NICOR INC. FORM 10-Q 03-31-2007




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934

                            For the quarterly period ended March 31, 2007

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 Number)

1844 Ferry Road
 
Naperville, Illinois 60563-9600
(630) 305-9500
(Address of principal executive offices)
(Registrant’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [X]
Accelerated filer [ ]
Non-accelerated filer [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Common stock, par value $2.50, outstanding at April 26, 2007, were 45,024,851 shares.






Table of Contents

 
ii
       
Part I - Financial Information
 
       
 
Item 1.
Financial Statements (Unaudited)
 
       
   
1
   
Three months ended March 31, 2007 and 2006
 
       
   
2
   
Three months ended March 31, 2007 and 2006
 
       
   
3
   
March 31, 2007 and 2006, and December 31, 2006
 
       
   
4
       
 
Item 2.
16
   
Condition and Results of Operations
 
       
 
Item 3.
27
       
 
Item 4.
27
       
Part II - Other Information
 
       
 
Item 1.
28
       
 
Item 1A.
28
       
 
Item 2.
28
       
 
Item 6.
29
       
   
30






Glossary

ARO. Asset retirement obligation.

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

Degree day. The extent to which the daily average temperature falls below 65 degrees Fahrenheit. Normal weather for Nicor Gas’ service territory, for purposes of this report, is considered to be 5,830 degree days per year.

EN Engineering. EN Engineering, L.L.C., a 50-percent-owned joint venture that provides engineering and consulting services.

FASB. Financial Accounting Standards Board.

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

FSP. FASB Staff Position.

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.

MMBtus. Million British thermal units.

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, 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), a wholly owned public utility business and one of the nation’s largest distributors of natural gas.
 
ii
 
Nicor. Nicor Inc., or the registrant.

Nicor Services. Nicor Energy Services Company, a wholly owned business that provides customer relationship management services to businesses 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.

PBR. Performance-based rate, a regulatory plan which ended on January 1, 2003, that provided economic incentives based on natural gas cost performance.

PGA. Nicor Gas’ Purchased Gas Adjustment.

SEC. The United States Securities and Exchange Commission.

SFAS. Statement of Financial Accounting Standard.

TEL. Tropic Equipment Leasing Inc., an indirectly wholly owned subsidiary of Nicor, holds the company’s interests 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


         
                
 
 
         
                
              
Condensed Consolidated Statements of Operations (Unaudited)
         
(millions, except per share data)
         
        
Three months ended
 
        
March 31
 
        
2007
 
2006
 
Operating revenues
           
Gas distribution (includes revenue taxes of $72.3 and $72.6, respectively)
       
$
1,208.4
 
$
1,210.8
 
Shipping
         
99.1
   
95.3
 
Other energy ventures
         
76.6
   
64.4
 
Corporate and eliminations
         
(49.4
)
 
(51.1
)
Total operating revenues
         
1,334.7
   
1,319.4
 
                     
Operating expenses
           
Gas distribution
                   
Cost of gas
         
948.4
   
956.7
 
Operating and maintenance
         
79.7
   
82.7
 
Depreciation
         
41.5
   
40.1
 
Taxes, other than income taxes
         
75.9
   
76.8
 
Mercury-related recoveries, net
         
(8.0
)
 
(3.8
)
Property sale gains
         
-
   
(.1
)
Shipping
         
89.2
   
85.0
 
Other energy ventures
         
79.3
   
71.7
 
Other corporate expenses and eliminations
         
(47.9
)
 
(55.8
)
Total operating expenses
         
1,258.1
   
1,253.3
 
                     
Operating income
 
76.6
   
66.1
 
Interest expense, net of amounts capitalized
 
13.8
   
15.3
 
Equity investment income, net
 
.8
   
1.6
 
Interest income
 
1.6
   
2.1
 
Other income, net
 
.2
   
.2
 
                     
Income before income taxes
 
65.4
   
54.7
 
Income tax expense
 
18.2
   
10.8
 
                     
Net income
$
47.2
 
$
43.9
 
                     
Average shares of common stock outstanding
           
Basic
         
45.0
   
44.3
 
Diluted
         
45.2
   
44.5
 
                     
Earnings per average share of common stock
           
Basic
       
$
1.05
 
$
.99
 
Diluted
         
1.04
   
.99
 
                     
Dividends declared per share of common stock
$
.465
 
$
.465
 
                     
                     
The accompanying notes are an integral part of these statements.
           

1
 


         
Condensed Consolidated Statements of Cash Flows (Unaudited)
         
(millions)
         
   
Three months ended
 
   
March 31
 
   
2007
 
2006
 
               
Operating activities
             
Net income
 
$
47.2
 
$
43.9
 
Adjustments to reconcile net income to net cash flow
             
provided from operating activities:
             
Depreciation
   
46.1
   
44.4
 
Deferred income tax expense (benefit)
   
.7
   
(21.0
)
Changes in assets and liabilities:
             
   Receivables, less allowances
   
(195.5
)
 
182.6
 
   Gas in storage
   
150.3
   
231.0
 
   Accrued gas costs
   
(32.9
)
 
(97.1
)
   Other assets
   
(.7
)
 
36.6
 
   Accounts payable
   
(115.4
)
 
(295.4
)
   Temporary LIFO liquidation
   
409.5
   
443.8
 
   Other liabilities
   
(38.5
)
 
11.7
 
Other items
   
21.3
   
(7.3
)
Net cash flow provided from operating activities
   
292.1
   
573.2
 
               
Investing activities
             
Additions to property, plant & equipment
   
(39.6
)
 
(43.4
)
Purchases of held-to-maturity securities
   
(1.2
)
 
-
 
Proceeds from sales or maturities of held-to-maturity securities
   
.7
   
-
 
Net increase in other short-term investments
   
(8.3
)
 
(9.7
)
Other investing activities
   
(2.3
)
 
(.7
)
Net cash flow used for investing activities
   
(50.7
)
 
(53.8
)
               
Financing activities
             
Repayments of long-term debt
   
-
   
(7.0
)
Net repayments of commercial paper with maturities of
             
90 days or less
   
(253.0
)
 
(498.0
)
Dividends paid
   
(20.9
)
 
(20.7
)
Proceeds from exercise of stock options
   
1.5
   
5.2
 
Other financing activities
   
(.1
)
 
1.4
 
Net cash flow used for financing activities
   
(272.5
)
 
(519.1
)
               
Net increase (decrease) in cash and cash equivalents
   
(31.1
)
 
.3
 
               
Cash and cash equivalents, beginning of period
   
41.1
   
118.9
 
               
Cash and cash equivalents, end of period
 
$
10.0
 
$
119.2
 
               
               
The accompanying notes are an integral part of these statements.
             

2
 


             
                   
Condensed Consolidated Balance Sheets (Unaudited)
                 
(millions)
             
                   
       
March 31
 
December 31
 
March 31
 
       
2007
 
2006
 
2006
 
Assets
     
* As Adjusted
 
* As Adjusted
 
                           
Current assets
                 
Cash and cash equivalents
       
$
10.0
 
$
41.1
 
$
119.2
 
Restricted short-term investments
         
10.3
   
10.2
   
-
 
Short-term investments, at cost which approximates market
         
24.6
   
16.3
   
18.5
 
Receivables, less allowances of $34.9, $33.4
                         
and $44.9, respectively
         
759.0
   
563.5
   
706.5
 
Gas in storage
         
35.7
   
186.0
   
30.3
 
Deferred income taxes
         
30.2
   
39.1
   
10.3
 
Other
         
52.6
   
54.5
   
35.2
 
Total current assets
         
922.4
   
910.7
   
920.0
 
                           
Property, plant and equipment, at cost
                 
Gas distribution
         
4,178.8
   
4,157.1
   
4,073.8
 
Shipping
         
302.9
   
302.9
   
294.6
 
Other
         
20.2
   
19.7
   
16.3
 
           
4,501.9
   
4,479.7
   
4,384.7
 
Less accumulated depreciation
         
1,787.8
   
1,765.0
   
1,714.6
 
Total property, plant and equipment, net
         
2,714.1
   
2,714.7
   
2,670.1
 
                           
Pension benefits
 
164.0
   
161.0
   
190.1
 
Long-term investments
 
135.4
   
134.7
   
134.2
 
Other assets
 
169.3
   
169.0
   
60.7
 
                           
Total assets
$
4,105.2
 
$
4,090.1
 
$
3,975.1
 
                           
                           
