nicorincform10q033110.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 March 31, 2010
 
or

[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
Commission File Number 1-7297
 
NICOR INC. LOGO
NICOR INC.
(Exact name of registrant as specified in its charter)

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

1844 Ferry Road
 
Naperville, Illinois 60563-9600
(630) 305-9500
(Address of principal executive offices) (Zip Code)
(Registrant’s telephone number, including area code)
 
        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 April 26, 2010, were 45,271,489 shares.
 




 

 
 
Table of Contents

 
ii
       
Part I - Financial Information
 
       
 
Item 1.
Financial Statements (Unaudited)
 
       
   
1
     
   
2
       
   
3
       
   
4
       
 
Item 2.
22
       
 
Item 3.
33
       
 
Item 4.
34
       
Part II - Other Information
 
       
 
Item 1.
34
       
 
Item 2.
34
       
 
Item 6.
35
       
   
36
 

i
 


 
Glossary

ALJs.  Administrative Law Judges.

ARO.  Asset retirement obligation.

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

Degree day.  The extent to which the daily average temperature falls below 65 degrees Fahrenheit.  Normal weather for Nicor Gas’ service territory, for purposes of this report, is considered to be 5,600 degree days.
 
EN Engineering.  EN Engineering, L.L.C., a previously owned joint venture that provides engineering and consulting services.  Nicor sold its ownership on March 31, 2009.

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

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

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

IDR.  Illinois Department of Revenue.

IRS.  Internal Revenue Service.

Jobs Act.  American Jobs Creation Act of 2004.

LIBOR.  London Inter-bank Offered Rate.

LIFO.  Last-in, first-out.

Mcf, MMcf, Bcf.  Thousand cubic feet, million cubic feet, billion cubic feet.

Nicor.  Nicor Inc., or the registrant.

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

Nicor Enerchange.  Nicor Enerchange, L.L.C., a wholly owned business that engages in wholesale marketing of natural gas supply services primarily in the Midwest, administers the Chicago Hub for Nicor Gas, serves commercial and industrial customers in the 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.
 

ii
 

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

Nicor Solutions.  Nicor Solutions, L.L.C., a wholly owned business that offers residential and small commercial customers energy-related products that provide for natural gas cost stability and management of their utility bill.
 
NYMEX.  New York Mercantile Exchange.
 
PBR.  Performance-based rate, a regulatory plan which ended on January 1, 2003, that provided economic incentives based on natural gas cost performance.

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

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

SEC.  The United States Securities and Exchange Commission.

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

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

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

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

U.S.  United States of America.

 
iii
 



Part I - FINANCIAL INFORMATION
         
           
Item 1.   Financial Statements
         
           
Nicor Inc.
         
         
(millions, except per share data)
         
 
Three months ended
 
 
March 31
 
 
2010
   
2009
 
Operating revenues
         
Gas distribution (includes revenue taxes of $73.9 and $74.7, respectively)
$ 1,068.8     $ 984.0  
Shipping
  83.5       89.4  
Other energy ventures
  65.7       77.1  
Corporate and eliminations
  (25.1 )     (39.7 )
Total operating revenues
  1,192.9       1,110.8  
               
Operating expenses
             
Gas distribution
             
Cost of gas
  787.9       716.4  
Operating and maintenance
  63.8       90.6  
Depreciation
  46.0       44.4  
Taxes, other than income taxes
  77.9       78.8  
Shipping
  84.0       82.8  
Other energy ventures
  61.3       74.5  
Other corporate expenses and eliminations
  (24.0 )     (36.6 )
Total operating expenses
  1,096.9       1,050.9  
               
Operating income
  96.0       59.9  
Interest expense, net of amounts capitalized
  9.0       9.3  
Equity investment income, net
  1.5       11.7  
Interest income
  .2       .6  
Other income, net
  .2       .2  
               
Income before income taxes
  88.9       63.1  
Income tax expense, net of benefits
  28.4       19.3  
               
Net income
$ 60.5     $ 43.8  
               
Average shares of common stock outstanding
             
Basic
  45.4       45.4  
Diluted
  45.6       45.4  
               
Earnings per average share of common stock
             
Basic
$ 1.33     $ .97  
Diluted
  1.33       .96  
               
Dividends declared per share of common stock
$ .465     $ .465  
               
The accompanying notes are an integral part of these statements.
             
 
 
 



Nicor Inc.
           
           
(millions)
           
             
   
Three months ended
 
   
March 31
 
   
2010
   
2009
 
             
Operating activities
           
Net income
  $ 60.5     $ 43.8  
Adjustments to reconcile net income to net cash flow provided from operating activities:
               
Depreciation
    50.6       49.0  
Deferred income tax expense (benefit)
    (4.2 )     3.2  
Gain on sale of equity investment
    -       (10.1 )
Changes in assets and liabilities:
               
Receivables, less allowances
    (44.1 )     99.3  
Gas in storage
    113.5       188.1  
Deferred/accrued gas costs
    36.6       (.5 )
Derivative instruments
    72.4       63.6  
Margin accounts - derivative instruments
    (48.1 )     (73.4 )
Other assets
    8.7       17.1  
Accounts payable
    (117.3 )     (151.9 )
Customer credit balances and deposits
    (57.8 )     (58.8 )
Temporary LIFO inventory liquidation
    229.9       197.1  
Other liabilities
    24.7       (1.2 )
Other items
    (1.1 )     6.8  
Net cash flow provided from operating activities
    324.3       372.1  
                 
Investing activities
               
Additions to property, plant & equipment
    (42.4 )     (51.2 )
Proceeds from maturities of held-to-maturity securities
    .5       .6  
Net decrease in other short-term investments
    6.6       1.7  
Proceeds from sale of equity investment
    -       13.0  
Net cash flow used for investing activities
    (35.3 )     (35.9 )
                 
Financing activities
               
Repayments of long-term debt
    -       (50.0 )
Net repayments of commercial paper
    (266.0 )     (255.9 )
Dividends paid
    (21.2 )     (21.1 )
Borrowing against cash surrender value of life insurance policies
    -       3.4  
Other financing activities
    .4       -  
Net cash flow used for financing activities
    (286.8 )     (323.6 )
                 
Net increase in cash and cash equivalents
    2.2       12.6  
                 
Cash and cash equivalents, beginning of period
    55.7       26.0  
                 
Cash and cash equivalents, end of period
  $ 57.9     $ 38.6  
                 
The accompanying notes are an integral part of these statements.
               
