Item 1. Business
Northern Illinois Gas Company (doing business as Nicor Gas Company), an Illinois corporation formed in 1954, is a wholly owned subsidiary of Nicor Inc., a holding company. Certain terms used herein are defined in the glossary on page i.
GENERAL
Nicor Gas, a regulated natural gas distribution utility, is one of the nation's largest distributors of natural gas. The company serves 2 million customers in a service territory that encompasses most of the northern third of Illinois, excluding the city of Chicago. The company's service territory is diverse and has grown steadily over the years, providing the company with a well-balanced mix of residential, commercial and industrial customers. In 2001, residential customers accounted for approximately 45 percent of natural gas deliveries, while commercial and industrial customers accounted for about 25 percent and 30 percent, respectively. The company's large residential customer base provides relative stability during weak economic periods. In addition, Nicor Gas' industrial and commercial customer base is well diversified, lessening the impact of industry-specific economic swings. See Operating Statistics on page 10 for operating revenues, deliveries and number of customers by customer classification. The company has approximately 2,300 employees.
Gas deliveries are seasonal since about one-half are used for space heating. Typically, about 70 percent of deliveries and revenues occur from October through March. Fluctuations in weather can have a significant impact on year-to-year comparisons of operating income and cash flow. To provide protection from the financial impact of unusually warm weather, Nicor Gas entered into an agreement with a third party designed to protect the company's 2002 earnings and cash flow if weather is warmer than 5,700 degree days. To partially offset the cost of this earnings protection, Nicor Gas has also agreed to pay this party if weather for 2002 is colder than 6,100 degree days, which is approximately normal for Nicor Gas' service territory. Under the terms of these agreements, the maximum payout or receipt is limited to $10 million.
Nicor Gas maintains franchise agreements with most of the communities it serves, allowing it to construct, operate and maintain distribution facilities in those communities. Franchise agreement terms range up to 50 years. Currently, less than 5 percent of the agreements will expire within five years.
CUSTOMER SERVICES
In addition to gas sales to all customer classes, Nicor Gas provides transportation service to commercial and industrial customers who purchase their own gas supplies. Beginning in 1999, the company's Customer Select(R) voluntary pilot program also allowed residential customers in certain communities to choose their natural gas supplier. In January 2002, the company received final approval from the Illinois Commerce Commission (ICC) to make its Customer Select program available to all of its customers beginning in March 2002. Additional information on the program is presented under the heading Unbundling of Services on page 9. Transportation customers have options that include the use of the company's storage system and the ability to choose varying supply backup levels. The company receives a margin generally comparable to gas sales for transportation service with full supply backup.
Nicor Gas Company Page 2
Item 1. Business (continued)
In recent years, Nicor Gas has been pursuing several nontraditional activities. These activities include finding innovative ways to utilize its physical assets by providing natural gas storage and transmission-related services to marketers, other gas distribution companies and electric power-generation facilities.
SOURCES OF NATURAL GAS SUPPLY
Nicor Gas purchases natural gas supplies in the open market by contracting directly with producers and marketers. Pipeline transportation and purchased storage services are contracted for at rates regulated by the Federal Energy Regulatory Commission (FERC). Firm pipeline capacity and purchased storage services held by the company that are temporarily not needed can be released in the secondary market under FERC-mandated capacity release provisions, with proceeds reducing the company's cost of gas charged to customers.
The company's peak-day requirements are met through utilization of company-owned storage facilities, firm pipeline capacity, purchased storage services and other supply arrangements. Nicor Gas has been able to obtain sufficient supplies of natural gas to meet customer requirements. The company believes natural gas supply availability will be sufficient to meet market demands in the foreseeable future.
Natural gas supply. Nicor Gas maintains a diversified portfolio of natural gas supply contracts. Firm supply contracts are diversified by supplier, producing region, quantity and available transportation. Contract pricing is generally tied to published price indices so as to approximate current market prices. The contracts also generally provide for the payment of fixed demand charges to ensure the availability of supplies on any given day and are generally negotiated annually.
The company also purchases gas supplies on the spot market to fulfill its supply requirements or to take advantage of favorable short-term pricing. Spot gas purchases accounted for about one-half of the company's total gas purchases in the last three years.
Customers served under the company's transportation service tariffs purchase their own gas supplies. About one-half of the gas that the company delivered in 2001 was purchased by transportation customers directly from producers and marketers rather than from the company.
Pipeline transportation. Nicor Gas is directly connected to seven interstate pipelines which provide access to most of the major natural gas producing regions in North America. The company's primary firm transportation contracts are with: Natural Gas Pipeline Company of America, Northern Natural Gas Company, Tennessee Gas Pipeline Company and Midwestern Gas Transmission Company. All of the capacity covered by these contracts will expire by 2004 and Nicor Gas anticipates that some or all of these contracts will be renewed. Nicor Gas has also entered into a 10-year firm transportation agreement beginning in 2002 with the Horizon Pipeline, a 50/50 joint venture between Nicor and Natural Gas Pipeline Company of America.
Storage. Nicor Gas owns and operates seven underground natural gas storage facilities. This storage system is one of the largest in the gas distribution industry. With about 140 Bcf of top storage capacity, the system is designed to meet about 55 percent of the company's estimated peak-day deliveries and approximately 30 percent of its normal winter deliveries. In addition to company-owned facilities, Nicor Gas purchases about 40 Bcf of storage service. Storage provides supply flexibility and improves reliability of deliveries.
Nicor Gas Company Page 3
Item 1. Business (concluded)
COMPETITION/DEMAND
Nicor Gas is one of the largest utility energy suppliers in Illinois, delivering about one-third of all utility energy consumed in the state. Substantially all single-family homes in Nicor Gas' service territory are heated with natural gas. The company's gas services compete with other forms of energy, such as electricity and oil, based on such factors as price, service, reliability and environmental impact. Significant factors that impact demand for natural gas include weather, economic conditions and the price of gas relative to competitive fuels.
The energy industry has undergone fundamental changes over the past several years. In 1997, Illinois adopted legislation directing the process of deregulating the state's electric utility industry. Nearly all customers will be given a choice of electric supplier beginning in May 2002. While natural gas prices fluctuated greatly over the last two years, Nicor Gas has traditionally maintained a pricing advantage over electricity and expects to maintain an advantage in the foreseeable future.
Additional information on competition and demand is presented in Factors Affecting Business Performance beginning on page 7.
REGULATION
Nicor Gas is regulated by the ICC, which establishes the rules and regulations governing utility rates and services in Illinois. Rates are generally designed to allow the company to recover its costs and provide an opportunity to earn a fair return for its investors. Significant changes in the regulations applicable to Nicor Gas or its affiliates, or the regulatory environment in general, could affect the performance of Nicor Gas.
The cost of gas the company purchases for customers is recovered through a monthly gas supply charge, which accounted for approximately 75 percent of a typical residential customer's annual bill in the last three years. The company's cost of gas is passed on to the customer without markup.
Nicor Gas' performance-based rate (PBR) plan for natural gas costs went into effect January 1, 2000. Under the PBR plan, Nicor Gas' total gas supply costs are compared to a market-sensitive benchmark. Annual savings and losses relative to the benchmark are shared equally with customers. In 2002, the plan is subject to ICC review as prescribed by Illinois law. Nicor Gas continues to operate under the current PBR plan while the review is being conducted. The review process is expected to conclude in the fourth quarter of 2002. Additional information on the plan is presented under the heading Performance-Based Rate Plan on page 8.
Customer Select is a program that offers customers a choice of natural gas suppliers. Additional information on the program is presented under the heading Unbundling of Services on page 9.
ENVIRONMENTAL MATTERS
For information on environmental matters, see Contingencies beginning on page 26.
Nicor Gas Company Page 4
Item 2.
Item 2. Properties
The company's properties are located in the territory described under Item 1, Business, and are suitable, adequate and utilized in its operations.
The gas distribution, transmission and storage system includes approximately 31,000 miles of steel, plastic and cast iron main; approximately 28,000 miles of steel, plastic/aluminum composite, plastic and copper service pipe connecting the mains to customers' premises; and seven underground storage fields. Other properties include buildings, land, motor vehicles, meters, regulators, compressors, construction equipment, tools, communication and computer equipment, software, and office equipment.
Most of the company's distribution and transmission property, and underground storage fields are located on property owned by others and used by the company through easements, permits or licenses. The company owns most of the buildings housing its administrative offices and the land on which they sit.
Substantially all properties are subject to the lien of the indenture securing the company's first mortgage bonds.
Item 3.