Liabilities and Capitalization
                 
                           
Current liabilities
                 
Long-term debt due within one year
       
$
-
 
$
-
 
$
50.0
 
Short-term debt
         
97.0
   
350.0
   
88.0
 
Accounts payable
         
446.7
   
562.1
   
360.4
 
Temporary LIFO inventory liquidation
         
409.5
   
-
   
443.8
 
Accrued gas costs
         
17.1
   
50.0
   
126.1
 
Dividends payable
         
20.9
   
20.9
   
20.6
 
Deferred income taxes
         
-
   
-
   
3.3
 
Obligations related to restricted investments
         
10.0
   
10.0
   
-
 
Other
         
115.7
   
147.0
   
95.8
 
Total current liabilities
         
1,116.9
   
1,140.0
   
1,188.0
 
                           
Deferred credits and other liabilities
                 
Regulatory retirement cost liability
         
687.5
   
676.7
   
642.5
 
Deferred income taxes
         
395.3
   
399.6
   
410.8
 
Health care and other postretirement benefits
         
183.0
   
181.6
   
103.1
 
Asset retirement obligation
         
171.1
   
169.3
   
165.3
 
Regulatory income tax liability
         
53.0
   
53.8
   
40.5
 
Unamortized investment tax credits
         
29.1
   
29.6
   
31.2
 
Other
         
58.1
   
65.3
   
71.0
 
Total deferred credits and other liabilities
         
1,577.1
   
1,575.9
   
1,464.4
 
                           
Commitments and contingencies
                 
                           
Capitalization
                 
Long-term obligations
                         
Long-term debt, net of unamortized discount
         
497.5
   
497.5
   
480.2
 
Mandatorily redeemable preferred stock
         
.6
   
.6
   
.6
 
Total long-term obligations
         
498.1
   
498.1
   
480.8
 
                           
Common equity
                         
Common stock
         
112.4
   
112.3
   
110.9
 
Paid-in capital
         
36.6
   
34.1
   
14.6
 
Retained earnings
         
770.7
   
743.0
   
721.1
 
Accumulated other comprehensive loss, net
         
(6.6
)
 
(13.3
)
 
(4.7
)
Total common equity
         
913.1
   
876.1
   
841.9
 
                           
Total capitalization
         
1,411.2
   
1,374.2
   
1,322.7
 
                           
Total liabilities and capitalization
$
4,105.2
 
$
4,090.1
 
$
3,975.1
 
                           
*    Pursuant to FSP No. AUG AIR-1, Accounting for Planned Major Maintenance Activities, one of Nicor's subsidiaries,
Tropical Shipping, changed its accounting method for planned major maintenance to the direct expensing method
effective January 1, 2007, and retrospectively increased retained earnings by $3.5 million for the earliest period presented.
                           
The accompanying notes are an integral part of these statements.
                 

3
 


Nicor Inc.

Notes to the Condensed Consolidated Financial Statements (Unaudited)

1.  BASIS OF PRESENTATION

The unaudited Condensed Consolidated Financial Statements of Nicor have been prepared by the company pursuant to the rules and regulations of the SEC. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to SEC rules and regulations. The unaudited Condensed Consolidated Financial Statements and Notes should be read in conjunction with the financial statements and the notes thereto included in the company’s 2006 Annual Report on Form 10-K.

The information furnished reflects, in the opinion of the company, all adjustments (consisting only of normal recurring adjustments and adjustments to reflect the changes in accounting policy as described in Note 3 - New Accounting Pronouncements) necessary for a fair statement of the results for the interim periods presented. Results for the interim periods presented are not necessarily indicative of the results to be expected for the full fiscal year due to seasonal and other factors.

2.  ACCOUNTING POLICIES

Gas in storage. Gas distribution segment inventory is carried at cost on a LIFO basis. Inventory decrements occurring during interim periods that are expected to be restored prior to year-end are charged to cost of gas at the estimated annual replacement cost, and the difference between this cost and the actual LIFO layer cost is recorded on the balance sheet as a current temporary LIFO liquidation. Interim inventory decrements not expected to be restored prior to year-end are charged to cost of gas at the actual LIFO cost of the layers liquidated.
 
Nicor Enerchange inventory is carried at the lower of weighted-average cost or market. In the first quarter of 2006, Nicor Enerchange recorded a charge of $2.4 million resulting from a lower of cost or market valuation.

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 applies SFAS No. 71, Accounting for the Effects of Certain Types of Regulation, which allows Nicor Gas 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 rate cases, upon approval by the ICC. Regulatory liabilities represent probable future reductions in revenues collected from ratepayers through a rate rider or base rates. If all or a portion of Nicor Gas’ operations become no longer subject to the provisions of SFAS No. 71, a write-off of net regulatory liabilities would be required.
 
4
 


The company had regulatory assets and liabilities as follows (in millions):

   
March 31
 
December 31
 
March 31
 
   
2007
 
2006
 
2006
 
Regulatory assets
                   
Regulatory postretirement asset - current
 
$
8.8
 
$
8.8
 
$
-
 
Regulatory postretirement asset - noncurrent
   
103.5
   
104.7
   
-
 
Deferred environmental costs
   
12.4
   
16.0
   
10.3
 
Unamortized losses on reacquired debt
   
17.3
   
17.6
   
18.4
 
Deferred rate case costs
   
2.9
   
3.0
   
3.4
 
Other
   
.7
   
1.0
   
.4
 
   
$
145.6
 
$
151.1
 
$
32.5
 

Regulatory liabilities
                   
Regulatory retirement cost liability - current
 
$
8.0
 
$
8.0
 
$
9.0
 
Regulatory retirement cost liability - noncurrent
   
687.5
   
676.7
   
642.5
 
Accrued gas costs
   
17.1
   
50.0
   
126.1
 
Regulatory income tax liability
   
53.0
   
53.8
   
40.5
 
Other
   
2.6
   
-
   
1.1
 
   
$
768.2
 
$
788.5
 
$
819.2
 

The current portion of the regulatory postretirement asset is classified in current other assets and all other regulatory assets are classified in noncurrent other assets. The current portion of the regulatory retirement cost liability is classified in current other liabilities. Regulatory liabilities - Other is classified in noncurrent other liabilities.

The ICC does not presently allow Nicor Gas the opportunity to earn a return on its regulatory postretirement asset. This regulatory asset is expected to be recovered from ratepayers over a period of approximately 10 to 15 years. The regulatory assets related to debt are not included in rate base, but are recovered over the term of the debt through the rate of return authorized by the ICC.

Revenue taxes. Nicor Gas classifies revenue taxes billed to customers as operating revenues and related taxes incurred as operating expenses. Revenue taxes included in operating expense for the quarters ended March 31, 2007 and 2006 were $71.1 million and $71.4 million, respectively.

Mercury-related recoveries, net. Mercury-related recoveries, net reflect the estimated costs, recoveries and reserve adjustments associated with the company’s mercury inspection and repair program.

Reclassifications. Certain reclassifications have been made to conform the prior year’s financial statements to the current year’s presentation.

3.  NEW ACCOUNTING PRONOUNCEMENTS

Uncertain tax positions. The company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. As of the date of adoption, the company recorded a cumulative effect adjustment that resulted in increasing retained earnings by $1.4 million. This Interpretation sets forth 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 an entity 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 ultimate settlement. In addition, previously recognized benefits from tax positions that no longer meet the new criteria would be derecognized.
 
5
 


The company’s major tax jurisdictions include the United States and the State of Illinois with tax returns examined by the IRS and the IDR, respectively. As of January 1, 2007, the years that remain subject to examination by the IRS include years beginning after 2001, and the years that remain subject to examination by the IDR include years beginning after 2002.  For tax positions within years that remain subject to examination, management has recognized the largest amount of tax benefit that it believes is greater than 50 percent likely of being realized upon settlement with the taxing authority. The company’s liability for unrecognized tax benefits was approximately $5 million at January 1, 2007, of which approximately $5 million, if recognized, would impact the company’s effective tax rate. There have been no significant changes to these amounts during the quarter ended March 31, 2007. Due to a number of factors, including the potential closure of examinations, the expiration of statute of limitations, and the potential resolution of court cases, the company anticipates that it is reasonably possible that a change to its unrecognized tax benefits could occur within 12 months, potentially decreasing or increasing results of operations by up to $5 million.

The company records interest accrued related to unrecognized tax benefits in interest expense, and penalties, if any, are recorded in operating expense. At January 1, 2007, approximately $11 million was accrued for the payment of interest.

Planned major maintenance activities. The company adopted the provisions of FSP No. AUG AIR-1, Accounting for Planned Major Maintenance Activities, on January 1, 2007. As of the date of adoption, the company retrospectively increased retained earnings by $3.5 million with an offsetting adjustment to accounts payable of $2.4 million and other non-current liabilities of $1.1 million for the earliest period presented in this report. This FSP disallowed the accrue-in-advance method of accounting for planned major maintenance activities, which was the method utilized by Tropical Shipping for the planned major maintenance of its owned vessels. Pursuant to this FSP, Tropical Shipping changed its accounting method for planned major maintenance to the direct expensing method. Since the adoption of the new method had no material impact on previously issued statements of operations, those statements have not been retrospectively adjusted.

