Edgar Filing: NICOR INC

Nicor Inc. 10Q

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 September 30, 2007

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

Commission File Number 1-7297

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 October 26, 2007, were 45,124,624 shares.

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Glossary			ii

Part I - Financial Information

	Item 1.	Financial Statements (Unaudited)

		Condensed Consolidated Statements of Operations:	1
		Three and nine months ended September 30, 2007 and 2006

		Condensed Consolidated Statements of Cash Flows:	2
		Nine months ended September 30, 2007 and 2006

		Condensed Consolidated Balance Sheets:	3
		September 30, 2007 and 2006, and December 31, 2006

		Notes to the Condensed Consolidated Financial Statements	4

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29

	Item 4.	Controls and Procedures	29

Part II - Other Information

	Item 1.	Legal Proceedings	29

	Item 1A.	Risk Factors	29

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30

	Item 6.	Exhibits	30

		Signature	31

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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.

FIN. FASB Interpretation.

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.

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.

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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.

PCBs. Polychlorinated Biphenyls.

PGA. Nicor Gas’ Purchased Gas Adjustment.

SEC. The United States Securities and Exchange Commission.

SFAS. Statement of Financial Accounting Standards.

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.

U.S. United States of America.

USEPA. United States Environmental Protection Agency.

iii

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Part I - FINANCIAL INFORMATION

Item 1. Financial Statements

Nicor Inc.
Condensed Consolidated Statements of Operations (Unaudited)
(millions, except per share data)
	Three months ended						Nine months ended
	September 30						September 30
	2007			2006			2007			2006
Operating revenues
Gas distribution (includes revenue taxes of
$12.8, $12.9, $114.0 and $111.5, respectively)	$	238.9		$	226.7		$	1,878.7		$	1,775.6
Shipping		97.5			98.3			293.6			288.1
Other energy ventures		37.3			34.0			159.0			135.1
Corporate and eliminations		(8.5	)		(7.9	)		(74.5	)		(77.0	)
Total operating revenues		365.2			351.1			2,256.8			2,121.8

Operating expenses
Gas distribution
Cost of gas		118.4			108.0			1,348.4			1,258.8
Operating and maintenance		59.7			56.6			201.5			199.9
Depreciation		41.4			40.1			124.4			120.3
Taxes, other than income taxes		17.0			17.0			126.1			123.2
Mercury-related recoveries, net		-			-			(8.0	)		(3.6	)
Property sale gains		(1.2	)		(.6	)		(2.0	)		(3.2	)
Shipping		88.8			87.8			266.7			258.6
Other energy ventures		26.8			27.1			143.2			134.4
Litigation charge		-			-			-			10.0
Other corporate expenses and eliminations		(8.5	)		(13.4	)		(72.8	)		(88.1	)
Total operating expenses		342.4			322.6			2,127.5			2,010.3

Operating income		22.8			28.5			129.3			111.5
Interest expense, net of amounts capitalized		10.4			11.1			34.3			35.5
Equity investment income, net		2.4			5.4			4.4			9.2
Interest income		2.3			2.5			7.1			7.9
Other income, net		-			-			.2			.4

Income before income taxes		17.1			25.3			106.7			93.5
Income tax expense		2.6			7.7			27.0			23.5

Net income	$	14.5		$	17.6		$	79.7		$	70.0

Average shares of common stock outstanding
Basic		45.2			44.7			45.1			44.5
Diluted		45.3			44.8			45.2			44.6

Earnings per average share of common stock
Basic	$	.32		$	.39		$	1.77		$	1.57
Diluted		.32			.39			1.76			1.57

Dividends declared per share of common stock	$	.465		$	.465		$	1.395		$	1.395


The accompanying notes are an integral part of these statements.

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Nicor Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(millions)
	Nine months ended
	September 30
	2007			2006

Operating activities
Net income	$	79.7		$	70.0
Adjustments to reconcile net income to net cash flow
provided from operating activities:
Depreciation		138.4			133.7
Deferred income tax benefit		(2.5	)		(45.2	)
Gain on sale of property, plant and equipment		(1.8	)		(3.1	)
Gain on sale of equity investment		-			(2.4	)
Changes in assets and liabilities:
Receivables, less allowances		260.5			554.9
Gas in storage		(59.1	)		58.0
Accrued gas costs		4.6			(114.3	)
Other assets		(11.6	)		14.1
Accounts payable		17.1			(138.8	)
Litigation charge		(10.0	)		-
Other liabilities		(53.1	)		48.7
Other items		7.2			(27.1	)
Net cash flow provided from operating activities		369.4			548.5