Item 3. Legal Proceedings
See Contingencies beginning on page 26, which is incorporated herein by reference.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
All of the outstanding common stock of Nicor Gas is owned by Nicor Inc. There is no public trading market for the company's common stock. During 2001 and 2000, the company declared quarterly dividends on its common stock totaling $90 million and $111 million, respectively.
Nicor Gas Company Page 5
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this financial review is to explain changes in Nicor Gas' operating results and financial condition from 1999 to 2001, and to discuss business trends and uncertainties that might affect Nicor Gas. Certain terms used herein are defined in the glossary on page i.
RESULTS OF OPERATIONS
Nicor Gas' net income was $119.4 million, $22.2 million and $96.1 million in 2001, 2000 and 1999, respectively.
Nicor Gas' net income changed dramatically over the three-year period due mainly to one significant item. An unusual charge of $148 million was recorded as operating expense in 2000 to establish a reserve related to the company's mercury inspection and repair program. A $9 million adjustment lowered the mercury-related reserve and reduced operating expense in 2001. Operating expense was also reduced by partial recoveries from insurers and contractors in 2001. For details of Nicor Gas' mercury inspection and repair program see page 26. Excluding these unusual mercury-related impacts, Nicor's net income was $112.0 million and $111.5 million in 2001 and 2000, respectively.
Net income, excluding the mercury-related impacts, remained essentially unchanged in 2001 compared to 2000. Results for 2001 reflect greater customer finance charges and increased contributions from the Chicago Hub, which provides gas supply-related services, and the company's performance-based rate (PBR) plan. These improvements were offset by certain increased operating expenses related to higher natural gas prices in the first quarter, the impact of reduced deliveries, and increased depreciation. Net income, excluding the unusual charge, was 16 percent higher in 2000 compared to 1999 due to higher gas deliveries and contributions from the PBR plan. Gas deliveries rose to 526 Bcf in 2000 compared with 508 Bcf in 1999 due to 8 percent colder weather and customer additions. Results for 2000 also reflect increased operating and maintenance expenses and depreciation.
Operating revenues. Operating revenues increased $222.2 million to $2,105.9 million in 2001 due primarily to significantly higher first quarter natural gas costs and related revenue taxes, which are both passed directly through to customers without markup in accordance with Illinois Commerce Commission (ICC) regulations. Partially offsetting the higher 2001 natural gas costs were lower deliveries due to warmer weather, energy conservation and economic conditions. Operating revenues increased $557.5 million to $1,883.7 million in 2000 due to higher natural gas prices and related revenue taxes, and increased natural gas deliveries.
Margin. Margin, defined as operating revenues less cost of gas and revenue taxes, which are both passed directly through to customers, increased slightly to $507.6 million in 2001 compared with $506.6 million in 2000. Positively affecting margin for 2001 were greater customer finance charges and larger contributions from the Chicago Hub. Negatively impacting 2001 results were lower customer demand, the higher cost of natural gas used to operate company equipment and facilities, and the absence of income relating to a large construction project recorded in 2000. In 2000, margin increased $19.4 million due primarily to the impact of colder weather compared to 1999, customer additions and increased income from power-generation services.
Operating and maintenance. Operating and maintenance expenses increased by $1.6 million in 2001 to $161.9 million. The increase was primarily due to higher bad debt expenses in 2001 resulting from higher natural gas prices. In 2000, operating and maintenance expenses increased $7 million to $160.3 million due, in part, to higher bad debt expense and weather protection costs. Operating and maintenance
Nicor Gas Company Page 6
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
expenses were partially offset by pension credits, net of capitalization, of $15.0 million, $19.9 million and $13.3 million in 2001, 2000 and 1999, respectively.
Other operating expense. Other operating expense reflects estimated costs, credits and recoveries associated with the company's mercury inspection and repair program. Additional information about this program is presented under the heading Mercury Program beginning on page 26.
Other income (expense). Other income increased $3 million in 2001 due to increased PBR plan contributions and increased interest income from higher short-term investment balances. These improvements were partially offset by decreased property sale gains in 2001. In 2000, other income increased $12.8 million due to PBR plan results and property sale gains.
Interest expense. Interest on debt increased 3 percent in 2001 and 7 percent in 2000 due to increased average borrowing levels in both years.
Income taxes. The 24 percent effective income tax rate for 2000 varied from its more typical level of about 37 percent due to the effect of the unusual charge by Nicor Gas related to the mercury program.
FINANCIAL CONDITION AND LIQUIDITY
The company believes it has access to adequate resources to meet its needs for capital expenditures, debt redemptions, dividend payments and working capital. These resources include net cash flow from operating activities, access to capital markets and lines of credit.
Operating cash flows. Net cash flow provided from operating activities was $437.3 million, $202.9 million and $170.9 million in 2001, 2000 and 1999, respectively. Year-to-year changes in operating cash flow result largely from fluctuations in working capital items because of factors including weather, the price of natural gas, the timing of collections from customers and gas purchasing practices. The company generally relies on short-term financing to meet temporary increases in working capital needs.
Capital expenditures. Capital expenditures were $149.8 million in 2001 compared with $124.6 million in 2000 and $127.4 million in 1999. Capital expenditures were higher in 2001 than in 2000 and 1999 due primarily to increased information technology projects and improvements to the company's operating system. Capital spending in 2002 is expected to be about $155 million. The estimated increase in 2002 capital expenditures is related primarily to higher capitalized employee benefit costs.
Financing activities. Nicor Gas has earned the highest long-term debt ratings given in the industry. Nicor Gas' financial statistics include:
2001 2000 1999 -------- -------- -------- Long-term debt, net of current maturities, as a percent of capitalization 41.8% 36.9% 38.2% Ratio of earnings to fixed charges 5.3 1.7 4.9
Interest coverage for 2000 was negatively affected by the unusual mercury-related charge.
Nicor Gas Company Page 7
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Long-term debt. At December 31, 2001, Nicor Gas had $225 million of First Mortgage Bonds remaining available for issuance under a July 2001 shelf registration filing. Net proceeds from securities issued are typically used for the refinancing of certain outstanding First Mortgage Bonds, construction programs to the extent not provided by internally generated funds, and general corporate purposes.
In 2001, Nicor Gas issued the following First Mortgage Bonds: $50 million due in 2006 at 5.55%, $75 million due in 2008 at 5.875%, $75 million due in 2011 at 6.625%, and $50 million due in 2016 at 7.2%. Retirements of First Mortgage Bonds in 2001 were as follows: $75 million due in 2001 at 6.45%, $50 million due in 2002 at 6.75%, $50 million due in 2021 at 8.875%, and $50 million due in 2025 at 7.26%. Nicor Gas also retired $50 million of variable-rate unsecured notes due in 2001. As a result of these activities, Nicor Gas' weighted average interest rate for long-term debt at December 31, 2001 was 6.3% compared with 6.8% at December 31, 2000.
In January 2000, Nicor Gas issued $50 million of variable-rate unsecured notes due in 2001 at an initial rate of 6.11% to fund the redemption of $50 million of unsecured notes at 5.065% due in 2000.
During 1999, Nicor Gas issued $50 million of First Mortgage Bonds at 5.37% due in 2009 and $50 million of unsecured notes at 5.065% due in 2000. Redemptions of First Mortgage Bonds during 1999 were as follows: $50 million at 5.875% due in 2000, $50 million at 7.375% due in 2023 and $50 million at 8.25% due in 2024.
Short-term debt. Nicor Gas maintains short-term line of credit agreements with major domestic and foreign banks. At December 31, 2001, these agreements, which serve as backup for the issuance of commercial paper, totaled $450 million. The company had $227 million and $315 million of commercial paper outstanding at year-end 2001 and 2000, respectively.
Common and preferred stock. The company paid dividends of $72.3 million, $106.4 million and $98.1 million in 2001, 2000 and 1999, respectively.
FACTORS AFFECTING BUSINESS PERFORMANCE
The following factors can impact year-to-year comparisons and may affect the future performance of Nicor Gas.
Nicor Gas, a regulated natural gas distribution utility, serves 2 million customers in a service territory that encompasses most of the northern third of Illinois, excluding the city of Chicago. The region's economy is diverse and has grown steadily over the years, providing Nicor Gas with a well-balanced mix of residential, commercial and industrial customers. In 2001, residential, commercial and industrial customers accounted for approximately 45 percent, 25 percent and 30 percent of natural gas deliveries, respectively.
Weather. Since about one-half of gas deliveries are used for space heating, fluctuations in weather have the potential to significantly impact year-to-year comparisons of operating income and cash flow. In 2000, Nicor Gas began purchasing protection against the impact of significant weather fluctuations. For 2002, Nicor Gas has entered into an agreement with a third party to protect the company's earnings if
Nicor Gas Company Page 8
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
weather is warmer than 5,700 degree days. To partially offset the cost of this earnings protection, Nicor Gas has also agreed to pay this party if weather for 2002 is colder than 6,100 degree days, which approximates normal weather. Under the terms of these agreements, the maximum payout or receipt is limited to $10 million, which is equivalent to approximately 500 degree days. As a result, this weather hedge limits the earnings impact of large variations in weather.
