10-Q 1 f10q20120930.htm FORM 10-Q Converted by EDGARwiz

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q


[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934


For the quarterly period ended:

September 30, 2012


[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934


For the transition period from _______________ to _______________


Commission

File No.

 

Name of Registrant, State of Incorporation, Address

of Principal Executive Offices, and Telephone No.

 

IRS Employer

Identification No.

000-49965

 

MGE Energy, Inc.

(a Wisconsin Corporation)

133 South Blair Street

Madison, Wisconsin 53703

(608) 252-7000

www.mgeenergy.com

 

39-2040501

000-1125

 

Madison Gas and Electric Company

(a Wisconsin Corporation)

133 South Blair Street

Madison, Wisconsin 53703

(608) 252-7000

www.mge.com

 

39-0444025


Indicate by check mark whether the registrants (1) have 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 (or for such shorter period that the registrant was required to file such reports), and (2) have been subject to such filing requirements for the past 90 days: Yes [X] No [ ]


Indicate by check mark whether the registrants have submitted electronically and posted on their corporate Web sites, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrants were required to submit and post such files):

Yes [X] No [ ]


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.


 

Large Accelerated Filer

Accelerated Filer

Non-accelerated Filer

Smaller Reporting

Company

MGE Energy, Inc.

X

 

 

 

Madison Gas and Electric Company

 

 

X

 


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

MGE Energy, Inc. and Madison Gas and Electric Company: Yes [ ] No [X]


Number of Shares Outstanding of Each Class of Common Stock as of October 31, 2012

MGE Energy, Inc.

Common stock, $1.00 par value, 23,113,638 shares outstanding.

Madison Gas and Electric Company

Common stock, $1.00 par value, 17,347,894 shares outstanding (all of which are

owned beneficially and of record by MGE Energy, Inc.).




1





Table of Contents



PART I. FINANCIAL INFORMATION.

3

Filing Format

3

Forward-Looking Statements

3

Where to Find More Information

3

Definitions, Abbreviations, and Acronyms Used in the Text and Notes of this Report

4

Item 1. Financial Statements.

5

MGE Energy, Inc.

5

Consolidated Statements of Income (unaudited)

5

Consolidated Statements of Comprehensive Income (unaudited)

5

Consolidated Statements of Cash Flows (unaudited)

6

Consolidated Balance Sheets (unaudited)

7

Consolidated Statements of Common Equity (unaudited)

8

Madison Gas and Electric Company

9

Consolidated Statements of Income (unaudited)

9

Consolidated Statements of Comprehensive Income (unaudited)

9

Consolidated Statements of Cash Flows (unaudited)

10

Consolidated Balance Sheets (unaudited)

11

Consolidated Statements of Common Equity (unaudited)

12

MGE Energy, Inc., and Madison Gas and Electric Company

13

Notes to Consolidated Financial Statements (unaudited)

13

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

33

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

48

Item 4. Controls and Procedures.

50

PART II. OTHER INFORMATION.

51

Item 1. Legal Proceedings.

51

Item 1A. Risk Factors.

51

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

51

Item 4. Mine Safety Disclosures.

51

Item 6. Exhibits.

52

Signatures - MGE Energy, Inc.

53

Signatures - Madison Gas and Electric Company

54




2





PART I. FINANCIAL INFORMATION.


Filing Format


This combined Form 10-Q is being filed separately by MGE Energy, Inc. (MGE Energy) and Madison Gas and Electric Company (MGE). MGE is a wholly owned subsidiary of MGE Energy and represents a majority of its assets, liabilities, revenues, expenses, and operations. Thus, all information contained in this report relates to, and is filed by, MGE Energy. Information that is specifically identified in this report as relating solely to MGE Energy, such as its financial statements and information relating to its nonregulated business, does not relate to, and is not filed by, MGE. MGE makes no representation as to that information. The terms "we" and "our," as used in this report, refer to MGE Energy and its consolidated subsidiaries, unless otherwise indicated.


Forward-Looking Statements


This report, and other documents filed by MGE Energy and MGE with the Securities and Exchange Commission (SEC) from time to time, contain forward-looking statements that reflect management's current assumptions and estimates regarding future performance and economic conditions—especially as they relate to future load growth, revenues, expenses, capital expenditures, financial resources, regulatory matters, and the scope and expense associated with future environmental regulation. These forward-looking statements are made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Words such as "believe," "expect," "anticipate," "estimate," "could," "should," "intend," and other similar words generally identify forward-looking statements. Both MGE Energy and MGE caution investors that these forward-looking statements are subject to known and unknown risks and uncertainties that may cause actual results to differ materially from those projected, expressed, or implied.


The factors that could cause actual results to differ materially from the forward-looking statements made by a registrant (a) include those factors discussed in the Registrants' 2011 Annual Report on Form 10-K: Item 1A. Risk Factors, as updated by Part II. Item 1A. Risk Factors in this Report, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, as updated by Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations in this report, and Item 8. Financial Statements and Supplementary Data – Note 18, as updated by Part I, Item 1. Financial Statements – Note 8 in this report, and (b) other factors discussed herein and in other filings made by that registrant with the SEC.


Readers are cautioned not to place undue reliance on these forward-looking statements, which apply only as of the date of this report. MGE Energy and MGE undertake no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances after the date of this report.


Where to Find More Information


The public may read and copy any reports or other information that MGE Energy and MGE file with the SEC at the SEC's public reference room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. These documents also are available to the public from commercial document retrieval services, the website maintained by the SEC at http://www.sec.gov, MGE Energy's website at http://www.mgeenergy.com, and MGE's website at http://www.mge.com. Copies may be obtained from our websites free of charge. Information contained on MGE Energy's and MGE's websites shall not be deemed incorporated into, or to be a part of, this report.




3





Definitions, Abbreviations, and Acronyms Used in the Text and Notes of this Report


Abbreviations, acronyms, and definitions used in the text and notes of this report are defined below.


MGE Energy and Subsidiaries:

 

MAGAEL

MAGAEL, LLC

MGE

Madison Gas and Electric Company

MGE Construct

MGE Construct, LLC

MGE Energy

MGE Energy, Inc.

MGE Power

MGE Power, LLC

MGE Power Elm Road

MGE Power Elm Road, LLC

MGE Power West Campus

MGE Power West Campus, LLC

MGE Transco

MGE Transco Investment, LLC

 

 

Other Defined Terms:

 

AFUDC

Allowance for Funds Used During Construction

ATC

American Transmission Company LLC

BART

Best Available Retrofit Technology

Blount

Blount Station

CAA

Clean Air Act

CAIR

Clean Air Interstate Rule

CAVR

Clean Air Visibility Rule

Codification

Financial Accounting Standards Board Accounting Standards Codification

Columbia

Columbia Energy Center

cooling degree days

Measure of the extent to which the average daily temperature is above 65 degrees Fahrenheit, which is considered an indicator of possible increased demand for energy to provide cooling

CSAPR

Cross-State Air Pollution Rule

CWA

Clean Water Act

CWDC

Central Wisconsin Development Corporation

DOE

U.S. Department of Energy

Dth

Dekatherms, a quantity measure used in respect of natural gas

Elm Road Units

Elm Road Generating Station

EPA

United States Environmental Protection Agency

ERISA

Employee Retirement Income Security Act

EGU

Electric Generating Unit

FASB

Financial Accounting Standards Board

FTR

Financial Transmission Rights

GHG

Greenhouse Gas

HAPs

Hazardous Air Pollutants

heating degree days (HDD)

Measure of the extent to which the average daily temperature is below 65 degrees Fahrenheit, which is considered an indicator of possible increased demand for energy to provide heating

IRS

Internal Revenue Service

kWh

Kilowatt-hour, a measure of electric energy produced

MACT

Maximum Achievable Control Technology

MAP-21

Moving Ahead for Progress in the 21st Century Act

MATS

Mercury and Air Toxics Standards

MISO

Midwest Independent System Operator (a regional transmission organization)

MW

Megawatt, a measure of electric energy generating capacity

MWh

Megawatt-hour, a measure of electric energy produced

NAAQS

National Ambient Air Quality Standards

NGCC

Natural Gas Combined Cycle

NO2

Nitrogen Dioxide

NOV

Notice of Violation

NOx

Nitrogen Oxides

NSPS

New Source Performance Standards

OPRB

Other Postretirement Benefits

PGA

Purchased Gas Adjustment clause, a regulatory mechanism used to reconcile natural gas costs recovered in rates to actual costs

PJM

PJM Interconnection, LLC (a regional transmission organization)

PM

Particulate Matter

PPA

Purchased power agreement

PSCW

Public Service Commission of Wisconsin

PSD

Prevention of Significant Deterioration

RICE

Reciprocating Internal Combustion Engine

SEC

Securities and Exchange Commission

SIP

State Implementation Plan

SO2

Sulfur Dioxide

Stock Plan

Direct Stock Purchase and Dividend Reinvestment Plan of MGE Energy

UW

University of Wisconsin at Madison

VIE

Variable Interest Entity

WCCF

West Campus Cogeneration Facility

WDNR

Wisconsin Department of Natural Resources

Working capital

Current assets less current liabilities

WPDES

Wisconsin Pollutant Discharge Elimination System

WPL

Wisconsin Power and Light Company

WPSC

Wisconsin Public Service Corporation



4





Item 1. Financial Statements.


MGE Energy, Inc.

Consolidated Statements of Income (unaudited)

(In thousands, except per-share amounts)


 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2012

 

2011

 

2012

 

2011

Operating Revenues:

 

 

 

 

 

 

 

 

    Regulated electric revenues

$

118,914

$

114,963

$

305,189

$

291,804

    Regulated gas revenues

 

16,587

 

17,249

 

92,235

 

119,748

    Nonregulated revenues

 

2,337

 

1,360

 

6,894

 

3,884

        Total Operating Revenues

 

137,838

 

133,572

 

404,318

 

415,436

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

    Fuel for electric generation

 

16,395

 

16,656

 

36,727

 

39,304

    Purchased power

 

18,102

 

18,024

 

54,962

 

49,997

    Cost of gas sold

 

7,389

 

8,171

 

50,035

 

72,170

    Other operations and maintenance

 

41,975

 

39,744

 

126,202

 

119,814

    Depreciation and amortization

 

9,706

 

10,296

 

29,042

 

30,669

    Other general taxes

 

4,383

 

4,347

 

13,937

 

13,053

        Total Operating Expenses

 

97,950

 

97,238

 

310,905

 

325,007

Operating Income

 

39,888

 

36,334

 

93,413

 

90,429

 

 

 

 

 

 

 

 

 

Other income, net

 

2,856

 

2,341

 

7,975

 

6,880

Interest expense, net

 

(4,849)

 

(5,142)

 

(14,717)

 

(15,047)

    Income before income taxes

 

37,895

 

33,533

 

86,671

 

82,262

Income tax provision

 

(14,253)

 

(12,495)

 

(32,711)

 

(30,718)

Net Income

$

23,642

$

21,038

$

53,960

$

51,544

 

 

 

 

 

 

 

 

 

Earnings Per Share of Common Stock

 

 

 

 

 

 

 

 

(basic and diluted)

$

1.02

$

0.91

$

2.33

$

2.23

 

 

 

 

 

 

 

 

 

Dividends per share of common stock

$

0.395

$

0.383

$

1.161

$

1.133

 

 

 

 

 

 

 

 

 

Average Shares Outstanding

 

 

 

 

 

 

 

 

(basic and diluted)

 

23,114

 

23,114

 

23,114

 

23,114

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the above unaudited consolidated financial statements.