Fair value measurements. In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The Statement does not require any new fair value measurements, rather it provides guidance on how to perform fair value measurements as required or permitted under other accounting pronouncements. This Statement is effective for Nicor no later than January 1, 2008 and is expected to be adopted prospectively at that time. The company is currently evaluating the Statement and the impact it may have on the company’s results of operations and financial condition.

4.  RESTRICTED SHORT-TERM INVESTMENTS

At March 31, 2007, Nicor had $10.3 million of restricted short-term investments, including $0.3 million in interest earned, held in an escrow fund and a corresponding $10.0 million current liability. In July 2006, Nicor reached a tentative agreement with the staff of the Enforcement Division of the SEC in settlement of an anticipated civil action against the company for a payment of $10 million. At that time, the company deposited $10 million in an escrow account pending review and final approval of the tentative settlement by the SEC commissioners. On March 29, 2007, the SEC commissioners approved the tentative settlement. The settlement is subject to entry of a final judgment by a federal court. In accordance with the escrow agreement, the $10 million will not be distributed until a federal court order directs the distribution. There were no similar restricted short-term investments at March 31, 2006. For further information, see Note 14 - Contingencies - SEC and U.S. Attorney Inquiries.
 
6
 


5.  SHORT-TERM AND LONG-TERM DEBT

In October 2006, Nicor Gas established a $400 million, 210-day seasonal revolver, which expires in May 2007, to replace the $400 million, 210-day seasonal revolver, which expired in April 2006. In September 2005, Nicor and Nicor Gas established a $600 million, five-year revolver, expiring 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 $97.0 million, $350.0 million and $88.0 million of commercial paper borrowings outstanding at March 31, 2007, December 31, 2006 and March 31, 2006, respectively.

At March 31, 2006, Tropical Shipping had $33 million outstanding on a $40 million two-year senior unsecured term loan, which was paid in full by the fourth quarter of 2006.

The company believes it is in compliance with all debt covenants.

6.  INCOME AND OTHER TAXES

Effective January 2006, the company reorganized certain of its shipping and related operations primarily to take advantage of certain provisions of the Jobs Act that provide the opportunity for future tax savings. 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 determined to be indefinitely reinvested offshore, no deferred income tax expense would be recorded by the company. Income tax expense has not been provided on approximately $8 million of foreign company shipping earnings in the first quarter of 2007 that are expected to be indefinitely reinvested offshore.

In connection with these activities, a net income tax benefit of approximately $6 million was recorded in the first quarter of 2006 from the elimination of certain deferred taxes offset by $2.5 million in current tax expense associated with these activities. The net of these two items represents the majority of the change in the company’s effective tax rate from 19.7 percent for the quarter ended March 31, 2006 to 27.8 percent for the quarter ended March 31, 2007.

In 2003, Nicor received an income tax refund of approximately $100 million attributable to a tax loss carryback associated with a change in tax accounting method (which increased its deferred income tax liability) subject to IRS review and approval as part of normal ongoing audits. Through December 31, 2004, the total current tax benefits previously recorded under this accounting method approximated $135 million (amounts recorded were offset by increases to the deferred tax liability with no net effect on reported net federal income tax expense). In 2005, the IRS revised the regulations pertaining to the aforementioned tax accounting method. The new regulations required repayment in 2005 and 2006 of amounts previously taken as current tax deductions. During 2006 and 2005, the company reclassified income tax expense from deferred to current and repaid approximately $135 million equally over those years.

7.  ACCRUED UNBILLED REVENUES

Receivables include accrued unbilled revenues of $174.0 million, $159.5 million and $122.2 million at March 31, 2007, December 31, 2006 and March 31, 2006, respectively, related primarily to gas distribution operations. Nicor Gas accrues revenues for estimated deliveries to customers from the date of their last bill until the balance sheet date.


8.  FAIR VALUE OF FINANCIAL INSTRUMENTS

The recorded amount of short-term investments, restricted short-term investments and short-term borrowings approximates fair value because of the short maturity of the instruments. Long-term debt outstanding, including current maturities, is recorded at the principal balance outstanding, net of unamortized discounts. The principal balance of Nicor Gas’ First Mortgage Bonds outstanding at March 31, 2007, December 31, 2006 and March 31, 2006 was $500 million. Based on quoted market interest rates, the fair value of the company’s First Mortgage Bonds outstanding was approximately $518 million at March 31, 2007 and December 31, 2006 and $512 million at March 31, 2006.

Derivative financial instruments are recorded at fair value as determined primarily from actively quoted prices. The fair value of derivative financial instruments relates largely to Nicor Gas. The majority of derivative financial instruments held by Nicor Gas are for the purpose of hedging natural gas purchases for its customers, and their settlement is passed directly through to customers without markup, subject to ICC review. The gross asset and liability fair values of these instruments are reflected on the Condensed Consolidated Balance Sheets as follows (in millions):

   
March 31
 
December 31
 
March 31
 
   
2007
 
2006
 
2006
 
               
Current other assets
 
$
4.8
 
$
5.3
 
$
7.5
 
Noncurrent other assets
   
2.6
   
.5
   
2.0
 
   
$
7.4
 
$
5.8
 
$
9.5
 
                     
Current other liabilities
 
$
16.4
 
$
51.3
 
$
13.3
 
Noncurrent other liabilities
   
.4
   
1.2
   
2.0
 
   
$
16.8
 
$
52.5
 
$
15.3
 

Nicor maintains margin accounts related to financial derivative transactions. At March 31, 2007, December 31, 2006 and March 31, 2006, the balance of these accounts was $22.5 million, $16.2 million and $27.4 million, respectively, and was reflected on the Condensed Consolidated Balance Sheets as Receivables.

9.  POSTRETIREMENT BENEFITS

Nicor Gas maintains a noncontributory defined benefit pension plan covering substantially all employees hired prior to 1998. Pension benefits are based on years of service and highest average salary for management employees and job level for unionized employees. The benefit obligation related to collectively bargained benefits considers the company’s past practice of regular benefit increases to reflect current wages. Nicor Gas also provides health care and life insurance benefits to eligible retired employees under a plan that includes limits on the company’s share of cost for employees hired after 1982. The company’s postretirement benefit costs have historically been considered in rate proceedings in the period they are accrued. To the extent eligible employees perform services for non-regulated affiliates, such affiliates are charged for the cost of these benefits.


About one-fourth of the net periodic benefit cost or credit related to these plans has been capitalized as a cost of constructing gas distribution facilities and the remainder is included in gas distribution operating and maintenance expense. Net periodic benefit cost (credit) included the following components (in millions):
 
   
Pension benefits
 
Health care and
other benefits
 
Three months ended March 31
 
2007
 
2006
 
2007
 
2006
 
                           
Service cost
 
$
2.3
 
$
2.3
 
$
.6
 
$
.6
 
Interest cost
   
3.8
   
3.7
   
2.7
   
2.6
 
Expected return on plan assets
   
(9.0
)
 
(8.7
)
 
-
   
(.1
)
Recognized net actuarial loss
   
-
   
.1
   
1.2
   
1.2
 
Amortization of prior service cost
   
.1
   
.1
   
-
   
-
 
Net periodic benefit cost (credit)
 
$
(2.8
)
$
(2.5
)
$
4.5
 
$
4.3
 

In the first quarter of 2007, the company received federal subsidies of $1.2 million under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The subsidy relates to the company’s 2006 retiree health care benefits and is comparable to the benefit assumed in the most recent actuarial valuation.

10.  EQUITY INVESTMENT INCOME, NET

Net equity investment income totaled $0.8 million and $1.6 million for the quarters ended March 31, 2007 and 2006, respectively. These amounts include investment income from Triton of $0.9 million and $1.2 million, respectively, for the three-month periods ended March 31, 2007 and 2006. Nicor received cash distributions from equity investees of $4.1 million and $1.7 million, respectively, during the first quarter of 2007 and 2006.

11.  COMPREHENSIVE INCOME

Total comprehensive income, as defined by SFAS No. 130, Reporting Comprehensive Income, is equal to net income plus other comprehensive income and is as follows (in millions):
 
     
Three months ended 
 
     
March 31 
 
     
2007
   
2006 
 
               
Net income
 
$
47.2
 
$
43.9
 
Other comprehensive income (loss), after tax
   
6.7
   
(3.1
)
Total comprehensive income
 
$
53.9
 
$
40.8
 
 
Net other comprehensive income (loss) consists primarily of net unrealized gains and losses from derivative financial instruments accounted for as cash flow hedges, including Nicor’s share of such amounts from joint ventures and other equity-method investees.