 
 
 



Nicor Inc.
                 
                 
(millions)
                 
   
March 31
   
December 31
   
March 31
 
   
2010
   
2009
   
2009
 
Assets
                 
Current assets
                 
Cash and cash equivalents
  $ 57.9     $ 55.7     $ 38.6  
Short-term investments
    70.9       78.0       67.8  
Receivables, less allowances of $52.0, $33.0 and $52.8, respectively
    536.2       492.1       590.8  
Gas in storage
    23.7       137.2       20.4  
Derivative instruments
    54.3       30.9       61.2  
Margin accounts - derivative instruments
    81.4       46.1       191.4  
Other
    122.3         163.3       128.1  
Total current assets
    946.7       1,003.3       1,098.3  
                         
Property, plant and equipment, at cost
                       
Gas distribution
    4,614.9       4,598.2       4,488.6  
Shipping
    335.1       330.0       322.9  
Other
    38.8       32.8       27.5  
      4,988.8       4,961.0       4,839.0  
Less accumulated depreciation
    2,046.4       2,021.9       1,969.5  
Total property, plant and equipment, net
    2,942.4       2,939.1       2,869.5  
                         
Long-term investments
    130.5       128.8       130.2  
Other assets
    399.2       364.5       479.0  
                         
Total assets
  $ 4,418.8     $ 4,435.7     $ 4,577.0  
                         
Liabilities and Capitalization
                       
Current liabilities
                       
Long-term debt due within one year
  $ 75.0     $ -     $ -  
Short-term debt
    228.0       494.0       484.0  
Accounts payable
    236.6       353.9       259.4  
Customer credit balances and deposits
    83.9       141.7       128.5  
Temporary LIFO inventory liquidation
    229.9       -       197.1  
Derivative instruments
    151.2       72.3       219.1  
Other
    154.7       106.2       114.4  
Total current liabilities
    1,159.3       1,168.1       1,402.5  
                         
Deferred credits and other liabilities
                       
Regulatory asset retirement liability
    815.2       796.8       763.2  
Deferred income taxes
    415.9       409.9       399.8  
Health care and other postretirement benefits
    200.0       199.7       197.0  
Asset retirement obligation
    184.1       191.6       186.9  
Other
    143.1       133.6       177.3  
Total deferred credits and other liabilities
    1,758.3       1,731.6       1,724.2  
                         
Commitments and contingencies
                       
                         
Capitalization
                       
Long-term obligations
                       
Long-term debt, net of unamortized discount
    423.3       498.2       448.1  
Mandatorily redeemable preferred stock
    .1       .1       .6  
Total long-term obligations
    423.4       498.3       448.7  
                         
Common equity
                       
Common stock
    113.2       113.1       113.0  
Paid-in capital
    56.7       54.6       51.4  
Retained earnings
    920.3       881.0       852.9  
Accumulated other comprehensive loss, net
    (12.4 )     (11.0 )     (15.7 )
Total common equity
    1,077.8       1,037.7       1,001.6  
                         
Total capitalization
    1,501.2       1,536.0       1,450.3  
                         
Total liabilities and capitalization
  $ 4,418.8     $ 4,435.7     $ 4,577.0  
                         
The accompanying notes are an integral part of these statements.
                       
 
 
 


 
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 2009 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 the date the financial statements were issued.

2.
ACCOUNTING POLICIES

Gas in storage.  Nicor Gas’ 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 March 31, 2010 is expected to be restored prior to year-end.

Nicor Enerchange’s 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 the first quarter of 2010 and 2009, Nicor Enerchange recorded charges of $5.0 million and $2.8 million, respectively, 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 is required to recognize the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities.  Regulatory assets represent probable future revenue associated with certain costs that are expected to be recovered from customers through rate riders or base rates, upon approval by the ICC.  Regulatory liabilities represent probable future reductions in revenues collected from ratepayers through a rate rider or base rates, or probable future expenditures.  If Nicor Gas’ operations become no longer subject to rate regulation, a write-off of net regulatory liabilities would be required.



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

   
March 31
   
December 31
   
March 31
 
   
2010
   
2009
   
2009
 
Regulatory assets - current
                 
Regulatory postretirement asset
  $ 20.6     $ 20.6     $ 23.3  
Deferred gas costs
    -       24.9       15.4  
Deferred bad debt costs
    28.3       -       -  
Other
    6.9       5.4       1.4  
Regulatory assets - noncurrent
                       
Regulatory postretirement asset
    191.5       195.4       227.5  
Deferred gas costs
    20.6       4.4       39.1  
Deferred environmental costs
    19.9       18.1       15.0  
Unamortized losses on reacquired debt
    14.0       14.2       15.1  
Other
    13.3       8.9       13.3  
    $ 315.1     $ 291.9     $ 350.1  

Regulatory liabilities - current
                 
Regulatory asset retirement liability
  $ 14.5     $ 14.5     $ 15.0  
Accrued gas costs
    27.9       -       -  
Other
    8.2       2.7       -  
Regulatory liabilities - noncurrent
                       
Regulatory asset retirement liability
    815.2       796.8       763.2  
Regulatory income tax liability
    21.2       39.1       45.5  
Other
    3.8       .8       .8  
    $ 890.8     $ 853.9     $ 824.5  

All items listed above are classified in Other on the Condensed Consolidated Balance Sheets, with the exception of the noncurrent portion of the Regulatory asset retirement liability, which is stated separately.

The ICC does not presently allow Nicor Gas the opportunity to earn a return on its regulatory postretirement asset.  This regulatory postretirement asset is expected to be recovered from ratepayers over a period of approximately 10 to 12 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 recognition.  Nicor Gas accrues revenues for estimated deliveries to customers from the date of their last bill until the balance sheet date.  Receivables include accrued unbilled revenues of $102.8 million, $141.0 million and $89.7 million at March 31, 2010, December 31, 2009 and March 31, 2009, respectively, related primarily to gas distribution operations.

