Edgar Filing: NICOR INC

nicorincform10q063008.htm

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 June 30, 2008

[ ]	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, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in rule 12b-2 of the Exchange Act.

Large accelerated filer [X]	Accelerated filer [ ]

Non-accelerated filer [ ]	Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the 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 July 30, 2008, were 45,149,020 shares.

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Glossary			ii

Part I - Financial Information

	Item 1.	Financial Statements (Unaudited)

		Condensed Consolidated Statements of Operations:	1
		Three and six months ended June 30, 2008 and 2007

		Condensed Consolidated Statements of Cash Flows:	2
		Six months ended June 30, 2008 and 2007

		Condensed Consolidated Balance Sheets:	3
		June 30, 2008 and 2007, and December 31, 2007

		Notes to the Condensed Consolidated Financial Statements	4

	Item 2.	Management’s Discussion and Analysis of Financial	18
		Condition and Results of Operations

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29

	Item 4.	Controls and Procedures	29

Part II - Other Information

	Item 1.	Legal Proceedings	30

	Item 1A.	Risk Factors	30

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

	Item 4.	Submission of Matters to a Vote of Security Holders	30

	Item 6.	Exhibits	32

		Signature	34

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Glossary

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.

FIN. FASB Interpretation.

FSP. FASB Staff Position.

ICC. Illinois Commerce Commission, the agency that establishes the rules and regulations governing utility rates and services in Illinois.

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. Nicor Inc., or the registrant.

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

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

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

Nicor Services. Nicor Energy Services Company, a wholly owned business that provides customer and prospect 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.

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NYMEX. New York Mercantile Exchange

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

PCBs. Polychlorinated Biphenyls.

PGA. Purchased Gas Adjustment.

SEC. The United States Securities and Exchange Commission.

SFAS. Statement of Financial Accounting Standards.

TEL. Tropic Equipment Leasing Inc., a 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.

USEPA. United States Environmental Protection Agency.

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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						Six months ended
	June 30						June 30
	2008			2007			2008			2007
Operating revenues
Gas distribution (includes revenue taxes of
$36.7, $28.9, $117.0 and $101.2, respectively)	$	560.1		$	431.4		$	2,024.3		$	1,639.8
Shipping		102.6			97.0			200.3			196.1
Other energy ventures		52.7			45.1			122.9			121.7
Corporate and eliminations		(15.6	)		(16.6	)		(52.0	)		(66.0	)
Total operating revenues		699.8			556.9			2,295.5			1,891.6

Operating expenses
Gas distribution
Cost of gas		396.2			281.6			1,582.9			1,230.0
Operating and maintenance		59.7			62.1			148.3			141.8
Depreciation		42.9			41.5			85.7			83.0
Taxes, other than income taxes		40.6			33.2			124.4			109.1
Mercury-related recoveries, net		-			-			-			(8.0	)
Property sale gains		-			(.8	)		-			(.8	)
Shipping		96.9			88.7			190.7			177.9
Other energy ventures		41.7			37.1			110.9			116.4
Other corporate expenses and eliminations		(18.8	)		(16.4	)		(51.2	)		(64.3	)
Total operating expenses		659.2			527.0			2,191.7			1,785.1

Operating income		40.6			29.9			103.8			106.5
Interest expense, net of amounts capitalized		9.1			10.1			19.7			23.9
Equity investment income, net		2.8			1.2			4.3			2.0
Interest income		4.2			3.2			5.5			4.8
Other income, net		.2			-			.2			.2

Income before income taxes		38.7			24.2			94.1			89.6
Income tax expense		9.8			6.2			23.8			24.4

Net income	$	28.9		$	18.0		$	70.3		$	65.2

Average shares of common stock outstanding
Basic		45.3			45.2			45.3			45.1
Diluted		45.3			45.3			45.3			45.2

Earnings per average share of common stock
Basic	$	.64		$	.40		$	1.55		$	1.45
Diluted		.64			.40			1.55			1.44

Dividends declared per share of common stock	$	.465		$	.465		$	.930		$	.930


The accompanying notes are an integral part of these statements.

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Nicor Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(millions)
		Six months ended
		June 30
		2008			2007
					* As Adjusted
Operating activities
	Net income	$	70.3		$	65.2
	Adjustments to reconcile net income to net cash flow
	provided from operating activities:
	Depreciation		95.1			92.3
	Deferred income tax benefit		(20.5	)		(6.9	)
	Gain on sale of property, plant and equipment		(.1	)		(.6	)
	Changes in assets and liabilities:
	Receivables, less allowances		128.2			187.9
	Gas in storage		78.3			142.4
	Accrued gas costs		41.2			(43.9	)
	Derivative instruments		(163.4	)		(29.0	)
	Margin accounts - derivative instruments		91.2			(5.2	)
	Other assets		(32.2	)		(18.5	)
	Accounts payable and customer credit balances and deposits		30.9			(36.8	)
	Temporary LIFO inventory liquidation		399.2			263.0
	Litigation charge		-			(10.0	)
	Other liabilities		(13.8	)		(25.8	)
	Other items		9.6			12.8
	Net cash flow provided from operating activities		714.0			586.9

