nicorinc123110form10k.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the fiscal year ended December 31, 2010
or
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-7297
NICOR INC LOGO
NICOR INC.
(Exact name of registrant as specified in its charter)
Illinois
 
36-2855175
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
     
1844 Ferry Road
   
Naperville, Illinois 60563-9600
 
(630) 305-9500
(Address of principal executive offices) (Zip Code)
 
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $2.50 per share
 
New York Stock Exchange
   
Chicago Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes [X]   No [   ]
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes [   ]   No [X]
 
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 has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months.  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 a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer    [X]
Accelerated filer                     [   ]
   
Non-accelerated filer      [   ]
Smaller reporting company   [   ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes [   ] No [X]

The aggregate market value of common stock (based on the June 30, 2010 closing price of $40.50) held by non-affiliates of the registrant was approximately $1.8 billion.  As of February 16, 2011, there were 45,549,683 shares of common stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE

Portions of the company’s 2010 Annual Meeting Definitive Proxy Statement, to be filed on or about April 26, 2011, are incorporated by reference into Part III.




 
 


Nicor Inc.

 
       
 
Item No.
Description
Page No.
       
   
ii
       
   
Part I
 
 
1.
1
 
1A.
7
 
1B.
18
 
2.
18
 
3.
18
 
4.
18
   
19
       
   
Part II
 
 
5.
20
 
6.
22
 
7.
23
 
7A.
45
 
8.
47
 
9.
87
 
9A.
87
 
9B.
88
       
   
Part III
 
 
10.
89
 
11.
89
 
12.
90
 
13.
90
 
14.
90
       
   
Part IV
 
 
15.
91
   
93
   
94

i
 


Glossary

AGL Resources.  AGL Resources, Inc., the company with whom Nicor entered into an Agreement and Plan of Merger on December 6, 2010.

ALJs.  Administrative Law Judges.

ARO.  Asset retirement obligation.

Base gas.  The gas required in a storage reservoir to provide the pressure to cycle the normal working storage volume.

Central Valley.  Central Valley Gas Storage, L.L.C., a wholly owned business that is developing a natural gas storage facility in the Sacramento River valley of north-central California.

Chicago Hub.  A venture of Nicor Gas, which provides natural gas storage and transmission-related services to marketers and other gas distribution companies.

CPUC.  California Public Utilities Commission, the agency that regulates utility services in California.

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 5,600 degree days per year for 2010 and 2009 and 5,830 degree days per year for 2008.

EN Engineering.  EN Engineering, L.L.C., a previously owned joint venture that provides engineering and consulting services.  Nicor sold its ownership on March 31, 2009.

FERC.  Federal Energy Regulatory Commission, the agency that regulates the interstate transportation of natural gas, oil and electricity.

Financial Reform Legislation.  Dodd-Frank Wall Street Reform and Consumer Protection Act.

Health Care Act.  Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.

Horizon Pipeline.  Horizon Pipeline Company, L.L.C., a 50-percent-owned joint venture that operates an interstate regulated natural gas pipeline of approximately 70 miles, stretching from Joliet, Illinois to near the Wisconsin/Illinois border.

ICC.  Illinois Commerce Commission, the agency that establishes the rules and regulations governing utility rates and services in Illinois.
 
IDR.  Illinois Department of Revenue.
 
IRS.  Internal Revenue Service.
 
Jobs Act.  American Jobs Creation Act of 2004.

LIBOR.  London Inter-bank Offered Rate.

LIFO.  Last-in, first-out.

Mcf, MMcf, Bcf.  Thousand cubic feet, million cubic feet, billion cubic feet.
 
 
Nicor.  Nicor Inc., or the registrant.

Nicor Advanced Energy.  Prairie Point Energy, L.L.C. (doing business as Nicor Advanced Energy), a wholly owned business that provides natural gas and related services on an unregulated basis to residential and small commercial customers.

Nicor Enerchange.  Nicor Enerchange, L.L.C., a wholly owned business that engages in wholesale marketing of natural gas supply services primarily in the Midwest, administers the Chicago Hub for Nicor Gas, serves commercial and industrial customers in the northern Illinois market area, and manages Nicor Solutions’ and Nicor Advanced Energy’s product risks, including the purchase of natural gas supplies.

Nicor Gas.  Northern Illinois Gas Company (doing business as Nicor Gas Company) is a regulated wholly owned public utility business and one of the nation’s largest distributors of natural gas.

Nicor Services.  Nicor Energy Services Company, a wholly owned business that provides customer move connection services for utilities and product warranty contracts, heating, ventilation and air conditioning repair, maintenance and installation services and equipment to retail markets, including residential and small commercial customers.

Nicor Solutions.  Nicor Solutions, L.L.C., a wholly owned business that offers residential and small commercial customers energy-related products that provide for natural gas cost stability and management of their utility bill.

NYMEX.  New York Mercantile Exchange.

PBR.  Performance-based rate, a regulatory plan which ended on January 1, 2003, that provided economic incentives based on natural gas cost performance.
 
PCBs.  Polychlorinated Biphenyls.
 
PGA.  Purchased Gas Adjustment, a rate rider that passes natural gas costs directly through to customers without markup, subject to ICC review.

Rider.  A rate adjustment mechanism that is part of a utility’s tariff which authorizes it to provide specific services or assess specific charges.

Sawgrass Storage.  Sawgrass Storage, L.L.C., a 50-percent-owned natural gas storage development joint venture with Mill Creek Gas Storage, L.L.C., an affiliate of Samson Contour Energy E&P, L.L.C., involving the proposed development of a depleted natural gas reservoir located near Monroe, Louisiana.
 
SEC.  The United States Securities and Exchange Commission.

TEL.  Tropic Equipment Leasing, Inc., a wholly owned subsidiary of Nicor, holds the company’s interest in Triton.

TEU.  Twenty-foot equivalent unit, a measure of volume in containerized shipping equal to one 20-foot-long container.

Triton.  Triton Container Investments L.L.C., a cargo container leasing company in which Nicor Inc. has an investment.

Tropical Shipping.  A wholly owned business and a carrier of containerized freight in the Bahamas and the Caribbean region.

iii
 


PART I

Business

Nicor, an Illinois corporation formed in 1976, is a holding company.  Gas distribution is Nicor’s primary business.  Nicor’s major subsidiaries include Nicor Gas, one of the nation’s largest distributors of natural gas, and Tropical Shipping, a transporter of containerized freight in the Bahamas and the Caribbean region.  Nicor also owns several energy-related ventures, including Nicor Services, Nicor Solutions and Nicor Advanced Energy, which provide energy-related products and services to retail markets, Nicor Enerchange, a wholesale natural gas marketing company, and Central Valley, which is developing a natural gas storage facility.  As a consolidated group, Nicor had approximately 3,800 employees at year-end 2010.

Summary financial information for Nicor’s major businesses is included in Item 8 – Notes to the Consolidated Financial Statements – Note 14 – Business Segment and Geographic Information.  The following sections describe Nicor’s plan of merger with AGL Resources, followed by descriptions of Nicor’s larger businesses.  Certain terms used herein are defined in the glossary on pages ii and iii.

PROPOSED MERGER WITH AGL RESOURCES

In December 2010, Nicor entered into an Agreement and Plan of Merger (the “Merger Agreement”) with AGL Resources.  In accordance with the Merger Agreement, each share of Nicor common stock outstanding at the Effective Time (as defined in the Merger Agreement), other than shares to be cancelled, and Dissenting Shares (as defined in the Merger Agreement), will be converted into the right to receive consideration consisting of (i) $21.20 in cash and (ii) 0.8382 shares of AGL Resources common stock, subject to adjustment in certain circumstances.

The completion of the proposed merger is subject to various customary conditions, including, among others (i) shareholder approval by both companies, (ii) expiration or termination of any applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, (iii) the SEC’s clearance of a registration statement registering AGL Resources common stock and (iv) receipt of all required regulatory approvals from, among others, the ICC.

The Merger Agreement contains certain termination rights for both Nicor and AGL Resources, and further provides for the payment of fees and expenses upon termination under specified circumstances. The proposed merger is expected to be completed in the second half of 2011. Except for specific references to the proposed merger, the disclosures contained in this report on Form 10-K relate solely to Nicor.

In January 2011, Nicor, Nicor Gas and AGL Resources filed a joint application with the ICC for approval of the proposed merger. The application did not request a rate increase and included a commitment to maintain the number of full-time equivalent employees involved in the operation of Nicor’s gas distribution subsidiary at a level comparable to current staffing for a period of three years following merger completion. The ICC has eleven months to act upon the application.

For additional information relating to the proposed merger please see Nicor’s Form 8-K filed on December 7, 2010 and the joint proxy statement / prospectus contained in the registration statement on Form S-4 filed by AGL Resources on February 4, 2011.
 
1
 


GAS DISTRIBUTION
 
General

Nicor Gas, a regulated natural gas distribution utility, serves 2.2 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, providing the company with a well-balanced mix of residential, commercial and industrial customers.  Residential customers typically account for approximately 50 percent of natural gas deliveries, while commercial and industrial customers each typically account for approximately 25 percent.  See Gas Distribution Statistics on page 31 for operating revenues, deliveries and number of customers by customer classification.  Nicor Gas had approximately 2,200 employees at year-end 2010.

Nicor Gas maintains franchise agreements with most of the incorporated municipalities it serves, allowing it to construct, operate and maintain distribution facilities in those incorporated municipalities.  Franchise agreement terms range up to 50 years.  Currently, about one-third of the agreements will expire within five years.

Customers have the option of purchasing their own natural 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 natural gas sales service results in less revenue for Nicor Gas but has no direct impact on net operating results.  Nicor Gas continues to deliver natural gas, maintain its distribution system and respond to emergencies.

Nicor Gas also operates the Chicago Hub, which provides natural gas storage and transmission-related services to marketers and other gas distribution companies.  The Chicago area is a major market hub for natural gas, and demand exists for storage and transmission-related services by marketers, other gas distribution companies and electric power-generation facilities.  Nicor Gas’ Chicago Hub addresses that demand.  Chicago Hub revenues are passed directly through to customers as a credit to Nicor Gas’ PGA rider.

Sources of Natural Gas Supply

Nicor Gas purchases natural gas supplies in the open market by contracting with producers and marketers.  It also purchases transportation and storage services from interstate pipelines that are regulated by the FERC.  When firm pipeline 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 cost of natural 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 purchases are diversified by supplier, producing region, quantity, credit limits and available transportation.  Natural gas supply pricing is generally tied to published price indices so as to approximate current market prices.  These supply contracts also may require the payment of fixed demand charges to ensure the availability of supplies on any given day.  The company also purchases natural gas supplies on the spot market to fulfill its supply requirements or to take advantage of favorable short-term pricing.
 

As part of its purchasing practices, Nicor Gas maintains a price risk hedging strategy to reduce the risk of price volatility.  A disciplined approach is used to systematically forward hedge a predetermined portion of forecasted monthly volumes.

As noted previously, transportation customers purchase their own natural gas supplies.  About one-half of the natural gas that the company delivers is purchased by transportation customers directly from producers and marketers.

Pipeline transportation.  The Nicor Gas distribution and storage system is directly connected to eight interstate pipelines.  This provides the company with direct access to most of the major natural gas producing regions in North America.  The company has long-term transportation contracts with nearly all of these interstate pipelines and generally has a right-of-first-refusal for contract extensions.  The largest of these long-term transportation contracts is with Natural Gas Pipeline Company of America (“NGPL”) which provides approximately 70 percent of the firm transportation capacity. In addition, Nicor Gas enters into short-term winter-only transportation contracts and market-area transportation contracts that enhance Nicor Gas’ operational flexibility.

Storage.  Nicor Gas owns and operates eight underground natural gas storage facilities.  This storage system is one of the largest in the gas distribution industry.  The storage reservoirs provide a total inventory capacity of about 150 Bcf, approximately 135 Bcf of which can be cycled on an annual basis.  The system is designed to meet about 50 percent of the company’s estimated peak-day deliveries and approximately 40 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 2012 and 2013.  This level of storage capability provides Nicor Gas with supply flexibility, improves the reliability of deliveries, and can mitigate the risk associated with seasonal price movements.

Competition/Demand

Nicor Gas is the largest natural gas distributor in Illinois and is regulated by the ICC.  The company is the sole distributor of natural gas in essentially all of its service territory.  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.  In addition, the company has a tariff that allows negotiation with potential bypass customers.  Nicor Gas also offers commercial and industrial customers alternatives in rates and service, increasing its ability to compete in these markets.  Other significant factors that impact demand for natural gas include weather, conservation 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 three-quarters of the 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 impacts Nicor Gas’ distribution margin, net of income taxes, by approximately $1.3 million under the company’s current rate structure.

The effect of weather variations on Nicor Gas’ results is offset, in part, due to weather risks within the consolidated Nicor group related to the utility-bill management products marketed by Nicor Solutions and Nicor Advanced Energy.  The amount of this offset has approximated 30 percent to 65 percent and will vary depending upon the time of year, weather patterns, the number of customers for these products and the market price for natural gas.

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.  However, deliveries of natural
 
 
gas can be negatively affected by conservation, high natural gas prices and the use of alternative energy sources.

Regulation

Nicor Gas is regulated by the ICC, which governs utility rates and services in Illinois.  Those ICC orders and regulations that may significantly affect business performance include the following:

·  
Base rates, which are set by the ICC, are designed to allow the company an opportunity to recover its costs and earn a fair return for investors.  On March 25, 2009, the ICC issued an order approving an increase in Nicor Gas’ base revenues of approximately $69 million, a rate of return on rate base of 7.58 percent and a rate of return on equity of 10.17 percent.  On October 7, 2009, the ICC increased the annual base revenues approved for Nicor Gas in the March 25, 2009 order by approximately $11 million as a result of a rehearing decision and increased the rate of return on rate base to 8.09 percent.  Therefore, the total annual base revenue increase resulting from these ICC orders is approximately $80 million.  For additional information about the rate proceeding, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8 – Notes to the Consolidated Financial Statements – Note 18 – Regulatory Proceedings.

·  
The company’s ICC-approved tariffs provide that the cost of natural gas purchased for customers will be fully charged to customers without markup.  Therefore, the company does not profit from the sale of natural gas.  Rather, the company earns income from fixed monthly charges and from variable transportation charges for delivering natural gas to customers.  Annually, the ICC initiates a review of the company’s natural gas purchasing practices for prudence, and may disallow the pass-through of costs considered imprudent.  The annual prudence reviews for calendar years 1999-2010 are open for review.

·  
The company has ICC-approved tariffs that provide for the pass-through of prudently incurred environmental costs related to the remediation of former 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 of these sites.  As of December 31, 2010, the company had recorded a liability in connection with these matters of $28.7 million.  These costs are subject to annual ICC review.  For additional information on the company’s obligation for manufactured gas plants, see Item 8 – Notes to the Consolidated Financial Statements – Note 20 – Contingencies – Manufactured Gas Plant Sites.
 
·  
On February 2, 2010, the ICC approved a bad debt rider which provides for the recovery from (or refund to) customers of the difference between Nicor Gas’ actual bad debt experience on an annual basis and the benchmark bad debt expense included in its base rates for the respective year.  For additional information about the bad debt rider, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8 – Notes to the Consolidated Financial Statements – Note 18 – Regulatory Proceedings.

·  
As part of the rate order issued in 2009, the ICC approved an energy efficiency rider to fund the costs of energy savings programs.  Pursuant to an Illinois law enacted in 2009 that requires local gas distribution utilities to establish plans to achieve specified energy savings goals beginning in June 2011, Nicor Gas filed an application with the ICC seeking approval of a new energy efficiency plan on September 29, 2010.  The law provides utilities with a rider to collect the costs of the plan from customers.  Under its proposed plan, the company estimates that it would bill nearly $100 million to customers under the rider, over a three year period commencing June 1, 2011, to fund the costs of various energy savings programs identified in the company’s filing.  This new energy efficiency plan rider will replace the rider currently in effect.  The costs under these riders are subject to annual ICC review.