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 months ended March 31, 2010 and 2009 were $72.9 million and $73.6 million, respectively.

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 Condensed Consolidated Statement of Operations, 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 operating income.

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.

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 the current period 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 of loss deferred at settlement in accumulated other comprehensive income is being amortized to interest expense on a straight-line basis over the remaining life of the bonds.

In March 2010, Nicor entered into a forward-starting interest rate swap to hedge the risk associated with the interest payments attributable to the probable issuance of long-term fixed-rate debt in 2012 to finance the development of a natural gas storage facility.  Under the terms of the swap, Nicor agrees to pay a fixed swap rate and receive a floating rate based on LIBOR.  The swap is accounted for as a cash flow hedge, therefore, any changes in the fair value of the swap that are deferred in accumulated other comprehensive income will subsequently be amortized over the term of the fixed-rate debt as an adjustment to interest expense.



 
Credit risk and concentrations.  Nicor’s major subsidiaries have diversified customer bases and the company believes that it maintains prudent credit policies which mitigate customer receivable, supplier performance and derivative counterparty credit risk.  The company is exposed to credit risk in the event a customer or supplier defaults on a contract to pay for or deliver product at agreed-upon terms and conditions, or a counterparty to a derivative instrument defaults on a settlement or otherwise fails to perform under contractual terms.  To manage this risk, the company has established procedures to determine and monitor the creditworthiness of counterparties, to seek guarantees or collateral back-up in the form of cash or letters of credit, to acquire credit insurance in certain instances, and to limit its exposure to any one counterparty.  Nicor also, in some instances, enters into netting arrangements to mitigate counterparty credit risk.  Credit losses are accrued when probable and reasonably estimable.

On February 2, 2010, the ICC approved a bad debt rider that was filed in 2009 by Nicor Gas.  The bad debt rider provides for the recovery from (or refund to) customers of the difference between the actual bad debt expense Nicor Gas incurs on an annual basis and the benchmark bad debt expense included in its rates for the respective year.

3.         INVESTMENTS

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

   
March 31
   
December 31
   
March 31
 
   
2010
   
2009
   
2009
 
                   
Money market funds
  $ 111.8     $ 121.1     $ 90.2  
Corporate bonds
    .8       1.3       4.3  
Other investments
    5.0       4.8       3.2  
    $ 117.6     $ 127.2     $ 97.7  

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

   
March 31
   
December 31
   
March 31
 
   
2010
   
2009
   
2009
 
                   
Cash equivalents
  $ 41.2     $ 43.8     $ 26.0  
Short-term investments
    70.9       78.0       67.8  
Long-term investments
    5.5       5.4       3.9  
    $ 117.6     $ 127.2     $ 97.7  

Investments categorized as trading (including money market funds) totaled $113.8 million, $122.7 million and $91.5 million at March 31, 2010, December 31, 2009 and March 31, 2009, respectively.  Corporate bonds are categorized as held-to-maturity.  The contractual maturities of the held-to-maturity corporate bonds at March 31, 2010 are as follows (in millions):

Years to maturity
Less than
1 year
   
1-5
Years
   
Total
 
               
$ .2     $ .6     $ .8  



 
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 $3.0 million, $3.1 million and $1.9 million at March 31, 2010, December 31, 2009 and March 31, 2009, respectively.

There were no gains or losses on the sale of investments for the periods ended March 31, 2010 and 2009, respectively.

4.
SHORT-TERM AND LONG-TERM DEBT

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

In April 2010, Nicor Gas established a $400 million, 364-day revolver, expiring April 2011 to replace the $550 million, 364-day revolver, which was set to expire in May 2010 and Nicor and Nicor Gas established a $600 million, three-year revolver, expiring April 2013 to replace the $600 million, five-year revolver, which was set to expire in September 2010.  These facilities were established with major domestic and foreign banks and serve as backup for the issuance of commercial paper.  The company had $228 million, $494 million and $484 million of commercial paper borrowings outstanding at March 31, 2010, December 31, 2009 and March 31, 2009, respectively.

In March 2010, Nicor entered into a $50 million notional forward-starting interest rate swap to hedge the risk associated with the interest payments attributable to the probable issuance of long-term fixed-rate debt in 2012 to finance the development of a natural gas storage facility.  Under the terms of the swap, Nicor agrees to pay a fixed swap rate and receive a floating rate based on LIBOR.

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

5.         INCOME TAXES

The effective income tax rate for the three months ended March 31, 2010 increased to 32.0 percent from 30.6 percent in the prior-year period.  The higher effective income tax rate for the three months ended March 31, 2010 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), lower forecasted annual undistributed foreign earnings and the unfavorable impact of the tax law change with respect to Medicare Part D subsidies.  Partially offsetting these factors were favorable tax reserve adjustments recognized in the first quarter of 2010.

In March 2010, the Health Care Act was signed into law resulting in comprehensive health care reform legislation.  The Health Care Act contains a provision that eliminates the tax deduction related to Medicare Part D subsidies received after 2012.  Federal subsidies are provided to sponsors of retiree health benefit plans, such as Nicor Gas, that provide a benefit that is at least actuarially equivalent to the benefits under Medicare Part D.  Such subsidies have reduced the company’s actuarially determined projected benefit obligation and annual net periodic benefit costs.  Due to the change in taxation, in the first quarter of 2010 Nicor Gas reduced deferred tax assets by $17.5 million, reversed an existing regulatory income tax liability of $10.0 million, established a regulatory income tax asset of $7.0 million and recognized a $0.5 million charge to income tax expense.  Beginning in 2010, the change in taxation will also reduce earnings by an estimated $1.5 million annually for periods subsequent to the enactment date.



 
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 months ended March 31, 2010 and 2009, income tax expense (benefit) has not been provided on approximately ($3) million and $5 million, respectively, of foreign company shipping earnings (loss).  As of March 31, 2010, Nicor has not recorded deferred income taxes of approximately $57 million on approximately $162 million of cumulative undistributed foreign earnings.

