nicorincform10q063009.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, 2009

or

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

Commission File Number 1-7297

NICOR INC LOGO
NICOR INC.
(Exact name of registrant as specified in its charter)

Illinois
36-2855175
(State of Incorporation)
(I.R.S. Employer
 
Identification No.)

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months.  Yes [   ]   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 24, 2009, were 45,221,593 shares.



 
 

 

Table of Contents

 
ii
       
Part I - Financial Information
 
       
 
Item 1.
Financial Statements (Unaudited)
 
       
   
1
       
   
2
       
   
3
       
   
4
       
 
Item 2.
21
       
 
Item 3.
34
       
 
Item 4.
34
       
Part II - Other Information
 
       
 
Item 1.
35
       
 
Item 2.
35
       
 
Item 4.
35
       
 
Item 6.
36
       
   
38

 
i

Glossary

ALJs.  Administrative Law Judges.

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

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

FASB.  Financial Accounting Standards Board.

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

FSP.  FASB Staff Position.

GSA.  General Services Administration, a governmental agency of the United States.

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, serves commercial and industrial customers in the Chicago market area, and manages Nicor Solutions’ and Nicor Advanced Energy’s product risks, including the purchase of natural gas supplies.

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

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

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

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

PCBs.  Polychlorinated Biphenyls.

PGA.  Purchased Gas Adjustment, a rate rider that passes natural gas costs directly through to customers without markup, subject to ICC review.

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.

 

 
Part I - FINANCIAL INFORMATION
                       
                           
Item 1.   Financial Statements                        
                           
                       
Condensed Consolidated Statements of Operations (Unaudited)
                   
(millions, except per share data)
                       
     
Three months ended
   
Six months ended
 
     
June 30
   
June 30
 
     
2009
   
2008
   
2009
   
2008
 
Operating revenues
                       
Gas distribution (includes revenue taxes of $26.6, $36.7,
                       
$101.3 and $117.0, respectively)
  $ 326.3     $ 560.1     $ 1,310.3     $ 2,024.3  
Shipping
    83.8       102.6       173.2       200.3  
Other energy ventures
    51.2       52.7       128.3       122.9  
Corporate and eliminations
    (13.7 )     (15.6 )     (53.4 )     (52.0 )
Total operating revenues
    447.6       699.8       1,558.4       2,295.5  
                                   
Operating expenses
                               
Gas distribution
                               
Cost of gas
    156.6       396.2       873.0       1,582.9  
Operating and maintenance
    69.1       59.7       159.7       148.3  
Depreciation
    44.6       42.9       89.0       85.7  
Taxes, other than income taxes
    30.9       40.6       109.7       124.4  
Shipping
    81.3       96.9       164.1       190.7  
Other energy ventures
    38.5       41.7       113.0       110.9  
Other corporate expenses and eliminations
    (12.9 )     (18.8 )     (49.5 )     (51.2 )
Total operating expenses
    408.1       659.2       1,459.0       2,191.7  
                                   
Operating income
    39.5       40.6       99.4       103.8  
Interest expense, net of amounts capitalized
    8.8       9.1       18.1       19.7  
Equity investment income, net
    1.6       2.8       13.3       4.3  
Interest income
    .5       4.2       1.1       5.5  
Other income, net
    .3       .2       .5       .2  
                                   
Income before income taxes
    33.1       38.7       96.2       94.1  
Income tax expense, net of benefits
    10.2       9.8       29.5       23.8  
                                   
Net income
  $ 22.9     $ 28.9     $ 66.7     $ 70.3  
                                   
Average shares of common stock outstanding
                               
    Basic
      45.4       45.3       45.4       45.3  
    Diluted
    45.5       45.3       45.5       45.3  
                                   
Earnings per average share of common stock
                               
    Basic
    $ .50     $ .64     $ 1.47     $ 1.55  
    Diluted
    .50       .64       1.47       1.55  
                                   
Dividends declared per share of common stock
  $ .465     $ .465     $ .930     $ .930  
                                   
                                   
The accompanying notes are an integral part of these statements.
                         
