United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q


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


For the quarterly period ended:

March 31, 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 April 30, 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.

31

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

41

Item 4. Controls and Procedures.

43

PART II. OTHER INFORMATION.

44

Item 1. Legal Proceedings.

44

Item 1A. Risk Factors.

44

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

44

Item 6. Exhibits.

45

Signatures - MGE Energy, Inc.

46

Signatures - Madison Gas and Electric Company

47




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, 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.

 

 

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

CSAPR

Cross-State Air Pollution Rule

CWA

Clean Water Act

CWDC

Central Wisconsin Development Corporation

DOE

U.S. Department of Energy

Dth

Dekatherms

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

MACT

Maximum Achievable Control Technology

MAGAEL

MAGAEL, LLC

MATS

Mercury and Air Toxics Standards

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

MISO

Midwest Independent System Operator (a regional transmission organization)

MW

Megawatt

MWh

Megawatt-hour

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

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

 

 

 

 

March 31,

 

 

 

 

2012

 

2011

 

 

Operating Revenues:

 

 

 

 

 

 

    Regulated electric revenues

$

89,936

$

86,007

 

 

    Regulated gas revenues

 

57,019

 

77,437

 

 

    Nonregulated revenues

 

2,304

 

1,161

 

 

        Total Operating Revenues

 

149,259

 

164,605

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

    Fuel for electric generation

 

8,851

 

11,049

 

 

    Purchased power

 

19,546

 

17,581

 

 

    Cost of gas sold

 

34,845

 

50,947

 

 

    Other operations and maintenance

 

42,949

 

39,413

 

 

    Depreciation and amortization

 

9,624

 

10,016

 

 

    Other general taxes

 

5,000

 

4,701

 

 

        Total Operating Expenses

 

120,815

 

133,707

 

 

Operating Income

 

28,444

 

30,898

 

 

 

 

 

 

 

 

 

Other income, net

 

2,570

 

2,386

 

 

Interest expense, net

 

(5,104)

 

(4,850)

 

 

    Income before income taxes

 

25,910

 

28,434

 

 

Income tax provision

 

(9,862)

 

(10,651)

 

 

Net Income

$

16,048

$

17,783

 

 

 

 

 

 

 

 

 

Earnings Per Share of Common Stock

 

 

 

 

 

 

(basic and diluted)

$

0.69

$

0.77

 

 

 

 

 

 

 

 

 

Dividends per share of common stock

$

0.383

$

0.375

 

 

 

 

 

 

 

 

 

Average Shares Outstanding

 

 

 

 

 

 

(basic and diluted)

 

23,114

 

23,114

 


MGE Energy, Inc.

Consolidated Statements of Comprehensive Income (unaudited)

(In thousands)


 

 

 

Three Months Ended

 

 

 

 

March 31,

 

 

 

 

2012

 

2011

 

 

Net Income

$

16,048

$

17,783

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

    Unrealized gain on available-for-sale securities, net of

 

 

 

 

 

 

    tax ($5 and $48)

 

7

 

72

 

 

Comprehensive Income

$

16,055

$

17,855

 

 

 

 

 

 

 

 

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)


 

 

 

Three Months Ended

 

 

 

 

March 31,

 

 

 

 

2012

 

2011

 

 

Operating Activities:

 

 

 

 

 

 

    Net income

$

16,048

$

17,783

 

 

    Items not affecting cash:

 

 

 

 

 

 

        Depreciation and amortization

 

9,624

 

10,016

 

 

        Deferred income taxes

 

8,846

 

1,622

 

 

        Provision for doubtful receivables

 

1,167

 

1,038

 

 

        Employee benefit plan expenses

 

4,682

 

3,394

 

 

        Equity earnings in ATC

 

(2,242)

 

(2,097)

 

 

        Other items

 

660

 

178

 

 

    Changes in working capital items:

 

 

 

 

 

 

        Decrease in current assets

 

12,377

 

29,753

 

 

        Decrease in current liabilities

 

(6,631)

 

(7,279)

 

 

    Dividend income from ATC

 

1,740

 

1,682

 

 

    Cash contributions to pension and other postretirement plans

 

(20,789)

 

(19,188)

 

 

    Other noncurrent items, net

 

(746)

 

1,135

 

 

            Cash Provided by Operating Activities

 

24,736

 

38,037

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

    Capital expenditures

 

(15,467)

 

(9,843)

 

 

    Capital contributions to investments

 

(355)

 

(425)

 

 

    Purchase of investment - land

 

(3)

 

(1,794)

 

 

    Other

 

109

 

(419)

 

 

            Cash Used for Investing Activities

 

(15,716)

 

(12,481)

 

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

    Cash dividends paid on common stock

 

(8,843)

 

(8,670)

 

 

    Repayment of long-term debt

 

(667)

 

(500)

 

 

    Issuance of long-term debt

 

-

 

30,000

 

 

    Decrease in short-term debt

 

-

 

(22,500)

 

 

    Other

 

(19)

 

(311)

 

 

            Cash Used for Financing Activities

 

(9,529)

 

(1,981)

 

 

 

 

 

 

 

 

 

Change in Cash and Cash Equivalents:

 

(509)

 

23,575

 

 

    Cash and cash equivalents at beginning of period

 

41,169

 

7,110

 

 

    Cash and cash equivalents at end of period

$

40,660

$

30,685

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

    Significant noncash investing activities:

 

 

 

 

 

 

        Accrued capital expenditures

$

4,674

$

1,146

 

 

 

 

 

 

 

 

 

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

 




6




 



MGE Energy, Inc.