The company's major tax jurisdictions include the United States and Illinois, with tax returns examined by the IRS and IDR, respectively.  At March 31, 2010, the years that remain subject to examination include years beginning after 2006 for the IRS and years beginning after 2005 for the IDR.  The company’s liability for unrecognized tax benefits was $4.4 million at March 31, 2010 of which about $3 million, if recognized, would impact the company’s effective income tax rate.  The decrease in the liability for unrecognized tax benefits from $9.6 million at December 31, 2009 is due primarily to the settlement of an item concerning the timing of inclusion in taxable income of recoveries for environmental clean-up expenditures, lapses of statute of limitations and other tax reserve adjustments.  The company believes that it is reasonably possible that a change in the liability for unrecognized tax benefits could occur within 12 months, potentially decreasing it by $4 million.

The balance of unamortized investment tax credits at March 31, 2010, December 31, 2009 and March 31, 2009 was $24.7 million, $25.2 million and $25.4 million, respectively.



 
6.         FAIR VALUE MEASUREMENTS

The fair value of assets and liabilities that are measured on a recurring basis are categorized in the table below (in millions) into three broad levels (with Level 1 considered the most reliable) based upon the valuation inputs.
   
Quoted prices in active markets
   
Significant observable inputs
   
Significant unobservable inputs
       
   
(Level 1)
   
(Level 2)
   
(Level 3)
   
Total
 
March 31, 2010
                       
Assets
                       
Money market funds
  $ 111.8     $ -     $ -     $ 111.8  
Commodity derivatives
    26.4       38.0       4.8       69.2  
    $ 138.2     $ 38.0     $ 4.8     $ 181.0  
                                 
Liabilities
                               
Commodity derivatives
  $ 101.2     $ 75.1     $ 12.4     $ 188.7  
                                 
 December 31, 2009                                
 Assets                                
    Money market funds   $ 121.1     $         121.1   
    Commodity derivatives     14.6       16.8        8.8        40.2   
    $ 135.7     $ 16.8      8.8      161.3  
                                 
 Liabilities                                
    Commodity derivatives   $ 54.2     $ 29.3      $ 3.8      $ 87.3  
                                 
 March 31, 2009                                
 Assets                                
    Money market funds   90.2              90.2   
    Commodity derivatives     35.1        20.4        17.0        72.5   
    125.3      20.4      17.0      162.7  
 Liabilities                                
    Commodity derivatives   225.1      42.0      1.3      268.4  
 
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; the fair value of these over-the-counter items consider credit risk and are classified within Level 2.  In certain instances, the company may be required to determine a fair value using significant unobservable inputs such as indicative broker prices; 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 (liability) balances for the three months ended March 31 (in millions):

   
2010
   
2009
 
             
Beginning of period
  $ 5.0     $ 1.6  
Net realized/unrealized gains (losses)
               
Included in regulatory assets and liabilities
    (1.3 )     (.1 )
Included in net income
    (6.3 )     9.4  
Settlements, net of issuances
    .8       1.1  
Transfers into Level 3
    -       4.2  
Transfers out of Level 3
    (5.8 )     (.5 )
End of period
  $ (7.6 )   $ 15.7  
                 
Net realized/unrealized gains (losses) included in net income are attributable to Nicor Enerchange and are classified as operating revenues.  At March 31, 2010, net unrealized gains (losses) included in net income relating to derivatives still held were ($9.6) million.

Transfers into and out of Level 3 reflect the liquidity at the relevant natural gas trading locations which affects the significance of unobservable inputs used in the valuation.  In 2010, in accordance with new accounting guidance, the company elected to determine both transfers in and out of Level 3 using values at the end of the interim period in which the transfer occurred.  In 2009, transfers into Level 3 were determined using beginning of period values and transfers out of Level 3 were determined using end of period values.

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):

   
March 31
   
December 31
   
March 31
 
   
2010
   
2009
   
2009
 
Assets
                 
Margin accounts – derivative instruments
  $ 81.4     $ 46.1     $ 191.4  
Other – noncurrent
    26.6       13.8       45.7  
                         
In addition, the recorded amount of restricted short and long-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 March 31, 2010, December 31, 2009 and March 31, 2009 was $500 million, $500 million and $450 million, respectively.  Based on quoted prices or market interest rates, the fair value of the company’s First Mortgage Bonds outstanding was approximately $530 million at March 31, 2010, $543 million at December 31, 2009 and $453 million at March 31, 2009.
 
 
 
 
7.      
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 and Credit risk and concentrations.  All derivatives recognized on the Condensed Consolidated Balance Sheets are measured at fair value, as described in Note 6 – Fair Value Measurements.

Condensed Consolidated Balance Sheets.  Derivative assets and liabilities are shown in the table below (in millions):

   
March 31
   
December 31
   
March 31
 
   
2010
   
2009
   
2009
 
Derivatives designated as hedging instruments
                 
Assets
                 
Derivative instruments
  $ -     $ .3     $ -  
                         
Liabilities
                       
Derivative instruments
  $ 2.8     $ 1.0     $ 6.1  
Other – noncurrent
    .2       -       .5  
    $ 3.0     $ 1.0     $ 6.6  
                         
Derivatives not designated as hedging instruments
                       
Assets
                       
Derivative instruments
  $ 54.3     $ 30.6     $ 61.2  
Other – noncurrent
    14.9       9.3       11.3  
    $ 69.2     $ 39.9     $ 72.5  
                         
Liabilities
                       
Derivative instruments
  $ 148.4     $ 71.3     $ 213.0  
Other – noncurrent
    37.3       15.0       48.8  
    $ 185.7     $ 86.3     $ 261.8  

Volumes.  As of March 31, 2010, December 31, 2009 and March 31, 2009, Nicor Gas held outstanding derivative contracts of approximately 67 Bcf, 64 Bcf and 75 Bcf, respectively to hedge natural gas purchases for customer use, with hedges spanning approximately three years for each of the respective periods.  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 long position of 0.6 Bcf, net short position of 1.3 Bcf and net long position of 0.4 Bcf as of March 31, 2010, December 31, 2009 and March 31, 2009, respectively.  The above volumes exclude contracts such as variable-priced contracts and basis swaps, which are accounted for as derivatives but whose fair values are not directly impacted by changes in commodity prices.