 
1
 
           
Condensed Consolidated Statements of Cash Flows (Unaudited)
           
(millions)
           
   
Six months ended
 
   
June 30
 
   
2009
   
2008
 
             
Operating activities
           
Net income
  $ 66.7     $ 70.3  
Adjustments to reconcile net income to net cash flow provided from operating activities:
               
Depreciation
    98.1       95.1  
Deferred income tax expense (benefit)
    1.0       (20.5 )
Gain on sale of equity investment
    (10.1 )     -  
Changes in assets and liabilities:
               
  Receivables, less allowances
    379.2       128.2  
  Gas in storage
    179.9       78.3  
  Deferred/accrued gas costs
    56.9       41.2  
  Derivative instruments
    (21.2 )     (163.4 )
  Margin accounts - derivative instruments
    29.1       91.2  
  Other assets
    17.1       (32.2 )
  Accounts payable and customer credit balances and deposits
    (189.4 )     30.9  
  Temporary LIFO inventory liquidation
    82.9       399.2  
  Other liabilities
    (29.6 )     (13.8 )
Other items
    9.6       9.5  
Net cash flow provided from operating activities
    670.2       714.0  
                 
Investing activities
               
Additions to property, plant & equipment
    (111.2 )     (97.1 )
Purchases of held-to-maturity securities
    -       (1.1 )
Proceeds from maturities of held-to-maturity securities
    1.3       1.4  
Net increase in other short-term investments
    (3.7 )     (5.5 )
Proceeds from sale of equity investment
    13.0       -  
Business acquisition, net of cash acquired
    (.4 )     (5.6 )
Other investing activities
    2.3       6.2  
Net cash flow used for investing activities
    (98.7 )     (101.7 )
                 
Financing activities
               
Repayments of long-term debt
    (50.0 )     -  
Net repayments of commercial paper
    (462.9 )     (351.0 )
Dividends paid
    (42.3 )     (42.2 )
Borrowing against cash surrender value of life insurance policies
    3.4       -  
Repayment of loan against cash surrender value of life insurance policies
    -       (11.2 )
Other financing activities
    (1.8 )     (.1 )
Net cash flow used for financing activities
    (553.6 )     (404.5 )
                 
Net increase in cash and cash equivalents
    17.9       207.8  
                 
Cash and cash equivalents, beginning of period
    26.0       42.8  
                 
Cash and cash equivalents, end of period
  $ 43.9     $ 250.6  
                 
                 
The accompanying notes are an integral part of these statements.
               
                 
2
 
Nicor Inc.
Condensed Consolidated Balance Sheets (Unaudited)
(millions)
 
   
 June 30
   
 December 31
   
 June 30
 
   
 2009
   
 2008
   
 2008
 
Assets
                 
Current assets
                 
Cash and cash equivalents
  $ 43.9     $ 26.0     $ 250.6  
Short-term investments
    72.4       69.5       53.2  
Receivables, less allowances of $51.9, $44.9 and $55.5, respectively
    310.9       690.1       514.6  
Gas in storage
    28.6       208.5       75.7  
Derivative instruments
    53.3       49.7       226.4  
Margin accounts - derivative instruments
    116.8       134.4       17.0  
    Other
    117.4       160.7       106.4  
Total current assets
    743.3       1,338.9       1,243.9  
                         
Property, plant and equipment, at cost
                       
Gas distribution
    4,536.8       4,460.6       4,348.2  
Shipping
    323.2       315.1       312.2  
   Other
    29.3       26.7       25.1  
      4,889.3       4,802.4       4,685.5  
Less accumulated depreciation
    1,990.1       1,943.8       1,905.3  
Total property, plant and equipment, net
    2,899.2       2,858.6       2,780.2  
                         
Pension benefits
    36.5       36.4       223.2  
Long-term investments
    128.4       136.8       141.8  
Other assets
    380.2       413.3       166.6  
                         
Total assets
  $ 4,187.6     $ 4,784.0     $ 4,555.7  
                         
Liabilities and Capitalization
                       
Current liabilities
                       
Long-term debt due within one year
  $ -     $ 50.0     $ 125.0  
Short-term debt
    227.0       739.9       18.0  
Accounts payable
    266.1       411.3       555.1  
Customer credit balances and deposits
    143.1       187.3       138.5  
Temporary LIFO inventory liquidation
    82.9       -       399.2  
Derivative instruments
    152.4       167.3       66.4  
    Other
    104.5       112.2       259.2  
Total current liabilities
    976.0       1,668.0       1,561.4  
                         