Consolidated Balance Sheets (unaudited)

(In thousands)


 

 

March 31,

December 31,

ASSETS

 

2012

 

2011

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

40,660

$

41,169

    Receivable - margin account

 

2,500

 

2,477

    Accounts receivable, less reserves of $3,775 and $3,662, respectively

 

38,090

 

36,744

    Other accounts receivable, less reserves of $636 and $439, respectively

 

4,500

 

5,318

    Unbilled revenues

 

20,706

 

25,754

    Materials and supplies, at average cost

 

16,047

 

14,758

    Fossil fuel

 

8,238

 

5,468

    Stored natural gas, at average cost

 

10,385

 

19,575

    Prepaid taxes

 

20,118

 

22,251

    Regulatory assets - current

 

10,665

 

7,347

    Other current assets

 

7,095

 

8,270

        Total Current Assets

 

179,004

 

189,131

Regulatory assets

 

228,162

 

205,835

Other deferred assets and other

 

7,011

 

8,018

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

966,069

 

961,511

    Construction work in progress

 

40,854

 

34,055

        Total Property, Plant, and Equipment

 

1,006,923

 

995,566

Investments

 

61,197

 

60,332

        Total Assets

$

1,482,297

$

1,458,882

 

 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

2,667

$

2,667

    Accounts payable

 

32,000

 

34,532

    Accrued interest and taxes

 

4,542

 

4,085

    Accrued payroll related items

 

7,895

 

9,987

    Deferred income taxes

 

862

 

3,020

    Derivative liabilities

 

8,198

 

4,568

    Other current liabilities

 

6,047

 

4,215

        Total Current Liabilities

 

62,211

 

63,074

Other Credits:

 

 

 

 

    Deferred income taxes

 

210,999

 

199,850

    Investment tax credit - deferred

 

1,715

 

1,780

    Regulatory liabilities

 

18,387

 

20,463

    Accrued pension and other postretirement benefits

 

165,304

 

183,622

    Derivative liabilities

 

60,880

 

34,908

    Other deferred liabilities and other

 

44,388

 

43,330

        Total Other Credits

 

501,673

 

483,953

Capitalization:

 

 

 

 

    Common shareholders' equity

 

558,164

 

550,952

    Long-term debt

 

360,249

 

360,903

        Total Capitalization

 

918,413

 

911,855

Commitments and contingencies (see Footnote 8)

 

-

 

-

        Total Liabilities and Capitalization

$

1,482,297

$

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

 

 

 

 

 

 

17,783

 

 

 

17,783

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

72

 

72

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($0.375 per share)

 

 

 

 

 

 

(8,670)

 

 

 

(8,670)

 

 

Ending balance - March 31, 2011

23,114

$

23,114

$

316,268

$

194,669

$

214

$

534,265

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2011

23,114

$

23,114

$

316,268

$

211,458

$

112

$

550,952

 

 

Net income

 

 

 

 

 

 

16,048

 

 

 

16,048

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

7

 

7

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($0.383 per share)

 

 

 

 

 

 

(8,843)

 

 

 

(8,843)

 

 

Ending balance - March 31, 2012

23,114

$

23,114

$

316,268

$

218,663

$

119

$

558,164

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

March 31,

 

 

 

 

2012

 

2011

 

 

Operating Revenues:

 

 

 

 

 

 

    Regulated electric revenues

$

89,936

$

86,007

 

 

    Regulated gas revenues

 

57,019

 

77,437

 

 

    Nonregulated revenues

 

2,304

 

1,161

 

 

        Total Operating Revenues

 

149,259

 

164,605

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

    Fuel for electric generation

 

8,851

 

11,049

 

 

    Purchased power

 

19,546

 

17,581

 

 

    Cost of gas sold

 

34,845

 

50,947

 

 

    Other operations and maintenance

 

42,528

 

39,235

 

 

    Depreciation and amortization

 

9,624

 

10,016

 

 

    Other general taxes

 

5,000

 

4,701

 

 

    Income tax provision

 

8,969

 

9,891

 

 

        Total Operating Expenses

 

129,363

 

143,420

 

 

Operating Income

 

19,896

 

21,185

 

 

 

 

 

 

 

 

 

Other Income and Deductions:

 

 

 

 

 

 

    AFUDC - equity funds

 

154

 

87

 

 

    Equity in earnings in ATC

 

2,242

 