MGE Energy, Inc.

Consolidated Statements of Comprehensive Income (unaudited)

(In thousands)


 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2012

 

2011

 

2012

 

2011

Net Income

$

23,642

$

21,038

$

53,960

$

51,544

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

    Unrealized gain (loss) on available-for-sale

 

 

 

 

 

 

 

 

    securities, net of tax ($5 and $50, and $24 and

 

 

 

 

 

 

 

 

    $4)

 

(8)

 

(74)

 

35

 

7

    Reclassification of realized gain on available-

 

 

 

 

 

 

 

 

    for-sale securities, net of tax ($- and $-, and

 

 

 

 

 

 

 

 

    $- and $10)

 

-

 

-

 

-

 

(15)

Comprehensive Income

$

23,634

$

20,964

$

53,995

$

51,536

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the above unaudited consolidated financial statements.




5





MGE Energy, Inc.

Consolidated Statements of Cash Flows (unaudited)

(In thousands)


 

 

Nine Months Ended

 

 

September 30,

 

 

2012

 

2011

Operating Activities:

 

 

 

 

    Net income

$

53,960

$

51,544

    Items not affecting cash:

 

 

 

 

        Depreciation and amortization

 

29,042

 

30,669

        Deferred income taxes

 

54,602

 

16,854

        Provision for doubtful receivables

 

1,537

 

1,441

        Employee benefit plan expenses

 

13,815

 

10,259

        Equity earnings in ATC

 

(6,764)

 

(6,434)

        Other items

 

1,632

 

1,044

    Changes in working capital items:

 

 

 

 

        (Increase) decrease in current assets

 

(9,002)

 

27,868

        Decrease in current liabilities

 

(13,418)

 

(10,547)

    Dividend income from ATC

 

5,300

 

5,012

    Cash contributions to pension and other postretirement plans

 

(24,336)

 

(22,484)

    Other noncurrent items, net

 

9,518

 

1,299

            Cash Provided by Operating Activities

 

115,886

 

106,525

 

 

 

 

 

Investing Activities:

 

 

 

 

    Capital expenditures

 

(65,909)

 

(44,859)

    Capital contributions to investments

 

(1,988)

 

(958)

    Purchase of investment - land

 

(2)

 

(2,152)

    Other

 

(289)

 

80

            Cash Used for Investing Activities

 

(68,188)

 

(47,889)

 

 

 

 

 

Financing Activities:

 

 

 

 

    Cash dividends paid on common stock

 

(26,820)

 

(26,183)

    Repayment of long-term debt

 

(30,000)

 

(1,834)

    Issuance of long-term debt

 

28,000

 

30,000

    Decrease in short-term debt

 

-

 

(22,500)

    Other

 

(844)

 

(336)

            Cash Used for Financing Activities

 

(29,664)

 

(20,853)

 

 

 

 

 

Change in Cash and Cash Equivalents:

 

18,034

 

37,783

    Cash and cash equivalents at beginning of period

 

41,169

 

7,110

    Cash and cash equivalents at end of period

$

59,203

$

44,893

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

    Significant noncash investing activities:

 

 

 

 

        Accrued capital expenditures

$

7,649

$

2,606

 

 

 

 

 

The accompanying notes are an integral part of the unaudited consolidated financial statements.




6





MGE Energy, Inc.

Consolidated Balance Sheets (unaudited)

(In thousands)


 

September 30,

December 31,

ASSETS

 

2012

 

2011

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

59,203

$

41,169

    Receivable - margin account

 

1,653

 

2,477

    Accounts receivable, less reserves of $3,516 and $3,662, respectively

 

33,315

 

36,744

    Other accounts receivable, less reserves of $611 and $439, respectively

 

4,621

 

5,318

    Unbilled revenues

 

19,095

 

25,754

    Materials and supplies, at average cost

 

17,014

 

14,758

    Fossil fuel

 

6,863

 

5,468

    Stored natural gas, at average cost

 

17,218

 

19,575

    Prepaid taxes

 

43,590

 

22,251

    Regulatory assets - current

 

8,350

 

7,347

    Other current assets

 

8,885

 

8,270

        Total Current Assets

 

219,807

 

189,131

Regulatory assets

 

230,418

 

205,835

Other deferred assets and other

 

7,298

 

8,018

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

967,556

 

961,511

    Construction work in progress

 

75,748

 

34,055

        Total Property, Plant, and Equipment

 

1,043,304

 

995,566

Investments

 

63,829

 

60,332

        Total Assets

$

1,564,656

$

1,458,882

 

 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

2,667

$

2,667

    Accounts payable

 

29,238

 

34,532

    Accrued interest and taxes

 

4,064

 

4,085

    Accrued payroll related items

 

9,409

 

9,987

    Deferred income taxes

 

1,577

 

3,020

    Derivative liabilities

 

9,600

 

4,568

    Other current liabilities

 

3,421

 

4,215

        Total Current Liabilities

 

59,976

 

63,074

Other Credits:

 

 

 

 

    Deferred income taxes

 

256,689

 

199,850

    Investment tax credit - deferred

 

1,585

 

1,780

    Regulatory liabilities

 

25,817

 

20,463

    Accrued pension and other postretirement benefits

 

166,788

 

183,622

    Derivative liabilities

 

67,490

 

34,908

    Other deferred liabilities and other

 

48,685

 

43,330

        Total Other Credits

 

567,054

 

483,953

Capitalization:

 

 

 

 

    Common shareholders' equity

 

578,127

 

550,952

    Long-term debt

 

359,499

 

360,903

        Total Capitalization

 

937,626

 

911,855

Commitments and contingencies (see Footnote 8)

 

-

 

-

        Total Liabilities and Capitalization

$

1,564,656

$

1,458,882

 

 

 

 

 

The accompanying notes are an integral part of the above unaudited consolidated financial statements.




7





MGE Energy, Inc.

Consolidated Statements of Common Equity (unaudited)

(In thousands, except per-share amounts)


 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

Common Stock

 

Paid-in

 

Retained

 

Comprehensive

 

 

 

Shares

 

Value

 

Capital

 

Earnings

 

(Loss)/Income

 

Total

2011

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2010

23,114

$

23,114

$

316,268

$

185,556

$

142

$

525,080

Net income

 

 

 

 

 

 

51,544

 

 

 

51,544

Other comprehensive loss

 

 

 

 

 

 

 

 

(8)

 

(8)

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

($1.133 per share)

 

 

 

 

 

 

(26,183)

 

 

 

(26,183)

Ending balance - September 30, 2011

23,114

$

23,114

$

316,268

$

210,917

$

134

$

550,433

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2011

23,114

$

23,114

$

316,268

$

211,458

$

112

$

550,952

Net income

 

 

 

 

 

 

53,960

 

 

 

53,960

Other comprehensive income

 

 

 

 

 

 

 

 

35

 

35

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

($1.161 per share)

 

 

 

 

 

 

(26,820)

 

 

 

(26,820)

Ending balance - September 30, 2012

23,114

$

23,114

$

316,268

$

238,598

$

147

$

578,127

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the above unaudited consolidated financial statements.




8





Madison Gas and Electric Company

Consolidated Statements of Income (unaudited)

(In thousands)


 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2012

 

2011

 

2012

 

2011

Operating Revenues:

 

 

 

 

 

 

 

 

    Regulated electric revenues

$

118,914

$

114,963

$

305,189

$

291,804

    Regulated gas revenues

 

16,587

 

17,249

 

92,235

 

119,748

    Nonregulated revenues

 

2,337

 

1,360

 

6,894

 

3,884

        Total Operating Revenues

 

137,838

 

133,572

 

404,318

 

415,436

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

    Fuel for electric generation

 

16,395

 

16,656

 

36,727

 

39,304

    Purchased power

 

18,102

 

18,024

 

54,962

 

49,997

    Cost of gas sold

 

7,389

 

8,171

 

50,035

 

72,170

    Other operations and maintenance

 

41,766

 

39,558

 

125,320

 

119,162

    Depreciation and amortization

 

9,706

 

10,296

 

29,042

 

30,669

    Other general taxes

 

4,384

 

4,347

 

13,938

 

13,053

    Income tax provision

 

13,669

 

11,525

 

30,273

 

28,082

        Total Operating Expenses

 

111,411

 

108,577

 

340,297

 

352,437

Operating Income

 

26,427

 

24,995

 

64,021

 

62,999

 

 

 

 

 

 

 

 

 

Other Income and Deductions:

 

 

 

 

 

 

 

 

    AFUDC - equity funds

 

514

 

101

 

978

 

304

    Equity in earnings in ATC

 

2,280

 

2,167

 

6,764

 

6,434

    Income tax provision

 

(587)

 

(933)

 

(2,555)

 

(2,689)

    Other income, net

 

(77)

 

(56)

 

(207)

 

(217)

        Total Other Income and Deductions

 

2,130

 

1,279

 

4,980

 

3,832

    Income before interest expense

 

28,557

 

26,274

 

69,001

 

66,831

 

 

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

 

 

 

    Interest on long-term debt

 

5,065

 

5,214

 

15,335

 

15,428

    Other interest, net

 

25

 

8

 

(116)

 

(244)

    AFUDC - borrowed funds

 

(209)

 

(40)

 

(398)

 

(123)

        Net Interest Expense

 

4,881

 

5,182

 

14,821

 

15,061

Net Income

$

23,676

$

21,092

$

54,180

$

51,770

Less Net Income Attributable to Noncontrolling Interest, net of tax

 

(6,153)

 

(6,010)

 

(18,305)

 

(17,935)

Net Income Attributable to MGE

$

17,523

$

15,082

$

35,875

$

33,835

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the above unaudited consolidated financial statements.