Investing activities
	Additions to property, plant & equipment		(97.1	)		(78.4	)
	Purchases of held-to-maturity securities		(1.1	)		(1.3	)
	Proceeds from sales or maturities of held-to-maturity securities		1.4			1.9
	Release of restricted short-term investments		-			10.0
	Net increase in other short-term investments		(5.5	)		(17.5	)
	Business acquisition, net of cash acquired		(5.6	)		-
	Other investing activities		6.2			(2.7	)
	Net cash flow used for investing activities		(101.7	)		(88.0	)

Financing activities
	Net repayments of commercial paper with maturities of
	90 days or less		(351.0	)		(350.0	)
	Dividends paid		(42.2	)		(41.9	)
	Proceeds from exercise of stock options		-			8.1
	Repayment of loan against cash surrender value of life insurance policies		(11.2	)		-
	Other financing activities		(.1	)		.4
	Net cash flow used for financing activities		(404.5	)		(383.4	)

Net increase in cash and cash equivalents			207.8			115.5

Cash and cash equivalents, beginning of period			42.8			41.1

Cash and cash equivalents, end of period		$	250.6		$	156.6

* Prior periods were adjusted due to the retrospective application of FSP No. FIN 39-1. See New Accounting Pronouncements footnote for further information.

The accompanying notes are an integral part of these statements.

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Nicor Inc.
Condensed Consolidated Balance Sheets (Unaudited)
(millions)
		June 30		December 31			June 30
		2008		2007			2007
Assets				* As Adjusted			* As Adjusted
Current assets
Cash and cash equivalents		$	250.6	$	42.8		$	156.6
Short-term investments, at cost which approximates market			53.2		49.1			33.8
Receivables, less allowances of $55.5, $35.1 and $34.7, respectively			514.6		641.5			359.4
Gas in storage			75.7		154.0			43.6
Deferred income taxes			49.4		37.5			34.1
Derivative instruments			226.4		28.4			23.5
Other			74.0		89.8			112.1
Total current assets			1,243.9		1,043.1			763.1

Property, plant and equipment, at cost
Gas distribution			4,348.2		4,279.7			4,205.6
Shipping			312.2		309.2			303.8
Other			25.1		22.8			21.2
			4,685.5		4,611.7			4,530.6
Less accumulated depreciation			1,905.3		1,854.4			1,809.9
Total property, plant and equipment, net			2,780.2		2,757.3			2,720.7

Pension benefits			223.2		215.5			166.9
Long-term investments			141.8		132.9			134.7
Other assets			166.6		122.5			168.5

Total assets		$	4,555.7	$	4,271.3		$	3,953.9

Liabilities and Capitalization
Current liabilities
Long-term debt due within one year		$	125.0	$	75.0		$	-
Short-term debt			18.0		369.0			-
Accounts payable			555.1		428.2			368.8
Customer credit balances and deposits			138.5		234.5			156.5
Temporary LIFO inventory liquidation			399.2		-			263.0
Accrued gas costs			91.3		50.1			6.1
Dividends payable			21.0		21.0			21.0
Margin accounts - derivative instruments			79.4		-			-
Other			133.9		117.9			143.0
Total current liabilities			1,561.4		1,295.7			958.4

Deferred credits and other liabilities
Regulatory asset retirement cost liability			739.8		720.7			698.4
Deferred income taxes			399.4		400.4			391.7
Health care and other postretirement benefits			186.2		185.1			183.3
Asset retirement obligation			181.6		177.5			173.2
Regulatory income tax liability			48.1		49.5			52.2
Unamortized investment tax credits			26.4		27.5			28.6
Other			55.0		46.3			53.6
Total deferred credits and other liabilities			1,636.5		1,607.0			1,581.0

Commitments and contingencies

Capitalization
Long-term obligations
Long-term debt, net of unamortized discount			372.9		422.8			497.6
Mandatorily redeemable preferred stock			.6		.6			.6
Total long-term obligations			373.5		423.4			498.2

Common equity
Common stock			112.9		112.8			112.8
Paid-in capital			46.6		44.8			43.8
Retained earnings			823.5		795.5			767.6
Accumulated other comprehensive income (loss), net			1.3		(7.9	)		(7.9	)
Total common equity			984.3		945.2			916.3

Total capitalization			1,357.8		1,368.6			1,414.5

Total liabilities and capitalization		$	4,555.7	$	4,271.3		$	3,953.9

*	Prior periods were adjusted due to the retrospective application of FSP No. FIN 39-1. See New Accounting Pronouncements footnote for further information.

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 2007 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. The inventory decrement as of June 30, 2008 is expected to be restored prior to year-end.