2,097

 

 

    Income tax provision

 

(993)

 

(806)

 

 

    Other income, net

 

56

 

113

 

 

        Total Other Income and Deductions

 

1,459

 

1,491

 

 

    Income before interest expense

 

21,355

 

22,676

 

 

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

 

    Interest on long-term debt

 

5,197

 

4,991

 

 

    Other interest, net

 

7

 

(147)

 

 

    AFUDC - borrowed funds

 

(63)

 

(35)

 

 

        Net Interest Expense

 

5,141

 

4,809

 

 

Net Income

$

16,214

$

17,867

 

 

Less Net Income Attributable to Noncontrolling Interest, net of tax

 

(6,072)

 

(5,933)

 

 

Net Income Attributable to MGE

$

10,142

$

11,934

 


Madison Gas and Electric Company

Consolidated Statements of Comprehensive Income (unaudited)

(In thousands)


 

 

 

Three Months Ended

 

 

 

 

March 31,

 

 

 

 

2012

 

2011

 

 

Net Income

$

16,214

$

17,867

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

    Unrealized gain (loss) on available-for-sale securities, net of

 

 

 

 

 

 

    tax ($11 and $23)

 

(16)

 

35

 

 

Comprehensive Income

$

16,198

$

17,902

 

 

    Less: Comprehensive income attributable to Noncontrolling

 

 

 

 

 

 

    Interest, net of tax

 

(6,072)

 

(5,933)

 

 

Comprehensive Income attributable to MGE

$

10,126

$

11,969

 

 

 

 

 

 

 

 

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)


 

 

 

Three Months Ended

 

 

 

 

March 31,

 

 

 

 

2012

 

2011

 

 

Operating Activities:

 

 

 

 

 

 

    Net income

$

16,214

$

17,867

 

 

    Items not affecting cash:

 

 

 

 

 

 

        Depreciation and amortization

 

9,624

 

10,016

 

 

        Deferred income taxes

 

8,768

 

1,412

 

 

        Provision for doubtful receivables

 

1,005

 

1,038

 

 

        Employee benefit plan expenses

 

4,682

 

3,394

 

 

        Equity earnings in ATC

 

(2,242)

 

(2,097)

 

 

        Other items

 

792

 

390

 

 

    Changes in working capital items:

 

 

 

 

 

 

        Decrease in current assets

 

11,542

 

28,893

 

 

        Decrease in current liabilities

 

(6,991)

 

(7,441)

 

 

    Dividend income from ATC

 

1,740

 

1,682

 

 

    Cash contributions to pension and other postretirement plans

 

(20,789)

 

(19,188)

 

 

    Other noncurrent items, net

 

(762)

 

1,110

 

 

            Cash Provided by Operating Activities

 

23,583

 

37,076

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

    Capital expenditures

 

(15,467)

 

(9,843)

 

 

    Capital contributions to investments

 

(355)

 

(355)

 

 

    Other

 

49

 

88

 

 

            Cash Used for Investing Activities

 

(15,773)

 

(10,110)

 

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

    Cash dividends paid to parent by MGE

 

(6,728)

 

(6,596)

 

 

    Distributions to parent from noncontrolling interest

 

-

 

(33,000)

 

 

    Equity contribution received by noncontrolling interest

 

355

 

356

 

 

    Repayment of long-term debt

 

(667)

 

(500)

 

 

    Issuance of long-term debt

 

-

 

30,000

 

 

    Decrease in short-term debt

 

-

 

(3,500)

 

 

    Other

 

(9)

 

(309)

 

 

            Cash Used for Financing Activities

 

(7,049)

 

(13,549)

 

 

 

 

 

 

 

 

 

Change in Cash and Cash Equivalents:

 

761

 

13,417

 

 

    Cash and cash equivalents at beginning of period

 

13,898

 

4,494

 

 

    Cash and cash equivalents at end of period

$

14,659

$

17,911

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

    Significant noncash investing activities:

 

 

 

 

 

 

        Accrued capital expenditures

$

4,674

$

1,146

 

 

 

 

 

 

 

 

 

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)


 

 

March 31,

December 31,

ASSETS

 

2012

 

2011

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

14,659

$

13,898

    Receivable - margin account

 

2,500

 

2,477

    Accounts receivable, less reserves of $3,775 and $3,662, respectively

 

37,088

 

35,765

    Affiliate receivables

 

609

 

605

    Other accounts receivable, less reserves of $636 and $439, respectively

 

4,486

 

5,301

    Unbilled revenues

 

20,706

 

25,754

    Materials and supplies, at average cost

 

16,047

 

14,758

    Fossil fuel

 

8,238

 

5,468

    Stored natural gas, at average cost

 

10,385

 

19,575

    Prepaid taxes

 

20,685

 

21,977

    Regulatory assets - current

 

10,665

 

7,347

    Other current assets

 

7,080

 

8,245

        Total Current Assets

 

153,148

 

161,170

Affiliate receivable long-term

 