Madison Gas and Electric Company

Consolidated Statements of Comprehensive Income (unaudited)

(In thousands)


 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2012

 

2011

 

2012

 

2011

Net Income

$

23,676

$

21,092

$

54,180

$

51,770

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

    Unrealized loss on available-for-sale

 

 

 

 

 

 

 

 

    securities, net of tax ($5 and $35, and $20 and

 

 

 

 

 

 

 

 

    $14)

 

(7)

 

(52)

 

(30)

 

(20)

    Reclassification of realized gain on available-

 

 

 

 

 

 

 

 

    for-sale securities, net of tax ($- and $-, and

 

 

 

 

 

 

 

 

    $- and $10)

 

-

 

-

 

-

 

(15)

Comprehensive Income

$

23,669

$

21,040

$

54,150

$

51,735

    Less: Comprehensive income attributable to

 

 

 

 

 

 

 

 

    Noncontrolling Interest, net of tax

 

(6,153)

 

(6,010)

 

(18,305)

 

(17,935)

Comprehensive Income attributable to MGE

$

17,516

$

15,030

$

35,845

$

33,800

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the above unaudited consolidated financial statements.




9





Madison Gas and Electric Company

Consolidated Statements of Cash Flows (unaudited)

(In thousands)


 

 

Nine Months Ended

 

 

September 30,

 

 

2012

 

2011

Operating Activities:

 

 

 

 

    Net income

$

54,180

$

51,770

    Items not affecting cash:

 

 

 

 

        Depreciation and amortization

 

29,042

 

30,669

        Deferred income taxes

 

53,984

 

16,160

        Provision for doubtful receivables

 

1,537

 

1,441

        Employee benefit plan expenses

 

13,815

 

10,259

        Equity earnings in ATC

 

(6,764)

 

(6,434)

        Other items

 

2,028

 

1,468

    Changes in working capital items:

 

 

 

 

        (Increase) decrease in current assets

 

(10,446)

 

26,349

        Decrease in current liabilities

 

(14,052)

 

(10,407)

    Dividend income from ATC

 

5,300

 

5,012

    Cash contributions to pension and other postretirement plans

 

(24,336)

 

(22,484)

    Other noncurrent items, net

 

9,281

 

1,238

            Cash Provided by Operating Activities

 

113,569

 

105,041

 

 

 

 

 

Investing Activities:

 

 

 

 

    Capital expenditures

 

(65,909)

 

(44,859)

    Capital contributions to investments

 

(1,775)

 

(888)

    Other

 

(271)

 

373

            Cash Used for Investing Activities

 

(67,955)

 

(45,374)

 

 

 

 

 

Financing Activities:

 

 

 

 

    Cash dividends paid to parent by MGE

 

(13,456)

 

(19,921)

    Distributions to parent from noncontrolling interest

 

(15,500)

 

(43,000)

    Equity contribution received by noncontrolling interest

 

1,775

 

888

    Repayment of long-term debt

 

(30,000)

 

(1,834)

    Issuance of long-term debt

 

28,000

 

30,000

    Decrease in short-term debt

 

-

 

(3,500)

    Other

 

(795)

 

(297)

            Cash Used for Financing Activities

 

(29,976)

 

(37,664)

 

 

 

 

 

Change in Cash and Cash Equivalents:

 

15,638

 

22,003

    Cash and cash equivalents at beginning of period

 

13,898

 

4,494

    Cash and cash equivalents at end of period

$

29,536

$

26,497

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

    Significant noncash investing activities:

 

 

 

 

        Accrued capital expenditures

$

7,649

$

2,606

 

 

 

 

 

The accompanying notes are an integral part of the unaudited consolidated financial statements.




10





Madison Gas and Electric Company

Consolidated Balance Sheets (unaudited)

(In thousands)


 

September 30,

December 31,

ASSETS

 

2012

 

2011

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

29,536

$

13,898

    Receivable - margin account

 

1,653

 

2,477

    Accounts receivable, less reserves of $3,516 and $3,662, respectively

 

32,621

 

35,765

    Affiliate receivables

 

572

 

605

    Other accounts receivable, less reserves of $611 and $439, respectively

 

4,606

 

5,301

    Unbilled revenues

 

19,095

 

25,754

    Materials and supplies, at average cost

 

17,014

 

14,758

    Fossil fuel

 

6,863

 

5,468

    Stored natural gas, at average cost

 

17,218

 

19,575

    Prepaid taxes

 

44,515

 

21,977

    Regulatory assets - current

 

8,350

 

7,347

    Other current assets

 

8,851

 

8,245

        Total Current Assets

 

190,894

 

161,170

Affiliate receivable long-term

 

6,487

 

6,884

Regulatory assets

 

230,418

 

205,835

Other deferred assets and other

 

6,721

 

7,286

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

967,052

 

961,007

    Construction work in progress

 

75,748

 

34,055

        Total Property, Plant, and Equipment

 

1,042,800

 

995,062

Investments

 

60,743

 

57,556

        Total Assets

$

1,538,063

$

1,433,793

 

 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

2,667

$

2,667

    Accounts payable

 

29,238

 

34,532

    Affiliate payables

 

1,143

 

2,152

    Accrued interest and taxes

 

4,017

 

4,037

    Accrued payroll related items

 

9,409

 

9,987

    Deferred income taxes

 

1,646

 

3,020

    Derivative liabilities

 

9,600

 

4,568

    Other current liabilities

 

3,577

 

3,997

        Total Current Liabilities

 

61,297

 

64,960

Other Credits:

 

 

 

 

    Deferred income taxes

 

252,656

 

196,550

    Investment tax credit - deferred

 

1,585

 

1,780

    Regulatory liabilities

 

25,817

 

20,463

    Accrued pension and other postretirement benefits

 

166,788

 

183,622

    Derivative liabilities

 

67,490

 

34,908

    Other deferred liabilities and other

 

48,685

 

43,330

        Total Other Credits

 

563,021

 

480,653

Capitalization:

 

 

 

 

    Common shareholder's equity

 

435,315

 

412,926

    Noncontrolling interest

 

118,931

 

114,351

        Total Equity

 

554,246

 

527,277

    Long-term debt

 

359,499

 

360,903

        Total Capitalization

 

913,745

 

888,180

Commitments and contingencies (see Footnote 8)

 

-

 

-

        Total Liabilities and Capitalization

$

1,538,063

$

1,433,793

 

 

 

 

 

The accompanying notes are an integral part of the above unaudited consolidated financial statements.




11





Madison Gas and Electric Company

Consolidated Statements of Common Equity (unaudited)

(In thousands)


 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

Non-

 

 

 

Common Stock

 

Paid-in

 

Retained

Comprehensive

Controlling

 

 

 

Shares

 

Value

 

Capital

 

Earnings

(Loss)/Income

Interest

 

Total

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2010

17,348

$

17,348

$

192,417

$

192,480

$

71

$

141,993

$

544,309

Net income

 

 

 

 

 

 

33,835

 

 

 

17,935

 

51,770

Other comprehensive loss

 

 

 

 

 

 

 

 

(35)

 

 

 

(35)

Cash dividends paid to parent

 

 

 

 

 

 

 

 

 

 

 

 

 

by MGE

 

 

 

 

 

 

(19,921)

 

 

 

 

 

(19,921)

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

888

 

888

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(43,000)

 

(43,000)

Ending balance - September 30, 2011

17,348

$

17,348

$

192,417

$

206,394

$

36

$

117,816

$

534,011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2011

17,348

$

17,348

$

192,417

$

203,114

$

47

$

114,351

$

527,277

Net income

 

 

 

 

 

 

35,875

 

 

 

18,305

 

54,180

Other comprehensive loss

 

 

 

 

 

 

 

 

(30)

 

 

 

(30)

Cash dividends paid to parent

 

 

 

 

 

 

 

 

 

 

 

 

 

by MGE

 

 

 

 

 

 

(13,456)

 

 

 

 

 

(13,456)

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

1,775

 

1,775

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(15,500)

 

(15,500)

Ending balance - September 30, 2012

17,348

$

17,348

$

192,417

$

225,533

$

17

$

118,931

$

554,246

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the above unaudited consolidated financial statements.




12





MGE Energy, Inc., and Madison Gas and Electric Company

Notes to Consolidated Financial Statements (unaudited)

September 30, 2012


1.

Basis of Presentation - MGE Energy and MGE.


This report is a combined report of MGE Energy and MGE. References in this report to "MGE Energy" are to MGE Energy, Inc., and its subsidiaries. References in this report to "MGE" are to Madison Gas and Electric Company.


MGE Power Elm Road and MGE Power West Campus own electric generating assets and lease those assets to MGE. Both entities are variable interest entities under applicable authoritative guidance. MGE is considered the primary beneficiary of these entities as a result of contractual agreements. As a result, MGE has consolidated MGE Power Elm Road and MGE Power West Campus.


The accompanying consolidated financial statements as of September 30, 2012, and for the three and nine months ended, are unaudited, but include all adjustments that MGE Energy and MGE management consider necessary for a fair statement of their respective financial statements. All adjustments are of a normal, recurring nature except as otherwise disclosed. The year-end consolidated balance sheet information was derived from the audited balance sheet appearing in MGE Energy's and MGE's 2011 Annual Report on Form 10-K, but does not include all disclosures required by accounting principles in the United States of America. These notes should be read in conjunction with the financial statements and the notes on pages 54 through 107 of the 2011 Annual Report on Form 10-K.


2.

Equity and Financing Arrangements.


a.

Common Stock - MGE Energy.


MGE Energy purchases stock in the open market for issuance pursuant to its Stock Plan. All MGE Energy common stock issued under the Stock Plan is sold pursuant to a registration statement that has been filed with the SEC and is currently effective.


MGE Energy can issue new shares of its common stock through the Stock Plan. For both the nine months ended September 30, 2012 and 2011, MGE Energy did not issue any new shares of common stock under the Stock Plan.


b.

Preferred Stock – MGE Energy and MGE.


As of September 30, 2012, and December 31, 2011, MGE has 1,175,000 shares of $25 par value redeemable preferred stock (cumulative) that is authorized but unissued. On October 25, 2012, MGE amended and restated its existing Restated Articles of Incorporation, which eliminated the previously authorized cumulative preferred stock. There were no shares of cumulative preferred stock issued and outstanding at the date of the amendment.


c.

Dilutive Shares Calculation - MGE Energy.


MGE Energy does not hold any dilutive securities.


d.

Long-term Debt - MGE Energy and MGE.


On April 2, 2012, MGE issued $28 million in principal amount of its 4.38% senior notes, due April 1, 2042. The Notes were issued pursuant to a Note Purchase Agreement. The Notes are unsecured and are not issued under, or governed by, MGE's Indenture dated as of September 1, 1998, which governs MGE's Medium-Term Notes. MGE used the net proceeds from the sale of the Notes, together with other available corporate funds, to repay and retire on April 3, 2012, its obligations under a Loan Agreement dated as of April 1, 2002 with the City of Madison, Wisconsin, under which MGE received the net proceeds from the issuance of $28 million aggregate principal amount of 5.875% Series 2002A, Industrial Development Revenue Bonds that were issued by the City of Madison for MGE's benefit. The 5.875% Series 2002A Bonds were redeemed and retired on April 3, 2012, at 100% of their principal amount plus accrued interest with the proceeds of that loan repayment. Any interest savings in 2012 will be deferred.