Nicor Enerchange inventory is carried at the lower of weighted-average cost or market (market is represented by the cash price per the close of business on the last trading day of the period). In 2007, Nicor Enerchange recorded a charge of $5.0 million in the second quarter 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 requires 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):

	June 30		December 31		June 30
	2008		2007		2007
Regulatory assets
Regulatory postretirement asset – current	$	5.2	$	5.2	$	8.8
Regulatory postretirement asset – noncurrent		61.9		64.2		102.2
Deferred environmental costs		8.0		9.5		11.7
Unamortized losses on reacquired debt		15.9		16.5		17.0
Deferred rate case costs		4.2		2.6		2.8
Other		.1		.1		1.4
	$	95.3	$	98.1	$	143.9

Regulatory liabilities
Regulatory asset retirement cost liability – current	$	8.0	$	8.0	$	8.0
Regulatory asset retirement cost liability – noncurrent		739.8		720.7		698.4
Accrued gas costs		91.3		50.1		6.1
Regulatory income tax liability		48.1		49.5		52.2
Other		6.1		1.1		-
	$	893.3	$	829.4	$	764.7

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 asset 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.

Goodwill. Tropical Shipping had goodwill of $18.7 million, $15.6 million and $15.6 million at June 30, 2008, December 31, 2007 and June 30, 2007, respectively. The increase in goodwill from December 31, 2007 to June 30, 2008 is due to the acquisition of the assets of Caribtran, Inc., a provider of less-than-container load and full container load consolidation services from the United States to the Caribbean and Central America.

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 six months ended June 30, 2008 were $36.1 million and $115.0 million, respectively, and $28.5 million and $99.6 million, respectively, for the same periods ending June 30, 2007.

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.

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3.	NEW ACCOUNTING PRONOUNCEMENTS

Fair value measurements. Effective January 1, 2008, the company adopted SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a consistent framework for measuring fair value, and expands disclosure requirements about fair value measurements. This 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. It also provides for immediate recognition of trade-date gains and losses related to certain derivative transactions whose fair value has been determined using unobservable market inputs. Nicor elected the one-year deferral allowed by FSP SFAS 157-2, Effective Date of FASB Statement No. 157, for certain nonfinancial assets and liabilities. As it applies to Nicor, the deferral pertains to fair value measurements for business combinations, impairment testing of goodwill and other intangible assets, as well as asset retirement obligations. The effect of adopting SFAS No. 157 was not material to Nicor’s results of operations or financial condition.

Offsetting of amounts related to certain contracts. Effective January 1, 2008, Nicor adopted FSP No. FIN 39-1, Amendment of FIN 39, Offsetting of Amounts Related to Certain Contracts. 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. Upon adoption of this FSP, the company elected not to offset fair value assets and liabilities recognized for derivative instruments. As a result, any related cash collateral is not offset against the derivatives.

This FSP was required to be applied retrospectively to all prior periods. As a result of the application of this FSP, the company’s Condensed Consolidated Balance Sheets line items increased (decreased) by the following amounts (in millions):

	June 30 2008			December 31 2007			June 30 2007

Assets
Receivables	$	(37.9	)	$	(22.5	)	$	(25.3	)
Derivative instruments		160.8			13.0			12.5
Current other assets		17.0			28.8			50.3
Liabilities
Margin accounts – derivative instruments	$	79.4		$	-		$	-
Current other liabilities		60.5			19.3			37.5

Defined benefit pension and other postretirement plans. On December 31, 2006, Nicor adopted the recognition provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. In addition, SFAS No. 158 requires Nicor to change its plan measurement date to match its fiscal year-end. Such provision is effective for Nicor no later than December 31, 2008 and will be adopted prospectively at that time. In accordance with SFAS No. 158, Nicor has elected to use a 15-month approach for transitioning from an October 1 measurement date to a December 31 measurement date. An adjustment to retained earnings will be recorded on December 31, 2008 to account for the transition since the total impact will not be known until the December 31, 2008 actuarial valuation of the plan is complete.

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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.

5.	SHORT-TERM AND LONG-TERM DEBT

In April 2008, Nicor Gas entered into an agreement for the issuance of $75 million First Mortgage Bonds at 6.25 percent, due in 2038. The issuance is expected to occur, subject to the satisfaction of the conditions in the underlying agreements, on the maturity date of the $75 million 5.875 percent First Mortgage Bond series due in August 2008.

In October 2007, Nicor Gas established a $400 million, 210-day seasonal revolver, which expired 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 $18 million and $369 million of commercial paper borrowings outstanding at June 30, 2008 and December 31, 2007, respectively. The company had no commercial paper borrowings outstanding at June 30, 2007.

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

6. INCOME TAXES

The effective income tax rate for the three months ended June 30, 2008 decreased to 25.3 percent from 25.6 percent for the prior-year period. The effective income tax rate for the six months ended June 30, 2008 decreased to 25.3 percent from 27.2 percent for the prior-year period. The lower effective income tax rate for 2008 reflects the impact of lower projected annual pretax income (which causes a lower effective income tax rate since permanent differences and tax credits are a larger share of pretax income) and tax reserve adjustments offset, in part, by lower untaxed foreign shipping earnings.