4
 


·  
On July 1, 2009, Nicor Gas filed a petition seeking re-approval from the ICC of the operating agreement that governs many inter-company transactions between Nicor Gas and its affiliates.  The petition was filed pursuant to a requirement contained in the ICC order approving the company’s most recent general rate increase and requested that the operating agreement be re-approved without change.  For additional information regarding this proceeding, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

·  
On January 18, 2011, AGL Resources, Nicor and Nicor Gas filed a joint application with the ICC seeking approval of the merger of AGL Resources and Nicor and other approvals relating to the merger.  For additional information regarding this proceeding, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Nicor Gas enters into various service agreements with Nicor and its affiliates.  Nicor Gas, to the extent required, obtains ICC approvals for these agreements.

The ICC has other rules that impact the operations of utilities in Illinois.

A 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 natural 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 Item 8 – Notes to the Consolidated Financial Statements – Note 20 – Contingencies – PBR Plan.

Gas distribution, transmission and storage system, and other properties

The gas distribution, transmission and storage system includes approximately 34,000 miles of steel, plastic and cast iron main; approximately 2.0 million steel, plastic/aluminum composite, plastic and copper services connecting the mains to customers’ premises; and eight 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 Item 1A – Risk Factors, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8 – Notes to the Consolidated Financial Statements.

SHIPPING

Tropical Shipping is a transporter of containerized freight in the Bahamas and the Caribbean, a region which has historically been 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 these regions.  The company’s shipments consist primarily of southbound cargo such as building materials, food and other necessities for developers, manufacturers and residents in the Caribbean and the Bahamas, 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 primarily of interisland shipments and northbound shipments of apparel and agricultural products.  Other related services such as inland transportation and cargo insurance are also provided by Tropical Shipping or other Nicor subsidiaries.

5
 


At December 31, 2010, Tropical Shipping’s operating fleet consisted of 11 owned vessels and 3 chartered vessels with a container capacity totaling approximately 4,970 TEUs.  In addition to the vessels, the company owns and/or leases 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 Item 1A – Risk Factors, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8 – Notes to the Consolidated Financial Statements.

OTHER ENERGY VENTURES

Nicor owns several energy-related ventures, including three companies marketing energy-related products and services and a wholesale natural gas marketing company.  Nicor is also developing natural gas storage facilities and owns an interest in an interstate natural gas pipeline.

Nicor Services, Nicor Solutions and Nicor Advanced Energy are businesses that provide energy-related products and services to retail markets, including residential and small commercial customers.  Nicor Services operates primarily in northern Illinois and provides warranty and maintenance contracts, as well as repair and installation services of heating, air conditioning and indoor air-quality equipment, and customer move connection services for utilities.  In conjunction with national expansion efforts, Nicor Services began doing business under the Nicor National brand in 2009.  Nicor Solutions offers its residential and small commercial customers, primarily in the Nicor Gas service territory, energy-related products that provide for natural gas price stability and management of their utility bill.  These products mitigate and/or eliminate the risks to customers of colder than normal weather and/or changes in natural gas prices.  Nicor Advanced Energy is certified by the ICC as an Alternate Gas Supplier, authorizing it to be a non-utility marketer of natural gas for residential and small commercial customers.  Nicor Advanced Energy presently operates in northern Illinois, offering customers an alternative to the utility as its natural gas supplier.

Nicor Enerchange is a business that engages in wholesale marketing of natural gas supply services primarily in the Midwest, administers the Chicago Hub for Nicor Gas, serves commercial and industrial customers in the northern Illinois market area, and manages Nicor Solutions’ and Nicor Advanced Energy’s product risks, including the purchases of natural gas supplies.

Central Valley is developing an underground natural gas storage facility in the Sacramento River valley of north-central California and plans to provide approximately 11 Bcf of working natural gas capacity, offering flexible, high-deliverability multi-cycle services and interconnection to a regional pipeline.   In October 2010, the CPUC approved Central Valley’s Certificate of Public Convenience and Necessity to construct and operate the storage facility.  Central Valley plans to initiate construction activity during the first quarter of 2011 and expects completion during the fourth quarter of 2011, with firm storage services commencing in early 2012.  Nicor is also participating in a natural gas storage development joint venture known as Sawgrass Storage.  In 2010, Sawgrass Storage initiated the pre-filing process with the FERC.

Horizon Pipeline, a 50-percent-owned joint venture with NGPL, operates a natural gas pipeline of approximately 70 miles, stretching from Joliet, Illinois to near the Wisconsin/Illinois border.  Nicor Gas has contracted for approximately 80 percent of Horizon Pipeline’s capacity under an agreement expiring in 2012 at rates that have been accepted by the FERC.

EN Engineering, a previously-owned joint venture between Nicor and A. Epstein & Sons International, is an engineering and consulting firm that specializes in the design, installation and maintenance of natural gas, petroleum and liquid pipeline facilities.  EN Engineering provides engineering and corrosion services to Nicor Gas.  Nicor sold its ownership on March 31, 2009.

6
 


Additional information about Nicor’s other energy ventures is presented in Item 1A – Risk Factors, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8 – Notes to the Consolidated Financial Statements.

CORPORATE

Nicor has various equity investments, the largest of which is Triton, a cargo container leasing business.  Additional information on Nicor’s equity investments are presented in Item 8 – Notes to the Consolidated Financial Statements – Note 15 – Equity Investment Income, Net.

AVAILABLE INFORMATION

Nicor files various reports with the SEC.  These reports include the annual reports 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 section of the company’s Internet site at www.nicor.com as soon as reasonably practicable after Nicor files them with, or furnishes them to, the SEC.

Item 1A.        Risk Factors

The following factors are the most significant factors that can impact year-to-year comparisons and may affect the future performance of the company’s businesses.  New risks may emerge and management cannot predict those risks or estimate the extent to which they may affect the company’s financial performance.

The risks described below should be carefully considered in addition to the other cautionary statements and risks described elsewhere, and the other information contained in this report and in Nicor’s other filings with the SEC, including its subsequent reports on Forms 10-Q and 8-K.  The risks and uncertainties described below are not the only risks Nicor faces although they are the most significant risks.  See Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, Item 7A – Quantitative and Qualitative Disclosures About Market Risk, and Item 8 – Notes to the Consolidated Financial Statements for further discussion of these and other risks Nicor faces.  Additionally, see the joint proxy / prospectus contained in the registration statement on Form S-4 filed by AGL Resources on February 4, 2011.

Regulation of Nicor Gas, including changes in the regulatory environment in general, may adversely affect the company’s results of operations, cash flows and financial condition.

Nicor Gas is regulated by the ICC, which has general regulatory power over practically all phases of the public utility business in Illinois, including rates and charges, issuance of securities, services and facilities, system of accounts, investments, safety standards, transactions with affiliated interests and other matters.

Nicor Gas is permitted by the ICC’s PGA regulation to adjust the charge to its sales customers on a monthly basis to recover the company’s prudently incurred actual costs to acquire the natural gas it delivers to them.  The company’s gas costs are subject to subsequent prudence reviews by the ICC for which the company makes annual filings.  The annual prudence reviews for calendar years 1999-2010 are open for review and any disallowance of costs in those proceedings could adversely affect Nicor Gas’ results of operations, cash flows and financial condition.

Additionally, Nicor Gas is permitted by ICC regulations to periodically adjust the charge to its customers to recover the company’s prudently incurred actual costs associated with environmental remediation at
 
 
former manufactured gas plant sites, franchise payments to municipalities, energy efficiency programs and, as approved in February 2010, bad debt expense.  These charges are subject to subsequent prudence reviews by the ICC and any disallowance of costs by the ICC could adversely affect Nicor Gas’ results of operations, cash flows and financial condition.

Most of Nicor Gas’ other charges are changed only through a rate case proceeding with the ICC.  The charges established in a rate case proceeding are based on an approved level of operating costs and investment in utility property and are designed to allow the company an opportunity to recover those costs and to earn a fair return on that investment based upon an estimated volume of annual natural gas deliveries.  To the extent Nicor Gas’ actual costs to provide utility service are higher than the levels approved by the ICC, or its actual natural gas deliveries are less than the annual volume estimated by the ICC, Nicor Gas’ results of operations, cash flows and financial condition could be adversely affected until such time as it files for and obtains ICC approval for new charges through a rate case proceeding.

Nicor Gas is subject to rules and regulations pertaining to the integrity of its distribution system and environmental compliance.  The company’s results of operations, cash flows and financial condition could be adversely affected by any additional laws or regulations that are enacted that require significant increases in the amount of expenditures for system integrity and environmental compliance.

The ICC has other rules that impact the operations of utilities in Illinois.  Changes in these rules could impact the company’s results of operations, cash flows and financial condition.

Nicor Gas enters into various service agreements with Nicor and its affiliates. Nicor Gas obtains the required ICC approvals for these agreements.  The company’s results of operations, cash flows and financial condition could be adversely affected if, as a result of a change in law or action by the ICC, new restrictions are imposed that limit or prohibit certain service agreements between Nicor Gas and its affiliates.

A change in the ICC’s approved rate mechanism for recovery of environmental remediation costs at former manufactured gas plant sites, or adverse decisions with respect to the prudence of costs actually incurred, could adversely affect the company’s results of operations, cash flows and financial condition.

Current environmental laws may require the cleanup of coal tar at certain former manufactured gas plant sites for which the company may in part be responsible.  Management believes that any such costs that are not recoverable from other entities or from insurance carriers are recoverable through rates for utility services under an ICC-approved mechanism for the recovery of prudently incurred costs.  A change in this rate recovery mechanism, however, or a decision by the ICC that some or all of these costs were not prudently incurred, could adversely affect the company’s results of operations, cash flows and financial condition.

An adverse decision in the proceeding concerning Nicor Gas’ PBR plan could result in a refund obligation which could adversely affect the company’s results of operations, cash flows and financial condition.

In 2000, Nicor Gas instituted a PBR plan for natural gas costs.  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 was terminated effective January 1, 2003.  There are allegations that Nicor Gas acted improperly in connection with the PBR plan, and the ICC is reviewing these allegations in a pending proceeding.  An adverse decision in this proceeding could result in a refund to ratepayers or other obligations which could adversely affect the company’s results of operations, cash flows and financial condition.
 

Nicor Gas relies on direct connections to eight interstate pipelines and extensive underground storage capacity.  If these pipelines or storage facilities were unable to deliver natural gas for any reason it could impair Nicor Gas’ ability to meet its customers’ full requirements which could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor Gas meets its customers’ peak day, seasonal and annual gas requirements through deliveries of natural gas transported on interstate pipelines, with which it or its natural gas suppliers have contracts, and through withdrawals of natural gas from storage fields it owns or leases.  Nicor Gas contracts with multiple pipelines for transportation services.  If a pipeline were to fail to perform transportation or storage service, including as a result of war, acts or threats of terrorism, mechanical problems or natural disaster, on a peak day or other day with high volume gas requirements, Nicor Gas’ ability to meet all of its customers’ natural gas requirements may be impaired unless or until alternative arrangements for delivery of supply were put in place.  Likewise, if a storage field owned by Nicor Gas, or a principal Nicor Gas-owned transmission or distribution pipeline used to deliver natural gas to the market, were to be out of service for any reason, including as a result of war, acts or threats of terrorism, mechanical problems or natural disaster, this could impair Nicor Gas’ ability to meet its customers’ full requirements which could adversely affect the company’s results of operations, cash flows and financial condition.

Fluctuations in weather, conservation, economic conditions and use of alternative fuel sources have the potential to adversely affect the company’s results of operations, cash flows and financial condition.

When weather conditions are milder than normal, Nicor Gas has historically delivered less natural gas, and consequently may earn less income.  Nicor Gas’ natural gas deliveries are temperature-sensitive and seasonal since about one-half of all deliveries are used for space heating.  Typically, about three-quarters of the deliveries and revenues occur from October through March.  Mild weather in the future could adversely affect the company’s results of operations, cash flows and financial condition.  In addition, factors including, but not limited to, conservation, economic conditions and the use of alternative fuel sources could also result in lower customer demand.

Conversely, results from products sold by Nicor Solutions and Nicor Advanced Energy generally benefit from milder than normal weather.  Nicor Solutions and Nicor Advanced Energy offer utility-bill management products that mitigate and/or eliminate the risks to customers of variations in weather.  Benefits or costs related to these products resulting from variances from normal weather are recorded primarily at the corporate level as a result of an agreement between the parent company and certain of its subsidiaries.  To the extent weather is colder than normal in the future, Nicor Solutions and Nicor Advanced Energy’s results of operations, cash flows and financial condition could be adversely affected.

Conservation could adversely affect the company's results of operations, cash flows and financial condition.

As a result of recent legislative and regulatory initiatives, the company has put into place programs to promote additional energy efficiency by its customers.  Funding for such programs is being recovered through a cost recovery rider.  However, the adverse impact of lower deliveries and resulting reduced margin could adversely affect the company's results of operations, cash flows and financial condition until such time as it files for and obtains ICC approval for new charges through a rate case proceeding.

Possible legislation or regulation intended to address concerns about climate change could adversely affect the company’s results of operations, cash flows and financial condition.

Future laws may mandate reductions in greenhouse gas emissions by the company and its customers in an effort to address concerns about the possible effect of those emissions on the climate.  If enacted, such laws could require the company to reduce emissions and to incur compliance costs that could adversely affect the company’s results of operations, cash flows and financial condition.

9
 


Natural gas commodity price changes may affect the operating costs and competitive positions of the company’s businesses which could adversely affect its results of operations, cash flows and financial condition.

Nicor’s energy-related businesses are sensitive to changes in natural gas prices. Natural gas prices historically have been volatile and may continue to be volatile in the future.  Prices for natural gas are subject to a variety of factors that are beyond Nicor’s control.  These factors include, but are not limited to, the level of consumer demand for, and the supply of, natural gas, processing, gathering and transportation availability, the level of imports of, and the price of foreign natural gas, legislatively mandated gas supply purchase obligations, the price and availability of alternative fuel sources, weather conditions, natural disasters and political conditions or hostilities in natural gas producing regions.

Any changes in natural gas prices could affect the prices Nicor’s energy-related businesses charge, operating costs and the competitive position of products and services.  In accordance with the ICC’s PGA regulations, Nicor Gas adjusts its gas cost charges to sales customers on a monthly basis to account for changes in the price of natural gas.  However, changes in natural gas prices can also impact certain operating and financing costs that can only be reflected in Nicor Gas’ charges to customers if approved by the ICC in a rate case.  Increases in natural gas prices can also have an adverse effect on natural gas distribution margin because such increases can result in lower customer demand.

Nicor’s other energy businesses are also subject to natural gas commodity price risk, arising primarily from fixed-price purchase and sale agreements, natural gas inventories and utility-bill management arrangements.  Derivative instruments such as futures, options, forwards and swaps may be used to hedge these risks.

Nicor’s use of derivative instruments could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor uses derivative instruments, including futures, options, forwards and swaps, either traded on exchanges or executed over-the-counter with natural gas merchants as well as financial institutions, to hedge natural gas price risk.  Fluctuating natural gas prices cause earnings and financing costs of Nicor to be impacted.  The use of derivative instruments that are not perfectly matched to the exposure could adversely affect the company’s results of operations, cash flows and financial condition.  Also, when Nicor’s derivative instruments either do not qualify for hedge accounting treatment or for which hedge accounting is not elected, the company’s results of operations, cash flows and financial condition could be adversely affected.

Nicor is subject to margin requirements in connection with the use of derivative financial instruments and these requirements could escalate if prices move adversely.

Adverse decisions in lawsuits seeking a variety of damages allegedly caused by mercury spillage could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor Gas has incurred, and expects to continue to incur, costs related to its historical use of mercury in various kinds of equipment.  Nicor Gas remains a defendant in several private lawsuits, all in the Circuit Court of Cook County, Illinois, seeking a variety of unquantified damages (including bodily injury and property damages) allegedly caused by mercury spillage resulting from the removal of mercury-containing regulators.  Potential liabilities relating to these claims have been assumed by a contractor’s insurer subject to certain limitations.  Adverse decisions regarding these claims, if not fully covered by such insurance, could adversely affect the company’s results of operations, cash flows and financial condition.
 