Demand and natural gas prices. In addition to the impact of weather, significant changes in economic conditions or natural gas prices can impact customer gas usage. However, Nicor Gas' large residential customer base provides relative stability during weak economic periods, and the industrial and commercial customer base is well diversified, lessening the impact of industry-specific economic swings. Nicor Gas' growth in natural gas deliveries has traditionally come from customer additions and increased usage by existing commercial and industrial customers, including power-generation facilities. Although commercial and industrial deliveries declined in 2001, the company anticipates continued long-term growth attributable to these factors. A partial offset is expected as customers install more energy-efficient equipment.
Natural gas prices have decreased significantly since the extraordinarily high prices seen during late 2000 and early 2001. Changes in the price of natural gas have no direct impact on Nicor Gas' margin since gas costs are passed directly through to customers without markup. However, the unprecedented level of last winter's natural gas prices had an adverse effect on accounts receivable collections, customer demand, company gas usage expenses, financing costs and customer service expenses.
Performance-based rate plan. Nicor Gas' PBR plan for natural gas costs went into effect in 2000. Under the PBR plan, Nicor Gas' total gas supply costs are compared to a benchmark tied to a market index. Savings and losses relative to the benchmark are shared equally with sales customers. Transportation customers, who are responsible for their own gas supplies, are generally not affected by the PBR plan. Assuming a gas cost benchmark of $1 billion, each one-percent deviation from the benchmark would affect net income by about $3 million. Generally, changing natural gas market prices will not significantly affect PBR plan risk since the PBR benchmark is tied to market prices. However, unusually high natural gas prices may impact PBR plan results since any performance variance from the benchmark may be significantly greater in magnitude.
In 2002, the PBR plan is subject to ICC review as prescribed by Illinois law. Nicor Gas continues to operate under the current PBR plan while the review is being conducted. The review process is expected to conclude in the fourth quarter of 2002.
Competition. Nicor Gas competes with other energy suppliers based on such factors as price, service and reliability. The company is well positioned to deal with the possibility of fuel switching by customers because it has rates and services designed to compete against alternative fuels. In addition, the company has a rate that allows negotiation with potential bypass customers, and no customer has bypassed the Nicor Gas system since the rate became effective in 1987. Nicor Gas also offers commercial and industrial customers alternatives in rates and service, increasing its ability to compete in these markets.
Storage and supply. Direct connection to seven interstate pipelines and extensive underground storage capacity provide the company and its transportation customers with flexibility and alternatives for natural gas supply procurement and storage services. In addition, in an effort to ensure supply reliability, the company purchases gas from several different producing regions under varied contract terms.
Nicor Gas Company Page 9
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Unbundling of services. In January 2002, the company received final approval from the ICC to make its Customer Select(R) program available to all of its customers beginning in March 2002. Previously, the program was available to all industrial and commercial customers and about 15 percent of Nicor Gas' residential customers. In the program's first four years, about one-third of eligible business customers and one-quarter of eligible residential customers signed up. Under the program, customers are able to acquire their natural gas supplies from third-party marketers. The choice of another natural gas commodity supplier has no direct impact on Nicor Gas' distribution margin because natural gas costs are passed directly through to customers without markup. Nicor Gas continues to deliver the natural gas, maintain its distribution system and respond to emergencies.
Customer credit risk. Nicor Gas has a diversified customer base, which limits its exposure to concentrations of credit risk in any one industry or income class. The company maintains prudent credit policies, subject to ICC regulations. Customers also have options to help them manage their bills, such as energy assistance programs for low-income customers and a budget payment plan that spreads gas bills evenly throughout the year. However, unusually high natural gas prices can increase the risk of customer nonpayment.
Nicor Gas experienced increased bad debt expense in both 2001 and 2000 primarily due to significantly higher natural gas prices. Assuming current price levels, the company anticipates a reduction in bad debt expense in 2002.
Pension investment returns. Nicor Gas maintains noncontributory defined benefit pension plans covering substantially all employees hired prior to 1998. For actuarial valuation purposes, Nicor Gas utilizes an October 1 measurement date to determine the company's pension expense or credit for the subsequent calendar year. During the 12 months ended September 30, 2001, the pension plans experienced poor investment returns consistent with general market conditions, which will negatively impact the company's pension credit and operating income in 2002. The pension plans are adequately funded, and recent market performance is not expected to impact participant benefits or future company contributions.
Nontraditional activities. In order to generate additional contributions to earnings growth, Nicor Gas continues to pursue several nontraditional activities, including the Chicago Hub, which provides interruptible transportation and storage services. The Chicago area has become a major market hub for natural gas, and demand for storage- and transmission-related services by marketers, other gas distribution companies and electric power-generation facilities is expected to continue to increase. Nicor Gas also continues to assess its ownership of real estate holdings.
Regulation. Nicor Gas is regulated by the ICC, which establishes the rules and regulations governing utility rates and services in Illinois. Rates are generally designed to allow the company to recover its costs and provide an opportunity to earn a fair return for its investors. Significant changes in the regulations applicable to Nicor Gas or its affiliates, or the regulatory environment in general, could affect the performance of Nicor Gas.
Nicor Gas Company Page 10 - ---------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Operating Statistics 2001 2000 1999 -------- -------- -------- Operating revenues (millions) Sales Residential $1,486.4 $1,353.9 $ 899.8 Commercial 274.6 236.0 172.3 Industrial 41.5 37.0 24.5 -------- -------- -------- 1,802.5 1,626.9 1,096.6 -------- -------- -------- Transportation Residential 9.5 6.7 1.7 Commercial 75.0 78.9 70.3 Industrial 45.6 47.5 43.7 Other 7.5 6.2 4.2 -------- -------- -------- 137.6 139.3 119.9 -------- -------- -------- Other revenues Revenue taxes 112.3 101.7 84.6 Chicago Hub 13.4 6.3 6.0 Other 40.1 9.5 19.1 -------- -------- -------- 165.8 117.5 109.7 -------- -------- -------- $2,105.9 $1,883.7 $1,326.2 ======== ======== ========
Deliveries (Bcf) Sales Residential 201.5 219.0 209.0 Commercial 37.2 38.4 39.8 Industrial 5.9 6.2 6.1 -------- -------- -------- 244.6 263.6 254.9 -------- -------- -------- Transportation Residential 6.1 4.4 .9 Commercial 89.2 94.0 82.1 Industrial 135.3 163.9 170.2 -------- -------- -------- 230.6 262.3 253.2 -------- -------- -------- 475.2 525.9 508.1 ======== ======== ========
Year-end customers (thousands) Sales Residential 1,766.5 1,746.3 1,753.0 Commercial 102.7 98.9 108.9 Industrial 6.7 6.6 7.4 -------- -------- -------- 1,875.9 1,851.8 1,869.3 -------- -------- -------- Transportation Residential 58.1 52.8 16.2 Commercial 66.0 68.7 57.2 Industrial 7.1 7.4 6.6 -------- -------- -------- 131.2 128.9 80.0 -------- -------- -------- 2,007.1 1,980.7 1,949.3 ======== ======== ========
Other statistics Degree days 5,422 5,717 5,272 Average gas cost per Mcf sold $ 6.05 $ 4.80 $ 2.93
Nicor Gas Company Page 11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Market risk. The company is exposed to market risk in the normal course of its business operations, including the risk of loss arising from adverse changes in natural gas commodity prices and interest rates. It is Nicor Gas' practice to manage these risks utilizing derivative instruments and other methods, as deemed appropriate.
Commodity price risk. The company has established policies and procedures governing the management of commodity price risks and the use of derivative commodity instruments to hedge its exposure to such risks. A risk management committee oversees compliance with such policies and procedures.
Nicor Gas is generally not exposed to market risk caused by changes in commodity prices because of Illinois rate regulation allowing for the recovery of natural gas supply costs from customers. Although the company has a PBR plan for natural gas costs, the plan does not directly expose the company to commodity price risk because actual gas costs are compared to a market-sensitive benchmark as opposed to a fixed benchmark.
Substantial increases in natural gas prices may impact Nicor Gas' earnings by increasing the cost of gas used by the company, bad debt expense and other operating expenses. Higher natural gas prices may also lead to lower customer gas consumption. The company is addressing these risks by using fixed-rate purchase agreements, futures contracts and swap agreements to reduce the financial impacts arising from natural gas price changes.