In 2006, the company reorganized certain shipping and related operations. The reorganization allows the company to take advantage of certain provisions of the Jobs Act that provide the opportunity for tax savings subsequent to the date of the reorganization. Generally, to the extent foreign shipping earnings are not repatriated to the United States, such earnings are not expected to be subject to current taxation. In addition, to the extent such earnings are determined to be indefinitely reinvested offshore, no deferred income tax expense would be recorded by the company. For the three and six months ended June 30, 2008, income tax expense has not been provided on approximately $3 million of foreign company shipping earnings that are expected to be indefinitely reinvested offshore compared to approximately $5 million and $13 million, respectively, for the comparable periods in 2007. As of June 30, 2008, Nicor has not recorded deferred income taxes of approximately $44 million on approximately $126 million of cumulative undistributed foreign earnings that are expected in management’s judgment to be indefinitely reinvested offshore.

The company’s liability for unrecognized tax benefits was $8.0 million at June 30, 2008 of which about $1 million, if recognized, would impact the company’s effective income tax rate. The increase in unrecognized tax benefits from $5.7 million at December 31, 2007 is due primarily to an item concerning the timing of inclusion in taxable income of recoveries for environmental clean-up expenditures, partially offset by settlements and adjustments to estimates. The company believes that it is reasonably possible

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that a change in its unrecognized tax benefits could occur within 12 months, potentially increasing by $7 million or decreasing by $13 million its unrecognized tax benefits.

The company has approximately $7 million of net interest receivable related to interest and penalties at June 30, 2008 compared with $8 million of net interest payable related to interest and penalties at December 31, 2007. The change is due primarily to an interest payment made in the second quarter of 2008.

7.	ACCRUED UNBILLED REVENUES

Receivables include accrued unbilled revenues of $58.6 million, $191.2 million and $61.6 million at June 30, 2008, December 31, 2007 and June 30, 2007, 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

Effective January 1, 2008, SFAS No. 157, Fair Value Measurements, defines a three-level hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, with Level 1 considered the most reliable. For assets and liabilities measured at fair value on a recurring basis on the Condensed Consolidated Balance Sheets, the table below categorizes those fair values across the three levels as of June 30, 2008 (in millions):

	Fair Value Amount
	Quoted Prices in Active Markets		Significant Observable Inputs		Significant Unobservable Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Assets
Commodity Derivatives:
Financial - current	$	158.1	$	55.2	$	1.3	$	214.6
Financial - noncurrent		-		3.3		-		3.3
Physical - current		-		4.0		7.8		11.8
Physical - noncurrent		-		.4		.9		1.3
Total	$	158.1	$	62.9	$	10.0	$	231.0

Liabilities
Commodity Derivatives:
Financial - current	$	53.2	$	9.5	$	1.3	$	64.0
Physical - current		-		.7		1.7		2.4
Physical - noncurrent		-		-		.1		.1
Total	$	53.2	$	10.2	$	3.1	$	66.5

When available and appropriate, the company uses quoted market prices in active markets to determine fair value, and classifies such items within Level 1. Level 1 values only include derivative instruments traded on the NYMEX. The company enters into over-the-counter instruments with values that are similar to, and correlate with, quoted prices for exchange-traded instruments in active markets; these over-the-counter items are classified within Level 2. In certain instances, the company may be required to use one or more significant unobservable inputs for a model-derived valuation; the resulting valuation is classified as Level 3.

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The net fair value of commodity derivatives relates largely to Nicor Gas. The majority of derivatives held by Nicor Gas are for the purpose of hedging natural gas purchases for its customers, and therefore their values do not affect net income, as their settlement is passed directly through to customers without markup, subject to ICC review. The change in fair value for these derivatives is accounted for through regulatory assets and liabilities.

The current asset portion of the derivatives is stated separately within current assets on the Condensed Consolidated Balance Sheets. The current liabilities and the noncurrent assets and liability noted in the above table are classified as other.

The following table presents a reconciliation of the Level 3 beginning and ending net derivative asset balance for the periods ended June 30, 2008 (in millions):

	Three months ended			Six months ended

Beginning of Period	$	9.3		$	8.2
Net realized/unrealized gains
Included in regulatory assets and liabilities		-			5.9
Included in net income		-			2.5
Settlements, net of purchases		(1.0	)		(8.2	)
Transfers in and/or out of Level 3		(1.4	)		(1.5	)
End of period	$	6.9		$	6.9

Net realized/unrealized gains included in net income relating to derivatives still held at June 30, 2008	$	-		$	2.5

Net realized/unrealized gains included in net income are attributable to Nicor Enerchange and are classified as operating revenues.

Nicor maintains margin accounts related to financial derivative transactions. As of June 30, 2008, Nicor Gas recorded $79.3 million in margin accounts - derivative instruments and Nicor Enerchange recorded $17.0 million in current other assets related to margin accounts. The company’s policy is not to offset fair value assets and liabilities recognized for derivative instruments or any related margin account.

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 June 30, 2008, December 31, 2007 and June 30, 2007 was $500 million. Based on quoted market interest rates, the fair value of the company’s First Mortgage Bonds outstanding was approximately $503 million at June 30, 2008, $513 million at December 31, 2007 and $505 million at June 30, 2007.