Investing activities
Additions to property, plant & equipment		(119.1	)		(128.5	)
Release of (additions to) restricted short-term investments		10.0			(10.0	)
Purchases of available-for-sale securities		(156.7	)		-
Proceeds from the sales of available-for-sale securities		156.7			-
Net increase in other short-term investments		(23.9	)		(8.3	)
Proceeds from sale of equity investment		-			7.0
Net proceeds from sale of property, plant and equipment		1.8			3.6
Other investing activities		(.9	)		4.1
Net cash flow used for investing activities		(132.1	)		(132.1	)

Financing activities
Repayments of long-term debt		-			(28.0	)
Net repayments of commercial paper with maturities of
90 days or less		(188.0	)		(435.0	)
Dividends paid		(63.0	)		(62.1	)
Proceeds from exercise of stock options		8.1			14.1
Other financing activities		.4			3.7
Net cash flow used for financing activities		(242.5	)		(507.3	)

Net decrease in cash and cash equivalents		(5.2	)		(90.9	)

Cash and cash equivalents, beginning of period		41.1			118.9

Cash and cash equivalents, end of period	$	35.9		$	28.0


The accompanying notes are an integral part of these statements.

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Nicor Inc.

Condensed Consolidated Balance Sheets (Unaudited)
(millions)

	September 30			December 31			September 30
	2007			2006			2006
Assets				* As Adjusted			* As Adjusted

Current assets
Cash and cash equivalents	$	35.9		$	41.1		$	28.0
Restricted short-term investments		-			10.2			10.1
Short-term investments, at cost which approximates market		40.2			16.3			16.3
Receivables, less allowances of $34.0, $33.4
and $34.7, respectively		303.0			563.5			334.2
Gas in storage		245.1			186.0			203.3
Deferred income taxes		34.6			39.1			36.3
Other		74.7			54.5			54.4
Total current assets		733.5			910.7			682.6

Property, plant and equipment, at cost
Gas distribution		4,234.9			4,157.1			4,118.6
Shipping		306.3			302.9			296.7
Other		22.1			19.7			18.8
		4,563.3			4,479.7			4,434.1
Less accumulated depreciation		1,833.1			1,765.0			1,743.6
Total property, plant and equipment, net		2,730.2			2,714.7			2,690.5

Pension benefits		169.9			161.0			195.0
Long-term investments		133.6			134.7			132.1
Other assets		162.1			169.0			64.9

Total assets	$	3,929.3		$	4,090.1		$	3,765.1


Liabilities and Capitalization

Current liabilities
Long-term debt due within one year	$	75.0		$	-		$	50.0
Short-term debt		162.0			350.0			151.0
Accounts payable		579.2			562.1			517.0
Accrued gas costs		54.6			50.0			108.9
Dividends payable		21.0			20.9			20.8
Obligations related to restricted investments		-			10.0			10.0
Other		115.3			147.0			123.3
Total current liabilities		1,007.1			1,140.0			981.0

Deferred credits and other liabilities
Regulatory retirement cost liability		709.9			676.7			662.8
Deferred income taxes		396.4			399.6			415.3
Health care and other postretirement benefits		183.3			181.6			105.9
Asset retirement obligation		175.3			169.3			170.0
Regulatory income tax liability		51.4			53.8			38.7
Unamortized investment tax credits		28.1			29.6			30.2
Other		45.7			65.3			69.3
Total deferred credits and other liabilities		1,590.1			1,575.9			1,492.2

Commitments and contingencies

Capitalization
Long-term obligations
Long-term debt, net of unamortized discount		422.7			497.5			459.4
Mandatorily redeemable preferred stock		.6			.6			.6
Total long-term obligations		423.3			498.1			460.0

Common equity
Common stock		112.8			112.3			111.6
Paid-in capital		44.4			34.1			24.5
Retained earnings		761.1			743.0			705.7
Accumulated other comprehensive loss, net		(9.5	)		(13.3	)		(9.9	)
Total common equity		908.8			876.1			831.9

Total capitalization		1,332.1			1,374.2			1,291.9

Total liabilities and capitalization	$	3,929.3		$	4,090.1		$	3,765.1

* 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.

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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.

At September 30, 2006, the company had an inventory decrement of approximately 5 Bcf which was not restored prior to year-end. The liquidated inventory was charged to cost of gas at a LIFO cost of $7.82 per Mcf. If the company had deemed the decrement to be temporary, it would have charged cost of gas for an estimate of the annual replacement cost, which was about $6.32 per Mcf. Applying LIFO cost in valuing the decrement, as opposed to the estimated annual replacement cost, had the effect of increasing the cost of gas distributed by $7.5 million as of September 30, 2006. However, since the cost of gas, including inventory costs, is charged to customers without markup, subject to ICC review, this difference had no impact on net income. There was no permanent inventory decrement as of September 30, 2007.