13





e.

Remarketing of 4.875% Series 2002B, Industrial Development Revenue Bonds - MGE Energy and MGE.


On April 2, 2012, $19.3 million of 4.875% Series 2002B, Industrial Development Revenue Bonds were remarketed at an interest rate of 3.45%. The net proceeds of the 4.875% Series 2002B Bonds were originally loaned to MGE pursuant to a Loan Agreement dated as of April 1, 2002 with the City of Madison, which issued the Series 2002B Bonds in 2002. MGE is responsible for the payment of principal, premium, if any, and interest on the Bonds. The 4.875% Series 2002B Bonds were originally issued bearing an interest rate of 4.875% per annum for a period that ended April 1, 2012, at which point the Bonds were subject to mandatory tender by their holders and remarketing. The Series 2002B Bonds were remarketed and carry an interest rate of 3.45% per annum, which is payable semi-annually on April 1 and October 1, until their maturity on October 1, 2027. The Series 2002B Bonds are redeemable on or after April 1, 2017, at a redemption price equal to 100% of the principal amount of the Bonds to be redeemed, plus accrued interest to the redemption date.


3.

Investment in ATC - MGE Energy and MGE.


ATC owns and operates electric transmission facilities primarily in Wisconsin. MGE received an interest in ATC when it, like other Wisconsin electric utilities, contributed its electric transmission facilities to ATC. That interest is presently held by MGE Transco, which is jointly owned by MGE Energy and MGE.


MGE Transco has accounted for its investment in ATC under the equity method of accounting. For the nine months ended September 30, 2012 and 2011, MGE Transco recorded equity earnings from the investment in ATC of $6.8 million and $6.4 million, respectively. Dividend income received from ATC was $5.3 million and $5.0 million for the nine months ended September 30, 2012 and 2011, respectively. In addition, during the nine months ended September 30, 2012 and 2011, MGE Transco made $1.8 million and $0.9 million in capital contributions to ATC, respectively.


MGE Energy and MGE's investment in ATC as of September 30, 2012, and December 31, 2011, was $60.3 million and $57.0 million, respectively.


At September 30, 2012, MGE is the majority owner, and MGE Energy, the holding company, is the minority owner of MGE Transco. MGE Energy's proportionate share of the equity and net income of MGE Transco is classified within the MGE financial statements as noncontrolling interest.


ATC's summarized financial data for the three and nine months ended September 30, 2012 and 2011, is as follows:


 

 

Three Months Ended

 

Nine Months Ended

(In thousands)

 

September 30,

 

September 30,

 

 

2012

 

2011

 

2012

 

2011

Operating revenues

$

150,303

$

142,741

$

450,136

$

420,562

Operating expenses

 

(68,813)

 

(66,413)

 

(210,139)

 

(192,491)

Other expense, net

 

(5)

 

(173)

 

(832)

 

(665)

Interest expense, net

 

(20,983)

 

(19,517)

 

(61,260)

 

(60,893)

Earnings before members' income taxes

$

60,502

$

56,638

$

177,905

$

166,513


4.

Columbia Environmental Project Construction - MGE Energy and MGE.


MGE and two other utilities jointly own Columbia, a coal-fired generating facility. WPL is the plant operator and permit holder, and owns 46.2% of Columbia. WPSC owns a 31.8% interest, and MGE owns a 22% interest in Columbia. In early 2011, the PSCW issued a Certificate and Order authorizing the construction of scrubbers and bag houses and associated equipment on Columbia Units 1 and 2 to reduce SO2 and mercury emissions. The scrubbers and bag houses are expected to support compliance obligations for current and anticipated air quality regulations, including CAIR or CSAPR, the Utility MACT Rule and the Wisconsin Mercury Rule. The operator's current estimate shows that MGE's share of the capital expenditures required for this project will be approximately $140 million. As of September 30, 2012, MGE had accumulated $42.3 million (excluding carrying costs) related to its share of the project, which is reflected in the Construction Work in Progress balance on MGE Energy's and MGE's consolidated balance sheets. MGE expects to incur capital expenditures as follows: $18 million for the remainder of 2012, $68 million in 2013, and $12 million in 2014. These amounts may change as a result of modifications to the project estimate or timing differences. MGE has recognized $0.7 million (after tax) in AFUDC equity related to this project for the nine months ended September 30, 2012.



14





MGE expects that the costs pertaining to this project will be fully recoverable through rates. Additionally, MGE is entitled to a carrying cost on the related construction costs at 100% of the determined AFUDC rate.


5.

Taxes - MGE Energy and MGE.


a.

Accounting for Uncertainty in Income Taxes.


MGE Energy and MGE account for the difference between the tax benefit amount taken on prior year tax returns, or expected to be taken on a current year tax return, and the tax benefit amount recognized in the financial statements as an unrecognized tax benefit.


MGE Energy has adopted a tax method of accounting to accelerate tax deductions for repairs in accordance with Treasury Regulations and case law, as compared to the prior method of claiming tax depreciation on project costs. The method change for electric generation and transmission and distribution repairs was included on the 2009 tax return while the change for gas distribution repairs was included on the 2010 return. During 2011, the IRS issued guidance on the treatment of electric transmission and distribution repairs. This guidance prompted the reversal of a portion of the unrecognized tax benefits for these repairs during 2011. MGE Energy and MGE have an unrecognized tax benefit at September 30, 2012, and December 31, 2011, in the amount of $3.2 million and $2.4 million, respectively, for the tax uncertainty primarily related to the change in tax method of accounting for electric generation and gas distribution repairs.


b.

Effective Tax Rate.


MGE Energy's effective income tax rate for the three and nine months ended September 30, 2012, is 37.6% and 37.7%, respectively, compared to 37.3% and 37.3% for the same periods in 2011; and MGE's effective income tax rate for the three and nine months ended September 30, 2012, is 37.6% and 37.7%, respectively, compared to 37.1% and 37.3% for the same periods in 2011.


6.

Pension and Other Postretirement Plans - MGE Energy and MGE.


MGE maintains qualified and nonqualified pension plans, health care, and life insurance benefits. Additionally, MGE has defined contribution 401(k) benefit plans.


The following table presents the components of MGE Energy's and MGE's net periodic benefit costs recognized for the three and nine months ended September 30, 2012 and 2011. A portion of the net periodic benefit cost is capitalized within the consolidated balance sheets.


 

 

Three Months Ended

 

Nine Months Ended

(In thousands)

 

September 30,

 

September 30,

 

 

2012

 

2011

 

2012

 

2011

Pension Benefits

 

 

 

 

 

 

 

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

    Service cost

$

1,871

$

1,527

$

5,613

$

4,581

    Interest cost

 

3,236

 

3,055

 

9,711

 

9,165

    Expected return on assets

 

(3,917)

 

(3,502)

 

(11,756)

 

(10,507)

Amortization of:

 

 

 

 

 

 

 

 

    Prior service cost

 

111

 

108

 

333

 

324

    Actuarial loss

 

2,058

 

939

 

6,177

 

2,816

Net periodic benefit cost

$

3,359

$

2,127

$

10,078

$

6,379

 

 

 

 

 

 

 

 

 

Postretirement Benefits

 

 

 

 

 

 

 

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

    Service cost

$

626

$

500

$

1,879

$

1,501

    Interest cost

 

1,089

 

1,010

 

3,267

 

3,028

    Expected return on assets

 

(421)

 

(407)

 

(1,263)

 

(1,221)

Amortization of:

 

 

 

 

 

 

 

 

    Transition obligation

 

103

 

110

 

309

 

329

    Prior service cost

 

27

 

28

 

81

 

85

    Actuarial loss

 

601

 

114

 

1,802

 

342

Net periodic benefit cost

$

2,025

$

1,355

$

6,075

$

4,064




15





The PSCW allowed MGE to defer the 2009 incremental pension and OPRB costs above the amounts recovered in rates. During the three months ended September 30, 2012 and 2011, $0.3 million and $0.7 million, respectively, has been recovered in rates. During the nine months ended September 30, 2012 and 2011, $0.9 million and $2.0 million, respectively, has been recovered in rates. These costs are not reflected in the table above.


7.

Share-Based Compensation - MGE Energy and MGE.


Under MGE Energy's Performance Unit Plan, eligible participants may receive performance units that entitle the holder to receive a cash payment equal to the value of a designated number of shares of MGE Energy's common stock, plus dividend equivalent payments thereon, at the end of the set performance period.


In addition to units granted in 2008 through 2011, on February 17, 2012, 16,693 units were granted based on the MGE Energy closing stock price as of that date. These units are subject to a five-year graded vesting schedule. On the grant date, MGE Energy and MGE measure the cost of the employee services received in exchange for the award based on the current market value of MGE Energy common stock. The fair value of the awards has been subsequently re-measured at September 30, 2012, as required by applicable accounting standards. Changes in fair value have been recognized as compensation cost. Since this amount is re-measured quarterly throughout the vesting period, the compensation cost is subject to variability.


For nonretirement eligible employees, stock based compensation costs are accrued and recognized using the graded vesting method. Compensation cost for retirement eligible employees or employees that will become retirement eligible during the vesting schedule are recognized on an abridged horizon.


In April 2011, the MGE Energy Board approved an amendment to the outstanding awards under the Performance Unit Plan to provide for the continued vesting of those awards in the event of a bona fide retirement, provided the retired individual does not provide services to a competitor. The amendment did not change the number of performance units covered by any outstanding awards currently held by any of the participants. As a result of the changes made by the amendment, the Company accelerated the recognition of costs associated with the outstanding awards resulting in a compensation-related charge of $0.5 million in the second quarter of 2011.


During the nine months ended September 30, 2012 and 2011, MGE recorded $1.4 million and $0.9 million, respectively, in compensation expense as a result of the Performance Unit Plan. In January 2012, cash payments of $0.6 million were distributed relating to awards that were granted in 2007 and became payable under the Performance Unit Plan. No forfeitures occurred during the nine months ended September 30, 2012 or 2011. At September 30, 2012, $3.1 million of outstanding awards are vested.


8.

Commitments and Contingencies.


a.

Environmental - MGE Energy and MGE.


Water quality


Water quality regulations promulgated by the EPA and WDNR in accordance with the Federal Water Pollution Control Act, or more commonly known as the Clean Water Act (CWA), impose restrictions on emissions of various pollutants into surface waters. The CWA also regulates surface water quality issues that affect aquatic life, such as water temperatures, intake structures, and wetlands filling. The CWA regulates discharges from "point sources" such as power plants by establishing discharge limits in water discharge permits. MGE's power plants operate under Wisconsin Pollution Discharge Elimination System (WPDES) permits to ensure compliance with these discharge limits.