In March 2010, Nicor entered into a $50 million notional forward-starting interest rate swap to hedge the risk associated with the interest payments attributable to the probable issuance of long-term fixed-rate debt in 2012 to finance the development of a natural gas storage facility.  Under the terms of the swap, Nicor agrees to pay a fixed swap rate and receive a floating rate based on LIBOR.  At March 31, 2010, the fair value of the swap agreement was immaterial.



 
Condensed Consolidated Statements of Operations - 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 Condensed Consolidated Statements of Operations.  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 as shown in the following table (in millions):
 
   
Three months ended
March 31
 
   
2010
   
2009
 
                 
Pretax gain (loss) recognized in other comprehensive income (effective portion)
  $ (3.0 )   $ (6.5 )

The pretax gain (loss) reclassified from accumulated other comprehensive income into income (effective portion) is shown in the following table (in millions):

   
Three months ended
March 31
 
Location
 
2010
   
2009
 
             
Operating revenues
  $ (.4 )   $ (8.3 )
Operating and maintenance
    (.3 )     (4.5 )
    $ (.7 )   $ (12.8 )

As of March 31, 2010, December 31, 2009 and March 31, 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 span approximately two years for each of the respective periods.  For these hedges, the total pretax loss deferred in accumulated other comprehensive income at March 31, 2010, December 31, 2009 and March 31, 2009 was $3.1 million ($1.9 million after taxes), $0.9 million ($0.5 million after taxes) and $7.1 million ($4.3 million after taxes), respectively.  At the respective reporting dates, substantially all of these amounts were expected to be reclassified to earnings within the next 12 months.

Condensed Consolidated Statements of Operations - 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 net gain (loss) recognized in income are summarized in the table below (in millions):

   
Three months ended
March 31
 
Location
 
2010
   
2009
 
             
Operating revenues
  $ (1.0 )   $ (.8 )
Operating and maintenance
    (.9 )     (1.7 )
    $ (1.9 )   $ (2.5 )


 

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 $90.3 million and $117.1 million were recognized in regulatory assets for the three months ended March 31, 2010 and 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 March 31, 2010, December 31, 2009 and March 31, 2009 for agreements with such features, derivative contracts with liability fair values totaled approximately $43 million, $20 million and $38 million, respectively, 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 $42 million, $19 million and $37 million at March 31, 2010, December 31, 2009 and March 31, 2009, respectively.

8.
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 the highest average salary for management employees and job level for collectively bargained employees (referred to as pension bands).  The benefit obligation related to collectively bargained benefits considers the company’s past practice of regular benefit increases.  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 net 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 benefit cost 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 benefit cost included the following components (in millions):

   
Pension benefits
   
Health care and other benefits
 
   
2010
   
2009
   
2010
   
2009
 
Three months ended March 31
                       
Service cost
  $ 2.4     $ 2.2     $ .6     $ .6  
Interest cost
    4.0       4.1       3.0       3.0  
Expected return on plan assets
    (7.2 )     (6.3 )     -       -  
Recognized net actuarial loss
    3.0       3.8       1.0       1.1  
Amortization of prior service cost
    .1       .1       -       -  
Net benefit cost
  $ 2.3     $ 3.9     $ 4.6     $ 4.7  



 
The decrease in postretirement benefit expense in 2010 compared to 2009 is due to the positive impact on the value of plan assets of the partial capital market recovery in 2009, which was somewhat offset by the negative impact of a decrease in the discount rate.

The company is evaluating the provisions of the Health Care Act and will evaluate future interpretations to determine the impact it may have on the company’s future results of operations, cash flows and financial condition.

9.
EQUITY INVESTMENT INCOME, NET

Equity investment income includes investment income from Triton of $1.4 million and $1.2 million for the three months ended March 31, 2010 and 2009, respectively.  Nicor received cash distributions from equity investees for the three months ended March 31, 2010 and 2009 of $2.5 million and $2.8 million, respectively.  On March 31, 2009, the company sold its 50-percent interest in EN Engineering.  The company’s share of the sale price was $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.

10.
COMPREHENSIVE INCOME

Total comprehensive income is as follows (in millions):
   
Three months ended
 
   
March 31
 
   
2010
   
2009
 
             
Net income
  $ 60.5     $ 43.8  
Other comprehensive income (loss), after tax
    (1.4 )     4.0  
Total comprehensive income
  $ 59.1     $ 47.8  
 
Other comprehensive income (loss) consists primarily of net unrealized gains and losses from derivative financial instruments accounted for as cash flow hedges.

11.         BUSINESS SEGMENT INFORMATION

Financial data by reportable segment is as follows (in millions):
 
 
 

Nicor Inc.
           
Business Segments - Financial Data
           
   
Three months ended
 
   
March 31
 
   
2010
   
2009
 
Gas distribution
           
Operating revenues
           
External customers
  $ 1,050.0     $ 964.8  
Intersegment
    18.8       19.2  
    $ 1,068.8     $ 984.0  
                 
Operating income
  $ 93.2     $ 53.8  
                 
Shipping
               
Operating revenues
               
External customers
  $ 83.5     $ 89.4  
Intersegment
    -       -  
    $ 83.5     $ 89.4  
                 
Operating income (loss)
  $ (0.5 )   $ 6.6  
                 
Other Energy Ventures
               
Wholesale marketing
               
Operating revenues
               
External customers
  $ 5.6     $ (2.3 )
Intersegment
    5.7       20.0  
    $ 11.3     $ 17.7  
                 
Operating income
  $ 4.7     $ 9.7  
                 
Other
               
Operating revenues
               
External customers
  $ 53.8     $ 58.9  
Intersegment
    0.6       0.5  
    $ 54.4     $ 59.4  
                 
Operating loss
  $ (0.3 )   $ (7.1 )
                 
Corporate and eliminations
               
Operating revenues
               
External customers
  $ -     $ -  
Intersegment
    (25.1 )     (39.7 )
    $ (25.1 )   $ (39.7 )
                 
Operating loss
  $ (1.1 )   $ (3.1 )
                 
Consolidated
               
Operating revenues
               
External customers
  $ 1,192.9     $ 1,110.8  
Intersegment
    -       -  
    $ 1,192.9     $ 1,110.8  
                 
Operating income
  $ 96.0     $ 59.9  
 
 

 
Intersegment revenues include gas distribution revenues related to customers entering into utility-bill management contracts with Nicor Solutions and wholesale marketing revenues from the sale of natural gas to Nicor Advanced Energy.  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.  Nicor Advanced Energy provides natural gas and related services on an unregulated basis to residential and small commercial customers and purchases most of its natural gas supplies from Nicor Enerchange.  Intersegment revenues are eliminated in the Condensed Consolidated Financial Statements.