Counterparty credit risk. The company is also exposed to credit risk in the event a hedging transaction counterparty or supplier defaults on a contract to pay for or deliver product at agreed-upon terms and conditions. To manage this risk, the company has established procedures to determine and monitor the creditworthiness of counterparties and limits its exposure to any one counterparty. Nicor Gas is also in the process of entering into master netting arrangements to mitigate counterparty credit risk.
Interest rate risk. Nicor Gas is also exposed to changes in interest rates, primarily as a result of its short- and long-term debt. The company manages its interest rate risk by issuing long-term fixed-rate debt with varying maturities and refinancing certain debt. For further information about debt securities, interest rates and fair values, see the Consolidated Statements of Capitalization on page 18, the Fair Value of Financial Instruments note on page 23 and the Short- and Long-Term Debt note on page 23.
New accounting pronouncements. The Financial Accounting Standards Board issued a few key accounting pronouncements in 2001. The implementation of these standards is not expected to have a material impact on Nicor Gas' financial position or results of operations. For further information about these pronouncements, see New Accounting Pronouncements on page 21.
Nicor Gas Company Page 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (concluded)
Mercury program. Future operating results may be impacted by adjustments to the company's estimated mercury program liability of $37 million, or by mercury-related recoveries. Any such adjustments or recoveries could be material to operating results in the period recorded. Additional information about this program is presented under the heading Mercury Program beginning on page 26.
Manufactured gas plant sites. The company is conducting environmental investigations and remedial activities at former manufactured gas plant sites. Additional information about these sites is presented under the heading Manufactured Gas Plant Sites on page 28.
Other contingencies. The company is involved in legal or administrative proceedings before various courts and agencies with respect to rates, taxes and other matters. Although unable to determine the outcome of these contingencies, management believes that appropriate accruals have been recorded. Final disposition of these matters is not expected to have a material impact on the company's financial condition or results of operations.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
For disclosures about market risk, see Market Risk on page 11, which is incorporated herein by reference.
Nicor Gas Company Page 13
Item 8.
Item 8. Financial Statements and Supplementary Data
Page
Report of Independent Public Accountants................................... 14
Financial Statements:
Consolidated Statements of Operations................................... 15
Consolidated Statements of Cash Flows................................... 16
Consolidated Balance Sheets............................................. 17
Consolidated Statements of Capitalization............................... 18
Consolidated Statements of Retained Earnings............................ 19
Consolidated Statements of Comprehensive Income......................... 19
Notes to the Consolidated Financial Statements.......................... 20
Nicor Gas Company Page 14
Report of Independent Public Accountants
To Northern Illinois Gas Company (Doing business as Nicor Gas Company):
We have audited the accompanying consolidated balance sheets and statements of capitalization of Nicor Gas Company (an Illinois corporation and a wholly owned subsidiary of Nicor Inc.) and subsidiary company as of December 31, 2001 and 2000, and the related consolidated statements of operations, retained earnings, comprehensive income and cash flows for each of the three years in the period ended December 31, 2001. These financial statements and the schedule referred to below are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Nicor Gas Company and subsidiary company as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedule on page 31 is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP Chicago, Illinois January 21, 2002
Nicor Gas Company Page 15 - -------------------------------------------------------------------------------
Consolidated Statements of Operations (millions)
Year ended December 31 -------------------------------- 2001 2000 1999 --------- --------- ---------
Operating revenues $ 2,105.9 $ 1,883.7 $ 1,326.2 --------- --------- ---------
Operating expenses Cost of gas 1,489.4 1,277.1 756.2 Operating and maintenance 161.9 160.3 153.3 Depreciation 132.4 128.1 123.9 Taxes, other than income taxes 125.6 117.5 101.1 Other (12.2) 148.0 - Income taxes 60.7 (1.0) 56.4 --------- --------- --------- 1,957.8 1,830.0 1,190.9 --------- --------- ---------
Operating income 148.1 53.7 135.3 --------- --------- ---------
Other income (expense) Other, net 25.2 20.3 (.9) Income taxes on other income (9.8) (7.9) .5 --------- --------- --------- 15.4 12.4 (.4) --------- --------- ---------
Interest expense Interest on debt, net of amounts capitalized 44.6 43.3 40.4 Other (.5) .6 (1.6) --------- --------- --------- 44.1 43.9 38.8 --------- --------- ---------
Net income 119.4 22.2 96.1
Dividends on preferred stock .4 .4 .4 --------- --------- ---------
Earnings applicable to common stock $ 119.0 $ 21.8 $ 95.7 ========= ========= =========
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 16 - -------------------------------------------------------------------------------
Consolidated Statements of Cash Flows (millions)
Year ended December 31 -------------------------------- 2001 2000 1999 -------- -------- -------- Operating activities Net income $ 119.4 $ 22.2 $ 96.1 Adjustments to reconcile net income to net cash flow provided from operating activities: Depreciation 132.4 128.1 123.9 Deferred income tax expense (benefit) 30.1 (42.6) - Changes in assets and liabilities: Receivables, less allowances 275.7 (254.4) (80.3) Gas in storage 2.1 2.8 83.4 Deferred/accrued gas costs 149.1 (33.3) (45.8) Accounts payable (202.4) 303.6 .2 Prepaid pension costs (21.6) (26.6) (16.5) Accrued mercury-related costs (41.0) 78.0 - Other (6.5) 25.1 9.9 -------- -------- -------- Net cash flow provided from operating activities 437.3 202.9 170.9 -------- -------- --------
Investing activities Capital expenditures (149.8) (124.6) (127.4) Other 4.2 5.3 1.7 -------- -------- -------- Net cash flow used for investing activities (145.6) (119.3) (125.7) -------- -------- --------
Financing activities Net proceeds from issuing long-term debt 247.2 49.9 99.5 Disbursements to retire long-term debt (279.5) (50.0) (155.7) Short-term borrowings (repayments), net (88.6) 52.8 88.3 Dividends paid (72.3) (106.4) (98.1) Other (.5) (.5) (.4) -------- -------- -------- Net cash flow used for financing activities (193.7) (54.2) (66.4) -------- -------- --------
Net increase (decrease) in cash and cash equivalents 98.0 29.4 (21.2)
Cash and cash equivalents, beginning of year 39.7 10.3 31.5 -------- -------- --------
Cash and cash equivalents, end of year $ 137.7 $ 39.7 $ 10.3 ======== ======== ========
Supplemental information Income taxes paid, net of refunds $ 30.1 $ 43.4 $ 57.3 Interest paid, net of amounts capitalized 44.9 44.0 40.0
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 17 - ------------------------------------------------------------------------------
Consolidated Balance Sheets (millions)
December 31 -------------------- 2001 2000 -------- -------- Assets
Gas distribution plant, at cost $3,425.6 $3,292.8 Less accumulated depreciation 1,804.9 1,692.0 -------- -------- 1,620.7 1,600.8 -------- --------
Current assets Cash and cash equivalents - affiliates 137.7 - Cash and cash equivalents - other - 39.7 Receivables, less allowances of $9.6 and $13.4, respectively 285.0 563.0 Receivables - affiliates 10.6 8.3 Gas in storage, at last-in, first-out cost 17.2 19.3 Deferred gas costs - 49.2 Deferred income taxes 25.9 46.1 Other 9.3 14.8 -------- -------- 485.7 740.4 -------- --------
Prepaid pension costs 164.3 142.7 Other assets 29.5 28.7 -------- --------
$2,300.2 $2,512.6 ======== ========
Capitalization and Liabilities
Capitalization Long-term debt $ 446.4 $ 347.1 Preferred stock 7.5 8.0 Common equity 613.8 585.3 -------- -------- 1,067.7 940.4 -------- --------
Current liabilities Long-term obligations due within one year .5 125.5 Short-term borrowings - other 227.0 315.0 Short-term borrowings - affiliates 40.0 40.6 Accounts payable 344.3 546.7 Accrued gas costs 99.9 - Accrued mercury-related costs 7.0 78.0 Other 77.7 65.4 -------- -------- 796.4 1,171.2 -------- --------
Deferred credits and other liabilities Deferred income taxes 224.2 210.2 Regulatory income tax liability 66.3 70.4 Unamortized investment tax credits 39.0 41.1 Accrued mercury-related costs 30.0 - Other 76.6 79.3 -------- -------- 436.1 401.0 -------- --------
$2,300.2 $2,512.6 ======== ========
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 18 - -------------------------------------------------------------------------------
Consolidated Statements of Capitalization (millions, except share data)
December 31 --------------------------------------- 2001 2000 ------------------- ------------------ First Mortgage Bonds Maturity Interest rate -------- ------------- 2001 6.45% $ - $ 75.0 2002 6.75 - 50.0 2003 5.75 50.0 50.0 2006 5.55 50.0 - 2008 5.875 75.0 - 2009 5.37 50.0 50.0 2011 6.625 75.0 - 2016 7.20 50.0 - 2021 8.875 - 50.0 2025 7.26 - 50.0 2027 7.375 50.0 50.0 2028 6.58 50.0 50.0 --------- -------- 450.0 425.0 Less: Amount due within one year - 75.0 Unamortized debt discount, net of premium 3.6 2.9 --------- -------- 446.4 41.8% 347.1 36.9% --------- --------
Other long-term debt Notes payable due 2001 at variable interest rate - 50.0 Less amount due within one year - 50.0 --------- -------- - - - - --------- --------
Preferred stock, cumulative, $100 par value, 800,000 shares authorized Redeemable preferred stock, 4.48% and 5.00% series, 66,000 shares outstanding in 2001 and 71,000 shares outstanding in 2000 6.6 7.1 Less amount due within one year .5 .5 --------- -------- 6.1 .6 6.6 .7 --------- --------
Nonredeemable preferred stock, 4.60% and 5.00% convertible series, 14,008 shares outstanding 1.4 .1 1.4 .1 --------- --------
Common equity Common stock, $5 par value, 25,000,000 shares authorized, 32,365 shares reserved for conversion and 15,232,414 shares outstanding 76.1 76.1 Paid-in capital 108.0 108.0 Retained earnings 431.0 402.0 Accumulated other comprehensive income Cash flow hedges (.3) - Minimum pension liability (1.0) (.8) --------- -------- (1.3) (.8) --------- -------- 613.8 57.5 585.3 62.3 --------- ----- -------- ----- $ 1,067.7 100.0% $ 940.4 100.0% ========= ===== ======== =====
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 19 - -------------------------------------------------------------------------------
Consolidated Statements of Retained Earnings (millions)
Year ended December 31 ------------------------------ 2001 2000 1999 -------- -------- --------
Balance at beginning of year $ 402.0 $ 491.2 $ 495.1
Net income 119.4 22.2 96.1 Dividends declared on common stock (90.0) (111.0) (99.6) Dividends declared on preferred stock (.4) (.4) (.4) -------- -------- -------- Balance at end of year $ 431.0 $ 402.0 $ 491.2 ======== ======== ========
The accompanying notes are an integral part of these statements.