EPA Cooling Water Intake Rules (Section 316(b))

In April 2011, the EPA proposed and asked for public comment on standards to reduce entrainment (drawing aquatic life into a plant's cooling system) and impingement (trapping aquatic life on screens) from existing structures designed to take in cooling water for plants such as power plants. This rule is commonly referred to as Phase II of Section 316(b) of the CWA. Both our Blount and Columbia generating plants are subject to the impingement and entrainment aspects of the current proposed rule. Our WCCF plant is subject to the impingement aspect only. Under the current proposed rule, equipment would need to be installed at Blount, WCCF and Columbia to meet these new standards. The EPA has until June 27, 2013 to issue the final rule, pursuant to a recently announced settlement agreement. It is not presently possible to estimate the potential costs associated with the implementation of any of these initiatives because the rule has not been finalized.



16





WPDES Thermal Discharge Rule

WDNR rules to regulate thermal effluent discharges from point sources in Wisconsin became effective on October 1, 2010. We will need to meet the revised rule requirement as MGE's WPDES permits are issued or renewed. Blount's WPDES permit was renewed effective October 1, 2012, with thermal effluent discharge limits in place. We believe that the thermal limits set are achievable without additional capital expenditures. We will continue to monitor this requirement as our other plant permits come up for renewal. If we, in the case of WCCF, or the plant operator, in the cases of Columbia and Elm Road, are unable to demonstrate that any of these permitted plants are able to comply with its associated WPDES permit requirements, then we may face operational controls and/or incur capital costs associated with plant modifications to meet discharge requirements. Those expenditures could be material, but would be anticipated to be recoverable in rates.


WPDES Phosphorus Nutrient Standards

In December 2010, the WDNR established water quality standards for phosphorus and effluent limitations for permitted discharges into specific waterbodies. Phosphorus limitations will be added to water effluent discharge permits, as applicable, as they are issued or renewed. The WDNR will be developing site-specific phosphorus limits. MGE's facilities subject to these standards include Blount, Columbia, Elm Road and WCCF. Blount's WPDES permit was renewed effective October 1, 2012, with phosphorus discharge limits in place. We believe that the phosphorus limits set are achievable without additional capital expenditures. We will continue to monitor this requirement as our other plant permits come up for renewal. MGE may incur additional capital or operational expenditures and/or need to install additional pollution controls to meet any new phosphorus limits. MGE has, however, identified potential compliance options and believes compliance can be managed without significant capital investments.


Air quality


Air quality regulations promulgated by the EPA and the WDNR in accordance with the Federal Clean Air Act and the Clean Air Act Amendments of 1990 impose restrictions on emission of particulates, sulfur dioxide (SO2), nitrogen oxides (NOx), and other pollutants and require permits for operation of emission sources. These permits have been obtained by MGE and must be renewed periodically.


Various initiatives, including the EPA's interstate transport rules, are expected to result in additional operating and capital expenditure costs for electric generating units.


Maximum Achievable Control Technology (MACT) for Utility Boilers (Also Referred to as the Mercury and Air Toxics Standards or MATS)

In December 2011, the EPA finalized its Mercury and Air Toxics Standards for coal and oil-burning electric generating Unit (EGU) boilers. MATS will require emissions standards for mercury, non-mercury HAPs metals, and acid gases. MGE's Columbia and Elm Road Units are subject to MATS. The Elm Road Unit's current pollution controls and Columbia's planned mercury pollution controls are expected to allow both facilities to comply with the MATS rule (see the discussion regarding Columbia below).


Reciprocating Internal Combustion Engine (RICE) MACT

In December 2011, the EPA finalized its RICE MACT standard. RICE MACT applies to an industrial or electrical engine that is classified as a reciprocating internal combustion engine. Under the current RICE MACT, MGE may have to adjust its dispatching of several small generation units used for emergency and backup generation or install pollution controls. In June 2012, the EPA introduced a proposed rule that revised RICE MACT and introduced an amendment to the New Source Performance Standard for RICE based on a settlement agreement with several power companies. MGE is currently reviewing the proposed rule and evaluating potential impacts associated with complying with the proposed RICE MACT.


Vacation of EPA's Cross State Air Pollution Rule (CSAPR) and Reinstatement of the Clean Air Interstate Rule (CAIR)

EPA has so far promulgated three interstate air pollution rules [the NOx SIP Call, the Clean Air Interstate Rule (CAIR) and the Cross-State Air Pollution Rule (CSAPR)] which were each designed to reduce nitrogen oxide (NOx) and/or sulphur dioxide (SO2) air emissions from electric generating units (EGUs) located in Wisconsin and other states. NOx and SO2 interact in the atmosphere to form ambient ozone and fine particulate matter pollution. As explained below, only the CAIR currently affects MGE's generation assets.




17





In 2000, the U.S. Court of Appeals for the D.C. Circuit held that Wisconsin had been illegally included in a portion of the NOx SIP Call, but stayed the remaining legal challenges to the rule pending EPA's development of additional interstate transport rules. At this time, the requirements of the NOx SIP Call and the costs of compliance remain uncertain.  


In 2005, EPA promulgated the CAIR imposing additional controls on NOx and SO2 emissions from EGUs located in Wisconsin and other states. However, in December 2008, the U.S. Court of Appeals for the D.C. Circuit remanded the CAIR to the EPA with directions to revise or replace the rule. The Court's remand order directed that the CAIR remain in effect until the EPA promulgated a replacement rule. The Court's order did not include a deadline for the EPA to act.


In August 2011, the EPA responded to the remand of the CAIR by promulgating the CSAPR. However, in August, 2012, the U.S. Court of Appeals for the D.C. Circuit vacated CSAPR and instructed the EPA to continue administering the CAIR pending finalizing a valid replacement rule. The EPA has petitioned the U.S. Court of Appeals for the D.C. Circuit to reconsider its decision en banc. At this time, the CAIR remains currently effective.


The CAIR, which became effective in 2009 and remains effective currently, generally requires NOx and SO2 emission reductions from fossil fuel-fired electric generating units (25 MW or greater) (EGUs) in the eastern half of the United States in two phases and includes a regional cap-and-trade system. The first phase (currently in place) requires annual regional emission reductions from 2003 levels of 55% for NOx and 40% for SO2. The second phase (beginning in 2015) reduces regional NOx and SO2 emissions further from 2003 levels to 65% and 70%, respectively. MGE owns or has partial ownership in several generation units currently subject to the CAIR: Blount, Columbia, Elm Road, and its combustion turbines located in West Marinette and Fitchburg.


Our evaluation of the CAIR demonstrates that MGE will be in compliance with the CAIR's Phase I requirements without capital expenditures or modifications to our operations. We have also evaluated our potential expenditures if the CAIR remains in place for the Phase II reductions. New SO2 controls at Columbia are already underway and are planned to be completed by mid to late 2014 (see the discussion regarding the Columbia Environmental Project below). Once the new environmental control project is completed at Columbia, it is expected that the plant will emit below anticipated Phase II CAIR allocation levels. MGE expects that any costs incurred to meet Phase II of the CAIR will be fully recoverable through rates.


MGE will continue monitoring the EPA's actions in response to the August 2012 CSAPR vacature and the stayed NOx SIP Call litigation, but MGE is unable to predict the outcome of these matters and its impact on its operations or financial condition.


Clean Air Visibility Rule (CAVR)

Air modeling indicates that SO2 and NOx emissions (and to a lesser extent particulate matter, or PM) from Columbia may impair visibility at certain Class I Scenic Areas and may therefore be subject to the best available retrofit technology (BART) regulations, a subsection of the EPA's Clean Air Visibility Rule (CAVR), which requires pollution retrofits. The EPA had proposed that Columbia's compliance with emissions limitations in the CAIR and the CSAPR could also serve as compliance with the BART regulations for SO2 and NOx emissions. However, this proposal is now uncertain because of the D.C. Circuit remanding the CAIR to EPA and vacating the CSAPR. At this time the BART regulatory obligations, compliance strategies and costs remain uncertain.


Wisconsin State Mercury Rule

Beginning January 1, 2015, phase two of the Wisconsin mercury rule will require large coal-fired electric generating units (larger than 150 MW) to reduce mercury emissions by 90%, or choose a multi-pollutant reduction approach, which allows a stepped approach to mercury reduction while reducing NOx and SO2 emissions at prescribed rates. Elm Road currently meets this requirement. The Columbia co-owners expect to meet the 90% reduction option by installing bag houses and scrubbers by mid to late 2014 (see the discussion regarding the Columbia Environmental Project below).




18





National Ambient Air Quality Standards (NAAQS)

The EPA has developed National Ambient Air Quality Standards (NAAQS) for six compounds currently identified as criteria pollutants: nitrogen dioxide (NO2), particulate matter (PM), ozone, SO2, lead and carbon monoxide. The NAAQS for criteria pollutants establish acceptable ambient air levels based on effects to human health and the environment, and changes to those NAAQS can affect compliance requirements and associated capital and operating costs. The EPA is required to review NAAQS every five years. MGE is currently tracking two NAAQS developments: (1) EPA's proposed changes to the PM2.5 NAAQS announced in June 2012, which would lower the primary annual limit and add a secondary PM2.5 standard pertaining to a measure of visibility, and (2) the WDNR attainment/nonattainment designations associated with the EPA's June 2010 final revisions to its SO2 NAAQS. Because of uncertainties in how these NAAQS developments will be implemented in Wisconsin, we are tracking developments and evaluating potential costs at our generation facilities. Based on our current evaluation, these two NAAQS developments have the most potential to affect capital and maintenance costs at our Columbia plant. However, the potential impact at any of our plants will not be known until implementation of the rules is finalized.


EPA's Prevention of Significant Deterioration and Title V Greenhouse Gas Tailoring Rule

The EPA's Greenhouse Gas "Tailoring Rule" regulates stationary sources for GHG emissions by "phasing in" over time different types of facilities subject to Prevention of Significant Deterioration (PSD) pre-construction program or Title V permitting (i.e. new facilities and existing facilities with certain qualifying modifications). MGE facilities may become subject to this rule in the future if modifications at any facilities trigger PSD or if MGE invests in new facilities that trigger PSD.


GHG New Source Performance Standards for Electric Generating Units (EGU GHG NSPS)

On March 27, 2012, the EPA proposed greenhouse gas (GHG) New Source Performance Standards (NSPS) for coal fired and natural gas combined cycle (NGCC) electric generation units (EGUs). The proposal applies to new EGUs only; the EPA has stated that it does not intend for these rules to apply to modified or existing units at this time. The proposed NSPS may yet be finalized in 2012, but is not anticipated to significantly affect MGE's existing generation units.


Columbia


MGE and two other utilities jointly own Columbia, a coal-fired generating facility, which accounts for 225 MW (29%) of MGE's net summer generating capability. WPL is the plant operator and permit holder, and owns 46.2% of Columbia. Wisconsin Public Service Corporation (WPSC) owns a 31.8% interest, and MGE owns a 22% interest in Columbia. Based upon current available information, compliance with various environmental requirements and initiatives is expected to result in significant additional operating and capital expenditures at Columbia.