Costs associated with Nicor’s other energy ventures’ utility-bill management contracts attributable to colder than normal weather for the three months ended March 31, 2010 and 2009 were $1.3 million and $2.6 million, respectively.  This cost is recorded primarily at the corporate level as a result of an agreement between the parent company and certain of its subsidiaries.  The weather impact of these contracts generally serves to partially offset the gas distribution segment’s weather risk.

12.         REGULATORY PROCEEDINGS

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

On April 24, 2009, Nicor Gas filed a request for rehearing with the ICC concerning the capital structure contained in the ICC’s rate order contending the company’s return on rate base should be higher.  On May 13, 2009, the ICC agreed to conduct a rehearing.  On October 7, 2009, the ICC issued its decision on rehearing in which it increased the annual base revenues approved for Nicor Gas in the March 25, 2009 order by approximately $11 million, increasing the rate of return on rate base to 8.09 percent.  Nicor Gas placed the rates approved in the rehearing decision into effect on a prospective basis on October 15, 2009.  Therefore, the total annual base revenue increase authorized in the rate case originally filed by the company in April 2008 is approximately $80 million.

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

As a result of the February 2010 order, Nicor Gas recorded in the first quarter of 2010 a net recovery related to 2008 and 2009 of $31.7 million; substantially all of this amount is expected to be collected in 2010.  The benchmark, against which 2010 actual bad debt expense will be compared, is approximately $63 million.

Petition for Re-approval of Operating Agreement.  On July 1, 2009, Nicor Gas filed a petition seeking re-approval from the ICC of the operating agreement that governs many inter-company transactions between Nicor Gas and its affiliates.  The petition was filed pursuant to a requirement contained in the ICC order approving the company’s most recent general rate increase and requested that the operating agreement be re-approved without change.  A number of parties have intervened in the proceeding and are seeking modifications to the operating agreement to restrict or prohibit certain services Nicor Gas and its affiliates currently are permitted to provide to one another.  Nicor Gas does not believe these proposed modifications are appropriate and intends to oppose them.  If certain of the proposed modifications to the operating agreement are required by the ICC, they could adversely impact the company’s results of operations, cash flows and financial condition.


 

13.
GUARANTEES AND INDEMNITIES

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

Financial guarantees.  TEL has an obligation 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 obligation continues for the life of the Triton partnerships and any payment is effectively limited to the assets of TEL, which were approximately $7 million at March 31, 2010.  Nicor believes the likelihood of any such payment by TEL is remote.  No liability has been recorded for this obligation.

Performance guarantees.  Nicor Services markets 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 $2.4 million and $1.9 million were incurred in the three months ended March 31, 2010 and 2009, respectively.

Indemnities.  In certain instances, Nicor has undertaken to indemnify current property owners and others against costs associated with the effects and/or remediation of contaminated sites for which the company may be responsible under applicable federal or state environmental laws, generally with no limitation as to the amount.  These indemnifications relate primarily to ongoing coal tar cleanup, as discussed in 14 – Contingencies – Manufactured Gas Plant Sites.  Nicor believes that the likelihood of payment under its other environmental indemnifications is remote.  No liability has been recorded for such indemnifications.

Nicor has also indemnified, to the fullest extent permitted under the laws of the State of Illinois and any other applicable laws, its present and former directors, officers and employees against expenses they may incur in connection with litigation they are a party to by reason of their association with the company.  There is generally no limitation as to the amount.  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.
 
14.     CONTINGENCIES

The following contingencies of Nicor are in various stages of investigation or disposition.  Although in some cases the company is unable to estimate the amount of loss reasonably possible in addition to any amounts already recognized, it is possible that the resolution of these contingencies, either individually or in aggregate, will require the company to take charges against, or will result in reductions in, future earnings.  It is the opinion of management that the resolution of these contingencies, either individually or in aggregate, could be material to earnings in a particular period but is not expected to have a material adverse impact on Nicor’s liquidity or financial condition.

PBR Plan.  Nicor Gas’ PBR plan for natural gas costs went into effect in 2000 and was terminated by the company effective January 1, 2003.  Under the PBR plan, Nicor Gas’ total gas supply costs were compared to a market-sensitive benchmark.  Savings and losses relative to the benchmark were determined annually and shared equally with sales customers.  The PBR plan is currently under ICC review.  There are allegations that the company acted improperly in connection with the PBR plan, and the ICC and others are reviewing these allegations.  On June 27, 2002, the Citizens Utility Board (“CUB”) filed a motion to reopen the record in the ICC’s proceedings to review the PBR plan (the “ICC Proceedings”).  As a result of the motion to reopen, Nicor Gas, the 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.

Pursuant to the agreement of all parties, including the company, the ICC re-opened the 1999 and 2000 purchased gas adjustment filings for review of certain transactions related to the PBR plan and consolidated the reviews of the 1999-2002 purchased gas adjustment filings with the PBR plan review.

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

In 2004, the company became aware of additional information relating to the activities of individuals affecting the PBR plan for the period from 1999 through 2002, including information consisting of third party documents and recordings of telephone conversations from Entergy-Koch Trading, LP (“EKT”), a natural gas, storage and transportation trader and consultant with whom Nicor did business under the PBR plan.  Review of additional information completed in 2004 resulted in the $1.8 million adjustment to the previously recorded liability referenced above.

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



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

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.