Deferred credits and other liabilities
                       
Regulatory asset retirement cost liability
    774.7       751.7       739.8  
Deferred income taxes
    399.0       400.0       399.4  
Health care and other postretirement benefits
    197.5       196.6       186.2  
Asset retirement obligation
    188.9       185.0       181.6  
    Other
    146.9       161.0       129.5  
Total deferred credits and other liabilities
    1,707.0       1,694.3       1,636.5  
                         
Commitments and contingencies
                       
                         
Capitalization
                       
Long-term obligations
                       
Long-term debt, net of unamortized discount
    498.1       448.0       372.9  
Mandatorily redeemable preferred stock
    .6       .6       .6  
Total long-term obligations
    498.7       448.6       373.5  
                         
Common equity
                       
Common stock
    113.0       113.0       112.9  
Paid-in capital
    52.2       49.5       46.6  
Retained earnings
    854.6       830.3       823.5  
Accumulated other comprehensive income (loss), net
    (13.9 )     (19.7 )     1.3  
Total common equity
    1,005.9       973.1       984.3  
                         
Total capitalization
    1,504.6       1,421.7       1,357.8  
                         
Total liabilities and capitalization
  $ 4,187.6     $ 4,784.0     $ 4,555.7  
                         
                         
The accompanying notes are an integral part of these statements.
                 
 
3

Nicor Inc.

Notes to the Condensed Consolidated Financial Statements (Unaudited)

1.
BASIS OF PRESENTATION

The unaudited Condensed Consolidated Financial Statements of Nicor have been prepared by the company pursuant to the rules and regulations of the SEC.  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to SEC rules and regulations.  The unaudited Condensed Consolidated Financial Statements and Notes should be read in conjunction with the financial statements and the notes thereto included in the company’s 2008 Annual Report on Form 10-K.

The information furnished reflects, in the opinion of the company, all adjustments (consisting only of normal recurring adjustments) 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.

The company’s management evaluated subsequent events for potential recognition and disclosure through July 31, 2009, the date the financial statements were issued.

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 temporary LIFO inventory 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, 2009 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 2009, Nicor Enerchange recorded a charge of $2.8 million in the first 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, or probable future expenditures.  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.



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

   
June 30
   
December 31
   
June 30
 
   
2009
   
2008
   
2008
 
Regulatory assets
                 
Regulatory postretirement asset – current
  $ 23.3     $ 23.3     $ 5.2  
Regulatory postretirement asset – noncurrent
    222.7       232.3       61.9  
Deferred gas costs – current
    -       31.5       -  
Deferred gas costs – noncurrent
    15.2       22.5       -  
Deferred environmental costs
    11.8       19.5       8.0  
Unamortized losses on reacquired debt
    14.8       15.4       15.9  
Other
    15.0       6.2       4.3  
    $ 302.8     $ 350.7     $ 95.3  

Regulatory liabilities
                 
Regulatory asset retirement cost liability – current
  $ 15.0     $ 15.0     $ 8.0  
Regulatory asset retirement cost liability – noncurrent
    774.7       751.7       739.8  
Accrued gas costs
    18.1       -       91.3  
Regulatory income tax liability
    44.7       46.3       48.1  
Other
    1.2       .8       6.1  
    $ 853.7     $ 813.8     $ 893.3  

The current portion of the regulatory postretirement asset, the deferred gas costs and $2.3 million of other regulatory assets are classified in current assets – other.  All other regulatory assets are classified in noncurrent other assets.  The current portion of the regulatory asset retirement cost liability and accrued gas costs are classified in current liabilities – other.  All other regulatory liabilities are classified in noncurrent other liabilities.

The ICC does not presently allow Nicor Gas the opportunity to earn a return on its regulatory postretirement asset.  The regulatory postretirement asset is expected to be recovered from ratepayers over a period of approximately 10 to 13 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.  Nicor Gas is allowed to recover and is required to pay, using short-term interest rates, the carrying costs related to temporary under or overcollections of natural gas costs and certain environmental costs charged to its customers.