Consolidated Statements of Comprehensive Income (millions)
Year ended December 31 ------------------------------ 2001 2000 1999 -------- -------- --------
Net income $ 119.4 $ 22.2 $ 96.1 Other comprehensive income (loss), net of taxes Gain (loss) on cash flow hedges, net (.3) - - Decrease (increase) to minimum pension liability (.2) (.2) .2 -------- -------- -------- (.5) (.2) .2 -------- -------- -------- Comprehensive income $ 118.9 $ 22.0 $ 96.3 ======== ======== ========
The accompanying notes are an integral part of these statements.
Nicor Gas Company Page 20
Notes to the Consolidated Financial Statements
Nicor Gas is one of the nation's largest distributors of natural gas, serving 2 million customers in a service territory that encompasses most of the northern third of Illinois, excluding the city of Chicago.
ACCOUNTING POLICIES
General. Nicor Gas is a wholly owned subsidiary of Nicor Inc. Nicor Gas and its affiliates reimburse each other for transactions between the companies.
Consolidation. The consolidated financial statements include the accounts of Nicor Gas and its subsidiary. All significant intercompany balances and transactions have been eliminated.
Use of estimates. The preparation of the financial statements requires management to make estimates that affect reported amounts. Actual results could differ from those estimates, and such differences could be material. Accounting estimates requiring significant management judgment include accrued unbilled revenue, prepaid and accrued postretirement benefits, the allowance for doubtful accounts and the liability for the mercury inspection and repair program.
Reclassifications. Certain reclassifications have been made to conform the prior years' financial statements to the current year's presentation.
Regulation. Nicor Gas is regulated by the Illinois Commerce Commission (ICC) which establishes the rules and regulations governing utility rates and services in Illinois. The company applies accounting standards that recognize the economic effects of rate regulation and, accordingly, has recorded regulatory assets and liabilities. The company had regulatory assets and liabilities of $34.9 million and $173.2 million, respectively, at December 31, 2001 and $74.2 million and $70.5 million, respectively, at December 31, 2000.
Operating revenues and gas costs. Operating revenues are recorded when gas is delivered to customers. In accordance with ICC regulations, the cost of gas delivered is charged to customers without markup, although the timing of cost recovery can vary. Temporary undercollections and overcollections of gas costs are deferred or accrued as a regulatory asset or liability with a corresponding decrease or increase to cost of gas. Revenue taxes billed to customers are classified as operating revenues and related taxes due as operating expenses.
Depreciation. Property, plant and equipment are depreciated over estimated useful lives on a straight-line basis. The composite depreciation rate is 4.1 percent.
Income taxes. Nicor Gas files a consolidated federal income tax return with Nicor Inc. Income taxes are allocated to Nicor Gas based upon the tax liability which would have been incurred on a separate company basis. Deferred income taxes are provided for temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements. Nicor Gas amortizes prior investment tax credits and regulatory income tax liabilities to income over the lives of the related properties.
Cash and cash equivalents. The company considers investments purchased with an initial maturity of three months or less, or that are due on demand from an affiliate, to be cash equivalents.
Nicor Gas Company Page 21
Notes to the Consolidated Financial Statements (continued)
Derivative instruments. Derivative instruments are primarily utilized for natural gas procurement. Realized gains or losses on such derivatives are included in the cost of gas delivered and are therefore passed directly through to customers, having no direct impact on earnings. As such, unrealized changes in the fair value of these derivative instruments are being deferred or accrued as a regulatory asset or liability.
In 2001, Nicor Gas entered into futures contracts and swap agreements to reduce the earnings impact of certain operating expenses in the first quarter of 2002 arising from substantial fluctuations in natural gas prices. Unrealized changes in the fair market value of these derivative instruments are reported as a component of accumulated other comprehensive income. Upon settlement of the derivative instruments in 2002, accumulated other comprehensive income will be reclassified to operating and maintenance expense.
In 2001 and 2000, Nicor Gas held derivative instruments to limit the earnings impact of weather fluctuations. Since these instruments settle on December 31 of each year, any benefits recorded in those years did not involve a fair value estimation.
Credit risk. The company has a diversified customer base and prudent credit policies which mitigate customer receivable and derivative counterparty credit risk.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (FAS) No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. FAS 141 is effective for business combinations completed after June 30, 2001, and FAS 142 is effective for 2002. The implementation of these standards had no impact on the company's financial position or results of operations.
In August 2001, the FASB issued FAS 143, Accounting for Asset Retirement Obligations. The standard requires entities to record the fair value of a liability for an asset retirement obligation in the period in which the obligation is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. This standard is effective for 2003. The implementation of this standard is expected to create additional regulatory assets or liabilities, and it is not expected to have a material impact on the company's financial position or results of operations.
GAS IN STORAGE
Based on the average cost of gas purchased in December 2001 and 2000, the estimated replacement cost of inventory at December 31, 2001 and 2000, exceeded the last-in, first-out cost by $139.6 million and $491.7 million, respectively.
Nicor Gas Company Page 22
Notes to the Consolidated Financial Statements (continued)
INCOME TAXES
The components of income tax expense (benefit) are presented below (in millions):
2001 2000 1999 -------- -------- -------- Current Federal $ 33.7 $ 44.8 $ 47.7 State 8.8 6.2 9.7 -------- -------- -------- 42.5 51.0 57.4 -------- -------- -------- Deferred Federal 26.1 (37.7) (.4) State 4.0 (4.9) .4 -------- -------- -------- 30.1 (42.6) - -------- -------- --------
Amortization of investment tax credits, net (2.1) (1.5) (1.5) -------- -------- --------
Income tax expense, net $ 70.5 $ 6.9 $ 55.9 ======== ======== ========
The temporary differences which gave rise to the net deferred tax liability at December 31, 2001 and 2000, are as follows (in millions):
2001 2000 -------- -------- Deferred tax liabilities Property, plant and equipment $ 212.3 $ 215.1 Employee benefits 32.7 24.1 Gas costs recovery accounts 9.0 17.1 Other 14.7 10.1 -------- -------- 268.7 266.4 -------- -------- Deferred tax assets Unamortized investment tax credits 25.3 26.6 Regulatory income tax liability 16.3 17.4 Accrued mercury-related costs 14.7 30.9 Other 14.1 27.4 -------- -------- 70.4 102.3 -------- -------- Net deferred tax liability $ 198.3 $ 164.1 ======== ========
The effective combined federal and state income tax rate was 37.1 percent, 23.6 percent and 36.8 percent in 2001, 2000 and 1999, respectively. Differences between federal income taxes computed using the statutory rate and reported income tax expense are shown below (in millions):
2001 2000 1999 -------- -------- -------- Federal income taxes using statutory rate $ 66.5 $ 10.1 $ 53.2 State income taxes, net 8.3 1.5 7.3 Tax credits (2.3) (2.4) (2.4) Regulatory income tax liability (2.1) (2.4) (2.1) Other, net .1 .1 (.1) -------- -------- -------- Income tax expense, net $ 70.5 $ 6.9 $ 55.9 ======== ======== ========
Nicor Gas Company Page 23
Notes to the Consolidated Financial Statements (continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The recorded amount of short-term borrowings approximates fair value because of the short maturity of the instruments. Based on quoted market interest rates, the recorded amount of long-term debt outstanding, including current maturities, also approximates fair value.