Nicor Enerchange inventory is carried at the lower of weighted-average cost or market. Nicor Enerchange recorded a charge of $5.0 million in the second quarter of 2007 resulting from a lower of cost or market valuation. Nicor Enerchange also recorded charges of $11.8 million and $16.5 million for the three and nine-month periods ended September 30, 2006 resulting from lower of cost or market valuations.

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 base rates, upon approval by the ICC. Regulatory liabilities represent probable future reductions in revenues collected from ratepayers through a rate rider or base rates. If Nicor Gas’ operations become no longer subject to the provisions of SFAS No. 71, a write-off of net regulatory liabilities would be required.

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

	September 30		December 31		September 30
	2007		2006		2006
Regulatory assets
Regulatory postretirement asset - current	$	8.8	$	8.8	$	-
Regulatory postretirement asset - noncurrent		101.0		104.7		-
Deferred environmental costs		10.9		16.0		14.2
Unamortized losses on reacquired debt		16.8		17.6		17.9
Deferred rate case costs		2.7		3.0		3.1
Other		1.1		1.0		3.8
	$	141.3	$	151.1	$	39.0

Regulatory liabilities
Regulatory retirement cost liability - current	$	8.0	$	8.0	$	9.0
Regulatory retirement cost liability - noncurrent		709.9		676.7		662.8
Accrued gas costs		54.6		50.0		108.9
Regulatory income tax liability		51.4		53.8		38.7
Other		-		-		.1
	$	823.9	$	788.5	$	819.5

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 three and nine months ended September 30, 2007 were $12.6 million and $112.2 million, respectively, and $12.6 million and $109.0 million , respectively, for the same periods ending September 30, 2006.

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 FIN 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

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recognized benefits from tax positions that no longer meet the new criteria are required to be derecognized.

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 three and nine month periods ended September 30, 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 increasing by $6 million or decreasing by $7 million its unrecognized tax benefit.

The company records interest accrued related to unrecognized tax benefits in interest expense, and penalties, if any, are recorded in operating expense. Amounts accrued for the payment of interest totaled approximately $11 million and $17 million at January 1, 2007 and September 30, 2007, respectively.

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.

Offsetting of amounts related to certain contracts. In April 2007, FSP No. FIN 39-1, Amendment of FIN 39, Offsetting of Amounts Related to Certain Contracts, was issued. This FSP amends FIN 39 to replace the terms “conditional contracts” and “exchange contracts” with the term “derivative instruments” as defined in SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Also, this FSP provides guidance on whether the receivable or liability recognized upon payment or receipt of cash collateral in a master netting agreement must be offset against fair value amounts recognized for contracts that have been offset in the same master netting agreement. This FSP is effective for Nicor no later than January 1, 2008 and is expected to be adopted retrospectively at that time. The company is currently evaluating the FSP and the impact it may have on the company’s financial condition and related disclosures.

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4. RESTRICTED SHORT-TERM INVESTMENTS

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. The SEC commissioners approved the tentative settlement in March 2007. A final judgment, dated April 30, 2007, was entered by a federal court approving the settlement and the funds held in escrow were released. For further information, see Note 14 - Contingencies - SEC and U.S. Attorney Inquiries.

5. SHORT-TERM AND LONG-TERM DEBT

In October 2007, Nicor Gas established a $400 million, 210-day seasonal revolver, which expires in May 2008, to replace the $400 million, 210-day seasonal revolver, which expired in May 2007. 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 $162 million, $350 million and $151 million of commercial paper borrowings outstanding at September 30, 2007, December 31, 2006 and September 30, 2006, respectively.

At September 30, 2006, Tropical Shipping had $12 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. 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, in part, by approximately $3 million in current tax expense recognized in the first nine months of 2006 also associated with these activities. 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. For the three and nine-month periods ended September 30, 2007, income tax expense has not been provided on approximately $6 million and $19 million, respectively, of foreign company shipping earnings that are expected to be indefinitely reinvested offshore compared to approximately $6 million and $17 million, respectively, for the comparable periods in 2006.

The effective income tax rate for the quarter ended September 30, 2007 decreased to 15.2 percent from 30.3 percent for the quarter ended September 30, 2006 due primarily to a reduction in taxable foreign earnings which was recognized in the third quarter of 2007. The effective income tax rate for the nine months ended September 30, 2007 increased to 25.3 percent from 25.1 percent for the prior-year period. The rate for the first nine months of 2006 reflects the recognition of additional tax benefits related to the first quarter 2006 reorganization of the company’s shipping and related operations and second quarter 2006 favorable adjustments associated with tax audits (which occur in the ordinary course of business) offset, in part, by the second quarter of 2006 non-deductible $10 million charge associated with the company’s SEC inquiry. The rate for the first nine months of 2007 reflects the previously mentioned reduction in taxable foreign earnings recognized in the third quarter of 2007. Both nine-month periods reflect the ongoing benefit of untaxed foreign shipping earnings.

