**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 Washington,
        D.C. 20549
 
 **FORM
        10-Q**
 
 [X]
              QUARTERLY
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
                  EXCHANGE ACT OF 1934
 
 **For
        the quarterly period ended September 30, 2006**
 
 or
 
 [
                  ]
              TRANSITION
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
                  EXCHANGE ACT OF 1934
 
 
 Commission
        File Number 1-7297
 
 
 **NICOR
        INC.**
 (Exact
        name of registrant as specified in its charter)
 
 
 **Illinois**
              **36-2855175**(State
                  of Incorporation)
              (I.R.S.
                  EmployerIdentification
                  Number)
 
 **1844
                  Ferry Road****Naperville,
                  Illinois 60563-9600**
              **(630)
                  305-9500**(Address
                  of principal executive offices)
              (Registrant’s
                  telephone number)
 
 
 Indicate
        by check mark whether the registrant (1) has filed all reports required to
        be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months and (2) has been subject to such filing requirements
        for the
        past 90 days. Yes [X] No [ ]
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in rule 12b-2 of the Exchange Act. (Check
        one):
 
 Large
                  accelerated filer [X]
              Accelerated
                  filer [ ]
              Non-accelerated
                  filer [ ]
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act). Yes [ ] No [X]
 
 Indicate
        the number of shares outstanding of each of the issuer’s classes of common
        stock, as of the latest practicable date. Common stock, par value $2.50,
        outstanding at October 27, 2006, were 44,709,976 shares.
 
 
  
  **Table
        of Contents**
 
 **Glossary**
              
              ii**Part
                  I - Financial Information**Item
                  1.
              Financial
                  Statements (Unaudited)Condensed
                  Consolidated Statements of
                  Operations:
              1Three
                  and nine months endedSeptember
                  30, 2006 and 2005Condensed
                  Consolidated Statements of Cash
                  Flows:
              2Nine
                  months endedSeptember
                  30, 2006 and 2005Condensed
                  Consolidated Balance
                  Sheets:
              3September
                  30, 2006 and 2005, andDecember
                  31, 2005Notes
                  to the Condensed Consolidated Financial Statements
              4Item
                  2.
              Management’s
                  Discussion and Analysis of
                  Financial Condition and Results of Operations
              22Item
                  3.
              Quantitative
                  and Qualitative Disclosures About Market
                  Risk
              36Item
                  4.
              Controls
                  and Procedures
              36**Part
                  II - Other Information**Item
                  1.
              Legal
                  Proceedings
              37Item
                  2.
              Unregistered
                  Sales of Equity Securities and Use of
                  Proceeds
              37Item
                  6.
              Exhibits
              37Signature
              38
 
 
 
 
 
 
 i
  Table
            of Contents
  **Glossary**
 
 **Chicago
        Hub.** A
        venture of Northern Illinois Gas Company, doing business as Nicor Gas Company
        (“Nicor Gas”) which provides natural gas storage and transmission-related
        services to marketers and other gas distribution companies.
 
 **Degree
        day.** The
        extent to which the daily average temperature falls below 65 degrees Fahrenheit.
        Normal weather for Nicor Gas’ service territory, for purposes of this report, is
        considered to be 5,830 degree days per year.
 
 **EN
        Engineering.** EN
        Engineering, L.L.C., **** a
        50-percent-owned joint venture that provides engineering and corrosion
        services.
 
 **FERC.** Federal
        Energy Regulatory Commission, the agency that regulates the interstate
        transportation of natural gas, oil and electricity.
 
 **Horizon
        Pipeline.** Horizon
        Pipeline Company, L.L.C., a 50-percent-owned joint venture that operates
        an
        interstate regulated natural gas pipeline of approximately 70 miles, stretching
        from Joliet, Illinois to near the Wisconsin/Illinois border.
 
 **ICC.** Illinois
        Commerce Commission, the agency that establishes the rules and regulations
        governing utility rates and services in Illinois.
 
 **Mcf,
        MMcf, Bcf .** Thousand
        cubic feet, million cubic feet, billion cubic feet.
 
 **Nicor
        Enerchange.** Nicor
        Enerchange, L.L.C., a wholly owned business that engages in wholesale marketing
        of natural gas supply services primarily in the Midwest, administers the
        Chicago
        Hub for Nicor Gas, and manages Nicor’s other energy ventures’ product
        risks.
 
 **Nicor
        Gas.** Northern
        Illinois Gas Company (doing business as Nicor Gas Company) is a wholly owned
        public utility business and one of the nation’s largest distributors of natural
        gas.
 
 **Nicor
        Services.** Nicor
        Energy Services Company **,** a
        wholly
        owned business that provides customer relationship management services to
        businesses and product warranty contracts, heating, ventilation and air
        conditioning repair, maintenance and installation services and equipment
        to
        retail markets, including residential and small commercial
        customers.
 
 **Nicor
        Solutions.** Nicor
        Solutions, L.L.C., a wholly owned business that offers residential and small
        commercial customers energy-related products that provide for natural gas
        cost
        stability and management of their utility bill.
 
 **PBR.** Performance-based
        rate, a regulatory plan which ended on January 1, 2003, that provided economic
        incentives based on natural gas cost performance.
 
 **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 leading carrier of containerized freight in the Bahamas
        and
        the Caribbean region.
 
 ii




Table
          of Contents


**PART
                  I - FINANCIAL
                  INFORMATION****Item
                  1. Financial Statements****Nicor
                  Inc.****Condensed
                  Consolidated Statements of Operations (Unaudited)****(millions,
                  except per share data)****Three
                  months ended**
              
              **Nine
                  months ended****September
                  30**
              
              **September
                  30****2006**
              
              2005
              
              **2006**
              
              2005Operating
                  revenuesGas
                  distribution (includes revenue taxes of$12.9,
                  $12.8, $111.5 and $112.4, respectively)
              
              **$**
              **226.7**
              
              $
              241.5
              
              **$**
              **1,775.6**
              
              $
              1,692.6Shipping
              
              
              **98.3**
              
              
              91.9
              
              
              **288.1**
              
              
              274.7Other
                  energy ventures
              
              
              **34.0**
              
              
              9.2
              
              
              **135.1**
              
              
              89.7Corporate
                  and eliminations
              
              
              **(7.9**
              **)**
              
              (6.6
              )
              
              **(77.0**
              **)**
              
              (56.8
              )Total
                  operating revenues
              
              
              **351.1**
              
              
              336.0
              
              
              **2,121.8**
              
              
              2,000.2Operating
                  expensesGas
                  distributionCost
                  of gas
              
              
              **108.0**
              
              
              134.9
              
              
              **1,258.8**
              
              
              1,202.3Operating
                  and maintenance
              
              
              **56.6**
              
              
              51.0
              
              
              **199.9**
              
              
              178.4Depreciation
              
              
              **40.1**
              
              
              38.6
              
              
              **120.3**
              
              
              115.9Taxes,
                  other than income taxes
              
              
              **17.0**
              
              
              16.6
              
              
              **123.2**
              
              
              124.0Mercury-related
                  costs (recoveries), net
              
              
              -
              
              
              .1
              
              
              **(3.6**
              **)**
              
              .3Property
                  sale gains
              
              
              **(.6**
              **)**
              
              (.1
              )
              
              **(3.2**
              **)**
              
              (.2
              )Shipping
              
              
              **87.8**
              
              
              82.5
              
              
              **258.6**
              
              
              242.8Other
                  energy ventures
              
              
              **27.1**
              
              
              20.9
              
              
              **134.4**
              
              
              98.3Litigation
                  charges (recoveries), net
              
              
              -
              
              
              -
              
              
              **10.0**
              
              
              (29.9
              )Other
                  corporate expenses and eliminations
              
              
              **(13.4**
              **)**
              
              (9.1
              )
              
              **(88.1**
              **)**
              
              (60.1
              )Total
                  operating expenses
              
              
              **322.6**
              
              
              335.4
              
              
              **2,010.3**
              
              
              1,871.8Operating
                  income
              
              
              **28.5**
              
              
              .6
              
              
              **111.5**
              
              
              128.4Interest
                  expense, net of amounts capitalized
              
              
              **11.1**
              
              
              10.6
              
              
              **35.5**
              
              
              32.8Equity
                  investment income, net
              
              
              **5.4**
              
              
              2.9
              
              
              **9.2**
              
              
              6.8Interest
                  income
              
              
              **2.5**
              
              
              1.6
              
              
              **7.9**
              
              
              4.3Other
                  income (expense), net
              
              
              -
              
              
              (.1
              )
              
              **.4**
              
              
              .4Income
                  (loss) before income taxes
              
              
              **25.3**
              
              
              (5.6
              )
              
              **93.5**
              
              
              107.1Income
                  tax expense (benefit)
              
              
              **7.7**
              
              
              (2.9
              )
              
              **23.5**
              
              
              32.7Net
                  income (loss)
              
              **$**
              **17.6**
              
              $
              (2.7
              )
              **$**
              **70.0**
              
              $
              74.4Average
                  shares of common stock outstandingBasic
              
              
              **44.7**
              
              
              44.2
              
              
              **44.5**
              
              
              44.1Diluted
              
              
              **44.8**
              
              
              44.5
              
              
              **44.6**
              
              
              44.4Earnings
                  (loss) per average share of common stockBasic
              
              **$**
              **.39**
              
              $
              (.06
              )
              **$**
              **1.57**
              
              $
              1.69Diluted
              
              
              **.39**
              
              
              (.06
              )
              
              **1.57**
              
              
              1.67Dividends
                  declared per share of common stock
              
              **$**
              **.465**
              
              $
              .465
              
              **$**
              **1.395**
              
              $
              1.395The
                  accompanying notes are an integral part of these
                  statements.







1




Table
          of Contents


**Nicor
                  Inc.****Condensed
                  Consolidated Statements of Cash Flows (Unaudited)****(millions)****Nine
                  months ended****September
                  30****2006**
              
              2005Operating
                  activitiesNet
                  income
              
              **$**
              **70.0**
              
              $
              74.4Adjustments
                  to reconcile net income to net cash flowprovided
                  from operating activities:Depreciation
              
              
              **133.7**
              
              
              129.3Deferred
                  income tax benefit
              
              
              **(45.2**
              **)**
              
              (46.9
              )Gain
                  on sale of property, plant and equipment
              
              
              **(3.1**
              **)**
              
              (.1
              )Gain
                  on sale of equity investment
              
              
              **(2.4**
              **)**
              
              -Changes
                  in assets and liabilities:Receivables,
                  less allowances
              
              
              **554.9**
              
              
              291.0Gas
                  in storage
              
              
              **58.0**
              
              
              (136.6
              )Deferred/accrued
                  gas costs
              
              
              **(114.3**
              **)**
              
              217.2Other
                  assets
              
              
              **14.1**
              
              
              (92.0
              )Accounts
                  payable
              
              
              **(138.8**
              **)**
              
              130.1Other
                  liabilities
              
              
              **48.7**
              
              
              7.3Other
                  items
              
              
              **(27.1**
              **)**
              
              23.7Net
                  cash flow provided from operating activities
              
              
              **548.5**
              
              
              597.4Investing
                  activitiesCapital
                  expenditures
              
              
              **(128.5**
              **)**
              
              (145.4
              )Additions
                  to restricted short-term investments
              
              
              **(10.0**
              **)**
              
              -Net
                  increase in other short-term investments
              
              
              **(8.3**
              **)**
              
              (34.9
              )Net
                  proceeds from sale of property, plant and equipment
              
              
              **3.6**
              
              
              .4Net
                  proceeds from sale of equity investment
              
              
              **7.0**
              
              
              -Other
                  investing activities
              
              
              **4.1**
              
              
              (1.1
              )Net
                  cash flow used for investing activities
              
              
              **(132.1**
              **)**
              
              (181.0
              )Financing
                  activitiesRepayments
                  of long-term debt
              
              
              **(28.0**
              **)**
              
              -Net
                  repayments of commercial paper with maturities of90
                  days or less
              
              
              **(435.0**
              **)**
              
              (346.0
              )Dividends
                  paid
              
              
              **(62.1**
              **)**
              
              (61.6
              )Proceeds
                  from exercise of stock options
              
              
              **14.1**
              
              
              1.4Other
                  financing activities
              
              
              **3.7**
              
              
              .3Net
                  cash flow used for financing activities
              
              
              **(507.3**
              **)**
              
              (405.9
              )Net
                  increase (decrease) in cash and cash equivalents
              
              
              **(90.9**
              **)**
              
              10.5Cash
                  and cash equivalents, beginning of period
              
              
              **118.9**
              
              
              12.9Cash
                  and cash equivalents, end of period
              
              **$**
              **28.0**
              
              $
              23.4Supplemental
                  schedule of noncash investing activities:In
                  2004, one of Nicor's Directors and Officers insurance carriers
                  paid $29.0
                  million into an escrow accountto
                  be used to satisfy Nicor's directors' and officers' liabilities
                  and
                  expenses associated with claimsasserted
                  against them, with any remaining balance to be paid to
                  Nicor.During
                  the second quarter of 2005, the escrow arrangement was terminated
                  and the
                  full amount of theescrow
                  of $29.0 million plus the earnings thereon of $0.4 million, was
                  distributed to the company andrecorded
                  in income. The release of the amount from escrow and the change
                  in the
                  obligation related tothe
                  restricted investment are netted in Investing activities
                  above.The
                  accompanying notes are an integral part of these
                  statements.