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 collectively bargained employees. The benefit obligation related to collectively bargained employee 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 Nicor Gas employees

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perform services for non-regulated affiliates and to the extent such employees are eligible to participate in these plans, the 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 of amounts charged to affiliates. Net periodic benefit cost (credit) included the following components (in millions):

	Pension benefits						Health care and other benefits
	2008			2007			2008		2007
Three months ended June 30
Service cost	$	2.2		$	2.3		$	.5	$	.6
Interest cost		3.9			3.8			3.0		2.7
Expected return on plan assets		(10.0	)		(9.0	)		-		-
Recognized net actuarial loss		-			-			1.1		1.2
Amortization of prior service cost		.1			.1			-		-
Net periodic benefit cost (credit)	$	(3.8	)	$	(2.8	)	$	4.6	$	4.5

Six months ended June 30
Service cost	$	4.3		$	4.6		$	1.0	$	1.2
Interest cost		7.9			7.5			6.0		5.4
Expected return on plan assets		(20.0	)		(18.0	)		-		-
Recognized net actuarial loss		-			-			2.3		2.3
Amortization of prior service cost		.2			.3			-		-
Net periodic benefit cost (credit)	$	(7.6	)	$	(5.6	)	$	9.3	$	8.9

10.	EQUITY INVESTMENT INCOME, NET

Net equity investment income includes investment income from Triton of $2.2 million and $3.2 million, respectively, for the three and six months ended June 30, 2008 and $1.3 million and $2.2 million for the same periods ended June 30, 2007, respectively. Nicor received cash distributions from equity investees for the three and six months ended June 30, 2008 of $4.0 million and $7.3 million, respectively, and $2.2 million and $6.3 million, respectively, for the same periods ended June 30, 2007.

11.	COMPREHENSIVE INCOME

Total comprehensive income is as follows (in millions):

	Three months ended					Six months ended
	June 30					June 30
	2008		2007			2008		2007

Net income	$	28.9	$	18.0		$	70.3	$	65.2
Other comprehensive income (loss), after tax		4.0		(1.3	)		9.2		5.4
Total comprehensive income	$	32.9	$	16.7		$	79.5	$	70.6

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.

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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 June 30, 2008
Operating revenues
External customers	$	543.3	$	102.6	$	53.9		$	-		$	699.8
Intersegment		16.8		-		(1.2	)		(15.6	)		-
	$	560.1	$	102.6	$	52.7		$	(15.6	)	$	699.8

Operating income	$	20.7	$	5.7	$	11.0		$	3.2		$	40.6

Three months ended June 30, 2007
Operating revenues
External customers	$	416.7	$	97.0	$	43.2		$	-		$	556.9
Intersegment		14.7		-		1.9			(16.6	)		-
	$	431.4	$	97.0	$	45.1		$	(16.6	)	$	556.9

Operating income (loss)	$	13.8	$	8.3	$	8.0		$	(.2	)	$	29.9

Six months ended June 30, 2008
Operating revenues
External customers	$	1,976.0	$	200.3	$	119.2		$	-		$	2,295.5
Intersegment		48.3		-		3.7			(52.0	)		-
	$	2,024.3	$	200.3	$	122.9		$	(52.0	)	$	2,295.5

Operating income (loss)	$	83.0	$	9.6	$	12.0		$	(.8	)	$	103.8

Six months ended June 30, 2007
Operating revenues
External customers	$	1,593.0	$	196.1	$	102.5		$	-		$	1,891.6
Intersegment		46.8		-		19.2			(66.0	)		-
	$	1,639.8	$	196.1	$	121.7		$	(66.0	)	$	1,891.6

Operating income (loss)	$	84.7	$	18.2	$	5.3		$	(1.7	)	$	106.5

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 and six months ended June 30, 2008 were ($0.2) million and ($4.0) million, respectively, and $0.5 million and ($0.1) million, respectively, for the same periods in 2007. This benefit (cost) is recorded 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.

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13.	RATE PROCEEDING

On April 29, 2008, Nicor Gas filed with the ICC for an overall increase in rates of $140.3 million. The company’s filing provides for a rate of return on rate base of 9.21 percent, which reflects an 11.05 percent cost of common equity. The requested rate increase is needed to recover higher operating costs and increased capital investments.

In its rate filing, Nicor Gas has proposed some new rate adjustment mechanisms. These include mechanisms that would adjust rates to reflect certain changes in the company’s bad debt expense and cost of gas used for operations. Also included are a volume balancing rider that would adjust rates to recover fixed costs, an energy efficiency rider that would fund energy efficiency programs and a rider that would adjust rates to recover a portion of capital expenditures incurred to replace certain older infrastructure.

The ICC normally has 11 months to complete its review of the filing and to issue an order. The proposed rate increase has been suspended pending the completion of the ICC’s review.

14.	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 $5 million at June 30, 2008. Nicor believes the likelihood of any such payment by TEL is either remote, or the fair value of the indemnification was immaterial, and no liability has been recorded for this contingent liability.