Transporting and storing natural gas involves numerous risks that may result in accidents and other operating risks and costs that could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor Gas’ activities involve a variety of inherent hazards and operating risks, such as leaks, accidents and mechanical problems, which could cause substantial financial losses.  In addition, these risks could result in loss of human life, significant damage to property, environmental pollution and impairment of Nicor Gas’ operations, which in turn could lead to substantial losses.  In accordance with customary industry practice, Nicor Gas maintains insurance against some, but not all, of these risks and losses.  The location of pipelines and storage facilities near populated areas, including residential areas, commercial business centers and industrial sites, could increase the level of damages resulting from these risks.  The occurrence of any of these events if not fully covered by insurance could adversely affect the company’s results of operations, cash flows and financial condition.

A significant decline in the market value of investments held within the pension trust maintained by Nicor Gas adversely affects the company’s results of operations, cash flows and financial condition.

Nicor Gas sponsors a defined benefit pension plan and, over the years, has made contributions to a trust to fund future benefit obligations of the pension plan participants.  A significant decline in the market value of investments held in the trust of the pension plan unfavorably impacts the benefit costs associated with the pension plan and could adversely affect Nicor Gas’ liquidity if additional contributions to the trust are required. These impacts, either individually or in aggregate, may adversely affect the company’s results of operations, cash flows and financial condition.

An inability to access financial markets could affect the execution of Nicor’s business plan and could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor relies on access to both short- and long-term capital markets as a significant source of liquidity for capital and operating requirements not satisfied by the cash flows from its operations.  Management believes that Nicor and its subsidiaries will maintain sufficient access to these financial markets based upon current credit ratings.  However, certain disruptions outside of Nicor’s control or events of default under its debt agreements may increase its cost of borrowing or restrict its ability to access one or more financial markets.  Such disruptions could include an economic downturn, the bankruptcy of an unrelated energy company or downgrades to Nicor’s credit ratings.  Furthermore, Nicor’s ability to incur indebtedness or issue debt securities is restricted by the covenants set forth in the Merger Agreement.  Restrictions on Nicor’s ability to access financial markets may affect its ability to execute its business plan as scheduled and could adversely affect the company’s results of operations, cash flows and financial condition.

Changes in the rules and regulations of certain regulatory agencies could adversely affect the results of operations, cash flows and financial condition of Tropical Shipping.

Tropical Shipping is subject to the International Ship and Port-facility Security Code and is also subject to the United States Maritime Transportation Security Act, both of which require extensive security assessments, plans and procedures.  Tropical Shipping is also subject to the regulations of both the Federal Maritime Commission, and the Surface Transportation Board, other federal agencies as well as local laws, where applicable.  Additional costs that could result from changes in the rules and regulations of these regulatory agencies would adversely affect the results of operations, cash flows and financial condition of Tropical Shipping.
 
11
 


Tropical Shipping’s business is dependent on general economic conditions.  Changes or downturns in the economy could adversely affect the results of operations, cash flows and financial condition of Tropical Shipping.

Tropical Shipping’s business consists primarily of the shipment of building materials, food and other necessities from the United States and Canada to developers, manufacturers and residents in the Bahamas and the Caribbean region, as well as tourist-related shipments intended for use in hotels and resorts, and on cruise ships.  As a result, Tropical Shipping’s results of operations, cash flows and financial condition can be significantly affected by adverse general economic conditions in the United States, Bahamas, Caribbean region and Canada.  Also, a shift in buying patterns that results in such goods being sourced directly from other parts of the world, including China and India, rather than the United States and Canada, could significantly affect Tropical Shipping’s results of operations, cash flows and financial condition.

The occurrence of hurricanes, storms and other natural disasters in Tropical Shipping’s area of operations could adversely affect its results of operations, cash flows and financial condition.

Tropical Shipping’s operations are affected by weather conditions in Florida, Canada, the Bahamas and Caribbean regions.  During hurricane season in the summer and fall, Tropical Shipping may be subject to revenue loss, higher operating expenses, business interruptions, delays, and ship, equipment and facilities damage which could adversely affect Tropical Shipping’s results of operations, cash flows and financial condition.

Nicor has credit risk that could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor extends credit to its counterparties.  Despite what the company believes to be prudent credit policies and the maintenance of netting arrangements, the company is exposed to the risk that it may not be able to collect amounts owed to it.  If counterparties fail to perform and any collateral the company has secured is inadequate, it could adversely affect the company’s results of operations, cash flows and financial condition.

The company is involved in legal or administrative proceedings before various courts and governmental bodies that could adversely affect the company’s results of operations, cash flows and financial condition.

The company is involved in legal or administrative proceedings before various courts and governmental bodies with respect to general claims, rates, taxes, environmental issues, billing, credit and collection matters, intersegment services, gas cost prudence reviews and other matters.  Adverse decisions regarding these matters, to the extent they require the company to make payments in excess of amounts provided for in its financial statements, could adversely affect the company’s results of operations, cash flows and financial condition.

Changes in taxation could adversely affect the company’s results of operations, cash flows and financial condition.

Various tax and fee increases may occur in locations in which the company operates.  For example, the Illinois corporate income tax rate was increased effective January 1, 2011.  The company cannot predict whether other legislation or regulation will be introduced, the form of any legislation or regulation, or whether any such legislation or regulation will be passed by the legislatures or other governmental bodies.  New taxes or an increase in tax rates would increase tax expense and could adversely affect the company’s results of operations, cash flows and financial condition.
 

Changes in the laws and regulations regarding the sale and marketing of products and services offered by Nicor’s other energy ventures could adversely affect the results of operations, cash flows and financial condition of Nicor.

Nicor’s other energy ventures provide various energy-related products and services.  These include sales of natural gas and utility-bill management services to residential and small commercial customers, the sale, repair, maintenance and warranty of heating, air conditioning and indoor air quality equipment and wholesale natural gas supply services.  The sale and marketing of these products and services by Nicor’s other energy ventures are subject to various state and federal laws and regulations.  Changes in these laws and regulations could impose additional costs on, or restrict or prohibit certain activities by, Nicor’s other energy ventures which could adversely affect the results of operations, cash flows and financial condition of Nicor.

Risks Related to the Proposed Merger with AGL Resources

The merger may not be completed, which could adversely affect Nicor’s business operations and stock price.

To complete the merger, AGL Resources shareholders must approve the issuance of shares of AGL Resources common stock as contemplated by the Merger Agreement and the amendment to AGL Resources’ amended and restated articles of incorporation to increase the number of directors that may serve on AGL Resources’ board of directors, and Nicor shareholders must approve the Merger Agreement.  In addition, each of AGL Resources and Nicor must also make certain filings with and obtain certain other approvals and consents from various federal and state governmental and regulatory authorities.

AGL Resources and Nicor have not obtained all regulatory clearances, consents and approvals required to complete the merger.  Governmental or regulatory agencies could still seek to block or challenge the merger or could impose restrictions they deem necessary or desirable in the public interest as a condition to approving the merger.  If these approvals are not received, or they are not received on terms that satisfy the conditions set forth in the Merger Agreement, then neither AGL Resources nor Nicor will be obligated to complete the merger.

In addition, the Merger Agreement contains other customary closing conditions, which may not be satisfied or waived.  If AGL Resources and Nicor are unable to complete the merger, Nicor would be subject to a number of risks, including the following:

·  
Nicor would not realize the anticipated benefits of the merger, including increased operating efficiencies;
·  
the attention of Nicor’s management may have been diverted to the merger rather than to its own operations and the pursuit of other opportunities that could have been beneficial to Nicor;
·  
the potential loss of key personnel during the pendency of the merger as employees may experience uncertainty about their future roles with the combined company;
·  
Nicor will have been subject to certain restrictions on the conduct of its business, which may prevent it from making certain acquisitions or dispositions or pursuing certain business opportunities while the merger is pending; and
·  
the trading price of Nicor common stock may decline to the extent that the current market price reflects a market assumption that the merger will be completed.

Nicor is required to pay AGL Resources a termination fee and the reimbursement of merger-related out-of-pocket expenses if Nicor terminates the Merger Agreement under certain circumstances specified in the Merger Agreement.
 
13
 


The occurrence of any of these events individually or in combination could have a material adverse effect on Nicor’s results of operations or the trading price of Nicor common stock.

Nicor is subject to contractual restrictions in the Merger Agreement that may hinder its operations pending the merger.

The Merger Agreement restricts Nicor, without AGL Resources’ consent, from making certain acquisitions and taking other specified actions until the merger occurs or the Merger Agreement terminates.  These restrictions may prevent Nicor from pursuing otherwise attractive business opportunities and making other changes to its business prior to completion of the merger or termination of the Merger Agreement.

The value of shares of AGL Resources common stock to be received by Nicor shareholders in the merger will fluctuate.

In the merger, each share of Nicor common stock outstanding immediately prior to completion of the merger (other than shares of Nicor common stock owned by AGL Resources, Nicor or any of their respective subsidiaries and shares of Nicor common stock held by Nicor shareholders who have perfected their dissenters’ rights) will be converted into the right to receive $21.20 in cash and 0.8382 shares of AGL Resources common stock, subject to adjustment in certain circumstances.  The exchange ratio will not be adjusted to reflect stock price changes prior to the completion of the merger.

The market prices of AGL Resources common stock and Nicor common stock immediately prior to the effective time of the completion of the merger may vary significantly from their market prices on the date of the Merger Agreement, the date of this Annual Report on Form 10-K and at the date of the special meeting of the shareholders of Nicor that is called to vote to approve the Merger Agreement.  These variations may be the result of various factors, including, without limitation:
·  
changes in the business, operations or prospects of AGL Resources and/or Nicor;
·  
speculation regarding the likelihood that the merger will be completed and the timing of the completion;
·  
general market and economic conditions; and
·  
regulatory developments and/or litigation.

The merger may not be completed until a significant period of time has passed after the Nicor shareholder approval is received.  At the time of the Nicor special meeting, Nicor shareholders will not know the exact market value of the AGL Resources common stock that will be received as a result of the merger.

The actual market value of shares of AGL Resources common stock, when received by Nicor shareholders, will depend on the market value of those shares on that date.  This market value may be significantly less or significantly more than the value used to determine the number of shares to be issued pursuant to the merger, as that determination was made at the time the Merger Agreement was entered into by the parties.  Neither AGL Resources nor Nicor is permitted to terminate the Merger Agreement solely because of a change in the market price for AGL Resources common stock or Nicor common stock.

The merger is subject to receipt of consent or approval from governmental entities that could delay or prevent the completion of the merger or that could cause abandonment of the merger.

To complete the merger, AGL Resources and Nicor need to obtain approvals or consents from, or make filings with, a number of United States federal and state public utility, antitrust and other regulatory authorities, including, among others, the Federal Trade Commission, the Department of Justice, the ICC and the CPUC.
 

While Nicor believes that they will receive the required statutory approvals and other clearances for the merger, there can be no assurance as to the timing of these approvals and clearances.  If such approvals and clearances are received, they may impose terms that do not satisfy the conditions set forth in the Merger Agreement, which could permit AGL Resources or Nicor to terminate the Merger Agreement. A substantial delay in obtaining the required authorizations, approvals or consents or the imposition of unfavorable terms, conditions or restrictions contained in such authorizations, approvals or consents could prevent the consummation of the merger.

Governmental authorities could seek to block or challenge the merger as they deem necessary or desirable in the public interest.

The special meeting at which the Nicor shareholders will vote on the approval of the merger contemplated by the Merger Agreement may take place before all such approvals have been obtained and, in certain cases where they have not been obtained, before the terms of any conditions to obtain such approvals that may be imposed are known.  As a result, if shareholder approval of the transactions contemplated by the Merger Agreement is obtained at such meeting, Nicor may make decisions after the special meeting to waive a condition or approve certain actions required to obtain necessary approvals without seeking further shareholder approval.

Nicor will be subject to various uncertainties while the merger is pending that may cause disruption and may make it more difficult to maintain relationships with employees, suppliers or customers.

Uncertainty about the effect of the merger on employees, suppliers and customers may have an adverse effect on Nicor.  Although Nicor intends to take steps designed to reduce any adverse effects, these uncertainties may impair Nicor’s abilities to attract, retain and motivate key personnel until the merger is completed and for a period of time thereafter, and could cause customers, suppliers and others that deal with Nicor to seek to change or terminate existing business relationships with Nicor or not enter into new relationships or transactions.

Employee retention and recruitment may be challenging prior to the completion of the merger, as employees and prospective employees may experience uncertainty about their future roles with the combined company.  If, despite Nicor’s retention and recruiting efforts, key employees depart or fail to continue employment with Nicor because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with the combined company, Nicor’s financial results could be adversely affected.

Pending shareholder suits could delay or prevent the closing of the merger or otherwise adversely impact the business and operations of Nicor.

Nicor, its board of directors, AGL Resources, one or both of AGL Resources’ acquisition subsidiaries and, in one instance, Nicor’s Executive Vice President and Chief Financial Officer, have been named as defendants in five putative class action lawsuits brought by purported Nicor shareholders challenging Nicor’s proposed merger with AGL Resources.  The shareholder actions variously allege, among other things, that the Nicor board of directors breached its fiduciary duties to Nicor and its shareholders by (i) approving the sale of Nicor to AGL Resources at an inadequate purchase price (and thus failing to maximize value to Nicor shareholders); (ii) conducting an inadequate sale process by agreeing to preclusive deal protection provisions in the Merger Agreement; and (iii) failing to disclose material information regarding the proposed merger to Nicor shareholders.  The complaints also allege that AGL Resources and Nicor aided and abetted these alleged breaches of fiduciary duty.  The shareholder actions seek, among other things, declaratory and injunctive relief, including orders enjoining the defendants from consummating the proposed merger and, in certain circumstances, damages.  No assurances can be given as to the outcome of these lawsuits, including the costs associated with defending these lawsuits or any other liabilities or costs the parties may incur in connection with the litigation or settlement of these
 
 
lawsuits.  Furthermore, one of the conditions to closing the merger is that there are no injunctions issued by any court preventing the completion of the transactions.  No assurance can be given that these lawsuits will not result in such an injunction being issued which could prevent or delay the closing of the transactions contemplated by the Merger Agreement.

Nicor will incur significant transaction, merger-related and restructuring costs in connection with the merger.

Nicor expects to incur costs associated with combining its operations with those of AGL Resources, as well as transaction fees and other costs related to the merger.  These costs will be expensed as incurred.

The Merger Agreement contains provisions that limit Nicor’s ability to pursue alternatives to the merger, which could discourage a potential acquirer of Nicor from making an alternative transaction proposal and, in certain circumstances, could require Nicor to pay AGL Resources a termination fee of $67 million.

Under the Merger Agreement, Nicor is restricted, subject to limited exceptions, from entering into alternative transactions.  Unless and until the Merger Agreement is terminated, subject to specified exceptions, Nicor and its subsidiaries are restricted from initiating, soliciting, seeking, inducing or intentionally encouraging or facilitating any inquiries or the making of any proposal or offer for a competing acquisition proposal with any person.  Furthermore, Nicor and its subsidiaries are subject to limitations on their ability to participate in any discussions or negotiations, or to furnish any information to any person that has made an acquisition proposal with respect to Nicor or to approve, endorse or recommend any such acquisition proposal for Nicor.  Additionally, under the Merger Agreement, in the event of a potential change of recommendation by the board of directors of Nicor with respect to the merger-related proposals, Nicor must provide AGL Resources with five business days prior notice and, if requested, negotiate in good faith an adjustment to the terms and conditions of the Merger Agreement prior to changing its recommendation.