2




Table
          of Contents


**Nicor
                Inc.****Condensed
                Consolidated Balance Sheets (Unaudited)****(millions)****September
                30**
            
            December
                31
            
            September
                30**2006**
            
            2005
            
            2005**Assets**Current
                assetsCash
                and cash equivalents
            
            **$**
            **28.0**
            
            $
            118.9
            
            $
            23.4Restricted
                short-term investments
            
            
            **10.1**
            
            
            -
            
            
            -Short-term
                investments, at cost whichapproximates
                market
            
            
            **16.3**
            
            
            8.0
            
            
            87.3Receivables,
                less allowances of $34.7,$31.5
                and $26.6, respectively
            
            
            **334.2**
            
            
            889.1
            
            
            292.2Gas
                in storage
            
            
            **203.3**
            
            
            261.3
            
            
            357.3Deferred
                income taxes
            
            
            **36.3**
            
            
            3.0
            
            
            4.6Other
            
            
            **54.4**
            
            
            65.4
            
            
            163.7Total
                current assets
            
            
            **682.6**
            
            
            1,345.7
            
            
            928.5Property,
                plant and equipment, at costGas
                distribution
            
            
            **4,118.6**
            
            
            4,043.2
            
            
            3,933.2Shipping
            
            
            **296.7**
            
            
            293.9
            
            
            304.0Other
            
            
            **18.8**
            
            
            14.2
            
            
            12.4**4,434.1**
            
            
            4,351.3
            
            
            4,249.6Less
                accumulated depreciation
            
            
            **1,743.6**
            
            
            1,692.2
            
            
            1,650.4Total
                property, plant and equipment, net
            
            
            **2,690.5**
            
            
            2,659.1
            
            
            2,599.2Prepaid
                pension costs
            
            
            **195.0**
            
            
            187.6
            
            
            186.1Long-term
                investments
            
            
            **132.1**
            
            
            133.2
            
            
            132.1Other
                assets
            
            
            **64.9**
            
            
            65.6
            
            
            72.4Total
                assets
            
            **$**
            **3,765.1**
            
            $
            4,391.2
            
            $
            3,918.3**Liabilities
                and Capitalization**Current
                liabilitiesLong-term
                debt due within one year
            
            **$**
            **50.0**
            
            $
            50.0
            
            $
            1.0Short-term
                debt
            
            
            **151.0**
            
            
            586.0
            
            
            144.0Accounts
                payable
            
            
            **519.4**
            
            
            658.2
            
            
            633.0Accrued
                gas costs
            
            
            **108.9**
            
            
            223.2
            
            
            285.5Dividends
                payable
            
            
            **20.8**
            
            
            20.5
            
            
            20.5Obligations
                related to restricted investments
            
            
            **10.0**
            
            
            -
            
            
            -Deferred
                income taxes
            
            
            -
            
            
            7.4
            
            
            7.6Other
            
            
            **123.3**
            
            
            77.6
            
            
            70.0Total
                current liabilities
            
            
            **983.4**
            
            
            1,622.9
            
            
            1,161.6Deferred
                credits and other liabilitiesRegulatory
                retirement cost liability
            
            
            **662.8**
            
            
            631.7
            
            
            742.8Deferred
                income taxes
            
            
            **415.3**
            
            
            421.6
            
            
            484.7Asset
                retirement obligation
            
            
            **170.0**
            
            
            164.0
            
            
            -Regulatory
                income tax liability
            
            
            **38.7**
            
            
            41.3
            
            
            42.3Unamortized
                investment tax credits
            
            
            **30.2**
            
            
            31.7
            
            
            32.2Other
            
            
            **176.3**
            
            
            180.3
            
            
            177.5Total
                deferred credits and other liabilities
            
            
            **1,493.3**
            
            
            1,470.6
            
            
            1,479.5Commitments
                and contingenciesCapitalizationLong-term
                obligationsLong-term
                debt, net of unamortized discount
            
            
            **459.4**
            
            
            485.8
            
            
            495.7Mandatorily
                redeemable preferred stock
            
            
            **.6**
            
            
            .6
            
            
            .6Total
                long-term obligations
            
            
            **460.0**
            
            
            486.4
            
            
            496.3Common
                equityCommon
                stock
            
            
            **111.6**
            
            
            110.5
            
            
            110.5Paid-in
                capital
            
            
            **24.5**
            
            
            8.0
            
            
            7.9Retained
                earnings
            
            
            **702.2**
            
            
            694.5
            
            
            653.0Unearned
                compensation
            
            
            -
            
            
            (.1
            )
            
            (.1
            )Accumulated
                other comprehensive income (loss), net
            
            
            **(9.9**
            **)**
            
            (1.6
            )
            
            9.6Total
                common equity
            
            
            **828.4**
            
            
            811.3
            
            
            780.9Total
                capitalization
            
            
            **1,288.4**
            
            
            1,297.7
            
            
            1,277.2Total
                liabilities and capitalization
            
            **$**
            **3,765.1**
            
            $
            4,391.2
            
            $
            3,918.3The
                accompanying notes are an integral part of these
                statements.




3




Table
          of Contents




**Nicor
      Inc.**


**Notes
        to the Condensed Consolidated Financial Statements
        (Unaudited)**
 
 **1.**  **BASIS
        OF PRESENTATION**
 
 The
        unaudited Condensed Consolidated Financial Statements of Nicor Inc. (“Nicor”)
        have been prepared by the company pursuant to the rules and regulations of
        the
        United States Securities and Exchange Commission (“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 2005 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.
 
 **2.**  **ACCOUNTING
          POLICIES**
 **Gas
        in storage.** Gas
        distribution segment inventory is carried at cost on a last-in, first-out
        (“LIFO”) basis. Inventory decrements occurring during interim periods that are
        expected to be restored prior to year-end are charged to cost of gas at the
        estimated annual replacement cost, and the difference between this cost and
        the
        actual LIFO layer cost is recorded on the balance sheet as a current temporary
        LIFO liquidation. Interim inventory decrements not expected to be restored
        prior
        to year-end are charged to cost of gas at the actual LIFO cost of the layers
        liquidated.
 
 At
        September 30, 2006, the company had an inventory decrement of approximately
        5
        Bcf which it believes will not be restored prior to year-end. The liquidated
        inventory was charged to cost of gas at a LIFO cost of $7.82 per Mcf. If
        the
        company had deemed the decrement to be temporary, it would have charged cost
        of
        gas for the estimated annual replacement cost, currently estimated to be
        about
        $6.32 per Mcf. Applying LIFO cost in valuing the decrement, as opposed to
        the
        estimated annual replacement cost, had the effect of increasing the cost
        of gas
        distributed by $7.5 million during 2006. However, since the cost of gas,
        including inventory costs, is charged to customers without markup, subject
        to
        Illinois Commerce Commission (“ICC”) review, this difference had no impact on
        net income. There was no liquidation of any LIFO layers during 2005.
 
 **Regulatory
        assets and liabilities.** Northern
        Illinois Gas Company (doing business as Nicor Gas Company (“Nicor Gas”)), a
        wholly owned subsidiary of Nicor, is regulated by the 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 as follows (in
        millions):
  
 
 
 
 
 4
  Table
            of Contents
  
 **September
                  30**
              
              December
                  31
              
              September
                  30**2006**
              
              2005
              
              2005**Regulatory
                  assets**Deferred
                  environmental costs
              
              **$**
              **14.2**
              
              $
              15.1
              
              $
              20.0Unamortized
                  losses on reacquired debt
              
              
              **17.9**
              
              
              18.7
              
              
              19.0Deferred
                  rate case costs
              
              
              **3.1**
              
              
              3.5
              
              
              3.6Other
              
              
              **3.8**
              
              
              .3
              
              
              .4**$**
              **39.0**
              
              $
              37.6
              
              $
              43.0**Regulatory
                  liabilities**Regulatory
                  retirement cost liability - current
              
              **$**
              **9.0**
              
              $
              9.0
              
              $
              12.1Regulatory
                  retirement cost liability - noncurrent
              
              
              **662.8**
              
              
              631.7
              
              
              742.8Accrued
                  gas costs
              
              
              **108.9**
              
              
              223.2
              
              
              285.5Regulatory
                  income tax liability
              
              
              **38.7**
              
              
              41.3
              
              
              42.3Other
              
              
              **.1**
              
              
              1.8
              
              
              7.7**$**
              **819.5**
              
              $
              907.0
              
              $
              1,090.4
 
 All
        regulatory assets noted above are classified in noncurrent other assets.
        The
        current portion of the regulatory retirement cost liability is classified
        in
        current other liabilities. Regulatory liabilities - Other are classified
        in
        noncurrent other liabilities.
 
 **Revenue
        taxes.** Nicor
        Gas
        classifies revenue taxes billed to customers as operating revenues and related
        taxes incurred as operating expenses. Revenue taxes included in operating
        expense for the three and nine months ended September 30, 2006 were $12.6
        million and $109.0 million, respectively, and $11.9 million and $109.2 million,
        respectively, for the same periods ended September 30, 2005.
 
 **Reclassifications.** Certain
        reclassifications have been made to conform the prior year’s financial
        statements to the current year’s presentation.
 
 **3.** **NEW
        ACCOUNTING PRONOUNCEMENTS**
 
 **Uncertain
        tax positions.** In
        July
        2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation
        No. 48, *Accounting
        for Uncertainty in Income Taxes* .
        This
        Interpretation sets forth a recognition threshold and valuation method to
        recognize and measure an income tax position taken, or expected to be taken,
        in
        a tax return. The evaluation is based on a two-step approach. The first step
        requires an entity to evaluate whether the tax position would “more likely than
        not,” based upon its technical merits, be sustained upon examination by the
        appropriate taxing authority. The second step requires the tax position be
        measured at the largest amount of tax benefit that is greater than 50 percent
        likely of being realized upon ultimate settlement. In addition, previously
        recognized benefits from tax positions that no longer meet the new criteria
        would be derecognized. The application of this Interpretation will be considered
        a change in accounting principle with the cumulative effect of the change
        recorded to the opening balance of retained earnings in the period of adoption.
        This Interpretation will be effective for Nicor on January 1, 2007. The company
        is currently evaluating the Interpretation and the impact it may have on
        its
        results of operations and financial condition, but the impact of initial
        adoption is not expected to be material.
 
 
 
 
 
 
 5
  Table
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 **Fair
        value measurements.** In
        September 2006, the FASB issued Statement of Financial Accounting Standard
        (“SFAS”) No. 157, *Fair
        Value Measurements* .
        This
        Statement defines fair value, establishes a framework for measuring fair
        value
        and expands disclosures about fair value measurements. The Statement does
        not
        require any new fair value measurements, rather it provides guidance on how
        to
        perform fair value measurements as required or permitted under other accounting
        pronouncements. This Statement is effective for Nicor no later than January
        1,
        2008 and is expected to be adopted prospectively at that time. The company
        is
        currently evaluating the Statement and the impact it may have on the company’s
        results of operations and financial condition.
 
 **Defined
        benefit pension and other postretirement plans.** In
        September 2006, the FASB issued SFAS No. 158, *Employers’*  *Accounting
        for Defined Benefit Pension and Other Postretirement Plans* .
        This
        Statement will require an entity to immediately recognize the funded status
        of a
        defined benefit postretirement plan as an asset or liability in its balance
        sheet, and to recognize changes in that funded status through comprehensive
        income to the extent not recognized in net income pursuant to existing
        accounting rules. As a regulated utility, Nicor Gas expects continued full
        rate
        recovery of the costs of its defined benefit postretirement plans. Therefore,
        the company is evaluating whether changes in the plan’s funded status can be
        deferred as a regulatory asset or liability until recognized in net income,
        instead of being recorded in comprehensive income.
 
 Initial
        and prospective recognition of the funded status of these plans is required
        for
        Nicor beginning at December 31, 2006. The company is evaluating this Statement
        and has not yet determined the impact of adopting its recognition provisions.
        This Statement, had it been adopted at December 31, 2005, would have reduced
        the
        reported pension asset by approximately $50 million and increased the liability
        for health care and other benefits by approximately $85 million. Depending
        on
        the results of the company’s evaluation discussed above, offsetting these
        amounts would have been a regulatory asset of approximately $135 million
        or a
        charge to accumulated other comprehensive income of approximately $80 million
        ($135 million net of related deferred tax benefits).
 
 This
        Statement will also require Nicor to change its plan measurement date to
        December 31. Such provision is effective for Nicor no later than December
        31,
        2008 and will be adopted prospectively at that time. The company has not
        yet
        determined the impact of adopting this provision.
 
 **Planned
        major maintenance activities.** In
        September 2006, FASB Staff Position (“FSP”) No. AUG AIR-1, *Accounting
        for Planned Major Maintenance Activities* ,
        was
        issued. This FSP disallows the accrue-in-advance method of accounting for
        planned major maintenance activities, which is the method currently utilized
        by
        Nicor’s wholly owned subsidiary, Tropical Shipping, for the planned major
        maintenance of its owned vessels. Tropical Shipping carries an accrual of
        approximately $3.5 million as of September 30, 2006 for such future maintenance.
        Tropical Shipping will be required to change its accounting to one of the
        following methods; direct expensing, built-in overhaul or deferral, which
        are
        still permitted under this FSP. This FSP is effective for Nicor on January
        1,
        2007 and requires retrospective application. The company is currently evaluating
        the alternative methods permitted by this FSP and the impact the new method
        will
        have on its results of operations and financial condition, but the impact
        of
        initial adoption is not expected to be material.
 
 **Share-based
        payment** .
        Effective January 1, 2006, the company adopted SFAS No. 123 (revised 2004), *Share-Based
        Payment* (“SFAS
        123(R)”), using the modified-prospective transition method. Under such method,
        compensation cost recognized in 2006 includes: (a) compensation cost for
        all
        share-based equity awards granted prior to, but not yet vested as of January
        1,
        2006, based on the grant date fair value estimated in accordance with the
        original provisions of SFAS No. 123, *Accounting
        for Stock-Based Compensation* (“SFAS
        123”) and (b) compensation cost for all share-based equity awards granted
        subsequent to January 1, 2006, based on the grant-date fair value estimated
        in
        accordance with the
 
 6
  Table
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  provisions
        of SFAS 123(R). In addition, liability awards will be adjusted to fair value
        at
        each quarter-end. See Note 11 - Stock-Based Compensation for a description
        of
        the company’s stock-based compensation plans.
 
 Prior
        to
        January 1, 2006, the company accounted for its stock-based compensation plans
        under the recognition and measurement provisions of Accounting Principles
        Board
        Opinion No. 25, *Accounting
        for Stock Issued to Employees* (“APB
        25”), and related Interpretations, as permitted by SFAS 123. Under APB 25, Nicor
        did not recognize compensation cost for stock options or employee stock purchase
        plan discounts, and certain liability awards were adjusted to intrinsic value.
        Results from prior periods have not been restated.
 
 Upon
        adoption of SFAS 123(R), a $0.1 million after-tax benefit was recognized.
        As a
        result of adopting SFAS 123(R), net income, earnings per share and cash flows
        are not expected to be materially different than if the company had continued
        to
        account for share-based compensation under APB 25.
 
 The
        effect on net income and earnings per share for the three and nine months
        ended
        September 30, 2005 had the company applied the fair value recognition provisions
        of SFAS 123 is illustrated in the following table (in millions, except per
        share
        data).
 Three
                  months ended,
              
              Nine
                  months ended,September
                  30, 2005
              
              September
                  30, 2005**Net
                  income (loss)**As
                  reported
              
              $
              (2.7
              )
              $
              74.4Less:
                  Total stock-based employee compensation
                expense
                  determined under the fair value
                method
                  for all awards, net of tax
              
              
              .3
              
              
              .9Pro
                  forma
              
              $
              (3.0
              )
              $
              73.5**Earnings
                  (loss) per share**Basic
                  - As reported
              
              $
              (.06
              )
              $
              1.69Basic
                  - Pro forma
              
              
              (.07
              )
              
              1.66Diluted
                  - As reported
              
              
              (.06
              )
              
              1.67Diluted
                  - Pro forma
              
              
              (.07
              )
              
              1.65
 
 **4.**  **RESTRICTED
        SHORT-TERM INVESTMENTS**
 
 At
        September 30, 2006, Nicor had $10.1 million of restricted short-term
        investments, including $0.1 million in interest earned, held in an escrow
        fund
        and a corresponding $10.0 million current liability. As reported in the second
        quarter of 2006, Nicor reached a tentative agreement with the staff of the
        Enforcement Division of the SEC in settlement of an anticipated civil action
        against the company for a payment of $10 million. In July 2006, the company
        deposited $10 million in an escrow account pending review and final approval
        of
        the tentative settlement by the SEC commissioners. As of September 30, 2006,
        the
        SEC commissioners had not reviewed or approved the tentative settlement.
        For
        further information, see Note 17 - Contingencies - SEC and U.S. Attorney
        Inquiries.
 
 **5.**  **ASSET
        RETIREMENT OBLIGATIONS**
 
 Nicor
        has
        asset retirement obligations (“AROs”) associated with services, mains and other
        components of the distribution system and the buildings in its gas distribution
        segment and with certain equipment in its shipping segment. Nicor Gas has
        not
        recognized an ARO associated with gathering lines and storage wells because
        there is insufficient company or industry retirement history to reasonably
        estimate the fair value of the obligation.
 
 7
  Table
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 The
        following table presents a reconciliation of the beginning and ending AROs
        for
        the nine months ended September 30, 2006 (in millions):
 
 Beginning
                  of period
              
              **$**
              **164.8**Liabilities
                  incurred during the period
              
              
              **1.7**Liabilities
                  settled during the period
              
              
              **(2.1**
              **)**Accretion
              
              
              **7.1**Revision
                  in estimated cash flows
              
              
              **.5**End
                  of period
              
              **$**
              **172.0**
 
 Substantially
        all of the ARO is classified as a noncurrent liability.
 