 
12.  BUSINESS SEGMENT INFORMATION

Financial data by major business segment is presented below (in millions):
   
 
Gas distribution
 
 
 
Shipping
 
Other energy ventures
 
Corporate and
eliminations
 
 
 
Consolidated
 
                        
Three months ended March 31, 2007
                       
Operating revenues
                               
External customers
 
$
1,176.3
 
$
99.1
 
$
59.3
 
$
-
 
$
1,334.7
 
Intersegment
   
32.1
   
-
   
17.3
   
(49.4
)
 
-
 
   
$
1,208.4
 
$
99.1
 
$
76.6
 
$
(49.4
)
$
1,334.7
 
                                 
Operating income (loss)
 
$
70.9
 
$
9.9
 
$
(2.7
)
$
(1.5
)
$
76.6
 
                                 
Three months ended March 31, 2006
                       
Operating revenues
                               
External customers
 
$
1,170.0
 
$
95.3
 
$
54.1
 
$
-
 
$
1,319.4
 
Intersegment
   
40.8
   
-
   
10.3
   
(51.1
)
 
-
 
   
$
1,210.8
 
$
95.3
 
$
64.4
 
$
(51.1
)
$
1,319.4
 
                                 
Operating income (loss)
 
$
58.4
 
$
10.3
 
$
(7.3
)
$
4.7
 
$
66.1
 

The majority of intersegment revenues represent gas distribution revenues related to customers entering into utility-bill management contracts with Nicor Solutions. Under the utility-bill management contracts, Nicor Solutions bills a fixed amount to a customer, regardless of changes in natural gas prices or weather, and in exchange pays the customer’s utility bills from Nicor Gas. Intersegment revenues are eliminated in the Condensed Consolidated Financial Statements.

Benefits (costs) associated with Nicor’s other energy ventures’ utility-bill management contracts attributable to warmer (colder) than normal weather for the three months ended March 31, 2007 and 2006 were $(0.6) million and $5.2 million, respectively. The weather impact of these contracts generally serves to partially offset the gas distribution segment’s weather risk. This benefit (cost) is recorded at the corporate level as a result of an agreement between the parent company and certain of its subsidiaries.

13.  GUARANTEES AND INDEMNITIES

Nicor and certain subsidiaries enter into various financial and performance guarantees and indemnities providing assurance to third parties.

Financial guarantees. The company has issued guarantees of affiliate obligations to vendors and other third parties, requiring Nicor to repay the obligations should its affiliates default. The obligations of the company’s wholly owned subsidiaries are reflected in Nicor’s Condensed Consolidated Balance Sheets, while the obligations of its unconsolidated equity investments are not.

TEL has a contingent liability to restore to zero any deficit in its equity account for income tax purposes in the unlikely event that Triton is liquidated and a deficit balance remains. This contingent liability continues for the life of the Triton partnerships and any payment is effectively limited to the assets of TEL, which were approximately $14 million at March 31, 2007. Nicor believes the likelihood of any such payment by TEL is remote, and no liability has been recorded for this contingency.
 
10

 

 
Performance guarantees.  Nicor Services markets separately priced product warranty contracts that provide for the repair of heating, ventilation and air conditioning equipment, natural gas lines, and other appliances within homes.  Revenues from these product warranty contracts are recognized ratably over the coverage period, and related repair costs are charged to expense as incurred.  Repair expenses of $1.7 million and $1.5 million were incurred for the three months ended March 31, 2007 and March 31, 2006, respectively.
 
Indemnities.  In certain instances, Nicor has undertaken to indemnify current property owners and others against costs associated with the effects and/or remediation of contaminated sites for which the company may be responsible under applicable federal or state environmental laws, generally with no limitation as to the amount.  Aside from liabilities recorded in connection with coal tar cleanup, as discussed in Note 14 – Contingencies – Manufactured Gas Plant Sites, Nicor believes that the likelihood of payment under these indemnifications is either remote, or the fair value of the indemnification is immaterial, and no liability has been recorded for these indemnifications.
 
Nicor has also indemnified, to the fullest extent permitted under the laws of the State of Illinois and any other applicable laws, its present and former directors, officers and employees against expenses they may incur in connection with litigation they are a party to by reason of their association with the company.  There is generally no limitation as to the amount.  While the company does not expect to incur significant costs under these indemnifications, it is not possible to estimate the maximum future potential payments.
 
14.  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 Cook County State’s Attorney Office (“CCSAO”), the staff of the ICC and CUB entered into a stipulation providing for additional discovery.  The Illinois Attorney General’s Office (“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
 
11
 
attention of the special committee in the course of its investigation.  The special committee presented the report of its counsel (“Report”) to Nicor’s Board of Directors on October 28, 2002.
 
In response, the Nicor Board of Directors directed the company’s management to, among other things, make appropriate adjustments to account for, and fully address, the adverse consequences to ratepayers of the items noted in the Report, and conduct a detailed study of the adequacy of internal accounting and regulatory controls.  The adjustments were made in prior years’ financial statements resulting in a $24.8 million liability.  Included in such $24.8 million liability is a $4.1 million loss contingency.  A $1.8 million adjustment to the previously recorded liability, which is discussed below, was made in 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 as of March 31, 2007 of $1.6 million 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, the CCSAO and CUB filed a motion for $27 million in sanctions against the company in the ICC Proceedings.  In that motion, CCSAO and CUB alleged that Nicor Gas’ responses to certain CUB data requests were false.  Also on February 5, 2003, CUB stated in a press release that, in addition to $27 million in sanctions, it would seek additional refunds to consumers.  On March 5, 2003, the ICC staff filed a response brief in support of CUB’s motion for sanctions.  On May 1, 2003, the Administrative Law Judges issued a ruling denying CUB and CCSAO’s motion for sanctions.  CUB has filed an appeal of the motion for sanctions with the ICC, and the ICC has indicated that it will not rule on the appeal until the final disposition of the ICC Proceedings.  It is not possible to determine how the ICC will resolve the claims of CCSAO, CUB or other parties to the ICC Proceedings.
 
In November 2003, the ICC staff, CUB, CCSAO and the IAGO filed their respective direct testimony in the ICC Proceedings.  The ICC staff is seeking refunds to customers of approximately $108 million and CUB and CCSAO were jointly seeking refunds to customers of approximately $143 million.  The IAGO direct testimony alleges adjustments in a range from $145 million to $190 million.  The IAGO testimony as filed is presently unclear as to the amount which IAGO seeks to have refunded to customers.  On February 27, 2004, the above referenced intervenors filed their rebuttal testimony in the ICC Proceedings.  In such rebuttal testimony, CUB and CCSAO amended the alleged amount to be refunded to customers from approximately $143 million to $190 million.  In 2004, the evidentiary hearings on this matter were stayed in order to permit the parties to undertake additional third party discovery from Entergy-Koch Trading, LP (“EKT”), a natural gas, storage and transportation trader and consultant with whom Nicor did business under the PBR plan.  In December 2006, the additional third party discovery from EKT was obtained, Nicor Gas withdrew its previously filed testimony and the Administrative Law Judges issued a scheduling order that provided for Nicor Gas to submit direct testimony by April 13, 2007.  In its direct testimony filed pursuant to the scheduling order, Nicor Gas seeks a reimbursement of approximately $6 million as of March 31, 2007. No date has been set for evidentiary hearings on this matter.
 
12
 
During the course of the SEC investigation discussed below, the company became aware of additional information relating to the activities of individuals affecting the PBR plan for the period from 1999 through 2002, including information consisting of third party documents and recordings of telephone conversations from EKT.  Review of additional information completed in 2004 resulted in the $1.8 million adjustment to the previously recorded liability referenced above.
 
Although the Report of the special committee’s counsel did not find that there was criminal activity or fraud, a review of this additional information (which was not available to the independent counsel who prepared the Report) and re-interviews of certain Nicor Gas personnel in 2004 indicated that certain former Nicor Gas personnel may have engaged in potentially fraudulent conduct regarding the PBR plan in violation of company policy, and in possible violation of SEC rules and applicable law.  Further, certain former Nicor Gas personnel also may have attempted to conceal their conduct in connection with an ICC review of the PBR plan.  The company has reviewed all third party information it has obtained and will continue to review any additional third party information the company may obtain.  The company terminated four employees in connection with this matter in 2004.
 
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 March 31, 2007.
 
SEC and U.S. Attorney Inquiries.  In 2002, the staff of the SEC Division of Enforcement (“SEC Staff”) informed Nicor that the SEC is conducting a formal inquiry regarding the PBR plan.  A representative of the Office of the United States Attorney for the Northern District of Illinois (the “U.S Attorney”) also notified Nicor that that office was conducting an inquiry on the same matter that the SEC is investigating, and a grand jury was also reviewing this matter.  In April 2004, Nicor was advised by the SEC Staff that it intended to recommend to the SEC that it bring a civil injunctive action against Nicor, alleging that Nicor violated Sections 17(a) of the Securities Act of 1933 and Sections 10(b) and 13(a) of the Securities Exchange Act of 1934 and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder.  In July 2006, the company announced that it reached a tentative agreement with the SEC Staff in settlement of an anticipated civil action to which the company and the SEC will be parties and the SEC commissioners approved the settlement in March 2007.  Under the terms of the settlement, the company will be subject to disgorgement of one dollar, a monetary fine of $10 million and an injunction.  The company neither admits nor denies any wrongdoing.  In July 2006, the company deposited the $10 million in escrow. Those funds are expected to be released upon entry of a final judgment by a federal court approving the settlement.  Nicor recorded a $10 million charge to its 2006 second quarter earnings in connection with this matter.  The $10 million fine is not deductible for federal or state income tax purposes.  In December 2006, the U.S. Attorney advised that it is closing its separate inquiry and will not seek to prosecute the company or any individuals in connection with this matter.
 