Nicor may terminate the Merger Agreement and enter into an agreement with respect to a superior proposal only if specified conditions have been satisfied, including compliance with the non-solicitation provisions of the Merger Agreement.  In addition, under the Merger Agreement, Nicor may be required to pay AGL Resources a termination fee of $67 million if the Merger Agreement is terminated under certain circumstances related to an alternative acquisition proposal.  These provisions could discourage a third party that may have an interest in acquiring all or a significant part of Nicor from considering or proposing that acquisition, even if such third party were prepared to pay consideration with a higher per share cash or market value than the value of the merger consideration proposed to be received or realized in the merger, or might result in a potential competing acquirer proposing to pay a lower price than it would otherwise have proposed to pay because of the added expense of the termination fee that may become payable in certain circumstances.

As a result of these restrictions, Nicor may not be able to enter into an agreement with respect to a more favorable alternative transaction without incurring a potentially significant liability to AGL Resources.

AGL Resources’ inability to obtain the financing necessary to complete the transaction could delay or prevent the completion of the merger.

AGL Resources intends to finance the cash portion of the merger consideration with debt financing.  To this end, AGL Capital Corporation (a subsidiary of AGL Resources), entered into a bridge facility pursuant to which, subject to certain conditions and limitations, the lenders agree to provide loans to AGL Capital Corporation in an aggregate principal amount of $1.05 billion.  AGL Resources and/or AGL Capital Corporation may issue debt securities, preferred stock, common equity, or other securities, bank loans, or other debt financings in lieu of all or a portion of the drawing under the bridge facility.

16
 


Under the terms of the Merger Agreement, if all of the conditions to closing are satisfied and the proceeds of the financing or alternative financing necessary to complete the transaction are not available, the Merger Agreement may be terminated by either party, so long as such party is not in material breach of its representations, warranties or covenants in the Merger Agreement that was a proximate cause of the financing failure.  In such event, AGL Resources is required to pay Nicor a financing failure fee of $115 million.

The availability of funds under the bridge facility is subject to certain conditions including, among others, the absence of a material adverse effect on AGL Resources or Nicor, pro forma compliance with a consolidated total debt to total capitalization ratio of 70 percent, the ability of AGL Capital Corporation to achieve certain minimum credit ratings and the ability of AGL Capital Corporation to achieve a certain liquidity level at closing.  If AGL Resources is unable to timely obtain the financing because one of the conditions to the financing fails to be satisfied, the closing of the merger could be significantly delayed or may not occur at all.

The opinion rendered to the board of directors of Nicor by its financial advisor was based on the financial analyses it performed, which considered factors such as market and other conditions then in effect, and financial forecasts and other information made available to it, as of the date of its opinion.  As a result, this opinion does not reflect changes in events or circumstances after the date of the opinion.

The opinion rendered to the board of directors of Nicor by Nicor’s financial advisor was provided in connection with, and at the time of, the board of directors’ evaluation of the merger.  The opinion was necessarily based on the financial analyses performed, which considered market and other conditions then in effect, and financial forecasts and other information made available to the financial advisor, as of the date of its opinion, which may have changed after the date of the opinion.  The opinion did not speak as of the time that the merger would be completed or as of any date other than the date of such opinion.
 
17
 


Item 1B.        Unresolved Staff Comments

None.

Properties

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

Legal Proceedings

Illinois Attorney General Subpoena.  On February 8, 2010, the Office of the Attorney General for the State of Illinois (“IOAG”) issued a subpoena to Nicor to provide documents in connection with an IOAG investigation pursuant to the Illinois Whistleblower Reward and Protection Act.  On November 30, 2010, the IOAG issued Nicor an amended request for information.  According to the subpoena, the IOAG investigation relates to billing practices used with certain customer accounts involving government funds.  While the company believes its billing practices comply with ICC requirements, the company is unable to predict the outcome of this matter or reasonably estimate its potential exposure, if any, and has not recorded a liability associated with this matter.

Also see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Other Matters and Item 8 – Notes to the Consolidated Financial Statements – Note 1 – Proposed Merger with AGL Resources and Note 20 – Contingencies, which are incorporated herein by reference.

Item 4.            (Removed and Reserved)
 
18
 


Executive Officers of the Registrant

Name
 
Age
 
Position and Business Experience during past five years
         
Russ M. Strobel
 
58
 
Chairman, Nicor and Nicor Gas (since 2005); Chief Executive Officer, Nicor (since 2005); Chief Executive Officer, Nicor Gas (since 2003); President, Nicor and Nicor Gas (since 2002).
         
Richard L. Hawley
 
61
 
Executive Vice President and Chief Financial Officer, Nicor and Nicor Gas (since 2003).
         
Rocco J. D’Alessandro
 
52
 
Executive Vice President Operations, Nicor Gas (since 2006); Senior Vice President Operations, Nicor Gas (2002-2006).
         
Daniel R. Dodge
 
57
 
Executive Vice President Diversified Ventures, Nicor (since 2007); Senior Vice President Diversified Ventures and Corporate Planning, Nicor and Nicor Gas (2002-2007).
         
Claudia J. Colalillo
 
61
 
Senior Vice President Human Resources and Corporate Communications, Nicor (since 2002) and Nicor Gas (since 2006); Senior Vice President Human Resources and Customer Care, Nicor Gas (2002-2006).
         
Paul C. Gracey, Jr.
 
51
 
Senior Vice President, General Counsel and Secretary, Nicor and Nicor Gas (since 2006); Vice President, General Counsel and Secretary, Nicor and Nicor Gas (2002-2006).
         
Gerald P. O’Connor
 
 
59
 
Senior Vice President Finance and Strategic Planning, Nicor and Nicor Gas (since 2007); Senior Vice President Finance and Treasurer, Nicor and Nicor Gas (2007); Vice President Administration and Finance, Nicor and Nicor Gas (2004-2006).
         
Karen K. Pepping
 
46
 
Vice President and Controller, Nicor and Nicor Gas (since 2006); Assistant Vice President and Controller, Nicor and Nicor Gas (2005-2006).
         
Douglas M. Ruschau
 
52
 
Vice President and Treasurer, Nicor and Nicor Gas (since 2007); Vice President Finance and Treasurer, Peoples Energy Corporation (2002-2007).
         
Rick Murrell
 
64
 
Chairman, Tropical Shipping and Construction Company Limited (since 2006); President, Tropical Shipping and Construction Company Limited (2006 – January 2011).
 
19
 


PART II

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 16, 2011, there were approximately 16,700 common stockholders of record and the closing stock price was $52.51.

     
Stock price
   
Dividends
 
Quarter
   
High
   
Low
   
Declared
 
                     
2010
                   
First
    $ 43.75     $ 37.99     $ .465  
Second
      44.70       38.63       .465  
Third
      46.27       39.54       .465  
Fourth
      50.81       42.98       .465  
                           
2009
                         
First
    $ 36.34     $ 27.50     $ .465  
Second
      35.37       30.28       .465  
Third
      38.08       32.83       .465  
Fourth
      43.39       34.96       .465  
                           

In 2001, Nicor announced a $50 million common stock repurchase program, under which 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 have been no repurchases under this program since 2002.  As of December 31, 2010, $21.5 million remained authorized for the repurchase of common stock.
 
20
 


STOCK PERFORMANCE GRAPH

The following graph shows a five-year comparison of cumulative total returns for Nicor common stock, the S&P 500 Utilities Index and the S&P 500 Index (both of which include Nicor common stock) as of December 31 of each of the years indicated, assuming $100 was invested on January 1, 2006, and all dividends were reinvested.

Comparison of Five-Year Cumulative Total Return
 
 stock performance graph
 


   
2006
   
2007
   
2008
   
2009
   
2010
 
                               
Nicor
  $ 124     $ 117     $ 101     $ 129     $ 159  
S&P 500 Utilities Index
    121       144       103       115       121  
S&P 500 Index
    116       122       77       97       112  
 
21
 

 
Nicor Inc.
                             
                               
Item 6.           Selected Financial Data
                             
(in millions, except per share data)
                             
                               
   
Year ended December 31
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
                               
Operating revenues
  $ 2,709.8     $ 2,652.1     $ 3,776.6     $ 3,176.3     $ 2,960.0  
                                         
Operating income
  $ 235.7     $ 220.3     $ 185.0     $ 206.5     $ 202.5  
                                         
Net income
  $ 138.4     $ 135.5     $ 119.5     $ 135.2     $ 128.3  
                                         
Earnings per average share of common stock
                                       
Basic
  $ 3.02     $ 2.99     $ 2.64     $ 2.99     $ 2.88  
Diluted
    3.02       2.98       2.63       2.99       2.87  
                                         
Dividends declared per common share
  $ 1.86     $ 1.86     $ 1.86     $ 1.86     $ 1.86  
                                         
Property, plant and equipment
                                       
Gross
  $ 5,127.7     $ 4,961.0     $ 4,802.4     $ 4,611.7     $ 4,479.7  
Net
    3,022.8       2,939.1       2,858.6       2,757.3       2,714.7  
                                         
Total assets
  $ 4,496.5     $ 4,435.7     $ 4,784.0     $ 4,271.3     $ 4,137.2  
                                         
Capitalization
                                       
Long-term debt, net of unamortized discount (1)
  $ 498.4     $ 498.2     $ 498.0     $ 497.8     $ 497.5  
Mandatorily redeemable preferred stock
    -       .1       .6       .6       .6  
Common equity
    1,103.9       1,037.7       973.1       945.2       876.1  
    $ 1,602.3     $ 1,536.0     $ 1,471.7     $ 1,443.6     $ 1,374.2  
                                         
(1) Includes amounts due within one year.
                                       
                                         
See Item 1A - Risk Factors and Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations for factors that can impact year-to-year comparisons and may affect the future performance of Nicor's business.
 


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 2008 to 2010 and to discuss business trends that might affect Nicor.  Certain terms used herein are defined in the glossary on pages ii and iii.  The discussion is organized into seven sections – Summary, Results of Operations, Financial Condition and Liquidity, Other Matters, Outlook, Contingencies and Critical Accounting Estimates.

SUMMARY

Nicor is a holding company.  Gas distribution is Nicor’s primary business.  Nicor’s subsidiaries include Nicor Gas, one of the nation’s largest distributors of natural gas, and Tropical Shipping, a transporter of containerized freight in the Bahamas and the Caribbean region.  Nicor also owns several energy-related ventures, including Nicor Services, Nicor Solutions and Nicor Advanced Energy, which provide energy-related products and services to retail markets, Nicor Enerchange, a wholesale natural gas marketing company, and Central Valley, which is developing a natural gas storage facility.  Nicor also has equity interests in a cargo container leasing business, a FERC-regulated natural gas pipeline, a natural gas storage development project and certain affordable housing investments.

Net income and diluted earnings per common share are presented below (in millions, except per share data):
 
   
2010
   
2009
   
2008
 
                   
Net income
  $ 138.4     $ 135.5     $ 119.5  
                         
Diluted earnings per common share
  $ 3.02     $ 2.98     $ 2.63  

When comparing 2010 results to 2009, net income and diluted earnings per common share for 2010 include a $1.3 million pretax reduction ($.02 per share) to the company’s previously established reserve for its mercury inspection and repair program.  Year over year comparisons (excluding the effect of the mercury-related reserve adjustment) reflect higher operating income in the company’s gas distribution business, partially offset by lower operating income in the company’s shipping and other energy-related businesses, lower corporate operating results, lower equity investment income and a higher effective income tax rate.

When comparing 2009 results to 2008, net income and diluted earnings per common share for 2008 include an unfavorable pretax mercury-related reserve adjustment of $0.6 million ($.01 per share).  Year over year comparisons (excluding the effect of the mercury-related reserve adjustment) reflect improved operating results in the company’s gas distribution business and other energy-related businesses and higher equity investment income, partially offset by lower operating income in the company’s shipping business, lower interest income and a higher effective income tax rate.

Proposed merger with AGL Resources.  In December 2010, Nicor entered into a Merger Agreement with AGL Resources, which Nicor expects will be complete in the second half of 2011. In accordance with the Merger Agreement, each share of Nicor common stock outstanding at the Effective Time (as defined in the Merger Agreement), other than shares to be cancelled, and Dissenting Shares (as defined in the Merger Agreement), will be converted into the right to receive consideration consisting of (i) $21.20 in cash and (ii) 0.8382 shares of AGL Resources common stock, subject to adjustment in certain circumstances.

Completion of the proposed merger is conditioned upon, among other things, shareholder approval by both companies, expiration or termination of any applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and approval by, among others, the ICC. Nicor anticipates that the necessary approvals will be obtained.


In January 2011, Nicor, Nicor Gas and AGL Resources filed a joint application with the ICC for approval of the proposed merger. As stated above, approval by the ICC is a condition to completion of the merger. The application did not request a rate increase and included a commitment to maintain the number of full-time equivalent employees involved in the operation of Nicor’s gas distribution subsidiary at a level comparable to current staffing for a period of three years following merger completion. The ICC has eleven months to act upon the application.

The Merger Agreement contains certain termination rights for both Nicor and AGL Resources, and further provides for the payment of fees and expenses upon termination under specified circumstances. For additional information relating to the proposed merger please see Nicor’s Form 8-K filed on December 7, 2010. Further information concerning the proposed merger was included in a joint proxy statement/prospectus contained in the registration statement on Form S-4 that was filed with the SEC by AGL Resources on February 4, 2011.

For the year ended December 31, 2010, the company has incurred and expensed $4.6 million of merger-related costs.  No other adjustments have been made to the financial statements as a result of the proposed merger.

Rate proceeding.  On March 25, 2009, the ICC issued an order approving an increase in base revenues of approximately $69 million, a rate of return on rate base of 7.58 percent and a rate of return on equity of 10.17 percent.  The order also approved an energy efficiency rider.  Nicor Gas placed the rates approved in the March 25, 2009 order into effect on April 3, 2009.

On April 24, 2009, Nicor Gas filed a request for rehearing with the ICC concerning the capital structure contained in the ICC’s rate order contending the company’s return on rate base should be higher.  On October 7, 2009, the ICC issued its decision on rehearing in which it increased the annual base revenues approved for Nicor Gas in the March 25, 2009 order by approximately $11 million, increasing the rate of return on rate base to 8.09 percent.  Nicor Gas placed the rates approved in the rehearing decision into effect on a prospective basis on October 15, 2009.  Therefore, the total annual base revenue increase authorized in the rate case originally filed by the company in April 2008 is approximately $80 million.

Bad debt rider.  In September 2009, Nicor Gas filed for approval of a bad debt rider with the ICC under an Illinois state law which took effect in July 2009.  On February 2, 2010, the ICC issued an order approving the company’s proposed bad debt rider.  This rider provides for recovery from customers of the amount over the benchmark for bad debt expense established in the company’s rate cases.  It also provides for refunds to customers if bad debt expense is below such benchmarks.

As a result of the February 2010 order, Nicor Gas recorded in income a net recovery related to 2008 and 2009 of $31.7 million in the first quarter of 2010, all of which has been collected.  The benchmark, against which 2010 actual bad debt experience is compared, is approximately $63 million.  The company’s actual 2010 bad debt experience was $35.7 million, resulting in a refund to customers of $27.3 million which will be refunded over a 12-month period beginning June 2011.

Health Care Reform Legislation.  In March 2010, the Health Care Act was signed into law resulting in comprehensive health care reform.  The Health Care Act contains a provision that eliminates the tax deduction related to Medicare Part D subsidies received after 2012.  Federal subsidies are provided to sponsors of retiree health benefit plans, such as Nicor Gas, that provide a benefit that is at least actuarially equivalent to the benefits under Medicare Part D.  Such subsidies have reduced the company’s actuarially determined projected benefit obligation and annual net periodic benefit costs.  Due to the change in taxation, in the first quarter of 2010 Nicor Gas reduced deferred tax assets by $17.5 million, reversed an existing regulatory income tax liability of $10.0 million, established a regulatory income tax asset of $7.0 million and recognized a $0.5 million charge to income tax expense.  Beginning in 2010, the change in taxation will also reduce earnings by an estimated $1.7 million annually for periods subsequent to the enactment date.
 