 **6.**  **SHORT-TERM
        AND LONG-TERM DEBT**
 
 In
        October 2006, Nicor Gas established a $400 million, 210-day seasonal revolver,
        which expires in May 2007, to replace the $400 million, 210-day seasonal
        revolver, which expired in April 2006. In September 2005, Nicor and Nicor
        Gas
        established a $600 million, five-year revolver, expiring September 2010.
        These
        facilities were established with major domestic and foreign banks and serve
        as
        backup for the issuance of commercial paper. The company had $151.0 million,
        $586.0 million and $144.0 million of commercial paper borrowings outstanding
        at
        September 30, 2006, December 31, 2005 and September 30, 2005, respectively.
 
 In
        October 2006, Nicor Gas entered into an agreement for the issuance of $50
        million First Mortgage Bonds at 5.85 percent, due in 2036. The issuance is
        expected to occur, subject to the satisfaction of the conditions in the
        underlying agreements, on the maturity date of the $50 million 5.55 percent
        First Mortgage Bond series due in December 2006.
 
 In
        December 2005, Tropical Shipping obtained a $40 million two-year senior
        unsecured term loan used to fund a portion of the repatriation of its cumulative
        undistributed foreign earnings in connection with the American Jobs Creation
        Act
        (the “Jobs Act”). The term loan bears a floating interest rate based on the
        London Inter-bank Offered Rate (“LIBOR”) plus 0.50 percent per annum. As of
        September 30, 2006, $12 million of this loan remains outstanding.
 
 The
        company believes it is in compliance with all debt covenants.
 
 **7.**  **INCOME
        AND OTHER TAXES**
 
 In
        December 2005, the company repatriated $132 million under the Jobs Act.
        Effective January 2006, the company reorganized certain of its 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 expected to be indefinitely reinvested offshore, no deferred
        income
        tax expense would be recorded by the company. For the three and nine-month
        periods ended September 30, 2006, income tax expense has not been provided
        on
        approximately $6 million and $17 million, respectively, of foreign company
        shipping earnings that are expected to be indefinitely reinvested offshore.
        In
        connection with these activities, a net income tax benefit of approximately
        $6
        million was recorded in the first quarter of 2006 from the elimination of
        certain deferred taxes. The company expects to incur approximately $5 million
        in
        current tax expense associated with these activities, of which approximately
        $3
        million has been recognized in the first nine months of 2006.
 
 
 8
  Table
            of Contents
  
 The
        company’s effective income tax rate for the remainder of 2006 is estimated to be
        approximately 29 percent resulting from the ongoing benefit of untaxed foreign
        shipping earnings, recognition of certain tax credits and the amortization
        of
        excess deferred taxes. During the first nine months of 2006, the effective
        income tax rate was 25.1 percent. The lower rate for the first nine months
        reflects the recognition of additional tax benefits related to the first
        quarter
        2006 reorganization of the company’s shipping and related operations and second
        quarter 2006 favorable adjustments associated with tax audits (which occur
        in
        the ordinary course of business) offset, in part, in the second quarter of
        2006
        by the non-deductible $10 million charge associated with the company’s
        outstanding SEC inquiry. For the first nine months of 2005, the effective
        income
        tax rate was 30.6 percent which reflected the effects of recording 2005 net
        litigation recoveries and earnings thereon ($29.9 million) at the company’s
        marginal tax rate of approximately 40 percent as well as miscellaneous third
        quarter tax benefits ($1.5 million). The effective income tax rate for the
        quarters ended September 30, 2006 and 2005 was 30.3 percent and 51.3 percent,
        respectively. For the quarter ended September 30, 2005, in addition to the
        impact of miscellaneous tax benefits ($1.5 million), the quarter’s effective
        income tax rate increased due to changes in forecasted annual income. Such
        change was not significant for the year-to-date period, but did have a
        disproportionate impact on the third quarter effective income tax rate as
        the
        income before income taxes was relatively low.
 
 The
        company accrues tax and interest related to tax uncertainties. Tax uncertainties
        arise due to actual or potential disagreements about the tax treatment of
        specific items between the company and the governmental agency reviewing
        the
        company’s tax returns. At September 30, 2006, December 31, 2005 and September
        30, 2005, the company had accrued approximately $17.8 million, $17.1 million
        and
        $8.1 million, respectively, for such uncertainties.
 
 In
        2003,
        Nicor received an income tax refund of approximately $100 million attributable
        to a tax loss carryback associated with a change in tax accounting method
        (which
        increased its deferred income tax liability), subject to Internal Revenue
        Service (“IRS”) review and approval as part of normal ongoing audits. Through
        December 31, 2004, the total current tax benefits previously recorded under
        this  accounting
        method approximated $135 million (amounts recorded were offset by increases
        to
        the deferred tax liability with no net effect on reported net federal income
        tax
        expense). In the third quarter of 2005, the IRS revised the regulations
        pertaining to the aforementioned tax accounting method. The new regulations
        require repayment in 2005 and 2006 of amounts previously taken as current
        tax
        deductions. In the second half of 2005 and during the nine months ended
        September 30, 2006, Nicor reclassified income tax expense from deferred to
        current and repaid approximately $67 million and $50 million, respectively.
        The
        company expects to repay the remaining amounts during the fourth quarter
        of
        2006. The anticipated repayment is expected to have no direct impact on earnings
        and no material impact on the company’s financial condition.
 
 **8.**  **ACCRUED
        UNBILLED REVENUES**
 
 Receivables
        include accrued unbilled revenues of $52.9 million, $300.9 million and $52.9
        million at September 30, 2006, December 31, 2005 and September 30, 2005,
        respectively, related primarily to gas distribution operations. Nicor Gas
        accrues revenues for estimated deliveries to customers from the date of their
        last bill until the balance sheet date.
 
 
 
 
 
 
 
 9
  Table
            of Contents
  **9.**  **FAIR
        VALUE OF FINANCIAL INSTRUMENTS**
 
 The
        recorded amount of short-term investments and short-term borrowings approximates
        fair value because of the short maturity of the instruments. Long-term debt
        outstanding, including current maturities, is recorded at the principal balance
        outstanding, net of unamortized discount. The principal balance of Nicor
        Gas’
First Mortgage Bonds **** outstanding
        at September 30, 2006, December 31, 2005 and September 30, 2005 was $500
        million. Based on quoted market interest rates, the fair value of the company’s
        First Mortgage Bonds outstanding, including current maturities, was
        approximately $515 million, $525 million and $531 million at September 30,
        2006,
        December 31, 2005 and September 30, 2005, respectively. The recorded amount
        of
        the Tropical Shipping two-year senior unsecured term loan for the periods
        presented approximated fair value because of its variable interest
        rate.
 
 Derivative
        financial instruments are recorded at fair value as determined primarily
        from
        actively quoted prices. The fair value of derivative financial instruments
        relates largely to Nicor Gas. The majority of derivative financial instruments
        held by Nicor Gas are for the purpose of hedging natural gas purchases, and
        their settlement is passed directly through to customers without markup,
        subject
        to ICC review. The gross asset and liability fair values of these instruments
        are reflected on the Condensed Consolidated Balance Sheets as follows (in
        millions):
 
 **September
                  30**
              
              December
                  31
              
              September
                  30**2006**
              
              2005
              
              2005Current
                  other assets
              
              **$**
              **13.0**
              
              $
              29.2
              
              $
              100.2Noncurrent
                  other assets
              
              
              **1.1**
              
              
              2.3
              
              
              4.1**$**
              **14.1**
              
              $
              31.5
              
              $
              104.3Current
                  other liabilities
              
              **$**
              **50.3**
              
              $
              6.1
              
              $
              11.1Noncurrent
                  other liabilities
              
              
              **4.9**
              
              
              1.4
              
              
              2.4**$**
              **55.2**
              
              $
              7.5
              
              $
              13.5
 
 Nicor
        maintains margin accounts related to financial derivative transactions. At
        September 30, 2006, December 31, 2005 and September 30, 2005, the balance
        of
        these accounts was $35.7 million, $37.0 million and $3.2 million, respectively,
        and was reflected in the Condensed Consolidated Balance Sheets as
        Receivables.
 
 **10.**  **POSTRETIREMENT
        BENEFITS**
 
 Nicor
        Gas
        maintains a noncontributory defined benefit pension plan covering substantially
        all employees hired prior to 1998. Pension benefits are based on years of
        service and highest average salary for management employees and job level
        for
        unionized employees. The benefit obligation related to collectively bargained
        benefits considers the company’s past practice of regular benefit increases to
        reflect current wages. Nicor Gas also provides health care and life insurance
        benefits to eligible retired employees under a plan that includes limits
        on the
        company’s share of cost for employees hired after 1982. The company’s
        postretirement benefit costs have historically been considered in rate
        proceedings in the period they are accrued.
 
 
 
 
 
 
 10
  Table
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 About
        one-fourth of the net periodic benefit cost or credit related to these plans
        has
        been capitalized as a cost of constructing gas distribution facilities and
        the
        remainder is included in gas distribution operating and maintenance expense.
        Net
        periodic benefit cost (credit) included the following components (in
        millions):
 Pension
                  benefits
              
              Health
                  care and
                other
                  benefits**2006**
              
              2005
              
              **2006**
              
              2005**Three
                  months ended September 30**Service
                  cost
              
              **$**
              **2.3**
              
              $
              2.3
              
              **$**
              **.6**
              
              $
              .7Interest
                  cost
              
              
              **3.8**
              
              
              3.9
              
              
              **2.5**
              
              
              2.6Expected
                  return on plan assets
              
              
              **(8.8**
              **)**
              
              (8.3
              )
              
              **(.1**
              **)**
              
              (.2
              )Recognized
                  net actuarial loss
              
              
              **.1**
              
              
              .4
              
              
              **1.4**
              
              
              1.1Amortization
                  of prior service cost
              
              
              **.1**
              
              
              .2
              
              
              **(.1**
              **)**
              
              -Net
                  periodic benefit cost (credit)
              
              **$**
              **(2.5**
              **)**
              $
              (1.5
              )
              **$**
              **4.3**
              
              $
              4.2**Nine
                  months ended September 30**Service
                  cost
              
              **$**
              **7.0**
              
              $
              7.0
              
              **$**
              **1.8**
              
              $
              2.0Interest
                  cost
              
              
              **11.2**
              
              
              11.7
              
              
              **7.7**
              
              
              7.7Expected
                  return on plan assets
              
              
              **(26.2**
              **)**
              
              (24.9
              )
              
              **(.2**
              **)**
              
              (.7
              )Recognized
                  net actuarial loss
              
              
              **.2**
              
              
              1.1
              
              
              **3.8**
              
              
              3.8Amortization
                  of prior service cost
              
              
              **.4**
              
              
              .5
              
              
              **(.1**
              **)**
              
              (.1
              )Net
                  periodic benefit cost (credit)
              
              **$**
              **(7.4**
              **)**
              $
              (4.6
              )
              **$**
              **13.0**
              
              $
              12.7
 
 The
        company reflected its best estimate of the potential subsidy it may receive
        under the Medicare Prescription Drug, Improvement and Modernization Act of
        2003
        in its October 1, 2005 and 2004 measurement of the postretirement health
        care
        obligation and of net periodic postretirement health care costs. The estimated
        subsidy reduced such costs by $1.3 million and  $4.0
        million for the three and nine months ended September 30, 2006, respectively,
        and $0.6 million and $1.8 million, respectively, for the corresponding
        prior-year periods.
 
 **11.**  **STOCK-BASED
        COMPENSATION**
 
 Nicor
        has
        a long-term incentive compensation plan that permits the granting of restricted
        stock, performance units and stock options to key executives and managerial
        employees. The company may grant up to 1.5 million common shares under a
        plan
        approved in the second quarter of 2006. In addition, Nicor has a stock deferral
        plan, employee stock purchase plan and directors’ stock-based compensation
        plans.
 
 In
        2006,
        the company primarily granted restricted stock and performance units under
        these
        plans, whereas in prior years, grants consisted primarily of stock options
        and
        performance units.
 
 As
        of
        September 30, 2006, there was $1.1 million of total unrecognized compensation
        cost related to all nonvested share-based compensation arrangements. That
        cost
        is expected to be recognized over a weighted-average period of 3.3 years.
        The
        company recognized compensation cost and related tax effects for all share-based
        compensation arrangements as follows (in millions):
 
 
 
 
 
 
 
 11
  Table
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 Three
                  months ended
              
              Nine
                  months endedSeptember
                  30
              
              September
                  30**2006**
              
              2005
              
              **2006**
              
              2005Operating
                  and maintenance expense
              
              **$**
              **.9**
              
              $
              .6
              
              **$**
              **2.8**
              
              $
              2.3Income
                  tax benefits
              
              
              **.4**
              
              
              .2
              
              
              **1.1**
              
              
              .9
 
 Cash
        flows related to stock-based options were as follows (in millions):
 
 Three
                  months ended
              
              Nine
                  months endedSeptember
                  30
              
              September
                  30**2006**
              
              2005
              
              **2006**
              
              2005Proceeds
                  from the exercise of stock options
              
              **$**
              **7.6**
              
              $
              .5
              
              **$**
              **14.1**
              
              $
              1.4Associated
                  income tax benefits realized
              
              
              **.9**
              
              
              .2
              
              
              **1.8**
              
              
              .4
 
 The
        difference between the proceeds from the exercise of stock options and the
        par
        value of the stock is recorded within Paid-in capital on the balance sheet.
 
 **Restricted
        stock.** Restricted stock represents shares of common stock that are nontransferable
        during a vesting period of generally four years. Compensation cost was measured
        at the grant date share price for all periods.
 
 A
        summary
        of the status of the company’s restricted stock and changes during the nine
        months ended September 30, 2006 is as follows:
 Weighted-Number
                  of
              
              average
                  grant-shares
              
              date
                  fair valueNonvested
                  at January 1, 2006
              
              
              5,999
              
              $
              41.11Granted
              
              
              35,870
              
              
              41.62Vested
              
              
              (3,000
              )
              
              41.11Forfeited
              
              
              (1,670
              )
              
              41.62Nonvested
                  at September 30, 2006
              
              
              37,199
              
              
              41.58
 
 The
        weighted-average fair value of shares granted during the nine months ended
        September 30, 2006 was $41.62. There was no restricted stock granted during
        the
        three-month period ended September 30, 2006 or during the three and nine
        months
        ended September 30, 2005. The total fair value of shares vested for each
        of the
        year-to-date periods ended September 30, 2006 and 2005 was $0.1 million.
        There
        were no restricted stock awards that vested during the third quarters of
        2006 or
        2005.
 
 **Performance
        units.** These
        awards are paid out in cash based on a measure of relative total shareholder
        return over a three-year performance period as compared to the performance
        of
        the companies in a utility industry peer group (Standard & Poor’s utility
        group). Units vest over approximately three years, or upon retirement one
        year
        or more after the grant date. The liability for the units is adjusted to
        fair
        value each
 quarter-end,
        and compensation cost is ultimately measured as the settlement date fair
        value
        (or cash payment). Interim fair values are estimated by discounting
        probability-weighted expected cash flows. The company paid $0.8 million and
        $0.2
        million during the year-to-date periods ended September 30, 2006 and 2005,
        respectively, to settle performance unit obligations. There were no such
        payments made during the third quarters of 2006 or 2005.
  