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, 2009 were $26.3 million and $99.9 million, respectively, and $36.1 million and $115.0 million, respectively, for the same periods ending June 30, 2008.

Derivative instruments.  Cash flows from derivative instruments are recognized in the Condensed Consolidated Statements of Cash Flows, and gains and losses are recognized in the Condensed Consolidated Statements of Operations, in the same categories as the underlying transactions.

Cash flow hedge accounting may be elected only for highly effective hedges, based upon an assessment, performed at least quarterly, of the historical and probable future correlation of cash flows from the derivative instrument to changes in the expected future cash flows of the hedged item.  To the extent cash flow hedge accounting is applied, the effective portion of any changes in the fair value of the derivative instruments is reported as a component of accumulated other comprehensive income.  Ineffectiveness, if any, is immediately recognized in operating income.  The amount in accumulated other comprehensive income is reclassified to earnings when the forecasted transaction is recognized in the income statement,
 
5
 
even if the derivative instrument is sold, extinguished or terminated prior to the transaction occurring.  If the forecasted transaction is no longer expected to occur, the amount in accumulated other comprehensive income is immediately reclassified to earnings.

Nicor Gas.  Derivative instruments, such as futures contracts, options and swap agreements, are utilized primarily in the purchase of natural gas for customers.  These derivative instruments are reflected at fair value.  Realized gains or losses on such instruments are included in the cost of gas delivered and are passed directly through to customers, subject to ICC review, and therefore have no direct impact on earnings.  Unrealized changes in the fair value of these derivative instruments are deferred as regulatory assets or liabilities and classified on the balance sheet as deferred or accrued gas costs, respectively.

At times, Nicor Gas enters into futures contracts, options, swap agreements and fixed-price purchase agreements to reduce the earnings volatility of certain forecasted operating costs arising from fluctuations in natural gas prices, such as the purchase of natural gas for use in company operations.  These derivative instruments are carried at fair value, unless they qualify for the normal purchases and normal sales exception, in which case they are carried at cost.  To the extent hedge accounting is not elected, changes in such fair values are immediately recorded in current period earnings as operating and maintenance expense.

Nicor Enerchange.  Derivative instruments, such as futures contracts, options, forward contracts, swap agreements and other energy-related contracts are held by Nicor’s wholesale natural gas marketing business, Nicor Enerchange, for trading purposes.  Certain of these derivative instruments are used to economically hedge price risk associated with inventories of natural gas, fixed-price purchase and sale agreements and other future natural gas commitments.  Nicor Enerchange records such derivative instruments at fair value and generally does not elect hedge accounting.  As a result, changes in derivative fair values may have a material impact on Nicor’s financial statements.  Other derivative instruments are used by Nicor Enerchange to hedge price risks related to certain utility-bill management products.  These derivative instruments are carried at fair value and cash flow hedge accounting may or may not be elected.

Nicor.  For derivative instruments that were designated as hedges of interest payments on 30-year bonds issued by Nicor Gas in December 2003, the amount deferred in accumulated other comprehensive income is being amortized to interest expense on a straight-line basis over the remaining life of the bonds.

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.  In 2008, 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 pertained 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, in its entirety, was not material to Nicor’s results of operations or financial condition.
 

4.
INVESTMENTS

FSP No. SFAS 115-2 and SFAS 124-2, Recognition and Presentation of Other –Than-Temporary Impairments, is effective for interim reporting periods ending after June 15, 2009.  This FSP extends existing disclosure requirements for investments to interim reporting periods as well as provides new disclosure requirements.

The company’s investments are as follows (in millions):

   
June 30
   
December 31
   
June 30
 
   
2009
   
2008
   
2008
 
                   
Money market funds
  $ 100.8     $ 81.2     $ 290.5  
Corporate bonds
    3.5       4.8       7.1  
Certificates of deposit
    .7       .6       .7  
Other investments
    3.2       2.0       2.2  
Total investments
  $ 108.2     $ 88.6     $ 300.5  

Investments are classified on the Condensed Consolidated Balance Sheets as follows (in millions):

   
June 30
   
December 31
   
June 30
 
   
2009
   
2008
   
2008
 
                   
Cash equivalents
  $ 31.2     $ 15.3     $ 240.5  
Short-term investments
    72.4       69.5       53.2  
Long-term investments
    4.6       3.8       6.8  
Total investments
  $ 108.2     $ 88.6     $ 300.5  

Money market funds held by domestic subsidiaries are included in cash equivalents, whereas such funds held by non-U.S subsidiaries are included in short-term investments.