Fixed Bill Service.  On April 29, 2003, a second amended purported class action complaint was filed in the Circuit Court of Cook County, Illinois against Nicor Energy Services Company (“Nicor Services”) alleging violation of the Illinois Consumer Fraud Act (“ICFA”) by Nicor Services relating to the fixed bill service offered by Nicor Services.  Nicor Services offered a fixed bill product under which it paid the annual gas service portion of a customer’s Nicor Gas utility bill in exchange for twelve equal monthly payments by the customer to Nicor Services, regardless of changes in the price of natural gas or weather.  The plaintiff sought compensatory damages, prejudgment and postjudgment interest, punitive damages, attorneys’ fees and injunctive relief on behalf of a proposed class consisting of all purchasers of the fixed bill service from February 1, 2002 through December
 
13
 
31, 2002.  On October 7, 2005, the Circuit Court denied plaintiffs’ motion to certify the proposed class.  In March 2007, Nicor Services settled this matter and the lawsuit was dismissed with prejudice.
 
Mercury.  Nicor Gas has incurred, and expects to continue to incur, costs related to its historical use of mercury in various kinds of company equipment.
 
In the first quarter of 2007, Nicor Gas recorded a $7.2 million reduction to its previously established reserve for mercury-related matters. The reduction was attributable primarily to the favorable settlement during the quarter of certain lawsuits that had been pending against Nicor Gas. As of March 31, 2007, Nicor Gas had remaining an estimated liability of $3.4 million related to inspection, cleanup and legal defense costs.  This represents management’s best estimate of future costs based on an evaluation of currently available information.  Actual costs may vary from this estimate. 
 
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. 
 
Nicor Gas continues to pursue recovery from insurers and independent contractors that had performed work for the company.  When received, these recoveries are recorded as a reduction to gas distribution operating expense.  Nicor Gas received approximately $3.8 million, net of legal fees, from an independent contractor in the first quarter of 2006.  In 2004, the Circuit Court of Cook County, Illinois entered judgment in favor of Nicor and Nicor Gas and against various insurers in the amount of $10.2 million with respect to one of Nicor’s and Nicor Gas’ mercury-related insurance claims.  The insurers filed an appeal of the judgment.  In 2005, the First District Appellate Court reversed the Circuit Court’s judgment in favor of Nicor and Nicor Gas and remanded the case to the Circuit Court for proceedings consistent with the Appellate Court’s decision.  In November 2006, the Illinois Supreme Court upheld the decision of the Appellate Court and remanded the case to the trial court.  In the first quarter of 2007, an agreement to settle this matter was reached with the lead insurers resulting in an additional net insurance recovery of approximately $0.7 million.
 
The final disposition of these mercury-related matters is not expected to have a material adverse impact on the company’s financial condition.
  
Manufactured Gas Plant Sites.  Manufactured gas plants were used in the 1800’s and early to mid 1900’s to produce manufactured gas from coal, creating a coal tar byproduct.  Current environmental laws may require the cleanup of coal tar at certain former manufactured gas plant sites.
 
To date, Nicor Gas has identified about 40 properties for which it may have some responsibility.  Most of these properties are not presently owned by the company.  Nicor Gas and Commonwealth Edison Company (“ComEd”) are parties to an interim agreement to cooperate in cleaning up residue at many of these properties.  Under the interim agreement, mutually agreed costs are to be evenly split between Nicor Gas and ComEd until such time as they are finally allocated either through negotiation or arbitration.  On April 17, 2006, Nicor Gas initiated arbitration to determine the final allocations of these costs between Nicor Gas and ComEd.  The ultimate outcome of the arbitration is not presently determinable.  Information regarding preliminary site reviews has been presented to the Illinois Environmental Protection Agency for certain properties.  More detailed investigations and remedial activities are complete, in progress or planned at many of these sites.  The results of the detailed site-by-site investigations determine the extent additional remediation is necessary and provide a basis for
 
14
 
estimating additional future costs.  As of March 31, 2007, the company had recorded a liability in connection with these matters of $17.8 million.  In accordance with ICC authorization, the company has been recovering, and expects to continue to recover, these costs from its customers, subject to annual prudence reviews.
 
In December 2001, a purported class action lawsuit was filed against Exelon Corporation, ComEd and Nicor Gas in the Circuit Court of Cook County alleging, among other things, that the cleanup of a former manufactured gas plant site in Oak Park, Illinois was inadequate.  Since then, additional lawsuits have been filed related to this same former manufactured gas plant site.  These lawsuits seek, in part, unspecified damages for property damage, nuisance, and various personal injuries that allegedly resulted from exposure to contaminants allegedly emanating from the site, injunctive relief to compel the defendants to engage in various clean-up activities and punitive damages.  An agreement in principle to settle the purported class action lawsuit has been reached and, as of March 31, 2007, the company has a $2.3 million liability recorded in connection with this matter.  The proposed class action settlement was approved by the trial court.  An appeal was filed by one objector. In March 2007, the company reached an agreement in principle to settle the objector’s claim.  In accordance with ICC authorization, the company expects to recover costs of such settlement from its customers, subject to an annual prudence review.  Management cannot predict the outcome of certain other pending lawsuits relating to the Oak Park site or the company’s potential exposure thereto and has not recorded a liability associated with those other pending matters.
  
In April 2002, Nicor Gas was named as a defendant, together with ComEd, in a lawsuit brought by the Metropolitan Water Reclamation District of Greater Chicago (the “MWRDGC”) under the Federal Comprehensive Environmental Response, Compensation and Liability Act seeking recovery of past and future remediation costs and a declaration of the level of appropriate cleanup for a former manufactured gas plant site in Skokie, Illinois now owned by the MWRDGC.  In January 2003, the suit was amended to include a claim under the Federal Resource Conservation and Recovery Act.  The suit was filed in the United States District Court for the Northern District of Illinois.  Management cannot predict the outcome of this litigation or the company’s potential exposure thereto and has not recorded a liability associated with this contingency.
  
Since costs and recoveries relating to the cleanup of manufactured gas plant sites are passed directly through to customers in accordance with ICC regulations, subject to an annual ICC prudence review, the final disposition of manufactured gas plant matters is not expected to have a material impact on the company’s financial condition or results of operations.
 
Other.  In addition to the matters set forth above, the company is involved in legal or administrative proceedings before various courts and agencies with respect to general claims, taxes, environmental, gas cost prudence reviews and other matters.  Although unable to determine the ultimate outcome of these other contingencies, management believes that these amounts are appropriately reflected in the financial statements, including the recording of appropriate liabilities when reasonably estimable.
 
15


The following discussion should be read in conjunction with the Management’s Discussion and Analysis section of the Nicor 2006 Annual Report on Form 10-K. Results for the interim periods presented are not necessarily indicative of the results to be expected for the full fiscal year due to seasonal and other factors.

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, and Nicor Enerchange, a wholesale natural gas marketing company. Nicor also has equity interests in energy-related businesses.

Net income and diluted earnings per common share are presented below for the first quarter 2007 and 2006 (in millions, except per share data):
 
   
Three months ended
 
   
March 31
 
   
2007
 
 2006
 
               
Net income
 
$
47.2
 
$
43.9
 
               
Diluted earnings per common share
 
$
1.04
 
$
.99
 

Net income and diluted earnings per common share for the first quarter of 2007 included pretax mercury-related recoveries of $8.0 million ($.11 per share) associated with Nicor Gas’ mercury inspection and repair program which included a reduction of $7.2 million to the company’s previously established reserve and $0.8 million in cost recoveries. The first quarter of 2006 also included a pretax recovery of $3.8 million ($.05 per share) associated with Nicor Gas’ mercury inspection and repair program.

Quarter over quarter comparisons also reflect improved operating results in the company’s gas distribution business (excluding the aforementioned mercury-related recoveries) and other energy-related businesses, offset by lower operating results in the company’s shipping business and lower corporate operating income. Also included in 2006 were income tax benefits resulting from the reorganization of certain shipping and related operations.