Additionally, the Health Care Act contains other provisions that may impact Nicor Gas’ obligation for retiree health care benefits.  The company does not currently believe these provisions will materially increase its postretirement benefit obligation, but will continue to evaluate the impact of future regulations and interpretations.

Capital market environment.  The volatility in the capital markets over the past three years has caused general concern over the valuations of investments, exposure to increased credit risk and pressures on liquidity.  The company continues to review its investments, exposure to credit risk and sources of liquidity and does not currently expect any future material adverse impacts relating to this past volatility.

Operating income.  Operating income (loss) by the company’s major businesses is presented below (in millions):

   
2010
   
2009
   
2008
 
                   
Gas distribution
  $ 194.7     $ 149.7     $ 124.4  
Shipping
    14.4       29.2       39.3  
Other energy ventures
    34.4       45.5       25.3  
Corporate and eliminations
    (7.8 )     (4.1 )     (4.0 )
    $ 235.7     $ 220.3     $ 185.0  

The following summarizes operating income (loss) comparisons by the company’s major businesses:

·  
Gas distribution operating income increased $45.0 million in 2010 compared to the prior year due primarily to higher gas distribution margin ($47.4 million increase), a favorable mercury-related reserve adjustment ($1.3 million) and gains on property sales ($1.3 million), partially offset by higher depreciation expense ($6.2 million increase).

Gas distribution operating income increased $25.3 million in 2009 compared to the prior year due to higher gas distribution margin ($39.0 million increase), partially offset by higher depreciation expense ($6.5 million increase) and operating and maintenance expense ($5.8 million increase).

·  
Shipping operating income decreased $14.8 million in 2010 compared to the prior year due to lower operating revenues ($7.6 million decrease) and higher operating expenses ($7.2 million increase).  Operating revenues were lower due to lower volumes shipped, partially offset by higher average rates.  Operating expenses were higher due primarily to higher transportation-related costs and higher repairs and maintenance costs, partially offset by lower charter costs and lower payroll and benefit-related costs.

Shipping operating income decreased $10.1 million in 2009 compared to the prior year due to lower operating revenues ($72.6 million decrease), which were partially offset by lower operating costs ($62.5 million decrease).  Lower operating revenues were attributable to lower volumes shipped and lower average rates.  Operating costs were lower due primarily to lower transportation-related costs, charter costs and payroll and benefit-related costs.

·  
Nicor’s other energy ventures operating income decreased $11.1 million in 2010 compared to the prior year due to lower operating income at Nicor’s wholesale natural gas marketing business, Nicor Enerchange ($13.5 million decrease), partially offset by higher operating income at Nicor’s energy-related products and services businesses ($2.3 million increase).  Lower operating income at Nicor Enerchange was due to unfavorable results from the company’s risk management services associated with hedging the product risks of the utility-bill management contracts offered by Nicor’s energy-related products and services businesses and unfavorable costing of physical sales activity, partially offset by favorable changes in valuations of derivative instruments used to hedge purchases and sales of natural gas inventory.  Higher operating income at Nicor’s energy-related products and services
 
 
businesses was due to lower operating expenses ($11.4 million decrease), partially offset by lower operating revenue ($9.1 million decrease).
 
Nicor’s other energy ventures operating income increased $20.2 million in 2009 compared to the prior year due primarily to higher operating income at Nicor Enerchange ($18.2 million increase) and at Nicor’s energy-related products and services businesses ($1.7 million increase).  Higher operating income at Nicor Enerchange was due primarily to favorable results from the company’s risk management services associated with hedging the product risks of the utility-bill management contracts offered by Nicor’s energy-related products and services businesses.  Higher operating income at Nicor’s energy-related products and services businesses was due to lower operating expenses ($7.0 million decrease), partially offset by lower operating revenues ($5.3 million decrease).

Nicor Enerchange uses derivatives to mitigate commodity price risk in order to substantially lock-in the profit margin that will ultimately be realized.  A source of commodity price risk arises as Nicor Enerchange purchases and holds natural gas in storage to earn a profit margin from its ultimate sale.  However, gas stored in inventory is required to be accounted for at the lower of weighted-average cost or market, whereas the derivatives used to reduce the risk associated with a change in the value of the inventory are carried at fair value, with changes in fair value recorded in operating results in the period of change.  In addition, Nicor Enerchange also uses derivatives to mitigate the commodity price risks of the utility-bill management products offered by Nicor’s energy-related products and services businesses.  The gains and losses associated with the utility-bill management products are recognized in the months that the services are provided.  However, the underlying derivatives used to hedge the price exposure are carried at fair value.  For derivatives that either do not meet the requirements for hedge accounting or for which hedge accounting is not elected, the changes in fair value are recorded in operating results in the period of change.  As a result, earnings are subject to volatility as the fair value of derivatives change.  The volatility resulting from this accounting can be significant from period to period.

·  
Corporate and eliminations’ operating income for 2010, 2009 and 2008 was impacted by the following items:

In 2010, corporate and eliminations’ operating income included $4.6 million of merger-related costs.

In 2010, 2009 and 2008, corporate and eliminations’ operating income included costs of $1.3 million, $3.7 million and $6.2 million, respectively, associated with Nicor’s other energy ventures’ utility-bill management products attributable to colder than normal weather (excludes costs of approximately $0.4 million, $0.6 million and $0.6 million, respectively, recorded within other energy ventures).  The above noted benefits or costs resulting from variances from normal weather related to these products are recorded primarily at the corporate level as a result of an agreement between the parent company and certain of its subsidiaries.  The weather impact of these contracts generally serves to partially offset the gas distribution business weather risk.  The amount of the offset attributable to the utility-bill management products marketed by Nicor’s other energy ventures will vary depending upon a number of factors including the time of year, weather patterns, the number of customers for these products and the market price for natural gas.

In 2008, corporate and eliminations’ operating income included recoveries of previously incurred legal costs of $3.1 million.  The legal cost recoveries were from a counterparty with whom Nicor previously did business during the PBR timeframe.  The total recovery was $5.0 million, of which $3.1 million was allocated to corporate and $1.9 million was allocated to the gas distribution business (recorded as a reduction to operating and maintenance expense).
 

RESULTS OF OPERATIONS

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

Operating revenues.  Operating revenues by the company’s major businesses are presented below (in millions):

   
2010
   
2009
   
2008
 
                   
Gas distribution
  $ 2,204.4     $ 2,140.8     $ 3,206.9  
Shipping
    345.0       352.6       425.2  
Other energy ventures
    218.4       239.0       230.3  
Corporate and eliminations
    (58.0 )     (80.3 )     (85.8 )
    $ 2,709.8     $ 2,652.1     $ 3,776.6  

Gas distribution operating revenues are impacted by changes in natural gas costs, which are passed directly through to customers without markup, subject to ICC review.  Gas distribution operating revenues increased $63.6 million in 2010 compared the prior year due to higher natural gas costs (approximately $110 million increase), revenue from the bad debt and energy efficiency riders ($32.5 million and $8.8 million, respectively) and the impact of the increase in base rates (approximately $20 million increase), partially offset by warmer weather in 2010 (approximately $75 million decrease) and lower demand unrelated to weather (approximately $25 million decrease).

Gas distribution operating revenues decreased $1,066.1 million in 2009 compared to the prior year due primarily to lower natural gas costs (approximately $900 million decrease), warmer weather in 2009 (approximately $140 million decrease) and lower demand unrelated to weather (approximately $60 million decrease), partially offset by the impact of the increase in base rates (approximately $60 million increase).

Shipping operating revenues decreased $7.6 million in 2010 compared to the prior year due to lower volumes shipped ($11.8 million decrease), partially offset by higher average rates ($4.2 million increase).  Volumes shipped were adversely impacted by the continued economic slowdown.  Higher average rates were attributable to higher cost-recovery surcharges for fuel, partially offset by a reduction in base rates.

Shipping operating revenues decreased $72.6 million in 2009 compared to the prior year due to lower volumes shipped ($44.2 million decrease) and lower average rates ($28.4 million decrease).  Volumes shipped were adversely impacted by the economic slowdown.  Lower average rates were attributable to lower cost-recovery surcharges for fuel.

Nicor’s other energy ventures operating revenues decreased $20.6 million in 2010 compared to the prior year due to lower operating revenues at Nicor Enerchange ($11.5 million decrease) and Nicor’s energy-related products and services businesses ($9.1 million decrease).  Lower operating revenues at Nicor Enerchange were due to unfavorable results from the company’s risk management services associated with hedging the product risks of the utility-bill management contracts offered by Nicor’s energy-related products and services businesses and unfavorable costing of physical sales activity, partially offset by favorable changes in valuations of derivative instruments used to hedge purchases and sales of natural gas inventory.  Lower operating revenues at Nicor’s energy-related products and services businesses were due to lower average revenue per utility-bill management contract attributable to lower average natural gas prices, partially offset by higher average contract volumes.
 

Nicor’s other energy ventures operating revenues increased $8.7 million in 2009 compared to the prior year due primarily to higher operating revenues at Nicor Enerchange ($13.9 million increase), partially offset by lower operating revenues at Nicor’s energy-related products and services businesses ($5.3 million decrease).  Higher operating revenues at Nicor Enerchange were due to favorable results from the company’s risk management services associated with hedging the product risks of the utility-bill management contracts offered by Nicor’s energy-related products and services businesses.  Lower revenues at Nicor’s energy-related products and services businesses were due to lower average revenue per utility-bill management contract, partially offset by higher average contract volumes.

Corporate and eliminations reflects primarily the elimination of gas distribution revenues against Nicor Solutions’ expenses for customers purchasing the utility-bill management products and Nicor Enerchange net revenues from the sale of natural gas to Nicor Advanced Energy.

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 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, with equal and offsetting fluctuations in cost of gas and revenue tax expense, with no direct impact on gas distribution margin.  The 2009 rate orders included a franchise gas cost recovery rider and a rider to recover the costs associated with energy efficiency programs.  Additionally, in February 2010 the ICC approved the company’s bad debt rider.  As a result, changes in revenue included in gas distribution margin attributable to these riders are expected to generally be offset by changes within operating and maintenance expense.

A reconciliation of gas distribution revenues and margin follows (in millions):

   
2010
   
2009
   
2008
 
                   
Gas distribution revenues
  $ 2,204.4     $ 2,140.8     $ 3,206.9  
Cost of gas
    (1,364.1 )     (1,345.7 )     (2,427.8 )
Revenue tax expense
    (145.9 )     (148.1 )     (171.1 )
Gas distribution margin
  $ 694.4     $ 647.0     $ 608.0  

Gas distribution margin increased $47.4 million in 2010 compared to the prior year due primarily to revenue from the bad debt and energy efficiency riders ($32.5 million and $8.8 million, respectively) and the impact of the increase in base rates (approximately $20 million increase), partially offset by warmer weather in 2010 (approximately $8 million decrease), lower interest on customer balances ($5.5 million decrease) and lower demand unrelated to weather (approximately $4 million decrease).

Gas distribution margin increased $39.0 million in 2009 compared to the prior year due to the impact of the increase in base rates (approximately $60 million increase), partially offset by warmer weather (approximately $8 million decrease), lower demand unrelated to weather (approximately $5 million decrease) and lower revenue from cost recovery riders (approximately $3 million decrease).

Gas distribution operating and maintenance expense.  Gas distribution operating and maintenance expense decreased $0.4 million in 2010 compared to the prior year.  Factors contributing to the decrease include lower company use and storage-related gas costs ($7.9 million decrease), lower pension expense ($4.6 million decrease, net of capitalization), lower billing and call center-related costs ($2.9 million decrease), lower costs on legal matters ($2.6 million decrease), higher bad debt expense ($10.6 million increase) and higher costs associated with the energy efficiency program ($8.8 million increase).  Bad debt expense in 2010 was $63.8 million compared to $53.2 million in the prior year.  Bad debt expense in 2010 includes the recognition of the $31.7 million benefit associated with the net under recovery of bad debt expense from 2008 and 2009; $63.0 million of expense assumed to be collected through base rates; and $32.5 million of expense which is equal to the revenue recognized under the bad debt rider.


Gas distribution operating and maintenance expense increased $5.8 million in 2009 compared to the prior year due primarily to higher payroll and benefit-related costs ($26.5 million increase of which $21.8 million relates to higher pension expense, net of capitalization), the absence of prior year cost recoveries of previously incurred costs ($3.9 million, of which $2.0 million relates to a 2007 investigation of the presence of PCBs in the company’s distribution system and $1.9 million relates to legal cost recoveries from a counterparty with whom Nicor previously did business during the PBR timeframe), higher postage charges ($2.0 million increase) and higher costs on legal matters ($1.8 million increase).  Partially offsetting these amounts were lower bad debt expense ($17.5 million decrease due to lower revenues attributable principally to lower natural gas costs), lower company use and storage-related gas costs ($7.3 million decrease) and lower costs associated with the aforementioned cost recovery riders approved in the 2009 rate orders ($5.7 million decrease).

Other gas distribution operating expenses.  In 2010 and 2008, the company recorded favorable (unfavorable) reserve adjustments of $1.3 million and $(0.6) million, respectively, associated with the company’s mercury inspection and repair program.  Additional information about the company’s mercury inspection and repair program is presented in Item 8 – Notes to the Consolidated Financial Statements – Note 20 – Contingencies – Mercury.

Property sale gains and losses vary from year-to-year depending upon property sales activity.  During 2010 and 2008, Nicor Gas realized pretax gains of $1.3 million and $0.8 million, respectively.  The company periodically assesses its ownership of certain real estate holdings.

Shipping operating expenses.  Shipping operating expenses increased $7.2 million in 2010 compared to the prior year due primarily to higher transportation-related costs ($8.7 million increase, largely attributable to higher fuel prices) and higher repairs and maintenance costs ($1.9 million increase), partially offset by lower charter costs ($3.6 million decrease) and lower payroll and benefit-related costs ($2.0 million decrease).

Shipping operating expenses decreased $62.5 million in 2009 compared to the prior year due primarily to lower transportation-related costs ($36.9 million decrease, largely attributable to lower volumes shipped and fuel prices), charter costs ($10.1 million decrease) and payroll and benefit-related costs ($5.8 million decrease).

Other energy ventures operating expenses.  Nicor’s other energy ventures operating expenses decreased $9.5 million in 2010 compared to prior year due to a decrease in operating expenses at Nicor’s energy-related products and services businesses ($11.4 million decrease) attributable to lower average cost per utility-bill management contract resulting from lower average natural gas prices, partially offset by higher average contract volumes.

Nicor’s other energy ventures operating expenses decreased $11.5 million in 2009 compared to the prior year due primarily to a decrease in operating expenses at Nicor’s energy-related products and services businesses ($7.0 million decrease) and at Nicor Enerchange ($4.3 million decrease).  The decrease in operating expenses at Nicor’s energy-related products and services businesses was due to lower average costs associated with utility-bill management contracts, partially offset by higher average contract volumes and higher selling, general and administrative costs attributable to business growth.  The decrease in operating expenses at Nicor Enerchange was due primarily to lower transportation and storage charges attributable to lower natural gas prices.

Other corporate expenses and eliminations.  Other corporate operating expenses (income) were $6.8 million, $0.6 million and $(2.0) million in 2010, 2009 and 2008, respectively.  Included in other corporate operating expenses for 2010 is $4.6 million of merger-related costs.  In 2008, Nicor recorded a benefit of $3.1 million related to recoveries of previously incurred legal costs.  Also included in the amounts for all years presented are certain business development costs.
 

Intercompany eliminations were $(57.0) million, $(76.7) million and $(79.8) million in 2010, 2009 and 2008, respectively, and related primarily to utility-bill management products.

Interest expense.  Interest expense decreased $0.6 million in 2010 compared to the prior year.  Factors contributing to the decrease include lower interest on income tax matters ($2.9 million decrease), higher bank commitment fees ($1.7 million increase) and higher average borrowing levels ($1.1 million increase).