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 $1.6 million and $3.3 million were incurred in the three and six months ended June 30, 2008, respectively, and $1.5 million and $3.2 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 15 – 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 was 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 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.

15.	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.

In 2004, the company became aware of additional information relating to the activities of individuals affecting the PBR plan for the period from 1999 through 2002, including information consisting of third party documents and recordings of telephone conversations from 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 June 30, 2008.

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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 June 30, 2008, Nicor Gas had remaining an estimated liability of $2.3 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. In the first quarter of 2007, the company recorded a net recovery of approximately $0.8 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 January 3, 2008, Nicor Gas and ComEd entered into a definitive agreement concerning final cost allocations. The definitive agreement allocates to Nicor Gas 51.73 percent of clean-up costs for twenty-four sites, no portion of the clean-up costs for fourteen other sites and 50 percent of general remediation program costs that do not relate exclusively to particular sites. The definitive agreement is subject, among other things, to approval by the ICC. The arbitration that was initiated by Nicor Gas in 2006 currently is stayed pursuant to the arbitration panel’s order and is expected to be stayed pending the ICC review of the definitive allocation 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 June 30, 2008, the company had recorded a liability in connection with these matters of $12.7 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

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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 a previously established reserve. The remaining lawsuits relating to the Oak Park site were settled and the claims dismissed during the first quarter of 2008. In accordance with ICC authorization, the company expects to recover costs of such settlements from its customers, subject to an annual prudence review.

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 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. In July 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.

Municipal Tax Matters. Many municipalities in Nicor Gas’ service territory have enacted ordinances that impose taxes on gas sales to customers within municipal boundaries. Most of these municipal taxes are imposed on Nicor Gas based on revenues generated by Nicor Gas within the municipality. Other municipal taxes are imposed on natural gas consumers within the municipality but are collected from consumers and remitted to the municipality by Nicor Gas. A number of municipalities have instituted audits of Nicor Gas’ tax remittances. In May 2007, five of those municipalities filed an action against Nicor Gas in state court in DuPage County, Illinois claiming that Nicor Gas has not provided information requested by the municipalities’ audit firm. The action seeks an accounting and other unspecified relief against Nicor Gas. Nicor Gas filed a motion to dismiss the action. In June 2008, the trial court granted the motion to dismiss without prejudice. In December 2007, twenty-five additional municipalities, all represented by the same audit firm involved in the lawsuit, issued assessments to Nicor Gas claiming that it failed to provide information requested by the audit firm and owed the municipalities back taxes. Nicor believes the assessments are improper and has challenged them. While the company is unable to predict the outcome of these matters 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 these matters is not expected to have a material adverse impact on the company’s liquidity or financial condition.

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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 2007 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 (in millions, except per share data):

	Three months ended				Six months ended
	June 30				June 30
	2008		2007		2008		2007

Net income	$	28.9	$	18.0	$	70.3	$	65.2

Diluted earnings per common share	$	.64	$	.40	$	1.55	$	1.44

Net income and diluted earnings per common share for the six months ended June 30, 2007 includes 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.

Comparisons of the three months ended results reflect higher operating results in the company’s gas distribution and other energy-related businesses and higher corporate operating income, partially offset by lower operating results in the company’s shipping business. Comparisons of the six months ended results (excluding the effect of the mercury-related item noted above) reflect higher operating results in the company’s gas distribution and other energy-related businesses and improved corporate operating results, partially offset by lower operating results in the company’s shipping business.

Rate proceeding. On April 29, 2008, Nicor Gas filed with the ICC for an overall increase in rates of $140.3 million. The company’s filing provides for a rate of return on rate base of 9.21 percent, which reflects an 11.05 percent cost of common equity. The requested rate increase is needed to recover higher operating costs and increased capital investments.

The ICC normally has 11 months to complete its review of the filing and to issue an order. The proposed rate increase has been suspended pending the completion of the ICC’s review.

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

	Three months ended					Six months ended
	June 30					June 30
	2008		2007			2008			2007

Gas distribution	$	20.7	$	13.8		$	83.0		$	84.7
Shipping		5.7		8.3			9.6			18.2
Other energy ventures		11.0		8.0			12.0			5.3
Corporate and eliminations		3.2		(.2	)		(.8	)		(1.7	)
	$	40.6	$	29.9		$	103.8		$	106.5

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

Gas distribution operating income increased $6.9 million for the three months ended June 30, 2008 compared to the prior-year period due to higher gas distribution margin ($6.5 million increase) and lower operating and maintenance expense ($2.4 million decrease), partially offset by higher depreciation expense ($1.4 million increase).

Operating income decreased $1.7 million for the six months ended June 30, 2008 compared to the prior-year period due primarily to the absence of mercury-related recoveries recorded during the first quarter of 2007 ($8.0 million decrease), higher operating and maintenance expenses ($6.5 million increase) and depreciation expense ($2.7 million increase), partially offset by higher gas distribution margin ($16.2 million increase).