6,751

 

6,884

Regulatory assets

 

228,162

 

205,835

Other deferred assets and other

 

6,502

 

7,286

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

965,565

 

961,007

    Construction work in progress

 

40,854

 

34,055

        Total Property, Plant, and Equipment

 

1,006,419

 

995,062

Investments

 

58,386

 

57,556

        Total Assets

$

1,459,368

$

1,433,793

 

 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

2,667

$

2,667

    Accounts payable

 

32,000

 

34,532

    Affiliate payables

 

1,822

 

2,152

    Accrued interest and taxes

 

4,495

 

4,037

    Accrued payroll related items

 

7,895

 

9,987

    Deferred income taxes

 

927

 

3,020

    Derivative liabilities

 

8,198

 

4,568

    Other current liabilities

 

5,798

 

3,997

        Total Current Liabilities

 

63,802

 

64,960

Other Credits:

 

 

 

 

    Deferred income taxes

 

207,541

 

196,550

    Investment tax credit - deferred

 

1,715

 

1,780

    Regulatory liabilities

 

18,387

 

20,463

    Accrued pension and other postretirement benefits

 

165,304

 

183,622

    Derivative liabilities

 

60,880

 

34,908

    Other deferred liabilities and other

 

44,388

 

43,330

        Total Other Credits

 

498,215

 

480,653

Capitalization:

 

 

 

 

    Common shareholder's equity

 

416,324

 

412,926

    Noncontrolling interest

 

120,778

 

114,351

        Total Equity

 

537,102

 

527,277

    Long-term debt

 

360,249

 

360,903

        Total Capitalization

 

897,351

 

888,180

Commitments and contingencies (see Footnote 8)

 

-

 

-

        Total Liabilities and Capitalization

$

1,459,368

$

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

 

 

 

 

 

 

11,934

 

 

 

5,933

 

17,867

Other comprehensive income

 

 

 

 

 

 

 

 

35

 

 

 

35

Cash dividends paid to parent

 

 

 

 

 

 

 

 

 

 

 

 

 

by MGE

 

 

 

 

 

 

(6,596)

 

 

 

 

 

(6,596)

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

356

 

356

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(33,000)

 

(33,000)

Ending balance - March 31, 2011

17,348

$

17,348

$

192,417

$

197,818

$

106

$

115,282

$

522,971

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2011

17,348

$

17,348

$

192,417

$

203,114

$

47

$

114,351

$

527,277

Net income

 

 

 

 

 

 

10,142

 

 

 

6,072

 

16,214

Other comprehensive loss

 

 

 

 

 

 

 

 

(16)

 

 

 

(16)

Cash dividends paid to parent

 

 

 

 

 

 

 

 

 

 

 

 

 

by MGE

 

 

 

 

 

 

(6,728)

 

 

 

 

 

(6,728)

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

355

 

355

Ending balance - March 31, 2012

17,348

$

17,348

$

192,417

$

206,528

$

31

$

120,778

$

537,102

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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)

March 31, 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 March 31, 2012, and for the three 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 - MGE Energy.


a.

Common Stock.


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 three months ended March 31, 2012 and 2011, MGE Energy did not issue any new shares of common stock under the Stock Plan.


b.

Dilutive Shares Calculation.


MGE Energy does not hold any dilutive securities.


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 three months ended March 31, 2012 and 2011, MGE Transco recorded equity earnings from the investment in ATC of $2.2 million and $2.1 million, respectively. Dividend income received from ATC was $1.7 million for both the three months ended March 31, 2012 and 2011. In addition, during both the three months ended March 31, 2012 and 2011, MGE Transco made $0.4 million in capital contributions to ATC.


MGE Energy and MGE's investment in ATC as of March 31, 2012, and December 31, 2011, was $57.8 million and $57.0 million, respectively.


At March 31, 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.




13




 



ATC's summarized financial data for the three months ended March 31, 2012 and 2011, is as follows:


 

 

Three Months Ended

(In thousands)

 

March 31,

 

 

2012

 

2011

Operating revenues

$

147,662

$

139,617

Operating expenses

 

(69,566)

 

(63,126)

Other expense, net

 

(500)

 

(358)

Interest expense, net

 

(19,501)

 

(21,897)

Earnings before members' income taxes

$

58,095

$

54,236


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. MGE expects to incur capital expenditures as follows: $43 million for the remainder of 2012, $68 million in 2013, and $14 million in 2014. These amounts may change as a result of modifications to the project estimate or timing difference.


As of March 31, 2012, MGE had incurred $10.5 million (excluding carrying costs) in construction expenditures at Columbia related to its share of the project and had accrued $4.0 million in incurred but unpaid capital expenditures. At March 31, 2012, $14.5 million (excluding carrying costs) related to this project is reflected in the Construction Work in Progress balance on MGE and MGE Energy's consolidated balance sheets.