Rate proceeding. In the fourth quarter of 2005, Nicor Gas implemented a $54.2 million base rate increase. In March 2006, the ICC issued a rehearing order reducing the annual net rate increase to $49.7 million. Rate changes resulting from the rehearing order were prospective and went into effect on April 11, 2006. Because the orders shift certain items between base rates and Nicor Gas’ PGA rider, the company estimated that the annual net revenue increase resulting from implementing the rehearing order received in March 2006 is about $30.2 million (reduced from $34.7 million in the original order implemented in the fourth quarter of 2005).



Operating income by segment.  Operating income (loss) by major business segment is presented below (in millions):
 
   
Three months ended
 
   
March 31
 
   
2007
 
2006
 
               
Gas distribution
 
$
70.9
 
$
58.4
 
Shipping
   
9.9
   
10.3
 
Other energy ventures
   
(2.7
)
 
(7.3
)
Corporate and eliminations
   
(1.5
)
 
4.7
 
   
$
76.6
 
$
66.1
 

The following summarizes operating income (loss) comparisons by major business segment:

·  
Gas distribution operating income increased $12.5 million in the first quarter of 2007 compared to the prior-year period due to the positive effects of higher gas distribution margin ($6.2 million increase), mercury-related recoveries ($4.2 million increase) and lower operating and maintenance expenses ($3.0 million decrease), which were partially offset by higher depreciation expense ($1.4 million increase). Higher gas distribution margin was mainly attributable to the positive impact of colder weather than in 2006 (approximately $10 million increase) and higher demand unrelated to weather (approximately $7 million increase), partially offset by lower average distribution rates (approximately $7 million decrease which included the negative impact of approximately $2 million attributable to the ICC’s rate order rehearing decision that went into effect in April 2006) and the impact of customer interest (approximately $4 million decrease).

·  
Shipping operating income decreased $0.4 million in the first quarter of 2007 compared to the prior-year period. Higher operating revenues ($3.8 million increase) were more than offset by higher operating costs ($4.2 million increase). Higher operating revenues were attributable primarily to higher volumes shipped ($3.4 million increase). Higher operating costs were due primarily to higher employee-related costs ($2.3 million increase).

·  
Operating losses from Nicor’s other energy ventures decreased $4.6 million in the first quarter of 2007 compared to the prior-year period due to higher operating income at Nicor’s wholesale natural gas marketing business, Nicor Enerchange ($5.8 million increase). Improved operating results at Nicor Enerchange included favorable costing of physical sales activity and improved results from the company’s risk management activities associated with hedging the product risks of the utility-bill management contracts offered by Nicor’s energy-related products and services businesses, partially offset by unfavorable fair value adjustments related to derivative instruments used to hedge purchases and sales of natural gas inventory. Improved operating results at Nicor Enerchange were partially offset by lower operating results at Nicor’s energy-related products and services businesses ($1.1 million decrease) due primarily to increased operating costs ($7.4 million) more than offsetting increased operating revenues ($6.3 million).

Nicor Enerchange purchases and holds natural gas in storage to earn a profit margin from its ultimate sale. Nicor Enerchange uses derivatives to mitigate commodity price risk in order to substantially lock-in the profit margin that will ultimately be realized. 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 accounted for at fair value, with changes in fair value recorded in operating results in the period of change. As a result, earnings are subject to volatility as the market price of derivatives change, even when the underlying hedged value of the inventory is unchanged. The volatility resulting from this accounting can be significant from period to period.



·  
Corporate and eliminations operating income for the first quarter of 2007 was $6.2 million unfavorable versus the prior-year period due primarily to the impact of a natural weather hedge associated with the utility-bill management products offered by Nicor’s energy-related products and services businesses ($5.8 million decrease). In the current year period, the company recorded a $0.6 million charge associated with this hedge, in comparison to a prior year benefit of $5.2 million. Benefits or costs 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. The weather impact of these contracts generally serves to partially offset the gas distribution segment’s weather risk. The amount of the offset attributable to the utility-bill management contracts 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.

RESULTS OF OPERATIONS

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

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

   
Three months ended
 
   
March 31
 
   
2007
 
2006
 
               
Gas distribution
 
$
1,208.4
 
$
1,210.8
 
Shipping
   
99.1
   
95.3
 
Other energy ventures
   
76.6
   
64.4
 
Corporate and eliminations
   
(49.4
)
 
(51.1
)
   
$
1,334.7
 
$
1,319.4
 

Gas distribution revenues are impacted by changes in natural gas costs, which are passed directly through to customers without markup, subject to ICC review. For the first quarter of 2007 compared to the prior-year period, gas distribution revenues were essentially unchanged. Operating revenues were primarily impacted by lower natural gas costs (approximately $220 million decrease), the impact of colder weather (approximately $155 million increase) and higher demand unrelated to weather (approximately $75 million increase).

In the first quarter of 2007, shipping segment operating revenues increased $3.8 million compared with the prior-year period due to higher volumes shipped ($3.4 million increase) and higher average rates ($0.5 million increase). Volumes were higher due primarily to increased interisland shipments. Volumes continue to be adversely impacted by increased competition in several of the ports served, the strategic decision not to compete for certain low margin business, and changing global trade patterns. 

Revenues in the first quarter of 2007 for Nicor’s other energy ventures increased $12.2 million due primarily to higher revenues at Nicor’s energy-related products and services businesses ($6.3 million increase) attributable to an increased number of utility-bill management and warranty contract counts, and higher revenues at Nicor Enerchange ($5.9 million increase). Higher revenues at Nicor Enerchange were due primarily to favorable costing of physical sales activity and improved results from the company’s risk management activities associated with hedging the product risks of the utility-bill management contracts offered by Nicor’s energy-related products and services businesses, partially offset by unfavorable fair value adjustments related to derivative instruments used to hedge purchases and sales of natural gas inventory.
 



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

Gas distribution margin. Nicor utilizes a measure it refers to as “gas distribution margin” to evaluate the operating income impact of gas distribution revenues. Gas distribution revenues include natural gas costs, which are passed directly through to customers without markup, subject to ICC review, and revenue taxes, for which Nicor Gas earns a small administrative fee. These items often cause significant fluctuations in gas distribution revenues, and yet they have virtually no direct impact on gas distribution operating income.

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

   
Three months ended
 
   
March 31
 
   
2007
 
2006
 
               
Gas distribution revenues
 
$
1,208.4
 
$
1,210.8
 
Cost of gas
   
(948.4
)
 
(956.7
)
Revenue tax expense
   
(71.1
)
 
(71.4
)
Gas distribution margin
 
$
188.9
 
$
182.7
 

Gas distribution margin increased $6.2 million in the first quarter of 2007 compared with the corresponding prior-year period due primarily to colder weather than in 2006 (approximately $10 million increase) and higher demand unrelated to weather (approximately $7 million increase), partially offset by lower average distribution rates (approximately $7 million decrease which included the negative impact of approximately $2 million attributable to the ICC’s rate order rehearing decision that went into effect in April 2006) and the impact of customer interest (approximately $4 million decrease).

Gas distribution operating and maintenance expense. Gas distribution operating and maintenance expense decreased $3.0 million to $79.7 million in the first quarter of 2007 from $82.7 million in the prior-year period due to lower company use gas and storage-related gas costs ($7.4 million decrease) attributable largely to lower natural gas prices, partially offset by higher payroll and benefit-related costs ($2.7 million increase) and bad debt expense ($1.2 million increase).

Other gas distribution operating expenses. Mercury-related recoveries, net reflect the estimated costs, recoveries and reserve adjustments associated with the company’s mercury inspection and repair program. Net mercury-related recoveries were $8.0 million for the first quarter of 2007 and $3.8 million for the corresponding prior-year period. The first quarter 2007 net recoveries reflect a $7.2 million reserve adjustment and $0.8 million in cost recoveries. The first quarter 2006 net recovery resulted from a settlement reached with an independent contractor of Nicor Gas. Additional information about the company’s mercury inspection and repair program is presented in Item 1 - Notes to the Condensed Consolidated Financial Statements - Note 14 - Contingencies - Mercury.

Shipping operating expenses. Shipping segment operating expenses increased $4.2 million in the first quarter of 2007 as compared with the corresponding prior-year period. The increase was due, in part, to higher employee-related costs ($2.3 million increase).

Other energy ventures operating expenses. The $7.6 million increase in operating expenses in the first quarter of 2007 as compared with the corresponding prior-year period was due primarily to higher expenses at Nicor’s energy-related products and services businesses ($7.4 million increase) attributable primarily to costs related to an increase in customer contracts ($6.0 million increase).


Interest expense. Interest expense of $13.8 million in the first quarter of 2007 decreased $1.5 million over the prior-year period due primarily to lower average borrowing levels. Lower average borrowings were attributable to the $40 million Tropical Shipping term loan outstanding in the first quarter of 2006, which was paid in full by the fourth quarter of 2006, and lower commercial paper borrowings in the first quarter of 2007 as compared to the first quarter of the prior year.