SHORT- AND LONG-TERM DEBT
The company maintains short-term lines of credit with major domestic and foreign banks. These lines, which serve as backup for the issuance of commercial paper, totaled $450 million at December 31, 2001. Commitment fees of up to .08 percent per annum were paid on these lines. All lines of credit have variable interest rates tied to short-term markets.
The company had $227 million and $315 million of commercial paper outstanding with a weighted average interest rate of 2.8 percent and 6.5 percent at December 31, 2001 and 2000, respectively.
Bank cash balances averaged about $2 million during 2001, which partially compensated for the cost of maintaining accounts and other banking services. Such demand balances may be withdrawn at any time.
First Mortgage Bonds are secured by liens on substantially all property.
Interest on debt was net of amounts capitalized of $.2 million, $.4 million and $.1 million in 2001, 2000 and 1999, respectively.
Nicor Gas Company Page 24
Notes to the Consolidated Financial Statements (continued)
POSTRETIREMENT BENEFITS
Nicor Gas maintains noncontributory defined benefit pension plans covering substantially all employees hired prior to 1998 and provides health care and life insurance benefits to eligible retired employees. Most employees' postretirement health care benefits have been capped to a defined annual per capita medical cost. The following table sets forth the changes in the plans' benefit obligations and assets, and reconciles the funded status of the plans to the prepaid (accrued) benefit cost recorded on the balance sheet at December 31 (in millions):
Pension benefits Other benefits -------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Change in benefit obligation Benefit obligation at beginning of period $ 211.5 $ 209.4 $ 112.6 $ 116.1 Service cost 6.5 5.3 1.2 1.2 Interest cost 16.5 14.9 8.4 8.4 Actuarial loss (gain) 32.0 7.1 29.1 (5.3) Participant contributions - - .8 .7 Plan amendments - 3.0 - - Benefits paid (29.0) (28.2) (10.2) (8.5) -------- -------- -------- -------- Benefit obligation at end of period 237.5 211.5 141.9 112.6 -------- -------- -------- --------
Change in plan assets Fair value of plan assets at beginning of period 489.2 445.3 22.6 19.4 Actual gain (loss) on plan assets (60.5) 72.1 (2.9) 3.2 Employer contributions - - 9.4 7.8 Participant contributions - - .8 .7 Benefits paid (29.0) (28.2) (10.2) (8.5) -------- -------- -------- -------- Fair value of plan assets at end of period 399.7 489.2 19.7 22.6 -------- -------- -------- --------
Funded status 162.2 277.7 (122.2) (90.0) Unrecognized net actuarial (2.0) (135.9) 29.4 (4.7) (gain) loss Unrecognized transition (1.0) (4.8) 34.0 37.1 (asset) obligation Unrecognized prior service 5.1 5.7 - - cost Other - - (1.8) 1.2 -------- -------- -------- -------- Prepaid (accrued) benefit cost $ 164.3 $ 142.7 $ (60.6) $ (56.4) ======== ======== ======== ========
Net periodic benefit cost (credit) included the following components (in millions):
Pension benefits Other benefits ---------------------- ---------------------- 2001 2000 1999 2001 2000 1999 ------ ------ ------ ------ ------ ------ Service cost $ 6.5 $ 5.3 $ 6.2 $ 1.2 $ 1.2 $ 1.3 Interest cost 16.5 14.9 15.3 8.4 8.4 7.7 Expected return on plan assets (44.3) (39.1) (35.3) (2.1) (1.8) (1.6) Recognized net actuarial (loss) gain 2.9 (5.9) (1.9) - - - Amortization of unrecognized transition (asset) obligation (3.8) (3.9) (3.9) 3.1 3.1 3.1 Amortization of prior service cost .6 .4 .4 - - - ------ ------ ------ ------ ------ ------ Net periodic benefit cost (credit) $(21.6) $(28.3) $(19.2) $ 10.6 $ 10.9 $ 10.5 ====== ====== ====== ====== ====== ======
Nicor Gas Company Page 25
Notes to the Consolidated Financial Statements (continued)
Assumptions used in the computations included the following:
Pension benefits Other benefits -------------------- ------------------ 2001 2000 2001 2000 -------- -------- -------- -------- Discount rate 7.25% 7.75% 7.25% 7.75% Expected return on plan assets 9.25 9.25 9.25 9.25 Rate of compensation increase 4.00 4.00 4.00 4.00
For measurement purposes, the health care cost trend rate for pre-Medicare benefits was assumed to be 10 percent for 2002, declining to 5 percent by 2007 and remaining at that level thereafter. The health care cost trend rate for post-Medicare benefits was assumed to be 7.5 percent for 2002, declining to 5 percent by 2006 and remaining at that level thereafter.
Assumed health care cost trend rates can have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in the assumed health care cost trend rates would have the following effects (in millions):
One-percent ------------------ Increase Decrease -------- -------- Effect on total of service and interest cost components $ 1.0 $ (.8) Effect on benefit obligation 14.1 (11.9)
Nicor Gas also has a separate unfunded supplemental retirement plan. The plan is noncontributory with defined benefits. Plan costs were $.8 million, $.6 million and $.7 million in 2001, 2000 and 1999, respectively. The benefit obligation of the plan was $6.4 million and $5.7 million at December 31, 2001 and 2000, respectively.
The company also sponsors defined contribution plans covering substantially all domestic employees. These plans provide for employer matching contributions. The total cost of these plans was $3.9 million, $3.9 million and $3.7 million in 2001, 2000 and 1999, respectively.
REGULATORY MATTERS
Performance-based rate plan. On January 1, 2000, Nicor Gas' performance-based rate (PBR) plan for natural gas costs went into effect. Under the PBR plan, Nicor Gas' total gas supply costs are compared to a market-sensitive benchmark. Savings and losses relative to the benchmark are shared equally with customers. Nicor Gas recorded $14.9 million and $12.2 million for its share of PBR plan results as pretax other income in 2001 and 2000, respectively. In 2002, the plan is subject to ICC review.
Customer choice of commodity supplier. In January 2002, the company received final approval from the ICC to expand its Customer Select(R) program to include all customers beginning in March 2002. The program is currently available to all industrial and commercial customers and about 15 percent of residential customers. Under the program, customers are able to acquire their natural gas supplies from third-party marketers. The choice of another natural gas commodity supplier has no direct impact on Nicor Gas' margin because natural gas costs are passed through to customers without markup. Nicor Gas continues to deliver the natural gas, maintain its distribution system and respond to emergencies.
Nicor Gas Company Page 26
Notes to the Consolidated Financial Statements (continued)
RELATED PARTY TRANSACTIONS
Nicor Gas had $40 million of short-term notes payable due to an affiliated financing company as of December 31, 2001 and 2000, respectively. Nicor Gas recorded $2.2 million and $1.0 million of interest expense related to short-term borrowings from the affiliated financing company in 2001 and 2000, respectively. The Company also had $.6 million of short-term notes payable due to Nicor Inc. at December 31, 2000.
Nicor Gas enters into transactions to buy and sell natural gas with an affiliated wholesale natural gas marketing company. Such transactions are in the ordinary course of business at negotiated prices comparable to those available on the open market. Nicor Gas purchased $34.6 million and $14.9 million of natural gas from and sold $25.0 million and $24.2 million of natural gas to the affiliated wholesale natural gas marketing company in 2001 and 2000, respectively.