Investments categorized as trading (including money market funds) are carried at fair value, and totaled $102.2 million, $82.2 million and $291.7 million at June 30, 2009, December 31, 2008 and June 30, 2008, respectively.  Corporate bonds are categorized as held-to-maturity, and their carrying value approximates fair value.  The contractual maturities of the held-to-maturity corporate bonds at June 30, 2009 are as follows (in millions):
Years to maturity
Less
than 1
year
   
1-5
Years
   
 
Total
 
               
$
2.7
    $
.8
    $
3.5
 

Nicor’s investments also include certain restricted investments, including certificates of deposit and bank accounts, maintained to fulfill statutory or contractual requirements.  These investments totaled $2.5 million, $1.6 million and $1.7 million at June 30, 2009, December 31, 2008 and June 30, 2008, respectively.

Any gains or losses included in earnings resulting from the sale of investments were not significant.
 

5.
SHORT-TERM AND LONG-TERM DEBT

In February 2009, the $50 million 5.37 percent First Mortgage Bond series matured and was retired.  On July 30, 2009, Nicor Gas, through a private placement, issued $50 million First Mortgage Bonds at 4.70 percent, due in 2019.  As a result of this issuance, the company reclassified $50 million of short-term debt outstanding as of June 30, 2009 as a long-term obligation.

In August 2008, Nicor Gas, through a private placement, issued $75 million First Mortgage Bonds at 6.25 percent, due in 2038.  Nicor Gas retired the $75 million 5.875 percent First Mortgage Bond series that became due in August 2008.

In May 2009, Nicor Gas established a $550 million, 364-day revolver, expiring May 2010, to replace the $600 million, 9-month seasonal revolver, which expired in May 2009.  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 $277.0 million, $739.9 million and $18.0 million of commercial paper borrowings outstanding at June 30, 2009, December 31, 2008 and June 30, 2008, respectively.

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, 2009 increased to 30.9 percent from 25.3 percent in the prior-year period.  The effective income tax rate for the six months ended June 30, 2009 increased to 30.7 percent from 25.3 percent in the prior-year period.  The higher effective income tax rate for the three and six months ended June 30, 2009 is due primarily to higher forecasted annual pretax income (which causes a higher effective income tax rate since permanent differences and tax credits are a smaller share of pretax income).

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 six months ended June 30, 2009, income tax expense has not been provided on approximately $5 million of foreign company shipping earnings that are expected to be indefinitely reinvested offshore compared to approximately $3 million for the three and six months ended June 30, 2008.  As of June 30, 2009, Nicor has not recorded deferred income taxes of approximately $53 million on approximately $151 million of cumulative undistributed foreign earnings that are expected, in management’s judgment, to be indefinitely reinvested offshore.

The company has approximately $6 million of net interest receivable accrued at June 30, 2009 compared with $9 million of interest receivable as of December 31, 2008.  The change is due primarily to the settlement of interest in the first quarter of 2009 related to a state income tax matter.

The balance of unamortized investment tax credits at June 30, 2009, December 31, 2008 and June 30, 2008 was $24.7 million, $26.0 million and $26.4 million, respectively.
 

7.         ACCRUED UNBILLED REVENUES

Receivables include accrued unbilled revenues of $31.9 million, $199.1 million and $58.6 million at June 30, 2009, December 31, 2008 and June 30, 2008, 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 MEASUREMENTS

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 tables below categorize those fair values across the three levels (in millions):
   
Fair value amount
 
   
Quoted prices in active markets
   
Significant observable inputs
   
Significant unobservable inputs
       
   
(Level 1)
   
(Level 2)
   
(Level 3)
   
Total
 
June 30, 2009
 
Assets
 
Money market funds
  $ 100.8     $ -     $ -     $ 100.8  
Derivatives
    29.9       25.5       8.1       63.5  
Total
  $ 130.7     $ 25.5     $ 8.1     $ 164.3  
   