Net equity investment income. Net equity investment income decreased $0.8 million in the first quarter of 2007 compared with the corresponding prior-year period due, in part, to the absence of income from an equity investment sold in the third quarter of 2006 ($0.4 million decrease) and lower income from Triton ($0.3 million decrease).

Interest income. Interest income decreased $0.5 million in the first quarter of 2007 over the corresponding prior-year period due primarily to lower investment balances.

Income taxes. Effective January 2006, the company reorganized certain of its shipping and related operations primarily to take advantage of certain provisions of the Jobs Act that provide the opportunity for future tax savings. 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 determined to be indefinitely reinvested offshore, no deferred income tax expense would be recorded by the company. Income tax expense has not been provided on approximately $8 million of foreign company shipping earnings in the first quarter of 2007 that are expected to be indefinitely reinvested offshore.

In connection with these activities, a net income tax benefit of approximately $6 million was recorded in the first quarter of 2006 from the elimination of certain deferred taxes offset by $2.5 million in current tax expense associated with these activities. The net of these two items represents the majority of the change in the company’s effective tax rate from 19.7 percent for the quarter ended March 31, 2006 to 27.8 percent for the quarter ended March 31, 2007.
 

20

 
Nicor Inc.
         
Gas Distribution Statistics
         
           
           
   
Three months ended
 
   
March 31
 
   
2007
 
2006
 
Operating revenues (millions)
             
Sales
             
Residential
 
$
835.2
 
$
852.9
 
Commercial
   
193.3
   
199.6
 
Industrial
   
22.7
   
25.1
 
     
1,051.2
   
1,077.6
 
Transportation
             
Residential
   
12.3
   
9.3
 
Commercial
   
30.8
   
25.2
 
Industrial
   
12.4
   
10.0
 
Other
   
7.9
   
.4
 
     
63.4
   
44.9
 
Other revenues
             
Revenue taxes
   
72.3
   
72.6
 
Environmental cost recovery
   
5.5
   
5.1
 
Chicago Hub
   
7.5
   
2.5
 
Other
   
8.5
   
8.1
 
     
93.8
   
88.3
 
   
$
1,208.4
 
$
1,210.8
 
Deliveries (Bcf)
             
Sales
             
Residential
   
99.5
   
83.0
 
Commercial
   
23.0
   
19.0
 
Industrial
   
2.8
   
2.5
 
     
125.3
   
104.5
 
Transportation
             
Residential
   
9.7
   
7.3
 
Commercial
   
37.1
   
33.8
 
Industrial
   
32.9
   
30.7
 
     
79.7
   
71.8
 
     
205.0
   
176.3
 
Customers at end of period (thousands) (1)
             
Sales
             
Residential
   
1,810
   
1,812
 
Commercial
   
126
   
124
 
Industrial
   
7
   
7
 
     
1,943
   
1,943
 
Transportation
             
Residential
   
167
   
153
 
Commercial
   
56
   
58
 
Industrial
   
6
   
6
 
     
229
   
217
 
     
2,172
   
2,160
 
               
Other statistics
             
Degree days
   
3,018
   
2,657
 
Colder (warmer) than normal (2)
   
1
%
 
(11
)%
Average gas cost per Mcf sold
 
$
7.46
 
$
9.12
 
               
(1) The company redefined the customer count methodology in April 2006 in conjunction with its new
   
customer care and billing system.
             
               
(2) Normal weather for Nicor Gas' service territory, for purposes of this report, is considered to be 5,830
   
degree days per year.
             

21
 


Shipping Statistics

   
Three months ended
 
   
March 31
 
 
 
2007
 
2006
 
               
TEUs shipped (thousands)
   
50.9
   
49.1
 
Average revenue per TEU
 
$
1,949
 
$
1,940
 
At end of period
             
Ports served
   
27
   
26
 
Vessels operated
   
19
   
17
 

FINANCIAL CONDITION AND LIQUIDITY

Operating cash flows. The gas distribution business is highly seasonal and operating cash flow may fluctuate significantly during the year and from year-to-year due to factors such as weather, natural gas prices, the timing of collections from customers, natural gas purchasing, and storage and hedging practices. The company relies on short-term financing to meet seasonal increases in working capital needs. Cash requirements generally increase over the 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.

Net cash flow provided from operating activities decreased $281.1 million to $292.1 million in the 2007 first quarter from $573.2 million in the prior-year period. The decrease is primarily due to the impact of natural gas prices and weather on the gas distribution segment’s working capital.

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.

In 2003, Nicor received an income tax refund of approximately $100 million attributable to a tax loss carryback associated with a change in tax accounting method (which increased its deferred income tax liability), subject to IRS review and approval as part of normal ongoing audits. Through December 31, 2004, the total current tax benefits previously recorded under this accounting method approximated $135 million (amounts recorded were offset by increases to the deferred tax liability with no net effect on reported net federal income tax expense). In 2005, the IRS revised the regulations pertaining to the aforementioned tax accounting method. The new regulations required repayment in 2005 and 2006 of amounts previously taken as current tax deductions. During 2006 and 2005, the company reclassified income tax expense from deferred to current and repaid approximately $135 million equally over those years.
 
Investing activities. Net cash flow used from investing activities decreased $3.1 million to $50.7 million in the 2007 first quarter from $53.8 million in the prior-year period primarily due to lower capital expenditures.

Financing activities. The current credit ratings for Nicor and Nicor Gas have not changed since the filing of the December 31, 2006 Annual Report on Form 10-K.

Long-term debt. In the first quarter of 2006, Tropical Shipping repaid $7 million of its $40 million, two-year senior unsecured term loan. The repayment was primarily financed through the company’s cash flows from operating activities. This loan was paid in full by the fourth quarter of 2006.
 
22

 
Short-term debt. In October 2006, Nicor Gas established a $400 million, 210-day seasonal revolver, which expires in May 2007, to replace the $400 million, 210-day seasonal revolver, which expired in April 2006. In September 2005, Nicor and Nicor Gas established a $600 million, five-year revolver, expiring 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 $97.0 million, $350.0 million and $88.0 million of commercial paper borrowings outstanding at March 31, 2007, December 31, 2006 and March 31, 2006, respectively. As mid to late-year seasonal purchases of natural gas are made to replenish gas in storage, the company intends to rely on existing and/or replacement credit agreements, which the company expects to establish during the second half of 2007. The company believes it is in compliance with all debt covenants. 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.

Dividends. Nicor maintained its quarterly common stock dividend rate of $0.465 per common share during the first quarter of 2007. This quarterly dividend rate was also applicable in 2006. The company paid dividends on its common stock of $20.9 million and $20.7 million for the year-to-date periods ended March 31, 2007 and 2006, respectively. Nicor currently has no contractual or regulatory restrictions on the payment of dividends.

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 is currently under ICC review. There are allegations that the company acted improperly in connection with the PBR plan, and the ICC and others are reviewing these allegations. On June 27, 2002, the Citizens Utility Board (“CUB”) filed a motion to reopen the record in the ICC’s proceedings to review the PBR plan (the “ICC Proceedings”). As a result of the motion to reopen, Nicor Gas, the Cook County State’s Attorney Office (“CCSAO”), the staff of the ICC and CUB entered into a stipulation providing for additional discovery. The Illinois Attorney General’s Office (“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.
 
23

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 as of March 31, 2007 of $1.6 million 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, the CCSAO and CUB filed a motion for $27 million in sanctions against the company in the ICC Proceedings. In that motion, CCSAO and CUB alleged that Nicor Gas’ responses to certain CUB data requests were false. Also on February 5, 2003, CUB stated in a press release that, in addition to $27 million in sanctions, it would seek additional refunds to consumers. On March 5, 2003, the ICC staff filed a response brief in support of CUB’s motion for sanctions. On May 1, 2003, the Administrative Law Judges issued a ruling denying CUB and CCSAO’s motion for sanctions. CUB has filed an appeal of the motion for sanctions with the ICC, and the ICC has indicated that it will not rule on the appeal until the final disposition of the ICC Proceedings. It is not possible to determine how the ICC will resolve the claims of CCSAO, CUB or other parties to the ICC Proceedings.

In November 2003, the ICC staff, CUB, CCSAO and the IAGO filed their respective direct testimony in the ICC Proceedings. The ICC staff is seeking refunds to customers of approximately $108 million and CUB and CCSAO were jointly seeking refunds to customers of approximately $143 million. The IAGO direct testimony alleges adjustments in a range from $145 million to $190 million. The IAGO testimony as filed is presently unclear as to the amount which IAGO seeks to have refunded to customers. On February 27, 2004, the above referenced intervenors filed their rebuttal testimony in the ICC Proceedings. In such rebuttal testimony, CUB and CCSAO amended the alleged amount to be refunded to customers from approximately $143 million to $190 million. In 2004, the evidentiary hearings on this matter were stayed in order to permit the parties to undertake additional third party discovery from Entergy-Koch Trading, LP (“EKT”), a natural gas, storage and transportation trader and consultant with whom Nicor did business under the PBR plan. In December 2006, the additional third party discovery from EKT was obtained, Nicor Gas withdrew its previously filed testimony and the Administrative Law Judges issued a scheduling order that provided for Nicor Gas to submit direct testimony by April 13, 2007. In its testimony filed pursuant to the scheduling order, Nicor Gas seeks a reimbursement of approximately $6 million as of March 31, 2007. No date has been set for evidentiary hearings on this matter.