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 March 31, 2012, and December 31, 2011, in the amount of $2.7 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 and MGE's effective income tax rate for the three months ended March 31, 2012, is 38.1%, compared to 37.5% for the same period in 2011. The higher effective tax rate is, in part, attributable to a lower estimated domestic manufacturing deduction.




14




 



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 months ended March 31, 2012 and 2011. A portion of the net periodic benefit cost is capitalized within the consolidated balance sheets. The PSCW allowed MGE to defer the 2009 incremental pension and OPRB costs above the amounts recovered in rates. During the three months ended March 31, 2012 and 2011, $0.3 million and $0.7 million, respectively, has been recovered in rates.


 

 

Three Months Ended

(In thousands)

 

March 31,

 

 

2012

 

2011

Pension Benefits

 

 

 

 

Components of net periodic benefit cost:

 

 

 

 

    Service cost

$

1,823

$

1,540

    Interest cost

 

3,154

 

3,080

    Expected return on assets

 

(3,818)

 

(3,531)

Amortization of:

 

 

 

 

    Prior service cost

 

108

 

109

    Actuarial loss

 

2,006

 

946

Net periodic benefit cost

$

3,273

$

2,144

 

 

 

 

 

Postretirement Benefits

 

 

 

 

Components of net periodic benefit cost:

 

 

 

 

    Service cost

$

647

$

487

    Interest cost

 

1,125

 

982

    Expected return on assets

 

(435)

 

(396)

Amortization of:

 

 

 

 

    Transition obligation

 

106

 

107

    Prior service cost

 

28

 

27

    Actuarial loss

 

621

 

111

Net periodic benefit cost

$

2,092

$

1,318


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 March 31, 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.




15




 



During the three months ended March 31, 2012 and 2011, MGE recorded $0.4 million and $0.1 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 three months ended March 31, 2012 or 2011. At March 31, 2012, $2.6 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. 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.


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. If we are unable to demonstrate that any of MGE's permitted plants (Blount, WCCF, Columbia, Elm Road) are able to comply with its associated WPDES permit requirements, then we may need operational controls and/or incur capital costs associated with plant modifications to meet discharge requirements. Those expenditures could be material.


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 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. MGE may incur additional capital or operational expenditures and/or need to install additional pollution controls to meet the 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 recently finalized Cross-State Air Pollution Rule (CSAPR), maximum achievable control technology (MACT) standards, new source performance standards (NSPS) and the Clean Air Visibility Rule (also known as the Regional Haze Rule), as well as state mercury emissions limits, are expected to result in additional operating and capital expenditure costs for electric generating units.




16




 



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 will 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 combustion turbines that contain 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 January 2012, the EPA published in the Federal Register an intention to propose a revised RICE MACT based on a settlement agreement with several power companies. MGE will review the revised proposal when it is finalized and continue to evaluate the impacts associated with complying with RICE MACT.


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

The CAIR, which became effective in 2009, 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.


In December 2008, the U.S. Court of Appeals for the D.C. Circuit remanded the CAIR to the EPA for further review. In August 2011, the EPA published the Cross-State Air Pollution Rule (CSAPR) to replace the CAIR. Similar to the CAIR, CSAPR requires NOx and/or SO2 air emissions reductions by fossil fuel-fired EGUs (25 MW or greater) in 28 states in the eastern half of the U.S. CSAPR established state emission restrictions, referred to as budgets, for SO2 and NOx beginning in 2012 (Phase I). Under CSAPR, SO2 emission budgets in certain states, including Wisconsin, will be lowered further in 2014 (Phase II). CSAPR affects the same electric generation units at MGE as CAIR: Blount, Columbia, Elm Road, and the combustion turbines at West Marinette and Fitchburg. Plants in Wisconsin that are subject to CSAPR have been allocated CSAPR emission allowances and will need to hold sufficient allowances to cover emissions on an annual basis. If CSAPR allowances are not adequate for a given plant, emissions will need to be reduced at the plant level by fuel-switching, installation of controls, curtailment of operations or a combination thereof. MGE's Columbia plant, which is operated by WPL (MGE has a 22% ownership interest), has significantly fewer SO2 allocations under CSAPR in 2012 and 2013 than recent actual emissions.


In December 2011, the U.S. Court of Appeals for the D.C. Circuit stayed the implementation of CSAPR pending judicial review. The ruling leaves the CAIR in place while the court considers the merits and challenges to CSAPR. MGE expects to hold sufficient emissions allowances under the CAIR for 2012.


If CSAPR is reinstated in 2012 or 2013, the Columbia co-owners will need to evaluate and implement interim strategies to address anticipated SO2 allowance deficiencies under CSAPR. Current analysis shows that, if reinstated in 2013, additional allowances (if available) may need to be purchased, Columbia generation may need to be reduced to comply with CSAPR limits, or a combination of these two strategies may be employed. These interim measures may increase MGE's costs. MGE expects that the costs pertaining to meeting CSAPR requirements will be fully recoverable through rates. Planned new SO2 controls at Columbia are expected to be completed by mid 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 CSAPR allocation levels.