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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 $57.4 million, $159.5 million and $52.9 million at September 30, 2007, December 31, 2006 and September 30, 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 September 30, 2007, December 31, 2006 and September 30, 2006 was $500 million. Based on quoted market interest rates, the fair value of the company’s First Mortgage Bonds outstanding was approximately $508 million, $518 million and $515 million at September 30, 2007, December 31, 2006 and September 30, 2006, respectively.

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):

	September 30		December 31		September 30
	2007		2006		2006

Current other assets	$	7.5	$	5.3	$	13.0
Noncurrent other assets		.5		.5		1.1
	$	8.0	$	5.8	$	14.1

Current other liabilities	$	17.8	$	51.3	$	50.3
Noncurrent other liabilities		.8		1.2		4.9
	$	18.6	$	52.5	$	55.2

Nicor maintains margin accounts related to financial derivative transactions. At September 30, 2007, December 31, 2006 and September 30, 2006, the balance of these accounts was $22.8 million, $16.2 million and $35.7 million, respectively, and was reflected on the Condensed Consolidated Balance Sheets as Receivables.

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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
	2007			2006			2007			2006
Three months ended September 30
Service cost	$	2.2		$	2.3		$	.5		$	.6
Interest cost		3.8			3.8			2.7			2.5
Expected return on plan assets		(9.0	)		(8.8	)		-			(.1	)
Recognized net actuarial loss		-			.1			1.3			1.4
Amortization of prior service cost		.1			.1			(.1	)		(.1	)
Net periodic benefit cost (credit)	$	(2.9	)	$	(2.5	)	$	4.4		$	4.3

Nine months ended September 30
Service cost	$	6.8		$	7.0		$	1.7		$	1.8
Interest cost		11.3			11.2			8.1			7.7
Expected return on plan assets		(27.0	)		(26.2	)		-			(.2	)
Recognized net actuarial loss		-			.2			3.6			3.8
Amortization of prior service cost		.4			.4			(.1	)		(.1	)
Net periodic benefit cost (credit)	$	(8.5	)	$	(7.4	)	$	13.3		$	13.0

In the first quarter of 2007, the company received a federal subsidy 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 includes investment income from Triton of $1.5 million and $3.7 million, respectively, for the three and nine-month periods ended September 30, 2007 and $2.0 million and $4.5 million for the same periods ended September 30, 2006, respectively. Also included in net equity investment income for the three and nine months ended September 30, 2006 is a $2.4 million gain on a sale of an equity investment. Nicor received cash distributions from equity investees for the three and nine-month periods ended September 30, 2007 of $2.6 million and $8.9 million, respectively, and $1.5 million and $4.8 million, respectively, for the same periods ended September 30, 2006.

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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						Nine months ended
	September 30						September 30
	2007			2006			2007		2006

Net income	$	14.5		$	17.6		$	79.7	$	70.0
Other comprehensive income (loss), after tax		(1.6	)		(4.6	)		3.8		(8.3	)
Total comprehensive income	$	12.9		$	13.0		$	83.5	$	61.7

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 September 30, 2007
Operating revenues
External customers	$	232.8	$	97.5	$	34.9	$	-		$	365.2
Intersegment		6.1		-		2.4		(8.5	)		-
	$	238.9	$	97.5	$	37.3	$	(8.5	)	$	365.2

Operating income	$	3.6	$	8.7	$	10.5	$	-		$	22.8

Three months ended September 30, 2006
Operating revenues
External customers	$	219.7	$	98.3	$	33.1	$	-		$	351.1
Intersegment		7.0		-		.9		(7.9	)		-
	$	226.7	$	98.3	$	34.0	$	(7.9	)	$	351.1

Operating income	$	5.6	$	10.5	$	6.9	$	5.5		$	28.5

Nine months ended September 30, 2007
Operating revenues
External customers	$	1,825.8	$	293.6	$	137.4	$	-		$	2,256.8
Intersegment		52.9		-		21.6		(74.5	)		-
	$	1,878.7	$	293.6	$	159.0	$	(74.5	)	$	2,256.8

Operating income (loss)	$	88.3	$	26.9	$	15.8	$	(1.7	)	$	129.3

Nine months ended September 30, 2006
Operating revenues
External customers	$	1,714.4	$	288.1	$	119.3	$	-		$	2,121.8
Intersegment		61.2		-		15.8		(77.0	)		-
	$	1,775.6	$	288.1	$	135.1	$	(77.0	)	$	2,121.8

Operating income	$	80.2	$	29.5	$	.7	$	1.1		$	111.5

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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.