Liabilities
 
Derivatives
  $ 143.0     $ 28.8     $ 2.8     $ 174.6  

December 31, 2008
     
Assets
 
Money market funds
  $ 81.2     $ -     $ -     $ 81.2  
Derivatives
    33.8       21.7       8.5       64.0  
Total
  $ 115.0     $ 21.7     $ 8.5     $ 145.2  
   
Liabilities
 
Derivatives
  $ 161.4     $ 28.0     $ 6.9     $ 196.3  

June 30, 2008
                       
Assets
                       
Money market funds
  $ 290.5     $ -     $ -     $ 290.5  
Derivatives
    158.1       62.9       10.0       231.0  
Total
  $ 448.6     $ 62.9     $ 10.0     $ 521.5  
                                 
Liabilities
 
Derivatives
  $ 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.  For derivatives, Level 1 values include only those 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
 
9
 
may be required to use one or more significant unobservable inputs for a model-derived valuation; the resulting valuation is classified as Level 3.

The net fair value of 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 fair 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 following table presents a reconciliation of the Level 3 beginning and ending net derivative asset balances (in millions):
 
   
Three months ended
June 30
   
Six months ended
June 30
 
   
2009
   
2008
   
2009
   
2008
 
                         
Beginning of period
  $ 15.7     $ 9.3     $ 1.6     $ 8.2  
Net realized/unrealized gains (losses)
                               
Included in regulatory assets and liabilities
    (1.6 )     -       (1.7 )     5.9  
Included in net income
    .9       -       10.3       2.5  
Settlements, net of purchases
    .2       (1.0 )     1.3       (8.2 )
Transfers in and/or out of Level 3
    (9.9 )     (1.4 )     (6.2 )     (1.5 )
End of period
  $ 5.3     $ 6.9     $ 5.3     $ 6.9  
                                 
Net realized/unrealized gains (losses) included in net income relating to derivatives still held at June 30
  $ 2.2     $ -     $ 11.5     $ 2.5  
                                 
Net realized/unrealized gains (losses) included in net income are attributable to Nicor Enerchange and are classified as operating revenues.

Nicor maintains margin accounts related to financial derivative transactions.  The company’s policy is not to offset the fair value of assets and liabilities recognized for derivative instruments or any related margin account.  The following table represents the balances of margin accounts related to derivative instruments (in millions):
 
   
June 30
   
December 31
   
June 30
 
   
2009
   
2008
   
2008
 
Assets
                 
Margin accounts – derivative instruments
  $ 116.8     $ 134.4     $ 17.0  
Other – noncurrent
    17.7       29.3       -  
                         
Liabilities
                       
Other – current
  $ -     $ .1     $ 79.4  

In addition, the recorded amount of restricted short-term investments and short-term borrowings approximates fair value.  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, 2009 was $450 million and at December 31, 2008 and June 30, 2008 was $500 million.  Based on quoted market interest rates, the fair value of the company’s First Mortgage Bonds outstanding was approximately $485 million at June 30, 2009, $520 million at December 31, 2008 and $503 million at June 30, 2008.


9.         DERIVATIVE INSTRUMENTS

A description of the company’s objectives and strategies for using derivative instruments, and related accounting policies, is included in Note 2 – Accounting Policies – Derivative instruments.  All derivatives recognized on the Condensed Consolidated Balance Sheets are measured at fair value, as described in Note 8 – Fair Value Measurements.

Balance sheet.  Derivative assets and liabilities as of June 30, 2009, carried at fair value on the Condensed Consolidated Balance Sheets, are shown in the table below (in millions):

   
Derivatives
designated
as hedging instruments
   
Derivatives
not designated
as hedging
instruments
 
Assets
           
Derivative instruments
  $
.1
    $ 53.2  
Other – noncurrent
   
-
      10.2  
Total
  $ .1     $ 63.4  
                 
Liabilities
               
Derivative instruments
  $ 3.5     $ 148.9  
Other – noncurrent
    .2       22.0  
Total
  $ 3.7     $ 170.9  

Volumes.  As of June 30, 2009, Nicor Gas held outstanding derivative contracts of approximately 71 Bcf to hedge natural gas purchases for customer use, spanning approximately three years.  Commodity price-risk exposure arising from Nicor Enerchange’s activities and Nicor Gas’ natural gas purchases for company use is mitigated with derivative instruments that total to a net short position of 1.6 Bcf as of June 30, 2009.  The above volumes exclude contracts such as variable-priced contracts and basis swaps, which are accounted for as derivatives but are not directly impacted by changes in commodity prices.