Columbia Environmental Project

In early 2011, the PSCW issued a Certificate and Order authorizing the construction of scrubbers and bag houses and associated equipment on Columbia Units 1 and 2 to reduce SO2 and mercury emissions. The scrubbers and bag houses are expected to support compliance obligations for current and anticipated air quality regulations, including CAIR, CAIR's eventual replacement, the Mercury and Air Toxics Standards and the Wisconsin Mercury Rule. The operator's current estimate shows that MGE's share of the capital expenditures required for this project will be approximately $140 million. The project is underway and estimated to be completed in mid to late 2014.


As of September 30, 2012, various contractual commitments have been entered for the project. MGE's share of these commitments as of September 30, 2012, is $89.1 million. These costs are expected to be capitalized and included in the consolidated balance sheets of MGE Energy and MGE. See Footnote 4 for further information regarding the Columbia environmental construction project.




19





Title V Operating Permit Petition

In September 2008, the WDNR issued a Title V renewal operating permit to WPL for Columbia. A citizen group petitioned the EPA to object to the issuance of the permit renewal. In October 2009, the EPA issued an order granting in part and denying in part the petition and sent the operating permit back to the WDNR for further review based on the EPA order. The WDNR took various preliminary actions but has not yet fully responded to the EPA's order. In February 2011, the citizen group involved filed an action against the EPA in the U.S. District Court for the Western District of Wisconsin seeking to have the EPA take over the permit process. In June 2012, the EPA notified the plant operator of its intent to assume responsibility for issuing the renewed operating permit for Columbia, but agreed to provide the plant operator with more time to potentially resolve the issues raised in the EPA's order. MGE believes the permits currently in effect for Columbia remain in place at this time. MGE continues to follow these developments and is unable to predict the outcome of this matter and its impact on its operations or financial condition.


Columbia Clean Air Act Litigation

In December 2009, the EPA sent a notice of violation (NOV) to MGE as one of the co-owners of the Columbia generating station. The NOV alleges that WPL, as operator, and the co-owners failed to comply with appropriate pre-construction review and permitting requirements and, as a result, violated the PSD program requirements, the Title V operating permit requirements of the CAA and the Wisconsin State Implementation Plan (SIP). In September 2010, Sierra Club filed a lawsuit against WPL alleging violations of the CAA at Columbia and other WPL-operated Wisconsin facilities. WPL has stated it believes the projects at Columbia were routine, or not projected to increase emissions, and therefore did not violate the permitting requirements of the CAA. MGE and the other Columbia co-owners are defending against these allegations while actively pursuing settlement options with the EPA and Sierra Club.


MGE believes that the parties have reached a tentative agreement on the general terms of a settlement with the EPA and Sierra Club regarding various facilities, including Columbia. Sierra Club has stipulated to a dismissal of its lawsuit, without prejudice, while the parties attempt to reach a final settlement. The parties are currently negotiating a consent decree based upon those general terms, which may change during the negotiations. Once the parties agree to final terms, the court must approve the settlement agreement before it becomes final and effective. In accordance with applicable accounting standards, MGE has accrued an amount for this matter representing its best estimate of its probable liability, based upon its assessment of the settlement discussions. That accrued amount is not material to the financial statements. MGE believes the likelihood of a materially greater liability than the accrued amount is remote based upon the current status of the settlement discussions.


b.

Chattel Paper Agreement and Other Guarantees - MGE Energy and MGE.


MGE makes available to qualifying customers a financing program for the purchase and installation of energy-related equipment that will provide more efficient use of utility service at the customer's property. MGE is party to a chattel paper purchase agreement with a financial institution under which it can sell or finance an undivided interest with recourse, in up to $10.0 million of the financing program receivables, until July 31, 2013. At September 30, 2012, MGE has outstanding a $3.9 million interest in these receivables. MGE retains the servicing responsibility for these receivables. As of September 30, 2012, the servicing asset recognized by MGE is $0.2 million.


MGE accounts for servicing rights under the amortization method. Initial determination of the servicing asset fair value is based on the present value of the estimated future cash flows. The discount rate is based on the PSCW authorized weighted cost of capital.


MGE would be required to perform under its guarantee if a customer defaulted on its loan. The energy-related equipment installed at the customer sites is used to secure the customer loans. The loan balances outstanding at September 30, 2012, approximate the fair value of the energy-related equipment acting as collateral. The length of the MGE guarantee to the financial institution varies from one to ten years depending on the term of the underlying customer loan. Principal payments for the remainder of 2012 and the next four years on the loans are:


(In thousands)

 

2012

 

2013

 

2014

 

2015

 

2016

Chattel Paper

$

126

$

669

$

484

$

796

$

721




20





c.

Purchase Power Agreement Contract Dispute - MGE Energy and MGE.


MGE is seeking resolution to a contract dispute regarding its Purchase Power Agreement with Riverside Energy Center LLC, a Calpine subsidiary, for capacity and energy from the Riverside Energy Center located in Beloit, Wisconsin. MGE declared the PPA terminated. Any savings in capacity costs that ultimately result from the termination of the Riverside PPA will flow through to the Company's customers. MGE is currently deferring amounts equal to the capacity payments MGE would be making under the terms of the Riverside PPA if it were still in effect. This deferral will create a liability to MGE's customers for a future credit, assuming MGE's right to terminate the PPA is ultimately upheld. If MGE does not prevail in the dispute, the capacity payment deferred will be paid to Riverside Energy Center, LLC.


d.

Legal Matters - MGE Energy and MGE.


MGE is involved in various legal matters that are being defended and handled in the normal course of business including the Columbia matters discussed above. MGE maintains accruals for such costs that are probable of being incurred and subject to reasonable estimation. The accrued amount for these matters is not material to the financial statements.


e.

Purchase Contracts - MGE Energy and MGE.


MGE Energy and MGE have entered into various commodity supply, transportation and storage contracts to meet their obligations to deliver electricity and natural gas to customers. As of September 30, 2012, the future commitments related to these purchase contracts were as follows:


(In thousands)

 

2012

 

2013

 

2014

 

2015

 

2016

Coal(a)

$

2,483

$

21,884

$

9,459

$

6,340

$

1,623

Natural gas supply(b)

 

12,872

 

13,192

 

-

 

-

 

-

Purchase power(c)

 

39,266

 

51,455

 

49,372

 

47,523

 

48,491

  

$

54,621

$

86,531

$

58,831

$

53,863

$

50,114


(a)

Total coal commitments for the Columbia and Elm Road Units, including transportation. Fuel procurement for MGE's jointly owned Columbia and Elm Road Units are handled by WPL and WEPCO, respectively, who are the operators of those facilities. If any minimum purchase obligations must be paid under these contracts, management believes these obligations would be considered costs of service and recoverable in rates.


(b)

These commitments include market-based pricing. Management expects to recover these costs in future customer rates.


(c)

MGE has several purchase power agreements to help meet future electric supply requirements. Management expects to recover these costs in future customer rates.


f.

Smart Grid Investment Grant - MGE Energy and MGE.


MGE was approved in 2010 by the U.S. Department of Energy (DOE) under the federal stimulus program for a $5.5 million grant for smart grid projects. The DOE grant requires MGE to match the grant funding, bringing the total cost of the projects to more than $11 million. The projects involve the installation of technologies to boost efficiency, enhance service and improve reliability for customers. The stimulus grant is being used to fund the following projects: advanced metering infrastructure, plug-in hybrid electric vehicles support, and distribution management. As of September 30, 2012, MGE has spent $7.9 million related to these projects and has outstanding agreements to purchase $0.6 million in smart grid related products for the remainder of 2012 and $1.3 million in 2013.


g.

Other Commitments - MGE Energy.


On January 31, 2012, MGE Energy entered a subscription agreement to invest in a nonpublic venture capital fund. From time to time, this entity will require capital infusions from its investors. MGE Energy has committed to contribute $2.0 million in capital for such infusions. The timing of these infusions is dependent on the needs of the investee and is therefore uncertain at this time.




21





9.

Derivative and Hedging Instruments - MGE Energy and MGE.


a.

Purpose.


As part of its regular operations, MGE enters into contracts, including options, swaps, futures, forwards, and other contractual commitments, to manage its exposure to commodity prices and gas revenues. To the extent that these contracts are derivatives, MGE assesses whether or not the normal purchases or normal sales exclusion applies. For contracts to which this exclusion cannot be applied, MGE Energy and MGE recognize such derivatives in the consolidated balance sheets at fair value. The majority of MGE's derivative activities are conducted in accordance with its electric and gas risk management program, which is approved by the PSCW and limits the volume MGE can hedge with specific risk management strategies. The maximum length of time over which cash flows related to energy commodities can be hedged is four years. If the derivative qualifies for regulatory deferral, the derivatives are marked to fair value and are offset with a corresponding regulatory asset or liability. The deferred gain or loss is recognized in earnings in the delivery month applicable to the instrument. Gains and losses related to hedges qualifying for regulatory treatment are recoverable in gas rates through the PGA or in electric rates as a component of the fuel rules mechanism.


b.

Notional Amounts.


The gross notional volume of open derivatives is as follows:


 

September 30, 2012

 

December 31, 2011

Commodity derivative contracts

440,320  MWh

 

482,545  MWh

Commodity derivative contracts

4,170,000  Dth

 

4,030,000  Dth

FTRs

4,069  MW

 

2,382  MW


c.

Financial Statement Presentation.


MGE Energy and MGE offset fair value amounts recognized for the right to reclaim collateral (a receivable) or the obligation to return collateral (a payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement. At September 30, 2012, MGE Energy and MGE did not have any cash collateral netted against the net derivative positions. At December 31, 2011, MGE Energy and MGE had $3.0 million in collateral that was netted against the net derivative positions with counterparties.


MGE purchases and sells exchange-traded and over-the-counter options, swaps, and future contracts. These arrangements are primarily entered into to help stabilize the price risk associated with gas or power purchases. These transactions are employed by both MGE's gas and electric segments. Additionally, as a result of the firm transmission agreements that MGE holds on transmission paths in the MISO market, MGE holds FTRs. An FTR is a financial instrument that entitles the holder to a stream of revenues or charges based on the differences in hourly day-ahead energy prices between two points on the transmission grid. The fair values of these instruments are reflected as a regulatory asset/liability depending on whether they are in a net loss/gain position. Depending on the nature of the instrument, the gain or loss associated with these transactions will be reflected as cost of gas sold, fuel for electric generation, or purchased power expense in the delivery month applicable to the instrument. At September 30, 2012, the fair value of exchange traded derivatives and FTRs exceeded their cost basis by $1.8 million. At December 31, 2011, the cost basis of exchange traded derivatives and FTRs exceeded their fair value by $2.8 million.