Operating income in the “Corporate and eliminations” column includes the following items:

·	In the third quarter of 2006, the company recognized $5.2 million of insurance recoveries related to previously incurred legal expenses associated with the securities class action and shareholder derivative lawsuit settlements.

·	In the year-to-date 2006 period, the company recorded a $10 million charge (non-deductible for tax purposes) associated with the SEC inquiry. For more information, see Note 14 - Contingencies - SEC and U.S. Attorney Inquiries.

Benefits (costs) associated with Nicor’s other energy ventures’ utility-bill management contracts attributable to warmer (colder) than normal weather for the three and nine months ended September 30, 2007 were $0.3 million and $0.2 million, respectively, and $(0.1) million and $6.3 million, respectively, for the same periods ending September 30, 2006. The weather impact of these contracts generally serves to 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 pay 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 $18 million at September 30, 2007. Nicor believes the likelihood of any such payment by TEL is remote, and no liability has been recorded for this contingency.

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 $1.5 million and $4.7 million were incurred in the three and nine months ended September 30, 2007, respectively, and $1.5 million and $4.3 million, respectively, for the same periods last year.

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 clean-up, 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.

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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. During the second quarter of 2007, the SEC filed a civil injunctive action against three former officers of Nicor relating to the PBR Plan. Defense costs that are being incurred by these former officers in connection with the SEC action currently are being tendered to, and paid by, the company’s insurer. While the company does not expect to incur significant costs relating to the indemnification of present and former directors, officers and employees after taking into account available insurance, 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 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 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.

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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, which includes interest due to the company as noted above of $1.6 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 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 September 30, 2007.

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SEC and U.S. Attorney Inquiries. In 2002, the staff of the SEC Division of Enforcement (“SEC Staff”) informed Nicor that the SEC was 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 would be parties. The SEC commissioners approved the settlement in March 2007, and a final judgment was entered by a federal court approving the settlement on April 30, 2007. Under the terms of the settlement, the company was required to disgorge one dollar and pay a monetary fine of $10 million and is subject to an injunction prohibiting violations of certain provisions of the federal securities laws. The company neither admits nor denies any wrongdoing. In July 2006, the company deposited the $10 million in escrow. Those funds were released following entry of the federal court judgment 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 was closing its separate inquiry and would not seek to prosecute the company 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 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 that quarter of certain lawsuits that had been pending against Nicor Gas. As of September 30, 2007, Nicor Gas had remaining an estimated liability of $2.9 million related to inspection, clean-up 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

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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 liquidity or 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 clean-up 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. On July 24, 2007, Nicor Gas and ComEd entered into an agreement in principle concerning final cost allocations. The agreement in principle provides for final cost sharing that would have the effects of preserving the equal sharing with respect to mutually agreed clean-up costs incurred to date under the interim agreement and of allocating to Nicor Gas 51.73 percent of future clean-up costs for twenty-four sites and no portion of the future clean-up costs for fourteen other sites. The agreement in principle is subject, among other things, to negotiation of a definitive agreement and approval of that definitive agreement by the ICC. The matter currently is stayed pursuant to the panel’s order and is expected to be stayed pending the negotiation and ICC review of the definitive agreement. 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 will determine the extent additional remediation is necessary and provide a basis for estimating additional future costs. As of September 30, 2007, the company had recorded a liability in connection with these matters of $15.9 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 clean-up of a former manufactured gas plant site in Oak Park, Illinois was inadequate. Additional lawsuits were later filed related to this same former manufactured gas plant site. These lawsuits have sought, 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 was reached in the first quarter of 2006 at which time a $2.3 million reserve for this matter was recorded by the company. The settlement was approved by the trial court and the lawsuit was dismissed during the second quarter of 2007. Under the settlement, the company made a payment of $2.2 million which was charged against the previously established reserve. 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, if any, 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

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Comprehensive Environmental Response, Compensation and Liability Act seeking recovery of past and future remediation costs and a declaration of the level of appropriate clean-up 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, if any, and has not recorded a liability associated with this contingency.

Since costs and recoveries relating to the clean-up 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.