Interest expense decreased $1.4 million in 2009 compared to the prior year due to lower average interest rates ($5.3 million decrease), partially offset by the impact of higher interest on income tax matters ($1.9 million increase) and bank commitment fees ($1.5 million increase).

Net equity investment income.  Net equity investment income decreased $7.6 million in 2010 compared to the prior year due to the absence of a $10.1 million gain recognized on the sale of the company’s 50-percent interest in EN Engineering in 2009, partially offset by an increase in income from the company’s investment in Triton ($2.5 million increase).

Net equity investment income increased $6.4 million in 2009 compared to the prior year due primarily to the $10.1 million gain recognized on the sale of the company’s interest in EN Engineering, partially offset by the absence of income from the company’s investment in EN Engineering ($2.8 million decrease) and a decrease in income from the company’s investment in Triton ($1.1 million decrease).

Equity investment results include $7.8 million, $5.3 million and $6.4 million for 2010, 2009 and 2008, respectively, for Nicor’s share of income from Triton.

Interest income.  Interest income decreased $1.2 million in 2010 compared to the prior year due primarily to lower interest on tax matters ($1.1 million decrease).

Interest income decreased $6.5 million in 2009 compared to the prior year due primarily to the impact of lower average interest rates ($2.5 million decrease), interest on tax matters ($2.2 million decrease) and average investment balances ($1.5 million decrease).

Income tax expense.  In 2006, the company reorganized certain shipping and related operations.  The reorganization allows the company to take advantage of certain provisions of the Jobs Act that provide the opportunity for tax savings subsequent to the date of the reorganization.  Generally, to the extent foreign shipping earnings are not repatriated to the United States, such earnings are not expected to be subject to current taxation.  In addition, to the extent such earnings are expected to be indefinitely reinvested offshore, no deferred income tax expense would be recorded by the company.  For the years ended December 31, 2010, 2009 and 2008, income tax expense has not been provided on approximately $5 million, $19 million and $23 million, respectively, of foreign company shipping earnings.

At December 31, 2010, Nicor has approximately $12 million of deferred income tax liabilities related to approximately $34 million of cumulative undistributed earnings of its foreign subsidiaries.  Nicor has not recorded deferred income taxes of approximately $59 million on approximately $170 million of cumulative undistributed foreign earnings.

The effective income tax rate was 33.5 percent, 32.4 percent and 27.0 percent for 2010, 2009 and 2008, respectively.  The higher effective income tax rate in 2010 compared to 2009 is due primarily to lower untaxed foreign shipping earnings and the unfavorable impact of the tax law change with respect to Medicare Part D subsidies, partially offset by favorable tax reserve adjustments.  The higher effective income tax rate in 2009 compared to 2008 reflects higher pretax income in 2009 (which causes a higher effective income tax rate since permanent differences and tax credits are a smaller share of pretax income), as well as a decrease in untaxed foreign shipping earnings and the absence of the 2008 tax reserve adjustments.

 
Nicor Inc.                  
Gas Distribution Statistics
                 
                   
   
2010
   
2009
   
2008
 
                   
Operating revenues (millions)
                 
Sales
                 
Residential
  $ 1,443.9     $ 1,377.9     $ 2,176.2  
Commercial
    355.9       350.4       551.4  
Industrial
    39.9       38.2       61.9  
      1,839.7       1,766.5       2,789.5  
Transportation
                       
Residential
    46.3       47.1       40.9  
Commercial
    75.1       79.1       82.2  
Industrial
    40.3       39.4       38.3  
Other
    1.7       4.1       25.7  
      163.4       169.7       187.1  
Other revenues
                       
Revenue taxes
    148.1       150.3       174.0  
Environmental cost recovery
    10.7       12.5       9.7  
Chicago Hub
    4.1       7.7       11.3  
Other
    38.4       34.1       35.3  
      201.3       204.6       230.3  
    $ 2,204.4     $ 2,140.8     $ 3,206.9  
                         
Deliveries (Bcf)
                       
Sales
                       
Residential
    188.2       199.8       214.4  
Commercial
    49.0       52.7       54.7  
Industrial
    6.0       6.3       6.4  
      243.2       258.8       275.5  
Transportation
                       
Residential
    22.8       25.4       25.6  
Commercial
    83.3       89.6       93.1  
Industrial
    104.7       102.1       103.9  
      210.8       217.1       222.6  
      454.0       475.9       498.1  
                         
Year-end customers (thousands)
                       
Sales
                       
Residential
    1,788       1,763       1,760  
Commercial
    134       132       130  
Industrial
    8       8       8  
      1,930       1,903       1,898  
Transportation
                       
Residential
    206       218       222  
Commercial
    48       50       53  
Industrial
    4       5       5  
      258       273       280  
      2,188       2,176       2,178  
                         
Other statistics
                       
Degree days
    5,720       6,106       6,348  
Colder than normal (1)
    2%       9%       9%  
Average gas cost per Mcf sold
  $ 5.49     $ 5.06     $ 8.76  
                         
(1) Normal weather for Nicor Gas' service territory, for purposes of this report, is considered to be 5,600 degree days per year for 2010 and 2009 and 5,830 degree days per year for 2008.
 

31
 

 
Shipping Statistics
   
2010
   
2009
   
2008
 
                   
TEUs shipped (thousands)
    170.7       176.6       197.1  
Revenue per TEU
  $ 2,022     $ 1,997     $ 2,158  
At end of period
                       
Ports served
    25       25       25  
Vessels operated
    14       15       17  

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.  Capital market conditions are not currently expected to have a material adverse impact on the company’s ability to access capital.

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, natural gas purchasing, and storage and hedging practices.  The company relies on short-term borrowings, backed by bank lines of credit, to meet seasonal increases in working capital needs.  Cash requirements generally increase over the last half of the year due to increases in natural gas purchases, gas in storage and accounts receivable.  During the first half of the year, positive cash flow generally results from the sale of gas in storage and the collection of accounts receivable.  This cash is typically used to substantially reduce, or eliminate, short-term debt during the first half of the year.

Nicor 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 and investments.

Net cash flow provided from operating activities decreased $216.0 million for the year ended December 31, 2010 compared to the prior year.  The significant factors contributing to the decrease in cash flow are primarily a result of lower average natural gas prices during the 2009/2010 heating season compared to the 2008/2009 heating season and include: 
·  
a decrease of $178.6 million from changes in receivables due to higher receivable balances at the end of 2008 versus 2009; and
·  
a decrease of $102.8 million from changes in margin accounts related to derivative instruments due to the decline in gas prices.

In addition, the company had higher volumes of gas in storage at December 31, 2010 when compared to 2009.

Net cash flow provided from operating activities increased $598.2 million for the year ended December 31, 2009 compared to the prior year.  The significant factors contributing to the increase in cash flow are primarily a result of lower average natural gas prices during the 2008/2009 heating season compared to the 2007/2008 heating season and include:
·  
an increase of $245.6 million from changes in receivables due to higher receivable balances at the end of 2008 versus 2009; and
·  
an increase of $238.6 million from changes in margin accounts related to derivative instruments due to the decline in gas prices.
 

In addition, the company had lower volumes of gas in storage at December 31, 2009 when compared to 2008.

Investing activities.  Net cash flow used for investing activities was $229.2 million, $211.5 million and $265.3 million in 2010, 2009 and 2008, respectively.

Capital expenditures.  Capital expenditures is an internal measure utilized by management that represents cash additions to property, plant and equipment, adjusted for items including the accrual of work performed through period end and other non-cash items, contributions in aid of construction and expenditures associated with asset retirement obligations.  Capital expenditures by the company’s major businesses are presented in the following table (in millions):

   
Estimated
                   
   
2011
   
2010
   
2009
   
2008
 
                         
Gas distribution
  $ 205     $ 198     $ 203     $ 229  
Shipping
    26       15       22       17  
Other energy ventures
    129       28       6       4  
    $ 360     $ 241     $ 231     $ 250  

Gas distribution capital expenditures decreased in 2010 versus 2009.  Factors contributing to the decrease include lower expenditures associated with gas distribution, transmission and storage system improvements (approximately $6 million decrease), lower facility construction (approximately $3 million decrease), lower capitalized overhead costs attributable to lower postretirement benefit costs (approximately $2 million decrease) and higher information technology improvements (approximately $8 million increase).

Gas distribution capital expenditures decreased in 2009 versus 2008 due to the impact of lower customer additions (approximately $10 million decrease), information technology improvements (approximately $10 million decrease), facility construction (approximately $9 million decrease) and lower expenditures associated with gas distribution, transmission and storage system improvements (approximately $7 million decrease), partially offset by higher capitalized overhead costs attributable to higher postretirement benefit costs (approximately $9 million increase).

Gas distribution capital expenditures are expected to increase in 2011 versus 2010.  Factors contributing to the expected increase include higher expenditures associated with facility construction and new service additions and lower expenditures associated with gas distribution, transmission and storage system improvements.

Shipping capital expenditures decreased in 2010 versus 2009 due to a decrease in progress payments on the construction of a new vessel.

Shipping capital expenditures increased in 2009 versus 2008 due primarily to progress payments on the construction of a new vessel, partially offset by a decrease in facility expansion.

Shipping capital expenditures are expected to increase in 2011 versus 2010 due primarily to increased expenditures related to freight handling equipment, containers and information technology system improvements.

Other energy ventures’ capital expenditures increased in 2010 versus 2009 due primarily to expenditures related to the development of a natural gas storage facility by Central Valley (approximately $18 million increase).
 

Other energy ventures’ capital expenditures are expected to increase in 2011 by approximately $120 million due to the continued development of the storage facility by Central Valley.  Included in these capital expenditures is conditioning gas, to ready the field for use, that is expected to be injected in 2011 and withdrawn and sold in 2012.

Additional investing activities.  Yearly fluctuations in additional investing activities include the following items:
·  
2009 and 2008 reflect increased short-term investments primarily at the company’s shipping business.
·  
In March 2009, the company sold its 50-percent interest in EN Engineering and received cash of $13.0 million.

Financing activities.  Nicor and Nicor Gas’ access to financing at competitive rates is, in part, dependent on its credit ratings.  The current credit ratings for Nicor Inc. and Nicor Gas are as follows:

   
Standard
& Poor’s
 
Moody’s
 
Fitch
Nicor Inc.
           
Commercial Paper
 
  A-1+
 
P-2
 
F-1
Senior Unsecured Debt
 
AA
 
n/a
 
A
Corporate Credit Rating
 
AA
 
n/a
 
n/a

Nicor Gas
           
Commercial Paper
 
  A-1+
 
P-1
 
F-1
Senior Secured Debt
 
AA
 
Aa3
 
AA-
Senior Unsecured Debt
 
AA
 
A2
 
A+
Corporate Credit Rating
 
AA
 
n/a
 
n/a

In December 2010, Standard and Poor’s (“S&P”), Moody’s and Fitch affirmed Nicor and Nicor Gas’ credit ratings.  S&P changed Nicor and Nicor Gas’ outlooks from stable to credit watch with negative implications.  Moody’s affirmed Nicor’s outlook as stable, but changed Nicor Gas’ outlook from stable to negative.  Fitch maintained the outlook as stable for both Nicor and Nicor Gas.  Both S&P and Moody’s attributed the change in outlook to the proposed merger with AGL Resources.

Long-term debt.  The company typically uses the net proceeds from long-term debt for refinancing outstanding debt, for construction programs (to the extent not provided by internally generated funds) and for general corporate purposes.

In February 2011, Nicor Gas issued $75 million First Mortgage Bonds at 2.86 percent, due in 2016 through a private placement and utilized the proceeds to retire the $75 million 6.625 percent First Mortgage Bond series which matured in February 2011.

In February 2009, the $50 million 5.37 percent First Mortgage Bond series matured and was retired.  In July 2009, Nicor Gas issued $50 million in First Mortgage Bonds at 4.70 percent, due in 2019 through a private placement.

In determining that the bonds issued in 2011 and 2009 qualified for exemption from registration under Section 4(2) of the Securities Act of 1933, Nicor Gas relied on the facts that the bonds were offered only to a limited number of large institutional investors and each institutional investor that purchased the bonds represented that it was purchasing the bonds for its own account and not with a view to distribute them. 

Substantially all gas distribution properties are subject to the lien of the indenture securing Nicor Gas’ First Mortgage Bonds.
 

At December 31, 2010, Nicor Gas had the capacity to issue approximately $470 million of additional First Mortgage Bonds under the terms of its indenture.  On February 25, 2009, Nicor Gas filed a shelf registration with a $225 million capacity, which became effective on March 20, 2009.

In 2010, Nicor entered into forward-starting interest rate swaps with a notional totaling $90 million. The swaps hedge the risk associated with the interest payments attributable to the probable issuance of long-term fixed-rate debt in 2012 intended to finance the development of a natural gas storage facility.  Under the terms of the swaps, Nicor agrees to pay a fixed swap rate and receive a floating rate based on LIBOR.

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

Short-term debt.  In April 2010, Nicor Gas established a $400 million, 364-day revolving credit facility, expiring April 2011, to replace the $550 million, 364-day revolving credit facility, which was set to expire in May 2010 and Nicor and Nicor Gas established a $600 million, three-year revolving credit facility, expiring April 2013 to replace the $600 million, five-year revolving credit facility, which was set to expire in September 2010.  These facilities were established with major domestic and foreign banks and serve as backup for the issuance of commercial paper.  The company had $425 million and $494 million of commercial paper outstanding at December 31, 2010 and 2009, respectively.  During 2010, the commercial paper borrowing levels ranged from $512 million to no commercial paper and averaged $269 million.  During 2009, the commercial paper borrowing levels ranged from $759 million to $216 million and averaged $417 million.  The average borrowing levels are calculated using average daily balances for each day for the year.  The company expects that funding from commercial paper and related backup line-of-credit agreements will continue to be available in the foreseeable future and sufficient to meet estimated cash requirements.

Common stock. Nicor maintained its quarterly common stock dividend rate during 2010 of $0.465 per common share.  The company paid dividends on its common stock of $85.1 million, $84.8 million and $84.4 million in 2010, 2009 and 2008, respectively.  Pursuant to the Merger Agreement, Nicor is restricted from paying a dividend in excess of $0.465 per share in any quarter.  Other than the Merger Agreement, Nicor has no contractual or regulatory restrictions on the payment of dividends.

Nicor currently has a dividend reinvestment program that offers the opportunity to holders of Nicor common and preferred shares to purchase additional shares of Nicor common stock by reinvesting the dividends and/or making direct cash purchases.  Shares are acquired by Nicor on behalf of participants through purchases in the open market.  Nicor amended the program in 2009 to allow Nicor to issue new shares of common stock as an alternative to purchasing them in the open market. Any proceeds from newly issued shares may be used for advances to or equity investments in its subsidiaries, for other investment opportunities, or for general corporate purposes.  No new shares have been issued since the program was amended in 2009.

In 2001, Nicor announced a $50 million common stock repurchase program, under which 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 repurchases under this program since 2002.  As of December 31, 2010, $21.5 million remained authorized for the repurchase of common stock.

Preferred Stock.  In 2010 and 2009, Nicor redeemed 1,431 shares and 10,150 shares, respectively, of the 4.48 percent Mandatorily Redeemable Preferred Stock, $50 par value, at an average redemption price of $51.06 and $46.43 per share, respectively, plus accrued unpaid dividends.  As a result, there were no shares of the 4.48 percent Mandatorily Redeemable Preferred Stock outstanding at December 31, 2010.

In January 2011, Nicor redeemed 247 shares of the 5.00 percent Convertible Preferred Stock, $50 par value, at an average redemption price of $50.13 per share.  Nicor had no shares of preferred stock outstanding following such redemption.


Off-balance sheet arrangements.  Nicor has certain guarantees, as further described in Item 8 Notes to the Consolidated Financial Statements – Note 19 – Guarantees and Indemnities.  The company believes the likelihood of any such payment under these guarantees is remote.  No liability has been recorded for these guarantees.