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 has proposed that compliance with CAIR and with CSAPR emissions limitations could also serve as compliance with BART for SO2 and NOx emissions.



17




 



However, with the uncertainty regarding the future of CAIR and CSAPR, the future of BART regulation and compliance strategies and costs are also 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 plan to meet the 90% reduction option by installing pollution controls needed to meet this and other rules (see the discussion regarding the Columbia Environmental Project below).


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 five-year review of PM NAAQS that are scheduled to be released by June 2012, and (2) the WDNR' attainment/nonattainment designations associated with the EPA's June 2010 final revisions to its SO2 NAAQS. These two NAAQS developments could have a potential material effect on capital and maintenance costs at our generating facilities. The magnitude will not be known until the rules are implemented.


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 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 be finalized within 2012 and 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 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 March 31, 2012, Columbia has entered into various contractual commitments with vendors for a portion of the $140 million project. MGE is indirectly a party to these agreements as a result of its joint ownership of Columbia and is also contractually obligated, under the applicable ownership and operating agreements. MGE's share of these commitments is $109.7 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.




18




 



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 and in February 2011, issued a letter stating its determination not to issue either the proposed construction permit or a revised operating permit for Columbia. 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 May 2011, the WDNR proposed a revised operating permit for Columbia. The Columbia owners commented on the WDNR's draft permit and are awaiting the WDNR's response. 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 financial or operational conditions.


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 Columbia. The NOV alleges that WPL, as operator, and the Columbia co-owners failed to comply with appropriate pre-construction review and permitting requirements and as a result violated the PSD program requirements, Title V Operating Permit requirements of the CAA and the Wisconsin SIP. The parties are exploring possible settlement.


In September 2010, Sierra Club filed a civil lawsuit against WPL alleging violations of the CAA at Columbia and other Wisconsin facilities operated by WPL. The Sierra Club and the co-owners are engaged in settlement discussions. The parties recently requested and received a temporary stay of proceedings to further explore settlement options. The trial date is scheduled for December 2012. During the February 15, 2012 status conference, the Court reaffirmed the December 2012 trial date, but set a pre-trial schedule that allows the parties to continue work toward settlement.


MGE and the other co-owners of Columbia are defending against these allegations while actively pursuing settlement options with the EPA and Sierra Club. WPL has informed MGE that WPL believes the projects at Columbia were routine or not projected to increase emissions and therefore did not violate the permitting requirements of the CAA.


In response to similar EPA CAA enforcement initiatives, certain utilities have elected to settle with the EPA, while others have elected to litigate. If the EPA and/or Sierra Club successfully prove their claims that projects completed in the past at Columbia required either state or federal CAA permits, MGE may, under the applicable statutes, be required to pay civil penalties in amounts of up to $37,500 per day for each violation and/or complete actions for injunctive relief. Payment of fines and/or injunctive relief could be included in a settlement outcome. Injunctive relief contained in settlements or court-ordered remedies for other utilities in similar matters required the installation of pollution control technology, changed operating conditions (including use of alternative fuels other than coal), surrender of excess emission trading allowances, caps for emissions and limitations on generation (including retirement of generating units) and other beneficial environmental projects. If similar remedies are required for final resolution of these matters at Columbia, MGE would likely incur additional capital and operating expenditures. At this time, MGE is unable to predict with certainty the impact of these claims on its financial condition or results of operations but believes that should there ultimately be an adverse outcome, it could have a significant effect.


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, 2012. At March 31, 2012, MGE has outstanding a $4.2 million interest in these receivables. MGE retains the servicing responsibility for these receivables. As of March 31, 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.



19




 



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 March 31, 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 de pending 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

$

422

$

646

$

461

$

772

$

695


c.

Other Legal Matters - MGE Energy and MGE.


MGE is involved in various other legal matters that are being defended and handled in the normal course of business. MGE maintains accruals for such costs that are probable of being incurred and subject to reasonable estimation. MGE has accrued for such matters in the financial statements. The ultimate outcomes of such matters are uncertain and may have an adverse effect on MGE Energy's and MGE's results of operations, financial position, or cash flows.


d.

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 March 31, 2012, MGE has spent $6.8 million related to these projects and has outstanding agreements to purchase $0.8 million in smart grid related products for the remainder of 2012.


e.

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.


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.




20




 



b.

Notional Amounts.


The gross notional volume of open derivatives is as follows:


 

March 31, 2012

 

December 31, 2011

Commodity derivative contracts

451,750  MWh

 

482,545  MWh

Commodity derivative contracts

2,970,000  Dth

 

4,030,000  Dth

FTRs

962  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 March 31, 2012, and December 31, 2011, MGE Energy and MGE had $2.0 million and $3.0 million, respectively, 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 and PJM markets, 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 March 31, 2012, and December 31, 2011, the cost basis of exchange traded derivatives and FTRs exceeded their fair value by $2.5 million and $2.8 million, respectively.


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 March 31, 2012, and December 31, 2011, reflects a loss position of $69.0 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.