As of March 31, 2010, Nicor Gas had remaining an estimated liability of $2.0 million related to inspection, cleanup and legal defense costs.  This represents management’s best estimate of future costs based on an evaluation of currently available information.  Actual costs may vary from this estimate.  Nicor Gas remains a defendant in several private lawsuits, all in the Circuit Court of Cook County, Illinois, seeking a variety of unquantified damages (including bodily injury and property damages) allegedly caused by mercury spillage resulting from the removal of mercury-containing regulators.  Potential liabilities relating to these claims have been assumed by a contractor’s insurer subject to certain limitations.

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 cleanup of coal tar at certain former manufactured gas plant sites.

Nicor Gas has identified 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 agreement to cooperate in cleaning up residue at many of these properties.  The agreement allocates to Nicor Gas 51.73 percent of cleanup costs for 24 sites, no portion of the cleanup costs for 14 other sites and 50 percent of general remediation program costs that do not relate exclusively to particular sites.  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 March 31, 2010, the company had recorded a liability in connection with these matters of $28.2 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 April 2002, Nicor Gas was named as a defendant, together with ComEd, in a lawsuit brought by the Metropolitan Water Reclamation District of Greater Chicago (the “MWRDGC”) under the Federal Comprehensive Environmental Response, Compensation and Liability Act seeking recovery of past and future remediation costs and a declaration of the level of appropriate cleanup for a former manufactured gas plant site in Skokie, Illinois now owned by the MWRDGC.  In January 2003, the suit was amended to include a claim under the Federal Resource Conservation and Recovery Act.  The suit was filed in the United States District Court for the Northern District of Illinois.  Management cannot predict the outcome of this litigation or the company’s potential exposure thereto, if any, and has not recorded a liability associated with this contingency.

Since costs and recoveries relating to the cleanup of manufactured gas plant sites are passed directly through to customers in accordance with ICC regulations, subject to an annual ICC prudence review, the final disposition of manufactured gas plant matters is not expected to have a material impact on the company’s financial condition or results of operations.



 
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 relating to these tax audits.  Following a dismissal of this action without prejudice by the trial court, the municipalities filed an amended complaint.  The amended complaint seeks, among other things, compensation for alleged unpaid taxes.  Nicor Gas is contesting the claims in the amended complaint.  In December 2007, 25 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 Gas 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.

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.



 
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 2009 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 a cargo container leasing business, a FERC-regulated natural gas pipeline and certain affordable housing investments.

Net income and diluted earnings per common share are presented below (in millions, except per share data):
 
   
Three months ended
 
   
March 31
 
   
2010
   
2009
 
             
Net income
  $ 60.5     $ 43.8  
                 
Diluted earnings per common share
  $ 1.33     $ .96  

Comparisons of the three months ended results reflect higher operating income in the company’s gas distribution business and other energy-related businesses and improved corporate operating results, partially offset by lower operating results in the company’s shipping business, lower equity investment income and a higher effective income tax rate in 2010.

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

On April 24, 2009, Nicor Gas filed a request for rehearing with the ICC concerning the capital structure contained in the ICC’s rate order contending the company’s return on rate base should be higher.  On May 13, 2009, the ICC agreed to conduct a rehearing.  On October 7, 2009, the ICC issued its decision on rehearing in which it increased the annual base revenues approved for Nicor Gas in the March 25, 2009 order by approximately $11 million, increasing the rate of return on rate base to 8.09 percent.  Nicor Gas placed the rates approved in the rehearing decision into effect on a prospective basis on October 15, 2009.  Therefore, the total annual base revenue increase authorized in the rate case originally filed by the company in April 2008 is approximately $80 million.

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


 
As a result of the February 2010 order, Nicor Gas recorded in the first quarter of 2010 a net recovery related to 2008 and 2009 of $31.7 million; substantially all of this amount is expected to be collected in 2010.  The benchmark, against which 2010 actual bad debt expense will be compared, is approximately $63 million.

Health Care Reform Legislation.  The Health Care Act contains a provision that eliminates the tax deduction related to Medicare Part D subsidies received after 2012.  Federal subsidies are provided to sponsors of retiree health benefit plans, such as Nicor Gas, that provide a benefit at least actuarially equivalent to the benefits under Medicare Part D.  Such subsidies have reduced the company’s actuarially determined projected benefit obligation and annual net periodic benefit costs.  Due to the change in taxation, in the first quarter of 2010 Nicor Gas reduced deferred tax assets by $17.5 million, reversed an existing regulatory income tax liability of $10.0 million, established a regulatory income tax asset of $7.0 million and recognized a $0.5 million charge to income tax expense.  Beginning in 2010, the change in taxation will also reduce earnings by an estimated $1.5 million annually for periods subsequent to the enactment date.

The company is evaluating the other provisions of the Health Care Act and will evaluate future interpretations to determine the impact it may have on the company’s future results of operations, cash flows and financial condition.

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

Operating income.  Operating income (loss) by the company’s major businesses is presented below (in millions):
 
   
Three months ended
 
   
March 31
 
   
2010
   
2009
 
             
Gas distribution
  $ 93.2     $ 53.8  
Shipping
    (.5 )     6.6  
Other energy ventures
    4.4       2.6  
Corporate and eliminations
    (1.1 )     (3.1 )
    $ 96.0     $ 59.9  

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

·  
Gas distribution operating income increased $39.4 million for the three months ended March 31, 2010 compared to the prior year due primarily to lower operating and maintenance expense ($26.8 million decrease of which $31.7 million relates to the net under-recovery of bad expense discussed previously) and higher gas distribution margin ($14.0 million increase), partially offset by higher depreciation expense ($1.6 million increase).

·  
Shipping operating results decreased $7.1 million for the three months ended March 31, 2010 compared to the prior year due to lower operating revenues ($5.9 million decrease) and higher operating costs ($1.2 million increase).  Lower operating revenues were attributable to lower average rates. Operating costs were higher due primarily to higher transportation-related costs, partially offset by lower charter costs.
 