 12
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  **Other.** As
        noted
        in the company’s 2005 Annual Report on Form 10-K, the company has other
        stock-based compensation plans, but the impact on net income, earnings per
        share
        and cash flows for the three and nine months ended September 30, 2006 is
        immaterial.
  **12.**  **EQUITY
        INVESTMENT INCOME, NET**
 
 Net
        equity investment income includes investment income from Triton Container
        Investments L.L.C. (“Triton”), a cargo container leasing company, of $2.0
        million and $4.5 million, respectively, for the three and nine-month periods
        ended September 30, 2006 and $1.7 million and $5.3 million, for the same
        periods
        ended September 30, 2005, respectively. Also included in net equity investment
        income for the three and nine months ended September 30, 2006 is a $2.4 million
        gain on a sale of an equity investment. Nicor received cash distributions
        from
        equity investees for the three and nine-month periods ended September 30,
        2006
        of $1.5 million and $4.8 million, respectively, and $1.0 million and $3.5
        million, respectively, for the same periods ended September 30,
        2005.
  **13.** **COMPREHENSIVE
        INCOME**
 
 Total
        comprehensive income, as defined by SFAS No. 130, *Reporting
        Comprehensive Income* ,
        is
        equal to net income plus other comprehensive income and is as follows (in
        millions):
 
 Three
                  months ended
              
              Nine
                  months endedSeptember
                  30
              
              September
                  30**2006**
              
              2005
              
              **2006**
              
              2005Net
                  income (loss)
              
              **$**
              **17.6**
              
              $
              (2.7
              )
              **$**
              **70.0**
              
              $
              74.4Other
                  comprehensive income (loss), after tax
              
              
              **(4.6**
              **)**
              
              13.8
              
              
              **(8.3**
              **)**
              
              16.4Total
                  comprehensive income
              
              **$**
              **13.0**
              
              $
              11.1
              
              **$**
              **61.7**
              
              $
              90.8
 
 Net
        other
        comprehensive income (loss) generally consists of net unrealized gains and
        losses from derivative financial instruments accounted for as cash flow hedges,
        including Nicor’s share of such amounts from joint ventures and other
        equity-method investees.
 
 
 
 
 
 
 
 
 
 13
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 **14.**  **BUSINESS
        SEGMENT INFORMATION**
 
 Financial
        data by major business segment is presented below (in millions):
 Gas
                  distribution
              
              Shipping
              
              Other
                  energy ventures
              
              Corporate
                  and
                eliminations
              
              Consolidated**Three
                  months ended September 30, 2006**Operating
                  revenuesExternal
                  customers
              
              **$**
              **219.7**
              
              **$**
              **98.3**
              
              **$**
              **33.1**
              
              **$**
              **-**
              
              **$**
              **351.1**Intersegment
              
              
              **7.0**
              
              
              **-**
              
              
              **.9**
              
              
              **(7.9**
              **)**
              
              **-****$**
              **226.7**
              
              **$**
              **98.3**
              
              **$**
              **34.0**
              
              **$**
              **(7.9**
              **)**
              **$**
              **351.1**Operating
                  income
              
              **$**
              **5.6**
              
              **$**
              **10.5**
              
              **$**
              **6.9**
              
              **$**
              **5.5**
              
              **$**
              **28.5****Three
                  months ended September 30, 2005**Operating
                  revenuesExternal
                  customers
              
              $
              235.7
              
              $
              91.9
              
              $
              8.4
              
              $
              -
              
              $
              336.0Intersegment
              
              
              5.8
              
              
              -
              
              
              .8
              
              
              (6.6
              )
              
              -$
              241.5
              
              $
              91.9
              
              $
              9.2
              
              $
              (6.6
              )
              $
              336.0Operating
                  income (loss)
              
              $
              .4
              
              $
              9.4
              
              $
              (11.7
              )
              $
              2.5
              
              $
              .6**Nine
                  months ended September 30, 2006**Operating
                  revenuesExternal
                  customers
              
              **$**
              **1,714.4**
              
              **$**
              **288.1**
              
              **$**
              **119.3**
              
              **$**
              **-**
              
              **$**
              **2,121.8**Intersegment
              
              
              **61.2**
              
              
              **-**
              
              
              **15.8**
              
              
              **(77.0**
              **)**
              
              **-****$**
              **1,775.6**
              
              **$**
              **288.1**
              
              **$**
              **135.1**
              
              **$**
              **(77.0**
              **)**
              **$**
              **2,121.8**Operating
                  income
              
              **$**
              **80.2**
              
              **$**
              **29.5**
              
              **$**
              **.7**
              
              **$**
              **1.1**
              
              **$**
              **111.5****Nine
                  months ended September 30, 2005**Operating
                  revenuesExternal
                  customers
              
              $
              1,641.5
              
              $
              274.7
              
              $
              84.0
              
              $
              -
              
              $
              2,000.2Intersegment
              
              
              51.1
              
              
              -
              
              
              5.7
              
              
              (56.8
              )
              
              -$
              1,692.6
              
              $
              274.7
              
              $
              89.7
              
              $
              (56.8
              )
              $
              2,000.2Operating
                  income (loss)
              
              $
              71.9
              
              $
              31.9
              
              $
              (8.6
              )
              $
              33.2
              
              $
              128.4
 
 The
        majority of intersegment revenues represent gas distribution revenues related
        to
        customers entering into certain utility-bill management contracts with Nicor’s
        other energy ventures. Under these utility-bill management contracts, Nicor’s
        other energy ventures bill a fixed amount to a customer, regardless of changes
        in natural gas prices or weather, and in exchange pays the customer’s utility
        bills from Nicor Gas. Intersegment revenues are eliminated in the Condensed
        Consolidated Financial Statements.
 
 
 
 
 
 
 
 
 
 14
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 Operating
        income in the “Corporate and eliminations” column includes the following
        items:
 
 ·
              In
                  the third quarter of 2006 and 2005, the company recognized $5.2
                  million
                  and $2.6 million, respectively, of insurance recoveries related
                  to
                  previously incurred legal expenses associated with the securities
                  class
                  action and shareholder derivative lawsuit settlements. For more
                  information, see Note 17 - Contingencies -
                  Other.
 ·
              In
                  the year-to-date 2006 period, the company recorded a $10 million
                  charge
                  (non-deductible for tax purposes) associated with the outstanding
                  SEC
                  inquiry. In the year-to-date 2005 period, the company recorded
                  $29.9
                  million of net insurance recoveries and earnings thereon of securities
                  class action and derivative lawsuit settlements. For more information
                  on
                  both items, see Note 17 -
                  Contingencies.
 ·
              Benefits
                  (costs) associated with Nicor’s other energy ventures’ utility-bill
                  management contracts attributable to warmer (colder) than normal
                  weather
                  for the three and nine months ended September 30, 2006 were $(0.1)
                  million
                  and $6.3 million, respectively, and $0.5 million and $1.7 million,
                  respectively, for the same periods ending September 30, 2005. The
                  weather
                  impact of these contracts generally serves to offset the gas distribution
                  segment’s weather risk. This benefit (cost) is recorded at the corporate
                  level as a result of an agreement between the parent company and
                  certain
                  of its subsidiaries.
 
 
 **15.**  **RATE
        PROCEEDING**
 
 Nicor
        Gas
        filed a request with the ICC for an overall increase in base rates on November
        4, 2004. In late 2005, Nicor Gas received approval from the ICC for a $54.2
        million base rate increase which reflected an allowed rate of return on
        original-cost rate base of 8.85 percent, including a 10.51 percent cost of
        common equity. The order also included the authorization to pass all Chicago
        Hub
        revenues directly through to customers as a credit to Nicor Gas’ Purchased Gas
        Adjustment (“PGA”) rider and the shifting of certain storage-related costs from
        the PGA rider to base rates. In addition, rates were established using a
        10-year
        average for weather as opposed to the previous use of a 30-year average.
        These
        rates were implemented in the fourth quarter of 2005.
 
 In
        October 2005, Nicor Gas and six other parties filed applications for rehearing
        of the final order of the rate case. The ICC granted rehearing on seven issues,
        only two of which relate to the amount of the approved annual net revenue
        increase, and denied rehearing on all other issues raised in the applications.
        In March 2006, the ICC issued its decision on rehearing in which it adjusted
        the
        amount of the annual net rate increase to $49.7 million from the $54.2 million
        that had been approved in the earlier order. Rate changes resulting from
        the
        rehearing order are prospective and went into effect on April 11, 2006. Parties,
        including Nicor Gas, that appealed the ICC’s rate case decision to the state
        appellate courts have since withdrawn their appeals. As a result, the ICC
        rate
        order is no longer subject to judicial review.
 
 As
        a
        result of the rate order which became effective in the fourth quarter of
        2005,
        certain storage-related costs are now recorded in operating and maintenance
        expense. For the three and nine months ended September 30, 2006, storage-related
        gas costs in operating and maintenance expense totaled $1.0 million and $15.4
        million, respectively. Such costs totaled zero and $11.1 million, respectively,
        for the corresponding prior-year periods and since they were incurred prior
        to
        the effective date of the rate order were recorded as cost of gas.
 
 
 
 
 
 15
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 **16.**  **GUARANTEES
        AND INDEMNITIES**
 
 Nicor
        and
        certain subsidiaries enter into various financial and performance guarantees
        and
        indemnities providing assurance to third parties.
 
 **Financial
        guarantees.** The
        company has issued guarantees of affiliate obligations to vendors and other
        third parties, requiring Nicor to repay the obligations should its affiliates
        default. The obligations of the company’s wholly owned subsidiaries are
        reflected in Nicor’s Condensed Consolidated Balance Sheets, while the
        obligations of its unconsolidated equity investments are not. As of September
        30, 2006, Nicor had guaranteed the payment of $0.2 million of lease obligations
        extending through February 2007 in support of one of its unconsolidated equity
        investee’s operations. No liability has been recorded for this guarantee as
        Nicor believes the likelihood of payment under this guarantee is
        remote.
 
 Tropic
        Equipment Leasing Inc. (“TEL”), an indirectly wholly owned subsidiary of Nicor,
        holds the company’s interests in Triton. TEL has a contingent liability to
        restore to zero any deficit in its equity account for income tax purposes
        in the
        unlikely event that Triton is liquidated and a deficit balance remains. This
        contingent liability continues for the life of the Triton partnerships and
        any
        payment is effectively limited to the assets of TEL, which were approximately
        $9
        million at September 30, 2006. Nicor believes the likelihood of any such
        payment
        by TEL is remote, and no liability has been recorded for this
        contingency.
 
 **Performance
        guarantees.** Nicor
        Services markets separately priced product warranty contracts that provide
        for
        the repair of heating, ventilation and air conditioning equipment, natural
        gas
        lines, and other appliances within homes. Revenues from these product warranty
        contracts are recognized ratably over the coverage period, and related repair
        costs are charged to expense as incurred. Repair expenses of $1.5 million
        and
        $4.3 million were incurred in the three and nine months ended September 30,
        2006, respectively, and $1.2 million and $3.3 million, respectively, for
        the
        same periods last year.
 
 **Indemnities.** In
        certain instances, Nicor has undertaken to indemnify current property owners
        and
        others against costs associated with the effects and/or remediation of
        contaminated sites for which the company may be responsible under applicable
        federal or state environmental laws, generally with no limitation as to the
        amount. Aside from liabilities recorded in connection with coal tar cleanup,
        as
        discussed in Note 17 - Contingencies - Manufactured Gas Plant Sites, Nicor
        believes that the likelihood of payment under these indemnifications is either
        remote, or the fair value of the indemnification is immaterial, and no liability
        has been recorded for these indemnifications.
 
 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. Expenses associated with
        these indemnifications were insignificant in the three and nine-month periods
        ended September 30, 2006 and 2005. As of September 30, 2006, the company
        had a
        remaining estimated liability of $0.2 million in connection with these
        indemnifications. While the company does not expect to incur significant
        additional costs under these indemnifications, it is not possible to estimate
        the maximum potential payments.
 
 
 
 
 
 16
  Table
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  **17.** **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.
 
 **Performance-Based
        Rate (“PBR”) Plan.** Nicor
        Gas’ PBR plan for natural gas costs went into effect in 2000 and was terminated
        by the company effective January 1, 2003. Under the PBR plan, Nicor Gas’ total
        gas supply costs were compared to a market-sensitive benchmark. Savings and
        losses relative to the benchmark were determined annually and shared equally
        with sales customers. The PBR plan is currently under ICC review. There are
        allegations that the company acted improperly in connection with the PBR
        plan,
        and the ICC and others are reviewing these allegations. On June 27, 2002,
        the
        Citizens Utility Board (“CUB”) filed a motion to reopen the record in the ICC’s
        proceedings to review the PBR plan (the “ICC Proceedings”). As a result of the
        motion to reopen, Nicor Gas, the Cook County State’s Attorney Office (“CCSAO”),
        the staff of the ICC and CUB entered into a stipulation providing for additional
        discovery. The Illinois Attorney General’s Office (“IAGO”) has also intervened
        in this matter. In addition, the IAGO issued Civil Investigation Demands
        (“CIDs”) to CUB and the ICC staff. The CIDs ordered that CUB and the ICC staff
        produce all documents relating to any claims that Nicor Gas may have presented,
        or caused to be presented, false information related to its PBR plan. Parties
        who were plaintiffs in a dismissed class action proceeding against the company
        could potentially intervene in these proceedings. 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. In addition, 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. The net of these items and interest income on certain components results
        in a $1.0 million reimbursement the company is seeking as of September 30,
        2006,
        pending resolution of the proceedings discussed below. 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.
 
 
 
 
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  On
        February 5, 2003, the CCSAO and CUB filed a motion for $27 million in sanctions
        against the company in the ICC Proceedings. In that motion, CCSAO and CUB
        alleged that Nicor Gas’ responses to certain CUB data requests were false. Also
        on February 5, 2003, CUB stated in a press release that, in addition to $27
        million in sanctions, it would seek additional refunds to consumers. On March
        5,
        2003, the ICC staff filed a response brief in support of CUB’s motion for
        sanctions. On May 1, 2003, the Administrative Law Judges issued a ruling
        denying
        CUB and CCSAO’s motion for sanctions. CUB has filed an appeal of the motion for
        sanctions with the ICC, and the ICC has indicated that it will not rule on
        the
        appeal until the final disposition of the ICC Proceedings. It is not possible
        to
        determine how the ICC will resolve the claims of CCSAO, CUB or other parties
        to
        the ICC Proceedings.
 
 In
        November 2003, the ICC staff, CUB, CCSAO and the IAGO filed their respective
        direct testimony in the ICC Proceedings. The ICC staff is seeking refunds
        to
        customers of approximately $108 million and CUB and CCSAO were jointly seeking
        refunds to customers of approximately $143 million. The IAGO direct testimony
        alleges adjustments in a range from $145 million to $190 million. The IAGO
        testimony as filed is presently unclear as to the amount which IAGO seeks
        to
        have refunded to customers. On February 27, 2004, the above referenced
        intervenors filed their rebuttal testimony in the ICC Proceedings. In such
        rebuttal testimony, CUB and CCSAO amended the alleged amount to be refunded
        to
        customers from approximately $143 million to $190 million. Nicor Gas filed
        rebuttal testimony in January 2004, which is consistent with the findings
        of the
        special committee Report. Nicor Gas seeks a reimbursement of approximately
        $1
        million as referenced above. The parties to the ICC Proceedings have agreed
        to a
        stay of the evidentiary hearings on this matter in order to undertake additional
        third party discovery from Entergy-Koch Trading, LP (“EKT”), a natural gas,
        storage and transportation trader and consultant with whom Nicor did business
        under the PBR plan.
 
 During
        the course of the United States Securities and Exchange Commission (“SEC”)
        investigation discussed below, the company became aware of additional
        information relating to the activities of individuals affecting the PBR plan
        for
        the period from 1999 through 2002, including information consisting of third
        party documents and recordings of telephone conversations from EKT. Review
        of
        additional information completed in 2004 resulted in the $1.8 million adjustment
        to the previously recorded liability referenced above.
 