During the course of the SEC investigation discussed below, the company became aware of additional information relating to the activities of individuals affecting the PBR plan for the period from 1999 through 2002, including information consisting of third party documents and recordings of telephone
 
24
 
conversations from EKT. Review of additional information completed in 2004 resulted in the $1.8 million adjustment to the previously recorded liability referenced above.

Although the Report of the special committee’s counsel did not find that there was criminal activity or fraud, a review of this additional information (which was not available to the independent counsel who prepared the Report) and re-interviews of certain Nicor Gas personnel in 2004 indicated that certain former Nicor Gas personnel may have engaged in potentially fraudulent conduct regarding the PBR plan in violation of company policy, and in possible violation of SEC rules and applicable law. Further, certain former Nicor Gas personnel also may have attempted to conceal their conduct in connection with an ICC review of the PBR plan. The company has reviewed all third party information it has obtained and will continue to review any additional third party information the company may obtain. The company terminated four employees in connection with this matter in 2004.

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 March 31, 2007.

SEC and U.S. Attorney Inquiries. In 2002, the staff of the SEC Division of Enforcement (“SEC Staff”) informed Nicor that the SEC is conducting a formal inquiry regarding the PBR plan. A representative of the Office of the United States Attorney for the Northern District of Illinois (the “U.S. Attorney”) also notified Nicor that that office was conducting an inquiry on the same matter that the SEC is investigating, and a grand jury was also reviewing this matter. In April 2004, Nicor was advised by the SEC Staff that it intended to recommend to the SEC that it bring a civil injunctive action against Nicor, alleging that Nicor violated Sections 17(a) of the Securities Act of 1933 and Sections 10(b) and 13(a) of the Securities Exchange Act of 1934 and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. In July 2006, the company announced that it reached a tentative agreement with the SEC Staff in settlement of an anticipated civil action to which the company and the SEC will be parties and the SEC commissioners approved the settlement in March 2007. Under the terms of the settlement, the company will be subject to disgorgement of one dollar, a monetary fine of $10 million and an injunction. The company neither admits nor denies any wrongdoing. In July 2006, the company deposited the $10 million in escrow. Those funds are expected to be released upon entry of a final judgment by a federal court approving the settlement. Nicor recorded a $10 million charge to its 2006 second quarter earnings in connection with this matter. The $10 million fine is not deductible for federal or state income tax purposes. In December 2006, the U.S. Attorney advised that it is closing its inquiry and will not seek to prosecute the company or any individuals in connection with this matter.

Mercury. Information about mercury contingencies is presented in Item 1 - Notes to the Condensed Consolidated Financial Statements - Note 14 - 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 1 - Notes to the Condensed Consolidated Financial Statements - Note 14 - Contingencies - Manufactured Gas Plant Sites.

Fixed Bill Service. Nicor Services was a defendant in a purported class action. On October 7, 2005, the Circuit Court denied plaintiffs’ motion to certify the proposed class. In March 2007, Nicor Services settled this matter and the lawsuit was dismissed with prejudice. Information about this lawsuit is
 
25

 
presented within Item 1- Notes to the Condensed Consolidated Financial Statements - Note 14 - Contingencies - Fixed Bill Service.

Other contingencies. 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 1 - Notes to the Condensed Consolidated Financial Statements - Note 3 - New Accounting Pronouncements - Uncertain tax positions, Note 6 - Income and Other Taxes and Note 14 - Contingencies.

CRITICAL ACCOUNTING ESTIMATES

See Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates in the 2006 Annual Report on Form 10-K for a discussion of the company’s critical accounting estimates.

NEW ACCOUNTING PRONOUNCEMENTS

In 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, FASB Staff Position No. AUG AIR-1, Accounting for Planned Major Maintenance Activities, and SFAS No. 157, Fair Value Measurements. For more information, see Item 1 - Notes to the Condensed Consolidated Financial Statements - Note 3 - New Accounting Pronouncements.

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 to the direct or indirect effects of legal contingencies (including litigation) and the resolution of those issues, including the effects of an ICC review and an SEC inquiry, and undue reliance should not be placed on such statements.

Other factors that could cause materially different results include, but are not limited to, weather conditions; natural 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; 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 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.

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Item 3. 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.

There has been no material change in the company’s exposure to market risk since the filing of the 2006 Annual Report on Form 10-K.

Item 4. Controls and Procedures  

The company carried out an evaluation under the supervision and with the participation of the company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the company’s disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation”).

In designing and evaluating the disclosure controls and procedures, management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. Based on the Evaluation, the company’s Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures, as of the end of the period covered by this Quarterly Report on Form 10-Q, were effective at the reasonable assurance level to ensure that information required to be disclosed by the company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in United States Securities and Exchange Commission rules and forms.

There has been no change in the company’s internal controls over financial reporting during the company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.


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PART II - OTHER INFORMATION

Item 1. Legal Proceedings
 
See Part I, Item 1 - Notes to the Condensed Consolidated Financial Statements - Note 14 - Contingencies, which is incorporated herein by reference.

Item 1A. Risk Factors

The company has disclosed the most significant factors that can impact year-to-year comparisons and may affect the future performance of the company’s businesses in the company’s 2006 Annual Report on Form 10-K. On a quarterly basis, the company reviews these risks and makes updates as appropriate. The following are certain factors which have been edited or added based upon that review.

Tropical Shipping’s business is dependent on general economic conditions and could be adversely affected by changes or downturns in the economy.

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, the 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.

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

Various state tax and fee increases are being considered in the states in which the company operates. The company cannot predict whether 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 state legislatures or regulatory bodies. New taxes or an increase in tax rates would increase tax expense and could have a negative impact on the company’s results of operations, cash flows and financial condition.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

In September 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 during the first quarter of 2007 or 2006. As of March 31, 2007, $21.5 million remained authorized for the repurchase of common stock.


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Item 6. Exhibits

Exhibit
   
Number
 
Description of Document
     
3.01
*
Restated Articles of Incorporation of the company. (File No. 1-7297, Form 8-K for July 26, 2006, Nicor Inc.)
     
3.02
*
By-Laws of the company as amended by the company’s Board of Directors on January 15, 2004. (File No. 1-7297, Form 10-K for 2003, Nicor Inc., Exhibit 3.09.)
     
10.01
*
2007 Nicor Annual Incentive Compensation Plan for Officers. (File No. 1-7297, Form 8-K for February 28, 2007, Nicor Inc., Exhibit 10.1.)
     
10.02
*
2007 Nicor Gas Annual Incentive Compensation Plan for Officers. (File No. 1-7297, Form 8-K for February 28, 2007, Nicor Inc., Exhibit 10.2.)
     
10.03
*
Restricted Stock Unit Agreement between Nicor Inc. and Russ M. Strobel. (File No. 1-7297, Form 8-K for March 26, 2007, Nicor Inc., Exhibit 10.1.)
     
10.04
*
Restricted Stock Unit Agreement Form. (File No. 1-7297, Form 8-K for March 26, 2007, Nicor Inc., Exhibit 10.2.)
     
10.05
*
Performance Cash Unit Agreement Form. (File No. 1-7297, Form 8-K for March 26, 2007, Nicor Inc., Exhibit 10.3.)
     
10.06
*
2007 Long-Term Incentive Program. (File No. 1-7297, Form 8-K for March 26, 2007, Nicor Inc., Exhibit 10.4.)
     
10.07
*
Letter Agreement between Nicor Inc. and Richard L. Hawley. (File No. 1-7297, Form 8-K for March 26, 2007, Nicor Inc., Exhibit 10.5.)
     
31.01
 
     
31.02
 
     
32.01
 
     
32.02
 
 
*  
These exhibits have been previously filed with the SEC as exhibits to registration statements or to other filings with the SEC and are incorporated herein as exhibits by reference. The file number and exhibit number of each such exhibit, where applicable, are stated, in parentheses, in the description of such exhibit.

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Signature

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.




   
Nicor Inc.
     
May 1, 2007
 
/s/ KAREN K. PEPPING
(Date)
 
Karen K. Pepping
   
Vice President and Controller
   
(Principal Accounting Officer and
   
Duly Authorized Officer)


 
 
 
 
 
 
 
 
 
 
 
 
 

 
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