PCBs. In June 2007, Nicor Gas notified the USEPA of the discovery by Nicor Gas of PCBs at four homes in Park Ridge, Illinois. Nicor Gas has cleaned up the PCBs at these four homes. On July 13, 2007, the USEPA issued a subpoena to Nicor Gas pursuant to Section 11 of the Toxic Substances Control Act. In the subpoena, the USEPA indicated that it was investigating Nicor Gas’ identification of PCB-contaminated liquids in its distribution system. The subpoena sought documents related to Nicor Gas’ pipeline liquids and the extent and location of PCBs contained therein. The Illinois Attorney General made a similar request for information from Nicor Gas. Nicor Gas has provided documentation to the USEPA and the Illinois Attorney General, including information about the presence of PCBs in its system, and has conducted sample testing at additional customer locations. While Nicor is unable to predict the outcome of these inquiries or to reasonably estimate its potential exposure related thereto, if any, and has not recorded a liability associated with this contingency, the final disposition of this matter is not expected to have a material adverse impact on the company’s liquidity or financial condition.

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.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Management’s Discussion and Analysis section of the Nicor 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 three and nine-month periods ended September 30, 2007 and 2006 (in millions, except per share data):

	Three months ended				Nine months ended
	September 30				September 30
	2007		2006		2007		2006

Net income	$	14.5	$	17.6	$	79.7	$	70.0

Diluted earnings per common share	$	.32	$	.39	$	1.76	$	1.57

Year-to-date 2007 net income and diluted earnings per common share include 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. Included in year-to-date 2006 net income and diluted earnings per common share is a $10 million charge ($.22 per share and non-deductible for tax purposes) associated with the company’s SEC inquiry and a pretax recovery of $3.8 million ($.05 per share) associated with Nicor Gas’ mercury inspection and repair program.

Quarter over quarter comparisons reflect lower operating results in the company’s gas distribution and shipping businesses and lower corporate operating income, partially offset by improved results in the company’s other energy-related businesses. Year-to-date comparisons (excluding the items noted above) reflect improved operating results in the company’s gas distribution and other energy-related businesses, partially offset by lower operating results in the company’s shipping business and lower corporate operating income. Year-to-date comparisons were also impacted by the effects of certain income tax benefits recognized in 2006 and higher average shares outstanding in 2007.

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).

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

	Three months ended				Nine months ended
	September 30				September 30
	2007		2006		2007			2006

Gas distribution	$	3.6	$	5.6	$	88.3		$	80.2
Shipping		8.7		10.5		26.9			29.5
Other energy ventures		10.5		6.9		15.8			.7
Corporate and eliminations		-		5.5		(1.7	)		1.1
	$	22.8	$	28.5	$	129.3		$	111.5

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

Gas distribution operating income decreased $2.0 million in the third quarter of 2007 compared to the prior-year period due to higher operating and maintenance expenses ($3.1 million increase) and higher depreciation expense ($1.3 million increase), partially offset by higher gas distribution margin ($1.8 million increase).

Operating income increased $8.1 million for the nine months ended September 30, 2007 compared to the prior-year period due primarily to the positive impact of higher gas distribution margin ($10.3 million increase) and higher mercury-related recoveries ($4.4 million increase), partially offset by the negative impacts of higher depreciation expense ($4.1 million increase) and higher operating and maintenance expenses ($1.6 million increase).

Shipping operating income decreased $1.8 million in the third quarter of 2007, compared to the prior-year period due to lower operating revenues ($0.8 million decrease) and higher operating costs ($1.0 million increase). Lower operating revenues were attributable to lower average rates ($2.6 million decrease), partially offset by higher volumes shipped ($1.6 million increase). Higher operating costs were attributable to increased transportation-related costs on higher volumes shipped ($0.8 million increase) and higher employee-related costs ($0.8 million increase).

Operating income decreased $2.6 million for the nine months ended September 30, 2007 compared to the prior-year period as higher operating revenues ($5.5 million increase) were more than offset by higher operating costs ($8.1 million increase). Higher operating revenues were attributable primarily to higher volumes shipped ($9.5 million increase), partially offset by lower average rates ($4.1 million decrease). Higher operating costs were attributable primarily to higher employee-related costs ($3.6 million increase) and increased transportation-related costs on higher volumes shipped ($3.3 million increase).

Nicor’s other energy ventures operating income increased $3.6 million in the third quarter of 2007 compared to the prior-year period due primarily to higher operating income at Nicor’s wholesale natural gas marketing business, Nicor Enerchange ($3.2 million increase). For the nine months ended September 30, 2007, operating income increased $15.1 million compared to the prior-year period due primarily to higher operating income at Nicor Enerchange ($13.0 million increase) and higher operating income at Nicor’s energy-related products and services businesses ($2.0 million increase).

For the three and nine month periods, improved operating results 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,

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partially offset by lower positive fair value adjustments related to derivative instruments used to hedge purchases and sales of natural gas inventory. Improved operating results at Nicor’s energy-related products and services businesses were due primarily to an increase in average customer contracts.