Income statement cash flow hedges.  Changes in the fair value of derivatives designated as a cash flow hedge are recognized in other comprehensive income until the hedged transaction is recognized in the income statement.  Cash flow hedges used by the company’s other energy ventures, to hedge utility-bill management products, are eventually recognized within operating revenues.  Cash flow hedges used by Nicor Gas, to hedge purchases of natural gas for company use, are eventually recorded within operating and maintenance expense.  Cash flow hedges affected accumulated other comprehensive income and income as shown in the following tables (in millions):

Three months ended June 30, 2009
 
Pretax gain (loss)
recognized in other comprehensive income
(Effective portion)
 
Location
 
Pretax gain (loss)
reclassified from
accumulated other
comprehensive income
into income
(Effective portion)
   
Pretax gain (loss) recognized in income(Ineffective portion)
 
                 
$
(.2)
 
Operating revenues
  $
(1.7)
    $ -  
                       
 
.1
 
Operating and maintenance
   
(1.2)
      -  
$
(.1)
      $
(2.9)
    $ -  



Six months ended June 30, 2009
 
Pretax gain (loss)
recognized in other
comprehensive income
(Effective portion)
 
Location
 
Pretax gain (loss)
reclassified from
accumulated other
comprehensive income
into income
(Effective portion)
   
Pretax gain (loss) recognized in income
(Ineffective portion)
 
                 
$
(2.8)
 
Operating revenues
  $
(10.0)
    $ .2  
                       
 
(3.8)
 
Operating and maintenance
   
  (5.7)
      -  
$
(6.6)
      $
(15.7)
    $ .2  
                       
As of June 30, 2009, the time horizon of cash flow hedges of natural gas purchases for Nicor Gas company use and for utility-bill management products sold by Nicor’s other energy ventures extends to as long as 17 months.  For these hedges, the total pretax loss deferred in accumulated other comprehensive income at June 30, 2009 was $4.4 million (or $2.6 million after taxes), of which $4.1 million (or $2.5 million after taxes) is expected to be reclassified to earnings within the next 12 months.  

Income statement – derivatives not designated as hedges.  The earnings of the company are subject to volatility for those derivatives not designated as hedges.  Non-designated derivatives used by the company’s other energy ventures, to hedge energy trading activities and utility-bill management products, are recorded in operating revenues.  Non-designated derivatives used by Nicor Gas, to hedge purchases of natural gas for company use, are recorded within operating and maintenance expense.  Pretax earnings effects of these items are summarized in the table below for the periods ended June 30, 2009 (in millions):

   
Net gain (loss) recognized in income
 
Location
 
Three months ended
   
Six months ended
 
             
Operating revenues
  $ (7.9 )   $ (8.7 )
Operating and maintenance
    (.1 )     (1.8 )
    $ (8.0 )   $ (10.5 )

Nicor Gas’ derivatives to hedge the purchase of natural gas for its customers are also not designated as hedging instruments.  Gains or losses on these derivatives are not recognized in pretax earnings, but are deferred as regulatory assets or liabilities until the related revenue is recognized.  Net losses of $8.4 million and $125.5 million were recognized in regulatory assets for the three and six months ended June 30, 2009, respectively.



Credit-risk-related contingent features.  Provisions within certain derivative agreements require the company to post collateral if the company’s net liability position exceeds a specified threshold.  Also, certain derivative agreements contain credit-risk-related contingent features, whereby the company would be required to provide additional collateral or pay the amount due to the counterparty when a credit event occurs, such as if the company’s credit rating was to be lowered.  As of June 30, 2009, for agreements with such features, derivative contracts with liability fair values totaled approximately $25 million, for which the company had posted no collateral to its counterparties.  If it was assumed that the company had to post the maximum contractually specified collateral or settle the liability, the company would have been required to pay approximately $22 million.