 Although
        the Report of the special committee’s counsel did not find that there was
        criminal activity or fraud, a review of this additional information (which
        was
        not available to the independent counsel who prepared the Report) and
        re-interviews of certain Nicor Gas personnel in 2004 indicated that certain
        former Nicor Gas personnel may have engaged in potentially fraudulent conduct
        regarding the PBR plan in violation of company policy, and in possible violation
        of SEC rules and applicable law. Further, certain former Nicor Gas personnel
        also may have attempted to conceal their conduct in connection with an ICC
        review of the PBR plan. The company continues to cooperate with the SEC,
        the
        U.S. Attorney’s office and the ICC on this matter. The company has reviewed all
        third party information it has obtained and will continue to review any
        additional third party information the company may obtain. The company
        terminated four employees in connection with this matter in 2004.
 
 Nicor
        is
        unable to predict the outcome of the ICC’s review or the company’s potential
        exposure thereunder. Because the PBR plan and historical gas costs are still
        under ICC review, the final outcome could be materially different than the
        amounts reflected in the company’s financial statements as of September 30,
        2006.
  
 
 
 
 18
  Table
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  **SEC
        and U.S. Attorney Inquiries.** In 2002,
        the staff of the SEC Division of Enforcement (“SEC Staff”) informed Nicor that
        the SEC is conducting a formal inquiry regarding the PBR plan. A representative
        of the Office of the United States Attorney for the Northern District of
        Illinois (the “U.S Attorney”) has notified Nicor that that office is conducting
        an inquiry on the same matters that the SEC is investigating, and a grand
        jury
        is also reviewing these matters. In April 2004, Nicor was advised by the
        SEC
        Staff that it intended to recommend to the SEC that it bring a civil injunctive
        action against Nicor, alleging that Nicor violated Sections 17(a) of the
        Securities Act of 1933 and Sections 10(b) and 13(a) of the Securities Exchange
        Act of 1934 and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. On July
        7,
        2006, the company announced that it reached a tentative agreement with the
        SEC
        Staff in settlement of an anticipated civil action to which the company and
        the
        SEC will be parties. Under the terms of the tentative settlement, the company
        will be subject to disgorgement of one dollar, a monetary fine of $10 million
        and an injunction. The company will neither admit nor deny any wrongdoing.
        In
        July 2006, the company deposited the $10 million in escrow pending final
        approval of the tentative settlement by the SEC commissioners and entry of
        a
        final judgment by a federal court. The SEC Staff will submit the tentative
        settlement to the SEC commissioners for approval. The SEC commissioners have
        the
        authority to approve, modify or reject the tentative settlement. Nicor recorded
        a $10 million charge to its second quarter earnings in connection with this
        matter. The $10 million fine is not deductible for federal or state income
        tax
        purposes. Nicor is unable to predict the outcome of the separate inquiry
        by the
        U.S. Attorney or Nicor’s potential exposure related thereto and has not recorded
        a liability associated with the outcome of that matter.
  **Fixed
        Bill Service.** On April
        29, 2003, a second amended purported class action complaint was filed in
        the
        Circuit Court of Cook County, Illinois against Nicor Energy Services Company
        (“Nicor Services”) alleging violation of the Illinois Consumer Fraud Act
        (“ICFA”) by Nicor Services relating to the fixed bill service offered by Nicor
        Services. Nicor Services offered a fixed bill product under which it paid
        the
        annual gas service portion of a customer’s Nicor Gas utility bill in exchange
        for twelve equal monthly payments by the customer to Nicor Services, regardless
        of changes in the price of natural gas or weather. The plaintiff sought
        compensatory damages, prejudgment and postjudgment interest, punitive damages,
        attorneys’ fees and injunctive relief on behalf of a proposed class consisting
        of all purchasers of the fixed bill service from February 1, 2002 through
        December 31, 2002. On October 7, 2005, the Circuit Court denied plaintiffs’
motion to certify the proposed class. As a result, if the case proceeds in
        the
        Circuit Court, it will be as an individual action on behalf of the named
        plaintiff alone. The class certification decision remains subject to appeal.
        Nicor is unable to predict the outcome of this litigation or to reasonably
        estimate its potential exposure related thereto and has not recorded a liability
        associated with this contingency.
 
 **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.
 
 Nicor
        Gas
        is a defendant in several private lawsuits, all in the Circuit Court of Cook
        County, Illinois, seeking a variety of unquantified damages (including bodily
        injury, property and punitive damages) allegedly caused by mercury spillage
        resulting from the removal of mercury-containing regulators. Under the terms
        of
        a class action settlement agreement, Nicor Gas will continue, until 2007,
        to
        provide medical screening to persons exposed to mercury from its equipment,
        and
        was to use reasonable efforts to remove any remaining inside residential
        mercury
        regulators by March of 2006. Nicor Gas believes it is in compliance with
        its
        obligations under the settlement agreement. The class action settlement
        permitted class members to “opt out” of the settlement and pursue their claims
        individually. Nicor Gas is currently defending claims brought by 26
        households.
 
 
 
 
 19
 Table
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  As
        of
        September 30, 2006, Nicor Gas had remaining an estimated liability of $15.3
        million, representing 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
        continues to pursue recovery from insurers and independent contractors that
        had
        performed work for the company. When received, these recoveries are recorded
        as
        a reduction to gas distribution operating expense. Nicor Gas received
        approximately $3.8 million, net of legal fees, from an independent contractor
        in
        the first quarter of 2006. Amounts recovered during 2004 and 2005 were
        immaterial. On October 25, 2004, the Circuit Court of Cook County, Illinois
        entered judgment in favor of Nicor and Nicor Gas and against various insurers
        in
        the amount of $10.2 million with respect to one of Nicor’s and Nicor Gas’
mercury-related insurance claims. The insurers filed an appeal of the judgment.
        On November 29, 2005, the First District Appellate Court reversed the Circuit
        Court’s judgment in favor of Nicor and Nicor Gas and remanded the case to the
        Circuit Court for proceedings consistent with the Appellate Court’s decision.
        The Illinois Supreme Court has granted Nicor and Nicor Gas leave to appeal
        the
        decision of the Appellate Court.
 
 The
        final
        disposition of these mercury-related matters is not expected to have a material
        adverse impact on the company’s 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.
 
 To
        date,
        Nicor Gas has identified about 40 properties for which it may have some
        responsibility. Most of these properties are not presently owned by the company.
        Nicor Gas and Commonwealth Edison Company (“ComEd”) are parties to an interim
        agreement to cooperate in cleaning up residue at many of these properties.
        Under
        the interim agreement, mutually agreed costs are to be evenly split between
        Nicor Gas and ComEd until such time as they are finally allocated either
        through
        negotiation or arbitration. On April 17, 2006, Nicor Gas initiated arbitration
        to determine the final allocations of these costs between Nicor Gas and ComEd.
        The ultimate outcome of the arbitration is not presently determinable.
        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 determine the extent additional remediation is
        necessary and provide a basis for estimating additional future costs. As
        of
        September 30, 2006, the company had recorded a liability in connection with
        these matters of $14.1 million. In accordance with ICC authorization, the
        company has been recovering, and expects to continue to recover, these costs
        from its customers, subject to annual prudence reviews.
 
 In
        December 2001, a purported class action lawsuit was filed against Exelon
        Corporation, ComEd and Nicor Gas in the Circuit Court of Cook County alleging,
        among other things, that the cleanup of a former manufactured gas plant site
        in
        Oak Park, Illinois was inadequate. Since then, additional lawsuits have been
        filed related to this same former manufactured gas plant site. These lawsuits
        seek, in part, unspecified damages for property damage, nuisance, and various
        personal injuries that allegedly resulted from exposure to contaminants
        allegedly emanating from the site, and punitive damages. An agreement in
        principle to settle the purported class action lawsuit has been reached and,
        as
        of September 30, 2006, the company has recorded a $2.25 million liability
        in
        connection with this matter. In accordance with ICC authorization, the company
        expects to recover costs of such settlement from its customers, subject to
        an
        annual prudence review. Management cannot predict the outcome of certain
        other
        pending lawsuits relating to the Oak Park site or the company’s potential
        exposure thereto and has not recorded a liability associated with those other
        pending matters.
 
 20
 Table
            of Contents
  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 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.
 
 **Other.** On
        April
        27, 2004, one of Nicor’s Directors and Officers insurance carriers agreed to pay
        $29.0 million to a third party escrow agent on behalf of Nicor and its insured
        directors and officers to be used to satisfy Nicor directors’ and officers’
liabilities and expenses associated with claims asserted against them in
        securities class actions that were settled in 2004, the related shareholder
        derivative lawsuits that were settled in 2005 and related matters, with any
        remaining balance to be paid to Nicor. The escrow was terminated and the
        $29.0
        million, plus earnings of approximately $0.4 million, held by the escrow
        agent
        was paid to Nicor in the second quarter of 2005. In the second half of 2005,
        Nicor received $2.8 million of additional insurance proceeds related to legal
        defense costs. In connection with the settlement of the derivative lawsuits
        referred to above, in the first quarter of 2005, Nicor’s excess insurance
        carrier paid Nicor $4 million to settle certain claims that Nicor had asserted
        and Nicor paid $3.5 million of that amount to plaintiffs’ attorneys to reimburse
        them for the fees and costs expended in pursuing the derivative actions.
        In the
        third quarter of 2006, Nicor received a payment of $5.2 million from its
        excess
        insurance carrier as reimbursement of legal defense costs in connection with
        these matters. This payment has been recorded in “Other corporate eliminations
        and expenses” in the Condensed Consolidated Statement of Operations for the
        quarter ended September 30, 2006.
 
 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, rates, 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.
 
 
 
 
 
 
 21
  Table
            of Contents
  **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 Inc. (“Nicor”) 2005 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 with two principal business segments - gas distribution
        and
        shipping. Northern Illinois Gas Company (doing business as Nicor Gas Company
        (“Nicor Gas”)) is one of the nation’s largest natural gas distribution
        companies, and it is Nicor’s primary business. Tropical Shipping is a
        containerized shipping business serving the Bahamas and the Caribbean region.
        Nicor also owns or has equity interests in several energy-related
        businesses.
 
 Net
        income and diluted earnings per common share are presented below for the
        three
        and nine-month periods ended September 30, 2006 and 2005 (in millions, except
        per share data):
 
 Three
                  months ended
              
              Nine
                  months endedSeptember
                  30
              
              September
                  30**2006**
              
              2005
              
              **2006**
              
              2005Net
                  income (loss)
              
              **$**
              **17.6**
              
              $
              (2.7
              )
              **$**
              **70.0**
              
              $
              74.4Diluted
                  earnings (loss) per common share
              
              **$**
              **.39**
              
              $
              (.06
              )
              **$**
              **1.57**
              
              $
              1.67
 
 Included
        in year-to-date 2006 results is a second quarter $10 million charge ($.22
        per
        share and non-deductible for tax purposes) associated with the company’s
        outstanding United States Securities and Exchange Commission (“SEC”) inquiry and
        a first quarter pretax recovery of $3.8 million ($.05 per share) associated
        with
        Nicor Gas’ mercury inspection and repair program. Included in year-to-date 2005
        results is a pretax benefit of $29.9 million ($.41 per share) related to
        net
        insurance recoveries.
 
 Quarter
        over quarter comparisons reflect improved operating results across all business
        segments. Year-to-date comparisons (before consideration of the items noted
        above) reflect higher gas distribution, other energy ventures and corporate
        operating results, and the recognition of certain income tax benefits including
        those resulting from the reorganization of certain shipping and related
        operations, offset, in part, by lower operating results in the shipping
        segment.
 
 **Operating
        income by segment.** Operating
        income (loss) by major business segment is presented below (in
        millions):
 
 Three
                  months ended
              
              Nine
                  months endedSeptember
                  30
              
              September
                  30**2006**
              
              2005
              
              **2006**
              
              2005Gas
                  distribution
              
              **$**
              **5.6**
              
              $
              .4
              
              **$**
              **80.2**
              
              $
              71.9Shipping
              
              
              **10.5**
              
              
              9.4
              
              
              **29.5**
              
              
              31.9Other
                  energy ventures
              
              
              **6.9**
              
              
              (11.7
              )
              
              **.7**
              
              
              (8.6
              )Corporate
                  and eliminations
              
              
              **5.5**
              
              
              2.5
              
              
              **1.1**
              
              
              33.2**$**
              **28.5**
              
              $
              .6
              
              **$**
              **111.5**
              
              $
              128.4
 
 
 
 22
  Table
            of Contents
  
 The
        following summarizes operating income (loss) comparisons by major business
        segment:
 
 ·
              Gas
                  distribution operating income increased $5.2 million and $8.3 million
                  for
                  the three and nine months ended September 30, 2006, respectively,
                  compared
                  with the year-earlier periods due primarily to the positive effects
                  of
                  higher gas distribution margin ($11.4 million and $26.7 million
                  increases,
                  respectively), partially offset by higher operating and maintenance
                  expenses ($5.6 million and $21.5 million increases, respectively).
                  The
                  year-to-date 2006 results were also favorably impacted by a first
                  quarter
                  mercury-related recovery of $3.8
                  million.
 
 **·**
              Shipping
                  operating income increased $1.1 million to $10.5 million in the
                  third
                  quarter of 2006, compared to $9.4 million for the year-earlier
                  period as
                  higher operating revenues ($6.4 million increase) were partially
                  offset by
                  higher operating costs ($5.3 million increase). Higher operating
                  revenues
                  were attributable to higher average rates ($10.0 million increase),
                  partially offset by lower volumes shipped ($3.0 million decrease).
                  Higher
                  operating costs were due to higher fuel ($1.9 million increase),
                  employee-related costs ($1.2 million increase), repairs and maintenance
                  ($1.1 million increase) and leased freight equipment ($1.0 million
                  increase).
 
 For
        the
        nine-month period ended September 30, 2006, shipping operating income decreased
        $2.4 million compared to the year-earlier period as higher operating revenues
        ($13.4 million increase) were more than offset by higher operating costs
        ($15.8
        million increase). Higher operating revenues were attributable to higher
        average
        rates ($35.0 million increase), partially offset by lower volumes shipped
        ($21.0
        million decrease). Higher operating costs were due to higher fuel ($6.3 million
        increase), employee-related costs ($4.1 million increase), repairs and
        maintenance ($2.4 million increase) and leased freight equipment ($2.0 million
        increase).
 
 ·
              Operating
                  income from Nicor’s other energy ventures increased $18.6 million in the
                  third quarter of 2006 compared to the prior-year period due to
                  reductions
                  in the reported operating loss at Nicor’s wholesale natural gas marketing
                  business, Nicor Enerchange ($12.5 million reduction), and improved
                  operating results at Nicor’s energy-related products and services
                  businesses ($6.2 million increase). Nicor Enerchange’s favorable third
                  quarter operating results as compared with the prior year are due
                  primarily to a significant reduction in 2006 versus 2005 in net
                  unfavorable adjustments related to derivative instruments and inventory
                  carrying values. Nicor Enerchange uses derivative instruments to
                  economically hedge future purchases and sales of natural gas inventory.
                  Nicor Enerchange purchases and holds natural gas in storage to
                  earn a
                  profit margin from its ultimate sale. Nicor Enerchange uses derivatives
                  to
                  mitigate commodity price risk in order to substantially lock-in
                  the profit
                  margin that will ultimately be realized. However, gas stored in
                  inventory
                  is required to be accounted for at the lower of weighted-average
                  cost or
                  market, whereas the derivatives used to reduce the risk associated
                  with a
                  change in the value of the inventory are accounted for at fair
                  value, with
                  changes in fair value recorded in operating results in the period
                  of
                  change. As a result, earnings are subject to volatility as the
                  market
                  price of derivatives change, even when the underlying hedged value
                  of the
                  inventory is unchanged. The volatility resulting from this accounting
                  can
                  be significant from period to period. Improved operating results
                  at
                  Nicor’s energy-related products and services businesses were due primarily
                  to the recognition of a significant portion of previously deferred
                  revenues associated with its utility-bill management contracts.
                  Revenue is
                  recognized on such contracts as the lesser of cumulative earned
                  or
                  cumulative billed amounts, while expenses are recorded as
                  incurred.
 