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 2007 third quarter operating income decreased $5.5 million when compared to the prior-year period, reflecting the absence of the prior-year $5.2 million insurance recovery related to previously incurred legal costs associated with the securities class action and shareholder derivative lawsuits. Year-to-date 2007 operating results decreased by $2.8 million compared to the prior-year period, reflecting the absence of the prior year $6.3 million benefit of a natural weather hedge associated with the utility-bill management products offered by Nicor’s energy-related products and services businesses and the previously mentioned $5.2 million insurance recovery, partially offset by the absence of the prior year $10 million charge associated with the SEC inquiry settlement. 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						Nine months ended
	September 30						September 30
	2007			2006			2007			2006

Gas distribution	$	238.9		$	226.7		$	1,878.7		$	1,775.6
Shipping		97.5			98.3			293.6			288.1
Other energy ventures		37.3			34.0			159.0			135.1
Corporate and eliminations		(8.5	)		(7.9	)		(74.5	)		(77.0	)
	$	365.2		$	351.1		$	2,256.8		$	2,121.8

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 third quarter of 2007 compared to the prior-year period, gas distribution revenues increased $12.2 million. Operating revenues were impacted by higher natural gas costs (approximately $25 million increase), partially offset by warmer weather than 2006 (approximately $5 million decrease) and lower demand unrelated to weather (approximately $5 million decrease). For the nine months ended September 30, 2007 compared to the prior-year period, gas

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distribution revenues increased $103.1 million. Operating revenues were impacted by colder weather than 2006 (approximately $180 million increase) and higher demand unrelated to weather (approximately $50 million increase), partially offset by lower natural gas prices (approximately $105 million decrease).

For the three months ended September 30, 2007, shipping segment operating revenues decreased $0.8 million compared with the prior-year period due to lower average rates ($2.6 million decrease), partially offset by higher volumes shipped ($1.6 million increase). For the nine months ended September 30, 2007, shipping segment operating revenues increased $5.5 million compared with the prior-year period due primarily to higher volumes shipped ($9.5 million increase), partially offset by lower average rates ($4.1 million decrease). 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. Lower average rates were due primarily to the increase in interisland shipments and increased competition in several of the ports served.

Operating revenues in the third quarter of 2007 for Nicor’s other energy ventures increased $3.3 million from the prior-year period due to higher revenues at Nicor Enerchange ($3.6 million increase). Operating revenues for the nine months ended September 30, 2007 increased $23.9 million from the prior-year period due to higher revenues at Nicor Enerchange ($13.6 million increase) and Nicor’s energy-related products and services businesses ($10.3 million increase). For the three and nine month periods, 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 lower fair value adjustments related to derivative instruments used to hedge purchases and sales of natural gas inventory. Higher revenues at Nicor’s energy-related products and services businesses were due primarily to an increase in average customer contracts.

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						Nine months ended
	September 30						September 30
	2007			2006			2007			2006

Gas distribution revenues	$	238.9		$	226.7		$	1,878.7		$	1,775.6
Cost of gas		(118.4	)		(108.0	)		(1,348.4	)		(1,258.8	)
Revenue tax expense		(12.6	)		(12.6	)		(112.2	)		(109.0	)
Gas distribution margin	$	107.9		$	106.1		$	418.1		$	407.8

Gas distribution margin increased $1.8 million in the third quarter of 2007 compared with the corresponding prior-year period due to the impact of customer interest (approximately $2 million increase). Year-to-date 2007 gas distribution margin increased $10.3 million compared with the corresponding prior-year period due primarily to colder weather than in 2006 (approximately $12 million

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increase) and higher demand unrelated to weather (approximately $8 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 $3 million decrease).

Gas distribution operating and maintenance expense. Gas distribution operating and maintenance expense increased $3.1 million to $59.7 million in the third quarter of 2007 from $56.6 million in the prior-year period due to higher bad debt expense ($5.2 million increase) and costs associated with the investigation by the USEPA and the Illinois Attorney General into the presence of PCBs in the company’s distribution system ($1.5 million increase), partially offset by lower company use gas and storage-related gas costs ($2.9 million decrease). Additional information about the PCB investigation is presented in Item 1 - Notes to the Condensed Consolidated Financial Statements - Note 14 - Contingencies - PCBs.

Year-to-date operating and maintenance expense increased $1.6 million to $201.5 million from $199.9 million in the prior-year period. Factors contributing to the change include higher bad debt expense ($9.8 million increase), the previously mentioned costs associated with the PCB investigation ($1.5 million increase), and lower company use gas and storage-related gas costs ($11.3 million decrease) attributable primarily to lower natural gas prices.

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. Year-to-date 2007 mercury-related recoveries reflect a $7.2 million reserve adjustment and $0.8 million in cost recoveries recorded during the first quarter of 2007. During the first quarter of 2006, a mercury-related recovery of $3.8 million was realized. 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.