Contractual obligations.  At December 31, 2010, Nicor had contractual obligations with payments due as follows (in millions):
 
                                                                           Payments due by period
   
Less
than 1
year
   
1-3
years
   
3-5
years
   
More
than 5
years
   
 
Total
 
                               
Purchase obligations
  $ 480.8     $ 264.8     $ 32.1     $ 5.2     $ 782.9  
Long-term debt
    75.0       -       -       425.0       500.0  
Fixed interest on long-term debt
    26.1       51.3       51.3       342.7       471.4  
Operating leases
    17.5       14.7       5.3       11.5       49.0  
    $ 599.4     $ 330.8     $ 88.7     $ 784.4     $ 1,803.3  

In addition to the contractual obligations included in the table above, Nicor has potential liabilities to taxing authorities (unrecognized tax benefits) which are dependent on the resolution of particular income tax positions.  The timing of future cash outflows, if any, associated with such potential liabilities is uncertain.  The company had accrued a liability for estimated unrecognized tax benefits of $2.9 million at December 31, 2010, for which the amount and timing of payments is uncertain.

The company also has long-term obligations for postretirement benefits which are not included in the above table.  Information regarding the company’s obligations for postretirement benefits can be found in Item 8 – Notes to the Consolidated Financial Statements – Note 10 – Postretirement Benefits.

Purchase obligations consist primarily of natural gas purchase agreements, and natural gas transportation and storage contracts in the gas distribution and wholesale natural gas marketing businesses.  Natural gas purchase agreements include obligations to purchase natural gas at future market prices, calculated using NYMEX futures prices as of December 31, 2010.

Operating leases are primarily for vessels, containers and equipment in the shipping business, office space and equipment in the gas distribution business and office space for the other energy ventures.  Tropical Shipping has certain equipment operating leases which include escalation clauses for adjusting rent to reflect changes in price indices, various renewal options and options to purchase leased equipment.  Rental expense under operating leases was $25.7 million, $31.4 million and $41.7 million in 2010, 2009 and 2008, respectively.

The Merger Agreement contains termination rights for both Nicor and AGL Resources and provides that if Nicor terminates the Merger Agreement under specified circumstances, Nicor may be required to pay a termination fee of $67 million.

OTHER MATTERS

Storage Projects.  Central Valley is developing an underground natural gas storage facility in the Sacramento River valley of north-central California and plans to provide approximately 11 Bcf of working natural gas capacity, offering flexible, high-deliverability multi-cycle services and interconnection to a regional pipeline.  In October 2010, the CPUC approved Central Valley’s Certificate of Public Convenience and Necessity to construct and operate the storage facility.  Central Valley plans to initiate construction activity during the first quarter of 2011 and expects completion during the fourth quarter of 2011, with firm storage services commencing in early 2012.  The company estimates the net capital cost for the Central Valley project to be approximately $120 million.


Nicor is also participating in a natural gas storage development joint venture known as Sawgrass Storage.  In 2010, Sawgrass Storage initiated the pre-filing process with the FERC.

Application for Approval of Energy Efficiency Plan.  On September 29, 2010, Nicor Gas filed an application with the ICC seeking approval of an energy efficiency plan.  The filing was made pursuant to an Illinois law enacted in 2009 that requires local gas distribution utilities to establish plans to achieve specified energy savings goals beginning in June 2011 and provides utilities with a rider to collect the costs of the plan from customers.  Under its proposed plan, the company estimates that it would bill nearly $100 million to customers under the rider, over a three year period commencing June 1, 2011, to fund the costs of various energy savings programs identified in the company’s filing.

Petition for Re-approval of Operating Agreement.  On July 1, 2009, Nicor Gas filed a petition seeking re-approval from the ICC of the operating agreement that governs many inter-company transactions between Nicor Gas and its affiliates.  The petition was filed pursuant to a requirement contained in the ICC order approving the company’s most recent general rate increase and requested that the operating agreement be re-approved without change.  A number of parties have intervened in the proceeding and are seeking modifications on a prospective basis to the operating agreement.  Among the proposals are several by the ICC Staff and intervenors that would preclude Nicor Gas from continuing to provide certain services to support warranty products that are sold by Nicor Services.  Specifically, Nicor Services currently uses Nicor Gas personnel to assist in some sales solicitation for these warranty products and to provide repair services for some of these products.  Nicor Gas does not believe these proposed modifications are appropriate and is opposing them.  If these proposed modifications to the operating agreement are approved by the ICC, it would require changes in the way Nicor Services provides its warranty products and could adversely impact the future profitability of these products.  As the ICC will be required to evaluate future transactions between Nicor Gas and its affiliates in connection with the joint application of AGL Resources, Nicor and Nicor Gas for approval of the merger of AGL Resources and Nicor, Nicor Gas has a motion pending with the ICC to suspend this proceeding.

Financial Reform Legislation.  Financial Reform Legislation was enacted into law on July 21, 2010, and includes a provision that requires certain over-the-counter derivative transactions to be executed through an exchange or centrally cleared and also includes provisions under which the Commodity Futures Trading Commission may impose collateral requirements.  Final rules on major provisions in the legislation will be established through rulemakings.  While the company does not currently believe the legislation will have a material impact on its results of operations, cash flows and financial condition, the company will continue to evaluate the legislation and future rulemakings.
 
Synthetic Natural Gas Plant Legislation.  In January 2011, the Illinois House and Senate passed legislation regarding two proposed synthetic natural gas plants.  Unless vetoed by the governor,  the legislation will go into effect no later than March 15, 2011 and will require Nicor Gas and other major Illinois natural gas utilities to either: (a) submit to rate cases in 2011, 2013 and 2015, or (b) purchase under long-term contracts (30 years for one plant and 10 years for the other) natural gas from the plants at a cost that may exceed the market price of natural gas.  The legislation would allow Nicor Gas to recover the gas costs, and any related transportation costs, through the PGA without any further prudence review.

Other.  Restrictions imposed by regulatory agencies and loan agreements limiting the amount of subsidiary net assets that can be transferred to Nicor are not expected to have a material impact on the company’s ability to meet its cash obligations.
 

OUTLOOK

Nicor’s 2011 outlook assumes weather based on historical patterns, but excludes, among other things, the impact (including any merger and integration costs incurred in 2011) of the proposed merger with AGL Resources and the ICC’s PBR plan/PGA review, other contingencies or future changes in tax law.  The company’s outlook also does not reflect the additional variability in earnings due to fair value accounting adjustments at Nicor Enerchange and other impacts that could occur because of future volatility in the natural gas markets.  While these items could materially affect 2011 earnings, they are currently not estimable.

Gas distribution.  Nicor Gas’ estimated operating results will decrease in 2011 as the result of the absence of the prior year $32 million pretax benefit attributable to the ICC’s approval of the company’s bad debt rider, higher operating and maintenance costs and higher depreciation expense.

The company estimates that a 100 degree day variation from normal weather affects Nicor Gas’ distribution margin, net of income taxes, by approximately $1.3 million.  The consolidated impact, however, is generally reduced somewhat because of the natural weather hedge attributable to the utility-bill management products offered by certain of Nicor’s other energy ventures.

Shipping.  Tropical Shipping’s 2011 operating results are estimated to be higher than 2010 as a result of estimated increases in base rates and cost reduction initiatives.  The company also continues to expect relatively low tax costs on operating earnings in 2011 attributable to the 2006 reorganization of certain shipping and related operations.

Other energy ventures.  The company expects 2011 operating results from its other energy ventures to be similar to 2010’s.

Other.  The company also expects 2011 net income to be adversely impacted by the absence of favorable tax reserve adjustments recognized in 2010 and higher state income taxes.

CONTINGENCIES

The following contingencies of Nicor 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’s liquidity or financial condition.

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 staff of the ICC and CUB entered into a stipulation providing for additional discovery.  The Illinois Attorney General’s Office (“IAGO”) has also intervened in this matter.  In addition, the IAGO 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.  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 2004 increasing the recorded liability to $26.6 million.  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.  In addition, interest due to the company on certain components of these amounts has not been recognized in the financial statements due to the same uncertainties.  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, CUB filed a motion for $27 million in sanctions against the company in the ICC Proceedings.  In that motion, 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 ALJs assigned to the proceeding issued a ruling denying CUB’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 CUB or other parties to the ICC Proceedings.
 
In 2004, 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 Entergy-Koch Trading, LP (“EKT”), a natural gas, storage and transportation trader and consultant with whom Nicor did business under the PBR plan.  Review of additional information completed in 2004 resulted in the $1.8 million adjustment to the previously recorded liability referenced above.

The evidentiary hearings on this matter were stayed in 2004 in order to permit the parties to undertake additional third party discovery from EKT.  In December 2006, the additional third party discovery from EKT was obtained and the ALJs issued a scheduling order that provided for Nicor Gas to submit direct testimony by April 13, 2007.  In its direct testimony, Nicor Gas seeks a reimbursement of approximately $6 million, which includes interest due to the company, as noted above, of $1.6 million, as of March 31, 2007.  In September 2009, the staff of the ICC, IAGO and CUB submitted direct testimony to the ICC requesting refunds of $109 million, $255 million and $286 million, respectively.  No date has been set for evidentiary hearings on this matter.

Nicor is unable to predict the outcome of the ICC’s review or the company’s potential exposure thereunder.  Because the PBR plan and historical gas costs are still under ICC review, the final outcome could be materially different than the amounts reflected in the company’s financial statements as of December 31, 2010.


Litigation relating to proposed merger.  Nicor, its board of directors, AGL Resources and one or both of AGL Resources’ acquisition subsidiaries and, in one instance, Nicor’s Executive Vice President and Chief Financial Officer have been named as defendants in five putative class action lawsuits brought by purported Nicor shareholders challenging Nicor’s proposed merger with AGL Resources. The first shareholder action was filed on December 7, 2010 in the Eighteenth Circuit Court of DuPage County, Illinois, County Department, Chancery Division (Joseph Pirolli v. Nicor Inc., et al.).  The other four actions were filed between December 10, 2010 and December 17, 2010 in the Circuit Court of Cook County, Illinois, County Department, Chancery Division (Maxine Phillips v. Nicor Inc., et al., filed December 10, 2010; Plumbers Local #65 Pension Fund v. Nicor Inc., et al., filed December 13, 2010; Gus Monahu v. Nicor Inc., et al., filed December 17, 2010; and Roberto R. Vela v. Russ M. Strobel, et al., filed December 17, 2010).

The shareholder actions variously allege, among other things, that the Nicor Board breached its fiduciary duties to Nicor and its shareholders by (i) approving the sale of Nicor to AGL Resources at an inadequate purchase price (and thus failing to maximize value to Nicor shareholders); (ii) conducting an inadequate sale process by agreeing to preclusive deal protection provisions in the Merger Agreement; and (iii) failing to disclose material information regarding the proposed merger to Nicor shareholders.  The complaints also allege that AGL Resources, Nicor and the acquisition subsidiaries aided and abetted these alleged breaches of fiduciary duty. The shareholder actions seek, among other things, declaratory and injunctive relief, including orders enjoining the defendants from consummating the proposed merger and, in certain instances, damages.

On January 10, 2011, the four actions filed in the Circuit Court of Cook County, Illinois, County Department, Chancery Division were consolidated.  Nicor believes the claims asserted in each lawsuit to be without merit and intends to vigorously defend against them.  The final disposition of these shareholder litigation-related matters is not expected to have a material adverse impact on the company’s liquidity or financial condition.

Mercury.  Information about mercury contingencies is presented in Item 8 – Notes to the Consolidated Financial Statements – Note 20 – 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 Item 8 – Notes to the Consolidated Financial Statements – Note 20 – Contingencies – Manufactured Gas Plant Sites.

Municipal tax matters.  Information about municipal tax contingencies is presented in Item 8 – Notes to the Consolidated Financial Statements – Note 20 – Contingencies – Municipal Tax Matters.

Other. The company is involved in legal or administrative proceedings before various courts and agencies with respect to general claims, taxes, environmental, gas cost prudence reviews and other matters.  See Item 8 – Notes to the Consolidated Financial Statements – Note 20 – Contingencies – Other.
 

CRITICAL ACCOUNTING ESTIMATES

Nicor prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States, which regularly require Nicor’s management to exercise judgment in the selection and application of accounting methods.  The application of accounting methods includes making estimates using subjective assumptions and judgments about matters that are inherently uncertain.

The use of estimates and the selection of accounting policies affect Nicor’s reported results and financial condition.  The company has adopted several significant accounting policies and is required to make significant accounting estimates that are important to understanding its financial statements.  These significant policies and estimates are described throughout Item 8 – Notes to the Consolidated Financial Statements.

Although there are numerous areas in which Nicor’s management makes significant accounting estimates, it believes its critical estimates are those that require management’s most difficult and subjective or complex judgments.  Nicor’s management has a practice of reviewing its critical accounting estimates and policy decisions with the audit committee of its board of directors.  Its critical estimates typically involve loss contingencies, derivative instruments, pension and other postretirement benefits, income taxes, credit risk, unbilled revenues and regulatory assets and liabilities because they are estimates which could materially impact Nicor’s financial statements.

Loss contingencies.  Nicor and its subsidiaries record contingent losses as liabilities when a loss is both probable and the amount or range of loss, including related legal defense costs, is reasonably estimable.  When only a range of potential loss is estimable, the company records a liability for the minimum anticipated loss.  Nicor and its subsidiaries and affiliates are involved in various legal and regulatory proceedings and are exposed to various loss contingencies.  These loss contingencies are in some cases resolved in stages over time, estimates may change significantly from period to period, and the company’s ultimate obligations may differ materially from its recorded amounts.  Of particular note is the PBR plan contingency at Nicor Gas described in Item 8 – Notes to the Consolidated Financial Statements – Note 20 – Contingencies.

Derivative instruments.  The rules for determining whether a contract meets the definition of a derivative instrument, contains an embedded derivative requiring bifurcation, or qualifies for hedge accounting treatment are numerous and complex.  The treatment of a single contract may vary from period to period depending upon accounting elections, changes in management’s assessment of the likelihood of future hedged transactions or new interpretations of accounting rules.  As a result, management judgment is required in the determination of the appropriate accounting treatment.  In addition, the estimated fair value of derivative instruments may change significantly from period to period depending upon market conditions, and changes in hedge effectiveness may impact the accounting treatment.  These determinations and changes in estimates may have a material impact on reported results.

Pension and other postretirement benefits.  The company’s cost of providing postretirement benefits is dependent upon various factors and assumptions, including life expectancies, the discount rate used in determining the projected benefit obligation, the expected long-term rate of return on plan assets, the long-term rate of compensation increase and anticipated health care costs.  Actual experience in any one period, particularly the actual return on plan assets, often varies significantly from these mostly long-term assumptions.  When cumulatively significant, the gains and losses generated from such variances are amortized into operating income over the remaining service lives of employees covered by the plans (approximately 9 years for the pension plan and 12 years for the health care plan).  Additional information is presented in Item 8 – Notes to the Consolidated Financial Statements – Note 10 – Postretirement Benefits, including plan asset investment allocation, estimated future benefit payments, general descriptions of the plans, significant assumptions, the impact of certain changes in assumptions and significant changes in estimates.
 

The company’s postretirement benefit expense (net of capitalization) included in operating income was $19.6 million, $24.6 million and $2.7 million in 2010, 2009 and 2008, respectively.  The company expects to record postretirement benefit expense (net of capitalization) for 2011 of $18.7 million.  Significant market declines in the values of plan assets in 2008 caused the increase in postretirement benefit expense for the years after 2008.

Actuarial assumptions affecting 2011 include an expected long-term rate of return on plan assets of 8.25 percent and discount rates of 5.40 percent for the company’s defined benefit pension plan and 5.20 percent for the health care and other benefits plans, compared with an 8.25 percent rate of return on plan assets and discount rates of 5.45 percent and 5.75 percent, respectively, in the prior year.  Nicor Gas establishes its expected long-term return on asset assumption by considering historical and projected returns for each investment asset category, asset allocations and the effects of active plan management.  Projected returns are calculated with the assistance of independent firms via probability-based models.  The discount rates for each plan were determined by performing a cash flow matching study using the Citigroup Pension Discount Curve.  The Citigroup Pension Discount Curve is constructed from a Treasury yield curve and adjusted by adding a corporate bond spread.  The corporate bond spread is developed from a large pool of high quality corporate bonds and mitigates the risks associated with selecting individual corporate bonds whose values may not be representative of the broader market.