CONTRACTUAL OBLIGATIONS
As of December 31, 2001, Nicor Gas had contractual obligations with payments due as follows (in millions):
after 2002 2003 2004 2005 2006 2006 Total ------ ------ ------ ------ ------ ------ ------- Long-term debt $ - $ 50.0 $ - $ - $ 50.0 $350.0 $ 450.0 Unconditional purchase obligations 129.4 78.9 30.6 10.4 10.4 54.4 314.1 Other 1.8 .9 .6 .5 .5 5.0 9.3 ------ ------ ------ ------ ------ ------ ------- $131.2 $129.8 $ 31.2 $ 10.9 $ 60.9 $409.4 $ 773.4 ====== ====== ====== ====== ====== ====== =======
Unconditional purchase obligations primarily consist of transportation and storage contracts. This includes a 10-year transportation agreement between Nicor Gas and Horizon Pipeline totaling $103.7 million.
Other consists of redeemable preferred stock and operating leases. Operating leases are primarily for office space and equipment. Rental expense under operating leases was $1.5 million, $1.5 million and $1.2 million in 2001, 2000 and 1999, respectively.
CONTINGENCIES
Mercury program. Nicor Gas has incurred, and expects to continue to incur, significant costs related to its historical use of mercury in various kinds of company equipment.
Prior to 1961, gas regulators containing small quantities of mercury were installed in homes. These gas regulators reduce the pressure of natural gas flow from the service line to the inside of the home. During the third quarter of 2000, the company learned that in certain instances some mercury was spilled or left in residences.
As a result, in September 2000, Nicor Gas was named as a defendant in a civil lawsuit (the "Attorney General's Lawsuit") brought by the Illinois Attorney General and the State's Attorneys of Cook, DuPage and Will Counties seeking, among other things, to compel the company to inspect and clean up all homes and other sites that may have been affected by mercury from company equipment. The Circuit Court of
Nicor Gas Company Page 27
Notes to the Consolidated Financial Statements (continued)
Cook County hearing this action entered two preliminary injunctions requiring Nicor Gas, among other things, to conduct inspections and, where necessary, to clean up mercury, to pay for relocating residents until cleanup is completed, and to pay for medical screening of potentially affected persons. Potentially affected homes are being inspected using mercury vapor analyzers. Nicor Gas has called on every such home, although it still has been unable to gain entry to some homes. Approximately 1,060 homes have been found to have traces of mercury requiring cleanup.
On October 10, 2001 Nicor Gas entered into a settlement agreement with respect to the Attorney General's Lawsuit, and on the same date the Circuit Court of Cook County entered an order approving the settlement. Under the settlement, Nicor Gas will pay a total of approximately $2.25 million over a 5-year period. Of this amount, $.4 million will be used to reimburse the plaintiffs for their costs and the balance will be used to fund environmental programs. In addition, Nicor Gas will continue for a period of five years to provide medical screening to persons who may have been exposed to mercury from Nicor Gas equipment.
Nicor Gas is also the subject of an Administrative Order, and an amendment thereto, issued during the third quarter of 2000 by the U.S. Environmental Protection Agency (EPA) pursuant to Section 106 of the Comprehensive Environmental Response, Compensation and Liabilities Act. The order requires the company, among other things, to develop and implement work plans to address mercury spills at recycling centers where mercury regulators may have been taken, at company facilities where regulators and mercury may have been temporarily stored and at commercial/industrial sites where mercury-containing equipment may have been used in metering facilities. Pursuant to the injunctions and the EPA Administrative Order, Nicor Gas has completed the work described above for all affected recycling centers, commercial/industrial sites and company facilities. On July 12, 2001, Nicor Gas received a Notice of Completion letter from the EPA regarding the work performed under the Section 106 Administrative Order.
In addition to the matters described above, Nicor Gas has been named a defendant in several private lawsuits, all in the Circuit Court of Cook County, claiming a variety of unquantified damages (including bodily injury, property and punitive damages) allegedly caused by mercury-containing regulators. One of the lawsuits involves five previous class actions that have been consolidated before a single judge. On October 10, 2001, Nicor Gas entered into an agreement to settle the class action litigation. Under the terms of that agreement, Nicor Gas will pay a total of approximately $1.85 million, will continue for a period of five years to provide medical screening to persons exposed to mercury from its equipment, and will use its best efforts to replace any remaining inside residential mercury regulators within four years. The class action settlement permits class members to "opt out" of the settlement and pursue their claims individually. On February 7, 2002, the Circuit Court of Cook County entered a final order approving the class action settlement.
Nicor Gas charged $148 million to other operating expense in the third quarter of 2000 for estimated obligations related to the previously described work and for legal defense costs. A $9 million adjustment lowered the mercury-related reserve and reduced other operating expense in the third quarter of 2001. The adjustment reflects more recent experience which indicates a lower number of homes expected to be found with traces of mercury requiring cleanup and a lower average cleanup and repair cost. Through December 31, 2001, the company has incurred $102 million in associated costs, leaving a $37 million liability. The remaining liability represents management's best estimate of future costs, including potential liabilities relating to remaining lawsuits, based on an evaluation of currently available information. Actual costs may vary from this estimate. The company will continue to reassess its estimated obligation and will record any necessary adjustment, which could be material to operating results in the period recorded. Nicor Gas Company Page 28
Notes to the Consolidated Financial Statements (continued)
The company has certain insurance policies, has notified its insurers, and is vigorously pursuing recovery of mercury-related costs pursuant to its insurance coverage. In January 2001, the company filed suit in the Circuit Court of Cook County against certain of its insurance carriers for a declaration that the company's mercury-related losses are covered, and for the recovery of those losses. Nicor Gas is also pursuing certain insurance recoveries through arbitration. In addition, some of the removals of mercury-containing regulators were conducted by independent contractors working for the company. In November 2000, the company filed suit in the Circuit Court of Cook County seeking indemnification and contribution from these contractors. Through December 31, 2001, Nicor Gas has recovered, net of related expenses, $3.2 million from certain insurance carriers of the company and its independent contractors. These recoveries have been recorded as a reduction to other operating expense. At this stage, it is not possible to estimate the likelihood of additional recoveries from insurance carriers or other third parties related to the mercury spills, and Nicor Gas has not recorded any such amounts as assets in its financial statements.
Nicor Gas will not seek recovery of the costs associated with these mercury spills from its customers, and any proceeds from insurance carriers or third parties will be retained by the company to offset costs incurred.
It is management's opinion, taking into account the above information and uncertainties, including currently available information concerning the company's existing and potential obligations, insurance coverage, possible recoveries from third parties and available financial resources, that costs associated with the mercury spills will not have a material adverse effect on the liquidity or financial position of the company.
Manufactured gas plant sites. Gas manufacturing plants were used by Nicor Gas' predecessor companies in the early 1900's to produce natural gas from coal, producing a coal tar byproduct. Current environmental laws may require the cleanup of coal tar at certain former manufactured gas plant sites.
To date, Nicor Gas has identified about 40 properties for which it may, in part, be responsible. The majority of these properties are not presently owned by the company. Information regarding preliminary site reviews has been presented to the Illinois Environmental Protection Agency. More detailed investigations and remedial activities are either in progress or planned at many of these sites. The results of continued testing and analysis should determine to what extent additional remediation is necessary and may provide a basis for estimating any additional future costs which, based on industry experience, could be significant. In accordance with ICC authorization, the company has been recovering these costs from its customers.
In December 1995, Nicor Gas filed suit in the Circuit Court of Cook County against certain insurance carriers seeking recovery of environmental cleanup costs of certain former manufactured gas plant sites. Nicor Gas reached a settlement with one of the insurance carriers, and in February 2000, the court dismissed the company's case on summary judgment motions by certain other defendants. The company filed an appeal in March 2000. In May of 2001, Nicor Gas reached a recovery settlement with certain insurance carriers who were involved in this appeal. Management cannot predict the outcome of the lawsuit against the remaining insurance carriers. Recoveries are refunded to the company's customers.
In December 2001, a putative class action lawsuit was filed against Exelon Corporation, Commonwealth Edison Company and Nicor Gas in the Circuit Court of Cook County alleging, among other things, that the proposed residential cleanup of a manufactured gas plant site in Oak Park, Illinois was inadequate. The lawsuit claims that houses might have to be razed or removed and asks that residents be compensated for the alleged loss in the value of their homes. Management cannot predict the outcome of this litigation.
Nicor Gas Company Page 29
Notes to the Consolidated Financial Statements (concluded)
Since costs and recoveries relating to the cleanup of these manufactured gas plant sites are passed directly through to customers in accordance with ICC regulations, the final disposition of these matters is not expected to have a material impact on the company's financial condition or results of operations.
Other. The company is involved in legal or administrative proceedings before various courts and agencies with respect to rates, taxes and other matters.
Although unable to determine the outcome of these other contingencies, management believes that appropriate accruals have been recorded. Final disposition of these matters is not expected to have a material impact on the company's financial condition or results of operations.