Property sale gains vary from year-to-year depending upon property sales activity. The company realized pretax gains on sales of property of $2.0 million and $3.2 million for the nine months ended September 30, 2007 and 2006, respectively. The company continues to assess its ownership of certain real estate holdings.

Shipping operating expenses. Third quarter and year-to-date 2007 shipping segment operating expenses increased $1.0 million and $8.1 million, respectively, compared with the corresponding prior-year periods. Higher operating costs were attributable primarily to increased employee-related costs ($0.8 million and $3.6 million increases, respectively) and increased transportation-related costs on higher volumes shipped ($0.8 million and $3.3 million increases, respectively).

Other energy ventures operating expenses. Year-to-date 2007 other energy ventures operating expenses increased $8.8 million compared with the corresponding prior-year period. The increase was due primarily to higher expenses at Nicor’s energy-related products and services businesses ($8.3 million increase) attributable to costs related to an increase in average customer contracts.

Litigation charge. In the second quarter of 2006, Nicor recorded a $10 million charge (non-deductible for tax purposes) associated with the SEC inquiry. In July 2006, the company reached a tentative agreement with the staff of the SEC Enforcement Division in settlement of an anticipated civil action for a payment of $10 million. The SEC Commissioners approved the tentative settlement in March 2007. A final judgment, dated April 30, 2007, was entered by a federal court approving the settlement and the funds held in escrow were released. For more information, see Item 1 - Notes to the Condensed Consolidated Financial Statements - Note 14 - Contingencies - SEC and U.S. Attorney Inquiries.

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Interest expense. Interest expense of $10.4 million in the third quarter of 2007 decreased $0.7 million over the prior-year period due primarily to lower estimated interest on income tax matters. Interest expense of $34.3 million for the nine-month period ended September 30, 2007 decreased $1.2 million over the corresponding prior-year period due to lower average borrowing levels. Lower average borrowings were attributable primarily to the $40 million Tropical Shipping term loan, which was paid in full by the fourth quarter of 2006, and a decrease in average commercial paper borrowings.

Net equity investment income. Net equity investment income decreased $3.0 million and $4.8 million for the three and nine-month periods ended September 30, 2007, respectively, over the corresponding prior-year periods due primarily to the absence of the $2.4 million gain on a sale of an equity investment recorded in the third quarter of 2006.

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. 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, in part, by approximately $3 million in current tax expense recognized in the first nine months of 2006 also associated with these activities. 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. For the three and nine-month periods ended September 30, 2007, income tax expense has not been provided on approximately $6 million and $19 million, respectively, of foreign company shipping earnings that are expected to be indefinitely reinvested offshore compared to approximately $6 million and $17 million, respectively, for the comparable periods in 2006.

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Nicor Inc.
Gas Distribution Statistics


	Three months ended				Nine months ended
	September 30				September 30
	2007		2006		2007		2006
Operating revenues (millions)
Sales
Residential	$	146.9	$	136.8	$	1,263.1	$	1,207.5
Commercial		36.3		29.8		303.8		275.2
Industrial		2.3		2.7		32.3		31.9
		185.5		169.3		1,599.2		1,514.6
Transportation
Residential		6.4		6.1		26.0		21.9
Commercial		13.0		13.6		55.4		55.5
Industrial		10.7		11.6		30.9		31.1
Other		.6		.8		10.0		1.7
		30.7		32.1		122.3		110.2
Other revenues
Revenue taxes		12.8		12.9		114.0		111.5
Environmental cost recovery		.9		.8		8.0		7.2
Chicago Hub		3.4		8.1		13.1		13.9
Other		5.6		3.5		22.1		18.2
		22.7		25.3		157.2		150.8
	$	238.9	$	226.7	$	1,878.7	$	1,775.6
Deliveries (Bcf)
Sales
Residential		12.4		13.9		136.7		121.6
Commercial		3.5		3.2		33.6		27.9
Industrial		.2		.4		3.7		3.4
		16.1		17.5		174.0		152.9
Transportation
Residential		1.3		1.2		13.4		10.7
Commercial		9.2		9.0		58.0		54.7
Industrial		23.8		25.3		80.4		80.0
		34.3		35.5		151.8		145.4
		50.4		53.0		325.8		298.3
Customers at end of period (thousands) (1)
Sales
Residential		1,787		1,785
Commercial		124		121
Industrial		7		7
		1,918		1,913
Transportation
Residential		176		161
Commercial		54		57
Industrial		6		5
		236		223
		2,154		2,136

Other statistics
Degree days		45		84		3,699		3,301
Colder (warmer) than normal (2)