The discount rate is critical to the measurement of the plans’ costs.  Additionally, the assumed rate of return on plan assets is critical to the determination of the pension plan’s cost.  The following table illustrates the effect of a one-percentage-point change in these actuarial assumptions on 2010’s net benefit cost (in millions):

Actuarial assumption
 
Increase (decrease)
   
Effect on net benefit cost
 
             
Discount rate
   1.0 %     $(6.2 )  
     (1.0 %)      7.4    
Rate of return on plan assets
   1.0 %      (3.5 )  
     (1.0 %)    
 3.5
   

Income taxes.  A deferred income tax liability is not recorded on undistributed foreign earnings that are expected in management’s judgment to be indefinitely reinvested offshore.  Management considers, among other factors, actual cash investments offshore as well as projected cash requirements in making this determination.  Changes in management’s investment or repatriation plans or circumstances could result in a different deferred income tax liability.

The company records unrecognized tax benefits based on a recognition threshold and valuation method to recognize and measure an income tax position taken, or expected to be taken, in a tax return.  The evaluation is based on a two-step approach.  The first step requires the company to evaluate whether the tax position would “more likely than not,” based upon its technical merits, be sustained upon examination by the appropriate taxing authority.  The second step requires the tax position to be measured at the largest amount of tax benefit that is greater than 50 percent likely of being realized upon settlement.  Changes between what the company recognizes as an unrecognized tax benefit and what is actually settled with the taxing authority could be materially different.

Credit risk.  The company is required to estimate counterparty credit risk in estimating the fair values of certain derivative instruments.  The company’s counterparties consist primarily of major energy companies and financial institutions.  This concentration of counterparties may materially impact the company’s exposure to credit risk resulting from market, economic or regulatory conditions.  To manage this credit risk, the company believes it maintains prudent credit policies to determine and monitor the creditworthiness of counterparties.  In doing so, the company seeks guarantees or collateral, in the form of cash or letters of credit, acquires credit insurance in certain instances, limits its exposure to any one counterparty, and, in some instances, enters into netting arrangements to mitigate counterparty credit risk.  
 

However, the volatility in the capital markets over the past three years has made it more difficult for the company to assess the creditworthiness of its counterparties.  Based on this uncertainty, actual losses relating to credit risk could materially vary from Nicor’s estimates.

The company maintains an allowance for doubtful accounts for estimated losses from the failure of its customers to make required payments.  Such estimates are based on historical experience, existing economic conditions and certain collection-related patterns.  Circumstances which could affect these estimates include, but are not limited to, customer credit issues, natural gas prices, customer deposits and economic conditions.  Actual credit losses could vary materially from Nicor’s estimates.  Nicor’s allowance for doubtful accounts at December 31, 2010, 2009 and 2008 was $27.6 million, $33.0 million and $44.9 million, respectively, as presented on Schedule II in Item 15 – Exhibits, Financial Statement Schedules.  The impact of credit losses to Nicor’s results of operations is substantially mitigated by the bad debt rider that was approved by the ICC on February 2, 2010.  The bad debt rider provides for the recovery from (or refund to) customers of the difference between Nicor Gas’ actual bad debt experience on an annual basis and the benchmark bad debt expense included in its rates for the respective year.

Unbilled revenues.  Nicor Gas accrues revenues for natural gas deliveries not yet billed to customers from the last billing date to month-end.  Accrued unbilled revenue estimates are dependent upon a number of customer-usage factors which require management judgment, including weather factors.  These estimates are adjusted when actual billings occur, and variances in estimates can be material.  Accrued unbilled revenues for Nicor Gas at December 31, 2010 and 2009 were $141.8 million and $137.7 million, respectively.

Regulatory assets and liabilities.  Nicor Gas is regulated by the ICC, which establishes the rules and regulations governing utility rates and services in Illinois.  As a rate-regulated company, Nicor Gas is required to recognize the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities.  Regulatory assets represent probable future revenue associated with certain costs that are expected to be recovered from customers through rate riders or base rates, upon approval by the ICC.  Regulatory liabilities represent probable future reductions in revenues collected from ratepayers through a rate rider or base rates, or probable future expenditures.  If Nicor Gas’ operations become no longer subject to rate regulation, a write-off of net regulatory liabilities would be required.  Additional information on regulatory assets and liabilities is presented in Item 8 – Notes to the Consolidated Financial Statements – Note 2 – Accounting Policies.
 

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

This document includes certain forward-looking statements about the expectations of Nicor and its subsidiaries and affiliates.  Although Nicor 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,” “ultimate,” or similar phrases.  Actual results may differ materially from those indicated in the company’s forward-looking statements due, among other things, to the outcome of the proposed merger between Nicor and AGL Resources, the direct or indirect effects of legal contingencies (including litigation) and the resolution of those issues, including the effects of an ICC review, and undue reliance should not be placed on such statements.

Specifically with respect to the proposed merger between Nicor and AGL Resources, Nicor’s expectations are subject to future events, risks and uncertainties, and there are several factors – many beyond the company’s control – that could cause results to differ significantly from its expectations.  Such events, risks and uncertainties include, but are not limited to:
 
·  
the possibility that the company’s business may suffer as a result of the uncertainty surrounding the merger;
 
·  
the possibility that AGL Resources and Nicor will not receive the regulatory approvals required to complete the merger or that the merger will not be consummated for other reasons;
 
·  
the possibility of adverse decisions in pending and potential state and federal class action lawsuits, including five shareholder suits, relating to the merger;
 
·  
the possibility that the company may not be able to maintain relationships with its employees, suppliers, or customers as a result of the uncertainty surrounding the merger; and
 
·  
the possibility that the Merger Agreement will be terminated under circumstances in which the company would incur termination payment obligations.

Other factors that could cause materially different results include, but are not limited to, weather conditions; natural disasters; natural gas and other fuel prices; fair value accounting adjustments; inventory valuation; health care costs; insurance costs or recoveries; legal costs; borrowing needs; interest rates; credit conditions; economic and market conditions; accidents, leaks, equipment failures, service interruptions, environmental pollution, and other operating risks; tourism and construction in the Bahamas and Caribbean region; 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 customers, transporters, 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 undertakes no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances after the date of this filing.
 

Item 7A.        Quantitative and Qualitative Disclosures About Market Risk

Nicor is exposed to market risk in the normal course of its business operations, including the risk of loss arising from adverse changes in natural gas and fuel commodity prices and interest rates.  Nicor’s practice is to manage these risks utilizing derivative instruments and other methods, as deemed appropriate.

Commodity price risk.  With regard to commodity price risk, the company has established policies and procedures with respect to the management of such risks and the use of derivative instruments to hedge its exposure to such risks.  Company management oversees compliance with such policies and procedures.  Nicor’s other energy businesses utilize various techniques to limit, measure and monitor market risk, including limits based on volume, dollar amounts, maturity, and in some cases value at risk (“VaR”).

VaR is a tool to assess the potential loss for an instrument or portfolio from adverse changes in market factors, for a specified time period and at a specified confidence level.  The company has established exposure limits at such a level that material adverse economic results are not expected.  The company’s commodity price risk policies and procedures continue to evolve with its businesses and are subject to ongoing review and modification.

In accordance with SEC disclosure requirements, Nicor performs sensitivity analyses to assess the potential loss in earnings based upon a hypothetical 10 percent adverse change in market prices.  Management does not believe that sensitivity analyses alone provide an accurate or reliable method for monitoring and controlling risks and therefore also relies on the experience and judgment of its management to revise strategies and adjust positions as deemed necessary.  Losses in excess of the amounts determined in sensitivity analyses could occur if market prices exceed the 10 percent shift used for the analyses.

As a regulated utility, Nicor Gas’ exposure to market risk caused by changes in commodity prices is substantially mitigated because of Illinois rate regulation allowing for the recovery of prudently incurred natural gas supply costs from customers.  However, substantial changes in natural gas prices may impact Nicor Gas’ earnings by increasing or decreasing the cost of gas used by the company, storage-related gas costs, and other operating and financing expenses.  The company expects to purchase in 2011 about 2 Bcf of natural gas for its own use and to cover storage-related gas costs.  The volume of natural gas purchased by the company, which is exposed to market risk, has declined over the last two years as a result of certain changes approved in the 2009 rate orders.  The level of natural gas prices may also impact customer gas consumption and therefore gas distribution margin.  The actual impact of natural gas price fluctuations on Nicor Gas’ earnings is dependent upon several factors, including the company’s hedging practices.  The company generally hedges its forecasted company use and storage-related gas costs through the use of swap agreements.

Nicor’s other energy businesses are subject to natural gas commodity price risk, arising primarily from purchase and sale agreements, transportation agreements, natural gas inventories and utility-bill management contracts.  Derivative instruments such as futures, options, forwards and swaps may be used to hedge these risks.  Based on Nicor’s other energy businesses unhedged positions at December 31, 2010, a 10 percent adverse change in natural gas prices would have decreased Nicor’s earnings for the periods ended December 31, 2010 and 2009 by about $0.2 million.

In the fourth quarter of 2010, Nicor’s other energy businesses entered into derivative instruments to hedge the natural gas commodity price risk associated with its forecasted purchase of base gas that will be injected as part of the development of the Central Valley natural gas storage facility.  At December 31, 2010, these derivatives totaled approximately 1.4 Bcf and had a fair value of approximately $0.2 million.  Gains and losses on these derivatives are deferred in accumulated other comprehensive income until the storage facility is retired and the base gas is sold.
 

At December 31, 2010, Nicor Enerchange, Nicor’s wholesale natural gas marketing business, held derivative contracts with the following net asset (liability) fair values (in millions):

         
Maturity
 
 
Source of Fair Value
 
Total
Fair Value
   
Less than
1 Year
   
1 to 3
Years
 
                   
Prices actively quoted
  $ (8.3 )   $ (4.7 )   $ (3.6 )
Prices correlated to external sources
    28.2       18.9       9.3  
Prices based on models and other valuation methods
    (6.9 )     (5.2 )     (1.7 )
Total
  $ 13.0     $ 9.0     $ 4.0  

Actively quoted prices are for those derivative instruments traded on the NYMEX.  Nicor Enerchange enters into over-the-counter derivative instruments with values that are similar to, and correlate with, quoted prices for exchange-traded instruments in active markets.  Nicor Enerchange uses one or more significant unobservable inputs such as indicative broker prices.

Tropical Shipping’s objective is to substantially mitigate its exposure to higher fuel costs through fuel surcharges.

Credit risk.  The company has a diversified customer base, which limits its exposure to concentrations of credit risk in any one industry or income class and believes that it maintains prudent credit policies.  Additionally, the gas distribution business offers options to help customers manage their bills, such as energy assistance programs for low-income customers and a budget payment plan that spreads gas bills more evenly throughout the year.  This risk has been substantially mitigated by the bad debt rider approved by the ICC on February 2, 2010.  The bad debt rider provides for the recovery from (or refund to) customers of the difference between Nicor Gas’ actual bad debt experience on an annual basis and the benchmark bad debt expense included in its rates for the respective year.

The company is also exposed to credit risk in the event a counterparty, customer or supplier defaults on a contract to pay for or deliver product at agreed-upon terms and conditions.  To manage this credit risk, the company believes it maintains prudent credit policies to determine and monitor the creditworthiness of counterparties.  In doing so, the company seeks guarantees or collateral, in the form of cash or letters of credit, acquires credit insurance in certain instances, limits its exposure to any one counterparty, and, in some instances, enters into netting arrangements to mitigate counterparty credit risk.  However, the volatility in the capital markets over the past three years has made it more difficult for the company to assess the creditworthiness of its counterparties.  Based on this uncertainty, the company has taken additional steps including, but not limited to, reducing available credit to some of its counterparties.

Interest rate risk.  Nicor is exposed to changes in interest rates.  The company manages its interest rate risk by issuing primarily fixed-rate long-term debt with varying maturities, refinancing certain debt and, at times, hedging the interest rate on anticipated borrowings.  At December 31, 2010, if market rates were to hypothetically increase by 10 percent from Nicor’s weighted-average floating interest rate on commercial paper, interest expense would have increased causing Nicor’s earnings to decrease by less than $0.1 million in 2010.  Nicor holds forward-starting interest rate swaps maturing in 2012 with a notional totaling $90 million.  These swaps had a net liability fair value of $2.2 million at December 31, 2010.  The fair value of these derivatives is determined based on prices that correlate to external sources.  Gains and losses on the interest rate swaps are deferred in accumulated other comprehensive income until settlement and then amortized to interest expense over the life of the related debt.  For further information about debt securities, interest rates and fair values, see Item 8 – Notes to the Consolidated Financial Statements – Note 6 – Short-Term and Long-Term Debt and Note 7 – Fair Value Measurements.


Nicor Inc.

Financial Statements and Supplementary Data
 
   
Page
     
48
     
Financial Statements:
 
     
 
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51
     
 
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54
     
 
54
     
 
55
 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of Nicor Inc.
 
We have audited the accompanying consolidated balance sheets of Nicor Inc. and subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of income, common equity, comprehensive income, and cash flows for each of the three years in the period ended December 31, 2010.  Our audits also included the financial statement schedule at Item 15(a)(2).  We also have audited the Company’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting.  Our responsibility is to express an opinion on these financial statements and financial statement schedule and an opinion on the Company's internal control over financial reporting based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.  Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances.  We believe that our audits provide a reasonable basis for our opinions.
 
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
 
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis.  Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (concluded)

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.  Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.  Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 
/s/ DELOITTE & TOUCHE LLP
 
Chicago, Illinois
February 24, 2011
 
 
Nicor Inc.
                 
                 
(millions, except per share data)
                 
                   
   
Year ended December 31
 
   
2010
   
2009
   
2008
 
Operating revenues
                 
Gas distribution (includes revenue taxes of $148.1, $150.3 and $174.0, respectively)
  $ 2,204.4     $ 2,140.8     $ 3,206.9  
Shipping
    345.0       352.6       425.2  
Other energy ventures
    218.4       239.0       230.3  
Corporate and eliminations
    (58.0 )     (80.3 )     (85.8 )
Total operating revenues
    2,709.8       2,652.1       3,776.6  
                         
Operating expenses
                       
Gas distribution
                       
Cost of gas
    1,364.1       1,345.7       2,427.8  
Operating and maintenance
    300.0       300.4       294.6  
Depreciation
    183.6       177.4       170.9  
Taxes, other than income taxes
    164.6       167.6       189.4  
Other
    (2.6 )     -       (.2 )
Shipping
    330.6       323.4       385.9  
Other energy ventures
    184.0       193.5       205.0  
Other corporate expenses and eliminations
    (50.2 )     (76.2 )     (81.8 )
Total operating expenses
    2,474.1       2,431.8       3,591.6  
                         
Operating income
    235.7       220.3       185.0  
Interest expense, net of amounts capitalized
    38.1       38.7       40.1  
Equity investment income, net
    8.2       15.8       9.4  
Interest income
    1.1       2.3       8.8  
Other income, net
    1.2       .9       .7  
                         
Income before income taxes
    208.1       200.6       163.8  
Income tax expense, net of benefits
    69.7       65.1       44.3  
                         
Net income
  $ 138.4     $ 135.5     $ 119.5  
                         
Average shares of common stock outstanding
                       
Basic
    45.7       45.4       45.3  
Diluted
    45.7       45.5       45.4  
                         
Earnings per average share of common stock
                       
Basic
  $ 3.02     $ 2.99     $ 2.64  
Diluted
    3.02       2.98       2.63  
                         
The accompanying notes are an integral part of these statements.
                       

50
 


Nicor Inc.