Shipping operating income decreased $2.6 million and $8.6 million for the three and six months ended June 30, 2008, respectively, compared to the corresponding prior-year periods due to higher operating costs ($8.2 million and $12.8 million increases, respectively), which were partially offset by higher operating revenues ($5.6 million and $4.2 million increases, respectively). Operating costs were higher attributable to increased transportation-related costs ($6.6 million and $11.7 million increases, respectively) due primarily to increased fuel costs. Operating revenues were higher due to higher average rates ($8.6 million and $12.8 million increases, respectively), partially offset by lower volumes shipped ($3.0 million and $8.6 million decreases, respectively).

Nicor’s other energy ventures operating income increased $3.0 million for the three months ended June 30, 2008 compared to the prior-year period due to improved results at Nicor’s wholesale natural gas marketing business, Nicor Enerchange ($5.5 million increase), partially offset by lower operating income at Nicor’s energy-related products and services businesses ($2.2 million decrease). Improved operating results at Nicor Enerchange were due 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 changes in valuations of derivative instruments used to hedge purchases and sales of natural gas inventory. Lower operating results at Nicor’s energy-related products and services businesses were due to lower operating revenues ($3.7 million decrease), partially offset by lower operating expenses ($1.5 million decrease).

Operating income increased $6.7 million for the six months ended June 30, 2008 compared to the prior-year period due to higher operating results at Nicor’s energy-related products and services businesses ($8.4 million increase), partially offset by lower operating income at Nicor

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Enerchange ($1.4 million decrease). Improved operating results at Nicor’s energy-related products and services business were due to lower operating expenses ($17.7 million decrease), partially offset by lower operating revenues ($9.3 million decrease). Lower operating results at Nicor Enerchange were due primarily to unfavorable changes in valuations of derivative instruments used to hedge purchases and sales of natural gas inventory, partially offset by 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.

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 fair value 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 results increased $3.4 million for the three months ended June 30, 2008 compared to the prior-year period due to recoveries of previously incurred legal costs ($3.1 million) and benefits realized on life insurance contracts ($1.0 million). The legal cost recoveries were from a counterparty with whom Nicor previously did business during the PBR timeframe. The total recovery was $5.0 million, of which $3.1 million was allocated to corporate and $1.9 million was allocated to the gas distribution segment (recorded as a reduction to operating and maintenance expense). Operating results increased $0.9 million for the six months ended June 30, 2008 compared to the prior-year period due primarily to the previously mentioned recoveries of legal costs ($3.1 million) and benefits realized on life insurance contracts ($1.3 million), partially offset by the impact of a natural weather hedge associated with the utility-bill management products offered by Nicor’s energy-related products and services business ($3.9 million decrease). Benefits or costs resulting from variances from normal weather related to these products are recorded primarily at the corporate level as a result of an agreement between the parent company and certain of its subsidiaries. The weather impact of these products 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						Six months ended
	June 30						June 30
	2008			2007			2008			2007

Gas distribution	$	560.1		$	431.4		$	2,024.3		$	1,639.8
Shipping		102.6			97.0			200.3			196.1
Other energy ventures		52.7			45.1			122.9			121.7
Corporate and eliminations		(15.6	)		(16.6	)		(52.0	)		(66.0	)
	$	699.8		$	556.9		$	2,295.5		$	1,891.6

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Gas distribution revenues are impacted by changes in natural gas costs, which are passed directly through to customers without markup, subject to ICC review. Gas distribution revenues increased $128.7 million for the three months ended June 30, 2008 compared to the prior-year period due primarily to higher natural gas costs (approximately $95 million increase). Gas distribution revenues increased $384.5 million for the six months ended June 30, 2008 compared to the prior-year period due primarily to higher natural gas costs (approximately $265 million increase) and colder weather in 2008 (approximately $105 million increase).

Shipping segment operating revenues increased $5.6 million and $4.2 million for the three and six months ended June 30, 2008, respectively, compared with the corresponding prior-year periods due to higher average rates ($8.6 million and $12.8 million increases, respectively), partially offset by lower volumes shipped ($3.0 million and $8.6 million decreases, respectively). Rates were higher due primarily to cost-recovery surcharges for fuel. Volumes shipped were adversely impacted by decreased construction cargo, decreased tourism and increased competition. Tropical Shipping recently completed an acquisition of the assets of Caribtran, Inc., which is expected to add approximately 4 percent to expected shipping revenues on an annual basis.

Nicor’s other energy ventures operating revenues increased $7.6 million for the three months ended June 30, 2008 compared to the prior-year period due to higher revenues at Nicor Enerchange ($11.3 million increase), partially offset by lower revenues at Nicor’s energy-related products and services businesses ($3.7 million decrease). Operating revenues increased $1.2 million for the six months ended June 30, 2008 compared to the prior-year period due to higher revenues at Nicor Enerchange ($10.5 million increase), partially offset by lower revenues at Nicor’s energy-related products and services businesses ($9.3 million decrease). 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 business, partially offset by unfavorable changes in valuations of derivative instruments used to hedge purchases and sales of natural gas inventory. Lower revenues at Nicor’s energy-related products and services businesses were due to lower average utility-bill management contract volumes.