MGE has also entered into a ten-year purchased power agreement that provides MGE with firm capacity and energy during a base term from June 1, 2012, through May 31, 2022. The agreement also allows MGE an option to extend the contract after the base term. The agreement is accounted for as a derivative contract and is recognized at its fair value on the balance sheet. However, the derivative qualifies for regulatory deferral and is recognized with a corresponding regulatory asset or liability depending on whether the fair value is in a loss or gain position. The fair value of the contract at September 30, 2012, and December 31, 2011, reflects a loss position of $77.1 million and $39.5 million, respectively. The actual fuel cost will be recognized in purchased power expense in the month of purchase.


The following table summarizes the fair value of the derivative instruments on the balance sheet. All derivative instruments in this table are presented on a gross basis and are calculated prior to the netting of instruments with the same counterparty under a master netting agreement as well as the netting of collateral. For financial statement purposes, MGE Energy and MGE have netted instruments with the same counterparty under a master netting agreement as well as the netting of collateral.



22






 

Asset Derivatives

 

Liability Derivatives

(In thousands)

Balance Sheet Location

 

Fair Value

 

Balance Sheet Location

 

Fair Value

September 30, 2012

 

 

 

 

 

 

 

Commodity derivative contracts

Other current assets

$

1,463

Derivative liability (current)

$

245

Commodity derivative contracts

Other deferred charges

 

114

 

Derivative liability (long-term)

 

60

FTRs

Other current assets

 

561

 

Derivative liability (current)

 

-

Ten-year PPA

N/A

 

N/A

 

Derivative liability (current)

 

9,600

Ten-year PPA

N/A

 

N/A

 

Derivative liability (long-term)

 

67,490

 

 

 

 

 

 

 

 

December 31, 2011

 

 

 

 

 

 

 

Commodity derivative contracts

Other current assets

$

177

 

Derivative liability (current)

$

3,060

Commodity derivative contracts

Other deferred charges

 

92

 

Derivative liability (long-term)

 

231

FTRs

Other current assets

 

186

 

Derivative liability (current)

 

-

Ten-year PPA

N/A

 

N/A

 

Derivative liability (current)

 

4,600

Ten-year PPA

N/A

 

N/A

 

Derivative liability (long-term)

 

34,920


The following tables summarize the unrealized and realized gains (losses) related to the derivative instruments on the balance sheet at September 30, 2012 and 2011, and the income statement for the three and nine months ended September 30, 2012 and 2011.


 

 

2012

 

 

2011

(In thousands)

 

Current and

long-term

regulatory asset

 

Other current

assets

 

 

Current and

long-term

regulatory asset

 

Other current

assets

Three Months Ended September 30:

 

 

 

 

 

 

 

 

 

Balance at July 1,

$

79,362

$

718

 

$

22,604

$

1,001

Change in unrealized loss

 

(468)

 

-

 

 

3,839

 

-

Realized loss reclassified to a deferred account

 

(223)

 

223

 

 

(210)

 

210

Realized gain (loss) reclassified to income

 

 

 

 

 

 

 

 

 

statement

 

(3,414)

 

(161)

 

 

350

 

(233)

Balance at September 30,

$

75,257

$

780

 

$

26,583

$

978

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30:

 

 

 

 

 

 

 

 

 

Balance at January 1,

$

42,356

$

1,604

 

$

19,230

$

1,411

Change in unrealized loss

 

42,633

 

-

 

 

7,775

 

-

Realized loss reclassified to a deferred account

 

(3,103)

 

3,103

 

 

(1,484)

 

1,484

Realized gain (loss) reclassified to income

 

 

 

 

 

 

 

 

 

statement

 

(6,629)

 

(3,927)

 

 

1,062

 

(1,917)

Balance at September 30,

$

75,257

$

780

 

$

26,583

$

978


 

 

Realized losses (gains)

 

 

 

 

Fuel for electric

 

 

 

 

Regulated

 

generation/

 

Cost of

(In thousands)

 

gas revenues

 

purchased power

 

gas sold

Three Months Ended September 30, 2012:

 

 

 

 

 

 

Commodity derivative contracts

$

-

$

176

$

-

FTRs

 

-

 

(256)

 

-

Ten-year PPA

 

-

 

3,655

 

-

 

 

 

 

 

 

 

Three Months Ended September 30, 2011:

 

 

 

 

 

 

Commodity derivative contracts

$

-

$

(94)

$

-

FTRs

 

-

 

(23)

 

-

Ten-year PPA

 

-

 

-

 

-

 

 

 

 

 

 

 

Nine Months Ended September 30, 2012:

 

 

 

 

 

 

Commodity derivative contracts

$

-

$

2,685

$

3,090

FTRs

 

-

 

(93)

 

-

Ten-year PPA

 

-

 

4,874

 

-

 

 

 

 

 

 

 

Nine Months Ended September 30, 2011:

 

 

 

 

 

 

Commodity derivative contracts

$

-

$

(465)

$

1,315

FTRs

 

-

 

5

 

-

Ten-year PPA

 

-

 

-

 

-



23





MGE's commodity derivative contracts, FTRs, and ten-year PPA are subject to regulatory deferral. These derivatives are marked to fair value and are offset with a corresponding regulatory asset or liability. Realized gains and losses are deferred on the balance sheet and are recognized in earnings in the delivery month applicable to the instrument. As a result of the above described treatment, there are no unrealized gains or losses that flow through earnings.


The ten-year PPA has a provision that may require MGE to post collateral if MGE's debt rating falls below investment grade (i.e., below BBB-). The amount of collateral that it may be required to post varies from $20.0 million to $40.0 million, depending on MGE's nominated capacity amount. As of September 30, 2012, no collateral has been posted. Certain counterparties extend MGE a credit limit. If MGE exceeds these limits, the counterparties may require collateral to be posted. As of September 30, 2012, and December 31, 2011, no counterparties were in a net liability position.


Nonperformance of counterparties to the non-exchange traded derivatives could expose MGE to credit loss. However, MGE enters into transactions only with companies that meet or exceed strict credit guidelines, and it monitors these counterparties on an ongoing basis to mitigate nonperformance risk in its portfolio. As of September 30, 2012, no counterparties have defaulted.


10.

Rate Matters - MGE Energy and MGE.


a.

Rate Proceedings.


On March 23, 2012, MGE filed an application with the PSCW requesting a 5.8% increase to electric rates and a 2.6% increase to gas rates. The proposed electric increase will cover costs for new environmental equipment at Columbia, final construction costs for the Elm Road Units (including the prudence of construction costs incurred above a previously approved cap), transmission reliability enhancements, and purchased power costs. MGE has requested that these rates become effective January 1, 2013.


On December 15, 2011, under a limited reopener of MGE's last rate order, the PSCW authorized MGE to increase 2012 rates for retail electric customers by 4.3% or $15.7 million and to increase gas rates by 0.3% or $0.6 million. The change in retail electric rates was driven by MGE's electric fuel and purchased power costs, increased transmission costs, an update to the Elm Road Units' costs, and an increase for energy efficiency programs. The PSCW also approved deferral of CSAPR costs.


On January 12, 2011, the PSCW authorized MGE to increase 2011 rates for retail electric customers by 2.3% or $8.0 million and to increase gas rates by 1.0% or $1.9 million. The increase in retail electric rates is driven by costs for MGE's share of the Elm Road Units. Pursuant to the provisions of this rate order, the fuel rules bandwidth effective January 1, 2011, will be plus or minus 2%. See below for further description of fuel rules. Authorized return on common stock equity was set at 10.3% based on a 58.1% utility common equity.


b.

Fuel Rules.


The PSCW approved new fuel rules that became effective January 1, 2011. The new rules require the PSCW and Wisconsin utilities to defer electric fuel-related costs that fall outside a symmetrical cost tolerance band around the amount approved for a utility in its most recent base rate proceedings. Any over/under recovery of the actual costs is determined on an annual basis and will be adjusted in future billings to electric retail customers. Under fuel rules, MGE would defer costs, less any excess revenues, if its actual electric fuel costs exceeded 102% of the electric fuel costs allowed in its latest rate order. Excess revenues are defined as revenues in the year in question that provide MGE with a greater return on common equity than authorized by the PSCW in MGE's latest rate order. Conversely, MGE is required to defer the benefit of lower costs if actual electric fuel costs were less than 98% of the electric fuel costs allowed in that order. As of September 30, 2012, MGE has deferred $5.9 million (for credit back to customers) of electric fuel-related savings that are outside the 98% range authorized by the PSCW in the most recent rate order.




24





11.

Fair Value of Financial Instruments - MGE Energy and MGE.


a.

Fair Value of Financial Assets and Liabilities Recorded at the Carrying Amount.


At September 30, 2012, and December 31, 2011, the carrying amount of cash and cash equivalents approximates fair market value due to the short maturity of those investments and obligations. The estimated fair market value of MGE Energy's and MGE's long-term debt is based on quoted market prices for similar financial instruments at September 30, 2012, and December 31, 2011. Since the long-term debt is not traded in an active market, it is classified as Level 2 (see discussion regarding the fair value level hierarchy below in section b). The estimated fair market value, of MGE Energy's and MGE's financial instruments are as follows:


 

 

September 30, 2012

 

 

December 31, 2011

 

 

Carrying

 

Fair

 

 

Carrying

 

Fair

(In thousands)

 

Amount

 

Value

 

Amount

 

Value

MGE Energy

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

$

59,203

$

59,203

 

$

41,169

$

41,169

Liabilities:

 

 

 

 

 

 

 

 

 

    Long-term debt*

 

362,473

 

436,747

 

 

364,473

 

432,515

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

 

29,536

 

29,536

 

 

13,898

 

13,898

Liabilities:

 

 

 

 

 

 

 

 

 

    Long-term debt*

 

362,473

 

436,747

 

 

364,473

 

432,515

 

 

 

 

 

 

 

 

 

 

*Includes long-term debt due within one year.

 

 

 

 

 

 

 


b.

Recurring Fair Value Measurements.


Fair value is defined as the price that would be received to sell an asset or would be paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The standard clarifies that fair value should be based on the assumptions market participants would use when pricing the asset or liability including assumptions about risk. The standard also establishes a three level fair value hierarchy based upon the observability of the assumptions used and requires the use of observable market data when available. The levels are:


Level 1 - Pricing inputs are quoted prices within active markets for identical assets or liabilities.


Level 2 - Pricing inputs are quoted prices within active markets for similar assets or liabilities; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations that are correlated with or otherwise verifiable by observable market data.


Level 3 - Pricing inputs are unobservable and reflect management's best estimate of what market participants would use in pricing the asset or liability.




25





The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for MGE Energy and MGE.