 
 
 
 23
  Table
            of Contents
  
 For
        the
        nine months ended September 30, 2006, operating income increased $9.3 million
        due primarily to reductions in the reported operating loss at Nicor Enerchange
        ($12.5 million reduction), offset by lower operating results at Nicor’s
        energy-related products and services businesses ($3.1 million decrease).
        Improved operating results at Nicor Enerchange were due primarily to the
        net
        adjustments to derivative instruments and inventory carrying values discussed
        previously in the quarter over quarter comparison. Lower operating results
        at
        Nicor’s energy-related products and services businesses were due to higher
        operating costs ($34.7 million increase) offset, in part, by higher revenues
        ($31.6 million increase).
 
 ·
              “Corporate
                  and Eliminations” operating income for the quarter ended September 30 for
                  both years reflects the positive impact of insurance recoveries
                  related to
                  previously incurred legal expenses associated with the securities
                  class
                  action and shareholder derivative lawsuits. The recoveries totaled
                  $5.2
                  million and $2.6 million for the three months ended September 30,
                  2006 and
                  2005, respectively.
 
 “Corporate
        and eliminations” operating income for both year-to-date periods were impacted
        by noteworthy items. In July 2006, the company reached a tentative agreement
        with the staff of the SEC Enforcement Division in settlement of an anticipated
        civil action for a payment of $10 million. For more information, see Item
        1 -
        Notes to the Condensed Consolidated Financial Statements - Note 17 -
        Contingencies - SEC and U.S. Attorney Inquiries. In the second quarter of
        2006,
        Nicor recorded a $10 million charge (non-deductible for tax purposes) associated
        with the outstanding SEC inquiry. In 2005, the company recorded a $29.4 million
        pretax recovery from an insurance carrier related to costs previously incurred
        by Nicor in connection with a securities class action and a related shareholder
        derivative action which were previously settled and a $0.5 million pretax
        net
        recovery which was comprised of a shareholder derivative action settlement
        ($3.5
        million) and a related Directors and Officers insurance recovery ($4.0 million).
        For more information, see Item 1 - Notes to the Condensed Consolidated Financial
        Statements - Note 17 - Contingencies - Other.
  Financial
        results within “Corporate and eliminations” for the year-to-date periods ended
        September 30, 2006 and 2005 also include approximately $6.3 million and $1.7
        million, respectively, of benefits associated with Nicor’s other energy
        ventures’ utility-bill management contracts attributable to warmer than normal
        weather. Benefits or costs resulting from variances from normal weather are
        recorded at the corporate level as a result of an agreement between the parent
        company and certain of its subsidiaries. The weather impact of these contracts
        generally serves to partially offset the gas distribution segment’s weather
        risk. The amount of the offset attributable to the utility-bill management
        contracts marketed by Nicor’s other energy ventures will vary depending upon a
        number of factors including the time of year, weather patterns, the number
        of
        customers for these products and the market price for natural gas.
 
 **Rate
        proceeding** .
        Nicor
        Gas filed a request with the Illinois Commerce Commission (“ICC”) for an overall
        increase in base rates on November 4, 2004. In late 2005, Nicor Gas received
        approval from the ICC for a $54.2 million base rate increase which reflected
        an
        allowed rate of return on original-cost rate base of 8.85 percent, including
        a
        10.51 percent cost of common equity. The order also included the authorization
        to pass all Chicago Hub revenues directly through to customers as a credit
        to
        Nicor Gas’ Purchased Gas Adjustment (“PGA”) rider and the shifting of certain
        storage-related costs from the PGA rider to base rates. In addition, rates
        were
        established using a 10-year average for weather as opposed to the previous
        use
        of a 30-year average. These rates were implemented in the fourth quarter
        of
        2005. Because the order shifts certain items between base rates and Nicor
        Gas’
PGA rider, the company estimated that, under normal weather conditions and
        demand as reflected in the rate case, the annual net revenue increase resulting
        from implementing the rate order would have been about $34.7 million under
        the
        tariffs that were placed into effect.
 24
 Table
            of Contents
  In
        October 2005, Nicor Gas and six other parties filed applications for rehearing
        of the final order of the rate case.  The ICC granted rehearing on seven
        issues, only two of which relate to the amount of the approved annual net
        revenue increase, and denied rehearing on all other issues raised in the
        applications. In March 2006, the ICC issued its decision on rehearing in
        which
        it adjusted the amount of the annual net rate increase to $49.7 million from
        the
        $54.2 million that had been approved in the earlier order. The company estimates
        that because the revised order similarly shifts certain items between base
        rates
        and Nicor Gas’ PGA rider, under normal weather conditions and demand as
        reflected in the rate case, the annual net revenue increase will decrease
        to
        $30.2 million from the estimated $34.7 million under the previous order.
        Rate
        changes resulting from the rehearing order are prospective and went into
        effect
        on April 11, 2006. Parties, including Nicor Gas, that appealed the ICC’s rate
        case decision to the state appellate courts have since withdrawn their appeals.
        As a result, the ICC rate order is no longer subject to judicial review.
 
 As
        a
        result of the rate order which became effective in the fourth quarter of
        2005,
        certain storage-related costs are now recorded in operating and maintenance
        expense. For the three and nine months ended September 30, 2006, storage-related
        gas costs in operating and maintenance expense totaled $1.0 million and $15.4
        million, respectively. Such costs totaled zero and $11.1 million, respectively,
        for the corresponding prior-year periods and since they were incurred prior
        to
        the effective date of the rate order were recorded as cost of gas.
 
 **RESULTS
        OF OPERATIONS**
 
 Details
        of various financial and operating information by segment can be found in
        the
        tables throughout this review. The following discussion summarizes the major
        items impacting Nicor’s operating income.
 
 **Operating
        revenues.** Operating revenues by major business segment are presented below (in
        millions):
 
 Three
                  months ended
              
              Nine
                  months endedSeptember
                  30
              
              September
                  30**2006**
              
              2005
              
              **2006**
              
              2005Gas
                  distribution
              
              **$**
              **226.7**
              
              $
              241.5
              
              **$**
              **1,775.6**
              
              $
              1,692.6Shipping
              
              
              **98.3**
              
              
              91.9
              
              
              **288.1**
              
              
              274.7Other
                  energy ventures
              
              
              **34.0**
              
              
              9.2
              
              
              **135.1**
              
              
              89.7Corporate
                  and eliminations
              
              
              **(7.9**
              **)**
              
              (6.6
              )
              
              **(77.0**
              **)**
              
              (56.8
              )**$**
              **351.1**
              
              $
              336.0
              
              **$**
              **2,121.8**
              
              $
              2,000.2
 
 Gas
        distribution revenues are impacted by changes in natural gas costs, which
        are
        passed directly through to customers without markup, subject to ICC review.
        For
        the third quarter of 2006 compared with a year ago, gas distribution revenues
        decreased $14.8 million due to lower natural gas costs (approximately
        $50 million decrease), partially offset by the impact of colder weather than
        in
        2005 (approximately $13 million increase) and the base rate increase
        (approximately $11 million). For the 2006 year-to-date period compared with
        a
        year ago, gas distribution revenues increased $83.0 million due to higher
        natural gas costs (approximately $175 million increase) and the impact of
        the
        base rate increase (approximately $36 million), partially offset by the negative
        impact of warmer weather than the corresponding period in 2005 (approximately
        $126 million decrease) and lower demand unrelated to weather (approximately
        $21
        million decrease).
 
 Third
        quarter and year-to-date 2006 shipping segment operating revenues increased
        $6.4
        million and $13.4 million, respectively, compared with the prior-year periods
        due to higher average rates ($10.0 million and $35.0 million increases,
        respectively), partially offset by lower volumes shipped ($3.0 million and
        $21.0
        million decreases, respectively). Rates were higher due to general rate
        increases across all markets and higher cost-recovery surcharges for fuel
        and
        security.
 
 25
 Table
            of Contents
  Third
        quarter 2006 revenues for Nicor’s other energy ventures increased $24.8 million
        due to higher revenues at Nicor Enerchange ($12.7 million increase) and at
        Nicor’s energy-related products and services businesses ($12.2 million
        increase). Nicor Enerchange revenues increased due primarily to the net
        adjustments to derivative instruments and inventory carrying values discussed
        previously under the “Operating income by segment” section. Higher revenues at
        Nicor’s energy-related products and services businesses are attributable to the
        recognition of previously deferred revenues associated with its utility-bill
        management contracts ($7.2 million increase) and an increase in contract
        volumes
        ($3.0 million increase). Year-to-date 2006 revenues increased $45.4 million
        due
        primarily to higher revenues at Nicor’s energy-related products and services
        businesses ($31.6 million increase) and higher revenues at Nicor Enerchange
        ($13.9 million increase). Higher revenues at Nicor’s energy-related products and
        services businesses were attributable to higher average gas costs ($15.3
        million
        increase) and an increase in customer contracts ($10.7 million increase).
        Higher
        revenues at Nicor Enerchange ($13.9 million increase) reflect the net
        adjustments discussed in the quarter over quarter comparison.
 
 Corporate
        and eliminations reflects primarily the elimination of gas distribution revenues
        against Nicor’s other energy ventures’ expenses for customers purchasing the
        utility-bill management products.
 
 **Gas
        distribution margin.** Nicor
        utilizes a measure it refers to as “gas distribution margin” to evaluate the
        operating income impact of gas distribution revenues. Gas distribution revenues
        include natural gas costs, which are passed directly through to customers
        without markup, subject to ICC review, and revenue taxes, for which Nicor
        Gas
        earns a small administrative fee. These items often cause significant
        fluctuations in gas distribution revenues, and yet they have virtually no
        direct
        impact on gas distribution operating income.
 
 A
        reconciliation of gas distribution revenues and margin follows (in
        millions):
 
 Three
                  months ended
              
              Nine
                  months endedSeptember
                  30
              
              September
                  30**2006**
              
              2005
              
              **2006**
              
              2005Gas
                  distribution revenues
              
              **$**
              **226.7**
              
              $
              241.5
              
              **$**
              **1,775.6**
              
              $
              1,692.6Cost
                  of gas
              
              
              **(108.0**
              **)**
              
              (134.9
              )
              
              **(1,258.8**
              **)**
              
              (1,202.3
              )Revenue
                  tax expense
              
              
              **(12.6**
              **)**
              
              (11.9
              )
              
              **(109.0**
              **)**
              
              (109.2
              )Gas
                  distribution margin
              
              **$**
              **106.1**
              
              $
              94.7
              
              **$**
              **407.8**
              
              $
              381.1
 
 Gas
        distribution margin increased $11.4 million in the third quarter of 2006
        compared with the corresponding prior-year period due primarily to the impact
        of
        the base rate increase (approximately $11 million assuming normal weather).
        Year-to-date 2006 gas distribution margin increased $26.7 million compared
        with
        the corresponding prior-year period due primarily to the impact of the base
        rate
        increase (approximately $36 million), partially offset by the negative impact
        of
        warmer weather than in 2005 (approximately $8 million decrease) and lower
        demand
        unrelated to weather (approximately $3 million decrease).
 
 **Gas
        distribution operating and maintenance expense.** Gas
        distribution operating and maintenance expense increased **** $5.6
        million to $56.6 million in the third quarter of 2006 from $51.0 million
        in the
        prior-year period due to higher company use gas ($4.1 million increase) and
        higher bad debt expense ($1.3 million increase). Year-to-date operating and
        maintenance expense increased $21.5 million to $199.9 million from $178.4
        million in the prior-year period due primarily to higher storage-related
        gas
        costs ($15.4 million increase), company use gas ($11.0 million increase)
        and bad
        debt expense ($3.3 million increase), partially offset by lower payroll and
        benefit-related costs ($3.6 million decrease) and claims arising from normal
        operations ($4.2 million decrease).
 
 
 26
  Table
            of Contents
  
 Transfer,
        in the 2005 rate order, of recovery of certain storage-related gas costs
        from
        the PGA rider to base rates results in those costs being charged to operating
        and maintenance expense. Prior to the effective date of the rate order, these
        storage-related gas costs, which were zero and $11.1 million in the three
        and
        nine-month periods ended September 30, 2005, respectively, were charged to
        cost
        of gas and passed through to customers as part of the PGA rider.
 
 **Other
        gas distribution operating expenses.** Mercury-related
        costs (recoveries), net reflect estimated costs, credits and recoveries
        associated with the company’s mercury inspection and repair program. During the
        first quarter of 2006, a mercury-related recovery of $3.8 million was realized.
        This net recovery resulted from a settlement reached with an independent
        contractor of Nicor Gas. Additional information about the company’s mercury
        inspection and repair program is presented in Item 1 - Notes to the Condensed
        Consolidated Financial Statements - Note 17 - Contingencies -
        Mercury.
 
 Property
        sale gains and losses vary from year-to-year depending upon property sales
        activity. Nicor Gas realized a $0.6 million and $3.2 million pretax gain
        on the
        sale of property for the three and nine months ended September 30, 2006,
        respectively. The company continues to assess its ownership of certain real
        estate holdings.
 
 **Shipping
        operating expenses.** Third
        quarter and year-to-date 2006 shipping segment operating expenses increased
        $5.3
        million and $15.8 million, respectively, compared with the corresponding
        prior-year periods. Higher operating costs were attributable, in part, to
        higher
        fuel ($1.9 million and $6.3 million increases, respectively), employee-related
        costs ($1.2 million and $4.1 million increases, respectively), repairs and
        maintenance ($1.1 million and $2.4 million increases, respectively) and leased
        freight equipment ($1.0 million and $2.0 million increases,
        respectively).
 
 **Other
        energy ventures operating expenses.** Third
        quarter and year-to-date 2006 other energy ventures operating expenses increased
        $6.2 million and $36.1 million, respectively, compared with the corresponding
        prior-year periods. These increases were due primarily to higher expenses
        at
        Nicor’s energy-related products and services businesses ($5.9 million and $34.7
        million increases, respectively) reflecting a higher average cost of gas
        for the
        year-to-date period ($12.9 million increase), costs related to an increase
        in
        customer contracts ($1.9 million and $6.8 million increases, respectively),
        higher selling, general and administrative costs attributable to acquiring
        new
        customer contracts ($2.7 million and $6.2 million increases, respectively),
        and
        higher bad debt expense ($1.4 million and $2.4 million increases, respectively).
 
 **Litigation
        charges (recoveries), net.** In
        the
        second quarter of 2006, Nicor recorded a $10 million charge (non-deductible
        for
        tax purposes) associated with the outstanding SEC inquiry. In July 2006,
        the
        company reached a tentative agreement with the staff of the SEC Enforcement
        Division in settlement of an anticipated civil action for a payment of $10
        million. For more information, see Item 1 - Notes to the Condensed Consolidated
        Financial Statements - Note 17 - Contingencies - SEC and U.S. Attorney
        Inquiries.
 
 In
        2005,
        the company recorded a $29.4 million pretax recovery from an insurance carrier
        related to costs previously incurred by Nicor in connection with a securities
        class action and a related shareholder derivative action which were previously
        settled and a $0.5 million pretax net recovery which was comprised of a
        shareholder derivative action settlement ($3.5 million) and a related Directors
        and Officers insurance recovery ($4.0 million). For more information, see
        Item 1
        - Notes to the Condensed Consolidated Financial Statements - Note 17 -
        Contingencies - Other.
 