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

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

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

	Three months ended						Six months ended
	June 30						June 30
	2008			2007			2008			2007

Gas distribution revenues	$	560.1		$	431.4		$	2,024.3		$	1,639.8
Cost of gas		(396.2	)		(281.6	)		(1,582.9	)		(1,230.0	)
Revenue tax expense		(36.1	)		(28.5	)		(115.0	)		(99.6	)
Gas distribution margin	$	127.8		$	121.3		$	326.4		$	310.2

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Gas distribution margin increased $6.5 million for the three months ended June 30, 2008 compared to the corresponding prior-year period due primarily to higher demand unrelated to weather (approximately $3 million increase) and the impact of customer interest (approximately $3 million increase). Gas distribution margin increased $16.2 million for the six months ended June 30, 2008 compared to the corresponding prior-year period due primarily to colder weather in 2008 (approximately $7 million increase), the impact of customer interest (approximately $5 million increase) and higher demand unrelated to weather (approximately $4 million increase).

Gas distribution operating and maintenance expense. Gas distribution operating and maintenance expense decreased $2.4 million for the three months ended June 30, 2008 compared to the corresponding prior-year period due primarily to recoveries of previously incurred costs ($3.9 million, of which $2.0 million relates to a recovery of costs associated with the prior year PCB matter and $1.9 million relates to legal cost recoveries from a counterparty with whom Nicor previously did business during the PBR timeframe) and lower company use gas and storage-related gas costs ($3.1 million decrease attributable primarily to favorable fair value adjustments on derivatives hedging company usage), partially offset by higher bad debt expense ($2.8 million increase) and payroll and benefit-related costs ($2.2 million increase). Operating and maintenance expense increased $6.5 million for the six months ended June 30, 2008 compared to the corresponding prior-year period due primarily to higher bad debt expense ($13.4 million increase), partially offset by lower company use gas and storage-related gas costs ($4.2 million decrease) and the previously mentioned cost recoveries ($3.9 million).

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. For the six months ended June 30, 2007, net recoveries reflect a $7.2 million reserve adjustment and $0.8 million in cost recoveries. Additional information about the company’s mercury inspection and repair program is presented in Item 1 – Notes to the Condensed Consolidated Financial Statements – Note 15 – Contingencies – Mercury.

Shipping operating expenses. Shipping segment operating expenses increased $8.2 million and $12.8 million for the three and six months ended June 30, 2008, respectively, compared to the corresponding prior-year periods. Higher operating costs were attributable to increased transportation-related costs ($6.6 million and $11.7 million increases, respectively) due primarily to increased fuel costs.

Other energy ventures operating expenses. Other energy ventures operating expenses increased $4.6 million for the three months ended June 30, 2008 compared to the corresponding prior-year period due primarily to an increase in operating expenses at Nicor Enerchange ($5.8 million increase), partially offset by a decrease in operating expenses at Nicor’s energy-related products and services businesses ($1.5 million decrease). The variance in operating expense at Nicor Enerchange was due primarily to transportation and storage charges. The decrease in operating expenses at Nicor’s energy-related products and services businesses was due primarily to lower average utility-bill management contract volumes. Operating expenses decreased $5.5 million for the six months ended June 30, 2008 compared to the corresponding prior-year period due to a decrease in operating expenses at Nicor’s energy-related products and services businesses ($17.7 million decrease), partially offset by an increase in operating expenses at Nicor Enerchange ($11.9 million increase). The decrease in operating expenses at Nicor’s energy-related products and services businesses was due primarily to lower average-utility bill management contract volumes and lower average costs associated with customer contracts. The variance in operating expense at Nicor Enerchange was due primarily to transportation and storage charges.

Interest expense. Interest expense decreased $1.0 million for the three months ended June 30, 2008 compared to the prior-year period due primarily to lower estimated interest on income tax matters ($0.7 million decrease). Interest expense decreased $4.2 million for the six months ended June 30, 2008 compared to the prior-year period due primarily to lower estimated interest on income tax matters ($2.6 million decrease), lower average interest rates ($1.0 million decrease) and lower average borrowing levels ($0.5 million decrease).

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Net equity investment income. Net equity investment income increased $1.6 million and $2.3 million for the three and six months ended June 30, 2008, respectively, compared to the corresponding prior-year periods due primarily to an increase in income from the company’s investment in Triton ($0.9 million and $1.0 million increases, respectively) and reduced losses from affordable housing investments ($0.7 million decrease for the three and six months ended).

Income taxes. In 2006, the company reorganized certain shipping and related operations. The reorganization allows the company to take advantage of certain provisions of the Jobs Act that provide the opportunity for tax savings subsequent to the date of the reorganization. Generally, to the extent foreign shipping earnings are not repatriated to the United States, such earnings are not expected to be subject to current taxation. In addition, to the extent such earnings are determined to be indefinitely reinvested offshore, no deferred income tax expense would be recorded by the company.&