies.

In 2003, 2002 and 2001, Nicor Services, one of Nicor’s retail energy-related products and services businesses, acquired existing operations and assets to establish a heating, ventilation and air conditioning (HVAC) business. All purchases were made with shares of Nicor stock. Currently, Nicor Services has no plans for further HVAC acquisitions.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

In 2002, Tropical Shipping purchased certain assets of Tecmarine Lines Inc. and TMX Logistics Inc. for cash, expanding its network of Caribbean and South American destinations. In 2001, Tropical Shipping acquired the container assets of Kent Line International for cash, allowing Tropical Shipping to offer Canadian customers an all-water service from New Brunswick, Canada, to Tropical Shipping’s network of Caribbean destinations and Florida.

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.

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 Inc.’s commercial paper from F1+ to F1, 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’s debt-related financial statistics at December 31 include:

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 is in compliance with its debt covenants and believes it will continue to remain so. Nicor’s long-term debt agreements do not include ratings triggers or material adverse change provisions.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

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.

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 Inc. and Nicor Gas maintain 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 $2.9 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 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. In 2001, Nicor completed a previously initiated $50 million common stock repurchase program and announced a new $50 million common stock repurchase program. Purchases may be made as market conditions permit through open market transactions and to the extent cash flow is available after other cash needs and investment opportunities. The company purchased and retired .4 million and 1.1 million common shares in 2002 and 2001, respectively, at a cost of $18 million and $42 million, respectively, under the stock repurchase programs. There were no purchases under the existing program in 2003, and at December 31, 2003, approximately $22 million remained authorized for the repurchase of common stock.

Nicor increased its quarterly common stock dividend rate during 2003 by 1.1 percent to $.465 per common share. The company paid dividends on its common stock of $81.7 million, $80.4 million and $78.5 million in 2003, 2002 and 2001, respectively. Nicor currently has no contractual or regulatory restrictions on the payment of dividends.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Contractual obligations. As of December 31, 2003, Nicor had contractual obligations with payments due as follows (in millions):