Concentrations of credit risk.  In instances in which the company holds an uncollateralized net asset per an over-the-counter derivative contract, there is potential credit risk in the event the counterparty defaults on a settlement or fails to perform under the agreed-upon terms.  To manage this credit risk, the company maintains prudent credit policies to determine and monitor the creditworthiness of counterparties, seeks guarantees or collateral, in the form of cash or letters of credit, acquires credit insurance in certain instances and limits its exposure to any one counterparty.  The company also, in some instances, enters into netting arrangements to mitigate counterparty credit risk.

10.
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 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 a limit 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.  As a regulated utility, Nicor Gas expects continued rate recovery of the eligible costs of its defined benefit postretirement plans and, accordingly, associated changes in the plan’s funded status have been deferred as a regulatory asset or liability until recognized in income, instead of being recorded in accumulated other comprehensive income.  However, to the extent Nicor Gas employees 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 and the changes in the funded status relating to these employees are recorded in accumulated other comprehensive income.

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
 
   
2009
   
2008
   
2009
   
2008
 
Three months ended June 30
                       
Service cost
  $ 2.1     $ 2.2     $ .5     $ .5  
Interest cost
    4.1       3.9       3.0       3.0  
Expected return on plan assets
    (6.3 )     (10.0 )     -       -  
Recognized net actuarial loss
    3.9       -       1.2       1.1  
Amortization of prior service cost
    .1       .1       -       -  
Net periodic benefit cost (credit)
  $ 3.9     $ (3.8 )   $ 4.7     $ 4.6  
                                 
 
13
 
 
 
 
Pension benefits
   
Health care and
other benefits
 
   
2009
   
2008
   
2009
   
2008
 
Six months ended June 30
                       
Service cost
  $ 4.3     $ 4.3     $ 1.1     $ 1.0  
Interest cost
    8.2       7.9       6.0       6.0  
Expected return on plan assets
    (12.6 )     (20.0 )     -       -  
Recognized net actuarial loss
    7.7       -       2.3       2.3  
Amortization of prior service cost
    .2       .2       -       -  
Net periodic benefit cost (credit)
  $ 7.8     $ (7.6 )   $ 9.4     $ 9.3  
                                 
Due to the significant decline in the fair value of the pension plan’s assets during 2008, the expected return on plan assets has decreased in 2009 as compared to 2008.  Also, the fair value decline in 2008 has created an actuarial loss that is being amortized over the average remaining service lives of employees covered by the plan.

11.
EQUITY INVESTMENT INCOME, NET

On March 31, 2009, the company sold its 50-percent interest in EN Engineering.  The company’s share of the sale price is $16.0 million, with an additional $1.5 million which is contingent on EN Engineering’s 2010 performance and would be due in 2011.  After closing costs and other adjustments, Nicor received cash of $13.0 million and recorded a gain on the sale of $10.1 million.  Equity investment income also includes investment income from Triton of $1.3 million and $2.5 million for the three and six months ended June 30, 2009, respectively, and $2.2 million and $3.2 million, for the same periods ended June 30, 2008, respectively.  Nicor received cash distributions from equity investees for the three and six months ended June 30, 2009 of $3.7 million and $6.5 million, respectively, and $4.0 million and $7.3 million, respectively for the same periods ended June 30, 2008.

12.      COMPREHENSIVE INCOME

Total comprehensive income is as follows (in millions):

   
Three months ended
   
Six months ended
 
   
June 30
   
June 30
 
   
2009
   
2008
   
2009
   
2008
 
                         
Net income
  $ 22.9     $ 28.9     $ 66.7     $ 70.3  
Other comprehensive income, after tax
    1.8       4.0       5.8       9.2  
Total comprehensive income
  $ 24.7     $ 32.9     $ 72.5     $ 79.5  
 
Other comprehensive income 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.
 

13.         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, 2009
                         
Operating revenues
                             
External customers
  $ 318.4     $ 83.8     $ 45.4     $ -     $ 447.6  
Intersegment
    7.9       -       5.8       (13.7 )     -  
    $ 326.3     $ 83.8     $ 51.2     $ (13.7 )   $ 447.6  
                                         
Operating income (loss)
  $ 25.1     $ 2.5     $ 12.7     $ (.8 )   $ 39.5  
                                         
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