21




 




 

Asset Derivatives

 

Liability Derivatives

(In thousands)

Balance Sheet Location

 

Fair Value

 

Balance Sheet Location

 

Fair Value

March 31, 2012

 

 

 

 

 

 

 

Commodity derivative contracts

Other current assets

$

266

Derivative liability (current)

$

2,723

Commodity derivative contracts

Other deferred charges

 

153

 

Derivative liability (long-term)

 

160

FTRs

Other current assets

 

-

 

Derivative liability (current)

 

40

Ten-year PPA

N/A

 

N/A

 

Derivative liability (current)

 

8,130

Ten-year PPA

N/A

 

N/A

 

Derivative liability (long-term)

 

60,880

 

 

 

 

 

 

 

 

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 March 31, 2012 and 2011, and the income statement for the three months ended March 31, 2012 and 2011 (a).


 

 

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 March 31:

 

 

 

 

 

 

 

 

 

Balance at January 1,

$

42,356

$

1,604

 

$

19,230

$

1,411

Change in unrealized loss

 

33,310

 

-

 

 

3,047

 

-

Realized loss reclassified to a deferred account

 

(2,658)

 

2,658

 

 

(663)

 

663

Realized gain (loss) reclassified to income

 

 

 

 

 

 

 

 

 

statement

 

(1,494)

 

(3,590)

 

 

63

 

(1,569)

Balance at March 31,

$

71,514

$

672

 

$

21,677

$

505


 

 

 

Realized losses (gains)

 

 

 

 

 

 

Fuel for electric

 

 

 

 

 

 

Regulated

 

generation/

 

Cost of

 

 

(In thousands)

 

gas revenues

 

purchased power

 

gas sold

 

 

Three Months Ended March 31, 2012:

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

-

$

1,928

$

3,090

 

 

FTRs

 

-

 

66

 

-

 

 

Ten-year PPA

 

-

 

-

 

-

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2011:

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

-

$

254

$

1,315

 

 

FTRs

 

-

 

(63)

 

-

 

 

Ten-year PPA

 

-

 

-

 

-

 


(a)

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.




22




 



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-) once MGE begins purchasing energy under the contract in 2012. 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. Certain counterparties extend MGE a credit limit. If MGE exceeds these limits, the counterparties may require collateral to be posted. As of March 31, 2012, certain counterparties were in a net liability position of $0.4 million. As of 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 March 31, 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, 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 automatically defer electric fuel-related costs that fall outside a symmetrical cost tolerance band. Any over/under recovery of the deferred 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 March 31, 2012, MGE did not defer any electric fuel-related costs.


c.

Purchased Gas Adjustment Clause.


MGE's natural gas rates are subject to a fuel adjustment clause designed to recover or refund the difference between the actual cost of purchased gas and the amount included in rates. Differences between the amounts billed to customers and the actual costs recoverable are deferred and recovered or refunded in future periods by means of prospective monthly adjustments to rates. At March 31, 2012, and December 31, 2011, MGE had over collected $3.3 million and $0.9 million, respectively. These amounts were recorded in other current liabilities on the consolidated balance sheet.




23




 



11.

Fair Value of Financial Instruments - MGE Energy and MGE.


a.

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


At March 31, 2012, and December 31, 2011, the carrying amount of cash, cash equivalents, and outstanding commercial paper 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 March 31, 2012, and December 31, 2011. The estimated fair market value of MGE Energy's and MGE's financial instruments are as follows:


 

 

March 31, 2012

 

 

December 31, 2011

 

 

Carrying

 

Fair

 

 

Carrying

 

Fair

(In thousands)

 

Amount

 

Value

 

Amount

 

Value

MGE Energy

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

$

40,660

$

40,660

 

$

41,169

$

41,169

Liabilities:

 

 

 

 

 

 

 

 

 

    Long-term debt*

 

363,806

 

424,359

 

 

364,473

 

432,515

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

 

14,659

 

14,659

 

 

13,898

 

13,898

Liabilities:

 

 

 

 

 

 

 

 

 

    Long-term debt*

 

363,806

 

424,359

 

 

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.




24




 



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 March 31, 2012

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

MGE Energy

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

    Exchange-traded investments

$

361

$

361

$

-

$

-

    Total Assets

$

361

$

361

$

-

$

-

Liabilities:

 

 

 

 

 

 

 

 

    Derivatives, net(a)

$

71,514

$

326

$

-

$

71,188

    Deferred compensation

 

1,771

 

-

 

1,771

 

-

    Total Liabilities

$

73,285

$

326

$

1,771

$

71,188

  

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

    Exchange-traded investments

$

162

$

162

$

-

$

-

    Total Assets

$

162

$

162

$

-

$

-

Liabilities:

 

 

 

 

 

 

 

 

    Derivatives, net(a)

$

71,514

$

326

$

-

$

71,188

    Deferred compensation

 

1,771

 

-

 

1,771

 

-

    Total Liabilities

$

73,285

$

326

$

1,771

$

71,188

  

 

 

 

 

 

 

 

 

        (a)   These amounts are shown gross and exclude $2.0 million of collateral that was posted

                against derivative positions with counterparties.