 
 
 
 27
  Table
            of Contents
  
 **Interest
        expense.** Interest
        expense of $11.1 million in the third quarter of 2006 increased $0.5 million
        from the corresponding 2005 period due to higher estimated interest on income
        tax matters ($0.9 million increase). Interest  expense
        of $35.5 million for the nine-month period ended September 30, 2006 increased
        $2.7 million over the corresponding prior-year period due to higher average
        borrowing levels ($2.2 million increase) and higher average interest rates
        ($0.6
        million increase).
 
 Higher
        average borrowings were attributable, in part, to a $40 million two-year
        senior
        unsecured term loan obtained in December 2005 and used to fund a portion
        of the
        repatriation of cumulative undistributed foreign earnings of Tropical Shipping
        in connection with the American Jobs Creation Act (the “Jobs Act”). As of
        September 30, 2006, $12 million of this term loan remained
        outstanding.
 
 **Equity
        investment income, net.** Equity
        investment income increased for the three and nine-month period ended September
        30, 2006 over the corresponding prior-year periods due primarily to the $2.4
        million gain on a sale of an equity investment recognized in the third quarter
        of 2006.
 
 **Interest
        income.** Interest
        income increased $0.9 million and $3.6 million for the three and nine-month
        periods ended September 30, 2006, respectively, over the corresponding
        prior-year periods due primarily to higher investment balances and higher
        average rates.
 
 **Income
        taxes.** In
        December 2005, the company repatriated $132 million under the Jobs Act.
        Effective January 2006, the company reorganized certain of its 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 expected to be indefinitely reinvested offshore, no deferred
        income
        tax expense would be recorded by the company. For the three and nine-month
        periods ended September 30, 2006, income tax expense has not been provided
        on
        approximately $6 million and $17 million, respectively, of foreign company
        shipping earnings that are expected to be indefinitely reinvested offshore.
        In
        connection with these activities, a net income tax benefit of approximately
        $6
        million was recorded in the first quarter of 2006 from the elimination of
        certain deferred taxes. The company expects to incur approximately $5 million
        in
        current tax expense associated with these activities, of which approximately
        $3
        million has been recognized in the first nine months of 2006.
 
 The
        company’s effective income tax rate for the remainder of 2006 is estimated to be
        approximately 29 percent resulting from the ongoing benefit of untaxed foreign
        shipping earnings, recognition of certain tax credits and the amortization
        of
        excess deferred taxes. During the first nine months of 2006, the effective
        income tax rate was 25.1 percent. The lower rate for the first nine months
        reflects the recognition of additional tax benefits related to the first
        quarter
        2006 reorganization of the company’s shipping and related operations and second
        quarter 2006 favorable adjustments associated with tax audits (which occur
        in
        the ordinary course of business) offset, in part, in the second quarter of
        2006
        by the non-deductible $10 million charge associated with the company’s
        outstanding SEC inquiry. For the first nine months of 2005, the effective
        income
        tax rate was 30.6 percent which reflected the effects of recording 2005 net
        litigation recoveries and earnings thereon ($29.9 million) at the company’s
        marginal tax rate of approximately 40 percent as well as miscellaneous third
        quarter tax benefits ($1.5 million). The effective income tax rate for the
        quarters ended September 30, 2006 and 2005 was 30.3 percent and 51.3 percent,
        respectively. For the quarter ended September 30, 2005, in addition to the
        impact of miscellaneous tax benefits ($1.5 million), the quarter’s effective
        income tax rate increased due to changes in forecasted annual income. Such
        change was not significant for the year-to-date period, but did have a
        disproportionate impact on the third quarter effective income tax rate as
        the
        income before income taxes was relatively low.
 
 
 28




Table
          of Contents


**Nicor
                Inc.****Gas
                Distribution Statistics****Three
                months ended**
            
            **Nine
                months ended****September
                30**
            
            **September
                30****2006**
            
            2005
            
            **2006**
            
            2005**Operating
                revenues**(millions)SalesResidential
            
            **$**
            **136.8**
            
            $
            152.4
            
            **$**
            **1,207.5**
            
            $
            1,140.7Commercial
            
            
            **29.8**
            
            
            36.0
            
            
            **275.2**
            
            
            255.0Industrial
            
            
            **2.7**
            
            
            4.3
            
            
            **31.9**
            
            
            34.9**169.3**
            
            
            192.7
            
            
            **1,514.6**
            
            
            1,430.6TransportationResidential
            
            
            **6.1**
            
            
            4.8
            
            
            **21.9**
            
            
            19.1Commercial
            
            
            **14.7**
            
            
            11.5
            
            
            **57.7**
            
            
            51.0Industrial
            
            
            **10.7**
            
            
            10.4
            
            
            **29.1**
            
            
            29.4Other
            
            
            **1.1**
            
            
            1.0
            
            
            **2.0**
            
            
            8.6**32.6**
            
            
            27.7
            
            
            **110.7**
            
            
            108.1Other
                revenuesRevenue
                taxes
            
            
            **12.9**
            
            
            12.8
            
            
            **111.5**
            
            
            112.4Environmental
                cost recovery
            
            
            **.8**
            
            
            1.4
            
            
            **7.2**
            
            
            15.9Chicago
                Hub
            
            
            **8.1**
            
            
            2.4
            
            
            **13.9**
            
            
            7.5Other
            
            
            **3.0**
            
            
            4.5
            
            
            **17.7**
            
            
            18.1**24.8**
            
            
            21.1
            
            
            **150.3**
            
            
            153.9**$**
            **226.7**
            
            $
            241.5
            
            **$**
            **1,775.6**
            
            $
            1,692.6**Deliveries**(Bcf)SalesResidential
            
            
            **13.9**
            
            
            12.0
            
            
            **121.6**
            
            
            131.2Commercial
            
            
            **3.2**
            
            
            3.1
            
            
            **27.9**
            
            
            29.5Industrial
            
            
            **.4**
            
            
            .4
            
            
            **3.4**
            
            
            4.1**17.5**
            
            
            15.5
            
            
            **152.9**
            
            
            164.8TransportationResidential
            
            
            **1.2**
            
            
            1.1
            
            
            **10.7**
            
            
            12.7Commercial
            
            
            **11.2**
            
            
            8.8
            
            
            **59.5**
            
            
            60.9Industrial
            
            
            **23.1**
            
            
            25.1
            
            
            **75.2**
            
            
            84.7**35.5**
            
            
            35.0
            
            
            **145.4**
            
            
            158.3**53.0**
            
            
            50.5
            
            
            **298.3**
            
            
            323.1**Customers
                at end of period**(thousands)SalesResidential
            
            
            **1,784.5**
            
            
            1,771.2Commercial
            
            
            **121.6**
            
            
            117.9Industrial
            
            
            **7.1**
            
            
            7.3**1,913.2**
            
            
            1,896.4TransportationResidential
            
            
            **161.0**
            
            
            160.0Commercial
            
            
            **56.6**
            
            
            57.6Industrial
            
            
            **5.5**
            
            
            5.9**223.1**
            
            
            223.5**2,136.3**
            
            
            2,119.9**Other
                statistics**Degree
                days
            
            
            **84**
            
            
            26
            
            
            **3,301**
            
            
            3,572Colder
                (warmer) than normal*
            
            
            **20**
            **%**
            
            (63
            )%
            
            (12
            )%
            
            (5
            )%Average
                gas cost per Mcf sold
            
            **$**
            **6.05**
            
            $
            8.53
            
            **$**
            **8.18**
            
            $
            7.22*
                Normal weather for Nicor Gas' service territory, for purposes of
                this
                report, is considered to be 5,830degree
                days per year.




29




Table
          of Contents





**Shipping
      Statistics**





Three
                months ended
            
            Nine
                months endedSeptember
                30
            
            September
                30**2006**
            
            2005
            
            **2006**
            
            2005TEUs
                shipped (thousands)
            
            
            **50.0**
            
            
            51.7
            
            
            **147.3**
            
            
            159.6Revenue
                per TEU
            
            **$**
            **1,965**
            
            $
            1,765
            
            **$**
            **1,956**
            
            $
            1,718At
                end of periodPorts
                served
            
            
            **27**
            
            
            25Vessels
                operated
            
            
            **18**
            
            
            19








**FINANCIAL
      CONDITION AND LIQUIDITY**





**Operating
      activities.** The gas
      distribution business is highly seasonal and operating cash flow may fluctuate
      significantly during the year and from year-to-year due to factors such as
      weather, natural gas prices, the timing of collections from customers, natural
      gas purchasing, and storage and hedging practices. The company relies on
      short-term financing to meet seasonal increases in working capital needs. Cash
      requirements generally increase over the last half of the year due to increases
      in natural gas purchases, gas in storage and accounts receivable. During the
      first half of the year, positive cash flow generally results from the sale
      of
      gas in storage and the collection of accounts receivable. This cash is typically
      used to substantially reduce or eliminate short-term borrowings during the
      first
      half of the year. Net cash flow provided from operating activities
      decreased **** $48.9
      million to $548.5 million for the nine months ended September 30, 2006 from
      $597.4 million in the year-earlier period.





Nicor
      maintains margin accounts related to financial derivative transactions. These
      margin accounts may cause large fluctuations in cash needs or sources in a
      relatively short period of time due to daily settlements resulting from changes
      in natural gas futures prices. The company manages these fluctuations with
      short-term borrowings and investments.





In
      2003,
      Nicor received an income tax refund of approximately $100 million attributable
      to a tax loss carryback associated with a change in tax accounting method (which
      increased its deferred income tax liability), subject to Internal Revenue
      Service (“IRS”) review and approval as part of normal ongoing audits. Through
      December 31, 2004, the total current tax benefits previously recorded under
      this
      accounting method approximated $135 million (amounts recorded were offset by
      increases to the deferred tax liability with no net effect on reported net
      federal income tax expense). In the third quarter of 2005, the IRS revised
      the
      regulations pertaining to the aforementioned tax accounting method. The new
      regulations require repayment in 2005 and 2006 of amounts previously taken
      as
      current tax deductions. In the second half of 2005 and during the nine months
      ended September 30, 2006, Nicor reclassified income tax expense from deferred
      to
      current and repaid approximately $67 million and $50 million, respectively.
      The
      company expects to repay the remaining amounts during the fourth quarter of
      2006. The anticipated repayment is expected to have no direct impact on earnings
      and no material impact on the company’s financial condition.





**Investing
      activities.** Net
      cash
      flows used for investing activities decreased $48.9 million to $132.1 million
      for the nine months ended September 30, 2006 compared to $181.0 million in
      the
      prior-year period. This decrease largely reflects decreased short-term
      investments and reduced capital expenditures partially offset by the restricted
      short-term investments associated with the third quarter 2006 funding of an
      escrow account associated with the tentative agreement with the staff of the
      SEC
      Enforcement Division in settlement of an anticipated civil action. For more
      information, see Item 1 - Notes to the Condensed Consolidated Financial
      Statements - Note 4 - Restricted Short-Term Investments.





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**Financing
      activities.** In the
      second quarter of 2006, Standard and Poor’s and Fitch reaffirmed their credit
      ratings of Nicor and Nicor Gas. In July 2006, Moody’s Investors Service
      (“Moody’s”) downgraded Nicor’s commercial paper rating to Prime-2 from Prime-1,
      Nicor’s preferred stock rating to Baa2 from Baa1, Nicor Gas’ senior secured
      rating to A1 from Aa3 and Nicor Gas’ senior unsecured debt rating to A2 from A1.
      Nicor Gas’ Prime-1 commercial paper rating was not under review by Moody’s. The
      company does not expect this downgrade to have a significant impact on its
      results of operations, cash flows or financial condition.





*Long-term
      debt.* Through
      September 30, 2006, Tropical Shipping has repaid $28 million of its $40 million,
      two-year senior unsecured term loan. The repayment was primarily financed
      through the company’s cash flows from operating activities. In October 2006,
      Nicor Gas entered into an agreement for the issuance of $50 million First
      Mortgage Bonds at 5.85 percent, due in 2036. The issuance is expected to occur,
      subject to the satisfaction of the conditions in the underlying agreements,
      on
      the maturity date of the $50 million 5.55 percent First Mortgage Bond series
      due
      in December 2006.





*Short-term
      debt.* In
      October 2006, Nicor Gas established a $400 million, 210-day seasonal revolver,
      which expires in May 2007, to replace the $400 million, 210-day seasonal
      revolver, which expired in April 2006. In September 2005, Nicor and Nicor Gas
      established a $600 million, five-year revolver, expiring September 2010. These
      facilities were established with major domestic and foreign banks and serve
      as
      backup for the issuance of commercial paper. The company had $151.0 million,
      $586.0 million and $144.0 million of commercial paper borrowings outstanding
      at
      September 30, 2006, December 31, 2005 and September 30, 2005, respectively.
      The
      company believes it is in compliance with all debt covenants and believes it
      will continue to remain so. The company expects that funding from commercial
      paper and related backup line-of-credit agreements will continue to be available
      in the foreseeable future and sufficient to meet estimated cash
      requirements.





*American
      Jobs Creation Act* .
      During
      December 2005, under certain provisions of the Jobs Act, Nicor repatriated
      $132
      million of cumulative undistributed earnings. To the extent required,
      repatriated amounts have been properly used for qualifying investment uses
      under
      the Jobs Act. Qualifying investment uses included funding of United States-based
      employee-related costs, capital investments, and advertising and marketing
      expenditures.





*Dividends.* Nicor
      maintained its 2006 quarterly common stock dividend rate of $0.465 per common
      share during the third quarter of 2006. This quarterly dividend rate was also
      applicable in 2005. The company paid dividends on its common stock of $62.1
      million and $61.6 million for the year-to-date periods ended September 30,
      2006
      and 2005, respectively. Nicor currently has no contractual or regulatory
      restrictions on the payment of dividends.





**Contractual
      obligations.** In
      the
      third quarter of 2006, Tropical Shipping signed an agreement to purchase a
      new
      vessel for approximately $6 million with delivery expected in November
      2006. **** As
      previously disclosed, Nicor Gas signed an agreement in the second quarter of
      2006 to purchase approximately 16 Bcf of synthetic natural gas annually for
      a
      20-year term beginning as early as 2010. Since the agreement is contingent
      upon
      various milestones to be achieved by the counterparty to the agreement and
      the
      fact that the counterparty can terminate, without penalty, prior to the
      realization of these milestones, the company’s obligation under this agreement
      is not certain at this time.




















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          of Contents





**Gas
      in storage.** Gas
      distribution segment inventory is carried at cost on a last-in, first-out
      (“LIFO”) basis. Inventory decrements occurring during interim periods that are
      expected to be restored prior to year-end are charged to cost of gas at the
      estimated annual replacement cost, and the difference between this cost and
      the
      actual LIFO layer cost is recorded on the balance sheet as a current temporary
      LIFO liquidation. Interim inventory decrements not expected to be restored
      prior
      to year-end are charged to cost of gas at the actual LIFO cost of the layers
      liquidated.





At
      September 30, 2006, the company had an inventory decrement of approximately
      5
      Bcf which it believes will not be restored prior to year-end. The liquidated
      inventory was charged to cost of gas at a LIFO cost of $7.82 per Mcf. If the
      company had deemed the decrement to be temporary, it would have charged cost
      of
      gas for the estimated annual replacement cost, currently estimated to be about
      $6.32 per Mcf. Applying LIFO cost in valuing the decrement, as opposed to the
      estimated annual replacement cost, had the effect of increasing the cost of
      gas
      distributed by $7.5 million during 2006. However, since the cost of gas,
      including inventory costs, is charged to customers without markup, subject
      to
      ICC review, this difference had no impact on net income. There was no
      liquidation of any LIFO layers during 2005.