 


·  
Nicor’s other energy ventures operating income increased $1.8 million for the three months ended March 31, 2010 compared to the prior year due primarily to higher operating income at Nicor’s energy-related products and services businesses ($6.6 million increase), partially offset by lower operating results at Nicor’s wholesale natural gas marketing business, Nicor Enerchange  ($5.0 million decrease).  Higher operating income at Nicor’s energy-related products and services businesses was due to lower operating expenses ($11.6 million decrease), partially offset by lower operating revenues ($5.0 million decrease).  Lower operating income at Nicor Enerchange was due to unfavorable costing of physical sales activity and unfavorable results from the company’s risk management services associated with hedging the product risks of the utility-bill management contracts offered by Nicor’s energy-related products and services businesses, partially offset by favorable changes in valuations of derivative instruments used to hedge purchases and sales of natural gas inventory.

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

·  
Corporate and eliminations operating results improved $2.0 million for the three months ended March 31, 2010 compared to the prior year due to lower costs of a natural weather hedge associated with the utility-bill management products offered by Nicor’s energy-related products and services businesses ($1.3 million decrease) and an insurance recovery on a previously settled legal matter ($0.7 million).  The company recorded $1.3 million of costs associated with the natural weather hedge in the current year compared to $2.6 million of costs recorded in the prior year.  Benefits or costs resulting from variances from normal weather related to these products are recorded primarily at the corporate level as a result of an agreement between the parent company and certain of its subsidiaries.  The weather impact of these contracts generally serves to partially offset the gas distribution business’ weather risk.  The amount of the offset attributable to the utility-bill management products marketed by Nicor’s other energy ventures will vary depending upon a number of factors including the time of year, weather patterns, the number of customers for these products and the market price for natural gas.



 
RESULTS OF OPERATIONS

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

Operating revenues.  Operating revenues by the company’s major businesses are presented below (in millions):
   
Three months ended
 
   
March 31
 
   
2010
   
2009
 
             
Gas distribution
  $ 1,068.8     $ 984.0  
Shipping
    83.5       89.4  
Other energy ventures
    65.7       77.1  
Corporate and eliminations
    (25.1 )     (39.7 )
    $ 1,192.9     $ 1,110.8  

Gas distribution operating revenues are impacted by changes in natural gas costs, which are passed directly through to customers without markup, subject to ICC review.  Gas distribution operating revenues increased $84.8 million for the three months ended March 31, 2010 compared to the prior year due primarily to higher natural gas costs (approximately $115 million increase) and the impact of the increase in base rates (approximately $14 million increase), partially offset by warmer weather (approximately $50 million decrease).

Shipping operating revenues decreased $5.9 million for the three months ended March 31, 2010 compared to the prior year due primarily to lower average rates ($5.8 million decrease).

Nicor’s other energy ventures operating revenues decreased $11.4 million for the three months ended March 31, 2010 compared to the prior year due to lower operating revenues at Nicor Enerchange ($6.4 million decrease) and at Nicor’s energy-related products and services businesses ($5.0 million decrease).  Lower operating revenues at Nicor Enerchange were due to unfavorable costing of physical sales activity and unfavorable results from the company’s risk management services associated with hedging the product risks of the utility-bill management contracts offered by Nicor’s energy-related products and services businesses, partially offset by favorable changes in valuations of derivative instruments used to hedge purchases and sales of natural gas inventory.  Lower operating revenues at Nicor’s energy-related products and services businesses were due to lower average revenue per utility-bill management contract, partially offset by higher average contract volumes.

Corporate and eliminations reflects primarily the elimination of 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.  The 2009 rate orders included a franchise gas cost recovery rider and a rider to recover the costs associated with energy efficiency programs.  Additionally, in February 2010 the ICC approved the company’s bad debt rider.  As a result, changes in revenue included in gas distribution margin attributable to these items are expected to generally be offset by changes within operating and maintenance expense.



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

   
Three months ended
 
   
March 31
 
   
2010
   
2009
 
             
Gas distribution revenues
  $ 1,068.8     $ 984.0  
Cost of gas
    (787.9 )     (716.4 )
Revenue tax expense
    (72.9 )     (73.6 )
Gas distribution margin
  $ 208.0     $ 194.0  

Gas distribution margin increased $14.0 million for the three months ended March 31, 2010 compared to the prior year due to the impact of the increase in base rates (approximately $14 million increase) and higher revenue from cost recovery riders ($5.6 million attributable to the energy efficiency program and $3.4 million attributable to the bad debt rider), partially offset by the impact of warmer weather (approximately $5 million decrease) and lower interest on customer balances (approximately $2 million decrease).
 
Gas distribution operating and maintenance expense.   Gas distribution operating and maintenance expense decreased $26.8 million for the three months ended March 31, 2010 compared to the prior year due primarily to lower bad debt expense ($22.7 million decrease) and lower company use and storage-related gas costs ($6.5 million decrease), partially offset by costs associated with the energy efficiency program ($5.6 million).  Bad debt expense for three months ended March 31, 2010 was $1.4 million compared to $24.1 million in the prior year.  Bad debt expense in 2010 includes the recognition of the $31.7 million benefit associated with the net under recovery of bad debt expense from 2008 and 2009; $29.7 million, based on gas distribution revenues recognized in the quarter, of the approximately $63 million annual expense assumed to be collected through base rates; and $3.4 million of expense which is equal to the revenue billed under the bad debt rider.

Shipping operating expenses.  Shipping operating expenses increased $1.2 million for the three months ended March 31, 2010 compared to the prior year due to higher transportation-related costs ($3.5 million increase, largely attributable to higher fuel prices) and higher repairs and maintenance costs ($0.7 million increase), partially offset by lower charter costs ($3.0 million decrease).

Other energy ventures operating expenses.  Other energy ventures operating expenses decreased $13.2 million for the three months ended March 31, 2010 compared to the prior year due primarily to a decrease in operating expenses at Nicor’s energy-related products and services businesses ($11.6 million decrease).  The decrease in operating expenses at Nicor’s energy-related products and services businesses was due to lower average cost per utility-bill management contract, partially offset by higher average contract volumes.

Interest expense.  Interest expense decreased $0.3 million for the three months ended March 31, 2010 compared to the prior year due to lower interest on income tax matters ($0.7 million decrease), partially offset by higher bank commitment fees ($0.4 million increase).

Net equity investment income.