  

 

 

 

 

 

 

 

 

No transfers were made in or out of Level 1 or Level 2 for the three months ended March 31, 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(b)

$

42,356

$

1,695

$

-

$

40,661

    Deferred compensation(c)

 

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(b)

$

42,356

$

1,695

$

-

$

40,661

    Deferred compensation(c)

 

1,725

 

-

 

1,725

 

-

    Total Liabilities

$

44,081

$

1,695

$

1,725

$

40,661

  

 

 

 

 

 

 

 

 

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

                  against derivative positions with counterparties.

  

 

 

 

 

 

 

 

 

        (c)   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.




25




 



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.


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

 

95.8 %

    Off peak

 

95.4 %

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.




26




 



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

(In thousands)

 

March 31,

  

 

2012

 

2011

Beginning balance,

$

(40,661)

$

(19,216)

Realized and unrealized gains (losses):

 

 

 

 

    Included in regulatory liabilities (assets)

 

(30,527)

 

(2,932)

    Included in other comprehensive income

 

-

 

-

    Included in earnings

 

(1,502)

 

(8)

    Included in current assets

 

(50)

 

-

Purchases

 

50

 

-

Sales

 

31

 

71

Issuances

 

-

 

-

Settlements

 

1,471

 

(63)

Transfers in and/or out of Level 3

 

-

 

-

Balance as of March 31,

$

(71,188)

$

(22,148)

Total gains (losses) included in earnings attributed to

 

 

 

 

the change in unrealized gains (losses) related to

 

 

 

 

assets and liabilities held at March 31,(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

(In thousands)

 

March 31,

 

 

2012

 

2011

Purchased Power Expense

$

(1,502)

$

(8)

Cost of Gas Sold Expense

 

-

 

-

Regulated Gas Revenues

 

-

 

-

Total

$

(1,502)

$

(8)


(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.




27




 



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.


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 March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

89,936

$

57,019

$

2,304

$

-

$

-

$

-

$

149,259

Interdepartmental revenues

 

109

 

2,986

 

8,676

 

-

 

-

 

(11,771)

 

-

Total operating revenues

 

90,045

 

60,005

 

10,980

 

-

 

-

 

(11,771)

 

149,259

Depreciation and amortization

 

(6,478)

 

(1,370)

 

(1,776)

 

-

 

-

 

-

 

(9,624)

Other operating expenses

 

(72,788)

 

(49,741)

 

(12)

 

-

 

(421)

 

11,771

 

(111,191)

Operating income (loss)

 

10,779

 

8,894

 

9,192

 

-

 

(421)

 

-

 

28,444

Other income, net

 

164

 

46

 

-

 

2,242

 

118

 

-

 

2,570

Interest (expense) income, net

 

(2,727)

 

(769)

 

(1,645)

 

-

 

37

 

-

 

(5,104)

Income (loss) before taxes

 

8,216

 

8,171

 

7,547

 

2,242

 

(266)

 

-

 

25,910

Income tax (provision) benefit

 

(2,785)

 

(3,238)

 

(3,029)

 

(910)

 

100

 

-

 

(9,862)

Net income (loss)

$

5,431

$

4,933

$

4,518

$

1,332

$

(166)

$

-

$

16,048

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

86,007

$

77,437

$

1,161

$

-

$

-

$

-

$

164,605

Interdepartmental revenues

 

107

 

991

 

9,396

 

-

 

-

 

(10,494)

 

-

Total operating revenues

 

86,114

 

78,428

 

10,557

 

-

 

-

 

(10,494)

 

164,605

Depreciation and amortization

 

(6,977)

 

(1,337)

 

(1,702)

 

-

 

-

 

-

 

(10,016)

Other operating expenses

 

(70,916)

 

(63,053)

 

(39)

 

-

 

(177)

 

10,494

 

(123,691)

Operating income (loss)

 

8,221

 

14,038

 

8,816

 

-

 

(177)

 

-

 

30,898

Other income, net

 

157

 

44

 

-

 

2,097

 

88

 

-

 

2,386

Interest expense, net

 

(2,700)

 

(761)

 

(1,348)

 

-

 

(41)

 

-

 

(4,850)

Income (loss) before taxes

 

5,678

 

13,321

 

7,468

 

2,097

 

(130)

 

-

 

28,434

Income tax (provision) benefit

 

(1,601)

 

(5,248)

 

(2,997)

 

(852)

 

47

 

-

 

(10,651)

Net income (loss)

$

4,077

$

8,073

$

4,471

$

1,245

$

(83)

$

-

$

17,783




28




 



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


(In thousands)

 

 

 

 

 

Non-

 

 

 

Consolidation/

 

 

MGE

 

 

 

 

 

Regulated

 

Transmission

 

Elimination