**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.





*Performance-based
      rate (“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 is currently under ICC review. There are
      allegations that the company acted improperly in connection with the PBR plan,
      and the ICC and others are reviewing these allegations. On June 27, 2002, the
      Citizens Utility Board (“CUB”) filed a motion to reopen the record in the ICC’s
      proceedings to review the PBR plan (the “ICC Proceedings”). As a result of the
      motion to reopen, Nicor Gas, the Cook County State’s Attorney Office (“CCSAO”),
      the staff of the ICC and CUB entered into a stipulation providing for additional
      discovery. The Illinois Attorney General’s Office (“IAGO”) has also intervened
      in this matter. In addition, the IAGO issued Civil Investigation Demands
      (“CIDs”) to CUB and the ICC staff. The CIDs ordered that CUB and the ICC staff
      produce all documents relating to any claims that Nicor Gas may have presented,
      or caused to be presented, false information related to its PBR plan. Parties
      who were plaintiffs in a dismissed class action proceeding against the company
      could potentially intervene in these proceedings. 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. A copy of the report is available at the Nicor website and
      has
      been previously produced to all parties in the ICC Proceedings.

















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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. In addition, 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. The net of these items and interest income on certain components results
      in a $1.0 million reimbursement the company is seeking as of September 30,
      2006 *,* pending
      resolution of the proceedings discussed below. 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, the CCSAO and CUB filed a motion for $27 million in sanctions
      against the company in the ICC Proceedings. In that motion, CCSAO and CUB
      alleged that Nicor Gas’ responses to certain CUB data requests were false. Also
      on February 5, 2003, CUB stated in a press release that, in addition to $27
      million in sanctions, it would seek additional refunds to consumers. On March
      5,
      2003, the ICC staff filed a response brief in support of CUB’s motion for
      sanctions. On May 1, 2003, the Administrative Law Judges issued a ruling denying
      CUB and CCSAO’s motion for sanctions. CUB has filed an appeal of the motion for
      sanctions with the ICC, and the ICC has indicated that it will not rule on
      the
      appeal until the final disposition of the ICC Proceedings. It is not possible
      to
      determine how the ICC will resolve the claims of CCSAO, CUB or other parties
      to
      the ICC Proceedings.





In
      November 2003, the ICC staff, CUB, CCSAO and the IAGO filed their respective
      direct testimony in the ICC Proceedings. The ICC staff is seeking refunds to
      customers of approximately $108 million and CUB and CCSAO were jointly seeking
      refunds to customers of approximately $143 million. The IAGO direct testimony
      alleges adjustments in a range from $145 million to $190 million. The IAGO
      testimony as filed is presently unclear as to the amount which IAGO seeks to
      have refunded to customers. On February 27, 2004, the above referenced
      intervenors filed their rebuttal testimony in the ICC Proceedings. In such
      rebuttal testimony, CUB and CCSAO amended the alleged amount to be refunded
      to
      customers from approximately $143 million to $190 million. Nicor Gas filed
      rebuttal testimony in January 2004, which is consistent with the findings of
      the
      special committee Report. Nicor Gas seeks a reimbursement of approximately
      $1
      million as referenced above. The parties to the ICC Proceedings have agreed
      to a
      stay of the evidentiary hearings on this matter in order to undertake additional
      third party discovery from Entergy-Koch Trading, LP (“EKT”), a natural gas,
      storage and transportation trader and consultant with whom Nicor did business
      under the PBR plan.





During
      the course of the United States Securities and Exchange Commission (“SEC”)
      investigation discussed below, the company became aware of additional
      information relating to the activities of individuals affecting the PBR plan
      for
      the period from 1999 through 2002, including information consisting of third
      party documents and recordings of telephone conversations from EKT. Review
      of
      additional information completed in 2004 resulted in the $1.8 million adjustment
      to the previously recorded liability referenced above.

















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          of Contents




Although
      the Report of the special committee’s counsel did not find that there was
      criminal activity or fraud, a review of this additional information (which
      was
      not available to the independent counsel who prepared the Report) and
      re-interviews of certain Nicor Gas personnel in 2004 indicated that certain
      former Nicor Gas personnel may have engaged in potentially fraudulent conduct
      regarding the PBR plan in violation of company policy, and in possible violation
      of SEC rules and applicable law. Further, certain former Nicor Gas personnel
      also may have attempted to conceal their conduct in connection with an ICC
      review of the PBR plan. The company continues to cooperate with the SEC, the
      U.S. Attorney’s office and the ICC on this matter. The company has reviewed all
      third party information it has obtained and will continue to review any
      additional third party information the company may obtain. The company
      terminated four employees in connection with this matter in 2004.





Nicor
      is
      unable to predict the outcome of the ICC’s review or the company’s potential
      exposure thereunder. Because the PBR plan and historical gas costs are still
      under ICC review, the final outcome could be materially different than the
      amounts reflected in the company’s financial statements as of September 30,
      2006.





*SEC
      and U.S. Attorney Inquiries.* In 2002,
      the staff of the SEC Division of Enforcement (“SEC Staff”) informed Nicor that
      the SEC is conducting a formal inquiry regarding the PBR plan. A representative
      of the Office of the United States Attorney for the Northern District of
      Illinois (the “U.S. Attorney”) has notified Nicor that that office is conducting
      an inquiry on the same matters that the SEC is investigating, and a grand jury
      is also reviewing these matters. In April 2004, Nicor was advised by the SEC
      Staff that it intended to recommend to the SEC that it bring a civil injunctive
      action against Nicor, alleging that Nicor violated Sections 17(a) of the
      Securities Act of 1933 and Sections 10(b) and 13(a) of the Securities Exchange
      Act of 1934 and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. On July 7,
      2006, the company announced that it reached a tentative agreement with the
      SEC
      Staff in settlement of an anticipated civil action to which the company and
      the
      SEC will be parties. Under the terms of the tentative settlement, the company
      will be subject to disgorgement of one dollar, a monetary fine of $10 million
      and an injunction. The company will neither admit nor deny any wrongdoing.
      In
      July 2006, the company deposited the $10 million in escrow pending final
      approval of the tentative settlement by the SEC commissioners and entry of
      a
      final judgment by a federal court. The SEC Staff will submit the tentative
      settlement to the SEC commissioners for approval. The SEC commissioners have
      the
      authority to approve, modify or reject the tentative settlement. Nicor recorded
      a $10 million charge to its second quarter earnings in connection with this
      matter. The $10 million fine is not deductible for federal or state income
      tax
      purposes. Nicor is unable to predict the outcome of the separate inquiry by
      the
      U.S. Attorney or Nicor’s potential exposure related thereto and has not recorded
      a liability associated with the outcome of that matter.





*Mercury.* Future
      operating results may be impacted by adjustments to the company’s estimated
      mercury liability or by related recoveries. Additional information about mercury
      contingencies is presented in Item 1 - Notes to the Condensed Consolidated
      Financial Statements - Note 17 - Contingencies - Mercury.





*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 in Item 1 - Notes to the Condensed Consolidated Financial Statements
      -
      Note 17 - Contingencies - Manufactured Gas Plant Sites.





*Fixed
      Bill Service.* Nicor
      Services was a defendant in a purported class action. On October 7, 2005, the
      Circuit Court denied plaintiffs’ motion to certify the proposed class.
      Information about this lawsuit is presented within Item 1 - Notes to the
      Condensed Consolidated Financial Statements - Note 17 - Contingencies - Fixed
      Bill Service.











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*Other
      contingencies.* **** The
      company is involved in legal or administrative proceedings before various courts
      and agencies with respect to general claims, rates, taxes, environmental, gas
      cost prudence reviews and other matters. See Item 1 - Notes to the Condensed
      Consolidated Financial Statements - Note 7 - Income and Other Taxes and Note
      17
      - Contingencies.





On
      April
      27, 2004, one of Nicor’s Directors and Officers insurance carriers agreed to pay
      $29.0 million to a third party escrow agent on behalf of Nicor and its insured
      directors and officers to be used to satisfy Nicor directors’ and officers’
liabilities and expenses associated with claims asserted against them in
      securities class actions that were settled in 2004, the related shareholder
      derivative lawsuits that were settled in 2005 and related matters, with any
      remaining balance to be paid to Nicor. The escrow was terminated and the $29.0
      million, plus earnings of approximately $0.4 million, held by the escrow agent
      was paid to Nicor in the second quarter of 2005. In the second half of 2005,
      Nicor received $2.8 million of additional insurance proceeds related to legal
      defense costs. In connection with the settlement of the derivative lawsuits
      referred to above, in the first quarter of 2005, Nicor’s excess insurance
      carrier paid Nicor $4 million to settle certain claims that Nicor had asserted
      and Nicor paid $3.5 million of that amount to plaintiffs’ attorneys to reimburse
      them for the fees and expenses expended in pursuing the derivative actions.
      In
      the third quarter of 2006, Nicor received a payment of $5.2 million from its
      excess insurance carrier as reimbursement of legal defense costs in connection
      with these matters. This payment has been recorded in “Other corporate
      eliminations and expenses” in the Condensed Consolidated Statement of Operations
      for the quarter ended September 30, 2006.








**CRITICAL
      ACCOUNTING ESTIMATES**





See
      Item
      7 - Management’s Discussion and Analysis of Financial Condition and Results of
      Operations - Critical Accounting Estimates in the 2005 Annual Report on Form
      10-K for a discussion of the company’s critical accounting estimates. There have
      been no material changes to these estimates.





**NEW
      ACCOUNTING PRONOUNCEMENTS**





In
      the
      third quarter of 2006, the Financial Accounting Standards Board (“FASB”) issued
      Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes* ,
      Statement of Financial Accounting Standard (“SFAS”) No. 157, *Fair
      Value Measurements* ,
      SFAS
      No. 158, *Employers’
      Accounting for Defined Benefit Pension and Other Postretirement
      Plans,* and FASB
      Staff Position No. AUG AIR-1, *Accounting
      for Planned Major Maintenance Activities* .
      For
      more information, see Item 1 - Notes to the Condensed Consolidated Financial
      Statements - Note 3 - New Accounting Pronouncements.





**CAUTION
      CONCERNING FORWARD-LOOKING STATEMENTS**





This
      document includes certain forward-looking statements about the expectations
      of
      Nicor and its subsidiaries and affiliates. Although Nicor believes these
      statements are based on reasonable assumptions, actual results may vary
      materially from stated expectations. Such forward-looking statements may be
      identified by the use of forward-looking words or phrases such as “anticipate,”
“believe,” “expect,” “intend,” “may,” “planned,” “potential,” “should,” “will,”
“would,” “project,” “estimate,” “ultimate,” or similar phrases. Actual results
      may differ materially from those indicated in the company’s forward-looking
      statements due to the direct or indirect effects of legal contingencies
      (including litigation) and the resolution of those issues, including the effects
      of an ICC review and SEC and U.S. Attorney inquiries, and undue reliance should
      not be placed on such statements.

















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Other
      factors that could cause materially different results include, but are not
      limited to, weather conditions; natural disasters; natural gas and other fuel
      prices; fair value accounting adjustments; inventory valuation; health care
      costs; insurance costs or recoveries; legal costs; borrowing needs; interest
      rates; credit conditions; economic and market conditions; tourism and
      construction in the Bahamas and Caribbean region; energy conservation;
      legislative and regulatory actions; tax rulings or audit results; asset sales;
      significant unplanned capital needs; future mercury-related charges or credits;
      changes in accounting principles, interpretations, methods, judgments or
      estimates; performance of major suppliers and contractors; labor relations;
      and
      acts of terrorism.





Readers
      are cautioned not to place undue reliance on these forward-looking statements,
      which speak only as of the date of this filing. Nicor undertakes no obligation
      to publicly release any revision to these forward-looking statements to reflect
      events or circumstances after the date of this filing.





**Item
      3.****Quantitative
      and Qualitative Disclosures About Market Risk**





Nicor
      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 and
      fuel
      commodity prices, and interest rates.





There
      has
      been no material change in the company’s exposure to market risk since the
      filing of the 2005 Annual Report on Form 10-K.





**Item
      4.********Controls
      and Procedures**





The
      company carried out an evaluation under the supervision and with the
      participation of the company’s management, including its Chief Executive Officer
      and Chief Financial Officer, of the effectiveness of the design and operation
      of
      the company’s disclosure controls and procedures as of the end of the period
      covered by this Quarterly Report on Form 10-Q (the “Evaluation”).





In
      designing and evaluating the disclosure controls and procedures, management
      recognizes that any disclosure controls and procedures, no matter how well
      designed and operated, can provide only reasonable assurance of achieving the
      desired control objectives, and management is required to apply its judgment
      in
      evaluating the cost-benefit relationship of possible disclosure controls and
      procedures. Based on the Evaluation, the company’s Chief Executive Officer and
      Chief Financial Officer concluded that the company’s disclosure controls and
      procedures, as of the end of the period covered by this Quarterly Report on
      Form
      10-Q, were effective at the reasonable assurance level to ensure that
      information required to be disclosed by the company in reports that it files
      or
      submits under the Securities Exchange Act of 1934 is recorded, processed,
      summarized and reported within the time periods specified in United States
      Securities and Exchange Commission rules and forms.





There
      has
      been no change in the company’s internal controls over financial reporting
      during the company’s most recent fiscal quarter that has materially affected, or
      is reasonably likely to materially affect, the company’s internal control over
      financial reporting. In the second quarter of 2006, the company disclosed that
      Nicor Gas completed the implementation of a new customer care and billing
      system.


























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**PART
      II - OTHER INFORMATION**





**Item
      1.****Legal
      Proceedings**





See
      Item
      2 - Management’s Discussion and Analysis of Financial Condition and Results of
      Operations - Contingencies and Item 1 - Notes to the Condensed Consolidated
      Financial Statements - Note 15 - Rate Proceeding and Note 17 - Contingencies,
      which are incorporated herein by reference, for a discussion of the company’s
      contingencies.





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





In
      September 2001, Nicor announced a $50 million common stock repurchase program,
      under which Nicor may purchase its common stock as market conditions permit
      through open market transactions and to the extent cash flow is available after
      other cash needs and investment opportunities. There have been no repurchases
      under this program during 2006 or 2005. As of September 30, 2006, $21.5 million
      remained authorized for the repurchase of common stock.





**Item
      6.****Exhibits**





ExhibitNumber
            
            Description
                of Document3.01
            *
            Restated
                Articles of Incorporation of the company. (File No. 1-7297, Form
                8-K for
                July 26, 2006, Nicor Inc.)3.02
            *
            By-Laws
                of the company as amended by the company’s Board of Directors on January
                15, 2004. (File No. 1-7297, Form 10-K for 2003, Nicor Inc., Exhibit
                3.09)10.01
            
            210-Day
                Credit Agreement dated as of October 26, 200610.02
            
            Second
                Amendment to the 5-Year Credit Agreement dated as of October 26,
                2006





31.1
            
            Rule
                13a-14(a)/15d-14(a) Certification.31.2
            
            Rule
                13a-14(a)/15d-14(a) Certification.32.1
            
            Section
                1350 Certification.32.2
            
            Section
                1350 Certification.





*
            These
                exhibits have been previously filed with the United States Securities
                and
                Exchange Commission (“SEC”) as exhibits to registration statements or to
                other filings with the SEC 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.


























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**Signature**





Pursuant
      to the requirements 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
                Inc.November
                1, 2006
            
            /s/
                KAREN K. PEPPING(Date)
            
            Karen
                K. PeppingVice
                President and Controller(Principal
                Accounting Officer and
              Duly
                Authorized Officer)





































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