  

Fair Value as of September 30, 2012

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

MGE Energy

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

    Exchange-traded investments

$

409

$

409

$

-

$

-

    Total Assets

$

409

$

409

$

-

$

-

Liabilities:

 

 

 

 

 

 

 

 

    Derivatives, net

$

75,257

$

(858)

$

-

$

76,115

    Deferred compensation

 

1,922

 

-

 

1,922

 

-

    Total Liabilities

$

77,179

$

(858)

$

1,922

$

76,115

MGE

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

    Exchange-traded investments

$

138

$

138

$

-

$

-

    Total Assets

$

138

$

138

$

-

$

-

Liabilities:

 

 

 

 

 

 

 

 

    Derivatives, net

$

75,257

$

(858)

$

-

$

76,115

    Deferred compensation

 

1,922

 

-

 

1,922

 

-

    Total Liabilities

$

77,179

$

(858)

$

1,922

$

76,115

  

 

 

 

 

 

 

 

 

No transfers were made in or out of Level 1 or Level 2 for the nine months ended September 30, 2012.

  

 

 

 

 

 

 

 

 

  

Fair Value as of December 31, 2011

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

MGE Energy

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

    Exchange-traded investments

$

350

$

350

$

-

$

-

    Total Assets

$

350

$

350

$

-

$

-

Liabilities:

 

 

 

 

 

 

 

 

    Derivatives, net(a)

$

42,356

$

1,695

$

-

$

40,661

    Deferred compensation(b)

 

1,725

 

-

 

1,725

 

-

Total Liabilities  

$

44,081

$

1,695

$

1,725

$

40,661

MGE

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

    Exchange-traded investments

$

188

$

188

$

-

$

-

    Total Assets

$

188

$

188

$

-

$

-

Liabilities:

 

 

 

 

 

 

 

 

    Derivatives, net(a)

$

42,356

$

1,695

$

-

$

40,661

    Deferred compensation(b)

 

1,725

 

-

 

1,725

 

-

    Total Liabilities

$

44,081

$

1,695

$

1,725

$

40,661

  

 

 

 

 

 

 

 

 

        (a)     These amounts are shown gross and exclude $3.0 million of collateral that was posted

                  against derivative positions with counterparties.

  

 

 

 

 

 

 

 

 

        (b)     The deferred compensation liability at December 31, 2011, was transferred from Level 1

                  to Level 2.


Investments include exchange-traded investment securities valued using quoted prices on active exchanges and are therefore classified as Level 1.


Derivatives include exchange-traded derivative contracts, over-the-counter party transactions, a ten-year purchased power agreement, and FTRs. Most exchange-traded derivative contracts are valued based on unadjusted quoted prices in active markets and are therefore classified as Level 1. A small number of exchange-traded derivative contracts are valued using quoted market pricing in markets with insufficient volumes and are therefore classified as Level 3. Transactions done with an over-the-counter party are on inactive markets and are therefore classified as Level 3. These transactions are valued based on quoted prices with markets with similar exchange traded transactions. FTRs are priced based upon monthly auction results for identical or similar instruments in a closed market with limited data available and are therefore classified as Level 3.




26





The ten-year purchased power agreement (see Footnote 9) was valued using an internally-developed pricing model and therefore is classified as Level 3. The model projects future market energy prices and compares those prices to the projected power costs to be incurred under the contract. Inputs to the model require significant management judgment and estimation. Future energy prices are based on a forward power pricing curve using exchange-traded contracts in the electric futures market, where such exchange-traded contracts exist, and upon calculations based on forward gas prices, where such exchange-traded contracts do not exist. A basis adjustment is applied to the market energy price to reflect the price differential between the market price delivery point and the counterparty delivery point. The historical relationship between the delivery points is reviewed and a discount (below 100%) or premium (above 100%) is derived. This comparison is done for both peak times when demand is high and off peak times when demand is low. If the basis adjustment is lowered, the fair value measurement will decrease and if the basis adjustment is increased, the fair value measurement will increase.


The projected power costs anticipated to be incurred under the purchased power agreement are determined using many factors, including historical generating costs, future prices, and expected fuel mix of the counterparty. An increase in the projected fuel costs would result in a decrease in the fair value measurement of the purchased power agreement. A significant input that MGE estimates is the counterparty's fuel mix in determining the projected power cost. MGE also considers the assumptions that market participants would use in valuing the asset or liability. This consideration includes assumptions about market risk such as liquidity, volatility and contract duration. The fair value model uses a discount rate that incorporates discounting, credit, and model risks.


This model is prepared by members of the Energy Supply group. It is reviewed on a quarterly basis by management in Energy Supply and Finance to review the assumptions, inputs and fair value measurements.


The following table presents the significant unobservable inputs used in the pricing model.


Significant Unobservable Inputs

 

Model Input

Basis adjustment

 

  

    On peak

 

96.8 %

    Off peak

 

94.8 %

Counterparty fuel mix:

 

  

    Internal generation

 

49 % - 65 %

    Purchased power

 

51 % - 35 %


The deferred compensation plan allows participants to defer certain cash compensation into a notional investment account. These amounts are included within other deferred liabilities in the balance sheets of MGE Energy and MGE. The notional investments earn interest based upon the semiannual rate of U.S. Treasury Bills having a 26 week maturity increased by 1% compounded monthly with a minimum annual rate of 7%, compounded monthly. The notional investments are based upon observable market data, however, since the deferred compensation obligations themselves are not exchanged in an active market, they are classified as Level 2.




27





The following table summarizes the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for both MGE Energy and MGE.


  

 

Three Months Ended

 

Nine Months Ended

(In thousands)

 

September 30,

 

September 30,

  

 

2012

 

2011

 

2012

 

2011

Beginning balance,

$

(79,580)

$

(22,983)

$

(40,661)

$

(19,216)

Realized and unrealized gains (losses):

 

 

 

 

 

 

 

 

    Included in regulatory liabilities (assets)

 

3,465

 

(2,927)

 

(35,455)

 

(6,694)

    Included in other comprehensive income

 

-

 

-

 

-

 

-

    Included in earnings

 

(3,422)

 

182

 

(6,659)

 

815

    Included in current assets

 

-

 

(7)

 

(77)

 

(66)

Purchases

 

5,864

 

178

 

7,764

 

342

Sales

 

45

 

-

 

77

 

-

Issuances

 

-

 

-

 

-

 

-

Settlements

 

(2,487)

 

(353)

 

(1,104)

 

(1,091)

Transfers in and/or out of Level 3

 

-

 

-

 

-

 

-

Balance as of September 30,

$

(76,115)

$

(25,910)

$

(76,115)

$

(25,910)

Total gains (losses) included in earnings attributed to

 

 

 

 

 

 

 

 

the change in unrealized gains (losses) related to

 

 

 

 

 

 

 

 

assets and liabilities held at September 30,(d)

$

-

$

-

$

-

$

-


The following table presents total realized and unrealized gains (losses) included in income for Level 3 assets and liabilities measured at fair value on a recurring basis for both MGE Energy and MGE (d).


 

 

Three Months Ended

 

Nine Months Ended

(In thousands)

 

September 30,

 

September 30,

 

 

2012

 

2011

 

2012

 

2011

Purchased Power Expense

$

(3,422)

$

182

$

(6,659)

$

815

Cost of Gas Sold Expense

 

-

 

-

 

-

 

-

Regulated Gas Revenues

 

-

 

-

 

-

 

-

Total

$

(3,422)

$

182

$

(6,659)

$

815


(d) MGE's exchange-traded derivative contracts, over-the-counter party transactions, ten-year purchased power agreement, and FTRs are subject to regulatory deferral. These derivatives are therefore marked to fair value and are offset with a corresponding regulatory asset or liability.


12.

New Accounting Pronouncements - MGE Energy and MGE.


a.

Fair Value Measurements and Disclosures.


In May 2011, the FASB issued authoritative guidance within the Codification's Fair Value Measurements and Disclosures topic that provides guidance on additional disclosures about fair value measurements, specifically related to Level 3 assets and liabilities. This authoritative guidance became effective January 1, 2012. The authoritative guidance did not have any financial impact, but required additional disclosures. See Footnote 11 for additional information.


b.

Presentation of Comprehensive Income.


In June 2011, the FASB issued authoritative guidance within the Codification's Comprehensive Income topic that provides guidance on presentation of comprehensive income. Comprehensive income will be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This authoritative guidance became effective January 1, 2012. The authoritative guidance had an effect on our financial statement presentation of comprehensive income. See the Statement of Comprehensive Income for additional information.




28





c.

Disclosures about Offsetting Assets and Liabilities.


In December 2011, the FASB issued authoritative guidance within the Codification's Balance Sheet topic that provides guidance on disclosures about offsetting assets and liabilities. The new disclosure requirements mandate that entities disclose both gross and net information for instruments and transactions eligible for offset in the balance sheet as well as instruments and transactions subject to a master netting arrangement. In addition, the standard requires disclosure of collateral received and posted in connections with a master netting arrangement. This authoritative guidance will become effective January 1, 2013. The authoritative guidance will not have a financial impact, but will require additional disclosures.


13.

Segment Information - MGE Energy and MGE.


MGE Energy operates in the following business segments: electric utility, gas utility, nonregulated energy, transmission investment, and all other. See MGE Energy's and MGE's 2011 Annual Report on Form 10-K for additional discussion of each of these segments.




29






The following tables show segment information for MGE Energy's operations for the indicated periods:


(In thousands)

 

 

 

 

 

Non-

 

 

 

 

 

Consolidation/

 

 

MGE Energy

 

 

 

 

 

Regulated

 

Transmission

 

All

 

Elimination

 

Consolidated

 

 

Electric

 

Gas

 

Energy

 

Investment

 

Others

 

Entries

 

Total

Three Months Ended September 30, 2012

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

118,914

$

16,587

$

2,337

$

-

$

-

$

-

$

137,838

Interdepartmental revenues

 

159

 

4,658

 

8,679

 

-

 

-

 

(13,496)

 

-

Total operating revenues

 

119,073

 

21,245

 

11,016

 

-

 

-

 

(13,496)

 

137,838

Depreciation and amortization

 

(6,530)

 

(1,399)

 

(1,777)

 

-

 

-

 

-

 

(9,706)

Other operating expenses

 

(78,823)

 

(22,675)

 

(36)

 

-

 

(206)

 

13,496

 

(88,244)

Operating income (loss)

 

33,720

 

(2,829)

 

9,203

 

-

 

(206)

 

-

 

39,888

Other income, net

 

342

 

97

 

-

 

2,280

 

137

 

-

 

2,856

Interest (expense) income, net

 

(2,535)

 

(715)

 

(1,631)

 

-

 

32

 

-

 

(4,849)

Income (loss) before taxes

 

31,527

 

(3,447)

 

7,572

 

2,280

 

(37)

 

-

 

37,895

Income tax (provision) benefit

 

(11,873)

 

1,565

 

(3,039)

 

(909)

 

3

 

-

 

(14,253)

Net income (loss)

$

19,654

$

(1,882)

$

4,533

$

1,371

$

(34)

$

-

$

23,642