QUARTERLY RESULTS (UNAUDITED)
Summarized quarterly financial data is presented below (in millions).
Quarter ended ------------------------------------------- Mar. 31 June 30 Sept. 30 Dec. 31 --------- --------- ---------- ---------
Operating revenues $ 1,344.0 $ 271.8 $ 153.0 $ 337.1 Operating income 44.1 33.9 32.1 38.0 Net income 33.2 24.1 27.0 35.0
Operating revenues $ 572.4 $ 262.1 $ 197.6 $ 851.6 Operating income (loss) 44.2 32.5 (62.4) 39.4 Net income (loss) 34.1 24.7 (67.0) 30.4
Nicor Gas Company Page 30
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1) Financial Statements:
See Item 8, Financial Statements and Supplementary Data, on page 13 filed herewith, for a list of financial statements.
2) Financial Statement Schedules:
Schedule Number Page
Report of Independent Public Accountants 14 II Valuation and Qualifying Accounts 31
Schedules other than those listed are omitted because they are not applicable.
3) Exhibits Filed:
See Exhibit Index beginning on page 34 filed herewith.
(b) The company did not file a report on Form 8-K during the fourth quarter of 2001.
Nicor Gas Company Page 31 - -------------------------------------------------------------------------------
Schedule II
VALUATION AND QUALIFYING ACCOUNTS (millions)
Additions ---------------------- Balance at Charged to Charged to Balance beginning costs and other at end Description of period expenses accounts Deductions of period - -------------------- --------- --------- ---------- ---------- ----------
- ------- Allowance for uncollectible accounts receivable $ 13.4 $ 23.3 $ - $ 27.1 (a) $ 9.6
Accrued mercury-related costs 78.0 - - 41.0 (b) 37.0
- ------- Allowance for uncollectible accounts receivable $ 6.1 $ 16.6 $ - $ 9.3 (a) $ 13.4
Accrued mercury-related costs - 148.0 - 70.0 (b) 78.0
- ------- Allowance for uncollectible accounts receivable $ 6.1 $ 11.8 $ - $ 11.8 (a) $ 6.1
Accrued mercury-related costs - - - - -
(a) Accounts receivable written off, net of recoveries. (b) Expenditures and reductions charged to reserve.
Nicor Gas Company Page 32
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Nicor Gas Company
Date March 8, 2002 By /s/ KATHLEEN L. HALLORAN ------------------------ ------------------------ Kathleen L. Halloran Executive Vice President Finance and Administration
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 8, 2002.
Signature Title - ------------------------------------- ------------------------------------
/s/ THOMAS L. FISHER - ------------------------------------- Thomas L. Fisher Chairman, President and (Principal Executive Officer) Chief Executive Officer
/s/ KATHLEEN L. HALLORAN - ------------------------------------- Kathleen L. Halloran Executive Vice President Finance (Principal Financial and Accounting and Administration Officer)
ROBERT M. BEAVERS, JR.* Director
BRUCE P. BICKNER* Director
JOHN H. BIRDSALL, III* Director
THOMAS A. DONAHOE* Director
JOHN E. JONES* Director
DENNIS J. KELLER* Director
WILLIAM A. OSBORN* Director
JOHN RAU* Director
JOHN F. RIORDAN* Director
PATRICIA A. WIER* Director
* By /s/ JEFFREY L. METZ ---------------------- Jeffrey L. Metz (Attorney-in-fact)
Nicor Gas Company Page 33
Supplemental Information
Supplemental Information to be Furnished With Reports Filed Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Act:
No annual report or proxy material has been sent to security holders as Nicor Gas is a wholly owned subsidiary of Nicor Inc.
Nicor Gas Company Page 34
Exhibit Index
Exhibit Number Description of Document - ------ ------------------------------------------------------------------
1.01 Underwriting agreement, dated December 13, 2001, between the company and ABN AMRO Incorporated.
3.01 * Articles of Incorporation of the company. (File No. 1-7296, Form 10-K for 1980, Exhibit 3-01.)
3.02 * Amendment to Articles of Incorporation of the company. (File No. 1-7296, Form 10-Q for June 1994, Exhibit 3.01.)
3.03 * By-Laws of the company as amended by the company's Board of Directors on May 3, 1995. (File No. 1-7296, Form 10-Q for March 1995, Exhibit 3(ii).01.)
4.01 * Indenture of Commonwealth Edison Company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, dated as of January 1, 1954. (File No. 1-7296, Form 10-K for 1995, Exhibit 4.01.)
4.02 * Indenture of Adoption of the company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, dated February 9, 1954. (File No. 1-7296, Form 10-K for 1995, Exhibit 4.02.)
4.03 * Supplemental Indenture, dated June 1, 1963, of the company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, under Indenture dated as of January 1, 1954. (File No. 2-21490, Form S-9, Exhibit 2-8.)
4.04 * Supplemental Indenture, dated May 1, 1966, of the company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, under Indenture dated as of January 1, 1954. (File No. 2-25292, Form S-9, Exhibit 2-4.)
4.05 * Supplemental Indenture, dated June 1, 1971, of the company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, under Indenture dated as of January 1, 1954. (File No. 2-44647, Form S-7, Exhibit 2-03.)
4.06 * Supplemental Indenture, dated April 30, 1976, between Nicor Inc. and Continental Illinois National Bank and Trust Company of Chicago, Trustee, under Indenture dated as of January 1, 1954. (File No. 2-56578, Form S-9, Exhibit 2-25.)
4.07 * Supplemental Indenture, dated April 30, 1976, of the company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, under Indenture dated as of January 1, 1954. (File No. 2-56578, Form S-9, Exhibit 2-21.)
4.08 * Supplemental Indenture, dated August 15, 1991, of the company to Continental Bank, National Association, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 8-K for August 1991, Exhibit 4-01.)
4.09 * Supplemental Indenture, dated October 15, 1995, of the company to Bank of America Illinois, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for September 1995, Exhibit 4.01.)
Nicor Gas Company Page 35
Exhibit Index (continued)
Exhibit Number Description of Document - ------ ------------------------------------------------------------------
4.10 * Supplemental Indenture, dated May 10, 1996, of the company to Harris Trust and Savings Bank, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for June 1996, Exhibit 4.01.)
4.11 * Supplemental Indenture, dated August 1, 1996, of the company to Harris Trust and Savings Bank, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for June 1996, Exhibit 4.02.)
4.12 * Supplemental Indenture, dated June 1, 1997, of the company to Harris Trust and Savings Bank, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for June 1997, Exhibit 4.01.)
4.13 * Supplemental Indenture, dated October 15, 1997, of the company to Harris Trust and Savings Bank, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for September 1997, Exhibit 4.01.)
4.14 * Supplemental Indenture, dated February 15, 1998, of the company to Harris Trust and Savings Bank, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-K for 1997, Exhibit 4.19.)
4.15 * Supplemental Indenture, dated June 1, 1998, of the company to Harris Trust and Savings Bank, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for June 1998, Exhibit 4.01.)
4.16 * Supplemental Indenture, dated February 1, 1999, of the company to Harris Trust and Savings Bank, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-K for 1998, Exhibit 4.19.)
4.17 * Supplemental Indenture, dated February 1, 2001, of the company to BNY Midwest Trust Company, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-K for 2000, Exhibit 4.17.)
4.18 * Supplemental Indenture, dated May 15, 2001, of the company to BNY Midwest Trust Company, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for June 2001, Exhibit 4.01.)
4.19 * Supplemental Indenture, dated August 15, 2001, of the company to BNY Midwest Trust Company, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for September 2001, Exhibit 4.01.)
4.20 Supplemental Indenture, dated December 15, 2001, of the company to BNY Midwest Trust Company, Trustee, under Indenture dated as of January 1, 1954.
Other debt instruments are omitted in accordance with Item 601(b)(4)(iii)(A) of Regulation S-K. Copies of such agreements will be furnished to the Commission upon request.
Nicor Gas Company Page 36
Exhibit Index (concluded)
Exhibit Number Description of Document - ------ ------------------------------------------------------------------
12.01 Computation of Consolidated Ratio of Earnings to Fixed Charges.
23.01 Consent of Independent Public Accountants.
24.01 Powers of Attorney.
* These exhibits have been previously filed with the Securities and Exchange Commission as exhibits to registration statements or to other filings with the Commission and are incorporated herein as exhibits by reference. The file number and exhibit number of each such exhibit, where applicable, are stated, in parentheses, in the description of such exhibit.
Upon written request, the company will furnish free of charge a copy of any exhibit. Requests should be sent to Investor Relations at the corporate headquarters.